(Updated, 5:12 p.m.)
PROVIDENCE – The Securities and Exchange Commission on Monday filed charges against the R.I. Economic Development Corp. and its bond underwriter Wells Fargo Securities, alleging fraud that stems from a 2010 municipal bond offering to finance the now-defunct video game company 38 Studios LLC.
The SEC is accusing Wells Fargo and the EDC, a quasi-state agency that’s since rebranded as R.I. Commerce Corp., for defrauding investors during the issuance of $75 million in bonds for the company, which went bankrupt in 2012 and left Rhode Island taxpayers on the hook to pay back more than $100 million. The SEC also charged former EDC executives Keith W. Stokes and James Michael Saul for “aiding and abetting the fraud,” according to a press release. Both Stokes and Saul agreed to settle the charges without admitting or denying guilt and are prohibited from participating in any future municipal securities offering. The duo also must each pay a $25,000 penalty.
38 Studios was owned and run by Curt Schilling, the famed former Boston Red Sox pitcher and ESPN analyst, who isn’t charged in the suit.
The alleged fraudulent activity stems from 2010 when the state loaned $50 million in bond proceeds to 38 Studios and used the remaining proceeds to pay related-bond offering expenses and established a reserve fund and a capitalized interest fund. Bond investors, who expected to be repaid from revenue generated from the video game, were not told, however, that 38 Studios needed at least $75 million to produce a video game. The SEC alleges investors were not fully informed through the offering and purchased bonds that weren’t sufficient for the full development of the video game. When 38 Studios couldn’t obtain additional financing, subsequently going bankrupt, the company defaulted on the loan, according to Andrew Ceresney, director of the SEC Enforcement Division.
“Municipal issuers and underwriters must provide investors with a clear-eyed view of the risk involved in an economic development project being financed through bond offerings,” said Ceresney. “We allege that the RIEDC and Wells Fargo knew that 38 Studios needed an additional $25 million to fund the project, yet failed to pass that material information along to bond investors, who were denied a complete financial picture.”
Gabriel Boehmer, a spokesman for Wells Fargo Government & Institutional Banking, says the company disagrees with the accusations and plans to fight the case in court.
“Wells Fargo disputes the SEC’s allegations in connection with the placement of these municipal bonds,” Boehmer said in a prepared statement. “We will respond to the specific allegations in the complaint in court.”
The SEC is also charging Wells Fargo’s lead banker, Peter M. Cannava, accusing the man and his employer for having a side deal with 38 Studios, which allowed them to receive a placement agent fee through the bond offering along with a $50,000 payment from 38 Studios. The compensation, totaling $400,000, “created a conflict of interest that Wells Fargo should have disclosed to bond investors. Cannava was responsible for Wells Fargo’s failure to disclose its additional fees,” according to the SEC.
“An underwriter’s ‘skin in the game’ is material information to investors,” said LeeAnn Ghazil Gaunt, chief of the SEC Enforcement Division’s municipal securities sand public pensions unit.
“We allege that Wells Fargo failed to fully disclose its own economic interests in this bond transaction.”
In a separate case, the EDC’s former financial adviser for the bond offering, First Southwest Company LLC, agreed to settle charges it failed to fully disclose what services it was providing until seven months after the financial advisory relationship started, according to the release. The company settled and agreed to pay disgorgement of $120,000, prejudgment interest of $22,400 and a penalty of $50,000, according to the SEC.
The suit is separate from the state’s ongoing civil suit in which Rhode Island is suing Wells Fargo Securities LLC, Barclay’s Capital PLC and several others accused them for misleading the state into making the loan. The trial stemming from that suit is scheduled to start Sept. 15, according to court documents released last month. The state is seeking up to three times its liability for bonds floated in the failed investment, which could amount to more than $300 million.
Commerce RI on Monday said the state was still reviewing the allegations, but quickly pointed out the 38 Studios collapse happened under the watch of a previous administration. However, agency spokeswoman Kayla Rosen said in a statement that the SEC lawsuit is consistent with the state’s ongoing civil suit, which involves some of the same people.
“The Commerce Corporation, in its own lawsuit, has alleged that Wells Fargo, Keith Stokes and Michael Saul failed to disclose material information about the 38 Studios deal to the former [EDC] board of directors and to investors. Today’s filing makes consistent allegations,” Rosen said. “The corporation will continue to work toward its goals of recouping money for Rhode Island and holding the defendants in the Commerce Corporation’s lawsuit accountable.”