SEC Charges Wells Fargo Securities, Rhode Island Agency with Bilking Investors Over Municipal Bond Offering

The Securities and Exchange omission has filed charge against Wells Fargo Securities (WFC) and the Rhode Island Economic Development Corp. accusing them of fraud in a municipal bond offering. According to the regulator, RIEDC, now called Rhode Island Commerce Corporation, used $75M in bonds to finance 38 Studios, which is a startup video game company. Wells Fargo served as the bond underwriter.

The SEC is charging RIEDC and Wells Fargo with Securities Act of 1933 violations. Wells Fargo is also charged with violating the Securities Exchange Act of 1934 and the Municipal Securitas Rulemaking Board’s Rules G-17 and G-32.

The 38 Studios project was part of a state government program to increase economic development and employment opportunities through the lending of bond proceeds to private companies. The regulator said the RIEDC lent $50M in bond proceeds to the video game company, while the remaining proceeds went toward bond offering-related costs and the setting up of a reserve fund and a capitalized interest fund. The loan and investors were to be paid back through revenues made by video games that 38 Studios intended to make.

Unfortunately, the bond offering document purportedly did not disclose that the video game company needed at least $75M to make one particular game. This means that investors were not fully apprised that the company faced a funding shortfall even with proceeds from the loan and could not make the game without more money. When that additional funding could not be found, the game went unmanufactured and the company defaulted on the bond loan. Commenting on the case, SEC Enforcement Division head Andrew Ceresney said that it is the job of municipal issues and underwriters to make sure investors are fully apprised of the risks involved in projects financed via bond offerings.

The SEC believes that RIEDC and Wells Fargo were aware that 38 Studios needed $25M more for the 38 Studios project but neglected to tell investors about this fact. The Commission is also filing charges against Peter M. Cannava, who was the lead Wells Fargo banker on this deal, and RIEDC executives James Michael Saul and Keith W. Stokes, who are accused of aiding and abetting the fraud. The two executives have consented to settle the securities charges by each paying $25,000. They have not, however, admitted to or denied the charges. They are barred from future municipal securities offerings.

The cases against RIEDC, Wells Fargo, and Cannava are not yet resolved. The SEC claims that the bank and Cannava did not disclose all of the fees it received, save for its compensation for the bond offering that was a portion of the placement agent fee plus a $50K payment. Investors also were not purportedly notified that Wells Fargo had a side arrangement with 38 Studios that allowed the company to get almost twice the figure of the compensation noted in offering documents—that’s $400,000 from bond proceeds. The Commission said this presented a conflict of interest and bond investors should have been notified. Cannava, said the SEC, should have made sure that the additional fees to Wells Fargo were disclosed.

Also charged over its involvement in the bond offering is First Southwest Company LLC, which was RIEDC’s financial advisor in this deal. It consented to resolve SEC charges accusing it of violating MSRB rules by not documenting in writing the services it was providing in the bond offering until months after it took on the advisor rule. Without denying or admitting to the charges, First Southwest will pay $120K of disgorgement, $22,400 of prejudgment interest, and a $50K penalty.

According to InvestmentNews, approximately $51M of the money raised in this bond offering is still outstanding.

If you are an investor who suspects that your investment losses are due to municipal bond fraud, contact Shepherd Smith Edwards and Kantas, LTD LLP today.

Read the SEC Complaint (PDF)