The U.S. Securities and Exchange Commission (SEC) recently charged a Rhode Island agency and its bond underwriter, Wells Fargo Securities, with defrauding investors in a municipal bond offering to finance startup video game company 38 Studios.

The Rhode Island Economic Development Corporation (RIEDC), now called the Rhode Island Commerce Corporation, issued $75 million in bonds for the 38 Studios project as part of a state government program intended to spur economic development and increase employment opportunities by loaning bond proceeds to private companies.

The SEC also charged Wells Fargo’s lead banker on the deal, Peter M. Cannava, and two then-RIEDC executives, Keith W. Stokes and James Michael Saul, with aiding and abetting the fraud. Stokes and Saul agreed to settle the charges without admitting or denying the allegations and must each pay a $25,000 penalty. At the same time, they are prohibited from participating in any future municipal securities offerings. The SEC’s litigation is continuing against Cannava, Wells Fargo and RIEDC.

Andrew Ceresney, Director of the SEC Enforcement Division, commented:

Municipal issuers and underwriters must provide investors with a clear-eyed view of the risks involved in an economic development project being financed through bond offerings. 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.

LeeAnn Ghazil Gaunt, chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit, added:

An underwriter’s ‘skin in the game’ is material information to investors. We allege that Wells Fargo failed to fully disclose its own economic interest in this bond transaction.

The SEC’s complaint alleges:

• Wells Fargo disclosed its bond offering compensation as a share of the placement agent fee plus a $50,000 payment from 38 Studios. No other fees or compensation to Wells Fargo were disclosed, and the bond placement agreement stated that no other money was anticipated.
• Investors weren’t informed that Wells Fargo had a side deal with 38 Studios that enabled the firm to receive nearly double the amount of compensation disclosed in offering documents.
• This additional compensation, totaling $400,000 and paid from bond proceeds, 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.

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