PROVIDENCE, R.I. (CN) - Rhode Island fraudulently issued bonds to fund a now-bankrupt video gaming company owned by former baseball star Curt Schilling, the SEC claims in court.
The SEC on Monday sued Rhode Island Commerce Corp. fka Rhode Island Economic Development Corp. (EDC) in Federal Court. It also sued, Wells Fargo Securities, Wells Fargo Vice President Peter Cannava, and former EDC directors Keith W. Stokes and James Michael Saul.
The lawsuit describes the EDC as "a quasi-public Rhode Island corporation created by the State of Rhode Island to promote the expansion and development of new and existing businesses in Rhode Island and to encourage the State's economic development."
Curt Schilling is not a defendant in this case. He was chairman of the board of the video company, 38 Studios, and its majority shareholder.
In 2010, the EDC issued $75 million in taxable bonds to investors, and loaned most of the money to 38 Studios. It planned to develop a massive multiplayer online video game code-named Project Copernicus.
"The disclosure document provided to the investors who were offered the 38 Studios Bonds was materially misleading," the SEC says in the complaint. "This document failed to disclose that the project being financed by the bonds, the development of a video game, could not be completed with the financing the bonds would provide. The document did not disclose that even with the proceeds of the loan financed by the 38 Studios bonds, 38 Studios faced a known shortfall in funding."
38 Studios defaulted on its loan payments to EDC in spring of 2012, and filed for liquidation in bankruptcy court.
The SEC says defendants Stokes and Saul should be held personally liable for the commission's failure to make complete disclosures in its offering papers for the bonds.
Stokes and Saul settled with the SEC without admitting the allegations for $25,000 each, and are barred from participating in municipal bond offerings.
The case will proceed against the other defendants.
"While the EDC's Board may have been influenced by the star power of 38 Studios' personnel, or anxious to take action to address the significant unemployment in Rhode Island, Stokes and Saul had the obligation as EDC executives to disclose to investors the known financial truths about 38 Studios' inability to complete the project the Bonds would finance with the funds the bonds would provide," the complaint states.
The SEC says Wells Fargo's lead banker on the bond transaction, Peter Cannava, knew that 38 Studios could not complete the game's development with the bond money.
"38 Studios' funding gap meant that 38 Studios would need to raise at least $25 million in new financing within a year of the bond offering. That immediate need for more funding was a material risk, particularly in light of 38 Studios' failure to attract any equity investors when it sought, through Wells Fargo, to raise equity investments earlier in 2010," the SEC says.
It says the offering documents also failed to disclose the full compensation Wells Fargo would receive as lead placement agent.
"Wells Fargo's actual compensation from the offering was almost double that which was disclosed, as the result of a side deal that Wells Fargo had with 38 Studios," the SEC says.
It seeks civil penalties, and wants Cannava barred from participating in offerings of municipal securities.
Schilling won 216 games and struck out 3,115 in a 20-year career with five teams.