Written by The Business Journal Staff
(AP) — A federal judge on Friday refused to dismiss a U.S. Securities and Exchange Commission lawsuit that accuses Wells Fargo Securities of defrauding investors in Rhode Island’s failed $75 million deal with 38 Studios, the video game company started by former Red Sox pitcher Curt Schilling.
U.S. District Judge Jack McConnell on Friday did agree to dismiss a Wells Fargo banker from the complaint, but the SEC immediately said it would refile the lawsuit against him and address the judge’s concerns about how the complaint was worded.
The SEC sued Wells Fargo and Rhode Island’s economic development agency in March. It accuses them of making materially misleading statements when they sold the bonds used to fund the deal.
The SEC says they failed to disclose that 38 Studios needed at least $75 million but would receive only $50 million of proceeds from the bond offering, leaving a $25 million gap. It also alleges that Wells Fargo was receiving substantial fees for representing 38 Studios while also representing the state agency as bond placement agent and failed to disclose them, a potential conflict of interest.
Schilling moved his company from Massachusetts to Rhode Island in 2010, after the agency agreed to give it a $75 million loan guarantee. The deal was financed through bonds offered to investors. Less than two years later, 38 Studios ran out of money and filed for bankruptcy.
During a hearing Friday on motions to dismiss filed by Wells Fargo and banker Peter Cannava, Wells Fargo argued that no investors have been harmed because all the bondholders have been paid to date.
The company’s lawyer, Luke Cadigan, said 38 Studios’ failure in 2012 had started “a process of finger-pointing and Monday morning quarterbacking,” and pointed out that the U.S. attorney, FBI, state police and attorney general had all looked at the deal and found no criminal conduct.
“No investors were harmed, no investors were misled,” Cadigan said.
He said the investors who bought to binds were sophisticated, institutional investors who knew the risks.
Cannava’s lawyer said his client’s life has been “turned upside down” by the lawsuit.
“He’s a 30 year-old banker who now finds himself thrown into this fiasco because he was one of many people,” involved in the deal, lawyer Brian Kelly said, adding, “No doubt the Rhode Island investors got a bad deal here, but that’s not Mr. Cannava’s fault.”
The SEC argued it was irrelevant that bondholders have been paid and said their level of sophistication did not matter. SEC lawyer Kathleen Burdette Shields called it a “simple and straightforward fraud.” She said a bank acts through its employees, and Cannava knew there was a funding gap of $25 million.
The judge said the SEC’s action against Cannava failed to sufficiently show that he acted knowingly or recklessly in the matter. Shields said outside court she would file an amended complaint to address those concerns.
While the Rhode Island Commerce Corp. is also named in the SEC lawsuit, it has not made a similar request for a dismissal.
Still pending in state court is a lawsuit brought by the economic development agency against multiple people and companies involved in the deal, including Schilling and Wells Fargo. That lawsuit has so far resulted in nearly $17 million in settlements. It is scheduled to go to trial in the fall.