On Monday, the U.S. regulator - Securities and Exchange Commission (SEC) sued San Francisco-based Wells Fargo & CompanyWFC along with a Rhode Island government agency in a civil fraud. SEC accused both of misleading investors in a municipal bond offering, which was issued for financing a startup video game company. Notably, the former Phillies ace pitcher - Curt Schilling was the founder of the game company.
The SEC's investigation revealed that Schilling's company, 38 Studios' failed to produce a multiplayer online game in the market at the stipulated time due to shortage of financing.
Broadly, in 2010, the game company estimated $75 million for development of the game in relation to which Wells Fargo was hired. Notably, a loan worth $50 million was provided by the Rhode Island Economic Development Corp. (RIEDC) to 38 Studios in bond proceeds. RIEDC's interest was drawn towards selling the federally taxable municipal bonds with the expectation of creating hundreds of jobs as it planned to encourage Schilling to move his startup video game company from Massachusetts to Providence.
However, SEC found that bond offering proceeds fell short by $25 million to finance the game development, which was not disclosed to investors. Moreover, it was in the knowledge of RIEDC that proceeds from the bond sale will not be sufficient to provide financing to 38 Studios.
Therefore, on failure to get additional financing, the company failed to bring game to the market and defaulted on loan as well. Further, it got bankrupt in 2012 and taxpayers were held responsible for the repayment of money.
"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," said Andrew Ceresney, director of the SEC Enforcement Division. "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."
Wells Fargo's lead banker on the deal - Peter M. Cannava and two RIEDC executives at that time - Keith W. Stokes and James Michael Saul were also charged for supporting the fraud. SEC said Cannava did not disclose a "conflict of interest," in that the bank was paid $400,000 from bond proceeds.
With the denial of the charges, Wells Fargo would fight in the court. However, Stokes and Saul agreed to the settlement to a penalty of $25,000 though they did not admit or denied allegations. Therefore, the case will continue against Cannava, Wells Fargo and RIEDC.
"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 and Public Pensions Unit. "We allege that Wells Fargo failed to fully disclose its own economic interest in this bond transaction."
Banks across the globe have been facing increasing scrutiny for their business practices. Many of the firms have paid billions of dollars as fines and compensation to settle lawsuits and probes. Many investors have lost their hard-earned money as a result of such business malpractices. Such settlements help restore their confidence in law-enforcement agencies. Moreover, it reduces the existing litigation burden of banks.
Wells Fargo currently carries a Zacks Rank #3 (Hold). Some better-ranked finance stocks include Enterprise Financial Services Corp. EFSC with a Zacks Rank #1 (Strong Buy), while Old Second Bancorp Inc. OSBC and PrivateBancorp, Inc. PVTB carry a Zacks Rank #2 (Buy).
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