Brian Kelly
Brian Kelly and other lawyers from Nixon Peabody representing Peter Cannava, said the SEC “appears to desperately search for a scapegoat to blame for 38 Studios’ failure even while it concedes no investor lost a cent.”

WASHINGTON – The Securities and Exchange Commission is using Peter Cannava, a banker involved in an ill-fated private placement for a startup video game company, as a scapegoat and has no basis for charging him with defrauding investors, his lawyers claimed this week.

Cannava's lawyers made the claim in responding to the SEC's complaint against Cannava, which is pending in the U.S. District Court for the District of Rhode Island. They said the SEC complaint is factually and legally deficient.

"The complaint does not allege any facts to support a finding that Mr. Cannava acted knowingly or recklessly, as required to allege aiding and abetting a claim," Cannava's lawyers wrote. "Moreover, a review of the offering document at the core of the SEC's case reveals that the allegedly omitted information is in fact disclosed in the offering document, and, even if not disclosed, is not material as a matter of law."

The SEC's action stems from a $75 million private placement the Rhode Island Economic Development Corp. made in November 2010 to help finance a project being developed by now-defunct 38 Studios, whose board chair and majority shareholder was former baseball player Curt Schilling.

In addition to Cannava, who worked with Wells Fargo, an underwriter on the deal, the SEC charged the RIEDC and Wells Fargo in the U.S. District Court of the District of Rhode Island on March 7, alleging they defrauded investors by not revealing the complete financial status of the company or the extent of the compensation arrangement with the underwriter. Two former RIEDC employees have settled with the SEC.

The RIEDC, as part of a state program intended to spur economic development and promote job growth, loaned $50 million of the bond proceeds from the private placement to 38 Studios and used the rest to pay related bond offering expenses and establish a reserve fund and a capitalized interest fund. The state and investors expected 38 Studios would repay the loan with revenues generated from a multi-player video game project on which the company was working.

However, the SEC is basing its fraud charge in part on the failure of the bond placement memo to inform investors that Massachusetts-based 38 Studios needed at least $75 million to produce the game and even more money to relocate to Rhode Island. The company never obtained the extra financing and eventually defaulted on the loan in 2012. The default has not cost investors though, as the investments were backed by a state moral obligation to pay and were insured.

The SEC also alleged that Wells Fargo misled investors by not informing them that the firm had a side deal with 38 Studios that allowed it to receive almost double the amount of compensation as was disclosed. The additional compensation came from an earlier fee arrangement when Wells Fargo tried unsuccessfully to raise money for 38 Studios from an equity private placement. The arrangement created a conflict of interest, the commission said.

The SEC alleged Cannava had primary responsibility for Wells Fargo on the 38 Studios bond offering as well as the authority to sign contracts and agreements on behalf of Wells Fargo.

Cannava's lawyers, however, said that the SEC, in its complaint, "appears to desperately search for a scapegoat to blame for 38 Studios' failure even while it concedes no investor lost a cent."

The memo in support of Cannava's motion to dismiss depicts Cannava as a 30-year-old mid-level banker at the time of the private placement "who did his job diligently and properly, was part of a larger team of professionals, reasonably relied on counsel, and had no involvement in the decision-making process of the legislature, the [RI]EDC or the [RIEDC]'s board."

"Mr. Cannava did not play any role in the decision to provide 38 Studios with economic incentives to move to Rhode Island. [He] did not cause 38 Studios to fail," they wrote. "If one is looking to place blame for the state's troubles beyond Mr. Schilling and his company, it is the state's own [former] Governor [Donald] Carcieri and former Speaker [Gordon] Fox, along with the entire board of the [RI]EDC, who developed and implemented the economic plan to lend taxpayer money to a former baseball player's start-up company in a highly risky industry."

Brian Kelly, a partner with Nixon Peabody who was lead author on the memo supporting the motion to dismiss, rebuffed the SEC charges related to the separate fee arrangement. He said the SEC's complaint "does not allege that Mr. Cannava was in any way involved with the corporate investment banking services provided by Wells Fargo to 38 Studios, or that he knew of the existence of a specific fee agreement between Wells Fargo [and] 38 Studios."

Kelly and his colleagues also said the charges of misleading investors should be dismissed because the offering document "disclosed in very clear terms the many risks underlying 38 Studios' business," including: concerns over the viability of 38 Studios' untested and unknown products; the fact that the company had no revenue and therefore no track record; the real possibility that the company would not be able to make its loan payments; and a "going concern" that the company's auditors' had issued over whether the company would continue to exist as an operating business in the near future.

However, even if that information was not present, the lawyers argue that the charges should still be dismissed because the nature of the private placement, with backing from Rhode Island and insurance, made information about Rhode Island's fiscal health and details about the insurance backing all that was relevant to investors.

The lawyers based their argument on the fact that the private placement memo did not include any financial statements or financial information about the company such as cash flow projections, debts, expenditures, or other analysis. That "provides black and white evidence that investors who chose to enter into the transaction did not find 38 Studios' financial information material, and the inclusion of a particular financial projection would have been immaterial and out of place," they wrote.

"Essentially, if the SEC's central point is accurate, the SEC must argue that all of these qualified, institutional investors decided to act on an investment in which they were provided none of the information that is material to their decision," they said.

Additionally, each investor signed a "Big Boy" letter where they attested to the fact that they did not rely on the placement agent to determine what types of material was important, significant, or material, and they understood the risks of investments, the lawyers added.

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