WASHINGTON - Wells Fargo Securities and one of its bankers in an ill-fated private placement related to 38 Studios are asking a federal judge to prevent the Securities and Exchange Commission from using certain witness statements against them, alleging the SEC was dishonest in crafting the statements and failed to turn them over to defense attorneys.

Attorneys for Wells Fargo and banker Peter Cannava filed the motion late last month in the U.S. District Court for the District of Rhode Island, where two years ago the SEC filed charges against them and the Rhode Island Economic Development Corp. for making fraudulent disclosures related to $75 million of muni bonds that the RIEDC privately placed in November 2010.

The RIEDC, now called the Rhode Island Commerce Corp., agreed to settle the charges but Cannava and Wells are continuing to fight. They want the court to either refuse to allow some of the witness statements, or alternatively to allow defense lawyers to depose the witnesses.

Brian Kelly
Nixon Peabody's Brian Kelly, who represents Cannava, was among the authors of the motion.

The RIEDC bonds were issued to help finance a multi-player video game being developed by then-Massachusetts-based 38 Studios, whose board chair and majority shareholder was former baseball player Curt Schilling.

The RIEDC lent 38 Studios $50 million of bond proceeds and used the remaining funds to pay related issuance costs and to establish a reserve fund and a capitalized interest fund. The loan was meant to be repaid with revenue 38 Studios generated from the game.

However, the bond placement memo failed to disclose to investors that 38 Studios needed at least $75 million to produce the game and even more money to relocate to Rhode Island, the SEC said. The video game company never got the extra financing and eventually defaulted on its loan in 2012.

In their filing, the defense lawyers told the court that the alleged omissions from the private placement memorandum were not material to investors and that the SEC cooked up misleading investor declarations after depositions of investors witnesses indicated that they were already aware of the risks in the deal based on other disclosures.

“Knowing that it has a fatal weakness in its case, the SEC — without telling the defendants — crafted during the discovery period one-sided declarations for investors and potential investors in the hopes of creating materiality where there is none,” the defense lawyers wrote.

Further, even though the defense requested documents of this nature during the discovery phase of the trial, the lawyers said, the SEC didn’t hand them over. The filing alleges that the SEC may have done this to gain an unfair advantage at trial, as without their own diligence the defense may not have learned of these witness statements until after the SEC is expected to use them a few months from now to request summary judgment.

“The SEC’s failure to comply with its discovery obligations is unjustified and has unfairly prejudiced the defendants,” Wells’ and Cannava’s attorneys wrote. “As a result, the defendants request the court to preclude the SEC from using their declarations in connection with any motion for summary judgment or otherwise in this matter.”

Seven investor declarations were not disclosed to the defense, according to court filings, and include statements from individuals who purchased the RIEDC bonds or looked into the bonds and did not buy them. The declarations generally indicate that disclosure in the placement memo of the “funding gap” facing 38 Studios would have influenced their decisions whether to buy the bonds, and some also mentioned the lack of disclosure of a side agreement Wells Fargo had with the game company that allowed the bank to receive almost twice the compensation disclosed in the offering documents, which was a potential conflict of interest.

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Kyle Glazier

Kyle Glazier

Kyle Glazier is the Deputy Washington Bureau Chief of The Bond Buyer. He covers securities law, regulation, and enforcement.