Wells Fargo's (WFC) Bid Dismissed In The SEC Lawsuit

On Friday, a federal judge rescinded the bid filed by San Francisco-based Wells Fargo & Company (NYSE:WFC) to dismiss the U.S. regulator Securities and Exchange Commission's (SEC) lawsuit. The regulating body sued the bank along with Rhode Island government agency of misleading investors in a municipal bond offering, which was issued for financing a startup video game company in March. Notably, the former Phillies ace pitcher – Curt Schilling -- was the founder of the game company.

However, the U.S. District Judge John J. McConnell Jr. agreed to release a Wells Fargo banker from the complaint, but instantly the SEC said the lawsuit will be re-filed and will look into the matter as to the reason for releasing the banker.

Further, in a separate lawsuit, five existing and former state officials have been subpoenaed for a trial, which is expected to begin in October.

Proceedings in Detail

At the hearing on Friday for dismissal of the case by Wells Fargo and Cannava, with the denial of charges, Wells Fargo claimed no investors were harmed as all the bondholders were paid to date. Further, the company's lawyer, Luke Cadigan, said 38 Studios' failure in 2012 had started "a process of finger-pointing and Monday-morning quarterbacking," and noted that the U.S. Attorney, FBI, state police and attorney general are of the opinion that the deal has no criminal conduct.

"No investors were harmed, no investors were misled," Cadigan said. Further, sophisticated and institutional investors bought the bonds knowing 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. He added, "No doubt the Rhode Island investors got a bad deal here but that's not Mr. Cannava's fault."

However, according to the SEC, all arguments are inappropriate. Moreover, SEC lawyer Kathleen Burdette Shields called it a "simple and straightforward fraud."

On the other side, the judge dismisses the complaint against Cannava arguing that the SEC failed to prove Cannava’s intentional involvement in the case. However, Shields will file a modified case and look into the matter.

Notably, Rhode Island Commerce Corporation has not filed for the dismissal.

Background

In March, 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 toward selling the federally taxable municipal bonds with the expectation of creating hundreds of jobs as it planned to persuade 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 the 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 the 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.

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 aiding the fraud. SEC said Cannava did not disclose a “conflict of interest,” in that the bank was paid $400,000 from bond proceeds.

Wells Fargo agreed to fight in the court denying charges. 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 continued against Cannava, Wells Fargo and RIEDC.

Conclusion

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 #4 (Sell). Some better-ranked finance stocks include Enterprise Financial Services Corp. (NASDAQ:EFSC) and Comerica Incorporated (NYSE:CMA) , both sporting a Zacks Rank #1 (Strong Buy), and Old Second Bancorp Inc. (NASDAQ:OSBC) carrying a Zacks Rank #2 (Buy).

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