The Securities and Exchange Commission has charged Wells Fargo Securities and a Rhode Island agency with defrauding investors in a municipal bond offering to finance a startup video game company.

The case concerns the Rhode Island Economic Development Corp.’s issuance of $75 million in bonds for 38 Studios, the video game company started by former Red Sox pitcher Curt Schilling that closed in 2012, as part of a state program that aimed to boost economic development and jobs by loaning bond proceeds to private companies.

“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, in a statement.

“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,” Ceresney added.

In addition, the SEC has charged Wells Fargo’s lead banker on the deal, Peter M. Cannava, and two then-RIEDC executives, Keith W. Stokes and James Michael Saul, with “aiding and abetting the fraud.”

Stokes and Saul have agreed to settle these charges without admitting or denying the allegations. Each will pay a $25,000 penalty and is prohibited from participating in any future municipal securities offerings.

According to the SEC’s complaint, which was filed in the federal district court in Providence, the Rhode Island agency loaned $50 million in bond proceeds to 38 Studios. It used the remaining proceeds to pay bond offering expenses and to set up a reserve fund and a capitalized interest fund.

“Wells Fargo disputes the SEC’s allegations in connection with the placement of these municipal bonds. We will respond to the specific allegations in the complaint in court,” the company said in a statement.

As part of the loan program, the agency told bond investors they would be repaid from revenues generated by video games being developed by 38 Studios.

However, the agency and Wells Fargo “failed to disclose to investors that 38 Studios had conveyed it needed at least $75 million in funding to produce a particular video game,” according to the SEC.

Thus, investors were not told that 38 Studios had “a funding shortfall even with the loan proceeds and could not develop the video game without additional sources of financing,” it explains.

Later, when 38 Studios could not obtain more financing, it failed to develop the video game and defaulted on the loan.

The SEC’s complaint further alleges that Wells Fargo and Cannava “misled investors” by disclosing the bond offering compensation as a share of the placement agent fee plus a $50,000 payment from 38 Studios, but not informing investors that Wells Fargo had “a side deal with 38 Studios” which allowed the firm to collect close to double the amount of compensation disclosed in offering documents. This additional compensation totaled $400,000 and was paid from bond proceeds. Plus, it created a conflict of interest that Wells Fargo should have disclosed to bond investors, according to regulators, who also say that Cannava “was responsible for Wells Fargo’s failure to disclose its additional fees.”

“An underwriter’s ‘skin in the game’ is material information to investors,” explained LeeAnn Ghazil Gaunt, chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit, in a statement. “We allege that Wells Fargo failed to fully disclose its own economic interest in this bond transaction.”

In a separate case, the RIEDC’s financial advisor for the bond offering – First Southwest Co. – agreed to settle charges that it violated certain Municipal Securities Rulemaking Board rules for its failure to document the scope of services provided in the bond offering until seven months after the financial advisory relationship began.

First Southwest agreed to pay disgorgement of $120,000, prejudgment interest of $22,400 and a penalty of $50,000, though it did not admit or deny the findings.

— Check out Enforcement: SEC Suspends Rep for Sharing Client Info on ThinkAdvisor.