May 29, 2012

One Question: Who has benefited from 38 Studios Mess?

Marc Comtois

Curt Schilling's interview with the ProJo is a must read because it provides insight from another angle into the 38 Studios mess. Thus far, to paraphrase what seems to be the current Rhody Conventional Wisdom, Schilling (along with "Caaarcheeeri") made a backroom deal to fleece the state of millions and both have pocketed the dough (somehow, though we haven't found it yet...we will!). The truth is a little more complicated, and quite a few more people were involved.

According to the 38 Studios founder, the State made and then broke promises that would have helped the company get through a tough financial spot. You may or may not believe Schilling regarding "potential" investors who backed out or promises that were made to him by the EDC or others. But his side of the story brings up many worthwhile points to consider and is an important addition to the narrative so far.

Schilling explains that the company needed short-term cash to keep going, so they met with the state and asked for $8.7 million in 2011 film tax credits to tie them over and submitted paperwork to get the credits. Some of the EDC members knew of the plan. Things looked to be moving along, then things got weird:

38 Studios was dealing with Keith Stokes, then-EDC’s executive director, and David Gilden, the EDC’s lawyer. On April 30, Schilling says, the company talked to Stokes about deferring the $1.12-million payment that was due the next day, May 1, and using the money for the May 15 payroll. But the company also said that if the tax credits were issued in time, 38 Studios wouldn’t need the extension.

...The company missed the May 1 payment. As a result, on May 4, the EDC issued a notice that 38 Studios had defaulted on its state loan agreement, making the company ineligible for the film-tax credits that it needed to stay afloat.

Schilling says the company was blindsided by the notice. Under terms of 38 Studio’s original agreement with the state, he says, the company should have had 30 days to address the missed payment before being declared in default.

That touched off frantic negotiations among 38 Studios, the EDC and Chafee. By the end of the following week, the word had begun leaking to reporters. Then, on Monday, May 14, Chafee said publicly that the state was working with 38 Studios to keep the company “solvent.”

...Meanwhile, Schilling says, the EDC’s Stokes and Gilden had agreed to a deal in which 38 Studios would pay the $1.12-million fee and then EDC would facilitate the release of the tax credits, by certifying that 38 Studios was no longer in default.

The night before it was to go through, company director Thomas Zaccagnino says, he learned that the embattled Stokes, who was drawing heavy criticism for the 38 Studios deal, had resigned. Since Stokes had been a point person in talks with 38 Studios, a worried Zaccagnino texted Gilden, “Please tell me that this won’t affect our agreement.”

Responded Gilden: “it will not.”

But the next day, when 38 Studios tried to pay the $1.12 million with money from a tax-credit investor, executives say they found themselves in an embarrassing scene in which Chafee announced that 38 Studios had sent a bad check with insufficient funds.

Richard O. Wester, 38 Studio’s chief financial officer, says he went to the EDC’s offices at 5 p.m. that day with a check. Meanwhile, 38 Studios’ controller was back at the office, waiting for the funds to be wired from the buyer of the tax credits into 38 Studios’ account. When that happened, Wester would receive the green light to give the EDC the check.

But the tax-credit buyer, whom 38 Studios declined to identify, backed out –– because the EDC lawyer Gilden would not provide a state guarantee to the buyer. When Wester learned that, he says, he never handed over the check.

Fifteen minutes later, he says, he saw a news story on The Providence Journal’s website, quoting Chafee’s spokeswoman that the company had given the EDC a bad check.

The next day, Friday, May 18, another tax-credit investor wired the $1.12 million directly to the EDC. But the state did not release the tax credits to 38 Studios, and still hasn’t ––raising doubts about how that investor will ultimately be repaid.

The rest of the story is well known. Schilling is critical of the way Governor Chafee portrayed the situation publicly, especially with the Governor portraying the first game, Reckoning, as a failure as well as how the Governor gave out closely held secrets like the release date of Project Copernicus and the so-called “burn rate” of the money 38 Studios was spending monthly. According to Schilling:
“We made it clear in EDC meetings how damaging it was, what was happening to our company. [My workers] are sitting there, busting their [humps] without a paycheck, we’re grinding through this, and then he’s press-conferencing on a daily basis, saying this company is a failure, our games are a failure, this was a mistake –– over and over and over again.
Schilling believes these comments undermined a potential $35 million deal that would have seen a sequel to "Reckoning" published and another $55 million deal for further financing on Copernicus. Again, believe Schilling or not, but the way the Chafee Administration publicly handled that first missed payment to the EDC is worth examining. Why did they state 38 Studios had defaulted while negotiations were still going on? I keep going back to the question: who has benefited from all of the negatives surrounding this problem? It isn't Schilling or Carcieri, or members of the EDC or the General Assembly or RI taxpayers. No, the only person who benefits--politically--is Governor Chafee.

Chafee has been saying "I told you so" without actually saying "I told you so" since the story broke (instead, he's been saying things like "throwing good money after bad", or that "no criminal wrongdoing [has been found]...yet"). And while it's true that we often ascribe malice and conspiracy to people when ineptitude may be the best explanation, Governor Chafee has shown a sort of passively-aggressive malice in his frequent press availabilities over the last couple weeks. Is it possible he facilitated this crisis? I'm not ready to go that far. But he sure seems to be the sole beneficiary of it. At least, until now.

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It's a fair point and not at all (IMHO) off the mark. Chaffee campaigned against the deal and all deals like it. It didn't surprise me in the least to see him sabotage any action that would transfer more tax monies to the company. I was a bit surprised to see him being so public in his criticisms when such sensitive negotiations must surely have been going on. But I can see even that as calculated. If Chaffee is as clever as he'd like us to think he is, then it's possible he was trying to poison the well on these kinds of too big to fail deals. By showing the state is unwilling to support transplant companies if they get into trouble, it will almost certainly reduce the odds that another 38 Studios will be knocking at our door in the near future. Of course, it could just have been bumbling on his part, but since the effect is more r less what he claims to have wanted anyway, I doubt we'll ever really know.

Posted by: RM Barron at May 29, 2012 10:01 AM

This is precisely the problem with these political tax credits and public loans - only the corrupt and incompetent solicit these backroom deals because when the "next guy" comes in, all bets are off and there will be an incentive to clean house. Legitimate business needs to plan for the future and Rhode Island doesn't allow them to do that, so public-private abominations like 38 Studios are what's left. One of a dozen reasons why central economic planning is flawed.

Posted by: Dan at May 29, 2012 11:31 AM

Speaks volumes that our former Governor Don doesn't want to comment on the mess he created.

Posted by: Where's Donald? at May 29, 2012 11:34 AM

Chafee's claim that Amalur was a failure makes him suspect from the get go. I don't know who his gaming industry advisers are but from everything I read as a start-up it was pretty successful. I refer back to Monique's questions on a previous post:

1.) Who in Governor Chafee's EDC agreed to with 38 Studios' request that IBM switch from written to verbal reports and why did they do so?

2.) What happened to that information once it reached the EDC? Who at the EDC was receiving those reports, written and subsequently verbal? Did those reports contain information that foreshadowed the events of the last two weeks?

Do we still think our governor is a bungler or does he actually have a devious streak?

Posted by: Max D. at May 29, 2012 11:48 AM

The first game wasn't a failure. Chafee was out of line saying that much. It enjoyed moderate success, of course now we know that 38 Studios accepted a modest lump sum up front for the game that barely covered their annual personnel expenses (86k average salary for 300 employees - typical corporate welfare bloat).

Chafee's a politician, so of course he is going to do what's politically advantageous. He saw blood in the water so he piled on. None of this is at all a defense of the 38 Studios Loan, of course. It's just more evidence that the economy shouldn't be "politicized" in this way in the first place.

Posted by: Dan at May 29, 2012 12:04 PM

I don't think it's tin-foil hat time yet. I don't think Chafee would intentionally spoil the deal, but it's not his obligation to help it along once it's clear that it's become as mismanaged as it was.

Let's be clear here: If they couldn't make the $1.1M bond payment -or- the $4M payroll (which they missed on May 1st) -or- the health insurance premium for the month, then things were going Really Badly. That's the kind of thing you need to bring to your 'partners' (the state in this case) well before your employees are scratching their heads at the ATM.

I'm known for being 'too friendly' with my money, but when a friend asks me for a second loan so he can start paying me back for the first one, it's time to cut the cord.

This wasn't Linc setting-off a chain of events that unraveled the company, it's him not allowing us to get pulled any deeper. Even if the outside investments came through, it wouldn't have been enough to tide 38 over until the MMORPG came out.

And as for whether Amalur was a success or not... The reviews from actual gamers that I read were mostly mediocre; I'd say that the consensus view was 'good, but nothing special'. Hype on sites like Reddit and Facebook were virtually non-existent. I question if the management knew what they had (an 'OK' game) when they released it right alongside several massively anticipated sequels of established franchises. 38 overplayed their hand both financially and in their industry, and that's not the kind of partner you want to keep loaning money to. That they didn't let the state know that they were getting into shallow water in April AND they asked for the reporting to be 'verbal' shows that they're not trustworthy, as well.

In the end, even if Amalur was a wild success and 38 was able to self-finance Copernicus, which also sold well, the whole premise of 'starting a gaming cluster' isn't realistic. If Rhode Island wants to participate in industries that we might have a chance in, we should start with things like shipping and transport, brewing and distilling, gambling and nightlife, maritime stuff, healthcare, and prefabricated infrastructure manufacturing with advanced materials.

Posted by: mangeek at May 29, 2012 4:46 PM

I don't know, mangeek. If we start deciding through top-down planning which industries we should invest in "as a state," aren't we just doing the 38 Studios thing all over again? This wasn't just a case of poor implementation - there are fundamental economic problems with this type of central planning. It isn't efficient. As long as self-proclaimed experts are picking "ripe" industries from some board room or from the state house, it's not going to end well, regardless of whether the expert panel is made up of Gordon Gekkos or Jed Clampetts.

Frymaster likes to give a list of industries on which he wants the state to focus. His "picks," like he's playing the ponies or something. He worked for the EDC when this boondoggle was pushed through and he was justifying it all day long on RIFuture at the time. As the saying goes, he may know more than I do, but I know what I don't know far better than he does, and my brand of ignorance would have saved the state a lot of money in this case.

Why can't we just let market forces identify which industries make sense for the state? I have no problem admitting that I have no idea whether the state should have a "jewelry district" or not. This isn't Sim City - real economies don't work that way.

Posted by: Dan at May 29, 2012 5:44 PM


Who do you believe, Chafee or Shilling? I certainly couldn't pick between the two. they both have their own clear motives. As far as what Dan says, he's right on the money. The EDC should be developing ways for this State to become more competitive overall rather than picking winners. That however is a pipe dream.

Posted by: Max D at May 29, 2012 9:04 PM

Max and Dan, I agree. Don't think that I'm endorsing the typical EDC 'put money here' kinds of projects. What I'm saying is that we should identify where the problems are (e.g. 'old mill space that's not appropriate for high-tech manufacturing') and ease regulations on what kind of stuff can happen there (e.g. allow brewing and direct-sales of liquor under certain volumes). A secured loan here-and-there to do stuff like renovate a space to get a Certificate of Occupancy or lower energy costs shouldn't be out of the question, in my opinion. At least you have capital improvements in real assets if the business doesn't pan-out.

The problem is political. Nobody wants to make small loans to do little things that help industries, everyone wants to hold a giant gold scissors and cut ceremonial red tape. In reality, recovery has to be subtle and broad, not dramatic and specific.

The EDC should be inventorying unused infrastructure (like the unused mill spaces), identifying what could go in there, making calls to potential tenants, and sending lobbyists to the state house to make life easier for those industries. Between this kind of deal from the EDC and what Providence did with HUD, it's clear that the 'silver bullet' approach is favored in political circles.

Posted by: mangeek at May 29, 2012 11:04 PM


Mark Do you think that by changing the spelling of the name of the former Governor it will be even harder for him to be found and questioned about the 38 Studios deal?

Posted by: Phil at June 1, 2012 5:05 AM
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