Suit over 38 Studios deal risks collateral damage

KEITH STOKES, former executive director of the R.I. Economic Development Corporation. / PBN FILE PHOTO/BRIAN MACDONALD
KEITH STOKES, former executive director of the R.I. Economic Development Corporation. / PBN FILE PHOTO/BRIAN MACDONALD

Rhode Island’s $75 million loan guarantee to 38 Studios LLC was already synonymous with bad judgment. The state’s lawsuit against the deal’s participants now attempts to link it with fraud and incompetence.
In an effort to recover some of more than $100 million in potential taxpayer losses from the loan guarantee, the lawsuit blames approval of the 38 Studios deal on a broad conspiracy between R.I. Economic Development Corporation leaders, its advisers, lawyers, financial institutions and company executives such as former Red Sox pitcher Curt Schilling.
Whether or not the allegations are true, people familiar with the state’s economic-development apparatus say the legal action risks collateral damage to the state’s already checkered business reputation and efforts to boost the sluggish economy.
“I think it is a very bad move,” said Michael McMahon, a former EDC executive director and now managing director of Pine Brook Partners, a New York private-equity firm. “I think it smacks of a cheap political trick and is not going to help. It is just going to position Rhode Island in the minds of CEOs thinking of moving a business as a place you don’t want to set foot in.”
On top of furthering Rhode Island’s persistent image problem, McMahon said inside the state the suit could scare away potential talent from working or volunteering on future economic-development projects for fear of similar legal reprisals if something goes wrong.
“If I think of the people who volunteer to make Rhode Island grow economically: Why would they stick their necks out to help when there is the risk it can turn out this way?” McMahon said.
McMahon led the EDC from 2003 to 2006, one directorship removed from the tenure of Keith W. Stokes, the executive director who was named as a defendant in the suit for shepherding the 38 Studios deal through the quasi-state agency’s board of directors. Attempts to reach Stokes were unsuccessful last week.
“I think it will have a chilling effect,” said former EDC Executive Director Marcel Valois, now vice president of the private Rhode Island Economic Development Foundation in Cumberland. “We have to be careful we don’t extinguish volunteerism in the state.” The suit alleges that over months the defendants, in their various roles, hid from the EDC board of directors all details that would have allowed them to see the obvious fact that 38 Studios was destined to fail.
The allegations in many cases rise to the level of not just negligence, but unethical or criminal conduct, including legal malpractice, fraud and racketeering.
Of course, Stokes and former Deputy EDC Director J. Michael Saul, the two state employees named as defendants in the suit, are hardly the first Rhode Islanders accused of misusing state funds.
What is unusual about the 38 Studios suit is the breadth of defendants named, which includes not only the former state and company leaders who spearheaded the deal – Saul, Stokes, Schilling, 38 Studios CEO Jennifer MacLean, 38 Studios Chief Financial Officer Richard Wester and 38 Studios board member Thomas Zaccagnino – but the advisers and middlemen who acted as facilitators.
They include Adler Pollock & Sheehan PC, the Providence law firm that served as general counsel to the EDC for 20 years until 2011; Robert I. Stolzman, Adler Pollock shareholder and the primary attorney assigned to the EDC during the 38 Studios deal; Moses Afonso, the bond counsel to the EDC for the 38 Studios deal; Afonso’s law firm Moses Afonso Ryan Ltd.; Wells Fargo Securities LLC and Barclays Capital PLC, the financial-services firms that placed the 38 Studios bonds; First Southwest Company, the state’s financial adviser since 2002 and adviser to the EDC for the 38 Studios bonds; and Starr Indemnity and Liability Co., the insurance company that issued a policy for 38 Studios bonds.
Part of the reason for targeting the large firms that helped facilitate the deal could be their ability to pay.
The suit asks for up to three times the state’s liability for 38 Studios bonds, which could be more than $300 million.
Less than a week after the suit was filed in R.I. Superior Court, the Interstate 195 Commission severed ties with Stolzman, who had represented the volunteer panel in its acquisition of 34 acres of former highway land since June, because of possible conflicts arising from the lawsuit. Even more complicated could be Rhode Island’s relationship with First Southwest, which has represented the state in multiple capacities for a decade.
Gov. Lincoln D. Chafee’s office declined to comment last week on the lawsuit. Chafee spokeswoman Christine Hunsinger said a list of contracts companies named in the suit hold with the state is being compiled. She could not say whether they would be terminated.
In a statement accompanying the lawsuit, Chafee said that, “When it became clear that the company would not survive, I publicly stated my commitment to you that my primary goal would be to do everything within my power to protect the taxpayers of Rhode Island. The [EDC] board’s legal action was taken to rectify a grave injustice put upon the people of Rhode Island.”
Gary S. Sasse, former director of the department of administration under Gov. Donald L. Carcieri, said the state needs to quickly address any conflicts arising from the suit.
“To me, it seems that it is very ethically problematic for the state to purchase professional services and advice from firms it is suing,” Sasse said.
The only individuals intimately involved in the 38 Studios loan not named in the suit are elected officials (including Carcieri, who was Stokes’ boss) and EDC board members, the latter of which the complaint considered ignorant of the deal’s shortcomings.
If nothing else, the suit paints the state’s beleaguered EDC, already the subject of multiple reorganization proposals, as inept at handling such a high-stakes project.
Described in the suit as inexpert in “law, lending, video gaming or economic-development,” the board approved the 38 Studios deal despite receiving almost no specifics about the company’s financial plan or independent risk analysis of the deal.
Valois, who was part of a team with Sasse that formulated an economic-development restructuring plan earlier this year, was more upbeat about the effect that attention on 38 Studios’ failure, if not the lawsuit itself, would have on the state.
“The failure of the deal is helping the state focus on the more basic blocking and tackling of what needs to be done to be more competitive,” Valois said. •

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