What will it take for the state to finally move on from 38 Studios?

Scrawled on a piece of lined paper buried deep among thousands of court documents is a handwritten note:

“OK to be bold, but this is as aggressive as we’ve done.”

The word “aggressive” is underlined and there’s an arrow pointing at it with the circled phrase: “High Risk Deal.”

The note was written by attorney Robert I. Stolzman, of Adler Pollock & Sheehan, on July 14, 2010, during a special meeting of the R.I. Economic Development Corp. (now known as R.I. Commerce Corp.) The time period is significant to Rhode Island history because the next day the EDC officially offered a $75 million loan guarantee to the video game company 38 Studios LLC, in exchange for its relocation from Massachusetts to Providence. Stolzman served as counsel to the EDC at the time.

- Advertisement -

As most Rhode Islanders old enough to read have learned, the “aggressive,” “high-risk deal” failed miserably. The total cost to the state, by some estimates, totaled nearly $100 million, which is still being paid down.

But the saga does not end there, as the Ocean State has struggled to move beyond the deal and its aftermath.

The downward spiral of 38 Studios gave birth to a series of investigations, legislative hearings and litigation, which all still exist in some form today, including hearings before the House Oversight Committee. The resulting publicity has hampered statewide economic-development efforts, according to some state leaders.

“The 38 Studios debacle [which included the loss of approximately 400 jobs] created a negative impression nationally, hurting our state’s ability to attract new companies,” said House Speaker Nicholas A. Mattiello.

Whether 38 Studios is to blame for the economic stagnation that has gripped the state in recent years is a point of contention among developers, economists and state leaders. Some call it a tangible economic depressant, while others view it more as a boogeyman-like excuse used to vilify potential deals.

It’s true that since 38 Studios went bankrupt in 2012, few major employers have relocated to the Ocean State. General economic conditions, however, may be more to blame than the fallout from the failure of a single company.

“In a very tough economic climate, 38 Studios was just one more obstacle” to growing jobs, former Gov. Lincoln D. Chafee – in office at the time of the company’s demise – told Providence Business News last month.

The ghost of 38 Studios also continues to cast a shadow over prospective development and investment. It’s repeatedly been linked in recent months by opponents of state investment in such disparate proposals as the Pawtucket Red Sox pitch for a Providence ballpark and Gov. Gina M. Raimondo’s plan to raise money for bridge and road repairs through tolling.

So what will it take for Rhode Island to finally move on?

HAMPERING BUSINESS?

Rhode Island’s current economic struggles largely predate the video game company, says Scott A. Gibbs, president of The Economic Development Foundation of Rhode Island.

“The number of companies looking to come to Rhode Island since 2007 has been few and far between,” Gibbs said. “We got hit pretty hard [by the Great Recession] and we’ve not recovered as well as other states. … The collapse was unprecedented and painful.”

38 Studios didn’t emerge as a prospective business for Rhode Island until 2009, according to court documents.

Gibbs, whose nonprofit runs business parks, including Highland Corporate Park, home to CVS Health Corp., doesn’t see 38 Studios as having adversely affected Rhode Island’s image to outside business.

“I have not encountered any client who chose not to invest in Rhode Island because of 38 Studios,” Gibbs continued.

Commercial real estate isn’t a perfect barometer to measure economic activity, but both Gibbs and Neil Amper, vice president of Capstone Properties Inc., agree that 38 Studios hasn’t had much impact on business.

“Every state makes mistakes, but the problem with Rhode Island is the margin for error is much smaller than other states, so when we make a mistake, like 38 Studios, it becomes magnified in our community,” Amper said.

Lighting Science Group recently moved its 10-person headquarters from Florida to West Warwick. The failure of 38 Studios didn’t enter into the firm’s decision-making process, according to Ed D. Bednarcik, company president and CEO.

“It was embarrassing for the entire state and the administration that was there at the time,” Bednarcik said. “But I’m a big fan of [Gov. Gina M. Raimondo] … so from my perspective I didn’t see anything negative. I think the state learned its lesson.”

Bednarcik, who has lived in Rhode Island for 15 years, said the state needs to “plow ahead” and doubts the failed investment will play too much of a role in future business prospects.

Liam C. Malloy, economist at the University of Rhode Island, agrees with Bednarcik, saying outside businesses in search of greener pastures are more interested in other economic factors, rather than the state’s failed dealings with a company of the past.

“Companies are going to look at the general regulatory environment and the workforce more than anything else,” Malloy said. “If there’s anyone looking for a $75 million loan guarantee, yeah, they will probably look elsewhere.”

‘38 STADIUM’

The ghost of 38 Studios, however, does still find a way into everyday discussions.

Last year, owners of the Pawtucket Red Sox announced a plan to build a new ballpark in Providence. The owners’ initial proposal asked the state to pay $4 million per year for 30 years, along with no property tax.

Opposition groups formed, often citing the 38 Studios scenario as an example of why the state shouldn’t strike a deal with team owners. 38 Studios and the PawSox stadium plan became so intertwined that at one point a community Facebook page was created called, “STOP ‘38 Stadium.’ ”

The PawSox proposal was shelved and promises of a restructured deal never materialized, as politicians and others who also questioned the benefits of the proposal to the state eventually sided with those who feared another 38 Studios-type debacle and denounced the deal.

“The 38 Studios issue was on people’s minds as they assessed the public incentives that were proposed by the PawSox,” said Mattiello. “[It] has made people more skeptical than they otherwise would be.”

That includes opponents of Raimondo’s toll plan.

On Dec. 23, Rep. Patricia L. Morgan, R-West Warwick, took to Twitter to express her opinion on tolls, which the governor wants to implement in order to help finance a major road and bridge improvement project.

She tweeted:

“Tolls: 38 Studios times 10.”

The sentiment has been echoed among other opponents of tolls, including Michael Napolitano, who helped run Ken Block’s Republican bid for governor in 2014, and is a political consultant at Precision Political Consulting of Rhode Island.

He tweeted: “Governor’s lack of transparency, pushing tolls without doing the research reminds me of 38 Studios!”

Raimondo has noticed the trend.

“Every new idea is called ‘just like 38 Studios,’ even if it has no relationship,” she said. “It’s become the standard refrain.”

Though there’s little in common between a failed video game company, a proposed minor league baseball stadium and a multimillion dollar state infrastructure project, it’s easy to bundle the trio in the minds of voters, according to Wendy J. Schiller, associate professor of political science at Brown University.

“The idea of the state committing anything based on the expectation of revenue from another source is what makes people legitimately nervous,” Schiller said.

MAKE A DEAL

The failure of 38 Studios also has fed into an historical distrust of elected officials among many voters due to a series of high-profile corruption cases over the years. They include Gordon D. Fox, the House speaker at the time of the 38 Studios deal. Fox last year pleaded guilty to wire fraud, bribery and falsifying tax returns in an unrelated matter.

But it’s also true that some of Rhode Island’s biggest companies are here because of deals they struck with state leaders.

In 2001, Seattle-based Immunex Corp., a biopharmaceutical company, announced plans to spend $500 million to retrofit a manufacturing plant in West Greenwich. The state expedited the process, successfully pushing through five required permits.

It also offered incentives, including tax exemptions for construction material and equipment, which Immunex estimated would save $7 million. But the company never saw the project through to completion, as industry rival Amgen Inc. acquired the company later that year.

Amgen, headquartered in Thousand Oaks, Calif., today is the second-largest biotechnology and life sciences company in Rhode Island and the seventh-largest manufacturer, employing 640 locally, according to PBN research.

Amgen, growing quickly, required more space and in 2003 penned a deal to buy the West Greenwich headquarters of International Game Technology PLC, formerly GTECH.

The deal posed a problem for the state, as GTECH, then without a home, started flirting with the idea of moving to Massachusetts, along with its more than 830 employees.

The threat of losing such a large company pushed the state to quickly pass legislation granting incentives to keep the company in Rhode Island. The incentive package included a string of sales and property tax breaks, a long-term agreement with the state’s Lottery Commission and a tax-stabilization agreement with Providence.

AN OBLIGATION TO WHOM?

While the ongoing debate in House Oversight Committee hearings over who knew what, when continues to garner headlines and provide talk-radio fodder, the panel is also committed to gaining a better understanding of the financing of the 38 Studios deal, says Rep. Karen L. MacBeth, D-Cumberland, committee chairwoman.

“We’ve seen where some moral-obligation bonds have had problems and others that haven’t,” she said of the financing tool used to back 38 Studios.

Moral-obligation debt is typically secured by a capital reserve fund, which in Rhode Island means it’s always supposed to be paid back in the event of insolvency.

Unlike other types of bonds in Rhode Island, however, the controversial funding method doesn’t require a public vote of approval, making it ideal if the state needs a quick – and guaranteed – bargaining chip during negotiations.

And while the method has failed repeatedly, costing Rhode Island taxpayers millions even before 38 Studios, the state has always gotten up, dusted itself off, and used it again.

In the 1970s, R.I. Port Authority and the EDC financed a $4.1 million moral-obligation bond to support the acquisition of ITT-Grinnell foundry in Cranston by Fairmount Foundry. The state’s ultimate shortfall on the investment, paid back by taxpayers, was more than $4 million, according to the Office of the Auditor General.

The OAG investigated the failed investment and made a number of recommendations, including one that suggested moral-obligation bonds not exceed $10 million.

But the recommendations were largely ignored and by 1993, the EDC issued $30 million of special-obligation revenue bonds to lure Alpha-Beta, a Massachusetts pharmaceutical company, to relocate to Rhode Island.

The company went bankrupt in 1999 and the shortfall covered by state taxpayers was $5.7 million, according to the OAG.

So do moral-obligation bonds ever work?

In 1996, the EDC issued $25 million in bonds carrying moral obligation to finance an infrastructure project for Fidelity Investments. Similarly, in 1997, the EDC entered into an agreement with Fleet Bank, now Bank of America, and issued bonds with moral obligation totaling $11 million.

The outstanding debt of the Fidelity and Fleet National Bank projects as of June 30, 2015 was $19.2 million and $7.3 million, respectively. The companies to date haven’t had an issue making payments, according to Auditor General Dennis E. Hoyle.

“If we’re going to continue with moral-obligation bonds, what are the safeguards that we need to put into place?” asked MacBeth. “I think we’re at a point where we’re finally going to do something about it.”

Schiller is among those who think the House hearings could help the state move on from 38 Studios, though others question their value.

“If these hearings were held a year, or 18 months ago, they might have been productive. It’s not clear to me now what they will produce,” said Gary S. Sasse, director of the Hassenfeld Institute for Public Leadership at Bryant University.

Sasse believes the state could move past 38 Studios psychologically if a truly independent body were appointed to investigate the failed deal. “Everyone knows what happened, everyone knows the consequences of what happened. … To move forward and close the chapter on 38 Studios, the people need to get an independent appraisal.”

WINDS OF CHANGE?

38 Studios hangover or not, there’s some budding optimism about economic development in the new year.

The state’s fiscal 2016 budget contains a suite of economic incentives for companies looking to expand or relocate in Rhode Island. The incentives programs, which have rolled out since their passage, have guidelines about what’s required of qualifying companies.

“Every state in America offers incentives. You cannot get businesses here without incentives,” Raimondo told PBN. “If we do it right, we can create thousands of jobs, and that’s what we have to do. You can’t be afraid to move forward and compete.”

Saul Kaplan, founder and “chief catalyst” of the Business Innovation Factory, says the incentives could help state government regain some lost trust from the public.

“The new programs with a new administration could earn them creditability,” said Kaplan.

Kaplan served as the director of the EDC from 2006-2008, leaving just before the 38 Studios deal came to the table. He’s cautiously optimistic about the Raimondo administration and her rollout of the incentives.

“I think it’s still early, but they’re being very thoughtful about it,” Kaplan said.

And the optimism could be spreading, as the business community anticipates the completed revamp of South Street Landing in Providence and the benefits of last month’s closing of a deal with Wexford Science & Technology, which would involve the phased development of more than 1 million square feet of mixed-use space on the former Interstate 195 land in the city.

Will completion of those and other projects finally help the state to move on?

“Until the state can demonstrate success at bringing business to Rhode Island, or keeping business in Rhode Island, with government subsidies or tax credits, the specter of 38 Studios will continue to cast a really long shadow across voters’ opinions,” Schiller said.

Raimondo believes the commitment to new incentives – a departure from her predecessor’s distrust of such enticements to lure private investment – is a step in the right direction.

“We cannot stand still. We cannot use 38 Studios as an excuse. We need to move on,” she said.

More business activity could help the state get there, says Gibbs.

“If there were a lot of cranes in the sky, maybe there would be a little less focus on this [38 Studios] issue,” he said. •