Schilling’s 38 Studios Pitch Leads to Fraud Lawsuit: Muni Credit

Schilling Collapse Ensnares Wells Fargo as Rhode Island Sues
Curt Schilling, former Red Sox pitcher and founder of 38 Studios LLC, unveils the new "Kingdoms of Amalur: Reckoning" video game during the Electronic Arts Inc. annual Studio Showcase in Redwood City, California. Photographer: Tony Avelar/Bloomberg

Curt Schilling, the former baseball All-Star, struck up a conversation at a March 2010 fundraiser that would sow the seeds of financial ruin and has led to claims of a $75 million fraud.

During the event to benefit veterans at the ex-Boston Red Sox pitcher’s suburban Boston mansion, Schilling chatted with Donald Carcieri, a Republican in his final year as Rhode Island’s governor. Schilling offered to move his 38 Studios LLC video-game startup to Providence in exchange for taxpayer help, according to a state lawsuit filed Nov. 1 in the capital city.

Following their discussion, Schilling conspired with Wells Fargo & Co. bankers and other advisers to persuade the state to loan the company $75 million, knowing it wouldn’t be enough to finish development of Project Copernicus, a new game, according to the civil complaint brought in Rhode Island Superior Court. The deal won approval in July 2010. By May 2012, 38 Studios went bankrupt, leaving taxpayers on the hook for the loan.

“It’s just astounding what was going on here,” said state Representative Larry Ehrhardt, a Republican and former corporate treasurer from North Kingstown who opposed the program used to provide the game maker with a loan. “It was condemned to failure from the get-go.”

Risky Business

The collapse left almost 400 people out of work, including 300 in Rhode Island. It shows the risks confronting states and cities in doling out corporate incentives, which amount to about $70 billion a year, according to Kenneth P. Thomas, who teaches politics at the University of Missouri-St. Louis. Promising to bring as many as 450 jobs, Schilling extracted an unprecedented commitment from the Ocean State as it struggled to recover from the longest recession since World War II.

Rhode Island, with a jobless rate of 10.4 percent in October, is stuck with paying off $75 million of taxable debt taken on by its Economic Development Corp. on behalf of 38 Studios. Following the company’s collapse, the state drew from reserves funded by the borrowing to make bond payments through next year. It’s up to the Legislature to appropriate money needed to cover the remaining obligation.

Bonds maturing in November 2015 were the most recently traded among securities tied to the deal. The debt yielded 4.27 percent Oct. 15, compared with 6 percent when issued two years ago, according to data compiled by Bloomberg.

Insured Debt

The securities, which are federally taxable, have an Aa3 rating from Moody’s Investors Service, fourth-highest, when taking into account insurance from Assured Guaranty Ltd.

The Rhode Island Economic Development Corp. named 14 people and companies in its amended Nov. 16 complaint, including Schilling, Wells Fargo, London-based Barclays Plc and Dallas-based First Southwest Co. The state claimed they conspired to get the agency’s board of directors, which is led by the governor, to authorize the deal based on fraudulent information.

“The board’s legal action was taken to rectify a grave injustice,” Governor Lincoln Chafee, an independent who succeeded Carcieri in January 2011, said in a video posted on the state’s website last month after the lawsuit was filed. “For your tax dollars to be squandered is unacceptable.”

Carcieri Role

Katie Leighton, a spokeswoman for Schilling, declined to comment on the state’s claims. Carcieri, who isn’t named as a defendant, couldn’t be reached directly or through a former spokesman, John Robitaille, to comment on the part he played in conceiving the deal and voting for it.

In a September interview with WPRI, a Providence television station, Carcieri defended his role in promoting the deal.

“I’ll take responsibility for having it approved on my watch -- there’s no doubt about that -- and I’ll say I was a supporter,” Carcieri said, according to the station’s website.

The lawsuit may hinge on whether the state can show that agency’s staff, along with senior executives and board members of 38 Studios as well as the bankers, advisers and lawyers hired to examine the deal, either intentionally or negligently misled the directors -- including the governor -- who voted for it. The state, represented by Providence lawyer Max Wistow, is seeking compensatory damages of at least the amount it has to pay to bondholders, as well as punitive damages.

Wistow, who represented survivors of the deadly 2003 Station nightclub fire in West Warwick, declined to comment.

Support Whittled

After Schilling and Carcieri chatted in 2010, state officials and 38 Studios roughed out a $75 million investment, according to the complaint. Yet through ensuing negotiations, the company stood to get much less, it states. A $23 million reserve requirement and about $2 million in borrowing fees had to be covered with the money raised under the agreement. That left just $50 million for the company, only about two-thirds of what it had said it needed to move from Maynard, Massachusetts, and finish Copernicus, the complaint states.

Defendants “all knew or should have known” that even after the financing, it was “likely that 38 Studios would run out of cash and go out of business in 2012,” according to the complaint. E-mail and meeting notes are cited in the complaint as showing that agency executives and advisers were aware of the shortfall and the likelihood that the company would deplete its funds before completing Copernicus by a September 2012 deadline.

Second Game

Copernicus was to be the company’s second game -- the first one, Kingdoms of Amalur: Reckoning, was acquired when it bought another company.

Schilling had hired Wells Fargo to seek investors in 38 Studios before winning the Rhode Island deal. The bank withheld information about the shortfall in June 2010, as it sought to be hired by the agency to sell its bonds, according to the complaint. It also later prepared investor presentations that failed to disclose that state funds would be insufficient, the complaint states.

Dana Obrist, a Wells Fargo representative, declined to comment on the complaint. The San Francisco-based bank and Barclays were paid about $634,000 to privately place the state debt. Wells Fargo also got $473,512 from the company for helping it find an investor, an undisclosed conflict of interest, according to the court filing.

Brandon Ashcraft, a Barclays spokesman, declined to comment on the lawsuit.

Biggest Adviser

First Southwest is the largest financial adviser on municipal bond deals in Rhode Island, according to data compiled by Bloomberg. The company also failed to tell agency directors that the 38 Studios deal wouldn’t provide enough cash to the startup and gave faulty information about the company’s financial projections to bond raters, the complaint states.

First Southwest denies the claims and will defend itself vigorously, said Winsome McDonald, a spokeswoman.

The company still serves as the state’s financial adviser. Christine Hunsinger, a Chafee spokeswoman, said that “a determination will be made in the future about whether or not those named in the suit” will continue to do state work.

Judge Michael A. Silverstein has set a Jan. 25 conference on the lawsuit, according to Craig Berke, a court spokesman. None of the defendants had filed responses as of last week.

“I don’t see a conspiracy,” said Edward Mazze, a former business school dean at the University of Rhode Island in Kingston. “I see people who didn’t do their job well.”

Political Motive

Schilling, who became eligible for Major League Baseball’s Hall of Fame this year, released a statement last month saying the suit was brought for “political reasons,” and that the state did the deal “with its eyes wide open and a full understanding of any risks.”

In May, he blamed Chafee for the company’s demise, saying the governor refused to release promised state tax credits.

Rhode Island is liquidating 38 Studios, which sought bankruptcy protection in June with $150 million of liabilities and $20 million of assets. The state has raised $830,000 from asset sales and is preparing to auction the company’s intellectual property, according to receiver Richard Land, a lawyer at Providence-based Chace Ruttenberg & Freedman LLP.

Schilling and his wife told the Providence Journal in June that they personally invested $38 million in 38 Studios and also borrowed $12 million for the company.

Last month, the couple put their 26-acre estate in Medfield, Massachusetts, up for sale, asking $3.45 million. They bought the property in 2004 for $4.5 million from Drew Bledsoe, a former quarterback for the National Football League’s New England Patriots, according to Norfolk County records.

Property Attached

RBS Citizens, a unit of the Royal Bank of Scotland Group Plc, sought the attachment of $2.5 million of Schilling’s property, according to the records. The writ of attachment was filed June 7 in Suffolk County Superior Court in Boston. The bank has said Schilling personally guaranteed that amount in credit for 38 Studios.

“The deal just doesn’t make sense,” said Saul Kaplan, who ran the Rhode Island agency for six years, leaving in 2008. “The state should never have done that.”

The case is Rhode Island Economic Development Corp. v. Wells Fargo et al, C.A. PB12-5616, Superior Court, Providence.

Following are pending municipal sales:

NEW JERSEY TRANSPORTATION TRUST FUND AUTHORITY plans to sell about $1.25 billion of revenue debt as soon as today, data compiled by Bloomberg show. The bonds are backed by gas-tax revenue the Legislature appropriates annually. Proceeds help finance highways, bridges and mass-transit. (Updated Dec. 4)

MASSACHUSETTS is set to issue about $381 million of general-obligation bonds as soon as this week, data compiled by Bloomberg show. The deal includes about $231 million of securities that will be priced off the SIFMA index and will refund debt, according to bond documents. (Added Dec. 4)

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