38 Studios bondholders didn’t vet company’s finances, SEC docs show

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PROVIDENCE, R.I. (WPRI) – Newly released documents from the U.S. Securities and Exchange Commission’s investigation into 38 Studios show bondholders who loaned money for the deal were confident Rhode Island taxpayers would pay them back even if the company failed.

The notes from SEC officials’ November 2014 interviews with 38 Studios bondholders show the lenders paid little attention to the underlying financial condition of Curt Schilling’s company, instead seeing the bond offering as a routine round of taxpayer-backed borrowing that posed little risk of nonpayment.

Jon Spear, a senior executive at USAA, the largest 38 Studios bondholder, told the SEC his company “only looked at the state’s credit” and “did not look at 38 Studios’ credit,” nor did USAA examine the game company’s financials, according to notes from his interview. Spear said 38 Studios’ financial condition was not important to USAA “because Rhode Island would be paying us back,” the notes say.

Rhode Island’s economic-development agency floated $75 million in bonds in 2010 to lure 38 Studios to Rhode Island, only to see the company run out of cash and declare bankruptcy within two years. The political fallout from its demise included a fierce public backlash against paying off the bonds, though the state’s Democratic leaders have continued to make the payments.

The debacle has also resulted in multiple legal actions, beginning with a lawsuit filed in 2012 by the state against the architects of the 38 Studios deal; that case is supposed to go to trial later this year. Separately in March, the SEC filed fraud charges against state and banking officials over how the transaction was handled.

The newly released documents involve both those cases. The interview notes were taken by SEC staffers as they investigated the transaction for their case. But the material has only become public thanks to a May 19 legal filing by Barclays, one of the defendants in the separate state lawsuit over 38 Studios, which says they provide evidence that the state’s accusations against it are baseless.

The largest buyer of the 38 Studios bonds was San Antonio-based USAA, which purchased about $34 million of the $75 million issued, according to notes from the SEC interview with Spear, USAA’s vice president of insurance portfolios.

Spear said Rhode Island “seemed pleased with the money USAA loaned to them,” according to the notes. He said the “most important” part of the transaction for USAA was Rhode Island lawmakers’ moral-obligation pledge to backstop the bonds, since Rhode Island “would be able to pay USAA back,” the notes say. The company was enticed in part by the high interest rates of up to 7.5% offered on the bonds, he said.

Spear recalled that state Rep. Karen MacBeth, a then-Democrat and vocal critic of the 38 Studios deal, called USAA “and threatened not to repay [the] loan.” He also said Richard Licht, a top aide to then-Gov. Lincoln Chafee, asked to restructure the deal, but someone in USAA’s legal department “responded to both and said they expected Rhode Island to uphold the deal.”

In his interview with the SEC, Spear analogized the moral obligation to a parent co-signing a child’s loan, saying he saw a “very, very low” risk that Rhode Island would not pay the bonds and “never assumed that Rhode Island would ever violate the moral obligation.” On top of that, he noted, the state purchased bond insurance from Assured Guaranty to ensure USAA and other bondholders got paid no matter what.

Similar comments were made by executives at other bondholders contacted by the SEC: SIT Investment Associates, Country Financial, W.R. Berkley Corp. and United Heritage Life Insurance Co.

Paul Jungquist, a portfolio manager at SIT, acknowledged that knowing 38 Studios was going to go bankrupt might have been helpful, since its failure could have impacted the moral obligation or the bond insurance, but said the transaction was a “short-term deal” with enough protections that SIT nevertheless didn’t look at 38 Studios’ finances, according to notes from his interview.

Jungquist also said the 38 Studios bonds had “performed well, despite the bankruptcy,” the notes say.

Jack Winder of United Heritage told the SEC his firm sold its $500,000 share of the 38 Studios bonds in 2013 because of the “political firestorm that was starting” and the fact that Rhode Island “is a weaker state financially,” adding that the company “made a good profit,” notes from his interview say.

Officials at Country said they might not have purchased the bonds if they’d known 38 Studios still wouldn’t have enough money to complete its game following the Rhode Island transaction, as was the case.

The 38 Studios bondholders’ recollections fit with the message sent to credit-rating agencies in September 2010 by then-Gov. Don Carcieri, then-House Speaker Gordon Fox and Senate President M. Teresa Paiva Weed. Notes from their conference calls with S&P and Moody’s Investors Service showed the three leaders privately affirmed taxpayers would pay the bonds if 38 Studios failed.

Another document filed by Barclays is a deposition given to the SEC by J. Michael Saul, the former deputy director of the state economic-development agency who was targeted in both the state lawsuit and the SEC case.

Saul acknowledged under questioning that no one at the agency ever ran the numbers to ensure that 38 Studios was projecting it would have enough cash flow to complete its game successfully. “[N]o one ever analyzed the budget of the game development, and no one ever looked at the relocation budget, the construction budget,” he said.

In his SEC deposition, Keith Stokes, the former executive director of the economic-development agency and another target of both legal actions, reiterated that Chafee refused entreaties from 38 Studios to help shore up the company.

Stokes said a board member indicated at one May 2012 agency meeting during the height of the 38 Studios crisis that he and other directors had always known the company would need more money, but Chafee “shut him down immediately.” Stokes also reiterated that Chafee had refused to meet with 38 Studios officials after they’d approached the agency the prior November to discuss its looming cash-flow crunch.

Stokes said that after meeting with 38 Studios officials in April 2012, he and David Gilden, the agency’s legal counsel at the time, pressed Chafee to call a board meeting to discuss the company’s problems.

“And the governor would not meet,” Stokes said. “He’d keep deferring; he would not meet with them. 38 was in a panic circumstance, saying that, ‘This is real; we need the access to capital.’ I tried everything I could in my power to interact with the governor.”

The SEC documents published by Barclays suggest that more information about the 38 Studios deal has been collected for the various legal proceedings but not been released, even after a judge unsealed all the documents in the state lawsuit last September.Ted Nesi (tnesi@wpri.com) covers politics and the economy for WPRI.com. He writes The Saturday Morning Post and hosts Executive Suite. Follow him on Twitter, Facebook and Instagram

Copyright 2019 Nexstar Broadcasting, Inc. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

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