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INVESTIGATION: Secret Documents Reveal True Risks of 38 Studios

Thursday, June 14, 2012


A confidential investment memo obtained by GoLocalProv reveals in painstaking and dramatic detail the true risks of the 38 Studios venture back in 2009—in marked contrast with the highly optimistic picture that consultants and staff presented to board members of the state Economic Development Corporation one year later.


The document, technically known as a Private Placement Memo, was issued on May 1, 2009 by 38 Studios in a bid to secure $25 million in investment funds. The memo pulls no punches in describing the investment opportunity as “highly speculative and inherently risky.” It warns that membership interests in the company should be purchased only by those “who can afford to lose their entire investment.”

The longest section of the 37-page memo is devoted to spelling out 16 categories of risk—the unique unpredictability of the video game market, the challenges of launching in overseas markets, and the inherent risk in investing in a brand new company where the success of the venture rested on a few key individuals, to name a few.


“There is no guarantee of the economic success of any video game since the revenue derived from the production and distribution of a video game depends primarily upon the video game’s acceptance, which cannot be predicted,” the memo concludes.

(Click here to view a slideshow of excerpts from the memo.)

The memo is not mentioned in any of the meeting minutes or listed in any of the public documents the EDC has released regarding the deal with 38 Studios, the video game company founded by Red Sox star pitcher Curt Schilling.

Would memo have torpedoed deal?

“The worst part of this deal is that all of the risk—all of the risk—went to the taxpayer. If this document had come out at the time the deal … was being made there would have been an uproar,” said Ed Mazze, business professor at the University of Rhode Island.

In contrast to that memo, the three public slideshows presented to the EDC board of directors in the summer of 2010 devote a total of just two slides out of 38 total to discussing the risks, which had been whittled down to four brief bullet points. (Click here and here to view two of the slideshows.)

Photo: Google Man

And, in the space of two meetings prior to the vote approving the $75 million loan guarantee, the negative risks involved were discussed just twice.


Instead, the presentations from three consultants and EDC staff dwelled on the lucrative opportunities in a $72 billion global industry, which they predicted would nearly double by 2013. One after another slides flashed charts and other graphs showing the rapid growth in video game use among youth, U.S. subscriptions to massively multiplayer online games, and software sales as compared with hardware. One slideshow was devoted entirely to the hypothetical scenario of creating a cluster of video game companies in Rhode Island, with 38 Studios as an anchor.

‘Due diligence’?

In comparing the investment memo with the public presentations at the EDC meetings, it is clear that EDC board members—at least publicly—not only were not briefed on the full extent of the risks involved, but also that there were a number of additional risks that were not disclosed during the public board meetings.

“To me if you had a 30-slide show, perhaps 10 of them should have been on risk,” said state Sen. Ed O’Neill, an independent from Lincoln and a retired executive with Texas Instruments.

During his 35-year tenure with the company, O’Neill recalled his involvement in a number of complicated acquisitions, which he said required extensive due diligence. “We didn’t just peel the surface on those. We peeled 20 layers down to the core,” he said.

The confidential memo raised three questions for businessman Ken Block, the founder of the Moderate Party and a critic of the deal: Did the EDC staff even ask for the such documents from 38 Studios? Did 38 Studios provide them? And, if so, were those documents ever shared with EDC board members?


“The document you have contains a number of ‘boilerplate’ statements of risk that are standard for any such offering, the question is whether the EDC sought or prepared a comparable analysis of its proposed investment,” said state Rep. Laurence Ehrhardt, R-North Kingstown.

Such questions went unanswered by two spokeswomen for the EDC yesterday.

“I certainly don’t see anything referred to that in the minutes,” said Ehrhardt, who was a treasurer for a Fortune 500 company before his retirement. Consultant reports on the video game industry, he added, are “not the same thing as a detailed investigation of the company itself.”

Board members in the dark

In the summer of 2010, the membership of the EDC board, with few exceptions was comprised of heavy-hitting local business leaders—a hospital CEO, a Verizon regional president, the chairman of a top toy-maker and a senior executive at a construction company.

The risks listed in the confidential memo are common to the business and investment world, Mazze and Ehrhardt said. As experienced business people, EDC board members would have understood the general risks involved in the 38 Studios venture, Mazze said, but they “would not have understood how serious some of these risks are.”

The fact that such risks were minimized during the consultant presentations, Mazze added, made it that much easier for board members to ignore them. “I think they were a load of nonsense,” Mazze said, referring to the presentations, which were delivered by Wells Fargo, Strategy Analytics, and EDC staff. Mazze credited the prodding and “moral suasion” of the Governor and then-EDC Executive Director Keith Stokes with getting the board to approve the loan guarantee.


The type of investment the memo was seeking was riskier than the “secured debt” involved in the EDC deal, Ehrhardt added.

“However, if the collateral for the debt was the work product (the game being developed) all the warnings of risk would certainly apply to the potential value of the collateral (particularly in the event of failure) and argue strongly against assigning much value to the collateral thus rendering the statements of various people that the loan was safe because ‘it was secured’ absolutely unsupportable and meaningless,” he said.

Qualifications of board at issue too

The real issue, Mazze said, is the ability of board members to understand the risks involved and interpret the information presented to them. Having a member with banking experience would have been useful. A board member with investment experience—someone like state Treasurer Gina Raimondo, also would have been an asset to the board, O’Neill said.

O’Neill also questioned the qualification of the EDC staff, such as Stokes, who has a background in tourism, O’Neill noted. “Does he have the wherewithal to make an assessment on an investment like that? Probably not,” O’Neill said. “You need to have highly skilled, highly qualified people making these decisions.”

Efforts were made to reach every single member serving on the board in summer 2010. A handful were unavailable because they were traveling, but most simply did not respond to calls or e-mails requesting comments. Former board member Lynn Singleton, the head of PPAC, declined to comment and former board member Shivan Subramaniam, the CEO of FM Global, responded to a series of specific questions with this statement:

“Based on the information provided at the time, I voted along with the majority of the RIEDC board of directors in favor of the state supporting the project. Long term, the future of the Rhode Island economy must be built, in part, on developing a cluster of knowledge-based businesses and creating a qualified and well compensated local workforce that such enterprises demand.”


Messages left at the 38 Studios offices in Providence and Baltimore also were not returned.

Unsettling questions linger

Now, a week after 38 Studios declared bankruptcy, unanswered questions continue to pile up.

In 2010, EDC board members were assured that a third party would be monitoring 38 Studios and its progress. Two years later, O’Neill wonders why the bankruptcy came as such a surprise. “They should have known when the train was wobbling on the tracks,” O’Neill said. “They didn’t know until it was in the ditch.”

“The whole process on this from beginning to end smells,” Mazze said.

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"Secret Documents" is a complete misnomer. All Private Placement Memorandums contain this sort of language, most every registered security for that matter.

Most shocking in all of this is Governor Chaffee being asleep at the wheel once he became Governor and for the 17 months following while chairman of the Board of EDC.

Comment #1 by Jeffrey Brown on 2012 06 14

Did you actually expect ANYONE from EDC to read the documents, before falling head over heels for this?

Pockets were lined baby, that's all that matters in RI.

Comment #2 by pearl fanch on 2012 06 14

What is crazy is that it takes no confidential document to make these points.

The risks of that kind of business proposal are about as commonly known to businesspeople as is the term "spreadsheet".

It is like claiming you didn't know about gravity after you tipped over a cup of coffee and acting all amazed the coffee didn't stay in the cup.

Comment #3 by Caroline Evans on 2012 06 14

The presenters need to be indicted for fraud.

Comment #4 by John McGrath on 2012 06 14

This article discusses a Private Placement Memo issued on May 1, 2009 by 38 Studios looking for 25 million in private investment funds. In another story, link below, golocalprov outlined a Bridge Loan dated July 17, 2009 by 38 Bridge Partners, a group of private investors headed by Michael Sweeney (Duffy and Sweeney). This group of five or six investors certainly knew they were investing in a high risk venture. Sweeney says the loan was “7 digits”.

See “Providence Investors Gave Schilling 7-Figure Loan in 2009, http://www.golocalprov.com/news/38-studios-loan/

I doubt the collateral was merely the “work product (the game)”. You would not put down a high risk bet on simply work product. Elsewhere we learn from the EDC’s own Keith Stokes the collateral being eyed for any high tech investment is intellectual property. The EDC was specifically looking to invest in companies which had little to offer other than their patent rights. The collateral was likely the patent assignment, previously owned by Douglas MaCrae, a member of the board at 38 Studios, which was procured on 6/1/2009. The dates fit in a nice pattern, May, June, July, 2009. I’m getting this all from local reporting and the bankruptcy documents posted at ProJo. Anyone can do it.

I have written about the patent elsewhere. At the risk of being boring, I will repost the chain here.
“Stokes worked with the General Assembly to pass the Job Creation Guaranty Program which authorizes RIEDC "to guarantee up $125 million in private loans to innovative, technology-based companies with primarily intellectual-property assets to help them create permanent, high-paying, full-time jobs." The program most notably allowed RIEDC to guarantee former Red Sox pitcher Curt Schilling's, 38 Studios, an entertainment and IP creation company, $75 million (out of the $125 million that is available in government-backed loans).

Note in the above story that the Job Creation Guaranty Program was looking for technology companies with primarily intellectual property assets. Why?

My forensic audit would look something like this. I’m seeing a curious “patent assignment” on 6/1/2009 in the bankruptcy papers. The patent belongs or belonged at one time to Douglas MaCrea, who is on the board of directors of 38 Studios.

July 2009: A mysterious entity called 38 Bridge Partners (interview with Michael Sweeney of Duffy and Sweeney) made a “7-digit” loan to 38. What was the collateral? These well taught lawyers not only spin tax credits but they also spin other intangible wealth like intellectual property. That’s the collateral.

Who was on the 38 Studios board of directors? It’s gone from their website, but here’s a “cache” of the board of directors with a description of each of them. Interesting on there is the super wealthy Douglas MaCrae. This guy retired but then became buddies with Schilling over their love of adolescent video games.

If you look at the unsecured creditors in the bankruptcy, you will see a patent assignment on 6/1/09. The patent was previously owned by Doug MaCrae and Thomsas Westberg. These ultra rich people buy patents just to spin them and use them as collateral for loans. Whoever ends up with the collateral in the end is the winner. That won’t be Rhode Island. That will be the last bank to own it: JP Morgan. I believe the patent was assigned to JP Morgan bank as collateral on 3/17/2010 (date of execution).



Comment #5 by Jack Cottone on 2012 06 14

If anyone wants to back me up on any of this, be my guest. Just search the bankruptcy documents for people's names. You will find them. You will see that 38 owes Corso's Preservation Credit Fund 11 and a half million dollars. There are patent assignments and other documents dating back to 2008 and 2009. I hope the auditors are going back this far. Please, hope to God.

Comment #6 by Jack Cottone on 2012 06 14

Could it be that Rhode Island is a criminal conspiracy under the RICO act?

Comment #7 by John McGrath on 2012 06 14

This site has not yet fixed its clock. The time recorded on comments is "where the clock used to be" in winter.

Comment #8 by John McGrath on 2012 06 14

@Jeffrey Brown: I'm not a big fan of Chafee politics but given that 38 Studios managed to rack up $150M in debt and had little revenue, I doubt it would have made a difference if was told about the situation weeks ago, months ago or last year. The 38 Studios ship was going down and going down fast. Chafee warned about it before it happened. Blaming him is like blaming the guy on the Titanic the yelled "Iceberg, straight ahead" instead of blaming the ship's designer, captain, etc.

Comment #9 by Todd B on 2012 06 14

@Jeffry Brown

I know many folks like to mock the Governor but when they assert that his role as titular head of EDC is to personally monitor the day to day activities of all companies EDC has issued loans or loan guarantees to, they only mock themselves.

They also apparently don’t realize that the bundle of straws that broke the camel’s back didn’t come about until Feb/March of 2012 when the sales of the initial video game were good, but far from good enough to provide the needed ROI given a very lopsided deal with EA. Nothing short of having it be the top seller of 2012 would have saved the company.

Questions as to what was known of the high risk nature of this company, who knew it and when – and whether members of the G.A. knowingly gave the green light to risky legislation important to a friend of the Speaker of the House all need to be answered.

It’s ironic that in trying to create a badly needed “Knowledge District” in RI, that both the EDC and General Assembly seemed to move forward with a decided lack of knowledge about how high risk a venture this was.

Comment #10 by Swamp Yankee on 2012 06 14

So...... Did Fox or Paiva-Weed ever ask to see the supporting documentation?

Better yet, did they run it by their Legislative Counsels? If so, what was their take on it? If not, why not?

Any connection to Fox's Leg Counsel John Flynn recently being appointed a Magistrate at $140,00 per year?

Remember too, that Stokes' "severance package" included a provision prohibiting him from discussing Studio38...

"Silence is Golden."... In more ways than one!!

Comment #11 by Fabiano Terrenni on 2012 06 14

Here's a story about one of the families affected by this 38 studios mess.


Comment #12 by Joyce Bryant on 2012 06 14

No memo was necessary. Most of the people in RI knew this was going to happen outside of a few cheer leaders.

Comment #13 by Jim D on 2012 06 14

Since Cianci was convicted under RICO for "conspiring" to do take bribes/corruption, why can't Carcieri and the EDC Board at the time be indicted under RICO?

Comment #14 by John McGrath on 2012 06 14

This is why my wife and I was touring NC and VA last week. TAXED INTO OBLIVION AND NO ACCOUNTABILITY IN RI. We can't get out of this
s#!*hole of a state fast enough. Lifelong residents who have seen enough of this BS

Comment #15 by Joel Hovanesian on 2012 06 14

Two complaints about this website. It refreshes quite often when you're writing something, so be sure to write your stuff on your desktop first if you're long winded like me! And second, why aren't the hyperlinks highlighted and clickable? Seems simple to do these days.

Comment #16 by Jack Cottone on 2012 06 14

Agree, Joel, about getting out of this s#!*hole of a state, but some people just can't afford to move. It takes guts though. There are some places, like Austin TX, with low unemployment rates. Summertime is a good time to move and I see a high number of rentals around. Could be just students, but I think the state is and has been bleeding citizens for years. It's just kids coming here for college, some staying on in the new little city called Olneyville. If you can live in a warehouse you can go over there!

Comment #17 by Jack Cottone on 2012 06 14

That reminds me of something very obvious about this 38 Studios deal, it was a bunch of old fahts in suits trying to be cool, trying to be artsy and employ students from RISD and Brown who aren't even from RI. Schiller and all these rich guys behave like adolescents playing Monopoly with fake money, gravitating invisible wealth and watching it rise and fall. And now the big fall. Schilling can get away with it if he just goes to rehab. Wink wink.

Comment #18 by Jack Cottone on 2012 06 14

How come no one is talking about Dr. Ioanna T. Morfessis? Remember her? Too much salary heh? I seem to remember it was $250k or $70k more than the "local" guy from tourism in Newport got. The same guy who just got a severance which just about equals , ready? $70k.

Is this not so much RI?, too stupid to get out of it's own way. I bet Carcieri said, "oh? you don't like my QUALIFIED choice, here you go, take Keith and good luck with that."

We'll never know what Dr. Ioanna T. Morfessis would have thought of the deal but I kinda feel we may not be out 50mil .......

Comment #19 by Mike Conn on 2012 06 14

How come no one ever gets indicted for committing big financial frauds against taxpayers?

Comment #20 by John McGrath on 2012 06 14

Sorry about the above link. But the story is about a family who moved here to work at 38 Studios and was never paid. They are now on welfare in this state.Thanks to Shilling and the the rest of the thieves in this state.

Comment #21 by Joyce Bryant on 2012 06 15

The last 2 people who were offered the RDC job turned it down and I would love to know the real reasons behind that.

The woman from Arizona who was highly qualified (as Mike Conn has already mentioned) wanted nothing to do with this state after about a week or two of checking things out here.

Next week I'm leaving for Alaska. Unlimited work at more than twice what I make here and after 2 years as a resident they will be paying me to live there.

Comment #22 by Jim D on 2012 06 15

The head of a local toy company wouldn't have known the risks????? HASBRO, which has it's name all over almost everything to do with kids, ON THE PLANET, wouldn't have known??????

How can that be? Were they all dazzled by the number of zeros before the decimal point? The BILLIONS they saw on the phony presentations???

It's the same old story, all they saw was the money.. There was no thought to taxpayer risk. NONE!

It's almost, as if, when you hold office in R.I. you have to come up with new and different ways to shaft the voters. It's like a badge of honor. I mean, the voters keep sending these people back so they must like getting taken for a ride.

Comment #23 by Mike Hamel on 2012 06 15

Wait till Deepwater tanks leaving an absolute mess in the Block Island sound for someone else to clean up.

Comment #24 by Jim D on 2012 06 15

Jack Cottone -

Thanks for mentioning the problem with refreshing too frequently. This too has caught me and my gasbag proclivities when writing yet another windy post. Thought it was something going on, my computer, relieved it isn't.

Mike Hamel -

Right, head of the childrens' toy company who surely knows better but knows a good deal when he sees one - for him.

At a time when family, friends, and peers were contacting me asking why an elderly family member was neglecting their spouse's medical treatment to the point they almost died several times - and then did - this elderly relative was walking around showing anyone who would listen a scripted copy of announcement of his 'ten million dollar gift to a big, big, beautiful, beautiful crippled childrens hospital', seemingly oblivious to his spouse's grave condition.

Had they spent a fraction of what they squandered on that scam known as the lifespan/brown knowledge center, their spouse would be alive.

Guess which 'crippled childrens hospital'.

They 'hospital' even waited for a while after the death because they found 'problems' with an inviolable trust. No problem for Girard R. Visconti, however, whose peculiar talents obfuscated all the evidence.

Or so he thought.

Truth, as does murder, outs - always.
Our influence counts. Let's use it.

Paul Vincent Zecchino
Manasota Key, Florida

Comment #25 by paul zecchino on 2012 06 15

Jack Cotto
I agree you write well and check your facts more than the rest

So I am very happy to see the level of intelligence is rising.

Check out this jack and see if you concur :


Could never not pay for the cheap
"Bloody Sock Trick" Cherry Kool- Aid!

Too bad he kept the Kool-Aid the EDC all Drank"

Long live the CURSE OF THE BABE

Comment #26 by Donna Day on 2012 06 16

Commenting is not available in this channel entry.