Riley: Kushner and the “Hot Air Ball”

Tuesday, November 10, 2015

Michael G. Riley, GoLocalProv MINDSETTER™

 

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Recently released depositions related to the State of Rhode Island lawsuit against parties associated with the 2010 EDC loan to 38 Studios have been fascinating.  And by far, one of the most relevant depositions took place on June 2, 2014, when witness Sean Esten was under examination and was being deposed by Mr. Gerald Petros, counsel for Southwest Securities, and a defendant in the State's lawsuit. 

Mr. Esten was an employee with the EDC, hired in 2009. Esten's normal role was to issue a credit memorandum referencing EDC loans that would then be presented to lenders, i.e. banks. But the 38 studios financing was a whole different ballgame with serious implications as is evident in this deposition. 

Remember, even though there had already been significant lying and deception prior to June 2010, nothing would happen unless 38 Studios got a significant amount of money. Therefore no taxpayer money would have been lost.  38 studios needed a full $75 million cash just to survive to the next phase.  Watching all the excuses, characters, arm twisting and contortions is fascinating in this deposition. Mr. Esten almost immediately said he had serious doubts about 38 Studios viability. His testimony was that he was ignored by his boss Michael Saul and frozen out by players within and outside the EDC determined to make the financing happen.

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What is a Kushner?

Esten was responsible for analyzing the risk of loans processed through the EDC. He created “credit memorandums” for thousands of small businesses during his career. In the beginning he thought this was his role for 38 studios. These memorandums were then used by lenders to assess whether to lend money to the small businesses. In early 2010, Esten was named as part of the due diligence team for the EDC regarding 38 Studios.  However Esten was never able to even start producing a credit memorandum due to lack of information regarding 38 Studios and the intended scope of borrowing. Esten was swept aside by events and officials in the EDC and his warnings were ignored. 

In March 2010 the full court press was on to get Curt Schilling and 38 Studios financed by hook or, as it turns out, by crook. With the 2 year old EDC Job Creation Program languishing and unemployment still double digits, an unusual combination of insiders felt pressed to do something quickly. Simultaneously another less altruistic group of insiders looked ravenously at the approaching corpse that was Curt Schilling. Characters like Michael Corso stood to take tens of millions out of the deal. Several politicians of only one stripe saw an opportunity to extend and brighten their careers and issue favors that would be paid back in spades.  But one honest guy stood in their way. On March 31, 2010 the authorized size of the Job Guaranty program was $50 million dollars - total. A few days later it was $125 million. That’s when Esten learned what a “Kushner” was. The following testimony appears on pages 129 and 130 of Esten's deposition. The questioner is Mr. Petros.

Deposition June 2, 2014

Petros: Did you know what a Kushner was?

Esten: At that point in time, no.

Q.  Did you learn?

A. I did learn.

Q.  What is it?

A.  It is a certain method that the Legislature, I'm not sure when they came up with it, but it was a way to allow some subsidiary corporations to issue bonds and to get the backing of the state without it having to go to referendum of the voters. I don't understand the full legal structure of how it came about or how it works.

Q. When did you learn that, what that meant?

A. It was during the 38 Studios process.

Q. Was that a form of financing that was being discussed in the 38 Studios process?

A. Yes.

Hot Air Ball

The term “hot air ball” appears on pages 139 and 140. The notes on a memo at a meeting in June 2010 regarding risk are written by legal counsel for the EDC, Mr. Stolzman. The following exchange involves Esten, Max Wistow (Rhode Island's lawyer) and Mr. Petros:

Deposition June 2,2014 referring to the notes:

Q. Mr.Petros - Okay. Now, below that it seems to be an arrow that says collateral value and MMO?

A. Mr. Esten  - Correct.

Q. Can you tell what the next word is?

MR. WISTOW: Mr. Stolzman said it said, "hot air ball," that's his testimony. You can call the judge, do what you want.

MR. PETROS: I'm asking the witness.

MR. WISTOW: You're asking the witness what it says?

MR. PETROS: Don't testify.

MR. WISTOW: The guy who wrote it testified under oath it says “hot air ball” 

MR. PETROS: When you question the witness, you can ask him that. That's inappropriate.

MR. WISTOW: It's totally inappropriate for you knowing what he said – all right, do what you want. Go call the judge.

MR. PETROS: You've already done it.

MR. WISTOW:  You're damn right, I already did it.

MR. PETROS: Do you want to swear some more or do you yell at me some more? I object to your attitude. I object to you yelling at me, and I object to your interference with the deposition.

MR. WISTOW: I sorry to hear that. I object to the fact that you're trying to mislead the witness by having him read something that the guy who wrote it testified --

MR. PETROS: That is a bad faith

Later in the deposition:

Q. PETROS: Do you remember a discussion about an air ball?

A.  ESTEN:  Yes.

Q.  PETROS:   What is that?

A. ESTEN:  An air ball is when there's a difference between what the value of the collateral on a transaction is and what the amount that someone wants to borrow or is borrowing, so it's -- depending on where you are, it's called different things.

Q.  PETROS: So there is a gap between the amount that's being loaned and the value of the underlying collateral.

A. ESTEN: Correct.

Q. PETROS: And that's what's referred to as an air ball in your industry?

A. ESTEN: In this case, yes.

Q. PETROS: Was there a discussion of that gap at this April 2 meeting?

A. ESTEN:   Yes.

Q. PETROS: And can you recall anything about that discussion?

A.  ESTEN:  I don't recall.

Q. PETROS:  Did you perceive that air ball as being a significant number in this transaction?

A.    MR ESTEN:  Yes.

A “Kushner” is a method of financing used to get around the voters and an “air ball” is a term for overvalued collateral.  It’s nice to know that public private industry has its own quaint terms for fraud and chicanery.

After reading just this one deposition it becomes clear that lots of shady and yes, illegal behavior was taking place in our government. I suggest a law that no public financing above a minimal amount should ever take place again without voter referendum. It’s time to end the “Kushners” especially when the “hot air balls “make their appearance.

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Michael G. Riley is vice chair at Rhode Island Center for Freedom and Prosperity, and is managing member and founder of Coastal Management Group, LLC. Riley has 35 years of experience in the financial industry, having managed divisions of PaineWebber, LETCO, and TD Securities (TD Bank). He has been quoted in Barron’s, Wall Street Transcript, NY Post, and various other print media and also appeared on NBC News, Yahoo TV, and CNBC.  

 

Related Slideshow: Seven 38 Studios Facts You Would Not Believe

Here are the seven facts that you would not (want to) beleive about the 38 Studios deal.

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1.

Meetings Started a Year Before When We Were Told

The first story was that Governor Carcieri went to a fundraiser for a WWII Veteran’s event at Curt Schilling’s home and that served as the spark to a meeting between Keith Stokes and the 38 Studios officials to try and lure the company from Massachusetts to Rhode Island.

Then, it was disclosed that meeting Speaker Fox had had meetings earlier in the spring through his relationship with his close friend Mike Corso.

In the documents released Thursday, Bill Murphy attested to how he sat in on a meeting with Corso, Fox and Curt Schilling while he was still Speaker.

But now, emails starting in July of 2009 between Corso and 38 Studios’ Tom Zaccagnino show the wheels were put in motion even earlier than we thought.

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2.

If Not for RI, 38 Studios Would Have Closed Within 1 Month

If RIEDC had turned down the deal in July 2010, documents released showed that 38 Studios would likely have missed making payroll the next month.

In a July 7 email from Rick Wester to Tom Zaccagnino, he wrote, “The latest would be the August 15th payroll at this point. I’m having doubts we can get through the 30th."

The RIEDC board approved the $75 million in bonds on July 26.

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3.

The Original 38 Studios Deal Was Small and Inexpensive

An internal email at 38 Studios dated February 18, 2010 outlines a Rhode Island staffing plan starting at 10 employees in 2010 and increasing to 40 in the future.

However, RIEDC mandated a high staffing level and thus a high burn rate. 

For 38 Studios to receive its last payment the RIEDC agreement required staffing to elevate to 450 headcount.

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4.

38 Studios Knew RI Money Was Not Enough to Fund the Company

An email exchange between top 38 Studio leadership and Mike Corso, confidant to Speaker Gordon Fox, in preparation to meeting with the RIEDC Board led by Governor Don Carcieri showed that 38 Studios wanted to keep certain financial realities under wraps. 

Tom Zaccagnino wrote to CEO Jen MacLEan, CFO Rick Webster, and Corso, “I really don’t think we should highlight the fact we might be undercapitalized…won’t go over well with staff or board."

Two and a half weeks earlier EDC Board gave preliminary approval and on July 26, the RIEDC Board gives final approval to the $75 million.

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5.

Style Over Substance

In October of 2010, RIEDC was preparing a public relations strategy because “the Gubernatorial candidates have politicized the 38 Studios deal.”

The Strategy document outlined the key messages, and the need to  “accelerate development of an in-depth Providence Journal story, including offer of access to Board members. The Providence Journal team will be Andy Smith, Paul Grimaldi and Business Editor John Kostrzewa — we will push for Neil Dowling’s inclusion.”

At the same time as EDC was rolling out its PR strategy to sell to the public value of the 38 Studios deal, 38 Studios internal documents showed that the company was tittering on financial collapse.  In fact, a demand for payment from Speaker Fox’s confidant for a $500,000 payment could not be met because it would cripple payroll.

An October 27 internal memo from CEO Jen MacLean to Schilling, Zaccagnino, CFO Rick Wester, and COO Bill Thomas said, “After running payroll, we have less than $500K in our Maynard accounts. We simply can’t pay Mike before the bonds close, no matter how much he might wish otherwise.”

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6.

The Deal Was Done Before Anyone Could Imagine

How deep were top EDC staff in on the deal to fund 38 Studios?

In an April 12 (2010) memo from RIEDC’s Michael Saul to Mike Corso and RIEDC’s attorney Rob Stolzman, he proposes “Determine whether any local institutions (RISD endowment, RI Foundation, Hasbro, Brown endowment, State Pension fund, etc) would commit to purchase a share of bond issue.”  This is just one of ten “to do’s.”

EDC’s top staff were strategizing on how to sell the bonds, months before the bill ever hit the House floor for consideration. 

This April 12 strategy session was supposedly just a little over a month after Governor Don Carcieri and Curt Schilling met and two months before the loan guarantee program is signed into law.  

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7.

Did Rhode Island Pay for Improvements at Corso's Bar

In one email in May 2011, Mike Corso alerted top 38 Studio officials of over $600,000 in change orders to the build out of the Empire Street 38 Studios’ offices.

The change orders Corso pushed for increased the cost of contractor Nappa Constructions’ project cost from $10.9 million to $11.6 million. As GoLocal reported in 2014:

A former subcontractor for 38 Studios is alleging that his firm was ordered to work on former Speaker of the House Gordon Fox's business colleague Michael Corso's bar as part of their contract - and has produced what he says is documentation to prove it.

Project manager Michael Rossi with SyNet, Inc. has revealed a budget for work which he says shows at $25,000 line item for work to be done at Corso's Tazza Cafe in 2011 -- under a job order for the failed 38 Studios.

Warwick-based SyNet bills itself as "the premier design-build low voltage contractor of structured cabling, access control, surveillance and audio visual systems in the Northeast."

"I'm changing everything on job -- these were all no bids. Nappa construction picked Rossi Electric. I realize the job can't be done the way it's designed," said Rossi. "The money was getting kicked back in the form of goods and services to Corso and Fox. I said I'm not doing this. I knew I was getting set up for jail with this. I went out on sick leave, I was done."

 

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