38 Studios: Should the SEC Investigate?

Monday, June 02, 2014


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Questions of insider trading are among the latest to be raised in the ongoing look into the failed 38 Studios deal in Rhode Island. 

Michael Riley, founder of Coastal Management LLC and GoLocal MINDSETTER, posted on his blog "RI Shrugged" on May 28 that after combing through two years of limited trade data, he found a "very suspicious trade" in 38 Studios bonds on May 23, 2012 -- one day before 38 Studios announced it was laying off all its employees. 

"On May 23, 2012, a trade of $1,000,000 (face value) took place at a price of $121.75, representing a huge profit to the insider who sold. Not only was he collecting $77,500 a year in interest on his $1 million invested in just 18 months he had made an additional $210,000 in the market repricing the suspicious initial pricing of the insured bonds. The investor made approximately 25% annualized. Nice trade right?  Or was this actually an insider getting out because he got more inside info?" wrote Riley

Riley continued, "Just who was this inside privately placed investor who had such immaculate timing? I think the SEC should find out. I am surprised no investigative body in Rhode Island found this."

Former SEC lawyer and Forbes contributor Edward Siedle said he believed this could be something the SEC already had on its radar. 

"I think the SEC has been asked to get involved in [38 Studios] time and again," saide Siedle.  "I know that Representative MacBeth has called on them to get involved, it's certainly been in the media.  It's certainly something that the SEC is aware of, and [Riley's] revelation is just another reason for them to look into it."

Looking Deeper

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Riley explained how he came to find the trade in question.

"It wasn’t easy to find information on these bonds. They are not listed on any exchange, they were privately placed to accredited investors only," said Riley. "My goal was to find pricing info and see the effect that ratings changes and/or significant news like the bankruptcy filing had on the pricing of the bonds."

Riley continued, "What I found was very infrequent trading and the trade in question May 23, 2012 stuck out like a sore thumb. Given my direct experience in investigating insider trading and having been a victim before, it immediately struck me as suspicious. Overlay on top of that that the owners in the first place were likely very connected and this seems like an obvious trade for the SEC to investigate."

On "RI Shrugged," Riley wrote that the trade was a "heck of a coincidence."

"May 23 sold bonds, May 24 layoffs, May 26 bonds drop 9% in one day. The next trade reported in those bonds took place at $111.39 on May 26 2012.  The yield popped from 4.67% to 5.82% literally overnight. "

Siedle, a former SEC lawyer, commented on what he viewed as oversigh - or lack thereof -  in the municipal market.

"There's very little monitoring of insider trading in municipal market," said Siedle.  "But there are very few deals that have failed as spectacularly at 38 Studios."

"The municpal market has always been a backwater.  It's where political pay-to-play and relationships have been a significant factor," said Siedle. "After all, it's politicians who make these decisions, who picked SJ Advisors to investigate, and First Southwest to continue to be the state's financial advisor."

Looking Ahead

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"As most people know illegal insider trading is a felony and can result in disgorgement and prison. The investigation into the trade is where people get into trouble. Martha Stewart avoided a loss of $50,000 or so and served time in prison. Both the tippee and the person who acted are in trouble," said Riley.  "Far too many get away with illegal insider trading because its hidden in the data. This trade was not hidden and it would be easy to investigate if any RI government official asks [the SEC] to look into it. I have watched this whole debacle for 3 years, and I don’t trust anyone so I reported this trade as a resident of Rhode Island in this case."

"My guess is that both scandal include a wide circle of illegal behavior and unethical behavior. But this trade is an easy SEC investigation and any RI with an ounce of integrity would publicly ask for the SEC to look into the trade and the unusual timing," said Riley.

Siedle, who last fall conducted an investigation into the state's pension system, questioned what more it would take in Rhode Island for a "real investigation."

"My feeling on this latest discovery is how many more reasons is it going to take before the people of Rhode Island demand a real investigation into what going on," said Siedle. "Everyone who says pay the bonds are those who were in office then -- the only people who are questioning it weren't."

"I've said that between being told to accept secrecy about the pension investments, and now to pay bonds without question, Rhode Islanders are being told to hand over their car keys and their houses to Wall Street," said Siedle.  "As for this "moral obligation," there's a moral obligation for Rhode Islanders to fight against illegitimate bogus charges. Nobody gains by succumbing to pressure and paying bills that aren't legitimate."


Related Slideshow: 38 Studios Legal Fees

New state records show that state legal fees associated with the 38 Studios bankruptcy are nearing $1 million. Below is a breakdown of how much each firm has made - and stands to make in the future. Figures are taken from documents provided by the Rhode Island Commerce Corporation. 

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Cohen & Gresser, New York, NY

Billing rates:

Partners: $650-$750/hour
Counsel: $550-$650/hour
Associates: $300-$595/hour
Paralegal: $100-$225/hour

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Cohen & Gresser's Fees:

Total Fees (2013): $102,615.20

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Shechtman Halperin Savage, Providence, RI

Billing rates:

Attorneys: $250/hour
Paralegals: $100/hour
Legal Assistants: $50/hour

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Shechtman Halperin Savage's Fees

2012: $407,899.60
2013: $156,348.37
2014: $19,799.00

Total Fees: $584,046.97

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Wistow & Barylick, Providence, RI

Billing rates: 

Attorneys: $175/hour, $225/hour & $250/hour

Contingency Fee: The RI Commerce Corporation agreed to pay Wistow & Barylick 16 2/3% of the gross of any amount recovered from a lawsuit, compromise, settlement or otherwise. This is not stipulated with the other law firms. 

Note: Wistow & Barylick will only be paid at these rates if the state terminates its contract with the firm. 

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Wistow & Barylick's Fees:

2012: $18.121.05
2013: $90,630.15
2014: $48,054.17

Total Fees: $156,805.37

Note: The above amounts paid to Wistow & Barylick cover the cost of out-of-pocket expenses such as filing fees, costs of depositions, obtaining records, charges for computer-assisted legal research, costs of expert consultants, and the costs of witnesses.   


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