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JUL
7
2 MOS

Investors Say They Have Evidence of Paramount Pictures Financing Fraud

Months before various hedge funds put up $40 million for 25 films including "Mean Girls" and "The Manchurian Candidate," Paramount execs allegedly announced a secret strategy shift at a Viacom board meeting.

Mean Girls in hallway - H 2012
Paramount Pictures
"Mean Girls"

In an effort to advance a lawsuit against Paramount Pictures that has survived for more than a half-decade, some Wall Street institutional investment groups are now pointing to evidence they believe shows the studio "procured financing for a slate of motion pictures by fraud."

The lawsuit from Allianz Risk Transfer, Marathon Structured Finance Fund, Newstar Financial and Munich Re Capital Markets concerns "Melrose 1," a slate of 25 films released between April 2004 and March 2006 that included Mean Girls, Elizabethtown, Collateral, and remakes of The Manchurian Candidate, The Stepford Wives and Alfie.

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The plaintiffs put up $40 million for these films and say they lost their entire investment. They place blame on Paramount's alleged decision to abandon its historical practice of preselling distribution rights for movies in foreign territories to independent film distributors. According to the plaintiffs' latest court papers, "Had Paramount adhered to its past foreign preselling practices, Plaintiffs and other investors would have suffered at least $100 million less in their aggregate losses in the Melrose Slate."

Although the investors say they lost $40 million on those 25 films, Paramount is alleged to have "earned over $400 million in revenues from 'distribution fees' deducted from the revenues shared with the Melrose investors. Indeed, in a forecast with respect to the anticipated Melrose Slate prepared months before the closing of the transaction, Paramount privately predicted a loss on the 2004 films of $32 million for the investors and a profit of $37 million for Paramount."

In April, Paramount brought a summary judgment motion asserting that responsibility for the investment documents — the private placement memorandum — fell to Merrill Lynch as underwriter for Melrose. The bank allegedly was the investors' primary contact and marketed the upsides and risks of the investment opportunity. Further, Paramount asked the judge to kill the lawsuit because the investors were expressly informed that Paramount would have discretion on whether or not to enter co-financing arrangements.

The plaintiffs in an opposition to summary judgment (read here) say that much of the materials given to them at the time were "tentative" and "incomplete." Far from disclaiming Paramount's discretion, the plaintiffs insist they were led down a certain path. "They did not in any way alert Plaintiffs to Paramount's concealed change of strategy and fraud," state court documents delivered right before the beginning of the holiday weekend. "To the contrary, the evidence shows Paramount trying to make investors believe that, regardless of those tentative documents, investors were to look at Paramount's 'historical' presales practices and 'project' the same kinds of practices for the Melrose Slate."

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The investor-plaintiffs say that while investment literature might have advertised certain distribution models used before 2004, "unbeknownst to Plaintiffs, prior to their investment, Paramount abandoned its risk averse business model and employed virtually no foreign presales in the Melrose Slate."

As evidence, the plaintiffs point to a 2003 deal made between Viacom and Lakeshore Entertainment (Underworld, Million Dollar Baby) that "radically altered its arrangement" of foreign presales by ensuring more self-distribution for Paramount. In March 2004, the plaintiffs say, "this important change in business strategy was reflected in a PowerPoint presentation that Paramount made to the Board of its parent company, Viacom, Inc., in or about March 2004, several months before Plaintiffs invested."

At the Viacom board meeting, Paramount's senior executives are described as announcing the intention to "retain more foreign rights." The investors say they weren't made aware of this new strategy — an alleged shift as Paramount was a "standout among the Major Studios in its desire to participate in the foreign presale market."

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In their papers intended to get the judge to move the dispute to trial, the investors also attempt to bolster the argument that a concealment occurred. The papers cite emails between Paramount, Merrill Lynch and Moody's Investors Service. Paramount allegedly supplied the investment bank with data to create its projections and used the credit agency to "propagate the fiction" that presales would be exploited as in the past.

The plaintiffs' papers also reflect their own analysis of the potential slate deals. The due diligence yielded positive evaluations of the risk involved. But according to the plaintiffs, "Nevertheless, unbeknownst to any of Plaintiffs, no amount of reasonable variation and stressing of the HDS data could have accurately projected the Melrose Slate risk of loss because Paramount had secretly and unpredictably decided to bring foreign presales levels from 24% (for the HDS) all the way down to 3.5% for the Melrose Slate, a reduction of over 80%."

As for responsibility being held by someone other than Paramount, the plaintiffs argue to the contrary: "Melrose is a construct. It has no information to give or conceal. Every bit of information ostensibly imparted by Melrose is Paramount's information. A jury could (and likely would) find that Paramount 'made' the statements and omissions at issue."

Viacom declined comment.

Email: Eriq.Gardner@THR.com
Twitter: @eriqgardner