Sum of All Fears

Transparency in money handling is key in a post-Axium payroll environment

A year before Wall Street was slammed by Bernard Madoff, Hollywood had Axium.

It was not on the same scale as Madoff's pyramid scheme, but the collapse of the third-largest payroll service, which handled about $3 billion in transactions per year, was just as shocking for many in the entertainment industry. Some 100 of Axium's clients, including major studios, networks and independent movie and TV productions, saw millions in advance payments meant to cover salaries, taxes and workers' compensation suddenly evaporate, forcing them to scramble to cover their losses.

A year later, Axium is in Chapter 7 bankruptcy and the subject of numerous lawsuits. Court-appointed trustee Howard Ehrenberg is sorting through allegations that Axium was systematically looted over a period of years by its former chairman and CEO John Visconti and COO Ronald Garber and says he will soon file additional civil suits seeking to recover some of the millions that were lost.

However, even as the lawyers sift through the remains, the show must go on. Axium clients who were still solvent quickly found other payroll services, mostly long-established providers. A few, including the Yari Film Group's distribution division, which was out $6 million, were forced to go bankrupt, primarily because of the losses to Axium.

As a result, a cloud continues to linger over the entire payroll business a year after Axium's January 2008 bankruptcy filing.

"A lot of people are still nervous. They think if it could happen to Axium, it could happen to anyone," says Ed Spiegel, president and CEO of Cast & Crew, the second largest showbiz payroll service after Entertainment Partners. "Well, we know better than that. Axium was different than us, or Entertainment Partners, who have both been in the business over 30 years."

"The Axium closure was a terribly unfortunate, unique consequence of one particular company's policies and practices rather than of any conditions inherent to the business structure of the entertainment industry payroll companies," says Markham Goldstein, EP's president and CEO. "There has never been a single instance in our 30-plus-year history of an Entertainment Partners production worker employee not being paid for work performed."

In the first hours and days after Axium suddenly closed, there was a mad scramble to move the payroll functions to Cast & Crew, EP and others. Spiegel says they made special accommodations to take over those accounts so that no paychecks or tax payments were missed, which would have been a violation of union and guild rules, and the law.

"They would talk to us and say, 'Here's what I'm afraid of. What can we do?' " recalls Spiegel of the mad scramble after Axium folded. "We tried to work something out with each of them to satisfy those concerns."

A high level of transparency was needed not only because of what happened with Axium, but because payroll services are not regulated in any way. Anyone can rent an office and claim to be a payroll service.

That makes it a tempting business for scammers because the sums of cash being passed through the system can be enormous. "The payroll companies handle large dollars but make a very small profit margin on those dollars," says Ehrenberg.

Ehrenberg has spent the past year investigating not just the principals of the firm, but also why auditors failed to do their job. "Somebody missed the fact $100 million of payroll taxes hadn't been paid," Ehrenberg says.

Shortly before Axium collapsed, in an effort to forestall criminal indictments, the company's top managers paid the Internal Revenue Service about $31 million in liens for taxes owed. That put into default a $140 million loan by Axium's main lender, GoldenTree Asset Management, which then seized the last $22 million held by the company. Since all of the money -- from payroll advances to internal company funds -- was in one account, no cash remained to pay employees or taxes.

Ehrenberg's first move was to sell off whatever assets Axium did have. For $7.05 million, EP acquired Axium's proprietary software and servers, but it took on none of its liabilities.

Goldstein says EP did not actually use the Axium software but did incorporate some aspects into its own systems. The acquisition also allowed EP to take over servicing Axium clients without requiring them to change software on current productions, although some did so voluntarily. EP also hired about 40 former Axium employees to provide the expertise to use the software and ensure a quick and fairly smooth transition.

How can productions protect themselves from another Axium-style disaster? "You have to make sure your funds are held in some kind of a trust account," says Ehrenberg. "The problem (at Axium) is that all these production company monies were essentially deposited into a single concentration account. All the money was commingled and therefore lost its identity. Had the monies been held in a trust account, then that would be a very different story."

That sounds like a tidy solution but is not practical, say the payroll providers. "In this business, it is very difficult to actually put all these funds aside and only pay out of trust funds," says Spiegel, "because money has got to be paid out immediately. Taxes are all due the next day. You can't meet the timetable if all this money is in a trust account."

Producers would like to see all payments made before they pay anything, says Spiegel, but that isn't practical either. "You can't operate that way because we are the employer of record, and we have to pay that payroll whether we get paid by the production company or not."

In practice, that means the payroll companies often demand large sums be put in an escrow account to ensure all payments are made by small companies, independents and corporations formed just for one production.

Payroll services didn't become a major issue until the late 1970s, when more independent movie productions emerged. In the 1980s, studios and networks began using them for productions done off the lot or in another state or country. As the studios did more negative pickups, they sought to insulate themselves and outsource the payroll functions. That led more productions to turn to payroll companies as the employer of record.

Marcia Jacobson, founder of the Jacobson Group in Los Angeles, a boutique firm which provides about $100 million in payrolls annually, as well as production accounting and other services, says she has to be equally careful about whom she takes on as clients, especially post-Axium. "The money has to be upfront and they have to be good and clear funds," says Jacobson. "I can't have that trust level anymore with new business because I don't know who they are if I haven't worked with them before."

Jacobson specializes in servicing award shows like the Emmys and Grammys as well as sporting events and some reality shows such as ABC's "Supernanny."

While Jacobson agrees separate trust accounts would be impractical, she says she does track each client's funds in separate internal accounts. "We account for every penny," says Jacobson. "Somebody can come in here at any time and ask to see where they stand, and I would have no problem with that."

Both Spiegel and Goldstein say they also track each client's funds. They suggest that newcomers investigate a payroll company before they do business just as they get references on a new employee. They recommend looking for a high level of transparency in all the transactions, regular financial reporting, and checking into the business history for the company and its key managers.

"Bank of America has been Cast & Crew's banking partner since 1991 when it acquired our previous bank, with whom we had been doing business since the company's inception," says Spiegel. "Our insurance relationship with Aon, or its predecessors, has been for over 16 years. And Zurich has been our workers' compensation carrier for seven years. These relationships have continued so long because the carriers have complete confidence in our honesty and judgment."

In other words, know whom to trust. "We can't communicate more strongly that the specific situation of one company that occurred because of internal operations is not in any way an industry situation and that other companies are very healthy, and again, isolated incidents in the past are in the past," says Goldstein. "I'm confident my competitors -- whether big or small -- do not uphold to the practices of Axium."