You might say Louisiana’s film incentive program was born under a bad sign.
The state official who ran the film office in its early days, Mark Smith, and the lawyer who brokered most of the film deals back then, Malcolm Petal, both wound up in prison after they were caught in a bribery scheme.
Smith was in charge of interpreting the rules for the nascent program, and Petal wanted liberal interpretations. So he paid off Smith, who in turn signed off on Petal’s inflated expense reports, creating industry-friendly case law along the way.
“Those were the Wild West days. That really was Hollywood accounting meets Louisiana largesse,” said Robert Travis Scott, now president of the Public Affairs Research Council and formerly a Times-Picayune reporter who covered Smith’s and Petal’s travails. “It was just perfect.”
The embarrassing Smith scandal brought reforms, but it hardly ended the program’s corruption. Louisiana’s Inspector General Stephen Street, who investigates wrongdoing in state government, said the film program has “kept us very busy in recent years,” and he doesn’t expect that to change.
Since Smith’s 2007 indictment, at least eight other people have been charged with crimes related to the film incentive program. They include Wayne Read, who was sentenced to four years in prison for selling bogus tax credits to several members of the Saints, among others, and Michael Arata, a prominent attorney married to one of New Orleans Mayor Mitch Landrieu’s top aides, whose trial is set for January. More indictments appear to be in the works.
Why so many? Street isn’t sure. But one obvious reason is that the program is so generous, there’s a huge temptation to game it. Since the state pays for 30 percent of a film’s “Louisiana spend,” filmmakers have an incentive both to overstate their spending and to say it all happened in Louisiana.
The barriers to such chicanery are hardly impregnable.
“If a person is determined to steal from these programs, the way that it’s set up right now, it’s not that hard to do — if they get an auditor that is either willing to be part of the scheme or one that’s willing to sort of stick their head in the sand and just take what they’re provided without questioning the validity of it,” Street said.
To be sure, the film program has been shored up since its early days.
Back then, no audits were required; filmmakers simply turned in paperwork saying what they spent and credits were issued. Now, a certified public accountant must audit every film, and two state bureaucrats pore over the CPA’s reports before approving any credits, often kicking them back with a lengthy list of queries. In some cases, when the answers are unsatisfactory, they’ll order a deeper “forensic audit.”
Often, second audits are commissioned in cases where filmmakers acknowledge some spending involves “related party transactions” — that is, payments between firms that have shared ownership.
A number of the fraud cases have centered on allegations that such transactions were abused in order to generate credits. The pending case against Arata and his business partner, Peter Hoffman, for instance, charges that the two shuffled checks among a daisy chain of companies they owned while building a studio on Esplanade Avenue, racking up more tax credits with each payment.
State bureaucrats, while wary of “related party transactions,” hasten to say that most of them are not contrived. For instance, a studio might own a subsidiary that handles a certain type of work — lighting or prop rentals, say. It’s perfectly legitimate for the company to hire its sister firm, provided the rates it pays for the equipment are not inflated to gin up extra credits. The state requires proof that comparable rates have been charged elsewhere.
But other related-party transactions raise deeper questions. It’s not uncommon, for instance, for an actor or producer to invest in a movie, and then be paid a large salary by the production. The salary, of course, is an expense that qualifies for a 30 percent credit; the effect is that state taxpayers are offsetting the actor’s investment risk.
A recent example involved the 2014 film “Wild Card,” starring Jason Statham. Statham was a major investor in the film, but also was being paid $5 million as an actor. Typically, when actors help bankroll projects, they settle for lower fees, betting that they’ll make some money on the back end through box-office receipts.
Stephen Moret, head of the state’s Department of Economic Development, which administers the film program, says that because such transactions have “been abused a good bit,” the state is taking steps to rein them in. While the accountants who review film tax-credit applications are supposed to scrutinize those payments, the problems aren’t always flagged.
In the Arata-Hoffman case, the credits were approved after two auditors had signed off. And in some other cases, auditors aren’t aware of relationships that might exist between some of the parties.
In yet another case that is still being investigated by federal authorities, two men who knew each other are accused of cooking up a scheme to inflate the cost of building a film set for “Sports Trivia Clash” in order to game the system for extra tax credits.
An FBI search warrant application filed earlier this year alleges that Baton Rouge film producer George Kostuch persuaded contractor Zach Gyler to bill the production $89,000 for the set, even though it cost only $7,000 to build. That resulted in the state approving $26,700 in credits for the set alone, far more than its actual cost. All told, the production got nearly $200,000 in unearned credits, the feds allege. Neither man has been charged to date.
Such cases may point to another soft spot in the regulation of the film program: the ability of auditors to spot such shenanigans. In the Kostuch case, as with the Arata case, auditors found no problems with the transactions later deemed problematic.
The auditor in the case involving Kostuch, Clint Mock, said he did everything that could be reasonably expected of an auditor, even looking at photos of the set before signing off on the production report for “Sports Trivia Clash.”
“There’s nothing that a standard audit can do to discover this,” Mock said. “The intent is to deceive, and that’s what’s causing the trouble. This is about as creative as it gets,” calling the web of transactions a “very complex collusion scheme.”
A June report by the consultant Alvarez & Marsal, which was hired by the Jindal administration to find ways to wring savings from the state budget, noted that most of the film audits are being done by “three to four” firms. While not singling out any particular firm’s work, the consultant said audit reports are of “mixed quality” and sometimes “substandard.”
A dearth of auditors
The state does not track in any systematic way which firms do the bulk of the audits. But a review of 50 film files by The Advocate found that Mock’s firm, Mock and Associates, a Baton Rouge-based specialty outfit with three accountants that does only film- and entertainment-related work, handled the audits for more than half. A second firm, Malcolm M. Dienes LLC, of Metairie, did about 20 percent and the rest were handled by a handful of other accountants.
The Dienes firm handled one of two audits for the infrastructure project that led to the indictment of Arata and Hoffman. The firm later withdrew its audit.
Another potential weakness in the audit system noted by Alvarez & Marsal is that the auditors are hired by the filmmakers, who then include the cost of the audit as part of their expenses eligible for credit.
In some cases, state officials have found that the auditors were too cozy with their clients, in part because they sometimes advise filmmakers on the front end, telling them what expense will be approved, and then handle auditing duties. In one instance, state regulators last year rejected an audit by Mock on “Dallas Buyers Club,” deciding it had the appearance of a conflict because he had served in such an advisory role.
The Alvarez & Marsal report recommended that the state, not the filmmaker, should engage auditors in the future, so that it’s clear that the real client of the auditor is the state of Louisiana.
The recent rule revisions proposed by the Jindal administration do not make that change, but they do exclude the cost of the audit from the expenses that should qualify for a state subsidy.
Mock said in an interview that such steps are unnecessary, and that CPAs have a responsibility to the truth rather than to the people who hire them. “An auditor has to have professional skepticism,” he said. “We view ourselves as the guard dogs for Louisiana taxpayers.”
Too strict, or not strict enough?
The auditing process has become a source of some tension in the industry as the state, stung by fraud, has sought to take a more skeptical look at filmmakers’ tax-credit applications.
“They’re taking time to make sure every taxpayer dollar going out the door is legitimate and there’s no funny business going on,” said Daniel Lewis, chief operating officer of Active Entertainment, an independent film production company that has made 25 films in the state since 2007. “As a Louisiana taxpayer, that doesn’t really bother me.”
But some producers complain vocally of delays in getting their money from the state.
And the state’s decision to reject Mock’s audit of “Dallas Buyers Club” last year — a sign of a tighter regime at the state level — brought vocal protests from Will French, president of the Louisiana Film Entertainment Association and a tax-credit broker.
Earlier this year, French ripped into Stephen Hamner, director of the state’s film office, which gives final approval to tax credits, again for being too persnickety. In particular, French was irked by the state’s demands for additional documentation of Statham’s fees for “Wild Card.”
In an email to Hamner’s boss, Chris Stelly, he accused the office of “acting like a bull in a china shop,” adding: “Please rein in Stephen Hamner.”
Stelly responded that he didn’t understand the production’s refusal to turn over the requested tax forms, adding that he was just trying to guard against any bookkeeping trickery.
“Given the amount of potentially fraudulent activity within RPTs (related-party transactions), why would you disagree with our wanting to validate without a doubt the substance of any transaction?” Stelly wrote back. “This isn’t a bad decision or even bad policy, just trying to protect the taxpayers’ investment and ensure this program isn’t abused.
“When a production outright refuses, you can imagine the concern that raises.”
The documentation regarding Statham was eventually turned over, and state officals are still reviewing it.
French said in an interview that he understands the need to protect taxpayer money. But he says many in the industry simply don’t trust the bureaucrats they deal with. Too often, they feel as though Jindal’s Economic Development team is trying to squeeze them rather than nurture them.
“I’m worried about the Department of Economic Development,” French said. “I don’t think that they understand this industry. I don’t think they understand their own numbers. I don’t trust that what they say they will do, they will do, and that what they say they won’t do, they won’t do. It’s just the history of how they’ve operated.
“If there’s anybody that could screw this up, it’s them.”