Can someone explain what's so illegal?

They sold 25000% of the play to investors, in order to finance a musical they were confident would make a small loss (being a cheap musical). They would then pocket the money from the investors, minus the loss. Because the IRS wouldn't take any interest in a play that made a loss, they would never have to cover their tracks. They would use the investors' money to finance a luxurious retirement in Rio.

Illegal? Maybe not according to Judge Alito. However, it is clearly more than entrepreneurial.

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--It can be illegal

Oh, its illegal, all right.

-- but isn't that what hollywood producers do today

I assume that, the movie having been around nearly 40 years, the IRS or SEC or whoever would even bother to look into a huge flop.

-- look at King Kong 207 million to make it he probably has investors lined up to me because it won't fail

Well, but in the case of King Kong, the various investors were only promised a total of 100% of the profits, so you can pay them all.

"The Producers" were amatuers. If you want to see real money wrangling, check out the excellent articles over on Slate:
http://www.slate.com/id/2117309/

Here's how it works: Germany allows investors in German-owned film ventures to take an immediate tax deduction on their film investments, even if the film they're investing in has not yet gone into production. If a German wants to defer a tax bill to a more convenient time, a good way to do it is by investing in a future movie. The beauty of the German laws as far as Hollywood is concerned is that, unlike the tax laws in other countries, they don't require that films be shot locally or employ local personnel. German law simply requires that the film be produced by a German company that owns its copyright and shares in its future profits. This requisite presents no obstacle for studio lawyers.

The Hollywood studio starts by arranging on paper to sell the film's copyright to a German company. Then, they immediately lease the movie back—with an option to repurchase it later. At this point, a German company appears to own the movie. The Germans then sign a "production service agreement" and a "distribution service agreement" with the studio that limits their responsibility to token—and temporary—ownership.

For the privilege of fake ownership, the Germans pay the studio about 10 percent more than they'll eventually get back in lease and option payments. For the studio, that extra 10 percent is instant profit. It is truly, as one Paramount executive told me, "money for nothing."

It is not illegal to take a risk by investing alot in a project that might fail. Someone may want to take that risk, but that is because there is the possibility of a big payoff if the project is a success. The trick in The Producers is that they schemed to make a flop and got hundreds of people to make a relatively small investment but, since they own a large share of the profits, with the promise of a big gain if the play is a success. It was fraud because they lied to the investors about the nature of the investment. They could only lose their money, but there was no chance of success. They sold high percentages to hundreds of people, so in fact, they told those people they were buying 50 % or 100 % of the profits, when in fact they were buying only 1/10th of 1 % or something tiny like that.

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But also there can never be enough money to pay off the backers. Put simply if a play cost $6000 to produce but they raised $12000 by selling 100% to 2 people then they would have $6000 left. If the play doubled it's money then both backers would demand $12000, meaning they would owe $24000 but only have $18000. With the amount they raised for Springtime for Hitler, they would have ended up owing Billions.

Believe me, Mel Brooks nor Ayn Rand were the first to think of this scheme.

Actually it is not, and here is why:

Max and Leo appealed their convictions and the case went all the way to the United States Supreme Court. In "Bialystock, Bloom and Springtime for Hitler, Ltd vs. The State of New York" - Justice Scalia writing for the majority opinion said:

"the investors are capitalists and the free market should be able to dictate the consequences, not the State - otherwise we are just Russia. Whether the play is a hit or not is immaterial - they risked their money and lost. That is the American way. Just because they are old ladies is too bad - they have lived off their husbands and the government (social security, medicare) for too long! They got value for their money - to be part of a hit Broadway play and 2 hit movies! The appellants have every right to benefit from the investors since they took all the risk and should be rewarded!"

Therefore, in a 5 to 4 ruling the Supreme's released Bloom and Bialystock from Attica Prison and they went to work for Mitt Romeny's Super PAC.