Home |  Elder Rights |  Health |  Pension Watch |  Rural Aging |  Armed Conflict |  Aging Watch at the UN  

Mission  |  Contact Us  |  Internships  |  Donate Now!  

In Connecticut, a Pension Fund Trial Could Shake Wall Street

By Andrew Ross Sorkin, The New York Times

May 27, 2004

Theodore J. Forstmann and his private equity firm go to court next week.
Away from the limelight of recent corporate trials, a six-member jury in a Connecticut hamlet will begin hearing a little-publicized case next week that could have far reaching implications for Wall Street buyout firms and the big-money investors and institutions that back them.

On Tuesday morning, the colorful financier Theodore J. Forstmann and his private equity firm, Forstmann Little & Company, will go on trial in Rockville, about 130 miles north of Manhattan, to face accusations from Connecticut's attorney general and state treasurer that the firm improperly invested $125 million of the state's pension fund money and subsequently lost it.

The civil case, one of the first in which a state pension fund has sued such a vaunted buyout shop, could, if the plaintiffs prevail, presage a wave of potentially crippling suits against Forstmann Little and other buyout firms that have lost investors' money. Indeed, state pension funds across the nation, which have invested $40 billion in private equity funds and are increasingly taking activist roles in their investments, could seek the return of billions of dollars in bad investments.

"If Connecticut wins, everybody else will start piling on," said Kenneth A. Lefkowitz, a chairman of the mergers and acquisitions practice group at the law firm of Hughes Hubbard & Reed in New York. "It would open up every one of these kind of funds."

Still, that may not be so easy. Every other investor in Forstmann Little's fund refused to join the suit, and legal experts suggest that the firm may be standing on firmer ground than Connecticut's outspoken attorney general, Richard Blumenthal, and its treasurer, Denise L. Nappier, who some have accused of being more interested in her political career than in the merits of the case. 
There has also been speculation about other political motivation: Mr. Blumenthal and Ms. Nappier, who are Democrats, named Mr. Forstmann, a major Republican fund-raiser, in their original suit but did not name Erskine B. Bowles, a former partner who oversaw many of the investments in question but who is a Democrat running for a Senate seat in North Carolina. He was later named in an amended complaint.

Mr. Blumenthal and Ms. Nappier have repeatedly denied any political motivation behind their suit.

The case turns in large part on Forstmann Little's decision to invest in stakes in two telecommunications companies, McLeodUSA Inc. and XO Communications, high-growth, high-risk companies that Connecticut contends did not conform to the conservative investment strategy that it had signed onto when it invested about $200 million with the firm in 1997. Forstmann Little lost about $2 billion of its investors' money on those two deals, writing down its $1.5 billion investment in XO to zero in 2002 before the company filed for bankruptcy, in what could be the largest single loss ever by such a firm.

Forstmann Little is still trying to salvage its investment in McLeodUSA.
When Mr. Blumenthal and Ms. Nappier filed their suit in 2002, they used their entire legal arsenal, accusing Forstmann Little of breach of fiduciary responsibilities, breach of contractual obligations and violations of securities law.

"This firm Enronized Connecticut, through its blatant abuse of trust," Mr. Blumenthal said in a statement at the time. "They double-crossed us, pretending to be our partner but really selling us out."

But in an early victory for Forstmann Little, the firm persuaded the judge in the case to throw out two securities law charges, removing the potentially most inflammatory accusations.

The trial is now at its core a contractual dispute, a "he said, she said" fight. Connecticut contends Forstmann Little was not allowed to invest its money in minority stakes in risky ventures. Forstmann Little says the contractual language allowed for a broad array of investments, including the kind being challenged. 
"This firm treated Connecticut like a patsy," Mr. Blumenthal said. "It solicited and took our money with promises that it would apply its time-tested, trustworthy investment strategy suitable for our pension funds. Instead, it squandered our funds on unsafe, speculative telecommunications investments that tanked - lousy companies in a losing industry."

But Forstmann Little says the partnership agreements that Connecticut signed allowed for such investments.

"Connecticut and dozens of other sophisticated limited partners signed contracts with Forstmann Little which clearly permit the investments in dispute," said George Sard, a spokesman for Forstmann Little. "Connecticut claims minority investments are not permitted, but the contracts say, over and over again, that such investments are specifically permitted. Connecticut was informed in over 20 written disclosures exactly the nature and details of these investments and also received dividends on multiple occasions." 

Forstmann Little also suggested that Connecticut complained only after it began losing money.

"Despite knowing everything it now complains about, Connecticut took the dividends and never raised any issues regarding the propriety of the investments until after the general turndown in the telecom sector," Mr. Sard said.

Connecticut has kept the profits generated from another investment Forstmann Little made, in Citadel Communications.

Legal experts say that it is going to be hard for Connecticut to prove that Forstmann Little breached its duty and made investment decisions outside of the parameters of its agreement because the contracts appear to give the firm wide latitude in its investments. 

"I find it incredible," said Mr. Lefkowitz, who is not involved in the case. "These pension funds know, if you want to play with the big boys, you have to understand there is risk."