Dick Blumenthal’s Private Equity History

Today’s news cycle is all about Richard Blumenthal, the Connecticut senatorial candidate called out for falsely claiming to have “served in Vietnam” (common mistake — I used to think I stormed the beach at Normandy).

This über-gaffe obviously has nothing to do with private equity, but it’s worth taking a moment to remember that Blumenthal is the same guy who once sued one of the world’s biggest buyout firms for breach of fiduciary duty:

Blumenthal was first elected Connecticut’s Attorney General in 1990, and had his first private equity encounter later that decade when the state pension system became emroiled in a massive pay-to-play scandal. Federal prosecutors were responsible for sending then-Treasurer Paul Silvester to prison, but Blumenthal was instrumental in helping to recover certain monies and was widely lauded for efforts to stem government corruption.

But it was in February 2002 that Blumenthal really caught the private equity industry’s attention. That was when he sued Forstmann Little & Co. for breach of fiduciary duty, breach of contract and securities law violations.

“We want more than the $100 million-plus they wasted and wiped out,” Blumenthal said at the time. “We want to make Forstmann the poster child for fair-dealing in the investment community.”

At issue was Forstmann’s attempts to save telecom services provider McLeodUSA Inc., into which it originally invested $1 billion worth of convertible preferred stock for a 12% ownership position. McLeodUSA common shares were trading at around $30 per share at the time, but soon began to drop as the telecom market cooled. Rather than cutting bait, Forstmann kept making new bets. It first suspended coupon payments and pumped an additional $100 million into the company. Then, when McLeodUSA finally filed for bankruptcy, Forstmann invested an additional $175 million for a majority stake. 

Forstmann’s original investments came out of a fund in which Connecticut was a limited partner. The final deal, however, came out of a susequent fund in which Connecticut had not invested. As such, the state’s McLeodUSA investment was wiped out for the benefit of investors in an alternate Forstmann Little fund. making matters even worse, Forstmann Little eschewed aggregated returns, instead paying carried interest on a deal-by-deal basis. In other words, while GPs and LPs were paid proportional carry on successful investments, LPs takes more proportional loss on bad investments than does the GP.

The case went to trial in 2004, with a judge almost immediately throwing out the charges of bad faith, unfair dealing and violating security law. But breach of contract and fiduciary contract stood, with Teddy Forstmann himself taking the stand to be cross-examined by Blumenthal.

Most pundits (ahem, yours truly) assumed the case would get settled out of court, but it ended up in a jury room. Forstmann Little was found guilty of having breached both its contract (two counts) and its fiduciary duty (one count). The jurors also said that the firm had acted “with gross negligence, in bad faith or with willful misconduct.”

What the jury did not say, however, was if Connecticut was eligible for any compensation. Instead, it left the damages boxes blank on the verdict card.

At that point, both sides headed to a conference room. Forstmann Little agreed to repay $16.2 million, in exchange for Blumenthal promising to drop all future prosecutions.

Forstmann Little was jubilent, issuing a bizarre statement in which it claimed “complete victory.” Blumenthal also was boastful — noting how his office had spent just $3m to prosecute, while Forstmann Little had spent over $14m — although he obviously fell well short of his $100 million aims.

Blumenthal seemed not only to win the PR battle, but also was the one whose star continued to rise. The AG kept racking up wins, while Forstmann Little began winding down operations. And it was that way until this morning. Somewhere, I’m sure Teddy Forstmann is smiling.