Discretion, aggression and the benefit of hindsight

The row that has broken out between the State of Connecticut and Forstmann Little calls into question one of the most fundamental aspects to the relationship between LP and GP: who's managing?

As reported elsewhere in this issue (see Buyside, page 5), the State of Connecticut has decided to come out fighting in its dispute with Forstmann Little & Co., the fourth largest buyout firm in the US. Using language and methods that suggests a careful eye is being kept on the media, Connecticut's Attorney General Richard Blumenthal, who filed the suit against Forstmann Little in the state's Superior Court, said in a conference call to journalists that: ?[Forstmann Little] double-crossed us, pretending to be our partners and selling us out? We want to make them the poster child for shareholder fair dealing in the investment community.? The entire call is now available as an audio file on Bloomberg.

Ouch. Whether this be a calculated attempt to force the buyout firm to buy this investor's silence or not, many general partners will have winced at this kind of attack. Few need reminding that limited partners seem to be more restive recently as they too recover from the party that was the dot com boom. Starved of distributions and caught in an asset allocation bind courtesy of the collapse in value of their public market holdings, LP activism now seems a far more real concept. But is Connecticut just a particularly vivid instance of a general trend or is this spat far more specific, namely a fair and square case of an injured LP seeking recompense from a renegade GP?

Denise Nappier, Connecticut's State Treasurer alleges in the conference call that ?these were funds that were mismanaged or lost as they [Forstmann Little] violated their fiduciary responsibility.? When anyone starts using language like this lawyers' ears prick up. Commenting on the likelihood of such a claim being successful, legal specialists say the Connecticut has a long way to go before Forstmann Little can be proved to have breached its fiduciary responsibility. As one noted specialist commented: ?When you invest in a private equity fund you are granting the general partners [of that fund] the discretionary power to make investments: in some respects this is the essence of the investment proposition. You have bought into this team and unless they subsequently commit some criminal act you're on pretty thin ice when you then start shouting the odds.?

arm tactics it has elected to use and for trying to pin blame on Forstmann for anything other than making what with hindsight may seem as unsuccessful investment decisions. The claimants are especially irked at what they took to be the buyout firm's cavalier follow-on investments in what it judges to be doomed companies. ?But don't forget Teddy Forstmann (the eponymous founder of Forstmann Little) specialises in pulling companies back from the brink – look at the job he did on Gulfstream – so I think it's premature to be jumping up and down now,? says one US buyout specialist.

And isn't this part of what Connecticut was buying into? In committing to the firm's sixth and seventh funds – ?doesn't that successive investment suggest that this was an investor keen to have more, not less of the action?? commented one GP we talked to – Connecticut was accepting the fundamental pact between LP and GP that the latter takes the decisions, makes the investment and then delivers the return – or not. Nappier and Blumenthal seem therefore to be wanting now to apply some provisos of their own making to this pact.

Although Nappier has declared that she can accept that funds can deliver losses as well as gains, her allegation is that Forstmann Little reneged on an undertaking to invest in companies with market-dominant positions in industries with high barriers to entry. No sectors were specified as offlimits, but in the claimants' estimation this should have excluded the crowded telecom sector where the firm sank several billion dollars in XO Communications and McLeodUSA. The benefit of hindsight is a powerful thing, but we'd suggest that this investment story is far from over.

Nicholas Lockley returns next month.