Connecticut sues Forstmann over loss of $95 mln
February 25, 2002 6:04:00 PM ET
By Dane Hamilton
NEW YORK, Feb 25 (Reuters) - The normally private world of private equity opened into a rare public spat after the State of Connecticut filed suit on Monday against old-line buyout firm Forstmann Little & Co. over a failed $95 million investment.
The suit, filed in the Connecticut Superior Court, alleges that New York-based Forstmann misrepresented how it invested $95 million in pension fund money and subsequently lost it all in XO Communications (XOXO), a faltering telecoms company. It demanded a return of the money and other costs.
Forstmann, a firm founded in 1987 with some $12 billion under management, called the suit "totally without merit" and said it would "defend it vigorously."
The suit comes as pension fund managers are struggling with sharp declines in returns in their private equity portfolios, which can comprise up to 20 percent of their investment funds.
During the bull market in the late 1990s, pension funds piled into leveraged buyout (LBO) funds like Kohlberg Kravis Roberts & Co., Thomas H. Lee Co. and Forstmann, which typically aimed for at least a 30 percent return and sometimes made much more by buying undervalued companies and later selling them.
Now the market for selling companies is well down from the highs of a few years ago, and LBO shops are struggling to make these above-market returns.
That's put pressure on pension funds to justify their investments in risky "alternative assets" like venture capital, buyout funds and hedge funds. However, because pension funds are severely restricted in saying how buyout firms should invest money, some experts said it unlikely it would prevail in its suit, unless it can prove Forstmann made material misrepresentations about its investment plans.
"Unless they can substantiate some kind of misrepresentation, there's little likelihood they will get the money back," said David Stein, principal with Fund Evaluation Group, which advises pension funds on private equity investments. "These offering memos are written so broadly that buyout firms can pretty much invest how they want."
In the suit, Connecticut said Forstmann last year invested $95 million of Connecticut funds in XO Communications as part of a total commitment of $200 million. Then in November 2001, Forstmann completely wrote down the XO investment as part of a prearranged financial restructuring, losing the state's entire XO investment, the suit contends.
Forstmann "deliberately failed to inform the State of Connecticut about its plans to render the partnership investments in XO worthless," the suit alleges.
Forstmann refuted the claims, calling Connecticut "a sophisticated institutional investor which was fully informed about the nature and scope of these investments and didn't question them at the time."
It said it was "unfortunate that this fund has so far not performed as well as the firm's previous funds, but the investments were entirely proper." REUTERS
© 2002 Reuters
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