American International Group Inc. (NYSE: AIG) has reached a confidential out-of-court settlement with five former partners whom it had sued earlier this month for breach of contract, breach of fiduciary duty and computer fraud. Sources say that the deal allows the former partners continue building a new firm called Cartesian Capital Group, but requires that they amend fund offering documents and suspend fundraising until the end of April. It also ends any claims the former partners have to vested interest from past AIG funds that they helped manage.
“Cartesian Capital Group… [has] reached a universal settlement with American International Group regarding all outstanding contractual and statutory claims raised by both parties,” said Peter Yu, managing partner of Cartesian and former head of AIG Capital Partners. “We are pleased to have resolved all of the matters with AIG and look forward to continuing to grow Cartesian’s investment practice.”
The Cartesian fund originally targeted between $500 million and $750 million, and was expected to hold a first close north of $400 million at month’s end. It is unclear when a first close now will occur.
The AIG vs. Cartesian legal spat is rooted in AIG’s surprise decision to fire Yu and colleague Bill Jarosz last April-a move that resulted in multiple staff resignations and limited partner withdrawals from a closed fund.
Yu joined AIG nine years ago to help the insurance giant invest private equity into emerging markets like Latin American and Eastern Europe. The effort-called AIG Capital Partners-began with lots of small dedicated funds, but later evolved into a $1.04 billion umbrella fund-of-funds (GEM I) that included third-party investments.
Also evolving was Yu’s relationship within the AIG hierarchy. Rather than reporting up the usual chain of command, he befriended then-AIG chief Maurice “Hank” Greenberg and eventually became a direct report. In late 2004, Yu and Jarosz convinced Greenberg that it was in GEM’s best interest to become an independent entity via a management buyout (with AIG remaining a limited partner). Not only would this apply to the existing GEM fund, but also to a GEM II vehicle that was in the midst of being raised. The agreement, however, was informal.
Greenberg left AIG in early 2005 in the midst of various governmental investigations, and his successors believed that the management buyout was not in the best interest of AIG shareholders. According to the complaint, Yu and managing director Jarosz threatened to leave if the buyout did not occur.
AIG responded by terminating the pair in late April. After Yu and Jarosz were let go, they were led out of AIG headquarters without even being allowed to remove personal items from their desks.
“Given that they [Yu and Jarosz] had previously indicated they had no interest in remaining with AIG if the management buyout did not occur … we felt it was in the best interests of AIG and our investors to part ways with them swiftly,” said AIG spokeswoman Braden Bledsoe.
Bledsoe added that the terminations were “expressly without cause,” although she did not comment on why Yu and Jarosz were not given the 30-day termination notice required by their employment contracts.
Following the terminations, several members of AIG tendered their resignations, including Charles Mixon, investor relations pro; Kathleen Hegierski, client services manager; and Thomas Armstrong, senior advisor and a founding partner of Advent International.
Yu’s termination also triggered a super-key-man clause in GEM II, after which the fund lost about 90% of its limited partners. AIG pumped in a bit of extra funds from its own accounts, but saw the overall fund capitalization shrink from about $900 million to just $250 million ($100 million from outside LPs).
Several months after the terminations, Yu and Jarosz began to form Cartesian. AIG, however, believed that the pair had violated 12-month non-compete agreements. Moreover, it believed that Cartesian was improperly using GEM I performance information in its fund offering documents. Finally, AIG also discovered that Cartesian had access to several internal AIG emails written after Cartesian pros had either resigned or been fired. It filed suit for breach of contract, breach of fiduciary duty and computer fraud.
Cartesian responded by saying that the 12-month non-compete clause cited by AIG was inoperative, because subsequent language explicitly referred only to resignations or being terminated with cause. It also said that the initial terminations had been prompted by Yu and Jarosz’s willingness to discuss various matters with federal authorities, including a scheme in which former AIG Global Investment Corp. managing director David Pinkerton bribed officials in Azerbaijan (Pinkerton has been indicted, and is awaiting trial).
As for the alleged computer fraud, Cartesian dismissed any suggestion that it had tapped into AIG’s computer networks. Instead, it said that it had received the emails because of an “auto forward” rule that sent Thomas Armstrong’s AIG.com emails directly to a personal Mindspring account. In other words, AIG actually sent Cartesian the emails, because it never turned off Armstrong’s AIG.com account after his resignation.
A New York judge listed to arguments from both sides on Feb. 7, and expressed skepticism toward both the plaintiff and defendants. He then set a further hearing date for Feb 14.
After the second hearing, AIG filed forensic evidence alleging that Yu had downloaded thousands of AIG files from his laptop to an external drive following his termination. The two sides sat down soon after to work out a settlement, without Cartesian ever directly responding to the downloading allegations.
“Cartesian really didn’t have much choice,” said a source close familiar with the situation. “No matter who would have ultimately won, AIG had shown that it was willing to go to the mat in terms of both expense and time, which are two things Cartesian didn’t have much of. Even if they had won, there’s no way to raise a fund in the middle of ongoing litigation.” -D.P
ABRY Moves Forward With Providence Lawsuit
ABRY Partners can proceed with its lawsuit against Providence Equity Partners, after a Delaware judge last week denied Providence’s request to dismiss the complaint. The two sides now must either pick a trial date or settle, with the former looking far more likely than the latter.
The case involved alleged financial improprieties at specialty magazine publisher F&W Publications Inc., which ABRY bought from Providence last August for around $500 million. Shortly after taking control, ABRY claims to have discovered that F&W had been “channel stuffing through volume discounts,” which means that the company offered unusually high discounts to retailers in order to artificially inflate second-quarter revenue. Certain magazine publishers “channel-stuff” regularly, but ABRY alleges that it was out of the ordinary for F&W.
The suit also alleges that a promised distribution technology system was not ready as promised, that the U.K. book division secretly extended the June financial reporting deadline and that the magazine division engaged in “back-starting,” or sending back issues to new subscribers. In fact, ABRY even claims to have uncovered an employee who was keeping two sets of books, in case such shenanigans came to light.
ABRY explicitly claims that Providence was aware of the fraud, and is requesting that the entire deal be rescinded. What Providence knew and when it knew it will be the case’s key questions, according to the judge’s ruling. He emphasized that ABRY will have to prove that not only was such impropriety present, but that Providence was aware of the impropriety (i.e., its contractual representations were untrue).
“It is an experienced private equity firm that could have walked away without buying,” Vice Chancellor Leo Strine wrote. “It has no moral justification for escaping its own voluntarily-accepted limits on its remedies against the seller absent proof that the seller itself acted in a consciously improper manner.”