Connecticut vs. Forstmann Little: The End –

Forstmann Little & Co. and the State of Connecticut reached an out-of-court settlement last month, ending more than two years of legal squabbling. The agreement requires the individual partners at Forstmann Little to pay Connecticut $15 million, plus to return an additional $1.2 million that the buyout firm had withheld from the state to cover legal expenses.

Both sides, of course, claimed victory.

Connecticut originally sued Forstmann Little in February 2002, alleging that the New York-based firm had mismanaged much of the $198 million that Connecticut had invested in a pair of Forstmann Little funds during the 1990s. Among the specific charges were breaches of contract, breaches of fiduciary responsibility, securities law violations, bad faith and unfair dealing.

The state did not specify a dollar amount in its complaint, but Connecticut Attorney General Richard Blumenthal told reporters: “We want more than the $100 million-plus they wasted and wiped out. We want to make Forstmann Little the poster child for fair-dealing in the investment community.”

Most industry observers felt that the two sides would retreat to a common boardroom, but settlement talks went nowhere fast. A jury was seated this past May, and Forstmann Little founder Ted Forstmann took the stand in early June for two days of intense questioning. Forstmann acknowledged that he might not have exercised the best judgment when investing in certain telecom companies-McLeod USA and XO Communications, in particular-but he strongly denied any legal wrongdoing or liability.

Neither Connecticut Treasurer Denise Nappier nor former Forstmann Little partner Erskine Bowles were called to testify. Nappier’s non-appearance was surprising, considering she was listed as the case’s formal plaintiff. Bowles’ omission drew some charges of political favoritism aimed at AG Blumenthal (a Democrat), since Bowles is running as the Democratic candidate for U.S. Senate in North Carolina, while Ted Forstmann is a major GOP fund-raiser.

Just prior to opening arguments, Connecticut Superior Court Judge Samuel Sferraza threw out the securities law violation charges, which legal experts say were the most serious allegations facing Forstmann Little. Then, two weeks into the case, he also rejected the bad faith and unfair dealing charges, saying that the State had not presented sufficient evidence.

By the time the jury returned with its verdict on July 1, the only charges left on the table were various breaches of contract and of fiduciary duty. The final jury verdict found that Forstmann Little had breached both its contract (two counts) and its fiduciary duty (one count). It 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 that Connecticut was eligible for any compensation. Instead, it left the damages boxes blank on the verdict card.

“Think of it this way,” said William Bright, an attorney who represented Forstmann Little on the case. “[The jury] said Forstmann Little should not have done what it did, but the state knew exactly what Forstmann Little was doing.” Bright added that Forstmann Little’s affirmative defense also was successful in arguing that the firm had relied on the advice of counsel.

Connecticut lauded the finding of wrongdoing, but also filed an appeal to recover damages. As part of the $16.2 million settlement reached last week, however, the State has dropped all future prosecution of the case.

So Who Won?

Following the settlement, both sides declared victory.

Forstmann Little was the most boastful, issuing an unsigned statement that read, in part: “Forstmann Little had a complete victory in the contract litigation brought by the Treasurer of the State of Connecticut in early 2002 and tried in 2004. A Connecticut jury found no liability and awarded no damages. Any characterization other than that is totally incorrect.”

No one from Forstmann Little, including a third-party spokeswoman, would comment on the statement. Attorney General Blumenthal told Buyouts that he found Forstmann’s claim of “no liability” to be strange, and that the suit had, indeed, made Forstmann Little a poster child for fair dealing.

“From the outset, we had two unequivocal goals: recover money for the pension fund, and demonstrate in court that Forstmann Little had breached its contract,” said Nappier in a formal statement. “The unanimous jury verdict and monetary settlement achieve both goals, so for the Connecticut pension fund, this is a win-win and a landmark victory.”

What Nappier didn’t mention, of course, is that the jury never got to rule on most of the initial charges, nor did she note that Connecticut recovered just 10% of what it had publicly requested.

Connecticut did, however, make out better than Forstmann Little from a financial perspective. Blumenthal says that the state spent approximately $3 million in legal fees, while Forstmann is said to have spent just under $15 million (a figure that some litigators suggest Forstmann Little inflated to justify the verdict).

From a publicity perspective, Connecticut also seems to have a slight edge. Its elected officials get to claim victory over a big investment firm, while Forstmann Little must live with the stigma of a jury verdict that found that it breached its contract.

On the other hand, Connecticut could have difficulty investing in future buyout funds. Some general partners say the state’s money isn’t worth the headache of working with it.

“The short answer is that there is no clear winner, because Forstmann Little can rightfully claim that its affirmative defense worked-at least from a practical level of not having to pay out over $100 million-even though everyone knows that they were found in breach of contract,” says Carl Metzger, an attorney with Testa, Hurwitz & Thibeault.

Movement at Forstmann

One week following the settlement, a spokesman for Forstmann Little confirmed that Sandra Horbach is stepping down from her general partner position. She has spent the past 17 years with Forstmann Little, and will transition into a special limited partner role that allows her to maintain current board seats.

The spokesman was quick to point out that Horbach’s departure is not related to the situation with Connecticut.