Round II: Connecticut Bites Forstmann Little

The State of Connecticut last week made good on its threat to sue buyout shop Forstmann Little & Co. As first reported in Private Equity Week, the accusations include breaches of fiduciary responsibility, contract clause violations and securities law violations.

“This firm Enronized Connecticut through its blatant abuse of trust,” says Connecticut Attorney General Richard Blumenthal. “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.”

The move follows months of fruitless private negotiations, with each side publicly accusing the other of being unresponsive. The only apparent breakthrough came last December when Forstmann Little informed limited partners via a private memo that management fees would be discontinued on the $1.5 billion already lost on an investment in XO Communications.

The memo, which did not discuss money lost on now-bankrupt telecom services provider McLeodUSA Inc., apparently was not conciliatory enough for Connecticut. Instead, the state is arguing that it deserves to have its capital commitment returned because Forstmann Little violated a variety of spending restrictions contained in both the partnership offering memoranda and side letter agreements.

Prior to the lawsuit, a source close to Forstmann Little denied that such caps existed in the original partnership agreement. According to documents released by Connecticut, however, such caps seem relatively explicit. On page five of a 1997 memorandum for Forstmann Little & Co. Equity Partnership-VI LP, a clause says that no limited partners will be required to contribute more than 40% of such LP capital commitments to any single transaction. Another restriction was noted in a 1999 memorandum supplement in which no more than $400 million could be spent on any one so-called “strategic equity investment.”

Forstmann Little did not return repeated calls asking for clarification of this apparent contradiction. The firm did, however, release a general statement last week saying that it would fight the charges vigorously as it feels the suit is “without merit.”

The complaint itself does not specify desired reparations, but the state is publicly saying that it is interested in getting back more than it has already lost.

“This lawsuit against Forstmann Little is not about sour grapes,” says Connecticut Treasurer Denise Nappier in a conference call with reporters. “It’s about recovering funds that were mismanaged and lost by our general partner, Forstmann Little, as they violated contract clause obligations and securities law violations.”

The lawsuit was filed in Connecticut State Superior Court and names Forstmann Little and its individual partners as defendants.

In a clarification to an article published in the Feb. 18 issue of Private Equity Week on the Connecticut vs. Forstmann Little brouhaha, the state did not previously win a fraud case against Triumph Capital. The case was settled out of court, with Triumph returning a portion of Connecticut’s committed capital.

Dan Primack can be contacted