Carlyle goes on trial for a financial-crisis meltdown

Carlyle Capital Corp., or CCC, borrowed vast sums from banks to buy $ 23 billion in bonds. When a deteriorating US housing market spooked CCC’s lenders, investors in the fund lost their entire $ 945 million in capital.

Conway was summoned to Guernsey, where the fund was registered a decade ago, to testify in a $ 1 billion civil lawsuit by CCC’s liquidators. They allege that Conway and six other Carlyle and CCC officials acted recklessly and should have started selling the fund’s assets months before it failed. The defendants deny those allegations.

The trial, which hasn’t previously been reported on, demonstrates how fallout from the 2008 financial crisis continues to reverberate eight years on.

“We all lived through something that was worse than the worst-case scenario,” Conway said in court earlier in July. “Until March 2008, I was always convinced that CCC was going to make it.”

The 66-year-old is one of the highest-profile figures to appear at a civil trial tied to the financial crisis. Washington DC-based Carlyle Group manages $ 178 billion in private-equity and other funds.

“Carlyle always met its fiduciary obligations to CCC investors,” a Carlyle spokesman said. “We had more money at risk than anyone, having loaned $ 130 million in an effort to save the fund and with Carlyle individuals losing $ 85 million of their own money. Unfortunately, a 100-year storm overwhelmed our efforts, but we stayed focused on serving our investors.”

For six days in July, Conway answered questions from a lawyer of the liquidators about the fund’s business model, governance and funding problems. Among the specific allegations against him: that he refused to have CCC sell assets or restructure as loans dried up in the summer of 2007 because he didn’t want bad publicity from CCC to jeopardise an investment by an Abu Dhabi government fund in Carlyle Group. Conway denies that.

“I would say I always tried to do what was in CCC’s best interest,” Conway said in court.

Conway’s path to this courthouse on Guernsey, a bump of land in the waters between the UK and France, started when CCC was registered at a law firm’s office here in 2006. At that time, private equity firms and hedge funds were boosting their assets by floating publicly-traded investment funds. Carlyle Group came up with CCC to cash in on the trend and branch out from its business of buying and selling stakes in companies.

CCC aimed to make around 12% a year buying assets including Fannie Mae and Freddie Mac bonds with a type of short-term loan called repurchase agreements. Investors were told in fund documents that the bonds didn’t have any credit risk because the two government-chartered companies, which buy mortgages from lenders, had an implicit guarantee from the US government. But they were also informed that CCC was subject to risks involving its leverage, or amount of borrowed money, and funding.

From the start, Carlyle anticipated that its connections with Wall Street banks – which were making around $ 500 million a year in fees from the firm’s buyouts and other business – would help CCC secure favorable funding terms, according to documents in court and Conway’s testimony.

It hired John Stomber, a former Merrill Lynch treasurer, as CCC’s chief executive. David Rubenstein, one of Carlyle Group’s three co-founders, legendary for his fundraising ability, started talking CCC up to clients across the globe, according to court filings. Stomber, who is a defendant in the lawsuit, started testifying on July 13. Rubenstein isn’t a defendant and isn’t testifying.

Stomber didn’t respond to a request for comment through a representative. He denied the liquidators’ allegations against him in a court filing. Rubenstein declined to comment through a Carlyle spokesman.

In testimony that provided flashes of Carlyle Group’s rarefied perch in the investment world, Conway said the Angolan government, CCC’s biggest investor, considered putting $ 500 million in the fund. The West African country ended up taking a $ 150 million stake.

Several CCC investors, including former Republican US congressman Michael Huffington and Kuwait’s National Industries Group, later brought lawsuits against Carlyle Group, but only the liquidators’ case made it to trial. The other suits were all thrown out or dropped and are no longer active.

The liquidators were appointed by the Guernsey court in 2008 as part of the island’s insolvency procedures.

After raising $ 600 million privately in late 2006 and early 2007, CCC prepared to offer shares on Euronext Amsterdam in the summer of 2007. But alarm bells began to sound on US subprime mortgages, and other mortgage-related assets were hit. It was touch and go whether CCC’s initial public offering would go ahead, according to emails shown in court.

CCC’s Fannie Mae and Freddie Mac bonds had fallen in value, and banks wanted more cash and collateral to keep providing loans. CCC borrowed around 30 times its equity to increase returns and had little wiggle room.

“Pulling the deal will be a public black eye,” Rubenstein wrote in an email to Conway at the end of June 2007, according to court filings. “On the other hand I’m at a loss to say how the whole market can be wrong about the product at this time and we are right,” he wrote.

The shares were listed on July 4, 2007, at $ 19 apiece. By the time CCC threw in the towel 252 days later, on March 12, 2008, they traded for pennies.

A retired UK judge now living in Guernsey will decide the case, which centres around whether the defendants broke their duties to shareholders by not selling CCC’s assets and reducing its reliance on borrowed money.

After the IPO, it became even harder for CCC to get cheap, regular loans, the court heard. Markets melted down in August 2007 as fears grew over the US housing market and banks’ exposure.

“I am afraid,” Conway wrote to Stomber and CCC Chairman James Hance on August 10, 2007, according to an email shown in court. By the end of August, Carlyle Group lent CCC $ 100 million to cover margin calls, and Conway and Stomber called on Wall Street executives to try to lock in affordable funding for CCC, according to Conway’s testimony and documents shown in court.

Conway testified that he “was in shock” when Steve Black, then co-head of JP Morgan Chase & Co.’s investment bank, advised immediately selling a big chunk of CCC’s assets.

Selling around $ 4 billion in bonds was explored, but it would have meant swallowing big losses and CCC’s board and management decided not to proceed, according to a filing by the defendants.

Instead, CCC limped on for a few more months before defaulting on its loans. Banks liquidated its assets in March 2008.

Write to Margot Patrick at

This story was first published by The Wall Street Journal

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