NFL Stars, Charmed by Kirk Wright, Lose Millions in Hedge Fund

NFL Stars, Charmed by Kirk Wright, Lose Millions in Hedge Fund
By Monee Fields-White
Bloomberg, 2006-08-23

When the FBI finally caught up with hedge fund manager Kirk Wright, he was lounging by the pool with his wife, Kilssis, at the Ritz-Carlton hotel in Miami's South Beach neighborhood.

In his room, the Federal Bureau of Investigation agents discovered debit cards and an ID card with a different name -- one of three aliases Wright used while in Florida. They also found $28,000 in cash, a vestige of investors' funds estimated at $185 million, according to a sworn affidavit from FBI Special Agent William Cromer Jr.

Wright, 36, now faces 24 federal charges of mail and securities fraud, each carrying a maximum sentence of 20 years behind bars. He's pleaded not guilty.

He and the hedge fund company he founded, Marietta, Georgia- based International Management Associates LLC, also face a fraud lawsuit by the U.S. Securities and Exchange Commission and at least three separate lawsuits from investors and former business partners.

These include former pro football player Steve Atwater, who was so impressed with Wright and the returns he claimed to make on investments that he asked to join the firm as a client liaison.

Atwater, 39, brought in six other former football players, who invested a total of almost $20 million.

All the money is now gone, Atwater says, shaking his head. ``In my wildest dreams, I never thought he was stealing the money,'' says the former defensive back for the Denver Broncos and New York Jets.

Wright's Mother Invested

The tale is all too familiar to the roughly 500 people who invested with Wright, from a Los Angeles real estate developer to a 74-year-old retired car salesman in Las Vegas, to Wright's own mother, who's not a plaintiff in the suits.

Standing just less than 6 feet (1.8 meters) tall and sporting a trimmed goatee, Harvard-educated Wright told his clients he could bring them annual returns in the region of 27 percent by short selling stocks. He wooed them in seminars in Las Vegas, at the hospitality suite at Atlanta Falcons football games and at parties at his suburban home, which had a pool and three fountains.

``Kirk was a polished, young black man who was trying to do something,'' says Horace Noble, 74, who was the first black station commander of the Cook County, Illinois, sheriff's office in 1963. ``So, I put some money in there to help him, and to get a boost myself.


$1 Million Lost

``In the end, Kirk only cared about one color -- green,'' adds Noble, who lost almost $1 million when Wright's firm collapsed. In fact, most of Wright's clients were not black, Atwater says.

The SEC, in its Feb. 27 fraud lawsuit, alleges that since at least 2003, Wright falsified statements about the amount of the firm's assets and inflated the rates of return for the seven hedge funds under his management.

Nearly all of the money invested with Wright may be lost, according to the SEC suit. William Perkins, the state and federal court-appointed receiver, has recovered $6.3 million so far -- including about $1 million from the sale of Wright's home.

``There was a large amount of money that traveled through these accounts over the years,'' says Perkins, a partner at William G. Hays & Associates LLC, an Atlanta-based consulting firm that specializes in bankruptcy administration and fraud investigation. ``But after all of the expenses, losses and consumption throughout that period, there was never a significant balance.''


Doctors Sue

Wright is also being sued by his two former partners, Nelson Keith Bond and Fitz Harper Jr., both Atlanta-area anesthesiologists. The two doctors met Wright in 1998 when they were running a clinical practice, Axis Anesthesia Associates, and they helped him tap into a network of wealthy physicians in Atlanta.

In their March 31 lawsuit, the pair say they were duped and lost $1.5 million. Bond and Harper decline to comment, says Stephen LaBriola, their attorney. The two doctors haven't been charged with any wrongdoing.

The roster of investors expanded as word about the fund's success spread to include business executives, rich retirees and professional athletes.

``People grow lax in their due diligence,'' says Ivan Thornton, managing partner at New York-based Fiduciary Management Group LLC, which manages money for athletes and entertainers. ``Everything they read about hedge funds talks about them making high returns, and people feel like they are missing out.''

Wright gained some legitimacy by having the two doctors on board, says James Ellner, an Atlanta-based anesthesiologist and IMA investor, who has known Harper since 1992.


`Brilliant Guy'

``Everyone looked up to Wright as this brilliant guy,'' Ellner says. ``He was showy.'' Federal court records show Ellner lost about $100,000. Ellner declined to confirm that figure.

Wright and Bond were also registered as acceptable financial advisers by the National Football League Players Association, the players' union, Atwater says. Atwater and the other players sued the NFL and the players' union on June 23 for recommending unfit financial advisers.

``They fumbled,'' Blaine Bishop, a former Philadelphia Eagles and Tennessee Titans safety who also worked for IMA, said of the NFL and the union at a news conference when the suit was filed.

The players want to be reimbursed for their $20 million in losses and to see the union improve its screening of fund managers.


NFL Comment

NFL spokesman Brian McCarthy says the claims are unfounded and declined to comment further. Dana Hammond, director of the NFLPA's financial advisers program, didn't return phone calls seeking comment.

Wright told his investors that he was achieving phenomenal returns on their investments by short selling a particular stock. That exposed them to extreme risks, according to an order in February by Superior Court Judge Jackson Bedford freezing the assets of IMA and Wright.

A short sale is the sale of borrowed shares that the investor is committed to repurchase eventually. Investors use short sales to capitalize on an expected decline in the security's price.

Wright had $30.5 million in trading losses, Perkins says. The rest he likely used for personal purchases, including more than $6 million in real estate, jewelry and art, all of which is being sold.

``We are going to try and retrace all of the money and recoup those assets as much as possible,'' says Mark Kaufman, partner at McKenna Long & Aldridge LLP in Atlanta, the firm representing the investors' committee in IMA's bankruptcy.


Not Guilty Plea

Wright, who pleaded not guilty at his arraignment on July 13, is in an Atlanta jail awaiting trial. His court-appointed lawyer, Virginia Natasha Perdew-Silas, didn't return repeated calls for comment.

Jacob Frenkel, the attorney for Wright and IMA in the SEC case, says ``the charges are of such seriousness that resolution would be in the interests of all parties.''

It's a long way from the Bronx, New York, where Kirk Wright grew up and was a bright and polite young man, according to a person who knew him then. He earned a bachelor's degree in political science from Binghamton University, which is part of the State University of New York system, in 1993. Two years later, he received a master's degree in public policy from Harvard University's Kennedy School of Government.


Founds IMA

Fresh out of Harvard, Wright joined Kaiser Associates, a Washington-based corporate consulting firm, as a vice president. A year later, while still in his mid-20s, he founded International Management Associates in the basement of his home in Manassas, Virginia, 32 miles southwest of Washington.

Wright shared the home with his first wife, Kasandra Pantoja, with whom he had four sons.

By the time he met Harper and Bond in 1998, Wright had a small group of investors in his three hedge funds -- the Taurus Fund, Growth & Income Fund and Sunset Fund -- totaling less than $15 million, according to the doctors' suit.

Harper and Bond invested and began referring friends and family members to Wright, their lawsuit says. They set up seminars for their doctor friends at which Wright would court potential clients.

Noble, a retired owner of a Lincoln-Mercury dealership, went with a friend to one such seminar in Las Vegas on a September evening in 1999. More than 25 people, mostly physicians, gathered in a hotel conference room, Noble says. Wright praised the success of his company's funds, using charts and graphs on a video screen.


`Silver-Tongued Devil'

``He's a silver-tongued devil,'' Noble says.

In November 1999, Noble made his first investment of $140,000. He deposited an additional $336,000 during the first half of 2000 after receiving statements showing a 3 percent jump each month.

Wright eventually rolled all of Noble's money into the Platinum fund. According to the fund's marketing materials, ``It seeks to capitalize volumetrically on a few select opportunities characterized by moderate to high valuations, compelling business fundamentals and strong management teams.''

That language should have been a red flag for investors, Thornton says. ``If you have jargon-laced speech like this, that usually means you're covering something up,'' he says.

By 2000, Wright had moved to Atlanta, where Harper and Bond were based. The city at the time was a boomtown. From 1990 to 2000, its population grew by 1.15 million to 4.1 million, according to the Metro Atlanta Chamber of Commerce. Almost two- thirds of that growth was due to newcomers.


Atlanta Hawks, Falcons

Wright, who worked from the ground floor of a glass office tower in suburban Marietta, 13 miles north of Atlanta, adopted a high-profile lifestyle. He rented corporate suites at Atlanta Hawks basketball and Falcon football games, bringing along potential clients.

He also bought a vintage 1967 BMW 2000CS, a 2000 Jaguar Coupe XK8 and a gray 2003 Aston Martin two-door coupe.

Wright moved into a four-bedroom, three-bath, stucco and brick home at the end of a cul-de-sac in Marietta. Then he doubled the size of the house, adding a vaulted marble-floor family and entertainment room, with a curved-glass staircase and cathedral- like window that overlooked the pool and backyard fountains.

``He often said it was his dream home,'' says former neighbor Evelyn Kernachan, who has lived in the quiet Turtle Lake Court neighborhood for 27 years. ``He was engaging and personable, but at times he could be inconsiderate of his neighbors.''

She says the vehicles of construction workers blocked her mailbox and driveway.

Harper and Bond officially joined IMA in November 2000, while still practicing medicine on a part-time basis. Harper -- who had no background in finance -- became chief financial officer, while Bond became the chief operating officer.


Las Vegas Office

During the next four years, the doctors helped Wright open offices in Las Vegas, New York and Los Angeles, where they hired Thomas Birk, who previously worked in the marketing department of Lehman Brothers Holdings Inc., as managing director.

Wright began investing in other business ventures outside of IMA, including a Southern-style restaurant in Cleveland, that later failed.

In partnership with GTO Development LLC, a Santa Monica, California-based real estate developer, he entered into a deal to develop condominiums in Los Angeles and Lake Arrowhead, California.

GTO's principal, Roger O'Neal, also invested in IMA. He says he wanted to withdraw money from his IMA accounts to fund the projects. Wright discouraged him from doing so and told O'Neal that IMA would put up $6 million toward the condominiums. ``Kirk said he wanted to diversify some of his high-net-worth clients,'' O'Neal says.


`Just a Scam'

The properties have been seized by Perkins, the liquidator. ``It was just a scam,'' says O'Neal, who lost $13.5 million. ``He wanted to invest my own money in my own company. Not only did I get victimized personally, now I'm becoming a victim in my business.''

During this time, Harper and Bond repeatedly asked Wright to let them see the brokerage statements showing how IMA was investing its money, according to their lawsuit, filed on March 31, in Superior Court in Fulton County, Georgia.

At the start of 2004, Harper and Bond began pushing Wright to start a new company that would offer more transparency, according to their lawsuit.

The new firm, called IMA Advisory Group, hired Lehman Brothers as its prime broker and a certified public accountant, Kenneth Turchin, to manage the company's books. Wright was the principal trader.


A Round of Golf

It was in May 2004 that Atwater, who holds a bachelor's degree in finance and banking from the University of Arkansas, heard about IMA from one of its clients at a conference for entrepreneurs in San Antonio, he says. The investor gave the football player Bond's number.

Atwater invited Bond to his Duluth, Georgia, home, which is located in the Sugarloaf Country Club community, and they played a round of golf and talked about money. ``I didn't hit the ball that good but we did hit it off pretty good,'' Atwater says.

Atwater trolled through information about the funds. He noted that Wright was registered with the players' union. ``We felt comfortable,'' Atwater says.

At the start of August, Atwater invested $1.5 million. His statement for the first month showed a 9.39 percent gain, or $140,000. The jump seemed so unreal to him that he called Bond to make sure the numbers were correct.

Atwater's balance continued to grow, by 4.6 percent in September, 4.4 percent in October, 7.3 percent in November and 2.5 percent in December.


NFL Players Join

Atwater began telling his football buddies about IMA, including Bishop, 36, with whom Atwater competed in the 1995 and 1996 Pro Bowls, the NFL's all-star games. Atwater also spoke to Ray Crockett, 39, who'd played with Atwater in the Denver Broncos backfield for four years, winning the Super Bowl in 1998.

Bishop, who invested in late 2004, and Crockett, who invested in January 2005, declined to comment.

In December 2004, Atwater met Kirk Wright for the first time, when Wright invited Atwater's family to his hospitality suite during a Falcons game.

Atwater recalls Wright making his way around the room, shaking hands and chatting with each guest. Wright talked to Atwater about IMA's future and said that he was thinking about buying an NBA basketball team.

``The first impression I got from him was that he was a really sharp guy,'' Atwater says. ``He really put on a good show that day.''

In early 2005, Atwater approached Bond about working at the firm. Atwater, who owned some commercial properties in Southern California, told Bond he wanted to help other players with their post-career investments.


Studying for License

Bond liked the idea, and in March, Atwater joined as a client liaison at IMA Advisory Group. Bishop followed in May 2005.

In a shared office, the two former football players spent several months studying to become registered investment advisers. Over the summer, the pair recruited more former NFL players as investors.

They added Terrell Davis, 33, a former Denver Broncos all- star running back; Al Smith, 42, a former Houston Oilers all-pro linebacker; and Clyde Simmons, 42, a former defensive end for five teams, including the Philadelphia Eagles. The only active NFL player to invest was Rod Smith, 36, a Broncos wide receiver.


Accountants' Questions

Later that summer, Turchin began asking questions about IMA's books. In an Aug. 23 e-mail message to Harper, a copy of which is included in the SEC court case, the accountant said there were inconsistencies in the brokerage statements produced by Lehman Brothers and Bisys Group Inc., a Roseland, New Jersey-based company that executed and administered trades for Wright, and those sent to investors.

For example, Turchin wrote, Lehman and Bisys reported a 24 percent loss for two funds during the period ended on March 31, 2005. IMA told investors the same two funds gained more than 6 percent in the period.

``There is no validation of fund performance for IMA and IMAAG funds,'' Turchin wrote. ``The portfolio manager is the only person authorized to trade the funds and is the only person receiving broker statements.''

The portfolio manager was Kirk Wright.

Turchin's lawyer, Jason Brown, declined to make his client available for comment.

Shortly after that, the football players called a personal foul. Atwater says Wright, Bond and Harper stopped coming to the office. Rod Smith also spotted errors in the balances on his account statements.


Proprietary Information

Atwater and Bishop wanted more information about the funds and asked to see the broker statements. Wright refused, claiming they were proprietary information.

``I assumed that once I got my license that it wouldn't be an issue, but I was wrong,'' says Atwater, who became a licensed investment adviser in July 2005.

Regulators also began asking questions. In September, the SEC and the New York State attorney general's office requested the company submit account statements for review, the doctors say in their lawsuit.

Wright seemed concerned by the requests, and stood before the staff and warned that they all must cooperate with the SEC, Atwater recalls. ``This just seemed strange because I kept thinking, 'I don't have any part in the documentation,''' Atwater says. ``This was all Kirk.''

William Hicks, SEC Atlanta district trial counsel, wouldn't comment on how long the agency has been investigating the hedge fund. Brad Maione, a spokesman for the New York attorney general's office, declined to comment.


SEC Review

In October, Atwater and Bishop met with Wright, Bond, Harper and Birk, who had come from the Los Angeles office. They talked about the status of the SEC review, and Wright came with a copy of statements for four TD Ameritrade Holding Corp. accounts, showing a total balance of about $155 million. Atwater says seeing the statements alleviated his doubts.

And on Oct. 22, Atwater and Bishop attended Wright's wedding to Kilssis Delos Collado, whom Wright had met in 2002 when she was a part-time hostess at Georgia Brown's restaurant in Washington.

Wright's four sons from his first marriage were at the wedding, held at St. Luke's Episcopal Church in Atlanta. The bride flashed an engagement ring worth more than $50,000, according to Perkins, the liquidator.

The reception was held in the backyard of Wright's home, where the newlyweds shared the traditional first dance on a platform that stretched across the pool, says Calvin Paris, an IMA investor who attended.


'Ostentatious'

Guests feasted on a seafood buffet that included shrimp and lobster and on a dessert buffet. Bartenders served champagne from three bars sculpted from ice.

``It was ostentatious to a fault,'' Paris says. ``I can't understand how anybody can do that, knowing full well they are not only deceiving themselves but their investors and family.''

``Kirk is worse than greed,'' Paris adds. ``He took people's money that didn't belong to him.''

Atwater, who says he didn't know about the Turchin e-mail, began to get uneasy again. He says Bond began avoiding meeting with him.

On Dec. 5, Atwater, Bishop and the other NFL players requested their money back. Wright, Harper and Bond tried to convince them to do otherwise, telling them of future goals of growing into a $300 million company, Atwater says.

On Dec. 27, Atwater says, the players received letters stating they would get their funds in less than 21 days. By Jan. 23, they hadn't received any money.

Wright had long before stopped showing up at the office, and now he didn't return phone calls. Atwater and Bishop drove to Turtle Lake Court and stopped at Wright's house. They spoke with Kilssis, who said she didn't know where he was.


$3.2 Million Transfer

On the morning of Jan. 26, Atwater, who'd been checking the balance of his bank account compulsively, saw something new: a deposit in the amount of $3.2 million. The bank said the funds wouldn't be available for 14 days, so he went there to ask about the long wait and retrieve a copy of the check.

To his surprise, the check had been drawn not from IMA accounts but from one held by a business partnership Wright had with Willie Clay, a former safety for several teams, including the New England Patriots.

Clay's signature was forged on the front of the check and Atwater's signature was forged on the back, the players' lawsuit says. ``When I saw the check, I was sick,'' Atwater says. The check bounced, he says. Clay didn't return phone calls.

Atwater began calling the other football players. Now, he says, he has little hope they'll find any large sum. The SEC lawsuit says IMA's Ameritrade accounts, which Wright told Atwater had held $155 million, in reality held less than $150,000.

``None of us were thinking it would happen this way,'' Atwater says.

At Wright's home in Marietta shortly after his arrest, little was left of the grand life he once led. Clothes were strewn across the bedroom floor, furniture was slashed and a coffee table's glass top had been shattered, scattering diamond-shaped shards across the marble floor.

The Quintessential Quant

The Quintessential Quant
Meet the most wanted man in high finance
Businessweek, August 21, 2006
By Roben Farzad

James H. Simons, the former math professor who founded the $12 billion quantitative shop Renaissance Technologies Corp., pocketed an estimated $1.5 billion last year. That was thanks to the 5% in fees and nearly 44% of profits that Renaissance docks its investors (vs. traditional hedge funds' typical "2 and 20"). Clients don't complain; Renaissance's leading fund has returned 35%, after fees, since 1989. And D.E. Shaw & Corp., the brainchild of ex-Columbia University computer science professor David E. Shaw, with $23 billion in capital, has netted investors 21% a year for 17 years, without a single losing 12-month stretch.

Landing a job at either of these shops can be insanely lucrative -- and even more insanely competitive. "Using a self-consciously obnoxious term, we're looking for superstars, the kinds of people who would be extraordinarily good at nearly anything," says Nicholas P. Gianakouros, head of global recruiting for New York-based D.E. Shaw.

He is being euphemistic. The handful of quant and programming geniuses who get into the toughest mathematics, physics, and computer science PhD programs on the planet are already best in class. So screening for the 5 or ten very best of that best means establishing a whole new set of prerequisites. "The quant shops are a different animal," says Alison Seanor, vice-president at Glocap Search, a Manhattan hedge-fund recruiter. What is the "it" factor that distinguishes the crème de la crème? All Seanor will say is, "I know it when I see it."

One obvious filter is that liberal arts students -- or even bankers and stock jockeys -- need not apply. What you will need is a nosebleed grade-point average in applied mathematics, physics, or computer science at an elite school like the Massachusetts Institute of Technology, California Institute of Technology, or Indian Institutes of Technology. Many of these students are published and have won high math honors such as the Putnam Fellowship. Often, their names are already so well known in the field that the quant funds make the first approach.

Another must-have: an 800 math SAT score (even if you sat for that exam in your awkward adolescence). Although the funds diplomatically claim the number is "just another data point," it's pretty well understood to be a critical credential.

The quant shops want malleable intellect untainted by Wall Street dogma -- i.e., not "buy, sell, or hold" types. "They're not really looking to make money on corporate events like takeovers," says Emanuel Derman, director of the financial engineering program at Columbia University and head of risk for quant house Prisma Capital Markets. "They're looking to make money on mathematical models." Top funds often advertise in esoteric scientific journals. "You'll not likely find our ads in a dentist's waiting room," says D.E. Shaw's Gianakouros.

If yours is one of the lucky 1% to 3% of résumés to survive an exhaustive initial culling, you can look forward to an hour-long phone interview peppered with thought problems and brain teasers. Pass that test and you will then be summoned as many as three times to undergo up to a dozen grueling interviews. "Every interviewer uses a different approach," says Gianakouros, citing programming problems and math proofs. Expect to be asked to build an intricate Excel model on the spot. Whatever the case, advises Derman, "don't say anything unless you're ready to be quizzed on it."

The firm will then solicit references for areas in which a candidate may appear weak. Ultimately, it takes a consensus among everyone who has met the candidate to extend a coveted offer. D.E. Shaw says that out of every 500 candidates who got the initial callback, only one makes the final cut. Many agree it's even harder to get into secretive Renaissance, which would not comment for this story.

A typical offer, say sources, starts with a base salary of around $250,000, plus a guaranteed annual bonus that could double that. The best can command a cut of a fund's upside -- beaucoup bucks when you consider the multibillion-dollar asset pots. All this, yet, says Seanor, "most of these guys have never even had a real job."

Hedge Fund Managers Earned Billions in 2005

Simons, Pickens Top $1 Billion for Managing Hedge Funds in 2005
By David Clarke and Katherine Burton

May 26 (Bloomberg) -- James Simons earned an estimated $1.5 billion last year, the most of any hedge-fund manager, followed by Boone Pickens at $1.4 billion, according to Institutional Investor's Alpha magazine.

The average pay of the top 26 earners rose 45 percent in 2005 to $363 million, the magazine said. Hedge funds returned 9.2 percent last year, double the Standard & Poor's 500 Index and about the same as in 2004, according to Chicago-based Hedge Fund Research.

``The founders and owners are taking the lion's share of the profit,'' said Henry Higdon, chairman of Higdon Barrett LLC, a New York-based executive search firm. ``These guys created firms and risked capital, you can't say they don't earn it.''

Hedge funds, private partnerships that typically require an initial investment of at least $1 million, try to make money whether financial markets rise or fall. While the average fund beat the S&P 500's 4.9 percent return in 2005, the industry continues to lag behind the 16 percent average gains in the 1990s.

Alpha arrives at the managers' earnings based on estimates of assets under management, fees, returns, personal investments in the funds and ownership stakes in their firms.

Top hedge-fund managers often earn far more than the best-paid chief executive officers, sports stars and celebrities.

Henry Paulson, 60, head of Goldman Sachs Group Inc., was the highest paid Wall Street executive last year, earning $38.3 million in salary, stock and options, up 28 percent from a year earlier. Film director George Lucas brought home $290 million last year, and golfer Tiger Woods earned $87 million, according to Forbes magazine.

The highest paid chief executive in 2005 was Richard Fairbank of Capital One Financial Corp., who earned $249.4 million, according to Forbes.

Simons, Pickens

Simons, 68, of Renaissance Technologies Corp., more than doubled the $670 million he earned in 2004, when he ranked second among hedge-fund managers. His $5.3 billion Medallion fund's return after taking 5 percent of the fund's assets and a 44 percent performance fee was 29.5 percent in 2005.

Pickens, 78, profited from energy investments that boosted his BP Capital Commodity Fund to a sevenfold return and returned 89 percent net for his BP Capital Energy Equity Fund.

George Soros, 75, was third on Institutional Investor's list with $840 million of income.

He ranked sixth in the 2004 survey, after taking home $305 million. The Hungarian-born billionaire rose to prominence by betting against the British pound in 1992. Soros's Quantum Endowment Fund climbed 12.3 percent last year, according to data compiled by Bloomberg.

Below is a table of the 10 hedge fund managers with the highest pay, according to Institutional Investor.

Steven Cohen, 49, retained fourth spot in the magazine's rankings. Cohen, who runs the $8 billion hedge fund SAC Capital Advisors LLC, increased his compensation to $550 million from $450 million in 2004.

Edward Lampert, a Yale economics graduate, fell to sixth place from first on the magazine's previous list, which put his earnings at $1 billion in 2004. His fund returned 9 percent last
year.

Lampert, 43 orchestrated the merger of Kmart and Sears, ESL's two biggest holdings.

In January 2003, Lampert was kidnapped outside his office by two armed men and held for 30 hours. He persuaded the kidnappers to let him go with a promise -- never fulfilled -- to pay ransom.

Bruce Kovner, 61, chairman of Caxton Associates LLC, ranked seventh. His Caxton Global Offshore fund had an 8 percent return. Kovner held the third place spot in 2004 by earning $550 million, according to Institutional Investor.

1. James Simons $1.5 billion Renaissance Technologies
2. Boone Pickens $1.4 billion BP Capital Management
3. George Soros $840 million Soros Fund Management
4. Steven Cohen $550 million SAC Capital Advisors
5. Paul Tudor Jones $500 million Tudor Investment
6. Edward Lampert $425 million ESL Investments
7. Bruce Kovner $400 million Caxton Associates
7. David Tepper $400 million Appaloosa Management
9. David Shaw $340 million D.E. Shaw
10. Stephen Mandel $275 million Lone Pine Capital

In Today's Buyouts, Payday For Firms Is Never Far Away

In Today's Buyouts, Payday For Firms Is Never Far Away
By GREG IP and HENNY SENDER
He Wall Street Journal, July 25, 2006

New Owners Extract Stream Of Charges and Dividends, Running Up Company Debt Burger King's Menu of Fees

When a trio of private investment firms acquired Burger King Corp. in late 2002, the chain was unprofitable. But immediately, it started paying off for the investors.

At the time of the acquisition, Burger King paid its new owners -- Texas Pacific Group, the private-equity arm of Goldman Sachs Group Inc. and Bain Capital -- $22.4 million of unspecified "professional fees." Burger King also started paying the group quarterly management fees for monitoring its business, serving on its board and other services. The total reached $29 million by this year.

In February, after three years of restructuring efforts under the new owners, Burger King announced plans to sell shares in an initial public offering. Three months before the sale, Burger King paid the owners a $367 million dividend. The company justified it in part by saying it had produced cash "in excess" of its needs -- and then borrowed to make the rich payment. Burger King also paid the owners a $30 million fee to terminate their management agreement.

According to company filings, the three firms collected a total of $448 million in dividends and fees from Burger King -- approximately what they initially invested. All that took place before the May stock sale, which valued their remaining stakes at $1.8 billion -- more than triple their original investment.

These are the new rules of the private-equity game, part of a growing wave of private money reshaping global financial markets. Just yesterday, hospital operator HCA Inc. announced it would be taken private by Bain Capital, Kohlberg, Kravis Roberts & Co., Merrill Lynch & Co. and HCA managers and founders for $21.3 billion plus assumed debt. Excluding debt, it would be the second largest buyout on record, after KKR's $25 billion buyout of RJR Nabisco Inc. in 1989, and the second time HCA has been taken private. (See related article.8)

In many of their deals, the private-equity firms have turned the buyout game on its head. In the late 1980s, it was a high-risk, high-reward business that sometimes took years to pay off. Nowadays, buyouts can often generate income for the firms almost immediately, long before a significant turnaround in the company has occurred. And since acquired companies frequently borrow money to pay off the new owners, many are left saddled with debt.

A slew of companies -- Burger King, Warner Music Group, mattress maker Simmons Bedding Co. and Remington Arms Co. -- have paid their private-equity owners large dividends mostly financed with debt. In late June, the parent of Hertz Corp. borrowed to pay a $1 billion dividend to Clayton, Dubilier & Rice Inc., Carlyle Group and Merrill Lynch, which acquired the company last December. They reaped that bonanza even though the rental-car company swung to a loss in the first quarter, primarily due to higher interest payments on debt incurred to complete the deal. Hertz has since announced plans for an initial public stock offering, whose proceeds will go to pay down that debt. A spokesman for Hertz declined to comment on the dividend.

Since 2003, companies have borrowed $69 billion primarily to pay dividends to private-equity owners, according to Standard & Poor's Corp. That compares with $10 billion in the previous six years.

The resurgence of the buyout investors, and their new skill at quickly extracting money long before any turnaround bears fruit, are signs of the ascendance of private money and its broad impact on the world of finance. The new power players are private financiers -- hedge funds, buyout firms and venture capital firms -- that often operate with limited scrutiny from the public and regulators.

Collectively, hedge funds, which invest in all types of assets; venture-capital firms, which invest in early-stage companies; and buyout firms, which generally buy mature businesses, managed some $1.5 trillion world-wide in 2005. That compares with $54 trillion managed by pension, insurance and mutual funds, according to International Financial Services, London, an industry group.

But the comparison understates the large and growing influence of private money. Hedge funds have become the biggest source of trading volume and commissions for the brokerage industry, sometimes accounting for half the daily volume at the New York and London stock exchanges, according to traders.

Growing Role

Private money is also playing a growing role in mergers and acquisitions, an area long dominated by companies. So far this year, buyout funds have been involved in 24% of mergers and acquisitions by value, according to Thomson, up from the 14% in 1988, the peak of the previous buyout boom. Venture-capital firms now manage $259 billion, more than six times as much as a decade ago, according to Thomson and the National Venture Capital Association.

Proponents say hedge funds give markets flexibility and encourage risk taking, key underpinnings to a dynamic economy. Venture-capital funds have nurtured many smaller companies, and private-equity firms have made the tough choices to turn around a host of troubled companies.

The many ways to generate returns from private equity -- collecting dividends, and fees for advising, stock underwriting and management -- are drawing Wall Street firms. Last week both J.P. Morgan Chase & Co. and Merrill Lynch cited hefty private-equity gains for steep rises in second-quarter profits. Goldman Sachs is now one of the largest private-equity investors in the world. In May, Goldman, along with other investors, teamed up with the management of Kinder Morgan Inc. in an agreement to buy out the pipeline operator for $13.5 billion, plus assumed debt. And Merrill is a lead investor in the blockbuster HCA deal.

The new quick-profit buyout game is fueled by low interest rates and willing credit markets. They let private-equity firms use their investors' capital, and lots of debt, to buy mature companies like Burger King from public shareholders or corporate parents.

Buyout funds averaged annual returns of 24% in 2004 and 2005, according to Thomson Financial, triple the return of Standard & Poor's 500 stock index. The returns have set off a scramble by investors ranging from college endowments to rich individuals to get in on the private-equity world.

But the payouts to private-equity firms that often follow deals come at the cost of mounting debts for the acquired companies. One caution sign: Two-thirds of the loans issued to pay dividends to private-equity firms are rated single-B or lower, a highly speculative rating, according to S&P. Historically, more than a quarter of loans rated single-B have defaulted after five years, S&P says. If interest rates keep rising or the economy stumbles, many of those companies could find themselves in trouble. Some might be forced to cut jobs or capital spending to manage their debt burden. Some could go bankrupt.

Michael Madden, a veteran investment banker who now runs his own private-equity firm, BlackEagle Partners LLC, says fees charged by private-equity firms can be compensation for the time and manpower required to turn around a company. They're less defensible, he says, if the buyout firm is simply attending board meetings "and not living on the scene day to day."

Dividends, he says, allow private-equity firms to reap a quicker return than through an IPO or sale. That in turn attracts more investors, enabling more and bigger deals. "Are they logical?" Mr. Madden asks. "Yes. Do they increase the systemic risk in the buyout business? Absolutely."

Warburg Pincus and Vestar Capital Partners, two major private-equity firms, generally don't extract fees from their portfolio companies, though both sometimes take dividends. Executives at both firms say the practice of charging fees means the new owners' interests are no longer aligned with those of the company: The company can do poorly while the private-equity firms do well.

The case of Dade Behring Inc., a medical diagnosis company, illustrates the risks when buyout firms take big payments. In 1994, Boston-based Bain Capital and the private-equity arm of Goldman Sachs bought Dade International, Deerfield, Ill., for about $450 million. Of that, only $85 million was the firms' own money.

Among private-equity firms, Bain is one of the largest recipients of dividends from its own companies, according to S&P. The firm, co-founded by Massachusetts Governor Mitt Romney, is also one of the most aggressive funds in the field. Last year, it bid for the entire National Hockey League.

In late 1996 Dade acquired a division from DuPont Co., boosting sales and debt. In 1997 it merged with Behring Diagnostics, a unit of Germany's Hoechst AG, which is now part of Sanofi-Aventis SA.

In 1999, Dade Behring borrowed again, in part to buy back a chunk of the equity stake belonging to Bain and Goldman. The $365 million paid to the firms was more than four times their original equity investment. The payment helped boost Dade's long-term debt to $902 million by the end of 1999, compared with $373 million a year earlier.

Over the next few years, the euro weakened against the dollar. Since half of Dade Behring's sales were in Europe, the company had fewer dollars coming in. At the same time, rising interest rates meant higher payments on its increased debt load. To deal with the one-two hit, Dade-Behring laid off 1,000 of its 7,000 employees and shuttered factories. In 2001, Dade Behring considered filing for bankruptcy protection to restructure its debts.

Some creditors formed a committee that examined the conduct of Dade's owners, directors and advisers, including Bain and Goldman. According to a company securities filing, they considered bringing claims relating to "illegal dividends, illegal stock redemption and impairment of capital," among a long list of items.

Though they said there was no merit to the matter, Goldman and Bain agreed to forgive some Dade debt they had purchased from other lenders after their own initial equity investment. The creditors decided not to sue. In August 2002, with the consent of most creditors, the company filed for Chapter 11 bankruptcy protection.

A Bain spokesman says the company was struggling when it was acquired by the private-equity firms. "We grew it and improved the products through several mergers," he says. The purpose of the 1999 payment was to boost Hoechst's ownership stake, he says, adding that the company's debt was "quite modest" by today's standards. Goldman and Dade declined to comment.

Dade emerged from bankruptcy and went public in 2002. Shorn of much of its debt, and aided by a stronger euro, it recovered. Ultimately, the investment proved to be among the best performing companies in the Bain fund that held it, according to people familiar with the matter.

Intelsat Ratings Lose Altitude

At Intelsat Ltd., an operator of communications satellites, debt taken on to pay new owners has stirred controversy. The storied organization traces its roots to the international consortium that captured the first images of man walking on the moon and operated the hotline between Washington and Moscow. Jobs at the company were secure and well paid and came with generous benefits.

In 2001, Intelsat became a privately owned corporation. After originally seeking an IPO, it agreed in 2004 to be bought by private-equity firms Apollo Management, Apax Partners, Madison Dearborn Partners and Permira. When the deal closed in early 2005, it looked like a risky proposition: Just weeks earlier, one of the company's satellites failed, the second malfunction in a few months. The financiers discussed renegotiating the deal at a lower price but decided against it.

The group put up $515 million of its own money to finance the acquisition for $3 billion, plus assumed debt.

Despite the shaky start, the new owners quickly issued more debt to pay themselves a $306 million dividend. Intelsat also paid the buyout firms a $50 million "transaction and advisory fee," and over the course of 2005, $21.5 million in other fees. In November, it paid them another dividend, of $198.8 million, according to Securities and Exchange Commission filings. In total, the buyout firms pocketed $576 million in dividends and fees.

Intelsat's debt load has led to multiple cuts in its credit rating. To maximize cash flow, the company says it will "aggressively manage" employee costs. It cut 43 of its 808 employees last year. It has also rebuffed retirees who say the company has wrongly cut their medical benefits.

Just before Intelsat was transformed into a private company in 2001, its governing board promised retirees their medical benefits would not change under the new structure. The board also said that if Intelsat's net worth ever fell below $300 million, it would finance a trust fund to ensure the continued payment of medical benefits. But shortly after privatization, the company concluded it was not bound by those promises and since then has stopped providing medical coverage to surviving spouses as retirees die. As a result of the leveraged buyout, its net worth fell from $2.3 billion to negative $290 million in March.

A group of retirees in 2004 sued Intelsat in U.S. District Court for the District of Columbia to make it abide by the old entity's promises. In a filing, Intelsat says those promises do "not create obligations that are enforceable" against the present company. Retirees say Intelsat has also told them it is not obligated to pay living retirees' benefits, either, though it continues to do so.

The tough new attitude has shocked retirees and their families. In September 2004, shortly after the leveraged buyout was announced, Patricia Magarinos de Acosta's husband, an Intelsat retiree, died after a long illness. A few weeks later, Intelsat told her it was ending her medical benefits. She was forced to purchase individual coverage, which now costs over $3,400 a year with a $2,000 annual deductible. Her annual income is only about $24,000, composed of her husband's pension and her own modest income as a freelance writer. Medical expenses forced her to sell her condominium a year ago and move to a cheaper neighborhood. Mrs. Acosta says her husband would be "horrified" by the behavior of the "solid institution" where he worked for about 15 years.

Some retirees contrast Intelsat's tight-fistedness toward retirees with its generosity to its managers and owners. John Tierney, who retired in 1995, says, "They're $11 billion in debt. Why not give us $75 million," the maximum needed, he says, to pay all the retirees' future medical benefits. He fears if the retirees lose in court, Intelsat will cut off all medical benefits. Like many former Intelsat employees, Mr. Tierney is not American and does not qualify for Medicare. So he is exploring returning to either Ireland or Canada, where he does qualify for health coverage, if his benefits are cut.

In an interview, David McGlade, Intelsat's new chief executive, says that in return for the management fees, Intelsat has received valuable advice on strategic deals, in particular the acquisition of PanAmSat Corp. The ownership group "collectively has some of the best merger and acquisition expertise in the market," he says.

Mr. McGlade adds that the new owners have attracted high-quality management and have brought greater financial discipline to the company. "If they did not feel we could support this level of debt, we wouldn't have this level of debt," Mr. McGlade says.

Intelsat referred questions about the dividend to its private-equity owners, all of whom either declined to comment or didn't respond to requests for comment.

Last year, Intelsat said it would borrow more than $3 billion to acquire PanAmSat, creating the world's largest satellite operator. PanAmSat was also controlled by private-equity funds -- KKR, Carlyle and Providence Equity Partners Inc. -- which bought the company for $4.3 billion in 2004. Two months after the firms initially bought PanAmSat, the company borrowed to pay its new owners a $245 million dividend. Five months after that, it paid them an additional $200 million dividend with proceeds from a March 2005 IPO.

Rating agencies fretted that the owners could continue paying themselves steep dividends instead of reducing the company's debt.

The merged company is expected to have less need for backup satellite capacity, reducing the need to launch more satellites in the future, boosting cash flow with which to service its debt. It also has a sizable business backlog, made up primarily of long-term contracts that are difficult to cancel. Still, to assuage the rating agencies' concerns, Intelsat promised to pay no dividends for 12 months after the deal's close, which took place July 3.

Nevertheless, "We and the market are rightly concerned about what is going to happen after 12 months," says Gerald Granovsky, an analyst at Moody's. "We are concerned that taking dividends will be really mortgaging the future of the company because you'll be taking out the [financial] capacity you may need in the future."

Burger King Is Gobbled Up

The Burger King deal took place in 2002, when British liquor giant Diageo PLC initially agreed to sell Burger King for $2.3 billion. The chain had gone through multiple CEOs, it was unprofitable and many of its franchisees were in dire financial straits.

The price was negotiated down to $1.4 billion by the trio of private-equity firms, led by Texas Pacific Group and its hard-charging founder, David Bonderman, who once made a splash by booking the Rolling Stones to play at his 60th-birthday party in Las Vegas. The private firms put up their own equity for a third of the purchase. The remainder was debt later taken on by the company, including a loan from the new owners.

Burger King's May IPO valued the three firms' holdings at $1.8 billion. A few days later, they sold 4% of those holdings for $64 million as part of their agreement with the underwriters. But their investment had already delivered handsome returns. In addition to the $448 million in dividend and fees, Burger King reimbursed its owners $500,000 for legal fees and $650,000 for unspecified expenses, and also paid them $55 million in interest on their loan, which the company repaid early with new borrowings. Separately, Goldman earned $6.35 million in fees for its part underwriting the IPO, according to Thomson Financial.

In all, the firms received $511 million in dividend, fees, expense reimbursements and interest from Burger King without having to relinquish control. Today they have a 76% stake, valued at about $1.5 billion.

Company security filings say the quarterly management fees were for "monitoring our business through board of director participation, executive team recruitment, [and] interim senior management services." The management and acquisition fees, the filing added, were "comparable" to those paid by other companies to their private-equity-firm owners. Spokesmen for Texas Pacific, Bain, and Goldman wouldn't comment on the Burger King fees and dividends.

Under its new owners, Burger King initiated a program to help struggling franchisees restructure their debts, revamped its menu and redesigned its stores. At first, its performance deteriorated further. Many franchises were closed or taken over by the company. Same-store sales fell, and the chief executive hired by the buyout firms quit.

Company performance has improved since 2004. Operating cash flow has risen to about where it was at the time of the buyout. Same-store sales are up. The company has also expanded abroad, opening stores in China, for example, for the first time. Burger King used its IPO proceeds to pay down debt that financed the dividend and has avoided credit-rating downgrades. Still, its market share has continued to fall, and since the IPO, Burger King Holdings' shares have slipped 13% to $14.85 in 4 p.m. New York Stock Exchange composite trading.

In a written statement, John Chidsey, Burger King's CEO, said that the fast-food chain "was a distressed, poorly performing business" before its buyout. Under the new ownership, its "performance has improved dramatically" thanks to the buyout firms' "continuing support of management's vision and direction."