Eight years after the collapse of the housing market and the ensuing financial crisis, The Carlyle Group has been called to Guernsey, a tiny British dependency in the English Channel, by a group of former shareholders who believe it's time for the firm to pay the piper.
The issue at hand: Carlyle Capital Corp. (CCC), a fund that employed heavy leverage (30x or more its capital on hand) to purchase $23 billion in mortgage bonds in the immediate lead-up to the crash. When the market tanked, investors in CCC lost all of the $945 million they had contributed, according to The Wall Street Journal (whose reporter Margot Patrick is on site and has led media coverage of the case). The fund’s liquidators are now seeking $1 billion in a civil suit in Guernsey—where CCC was initially registered—alleging seven senior Carlyle officials acted recklessly and negligently in managing the fund’s assets, prioritizing protection of the firm’s public image over its fiduciary responsibility.
The firm’s essential defense now seems to be a plea of ignorance: How could we have known how bad things were going to get?
“We all lived through something that was worse than the worst-case scenario,” Carlyle co-founder Ed Conway said in court, per WSJ. “It was highly leveraged, but I didn’t think the risks were going to happen.”
In retrospect, CCC was doomed from the start. As it was preparing to go public on the Amsterdam exchange during the summer of 2007, cracks had already begun to show in the U.S. subprime market. CCC eventually listed its shares at $19 apiece, below its planned price window. In less than a year, that figure had plummeted below $1, and the fund was shut down and liquidated.
According to court filings detailed in WSJ, emails from Carlyle co-founder David Rubenstein, sent before CCC went public, appear to indicate an awareness that the entity was likely to fail. “I’m at a loss to say how the whole market can be wrong about the product at this time and we are right,” Rubenstein wrote. More court filings indicate that the CCC board considered selling off $4 billion in bonds a few months before it defaulted on its loans, but chose not to because it would have meant absorbing significant losses.
This marks Carlyle’s second high-profile legal engagement, coming on the heels of the firm’s $115 million settlement from August 2014 in a bid-rigging case brought against it and a number of private equity heavyweights.
Although the CCC case will of course be prosecuted by the professionals in court, from the outside, it appears both Carlyle and its spurned investors have at least a partial point. Carlyle could have done more to minimize losses, but it also truly appears the firm did not see the market meltdown coming.
For evidence of that, one need only turn to an email sent by Conway to CCC chief executive John Stromber on August 14, 2007—a month after CCC had gone public and as the mortgage bond market continued to spiral further out of control.
“Maybe,” Conway wrote, “panic is appropriate.”