Rolling in War Bucks

How the state public employees' retirement system and the politically connected Carlyle Group profit from defense

Q: The President was in Santa Clara last week and he appeared at United Defense, a major defense contractor controlled by the Carlyle Group. The President's father is a paid advisor to the Carlyle Group. So you have a situation where the President was there touting the products of the company that directly benefits financially his father. Why isn't that unethical?

MR. FLEISCHER: The question is, are Bradley fighting vehicles part of what the military does that should be supported. The answer is, of course, yes, regardless of who serves on Carlyle.

Q: What if the President's father was, like, the President of United Defense? Would that be unethical?

MR. FLEISCHER: What if the President's father was on Social Security and the President wanted to strengthen the Social Security program so all Americans could have a strong retirement. (Laughter.)

-- from a May 8 White House press briefing by then-Press Secretary Ari Fleischer

When questions about corporate governance and transparency dominate the national news, you can be pretty sure you'll be reading cluck-clucking quotes from someone connected to CalPERS, our state's retirement system for public employees. With more than $145 billion in assets, the system is one of the bigger dogs on any financial block, and it is not shy about using its clout to influence entities with which it does business. Recently, CalPERS's bark added velocity to the defenestration of Dick Grasso, the longtime New York Stock Exchange chairman with the salary so large it made even the greediest of Wall Street investment bankers blanch.

Indeed, the retirement system has a long and public history of advocating for increased attention to corporate openness and ethics. For the last year or so, for example, state Treasurer and CalPERS board member Phil Angelides has been pushing the retirement system to "encourage" American companies that have moved their headquarters to offshore tax havens like the Cayman Islands to come back home. "You have 6,000 or 7,000 public companies in America playing by a common set of rules," the San Francisco Chroniclequoted Angelides as saying last year, "and two dozen or so outliers who want all the benefits of being part of this American society without paying their fair share."

That's not to say the notion of CalPERS as reformer lacks all comic undertones; when it is a subject of inquiry, CalPERS can sometimes be about as open as the Politburo. Last fall, for instance, the San Jose Mercury Newshad to sue the retirement system because it had stopped providing even cursory information about CalPERS's investments in venture capital funds. A few months later, the system capitulated, agreeing to provide some data on rates of return in the venture capital funds in which it had placed public employees' money.

At that point, though, CalPERS suggested it might be so generous as to tell its beneficiaries even more about what it does with their money when it is thrown into the venture capital realm. "We intend to work with other institutional investors, the private-equity industry, and the public to develop the best reporting standards,'' the San Jose Mercury Newsquoted CalPERS board President William Crist as saying.

In an effort to help CalPERS reach its financial transparency goals, I called the retirement system last week to ask for details about its investments in various entities related to the Carlyle Group, a "global private equity firm with $16 billion under management," according to the firm's Web site. Being the avid reader you undoubtedly are, you probably already know something about Carlyle; it's the firm wise enough to have hired former President George H.W. Bush, former Secretary of State James A. Baker III, former Office of Management and Budget Director Richard Darman, and former Secretary of Defense Frank Carlucci in advance of the election of Bush's son as president. (The Carlyle Web site says President Bush's father retired this month from his position as a senior adviser to Carlyle; Carlucci moved recently from the chairman's seat to a position called chairman emeritus.) It's the firm that takes money from institutional investors and high-wealth individuals -- notably, according to some publications, members of the Saudi Arabian ruling elite, including, until Sept. 11, 2001, intervened, the bin Laden family -- and invests it around the world. Those investments run the gamut of business sectors, from defense to energy to health care to telecommunications and beyond.

My interest in the CalPERS-Carlyle link was sparked by some Securities and Exchange Commission documents that skittered across my desk recently. The documents described an interesting or dismaying development (depending on one's views on defense investment) that had a CalPERS connection, and had received relatively little attention in the press. It's a fairly complicated development, though; excuse me while I drag you through some necessary detail.

In August, the owners of nearly half of the stock of a major U.S. military contractor, United Defense Industries Inc., decided to sell a chunk of their holdings. The sale brought the owners of the stock something like $270 million. The sale capitalized on significant increases in United Defense's revenues, earnings, and stock price realized in the first six months of this year -- a six-month period that also happened to include, in Bush administration terminology, "major combat operations" in Iraq.

It is, of course, hardly extraordinary when the owners of defense companies profit from war. There is something a wee bit unusual about this case of war profit-making, though. In this case, the entity that reaped profits from the U.S. defense buildup and the Iraq War was a company employing a host of political luminaries, many of whom served in past Republican administrations or have connections to the current Republic administration.

But that's not quite the whole of the development I found noteworthy.

Yes, the Carlyle Group arranged for a group of investors to buy into United Defense and, apparently, make money. The actual identities of many of those investors have not been publicly revealed; in fact, some of those identities are obscured in partnerships based in the secrecy-happy offshore tax haven of the Cayman Islands.

All the same, there is one known beneficiary of war involved in the interesting/dismaying developments of this summer. It is the California Public Employees Retirement System.


Because calling someone a "beneficiary of war" could seem impolite, let me put on my best Sunday suit and restate the matter: Carlyle and its strategic business partner, CalPERS, apparently made a lot of money this summer, and some of the profit might be reasonably attributed to war in Iraq. Here is how the moneymaking came about.

Carlyle's involvement with United Defense Industries began in 1997, in a transaction the firm's Web site describes this way: "United Defense was formed when Carlyle acquired the partnership interests of FMC Corporation and Harsco Corporation for $850 million in October 1997. Following a leveraged recapitalization during the summer of 2001, United Defense went public in an initial public offering completed in December 2001. 'United Defense has been a successful investment due to great execution,' says Carlyle's [managing director] Allan Holt. 'The management team has faced an ever changing defense environment and reacted quickly and appropriately.'"

That United Defense would profit in the post-9/11 environment of increased security spending seems axiomatic, given the broad range of military products and services the company provides. Among other endeavors, the firm is the prime contractor for the Bradley Fighting Vehicle, the Army's chief armored personnel carrier; an automated gun system for the U.S. Navy; a missile launch system for the Navy's surface ships; and the next generation of motorized artillery for the Army. The firm has a division that constitutes, according to the Carlyle Web site, "America's largest non-nuclear ship repair and modernization company." And United Defense has been selected to help develop ground combat vehicles for the Army's Future Combat Systems, a central component in Secretary of Defense Donald Rumsfeld's multibillion-dollar plan to use technology to "transform" some portions of the U.S. military into lighter, quicker striking forces.

A prospectus filed ahead of this summer's United Defense stock sale makes it clear that the likelihood of increased U.S. defense spending and continued U.S. war fighting makes the company's financial future seem bright. In a section titled "Industry Overview/Market Opportunity," the prospectus notes that defense spending will grow about 4 percent in the next fiscal year and is expected to continue to increase. Beyond those general trends, the prospectus says, the defense sector generally, and United Defense in particular, is likely to prosper because of "greater repair and maintenance requirements due to significant wear and tear on both naval vessels and armored vehicles from the United States' involvement in extended deployments as well as active military conflicts, such as the recent war in Iraq."

Carlyle's investment in United Defense has already paid, literally and figuratively, dividends. In addition to the $270 million raised in the August sale, the Bloomberg News Service reported, "Carlyle has sold almost $500 million in shares of [United Defense] in public offerings since 2001, pocketed about $350 million in dividends before the company went public, and still owns about $350 million of stock, according to Securities and Exchange Commission filings."

CalPERS's involvement with Carlyle began in 1996, with a commitment to put $80 million in a private equity fund called Carlyle Partners II. In 2000, the retirement system pledged to invest $150 million in Carlyle Partners III. A CalPERS press release from early 2001 says the retirement system was so happy with its Carlyle relationship that it would purchase a $175 million piece (or 5.5 percent) of the Carlyle Group itself and commit to place another $250 million in Carlyle equity funds. The press release says CalPERS had an option to invest an additional $425 million with Carlyle over two ensuing years.

The Carlyle Web site lists United Defense as one of the holdings in the portfolio of Carlyle Partners II, the first Carlyle partnership in which CalPERS invested. In an SEC document filed in August, a Carlyle-related management firm reports that it sold 10,569,808 United Defense shares for $25 each on behalf of an entity that includes both Carlyle Partners II and Carlyle Partners III, also a recipient of CalPERS funds. According to SEC documents, at least two other Carlyle partnerships -- Carlyle International Partners II and Carlyle International Partners III -- were also part of that entity. The latter partnerships have an interesting provenance. They were formed in the Cayman Islands. Yes, the Cayman Islands favored by many who wish to keep their business affairs secret. The Cayman Islands known as havens for some firms (including the ones CalPERS board member Angelides has roundly criticized) that seek to limit the amounts they pay in U.S. taxes.

So let's do another round of restating here: CalPERS partnered up with the Carlyle Group (which has received criticism over its political connections to the current Bush administration) and some largely unnamed wealthy investors (who, it seems, find the Cayman Islands congenial business territory) and made money from the Iraq War and the prospect of a continuing defense buildup for the War on Terror.

What's so wrong with that?


Even with the recent resignation of Bush the elder from its ranks, the Carlyle Group is no ordinary company, and the size and breadth of its worldwide financial and political connections are not common. It is a firm that has invested widely in the defense sector, and those investments have been controversial. In Europe, Carlyle's defense investments in England, Germany, and Italy have sparked concerns about technology transfer and loss of national control of defense assets. In the United States, eyebrows have raised over the closeness of current Defense Secretary Rumsfeld and Carlyle Chairman Emeritus Carlucci (college classmates and longtime friends) and the development of a new motorized artillery system for the Army. In Asia, there have been questions about whether Carlyle's investment in a South Korean bank influenced U.S. defense policy toward North Korea.

While complaining about being called secretive, Carlyle refuses to disclose many of its owners, and almost all information about investors in its partnerships. The firm's Web site puts it this way: "Carlyle's investors are public and private institutional investors and high net worth individuals. Carlyle does not disclose information about its investors."

Christopher Ullman, a spokesman for Carlyle, said most such equity firms are private and not required to disclose ownership information. Carlyle is "very honored" to be affiliated with CalPERS and believes the relationship benefits both entities, he said. "We've provided very good returns for their investors, and the credibility that comes with [CalPERS's] investment serves us well," Ullman said.

Carlyle's involvement in defense has been overemphasized by the press, Ullman said; the firm has just 6 percent of its portfolio in defense properties, and laid out for CalPERS all the areas in which its funds would invest ahead of time.

(In a side note, Ullman said former President Bush resigned from Carlyle because, at age 80, he "decided to ratchet back on his business activities. We very much enjoyed the relationship.")

As a private firm, the Carlyle Group has every right to keep most of its financial and ownership information private, to seek maximum profit allowed by law in any business sector, including defense, and to employ whomever it wishes, including public officials of any persuasion.

But CalPERS is a public entity that should be able to tell the public whether it is allied with, let us say (in the absolutely hypothetical case), a bunch of Saudi princes when it sells part of a major military contractor that's played a significant role in a U.S. military conflict in a country that borders Saudi Arabia. And it seems, at the least, odd that a public entity that portrays itself as a champion of openness and a foe of offshore tax shenanigans would be partnering with firms that set up shop in the Cayman Islands. That circumstance doesn't seem odd just to me.

Bill Allison, a spokesman for the Center for Public Integrity, a Washington, D.C.-based, nonpartisan government watchdog group, says CalPERS involvement with offshore entities "raises eyebrows."

"I have to say that is strange that a public pension fund is involved with offshore entities like that. ... You have something like CalPERS, which is supposed to have accountability and transparency, and you're dealing with a group [Carlyle] that is the opposite of that, very opaque," Allison says.

I asked the retirement system whether it would disclose its co-owners in the Carlyle Group and co-investors in Carlyle partnerships -- particularly the previously mentioned partnerships chartered in the Cayman Islands. In response, CalPERS Media Relations Manager Brad Pacheco said he had searched the system's meeting agendas and associated public paperwork in regard to Carlyle and found no disclosure of such ownership. Determining whether other CalPERS staff had ownership information, and whether the retirement system's contracts with Carlyle permitted disclosure of that information, would require more time than my deadline for writing this column allowed, he indicated.

He indicated it five days after receiving my written request for the ownership information.


When it comes to the retirement accounts of 1.4 million public employees, retirees, and their kin, I'm not a PC cause-pusher. The beneficiaries of CalPERS deserve a retirement system that's doing everything reasonable to keep returns and benefits high.

When it comes to the way business is done in Washington, I'm no doe-eyed do-gooder. Engaging in business with the federal government requires the use of people with experience and personal connections in the federal system. One acquaintance of mine describes it as a "player" system. Either you've got the right players on your side, or you lose; it's that simple.

When it comes to business-government relations, I'm no conspiratorialist. Carlyle employs many talented people, and a good deal of the firm's success is no doubt attributable to smarts and hard work, rather than inside dealing with government.

Still, as the generally staid New York Timesnoted in a recent unsigned editorial, "It is hard to enter the debate over postwar Iraq without tripping over a business associate or political ally of the White House." There is indeed a debate about the appearance of financial favoritism by members of the Bush administration, particularly in regard to defense and foreign affairs. Carlyle has become part of that debate.

I asked Pacheco, the CalPERS spokesman, whether the media controversy surrounding Carlyle had ever caused the retirement system board to rethink its investment strategy with the firm. He said he's been with CalPERS eight years and does not remember any such discussion, and a check of records for CalPERS board meetings also found none.

I was unable last week to reach Angelides or other CalPERS board members who might want to talk about the CalPERS-Carlyle connection. I think it's about time that the board and the retirement system's membership have a real discussion about that link, and openness, and defense investment, before someone trips while reading a retirement statement.

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