In a Too-Close Tango, Carlyle Trips Over Age-Old Missteps

And then, of course, there was the leverage. I'd really like to know when it became a "conservative" investment strategy to buy $22.7 billion worth of long-term securities with $21.2 billion in short-term loans, as Carlyle Capital did. And when was it decided that it was prudent business practice to have only $175 million in cash in the bank in case the value of those $22.7 billion in securities falls and the lenders decide they are only willing to finance 97 percent of the fair-market value rather than 98 percent?

And then there are the fees -- oh, the fees.

First, there's the annual management fee of 1.75 percent of equity paid by the investors of Carlyle Capital to the Carlyle Group. That's a guarantee of $15 million. Add to that the "incentive fee" if the fund earns more than an 8 percent return on equity, which is not much of a stretch when you're working with 96 percent leverage. The incentive fee for the first half of 2007 came to $4.7 million. And let's not forget the 6 percent of Carlyle Capital stock that was awarded to Carlyle Group and its employees upon successful completion of the IPO. By my calculation, that works out to another $55 million.

It comes to about $80 million in the first year alone, or nearly 9 percent of all the money provided by investors, net of investment banking fees.

And for what? Borrowing $21.2 billion from Wall Street broker-dealers at 5.3 percent and using it to buy asset-backed securities that yield 6.5 percent. How hard can that be?

Measured against any objective criteria -- the number of people and hours worked, the uniqueness of the skills, the creativity, the risk -- these fees are excessive. They are also very typical. And in that, they are another symptom of how out of whack things have become in the world of high finance.

Finally, there's the conflicts of interests woven all through the relationship between Carlyle Capital, a supposedly independent, publicly held company, and the Carlyle Group.

It's not just that Carlyle Group employees, partners and advisers run Carlyle Capital, control its board and own 17 percent of the stock. It also turns out that most of the other big investors in Carlyle Capital are also investors in Carlyle Group funds. And that Carlyle Capital's investment strategy includes buying the debt used to finance the Carlyle Group's private-equity deals and making equity investments in other Carlyle Group funds.

It's all perfectly legal and all disclosed in the offering documents. And indeed it's an increasingly common practice. But nobody has explained why it is a good idea to have the affairs of a supposedly independent, publicly traded company with small individual investors so hopelessly entwined with a complex set of private-equity partnerships. Whose interests will Carlyle Group put first when one of its deals turns sour and it has to balance the various and competing interests. In a crunch, which fund will be sacrificed and which fund will be saved?

I don't know about Guernsey, but in the United States, there are good reasons for our rules about corporate governance and investor protection. And there are good reasons why prudent bankers don't allow investors to buy securities on 98 percent margin. Why is it that every generation of financial wizards feels the need to learn these lessons all over again?