It was a great scam.
—Stephen Norris,

co-founder Carlyle Group, May 20, 2002

Stephen Norris is getting excited now. Even today, recalling the events that led to the formation of the Carlyle Group, the company that would eventually come to represent Norris' legacy, gives the 53-year-old Washington dealmaker a thrill. Though they didn't know it at the time, co-founders Norris and David Rubenstein, a young staffer from the Carter administration, were embarking on the ride of a lifetime.

With a nose for the big deal, the cocksure Norris is, by his own admission, a difficult man to get along with. His time with the Carlyle Group, ending abruptly in January 1995, was marked by tension, competition, and conflicting egos. He is a man with casual disregard of those with whom he is conversing. His eyes flit around the room. He looks at everything but you. He talks freely, with no fear of consequence, and rarely pauses for a retort. He talks over you. Athletic, fit, handsome, and with a healthy taste for the good life, Norris speaks longingly, even boastfully, of his time with the Carlyle Group, fondly recalling his blockbuster deals with rich Saudi princes and Fortune 500 companies. He is, and always has been, a man that swings for the fences.


In late 1986, Norris, then an executive with Marriott's mergers and acquisitions group and a tax whiz, got wind of a little-known tax loophole that allowed Eskimo-owned companies in Alaska to sell their losses to profitable companies. The origin of the loophole dated back to 1971, when Alaskan natives arrived at a unique settlement with the federal government over ownership claims of Alaskan land. Typically, when Native Americans sued the U.S. government over the atrocities committed during the nation's "manifest destiny" era, the settlements revolved around land, otherwise known as reservations.


The logic went that if the government could return some portion of the land they stole in claiming America for themselves, the irreparable cultural damage done to Native Americans in the process would somehow be forgotten. But the Eskimos weren't buying it. Unlike Native Americans in the lower 48 states, Alaska's natives eschewed the traditional award of land reservations.


Instead, the Alaskans chose cash. Under a unique settlement, Alaskan natives were allowed to set up native-run corporations to invest and manage the money they had been awarded. In the end, the Eskimos and other native Alaskans ended up with $962 million to manage as they saw fit. They also managed to negotiate for 44 million acres of land on which to run their businesses. It was the price paid to them for decades of oppression, and they took it. Because of some bureaucratic foot-dragging and truly unfortunate timing, the newly formed corporations missed out on Alaska's boom time in the mid-1970s.


Fishing, timber, and oil, three of the local industries most companies were set up around, experienced major downturns. Many of the companies fell prey to mismanagement, investing in foolish pursuits like tire manufacturers, concrete plants, and hotels. Even though they had chosen their own fate, the owners of the companies felt they had been set up to fail. More than 180 companies had been formed out of the settlement. Only one managed to consistently turn a profit. It was a total disaster. The companies soon found themselves facing huge losses, and limited options for turning things around.


In 1983, Alaskan Senator Ted Stevens worked to save his floundering constituency by incorporating a clause in the 1984 tax bill that allowed the Alaskan-owned companies to leverage their losses by selling them to profitable companies looking for a break on their taxes. Essentially, if an Alaskan company lost $10 million in a fiscal year, they would sell the losses for $7 million in much-needed cash. The buyer would then write the losses off against its profits, getting a $10 million tax credit for just $7 million. Everyone's happy, except, of course, the government. Norris smelled money. But he needed help from someone. Someone with exceptional connections. Someone that knew everybody, including some Alaskan Eskimos.


Someone like David Rubenstein.

Rubenstein: Carlyle's Beating Heart

Ask enough people about David M. Rubenstein, and you start to hear the same descriptors over and over: brilliant, driven, tireless. Norris still maintains an objective respect for Rubenstein, with whom he joined forces in 1986. Rubenstein had been toiling as a Washington, DC, lawyer for six years with the mergers and acquisitions groups at Shaw, Pittman, Potts &: Trowbridge and G. William Miller & Co. when Norris came calling.


Norris, who often transitions seamlessly between utterly eloquent and outright crude, calls Rubenstein "indefatigable, "indomitable," and "f**king brilliant." Rubenstein would go on to become the very heart and soul of Carlyle, driving the company forward through clashing egos and countless near-scandals. After graduating from the University of Chicago Law School in 1973, Rubenstein worked his way up the political ranks with blazing speed.


At the tender age of 27, he became the deputy domestic policy assistant to President Jimmy Carter. He was the first person in the office in the morning, and the last to leave. One of the most widely circulated stories about Rubenstein is that he survived solely on vending machine fare during his time at the White House, a claim he does not refute. He strongly believed in the nobility of being a public servant. He was young, idealistic, and most of all, innocent. In the spring of 1980, Rubenstein filed a memo to the president late one night.


Before he left to go home—some thought that he was actually living in the White House due to his late hours—he remembered something he had intended to add to the memo, and went into the president's office to fetch the document. After shuffling through some papers in the president's inbox, he found the memo, amended it, and returned it to the stack. The next morning, President Carter questioned Rubenstein about his late-night foray into his office, asking him pointedly and repeatedly what he had seen while he was there.


Rubenstein truthfully told the president that he simply got his memo, and then returned it, seeing nothing in the process. As it turns out, atop the stack of papers on Carter's desk, were the plans for the ill-fated rescue attempt of America's Iranian hostages in April 1980. The story, related to me by Norris, demonstrates Rubenstein's early naiveté. It also foreshadows the paranoia that some say has grown inside him over the past 20 years in Washington, DC. "He sees conspiracies," says Norris.


After Carter lost to Reagan in 1981, Rubenstein was released into the world of high-priced beltway lobbyists. It was a business that insulted Rubenstein's renowned intelligence and underutilized his many talents. His distaste for the work was captured in a 1993 article in New Republic, where he was quoted as saying, "I found it demeaning, it was legalized bribery." His opinion of lobbying would change later in his career. Rubenstein would soon be delivered from the tedium of Washington influence peddling, when Norris, while still working for Marriott, contacted him, looking for a way to cash in on what would come to be known within Carlyle as the Great Eskimo Tax Scam.


Norris' entire job at the time was to scour tax law and find ways to save Marriott millions. He hired Rubenstein and William Barr, the man who would go on to become attorney general from 1991 to 1993, from Shaw, Pittman, Potts & Trowbridge, a Washington law firm that had represented Marriott on the Hill in the past. Along with his relentless work ethic, Rubenstein had also garnered a reputation for his extensive Rolodex. When Norris asked him if he knew any native Alaskans, Rubenstein had no problem coming up with some names.


Marriott ended up paying Rubenstein and Barr a seven-figure fee for their help in saving them a bundle on their taxes in 1986. Norris, after reading the tax bill closely, decided there was a much greater opportunity here than just this one-shot deal. He figured if Rubenstein and Barr could make out so handsomely for their limited role in facilitating Marriott's tax relief, he could, too. Norris left Marriott and set up shop in Seattle to pursue the deals, all the while talking to investors about opening up a little business of his own.

Before long, Norris and Rubenstein were flying Eskimos into Washington, DC, buttering them up, and brokering deals between them and profitable American companies. Finding the loss-making Eskimos was easier than either of them had imagined, and the profitable counterparts couldn't get enough of the free money. Norris and Rubenstein took a 1 percent cut of the transactions and sent an estimated $1 billion through the loophole, A cottage industry had been born. After clearing close to $10 million, Norris and Rubenstein recognized the ongoing potential of the business, and decided to incorporate.


For corporate representation, the two hired none other than Ron Astin of the venerable Houston law firm Vinson & Elkins. (Astin would later find himself testifying before Congress about offshore partnerships he had helped set up for Enron.) With the crew in place, liabilities limited, and money coming in the door, the boys were ready to make something of themselves. All they needed now was a name.


During this time, Norris and Rubenstein frequented the Carlyle Hotel in New York. Norris loved the place. It was the kind of over-the-top lavishness he couldn't get enough of. It had a high-roller feel to it. His hero, Andre Meyer, the legendary head of investment bank Lazard Freres, had lived there for years. Norris felt the name lent the company a silk-stocking air. After selling Rubenstein on the idea, the Carlyle Group was born. That the Carlyle Group was formed out of a temporary tax loophole, which was eliminated a year later, is utterly appropriate.


David Rubenstein, as dedicated a public servant as there ever was, saw fit to found his company on a scheme that denied the federal government close to $1 billion in taxes. It was the first of many ironies that would compromise Rubenstein's political roots as his career with Carlyle progressed. As with many of the Carlyle Group's future deals, the Great Eskimo Tax Scam was entirely legal. Whether it was ethical, is another question.

The tax loophole unwittingly encouraged Eskimo companies to overstate their losses, and the IRS was called in to investigate. A discrepancy between "hard" and "soft" losses arose. Corporate appraisers took liberties in estimating the loss in value of certain goods, like timber and oil. Suddenly everyone in Alaska had losses for sale. It was a bonanza for accountants.


Though no charges were ever filed, the case portends the current corporate malfeasance in America, in which companies inflate revenues and earnings through marginally legal accounting. It bears mentioning that in certain cases, the tax loophole actually did what it was intended to do. Some Alaskan companies took the capital they received and reinvested, saving themselves from certain bankruptcy. Finally, however, just before Carlyle could complete a $500 million deal with a company called Cook Inlet, the government had seen enough of its money wasted, and sewed up the hole.


It was the end of a great scheme for Carlyle, and it would be the last easy money the company saw for half a decade.

Goin' Legit

After the tax loophole closed, Norris and Rubenstein briskly went about building an empire. They brought Dan D'Aniello over from Marriott, whose salary Norris personally guaranteed. They also signed up William Conway, a former chief financial officer at MCI Communications. Funding for what Rubenstein was pitching as a leveraged buy-out firm came mainly from Pittsburgh's wealthy Richard K. Mellon family and Ed Mathias at T. Rowe Price, the Baltimore-based investment bank. It only took $5 million to get them on their way. It was the go-go 1980s, and big business was flying high.


Leveraged buyouts were the name of the game. This particular brand of cutthroat business consisted of big banks borrowing billions, acquiring huge, positions in struggling companies, snatching them up on the cheap, and selling them off for parts or turning them around. Everyone was getting rich and Rubenstein was itching to get a piece of the action. He would later confess to a reporter that "I thought I had a pretty good IQ myself, and people were making a lot more money than me who I thought maybe weren't so smart."


The most important thing for buyout firms, otherwise known as private equity firms, is raising capital. The more money a given firm can raise, the more successful it can be. Like a mutual fund, a buyout fund collects money from a number of sources—wealthy individuals, institutional investors, pension funds—then invests it on their behalf. But instead of investing in stocks, buyout funds buy companies, with the intention of turning them around and selling them for a profit. Typically, the companies are bought with a mix of capital and debt, somewhat mitigating the risk of the buyer.


Hence, the leveraged buyout, or LBO, nickname. The companies are then held in a portfolio, or fund, which usually has a target market or theme. It can be a dangerous form of investing, open only to the extremely wealthy. Minimum investments in a given fund are usually no less than $1 million, and returns are generally expected to be more than 25 percent, usually within 10 years, sometimes less. Downside can be that much and more.


LBOs are not for the faint of heart. The Carlyle Group based themselves in Washington, DC, instead of the more traditional buy-out firm haunts of New York or Chicago, a move that surprised many in the business. Arthur Miltenberger, then chief investment officer of the Mellon Foundation, would tell Forbes at the time, "I was intrigued by a merchant bank based in Washington, DC, because foreigners have to come to Washington."


Upon incorporation, Carlyle hardly registered a blip on the radar of older, more established buyout firms like Kohlberg Kravis & Roberts and Fortsmann Little.

It was clear from the outset that what the Carlyle Group had to offer that was different from its more incumbent competitors was its access. Newspapers heralded the rise of a new breed of dealmaker: the access capitalist. Indeed, the Carlyle Group's first deals reflected the relationships that its founders had fostered. Carlyle took a $35 million stake in Consolidated Entertainment, a company that was part-owned by Gerald M. Rafshoon, a former Carter administration advisor.


The company was planning a six-hour miniseries for HBO called "The Great Satan," a detailed account of Ayatollah Khomeini and the Iranian hostage crisis, a topic that Rubenstein knew all to well. But it soon became apparent that it takes more to succeed in the world of high finance than a political pedigree and a bunch of swell friends. The company stumbled its way to a disastrous early record, overpaying for ill-advised investments, and getting beat out by more nimble competitors on the only deals that had potential.


In 1987, Carlyle launched a takeover bid of the Mexican restaurant chain Chi-Chi's, only to be outbid by Foodmaker. Then again in 1988, Carlyle began accumulating shares of Fairchild Industries, a Virginia-based defense contractor, only to be out-bid by Banner Industries, which up until that point had been in partner ship with Carlyle. It was a bruising introduction to the world of high finance.


Though the company made about $10 million in stock profits on both deals combined, they were discovering the hard way how the leveraged buyout game was played.

Counting the Jews

Then in September 1988, the Carlyle Group would get an infusion of experience, and controversy, when Frederic V. Malek, a former personnel chief for President Nixon, signed on. Malek, nicknamed "The Ax" for his days as Nixon's strongman, managed Norris and D'Aniello at Marriott in the early 1980s. Close friends with George H. W. Bush, Malek had just been rewarded for coordinating Bush's New Orleans convention with a position as deputy chairman of the Republican National Committee (RNC) in August 1988. But the excitement was to be short-lived.


Less than a month after Malek's appointment, scandal erupted in Washington. In early September 1988, the Washington Post reported that in July 1971, operating under instructions from President Nixon, Malek had compiled figures on the number of Jews working within the Bureau of Labor and Statistics (BLS). Nixon, then at the height of his paranoia, believed that a "Jewish cabal" within the Bureau was undermining him, releasing unfavorable and inaccurate data to the public to damage his approval ratings.


Malek, in a memo dated July 27, 1971, reported that 13 of the top 35 BLS officials were indeed Jewish, and provided their names to Nixon. In the months following, Chief Economist Peter Henle and Director of Current Employee Analysis Harold Goldstein were reassigned to lower level positions within the BLS. At the time these events occurred, nothing was known of Nixon's anti-Semitic sentiments. It wasn't until 17 years later that the incident came back to haunt Malek, when Washington Post reporters uncovered the fateful memo while digging through old files from the Nixon administration.


After the news broke, Malek resigned as RNC chairman immediately and admitted to compiling the figures for the president, but not for reassigning the two prominent Jews. The damage had been done though. Malek knew that he would be labeled an anti-Semite. He knew the public had no tolerance for that kind of ethnically fueled politicking. He knew that he was in danger and he knew immediately where to go. Norris called Malek the day the news hit the papers, and told him to calm down, and come over to the Carlyle offices on Pennsylvania Avenue.


Malek had his motorcade sneak into the garage, so as not to be seen by anyone.

"I've never seen a man so upset in my life," Norris recalls. "He was literally shaking."

Norris set Malek up with an office adjoining his own, and Carlyle gave him a draw, or a salary, which Malek would theoretically have to earn back. Malek was by far the best connected of the nascent company. He brought with him deep relationships with the Bush family, the Saudi Arabian royal family, and countless Washington insiders. Even with his freshly tainted reputation, he would go on to spearhead several big deals for the company, including an ill-fated buyout of Caterair, the Texas-based airline catering company that would hire George W. Bush.


Though Malek's stay at Carlyle would amount to nothing more than time on the lam, hiding out while the furor over his anti-Semitic actions died down, he did manage to set Carlyle up with a handful of high-powered Republican connections. He would soon return to public life to lead President George H. W. Bush's reelection campaign in 1991.


But after Bush lost to William Jefferson Clinton, Malek found that he was no longer welcome at Carlyle.

"No one wanted him back, and it was very embarrassing for Fred not to have a place to land," says Norris. "And it was wrong."

Malek still harbors resentment over what he feels was mistreatment. "His wife still hates me," says Norris. Though brief, Malek's time with Carlyle would ultimately change the face of the company forever.

"I brought a little more name recognition, a little more gray hair," recalled Malek in an interview for this book. He is quick to point out that he never joined the firm outright. "I was off icing there, just a freelancer," he says.

In the fall of 1988, Malek brought Carlyle in on yet another ill-conceived deal to acquire Coldwell Banker Commercial, the biggest commercial real estate broker in the United States at the time. To this day, he asserts his independence from Carlyle on that deal. "It was my deal, my capital, and they just participated in it," says Malek. This exclusive attitude toward Carlyle would eventually cause enough tension between Malek and Rubenstein, that Carlyle didn't see the need to welcome him back after Bush lost the election.


Rubenstein and Conway would often refer to Malek as a "self-centered freeloader." But it was Malek who demonstrated the power of political contacts in deal making, a lesson the boys at Carlyle would take very much to heart. Ultimately, the Coldwell deal was a bust when the real estate market did not cash in on Japanese investments as was anticipated. About the same time, Malek was helping a well-known Texas native by the name of George W. Bush, the son of then President George Bush Sr., buy the Texas Rangers major league baseball franchise.


Like other deals that Malek worked while he was "officing" at Carlyle, the same people who had brought Malek in from the cold found themselves, excluded from the negotiations on the Rangers. There was one deal that Malek would let Carlyle in on, however, that both parties wish had never happened. In a classic LBO, and one of the last major deals of the booming 1980s, Carlyle would facilitate a management-led buyout of Marriott's In-Flite airline catering business. The company would later go on to be nicknamed "Craterair" by Wall Street analysts, and would remain a black mark on Carlyle's record until the mid-1990s. Though the deal would be a major bust, it wasn't all bad.


It would introduce the foundering company to a young Texas businessman known simply by his middle initial: W.

Back to Contents




Coffee, tea, or bankruptcy?

—Forbes, September 26, 1994

Cast of Characters
J. W. Marriott Chairman of Marriott Corp., former boss to Stephen Norris, Fred Malek, and Dan Altobello.

Dan Altobello Former chairman of Caterair.
George W. Bush President of the United States of America.

Stephen Norris

Fred Malek

To understand how Carlyle works today, it is crucial to be fully acquainted with the company's long and sordid history. Each deal the Carlyle Group made, be it a wild success or tragic failure, helped shape what the company has become. Some buyouts that Carlyle participated in helped them gain a better understanding of a new industry. Some introduced them to new people—the human collateral that would open up future opportunities.


In engineering the Caterair deal, Fred Malek would accomplish both. In the case of the Caterair buyout, Carlyle made up for the money they lost— like many of the company's early deals, Caterair was horrendously unsuccessful—by hiring the man that would eventually be the leader of the most powerful country in the world: George W. Bush. Caterair may have been a complete failure by ordinary business standards, but the relationships cultivated therein were more than worth the stinging financial losses.


In Washington, it's not what you know, but who you know, and knowing George W. Bush, then son of the nation's president, was a valuable connection indeed. But getting an in with the president's son wasn't easy, and it all started when the man known simply as "Mr. Marriott" got a hankering to sell one of his businesses.

J. W. Marriott is among the most highly regarded businessmen in the world. He has a proven track record of deft management and strong leadership. His former employees, years after they've left the company, continue to refer to him as "Mr. Marriott," out of sheer respect. He has been known to sense trends in the industry with uncanny prescience. So in 1989, when Mr. Marriott made it known that his company's airline catering division, then known as Marriott In-Flite Services, was on the block, one had to suspect that he knew something the rest of the world didn't know.


Nevertheless, a group of zealous Marriott executives went ahead with plans to buy the stagnating division from Marriott Corp. with the help of the newest merchant bank on the block: Carlyle Group. Originally formed in 1937, Marriott In-Flite had ceased to be a growth area for Marriott by the late 1980s, and Mr. Marriott wanted out. Dan Altobello, who headed the division within Marriott since 1982, decided that he would spearhead a management-led leveraged buyout of In-Flite, meaning the current employees of the division would raise the capital necessary to buy the business from Marriott.


Altobello knew exactly who to call to structure the deal. In fact, he knew them quite well. Norris, Malek, and D'Aniello, were all former Marriott executives and former co-workers of Altobello's, and together they all got to work immediately on putting together a deal. Norris' role was to work the deal such that Marriott's tax liabilities were limited. Malek was needed to help Altobello manage the new independent company (this was a special request of Mr. Marriott).

D'Aniello managed the relationship with Merrill Lynch, which would provide a $250 million bridge loan to complete the deal, the last such deal Merrill Lynch would ever partake in. Negotiations progressed, capital was raised, and then, $650 million later, in July 1989, Marriott In-Flite was sold to its employees and renamed Caterair. Carlyle retained a stake in the new company, as well as collecting a fee for structuring the deal. It would be the last major LBO of the 1980s, the decade of LBOs.


Caterair consisted of 150 different airline customers at 45 U.S. and 38 foreign airports. It had an army of 19,000 employees and revenues of $800 million in 1988. It was a very big deal. Malek and Altobello became co-chairmen and greeted the press with promises of expansion in international markets, particularly the Soviet bloc.


But it was not to be.

Malek's Triangle Trade

At the same time he was working to complete the Caterair deal, Fred Malek was also putting together the largest buyout ever in the airline industry: a $3.65 billion buyout of Northwest Airlines, then the country's fourth largest carrier. Malek worked with Al Checchi and Gary Wilson, two more former Marriott executives, to buy out Northwest, and in June 1989, just days before the Caterair deal was finalized, Malek had successfully completed the Northwest deal.


That Malek was working on two colossal deals simultaneously was disconcerting to the boys at Carlyle, particularly when they had cut out of the Northwest deal entirely. Just a year removed from his disgraceful exit from public life on the Bush campaign trail, and Malek had multiple irons in the fire. (He was also helping George W. Bush to buy the Texas Rangers at this time.) Controversy had slowed down Malek's political ambitions, but it did nothing to hinder his business pursuits. By October 1989, Malek had been named president and CEO of Northwest.


The job required that Malek assume responsibility for day-to-day operations at Northwest, meaning he could no longer devote the time necessary to Caterair, and the burden of running the company fell solely to Altobello. But Malek was no fool. Though he was constantly distracted by his myriad responsibilities, he still had time to make some critical moves for Caterair. By 1990, Malek had decided that George W. Bush would make an excellent board member for Caterair.

"I began spending all my time on the Northwest deal, and when we did the Caterair deal, I thought he (George W. Bush) would be a good guy to be on that board," Malek told me.


"His office had been next to mine on [his father's] campaign, so I knew him real well. He was coming to Washington a lot anyway, and I thought he had a lot of business judgment and practical sense. I just thought he would be a good director."

George W. Bush became a board member of Caterair in 1990, the year after the company was bought out. Up to that point, Bush had a decade's worth of experience in the oil industry, but nothing even resembling the service-oriented business of airline catering. But George W. Bush had far more valuable things to offer than direct business experience.


His father was president of the United States at the time and one would think that had to be worth something, both to Malek personally and to Carlyle. In effect what Malek had constructed was his own personal triangle trade. Caterair did a sizeable business with Northwest. Northwest needed some help from the Bush administration on some regulatory issues, after Congress began questioning the airline's near-monopoly status at certain hubs. Finally, George W. Bush needed to bolster his business resume, and Malek of course was close friends with his father.


Between currying favor with the president and securing business for Caterair, Malek had killed two birds with one Bush. And that's how cronyism works. Despite Malek's public statements about Bush being appointed because of his business acumen, one Caterair board member said the real reason that Bush was named to the board was to help Malek out on with the regulatory issues he was facing at Northwest.


The board member also says that Malek, Bush, and Alto-bello would often huddle together at Caterair board meetings, excluding the rest of the board. Bush's involvement in the day-today activities of Caterair was nominal at best.

"We all coveted his custom Texas Ranger's boots, signed by Nolan Ryan," says the board member, recalling what George W. Bush added to the board. "He was really smart but not really engaged in Caterair's business."

The point at which arrangements like Caterair's break down is when the few individuals who control the company are maneuvering so feverishly for their own personal gain, that the well-being of a company, and its 19,000 employees, is overlooked. Business went on that way for a time until the airline catering industry hit a wall that Caterair was ill prepared to climb. War in the Gulf, higher oil prices, and a nationwide recession combined to devastate revenues in the airline industry. Airlines started shutting their doors, facing bankruptcy.


In 1991, alone, Caterair lost two of its best customers when both Pan Am and Eastern Air Lines stopped flying because of financial insolvency. Adding to Caterair's woes, airlines started aggressively cutting costs, and one of the first places they looked was their meal budget. By 1993, the nine major airlines had cut food costs by 8 percent. Peanuts and crackers took the place of hot meals. Low-cost airlines that rarely served meals at all, like Southwest, steadily gained popularity.


The pullback vanquished profitability in the catering business, which was already operating on razor-thin margins.

"They could not cut costs fast enough," Malek bitterly recalls of the airlines.

Norris' Self-Destruction

Caterair lost $185 million in fiscal 1993, down from a profit of $52 million the year before, and the company was in a dire position. At this point, dissension began to fester in the boardroom.

Norris wasn't making any friends at Caterair, riding management and looking for alternatives and exit strategies for the company's quickly evaporating business. He began taking matters into his own hands, looking for buyers and raising money from personal acquaintances. He even held meetings with potential acquirers, like Sodexho, a massive international facilities management company.


Norris was pushing his own agenda, and his fellow board members didn't appreciate it. But they all had their own agendas as well. With so much disparate intent in the boardroom, it's no wonder the company failed. Then Norris went too far. Carlyle had been attempting to negotiate a management fee at Caterair, a customary payment in a leveraged buyout, but something that Carlyle did not ask for until years after the deal had been done.


The Caterair board was about to approve the fee, which would at least bring some dividends from the deal back to Carlyle. To do so, the board held a meeting to vote on it. When it came time to vote, the board asked those members of the board who were also on staff at Carlyle to leave the room, due to their obvious conflict of interests. Norris, who had been attending the meeting from Paris via speakerphone, unleashed an inexplicable tirade of obscenities aimed at the board, according to people who were in the room.


Apparently indignant at having to hang up during the vote, a perfectly reasonable request, Norris refused. His fiery outburst incensed the other board members, and ended up costing Carlyle the management fee.


Reminded of the incident, one Carlyle staffer explained Norris' actions like this:

"That's just Steve. One minute he's a brilliant businessman, on the trail of a big deal. The next he's a maniac. Steve is incredibly erratic."

Norris then instructed one of his staffers at Carlyle to work up some numbers on how a sale to Sodexho might save the equity in Caterair. Norris had very little confidence in Altobello's ability to steer the company through these troubled waters.


He felt that Altobello had already missed opportunities to exit the business with their reputations and their bank accounts intact. Norris often criticized Altobello's ineptitude to colleagues and friends. So instead of bringing the paperwork to the company's CEO, he naively brought it to Malek, thinking he could confide in him. It didn't take long for Altobello to find out what was going on behind his back, and he went ballistic, according to Norris. Altobello told Norris he had no right to attempt a sale of "his" company. Norris was asked to leave the board, and it would signal the beginning of the end of his Carlyle career.


But it would get even uglier. Shortly after Norris left, in 1994, George W. Bush would also jump ship. In a move that would dog him throughout his Texas gubernatorial campaign, Bush quit the board in May, in the midst of Caterair's financial unraveling. Incumbent Governor Ann Richards attacked Bush's business record, questioning Bush's claims that he was a successful businessman.

"Mr. Bush continues to insist that he's a successful businessman, but when you take a hard look at his record, it's clear that he's not what he says he is," said Chuck McDonald, Governor Richards' spokesperson.

With layoffs and losses mounting at Caterair, it was hard to argue.


Bush responded feebly in the Dallas Morning News, saying simply that,

"the airline food business is going from hot meals to peanuts, and this company is in the process of adjusting."

The roof was caving in fast now, the result of squabbling in the boardroom and difficult economic circumstances. Forbes ran a scathing expose of the company in September 1994, entitled "Coffee, tea, or bankruptcy?"


In it, the magazine ridiculed Altobello for drawing more than half a million dollars in annual salary as his company went belly up. Competitors were beating Caterair to international markets, which were the only markets growing at this point. Finally, Caterair was unable to diversify into a number of the ancillary markets its competitors were exploring, because of a non-compete clause with Marriott the managers signed when they led the buyout five years earlier. It was now all too clear why Mr. Marriott couldn't wait to unload the catering business.


It was a lemon. Adding injury to insult, Representative Harold Ford told newspapers that he nearly choked to death during a Northwest flight in 1992, catered by Caterair. The Democratic congressman from Tennessee claimed there were multiple unidentified objects in his steak and potatoes that tore up his mouth and throat. He filed a lawsuit for $18 million against Caterair. It was horribly embarrassing for the faltering company, and it would coincide with Caterair's last gasp. In September 1995, Caterair completed a deal with Onex Food Services, the parent company of Sky Chefs, Inc.


The value of the transaction was slightly more than $500 million, far less than the $650 million that was originally paid for the company, which had grown its operations in the six years it had been independent, and should have been worth much, much more. It was, by all accounts, a disastrous deal. Carlyle, Malek, and Altobello had all taken a bath on it. By this time, Malek had been spurned by Carlyle upon his return from the unsuccessful Bush reelection campaign and had gone on to start up his own private equity concern—Thayer Capital.


He offers this understated comment on Caterair's ruination:

"What went wrong is that you had the Iraqi invasion of Kuwait and the explosion of oil prices, which led to reduced travel and higher oil prices for airlines. There was lower passenger count because people were afraid to travel, and now higher costs because of the huge spike in fuel. We were in a survival mode as the airlines uniformly and drastically cut food service. We had to find a way to come out of that as best we could, and we were able to do that by merging it into Sky Chefs. We got enough cash to pay off debts, and a little bit of equity. It was not a screaming home run."

The saga of Caterair serves as a microcosm of Carlyle's early years. The infighting, egos, petty jealousies, and conflicting agendas of the Caterair board were the same problems that Carlyle would wrestle with for years. Until Norris left the company in 1995, Carlyle would struggle with achieving solidarity among its upper management and creating a unified identity.


Caterair was the first of many examples of the fracturing within Carlyle in the first seven years of its existence. But Caterair wasn't all bad. Caterair turned out to be a very expensive introduction to then-President Bush's son for Carlyle. From George W. Bush, to James Baker, to George H. W. Bush, the connections made through Caterair would bolster Carlyle's ability to hook high-profile politicians leaving office. In the end, they had Malek, the man to whom they coldly turned their backs, to thank for it.


But it wasn't until 1989, after the Reagan administration had cleared out its desks, that Malek's stamp was permanently impressed on Carlyle. Rubenstein asked Malek who he thought would be a good person to hire coming out of the Reagan White House. Malek thought immediately of Frank Carlucci, the outgoing secretary of defense, and the man who had succeeded him as deputy director of the Office of Management and Budget in 1972. Malek held a cocktail party at his house in Washington, spoke to Carlucci, and quickly sealed the deal.


On January 26, Frank Carlucci became vice chairman of the Carlyle Group, and life at the young merchant bank would never be the same again.

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They used to call him "Spooky Frank Carluci."

—Former Carlyle employee, July 2002

The hiring of Frank C. Carlucci brought more than just the instant name recognition of one of the most dedicated public servants of the last three decades. It brought baggage—boatloads of baggage. Over time, the pattern of Carlyle's hiring practices emerges to reveal a series of old friends helping one another out. Norris helps out Malek, who brings in Carlucci, who helps land James Baker III, who places a call to George Bush Sr. Each successive hire helped cofounders Rubenstein and Norris climb the political ladder, which ultimately delivered Carlyle to its riches. But it was Carlucci that served as the foundation of Carlyle's political reputation. He was the first high-profile, well-publicized hire by Carlyle (Malek was kept quiet for fear of bad press). It was Carlucci that really got the ball rolling, despite his checkered past.


Depending on your political leanings, Carlucci's early curriculum vitae read either like a resume for president of the United States or a checklist of foreign policy snafus. From his days with the U.S. State Department in the explosive Congo to his clean up of the Iran-Contra affair, Carlucci has been everywhere, seen everything, and knows everyone.


He has been called "Mr. Clean" for his ability to mop up politically damaging situations, and "Carlucci the Cutter," for his relentless budget trimming. It was this type of ultimate Washington insider that Carlyle was fishing for when they hooked him in the winter of 1989. And that's exactly what they got. Carlucci's tenure at the firm would result in an astonishing litany of high-powered hirings, from James Baker III to John Major to George H. W. Bush, himself.


But it was Carlucci's dark political past, and the relationships fostered therein, that suddenly made Carlyle's future so bright. Born in Scranton, Pennsylvania, in 1930 to the son of an immigrant stonecutter from Southern Italy, the diminutive, soft-spoken Carlucci attended Princeton University, where he roomed, wrestled, and recreated with close friend Donald Rumsfeld.


He served two years in the U.S. Navy, took some classes at Harvard Business School, and signed up with the State Department as a Foreign Service officer in 1956. After two years as vice consul and economic officer to Johannesburg, South Africa, Carlucci was assigned to the volatile Congo (now known as Zaire) as second secretary in the U.S. Embassy. He was 30 years old.


The year was 1960, and the Congo was a dangerous place to be. The former Belgian colony received its independence in late June and was holding its first public election. But the mood was still uncertain, and the population was volatile. By July, Patrice Lumumba and his nationalist party had assumed control of the sprawling country. Lumumba was rumored to be tight with communist factions in the Soviet Union, and the election results put the United States on edge. Even after Congo's new leadership had been established by democratic means, sporadic violence throughout the country was not uncommon.


While negotiating through tribal violence, which had been fomented by the Belgian colonial government for years, Carlucci's daughter was threatened at bayonet-point, and Carlucci himself was stabbed between the shoulder blades and arrested after a car he was riding in struck and killed a bicyclist. But Carlucci, who was once called "a tough little monkey" by his father, stayed on in the Congo, despite the life-threatening circumstances. Lumumba stayed in power only two months, replaced by Mobuto Sese Seko, America's handpicked successor, in the fall.


But the threat of a Lumumba-led coup to recapture power remained. Uncomfortable with that prospect, the United States began planning an assassination attempt. A poisons expert was dispatched to the region to carry out the mission. An investigative committee led by Senator Frank Church would later reveal that President Eisenhower himself had ordered the assassination. Though many Americans suspected that their government engaged in this kind of murderous behavior during the Cold War, the Church report made it frighteningly real. And undeniably true.


Lumumba was eventually assassinated, though not by U.S. forces. Instead, rival factions within the Congo took his life during a scheduled prisoner transfer. Many still believe the United States was behind the assassination, sharing information on the time and place of the transfer with the executioners. The Church report ultimately cleared the CIA of involvement.


That didn't stop filmmaker Raoul Peck, a native of the Congo who has dedicated his professional life to researching and telling the story of Patrice Lumumba, from including a scene in his docudrama Lumumba that shows a group of men plotting Lumumba's murder. At one point during a vote on the means of assassination, an actor playing Carlucci is asked what he thinks.


His response, intended to appear disingenuous, is,

"My country's government is not in the habit of meddling in the democratic affairs of a sovereign nation. We'll respect your decision."

Peck says his extensive research uncovered that Carlucci was involved in the plot at the highest level, and the scene was used to illustrate that point. Carlucci would fight the filmmaker, and eventually have the scene edited (his name is bleeped out), saying it was a simple case of mistaken identity.

"I was never as fat as that guy," he charmingly told reporters at the film's opening. "The scene is tendentious, false, libelous; it never happened, and it is a cheap shot."

Peck says today that the film's distributor did not want to run the risk of a lawsuit, but Peck stands by the veracity of the film, and in particular, that scene.

Cold War Operative to Career Politician

Thus, began Frank Carlucci's rise through the ranks of the executive branch. Before being offered the number two job at the Office of Economic Opportunity (OEO) in 1969 under his old friend Donald Rumsfeld, he was accused of leading the overthrow of Joao Goulart in Brazil in 1964, Abeid Karume of Zanzibar in 1972, and Salvador Allende of Chile in 1973, according to the London Times.


He was also accused by Italian communists of being behind the 1978 kidnapping of Aldo Moro, and subverting the revolutionary process in Portugal. "He has been a specialist in dirty work and coup attempts in the Third World," Ramon Meneses, spokesman for the Sandinista Front in Nicaragua would tell reporters later. Carlucci denied everything, and nothing was ever proven.


But Carlucci had already earned a couple more nicknames—"Spooky Frank Carlucci," and "Creepy Carlucci"—and his reputation as a Cold War operative in charge of installing pro-Western governments throughout the world would follow him throughout his career. Carlucci went on to succeed Rumsfeld at the OEO, then followed it up with stints at the Office of Management and Budget (OMB) (where he was succeeded by Fred Malek), Department of Health, Education, and Welfare (HEW), and finally landed as the deputy director of the CIA in 1978, under Carter's administration.


During his time at the CIA, Carlucci was accused by conservative senators of weakening the agency through budget cuts, a charge that worked against him when those same senators voted against his nomination as deputy secretary of defense under Reagan (though he was ultimately approved for the job). He also pushed for legislation that limits the public's right to learn of CIA activity through Freedom of Information Act (FOIA) requests, an important tool for Americans wanting to know more about the actions of their elected officials.


By February 1981, working under Caspar Weinberger in the defense department, Carlucci was cultivating a new reputation, that of a master bureaucrat, efficient manager, and loyal citizen. He was seen as a problem fixer, dispatched to hot spots around the world to ensure a positive outcome for the United States. He had a history of attracting, then defusing, controversy.


His legacy in tact, his connections extensive, Carlucci left the public life in 1982 for his first real business endeavor: world trade.

Secret Arms Deals

In what would later become a model for the Carlyle Group, Carlucci signed on to work with the newly formed Sears World Trade, a subsidiary of Sears designed to post executives around the world and compete with Japanese sogo shosha (trading companies). These massive companies leveraged size and extensive resources to conduct international trade, like timber in Thailand for paper in Paraguay, always buying low and selling high.


Like the Carlyle Group five years later, Sears World Trade (SWT) curiously chose to base itself in Washington, DC, and hire ex-government officials as its top executives. Sears World Trade CEO Roderick Hills had been SEC chairman from 1975 to 1977, and knew Frank Carlucci from his time as counsel to President Gerald Ford, when Carlucci was working with Caspar Weinberger in HEW. Hills brought Carlucci on as president of Sears World Trade.


Among the other former government officials that wound up at SWT were Curtis Hessler, former assistant secretary of the treasury, and Alan Woods, former deputy secretary of defense. The group had grand dreams of an international trading powerhouse. The end result was far from it. The company hired more than 1,000 employees, which made it several times larger than comparable companies. And it lost money. A lot of money, very fast. Sears World Trade, lost $12 million in its first year. It lost $16.3 million in its second year. It racked up monstrous travel expenses en route to making precious few trades.


The strategy was ill-defined, and by 1984, Hills would resign abruptly amid growing losses. It was about this time when the press began speculating that company was a CIA cover up. It wasn't an illogical conclusion to draw. There was a conspicuous lack of deals. The numerous staff, many with political ties, in far-flung locations puzzled business analysts. The Washington, DC, address was very unusual. There was no income. And of course, Frank Carlucci was right in the middle of it all. Everything seemed to add up.


But Hills dismissed the claims, telling the Washington Post,

"People like to make fun of the fact that we hired high government officials," explains Hills. "We didn't do that."

Then in 1986, the press learned of covert arms deals that Sears World Trade had participated in over the previous three years. The news hit just as Carlucci, by then chairman of SWT, was chosen by President Reagan to head up the National Security Council, called in to replace John Poindexter, who resigned amid the furor over the Iran-Contra affair. The irony was thick.


A new national security advisor, another arms scandal. Using a subsidiary of SWT, called the International Planning and Analysis Center, Carlucci consulted on the buying and selling of anti-aircraft missiles, radar, jets, and other military equipment for the United States and Canada. IPAC was loaded with exmilitary, and also provided consulting to Third World countries. But nobody within SWT even knew about it.


Donald Rumsfeld, never to be found too far from Frank Carlucci, was a member of the SWT board, and was quoted as saying,

"We received periodic reports on Sears World Trade as an entire company, but I don't personally remember the arms deals."

Another board member reacted with astonishment when he heard the news. "You're kidding," he candidly exclaimed. It appeared to be at least a breach of the public's trust, not to mention shareholders. For a brief time, the news looked like it would be a devastating blow to Carlucci's future ambitions in politics. At a time when he was being called up to restore credibility to the National Security Council, he was being dogged by accusations of yet another controversial covert action.


But like so many times before, and in what would come to be his trademark, the Teflon-coated Carlucci miraculously sidestepped the controversy, and the story died quietly. Carlucci, a master at handling the press, quickly scuttled the potentially damaging story by pointing out that IPAC never did any consulting on "lethal weapons."


That was enough to pacify the press, and just like that, Carlucci was back in public office. Carlucci did not walk away from his time in corporate America empty handed. In fact, he made a small fortune, despite the dismal performance of Sears World Trade. In the disclosure papers he filed upon reassuming government work, he claimed his total income in 1986 was $1.2 million, which included more than $700,000 as a termination settlement from Sears World Trade.


Not bad for steering a company into bankruptcy.

A Farewell to Arms?

In the National Security Council, Carlucci was finally back in his element. He made fast friends with Congress and quickly cleaned house as Reagan's National Security Advisor. He jettisoned the dead weight. He called Senators. He kept an open office. And he hired a young Army Lt. General by the name of Colin Powell as his new deputy.


In short, he was a natural.

"Frank has a tremendous advantage in that he is one of the few people in Washington who gets on very, very well with both Cap [Weinberger] and Secretary Schultz," said Kenneth Adelman, director of the Arms Control and Disarmament Agency at the time.

In fact, Carlucci was well liked by just about everyone, which in DC politics can be as much a liability as it is an advantage. Carlucci is a man known to get things done without screaming and yelling. Norris says of Carlucci, "Frank doesn't like confrontation; he likes people to agree with him." In November 1987, Carlucci would succeed Caspar Weinberger as secretary of defense for the final year and a half of the Reagan administration.


He would spend much of his time refining the budgeting and weapons procurement process, experience that would serve him well in his future role with Carlyle. While in office, he would set up an advance procurement system that favored long-term contracts with various purveyors of military goods. When Carlucci left the office of secretary of defense to join Carlyle, he would have special knowledge of which defense contractors would later be cashing in on the long-term procurement system he had arranged.


And he would take advantage of that knowledge.

The relationships he established while in office would prove invaluable. In 14 months as secretary of defense, Carlucci would travel overseas 13 times, to Europe, the Middle East, Asia, and Africa. He was charming and diplomatic, and he gained supporters throughout the world. Everybody loved Frank. In another of the stunning ironies of Carlucci's career, he fought hard to decrease spending and eliminate unnecessary weapons programs, angering military contractors and the armed forces in the process.


Just 10 years later, he would find himself caught up in the same situation, only this time he would be siding with the contractors, fighting to keep outdated weapons programs alive in his role as chairman of Carlyle Group. Despite his controversy-ridden past, Carlucci was thriving both in and out of the public domain.

"Frank was washed clean by Cap Weinberger by selecting him, Ronald Reagan by nominating him, and the Senate by confirming him," says Norris.

By the time Carlucci took his place at the Carlyle Group, he would have accumulated a history of covert operations, controversial assignments, disastrous business dealings, and a string of connections so powerful that, despite his dismal track record in business, any company would bend over backwards to get him.


As it turned out, that company was the Carlyle Group.

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Being connected to Carlyle sure doesn't hurt.
—Phil Odeen,

chairman of TRW, August 21, 2002

When a Pentagon official leaves office, there are federal restrictions that prohibit that person from working for a defense contractor for at least one year. It is known as a "cooling-off period." Designed to put enough time between active public servants and (heir subsequent private lives, the cooling-off period is widely regarded in Washington as a joke. It is nominal and rather ineffective. The reason it exists, however, is because of the extraordinary temptations that former Pentagon officials face both while they are in office, and the moment they leave, from the many defense contractors eager to get new business.


Braddock, Dunn, McDonald (BDM) was one of those contractors. The company's history, both as a part of Carlyle's portfolio and outside of it, clearly demonstrates the secretive and sometimes surreptitious world of defense contracting—the world in which Carlyle has chosen to do business. In addition, Pentagon officials, like all public officials, are often in a position to capitalize on policy decisions they made while in office.


Carlyle's acquisition of RDM, as with many of their other deals, reflects more on Carlucci's knowledge of the system he helped create and his network of friends than the company's ability to identify a good deal. They are connections he made while acting as secretary of defense, as well as his many other government roles. They are very valuable connections. And it was Carlucci's connections that got Carlyle off its losing streak after a series of disastrous deals, when BDM turned into a bonanza.


Carlucci had accepted his position with Carlyle almost immediately after leaving office, but had only worked peripherally on defense deals. By September 1990, just 18 months after Frank Carlucci had resigned his post as defense secretary, the man who had reengineered defense spending and procurement at the Pentagon was ready to bring his expertise to bear on the industry he had shaped.


Though he had already been wheeling and dealing on behalf of Carlyle with regard to other defense properties, he was now legally able to accept an official position with a defense contractor, an important distinction that would attract defense companies to Carlyle. With Carlucci "cooled off," Carlyle's defense prospects were really heating up.


Defense spending was still anemic after the end of the Cold War and before the beginning of the Gulf War, and Ford Motor Company was looking to divest its defense holdings, namely Ford Aerospace. Carlyle fought hard to buy the entire unit, but it lacked the capital, a shortcoming that would often plague the company in the early going. In the end, the fledgling company lost Ford Aerospace to Loral, a much more established player in defense. Loral bought Ford Aerospace for $715 million in cash.


But thanks to Frank, Carlyle wasn't entirely cut out of the deal. Carlucci's contacts would prove valuable early and often in his career at Carlyle. In particular, his close friendship with Earle Williams, president and chief executive of BDM International, a defense consulting subsidiary of Ford Aerospace, would deliver Carlyle with the firm's most lucrative defense buy out of the early 1990s.


BDM is one of the most successful defense consulting businesses in the history of the industry. When it was founded in 1959 in El Paso, Texas, the company was focused on doing weapons systems analysis, a geeky trade they plied mostly at offices in New Mexico. In 1962, they hired Earle Williams, a young engineer from Alabama, who over the next three decades, that included his promotion to CEO in 1972, came to embody the new spirit of the company, a hard-driving consultancy intent on expanding its business to all parts of the armed forces.


In 1973, Williams and BDM put the harsh summers of Texas behind and moved to McLean, Virginia, just outside of Washington, DC, in order to be closer to the federal government with which it was now doing most of its business. He was moving them to where the money was. It didn't take long for the company to learn the harsh lessons of doing business in Washington, when competitors stole contract after contract from under them because of tight political connections and well-timed campaign donations. It was a lesson that Williams learned the hard way, but one he would never forget.


Over the next two decades, the outspoken Williams would thoroughly insinuate himself into the DC power scene. Suddenly, Williams was everywhere on Capitol Hill, holding fund-raisers, heading civic activities, rubbing elbows with key politicians, and landing on highly coveted advisory boards. Among the close ties that Williams forged during this time was a friendship with Marcia Carlucci, the wife of Frank Carlucci. Williams' ability to work the room was a style of doing business that Carlyle would learn much from.


And, as it turned out, it was highly lucrative.

"I didn't think there was anything unusual with what I was doing at the time," says Williams, who retains his Alabama drawl and speaks with the ease of a man who has long since fought his most meaningful battles. "I just figured if you want to know people, you go where they are. It doesn't take a rocket scientist to figure that out."

Williams got to know Frank through Marcia Carlucci, and also through his work with the Defense Department (DOD) when Carlucci was secretary of defense.

"When [Carlucci] was in the DOD, we had a V.P. that was working in the DOD that was on leave from us ... sort of," says Williams.

Williams' relentless gripping-and-grinning eventually paid off. In 1984, Williams was appointed to the Naval Research Advisory Board, which consulted the Navy on long-term strategic planning. BDM's competitors couldn't believe it. How did this man manage to convince the secretary of the Navy to place him on an advisory board that allowed access to confidential information and Navy officials?


Particularly when the bulk of BDM's business was with the Army and Air Force, not the Navy? (In 1983, BDM did just $1.9 million worth of business with the Navy, an insignificant fraction of their overall business and an unregistered blip on the Navy's massive procurement budget.) The answers would soon be forthcoming and would demonstrate just how much Williams had learned about doing business in the Beltway. In the spring of 1983, BDM hired a little-known market researcher by the name of Vicki Paisley for a yearly salary of $40,000. It turned out to be an excellent hire.


Paisley's husband, Melvyn Paisley, was in charge of awarding Navy contracts. A year after the hiring of Vicki Paisley, Williams landed the coveted position on the Navy's advisory board.

"Mel was instrumental in getting me on that board," recalls Williams, who says that Paisley approached him for the position, and Williams initially demurred. "I think you've got the wrong man, we work mostly with the Air Force and the Army," Williams told Paisley.

But Paisley wouldn't relent, and eventually succeeded in signing up Williams. It was a coup for Williams, and it paid off almost immediately. Between his appointment to the Naval Research Advisory Board in 1984 and the end of fiscal 1987, BDM had more than doubled its contracts with the Navy from $3.1 million to $6.6 million. Then, in the beginning of fiscal 1988, BDM was reporting to shareholders an expected $62 million in Navy contracts, according to a Washington Post article.


The build up in Navy contracts had other defense contractors from around the world scratching their heads. Competitors accused Williams of hiring Vicki Paisley as a favor to Melvyn, who then brought in Williams to the advisory board, and subsequently awarded Navy contracts to BDM. The situation reeked of perceived impropriety, and the newspapers covered the entire story in great detail, but inexplicably no investigation was called for at the time. Much of the new business BDM was garnering was in an area the Navy called Black Projects, or budgets that are kept secret because to publicize them would compromise national security.


Lawmakers often complain about Black Projects, citing that many contracts are thusly classified, not because of national security concerns, but rather to avoid the required congressional review. Regardless, BDM was suddenly ratcheting up its Navy business year after year. When Melvyn Paisley left the Pentagon in 1987, he took a job alongside his wife, consulting for BDM. It was a good time to get in. The company was clearly growing fast, and in the midst of its good fortune, was bought in May 1988 by Ford Aerospace for an eye-popping $425 million. Times were good, and Earle Williams had finally showed the cutthroat defense contractors how business was done in the Beltway.


Then in the summer of 1988, Operation Ill Wind swept through the Pentagon, exposing a ring of corruption, bribery, and fraud that would eventually send dozens of officials to jail for rigging the awarding of defense contracts. For years, various elements in the government had suspected widespread corruption in the Pentagon and the defense business. Several years of covert investigation proved those suspicions true. It was a crushing blow to the credibility of the Pentagon and the secretary of defense at the time, Frank Carlucci.


Arrests, arraignments, and convictions rained down weekly on the Pentagon, armed forces officials, and the defense contractors with whom they all did business. The most prominent official convicted in the seven-year investigation was none other than Melvyn Paisley, who pleaded guilty to conspiracy to defraud the government, bribery, and theft of government property. He was sentenced to four years in prison for taking kickbacks. The FBI investigated BDM and the connection between Williams, Paisley, and his wife. Documents from the Paisley home were confiscated, including at least a dozen relating to BDM.


Williams was told that he would eventually need to testify in front of the grand jury, but the bureau was unable to bring a case against BDM, and, as Williams says, "111 Wind just blew away."


Williams had this to say about his role in the investigation:

"In hindsight, I understand why people would have thought we participated [in illegal activity]. When Vicki Paisley came to see me, I didn't know who she was, but she wanted the job. I was aware of a potential conflict, and I told her that it probably wouldn't be suitable. But she said she really wanted to work for me. I asked her why she was leaving her job at Computer Sciences Corp. (CSC). She said it was because Mel told her to because CSC was doing too much Navy business, and it looked bad. I guess that's ironic. When 111 Wind hit, we started to lose business, but I told our clients we hadn't done anything wrong. There was never any real involvement of BDM in 111 Wind, and I guess the FBI just eventually figured we were small potatoes."

But the damage had been done. Between the residue left from the scandal and the end of the Cold War, the value of BDM, now a subsidiary of Ford Aerospace, plummeted. When Loral picked up Ford Aerospace in the fall of 1990, Williams was intent on not working for Bernie Schwartz, then the head of Loral, for personal reasons. Ironically, Williams convinced Schwartz that owning BDM would be a conflict of interest for Loral, since BDM had consulted the Pentagon on systems that Loral produced.


The perceived conflict of interest inherent in hiring Vicki Paisley seven years prior hadn't weighed on Williams' conscience quite as much, apparently. After Williams got in touch with his good friend Frank Carlucci, Conway negotiated the purchase, and $130 million later, BDM was the newest company in Carlyle's portfolio. That was less than a third of the $425 million Ford Aerospace had paid for the company just two years prior.


Carlucci landed a job as chairman, Conway snagged a seat on the board, and Williams stayed on as president and CEO.


It was a steal.

A New Friend

After a couple of years, Williams, age 62, aspired toward a career in government service and, in early 1992, announced his retirement from the $400,000-a-year CEO job at BDM. It was time for another friend of Frank. This time, Carlucci turned to an old buddy and tennis partner by the name of Phil Odeen, currently chairman of TRW. A vice chairman at Coopers Lybrand at the time, Odeen had known Carlucci for decades, having spent 13 years in the office of the secretary of defense early in his own career. Carlucci's wife had even worked with Odeen at Coopers.


Odeen was also good friends with Williams, and so the circle was complete. Over a tennis match in the winter of 1992, Carlucci popped the question.

"He asked me if I had any interest in the job, and I had just been promoted to vice chairman at Coopers and moved to New York," Odeen told me. "I said no thanks, but if you don't find the right person, give me a call."

Carlucci called the very next morning and arranged a Sunday morning breakfast meeting in DC between Conway, Rubenstein, and Carlucci. Apparently, Carlucci had indeed found the right person, and it was Odeen.


Within a week, Odeen had an offer, and by May, Odeen was the new president and CEO of BDM.

"It all happened very fast," recalls Odeen.

Under Odeen's watch, BDM would transform itself from a business heavily reliant on defense contracting to a more diversified services company.

"The Cold War was over, and defense budgets were coming down," explains Odeen. "Information and communications technology were more important than ships and tanks."

Odeen did a bang-up job getting BDM into emerging enterprise resource planning (ERP) and warehouse automation markets. But it was still defense that buttered BDM's bread.


And controversy in that arena was set to strike yet again. On Christmas Eve, 1994, the New York Times reported that Frank Carlucci had again been involved in a clandestine arms deal, this time with the Soviets. With Carlucci as chairman, BDM, now a Carlyle portfolio company, had brokered a deal between the Pentagon and the former Soviet Republic of Belarus to secretly purchase an S-300, the Soviet's version of the Patriot missile defense system the United States had used so effectively during the Gulf War. After the Cold War, the Russians were selling weapons to both allies and enemies of the United States.


They needed the cash and no longer had much use for weapons, so the Russians opened up an arms bazaar. In another black budget project, BDM was hired in 1992 to acquire the S-300 for the Defense Intelligence Agency's Missile and Space Intelligence Center in Alabama. American forces wanted the weapons so they could take them apart, see how they work, and develop ways to defeat them.

For the deal, BDM used the infamous Canadian arms dealer Emmanuel Weigensberg, the same man that brokered the Iran-Contra arms shipments for the Reagan White House. The reason for the secrecy around the deal, says Odeen, was that the Russians were selling the same weapons to America's enemies and wouldn't want those customers to know the Russians were playing both sides of the fence. But others speculated that the Russians had been duped.


That they never knew they were selling the S-300 to the Americans, and had they known, would never have gone through with the transaction. Hence, the need for a middleman like Weigensberg, to obfuscate the actual buyers.


Odeen denies those accusations.

"We did not do these deals openly or publicly, but they [the Russians] knew who they were selling to," says Odeen. "This was a decent business for us. We had the relationships, and we were essentially a broker."

But BDM's competitors didn't see it that way. Again, there were charges of favoritism, cronyism, and quid pro quo. Russian military officials were reportedly incensed by the transaction, claiming they had no knowledge of the ultimate buyer. Competitors griped about their inability to penetrate the relationship between BDM and the Pentagon. They said that BDM's connections, particularly within Carlyle, were to blame.


At the time, Pentagon spokesperson Kenneth Bacon told the Times that he was "concerned about any allegations of unfairness and will review them as appropriate." But BDM was cleared again. The company seemed to have acquired Carlucci's Houdini-esque ability to sidestep scandal. As it turned out, BDM had in place something called a "basic ordering agreement," or an ongoing, open-ended, long-term contract with the Pentagon. The agreement did put BDM on an inside track with regards to foreign weapons procurement. "Otherwise, it can get very bureaucratic," says Odeen.


As for Carlucci's potential involvement, having advocated long-term contracts that protect vendors like BDM when he was secretary of defense, Odeen recites an exculpatory mantra heard over and over again throughout Carlyle's history. "I don't think Frank had anything to do with that at all," says Odeen. He adds, "But being connected to Carlyle sure doesn't hurt." Indeed, BDM's connections to Carlyle have done nothing but help them.


And the deal didn't work out too badly for Carlyle, either. First, Carlyle took the company public in 1994. Then in 1997, TRW paid $975 million for BDM, making Carlyle's $130 million investment just seven years earlier, look brilliant. Phil Odeen went on to become the chairman at TRW, which then became one of the largest defense contractors in the country.


In the words of Fred Malek, this deal was a "screaming home run." Carlyle also used BDM in doing due diligence on future defense deals. It was a perfect setup. Because BDM had so much consulting experience and had worked with most of the major contractors, Carlyle had built in proprietary knowledge of dozens of defense companies. And this is where the bulk of Carlyle's early deals would come from. Some were more successful than others, but with defense, Carlyle had found a calling.


They had found a business that they understood, in which they had myriad connections, and could make loads of cash. They had found what would become their identity. But with the acquisition of BDM, Carlyle was agreeing to do business in the shadowy world of defense contracting; a murky business with which Carlucci was well acquainted, but Norris and Rubenstein knew little about.


The decision to go down this road would eventually make Carlyle one of the largest defense contractors in the country and would create the controversial behemoth it is today.

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It's tike shooting fish in a barrel.
—Former Chrysler chairman Lee lacocca,

Washington Post, March 31, 1985

Cast of Characters
M. W. Gambill Former CEO of defense contractor Harsco.
Norman Augustine Former CEO of defense contractor Martin Marietta.

William Conway

Frank Carlucci

Legendary former chairman of Chrysler, Lee lacocca, had a habit of asking his contractors, many of whom also sold goods to the military, whether making money in defense was a sure thing.

"They start chuckling, and they look around to see if the office is bugged," said lacocca in an interview in the mid-1980s. "And they say, 'It's like shooting fish in a barrel.'"

No one knew this better than Frank Carlucci, who fresh off his 18month stint as secretary of defense, was getting his feet wet in the world of high finance for the first time since his unsuccessful run with Sears World Trade. But this would be different than his earlier disasters. Carlucci was going to deal in the industry he knew best: defense. After the BDM deal was completed, the rest of the defense world knew Carlucci meant business.

In the years following the BDM acquisition, Carlyle would embark on a stunning series of defense dealings, fighting it out with the giants of defense contracting, and quite often having their hats handed to them. But many of the deals they did win were hugely successful, as well as controversial, and built them into the nation's eleventh largest defense contractor. The disconcerting pattern of doing business with questionable companies continued, however, and signaled Carlyle's willingness to dwell in the dark underworld of the defense industry.


With BDM's consulting help, Carlyle made a run at the top defense players in the nation and, when it was all said and done, carved themselves a place at the top.

An Arsenal of Democracy

The government has a long history of overpaying for weapons, offering interest-free loans, waiving federal taxes, bailing out floundering defense contractors, and even paying generous termination fees to unsuccessful vendors. The Defense Department has bailed out more than 6,000 defense companies since 1958, under an act of Congress known as the Extraordinary Contractual Relief Act. It is all done in the interests of "national security." And it amounts to a government-subsidized industry, doing business over a safety net. Carlucci had as much to do with the current state of defense spending as anybody.


As deputy defense secretary under Weinberger, Carlucci developed a Pentagon policy of procurement that called for higher profits for the defense industry. It also lowered the risks within defense contracting, ensuring long-term and no-bid contracts, both moves intended to encourage private companies to enter the market. Privatization, the practice of taking government-run offices and departments and forming for-profit, private companies, was all the rage.


The idea was to build up a healthy and happy private defense industry that would carry the United States to victory in the Cold War. And juice the economy while we were at it. It worked. The defense industry blossomed under Reagan's watch by creating, and the former president himself termed it, an "arsenal of Democracy." At one point in 1985, a Washington Post expose on the defense industry uncovered that the Pentagon was spending an average of $28 million an hour—24 hours a day, 7 days a week. The top 13 contractors had revenues of more than $122 billion.


Those same contractors were also the ones consulting the government on which weapons to buy and when. And few of the defense contractors were paying taxes. The numbers were astounding. It was a great time to be in the defense business. But it wouldn't last. Just nine months after Carlucci took his post at Carlyle, the defense business came to a screeching halt, marked by the felling of the Berlin Wall on November 10, 1989, and the subsequent end of the Cold War.


The defense industry went into instant retreat. Secretary of Defense Richard Cheney announced a "peacetime dividend" and quickly slashed $180 billion off the defense budget. Because of the end of the Cold War, everyone knew that the budget cuts were imminent, but no one thought it would be so quick, and so severe. Values of defense companies plummeted. Contractors didn't know what had hit them. It was a perfect time to get into defense buyouts, when all the properties were cheap, and Carlucci knew it.


After the BDM buyout, Carlyle began bearing down on the defense market in earnest. The first object of its affection was a Pennsylvania-based industrial company that owned an undervalued defense division that made howitzers and other military equipment, Harsco Corp. The defense division that Harsco harbored would later become the now well-known United Defense (much more on that later). The only problem was, Harsco wasn't interested in selling. Harsco employees didn't want to sell the company at such a low point, locking in their losses.


As a result, they resisted Carlyle's overtures, which often happens in the fierce world of leveraged buyouts, as companies struggle to maintain their independence during hard times, while the vultures circle above. Carlyle went to plan B. If they couldn't convince Harsco management to sell the company outright, they would start snatching up public shares.


It was more time-consuming and generally more expensive to acquire a company this way, but the thinking is that by gaining a large position in stock, they could begin to exert some pressure on Harsco's management. So Carlyle began accumulating a large stock position in Harsco, about 6 percent of the total shares outstanding. If they didn't want to sell, Carlyle was going to put the screws to them, threatening to acquire a majority share in the company.


Then, at 2:30 P.M. on Ground Hog Day 1990, Harsco CEO M. W. Gambill got the call from Frank Carlucci. It is known as a courtesy call, making a CEO aware of an aggressor's increasing position in a public company, as if Gambill hadn't already noticed. Carlucci and the boys at Carlyle had their eye on Harsco's defense division, whose value had been decimated by the retreat in defense spending.


But Harsco still wasn't interested. Carlyle quickly increased its position in the company, until it became the majority shareholder with nearly 7 percent of the company. It submitted a restructuring plan to the company that included a tempting $15-a-share dividend, an appeal to shareholders of the company, a move designed to outflank Harsco's management. Harsco still wouldn't budge, and the company rejected the proposal outright. It was a slap in the face to Carlyle, and symbolic of the company's early lack of clout.


Carlucci 's reputation alone was not enough to get potential buyout targets excited. The company had no track record, and Harsco could not be sure of its intentions. Would Carlyle just break the company up and sell it for parts? Or would they nurture it back to health, then sell it for a profit? There was no precedent by which Harsco could judge Carlyle. And they would just as soon not do business with them. Carlyle was not through, however.


The company upped its stock position to 10 percent, and demanded two positions on Harsco's board, as negotiations became more contentious. Harsco, under significant pressure now, compromised, offering Carlyle one position on its board. But Harsco never sold the unit to Carlyle outright. Harsco had maintained its independence and fended off a hostile takeover. It cost Carlyle $63 million in stock to gain that one board seat, not to mention the time and labor costs of doing due diligence on Harsco.


On the surface, it was a terrible deal. But six years later, when Carlyle used that board seat to steal United Defense away from General Dynamics, it would prove to be one of the best deals the company ever made.

More Ill Wind

Shortly after this failure, Carlyle turned its attention to another highly controversial acquisition target: Unisys Corp. Now known mostly for its mainframe computer and IT services business, Unisys was among many companies looking to divest itself of a money-losing defense division.


But in June 1988, in the middle of Carlucci's tenure as defense secretary, Operation 111 Wind, the same investigation that had attempted to nail BDM, took down Unisys. The probe, led by Assistant U.S. Attorney Joseph Aronica, resulted in convictions against 45 individuals and $225 million in fines. It was a comprehensive web of corporate and political corruption in the military, exactly what Eisenhower had warned against 30 years earlier.


And it was all uncovered during Carlucci's watch. In September 1991, after the probe was complete, Unisys alone paid $190 million in fines for bribing public officials en route to hundreds of millions of dollars in contracts. The company pleaded guilty to conspiracy, bribery, and illegally overtoiling the government. Unisys had been disgraced and, as a result, was thoroughly devalued. Of all the companies implicated in Operation 111 Wind, Unisys probably took the worst hit.


And now, Carlyle was looking to pick the defense division up on the cheap. Ultimately though, much like with Harsco, Carlyle would fail. Unisys and Carlyle would flirt for the better part of a year before Unisys chose to take the division public instead. Carlyle was having trouble convincing potential buyout partners to get in bed with them, an obstacle that is not uncommon for young buyout firms. Each failed takeover attempt costs money, though. And the payoffs were not forthcoming. It was another devastating setback for the incipient company, but it would not prove fatal. Not even close.


The folks at Carlyle were learning on the job. They had taken a few lumps, but in the company's 1992 bidding war for the defense and aerospace division of LTV Corp., they would show off their newly acquired erudition. The saga of LTV would ultimately consume a full year, involve multiple court battles, and even require a presidential intervention before it was done.


Rubenstein would call it the most difficult transaction he had ever been involved in. It was, in a word, wild. The fun once again started with a call from Frank Carlucci, this time to his friend Norman Augustine, chairman of defense giant Martin Marietta and former assistant secretary of the Army. Together with Lockheed Corp., Martin Marietta had announced on February 3, 1992, the purchase of LTV's defense and aerospace division, which was in bankruptcy at the time, for $355 million.


It was a steal and, for all intents and purposes, a done deal. But on March 27 of that year, Augustine took a call from Carlucci, who asked if Lockheed and Martin Marietta might be willing to cut Carlyle into the deal. Augustine was shocked and confused. For the past few months, Carlyle had been putting together a competitive bid for the division, with its partner Thomson-CSF, the French defense contractor.

Why would Carlucci be asking in on his deal? Especially now, when it was practically done? As it turned out, things weren't going so well between Carlyle and Thomson. Carlyle once again couldn't get the financing in order for its share of the deal, and Thomson wouldn't proceed without it. The fragile partnership the two had constructed was falling apart. Thomson chairman Alain Gomez was calling around, looking for other partners that had the capital, and could complete the deal.


All of which led Carlucci to call his old friend Augustine.

Bill's Will

Conway and Rubenstein met with Augustine and offered $50 million to get in, money they said would be useful if Thomson were to succeed in finding another partner and make a new more competitive bid at the eleventh hour. Augustine turned them down flatly, apparently unconvinced that Thomson would ever reemerge as a real threat. It looked like it was over.


Thomson officials had abandoned hope, and Augustine felt certain that LTV was his. But Bill Conway had other ideas. A relentless businessman, Conway was largely responsible for building MCI Communications into a major player in the telecommunications industry as chief financial officer during the 1980s. He had an impeccable reputation in financial circles, often cited as one of the top handful of CFOs in the country.


He was a fearsome manager in the Carlyle offices, building tight-knit groups of his favorite employees and largely ignoring the rest of the company. One former employee said, "You're either in with Bill or your out, and if you're out, he'll make your life miserable." Conway is a conservative businessman from New England and a real company man.


Many ex-employees credit him with cultivating an atmosphere of intimidation in the Carlyle offices, putting employees in place by firing off companywide e-mails stating,

"I'm sick and tired of people complaining about their offices and their office furniture. It's not your office or your furniture. It's mine."

He was notoriously cheap and would often gripe loudly about there being too many employees at Carlyle, "sitting around my offices, drinking strawberry flavored water." The way Carlyle was structured, the partners got very, very rich from big deals, and no one else saw a dime outside of their salary. Conway would inexplicably remind employees of this sore spot when he would close out a company meeting by proclaiming it was time to go out "and make me money."


According to those who worked for him, he could be alternately brilliant, driven, and despotic. And he never gave up on a deal. Two days before the bankruptcy judge was to award LTV's assets to Martin Marietta and Lockheed, Conway got the needed money together from Carlyle's old benefactor, the Mellon family, and called Thomson to make nice. With the money in hand, Thomson and Carlyle quickly resolved their differences, waltzed into bankruptcy court, and offered $400 million in cash for LTV aerospace, $45 million more than the Martin Marietta/Lockheed team had offered.


Conway had pulled it off, against all odds. Augustine was floored, and defeated. Or so it seemed. This war was just heating up. Augustine kicked it into overdrive, setting up meetings with Assistant Secretary of Defense Paul Wolfowitz, Deputy Secretary of Defense Don Atwood, and Assistant Secretary of the Army Stephen Conver. Augustine argued that selling LTV's defense and aerospace division to Thomson, a company partly owned by the French government, would be a breach of national security.


Martin Marietta sent a raft of lobbyist to the Hill to persuade lawmakers to come out against the deal. And quickly the tide turned. Augustine was making progress in blocking the sale. Carlucci worked the phones, as well, getting assurances from several Pentagon officials that the deal would go through, despite the concerns of lawmakers over foreign ownership. In the final day of bankruptcy court, the bidding escalated rapidly. Augustine had created enough uncertainty over whether the U.S. regulatory agencies would approve the deal, that the game was once again wide open. Because LTV's creditors were concerned over regulatory approval of the deal, which wouldn't be known until months after the actual sale, Carlyle and Thomson were forced to increase their bid to $430 million, plus a $17 million nonrefundable deposit.


In the event that the sale was denied by lawmakers under national security concerns, Carlyle would pay LTV $17 million for nothing. Martin Marietta and Lockheed upped their bid to $385 million and urged creditors to consider the likelihood that the Carlyle-Thomson deal would never get approved. Carlyle would eventually offer another $20 million, plus a $20 million nonrefundable deposit. That was enough, and the judge awarded LTV's missile division to Thomson and the aircraft division to Carlyle.


The boys from Carlyle had finally done it. They had gone up against the best, and won. Augustine said of the decision, "Even when it's over, it ain't really over;" words that would prove to be prescient. Sure enough, the Bush administration went on record opposing the sale, and Congress voted 93-4 that selling LTV to a French company would be "detrimental to the national security interests of the United States." Despite the assurances that Carlucci had gotten from the Pentagon, the sale never really had a chance in Congress.


Thomson would eventually pull out of the running altogether, flinging the door open to renewed bidding, and getting Augustine back into the game. The race was on again. This time Carlyle teamed up with Loral Corp. and Northrop, more formidable partners than Thomson, not to mention American companies, and finally outbid the Marietta-Lockheed team with a price of $475 million.


They renamed the division Vought Aircraft and managed to turn the flailing company around. Carlyle's contribution to the sale was $38 million, a stake that the company would then sell back to Northrop Grumman for $130 million in just two years. It was a lucrative deal. And it legitimized Carlyle's band of ex-politicians in the wheeling and dealing world of defense buyouts.


Finally, Carlyle was being viewed as a player. Though still accused of practicing access capitalism and suffering a number of brutal early setbacks, the LTV deal burnished their reputation as serious competitors, willing to do whatever it takes to make a deal happen. In conjunction with the BDM deal, Carlyle now had to be taken seriously around the Beltway.


But there was another deal in the works that would really put Carlyle on the map—the world map.

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Politically, it could be considered a quid pro quo for the United States.
—Shafiqul Islam,

senior fellow at the Council on Foreign Relations, Washington Post, February 22, 1991

The early part of 1991 was literally an explosive time in the I world. Bombs were raining down over Baghdad in the latter stages of the Gulf War. Scud missiles were careening their way past U.S. defenses in Saudi Arabia. And the savings and loan crisis had the nation's economy in full retreat. But this rare and tragic confluence of events had set up one of the best business deals of the year, and possibly the decade.


A deal that would put Carlyle on the front page of newspapers around the world. Prince Alwaleed bin Talal bin Abdul Aziz Al Saud, more economically known as Prince Alwaleed bin Talal, was 35 in 1991 and eager to invest his fortunes across the world. The nephew of Saudi Arabia's King Fahd bin Abdul Aziz Al Saud, the Prince was a glamorous, wealthy jet setter who had spent much of his formative years studying in the United States.


After earning his bachelor's degree in business administration at tiny Menlo College in California in 1979, he went to Syracuse University in upstate New York to get his masters in social science. Upon returning to Saudi Arabia, the Prince immediately began building his investment portfolio, mostly in real estate and construction. At first, he wasn't so good at it, and he burned through a $30,000 gift from his father within months. At that time, he approached Citigroup in Riyadh, an American bank, to ask for a loan. They rejected him flatly.


But he went on to accumulate millions, at least some of which came through acting as a liaison between foreign construction contractors and local businesses, though the source of much of the Prince's fortunes remains unknown. Through his gains, he formed the Kingdom Holding Company, an investment vehicle through which he could play with his millions. But the Prince was looking for more, much more. He was looking toward investing in America. The timing was right. America and Saudi Arabia were cooperating on defeating Saddam Hussein's aggression in Kuwait.


It was one of the first times the United States and Saudi Arabia had their political agendas in line. Saudi Arabia had committed more than a hundred thousand troops to the conflict in the gulf, and those soldiers were fighting beside American troops. Many saw this as the dawn of a new era of cooperation between the two nations, both politically and financially. And they were right. Back at home in the United States, the mighty banks were gasping for air. Stocks were plummeting all around the financial sector, and bankruptcies were not uncommon.


The fallout from the savings and loan crisis was littered along Wall Street. It was on this shaky ground that Citicorp, America's largest bank at the time, found itself in February 1991. The company's stock had collapsed, losing half its value between the summer and winter of 1990. It was in desperate need of financing, a lot of financing. Citicorp was looking for as much as $1.5 billion to stay afloat, and they were hoping to raise it through the sale of stock.


They were looking for a white knight.

A Saudi Savior

Enter the Prince. Prince Alwaleed was watching the events in the United States closely, as he always did, and he had decided it was time to put his money to work in America. Known for his eccentricities, the Prince would often drag a caravan of trucks out into the desert to relax. There, with the baking, barren desert glowing all around him, he would sit in a tent complex, entertain guests, and watch multiple satellite television hook ups, staying abreast of world news.


A seasoned critic of American media, he had been following the saga of Citicorp from the beginning. He decided it was time to invest. Working through his representative in the United States, San Francisco lawyer Faissel Fahad, the Prince was put in touch with a prominent DC-based law firm. Because of the tricky political nature of a deal involving a major U.S. bank and a foreign investor, the firm felt they needed an advisor that offered more than just traditional investment banking advice. They decided they needed the Carlyle Group, to help them navigate the choppy waters of federal approval for the deal.


After all, Carlyle had the government connections, they were based in DC, and a sensitive deal like this was going to need a delicate political touch. They called Norris. The Prince had loads of cash, and Citicorp needed it. But at the time, Treasury Secretary Nicholas Brady had been pushing reform in the banking industry, to allow banks more flexibility in the types of business they could enter. It was intended to diversify banks from the disastrous savings and loan business, and strengthen the industry by giving it more options.


But there was concern that opponents to the legislation would use the fear of foreign ownership in American banks as a sticking point to hold up the reform. A deal between a wealthy Saudi Prince and the nation's largest bank was all reform opponents needed to prove their case. It was, to say the least, a very sensitive time in the banking industry. Norris and the Prince knew this, and the two worked hard to structure a deal with Citicorp that would allay any and all concerns, but still get the much-needed capital into the hands of Citicorp. Norris and the Prince spoke often, sometimes two or three times a day, for hours on end.


One conversation was temporarily interrupted while the Prince watched the American Patriot Defense system shoot down an Iraqi Scud missile outside his window. Unphased by the attack, the Prince and Norris picked up the conversation where they had left off.

"It was a crazy time," remembers Norris. "The Prince and I were extremely close. I have a passport full of Saudi stamps. I don't even know how many times I went over there."

The negotiations were cordial but intense. During the deal-making process, Norris asked Citicorp for a board seat in return for the Prince's investment. It was a pure red herring.


A shrewd negotiating tactic, designed to be dropped in a show of concession, which it later was. Neither the Prince nor Norris thought they would get it. In fact, they knew it would make the Federal Reserve Board's approval of the deal nearly impossible. But it worked to perfection. After months of preparation, they got the deal pre-approved by the Federal Reserve Board (Fed), by conceding measures they never intended to secure and assuring members that the Prince would be a passive investor.


The thinking at the Fed was that everyone wanted the Prince to invest his money to save Citicorp, they just didn't want him to exercise any control over his investment. It was a lot to ask, but Norris and the Prince had expected it. The Fed also spent months researching where the Prince's money was coming from. Rumors that Prince was acting as a front for other investors ran rampant. There was concern about Middle Eastern investors using the Prince to launder their money. But finally, the Fed relented, and the deal went through.


On February 21, 1991, a mammoth deal was announced. The Prince would be purchasing $590 million worth of stock in Citicorp, and bailing out the bank that once turned him away when he needed a loan back in his home country. The shares were non-voting preferred stock, which meant that the Prince could not vote his shares in proxy battles. But, he would be allowed to convert the shares to common stock at an exercise price of $16 a share in just eight months. He already owned 4.9 percent of the common stock, which he had acquired over time in the fall of 1990.


That meant that if he were to convert his shares in October 1991, he would hold almost 15 percent of the common shares. In other words, he would be one of the company's largest shareholders.

Media Misteps

The stock jumped up 8 percent in the week following the announcement, and the press was all over the news. Who was Prince Alwaleed? How did he get so much money? Who is the Carlyle Group? Would the Prince be seeking a board seat in return for his investment? Is this a new beginning for financial cooperation between Saudi Arabia and the United States?


There with the answers to all of these pressing questions, in all his glory, was Stephen L. Norris, the co-founder of the Carlyle Group and the man who had engineered the biggest deal of the year. He was quoted everywhere, and figured prominently in a BusinessWeek profile of the deal. Norris told the press that the Prince would not be asking for a board seat. But that he didn't plan to be completely passive either.


After all, who invests $590 million of his own money and doesn't expect his voice to be heard on important decisions? No, Prince Alwaleed would be an "active" investor, said Norris. Norris' statements proved to be well off the mark, and they set off the alarm bells at the Federal Reserve Board, the same board that had already been promised Alwaleed would remain a passive investor. Originally, the Fed had been assured that Alwaleed would not attempt to "influence management" for at least five years, though he would be allowed to speak his views to the board of directors, says Norris today.


That was the deal. But Norris' statements to the press after the deal appeared to contradict that agreement, and the Fed wanted some answers. The Prince's people feverishly worked the phones that next day, desperately trying to convince the Fed that Norris was out of line, not expressing himself clearly, and that the Prince had every intention to remain passive. In the middle of all of this, a 1988 article in Forbes surfaced, in which Alwaleed is quoted as saying the role of the passive investor is not for him.

"I want my voice to be heard ... I would love to be a corporate raider," he said.

Suddenly, the whole reason that the Prince had chosen Carlyle in the first place—to help him traverse the rocky regulatory terrain—had blown up in his face. In addition, the Prince took grave offense at what he perceived as Norris taking credit for the deal in the press. The Prince, not unreasonably, wanted to be seen as the savior of Citicorp. Instead, Carlyle was getting all the credit.


Norris' Carlyle partners also felt he was becoming too personally involved in the success of a client, too public. The fiasco that resulted began the long, drawn-out process of Norris' excommunication from the firm. Ultimately, and after much cajoling, the Fed allowed the deal to go through. But they forced the Prince to sell the 4.9 percent of common shares he had previously accumulated, and mandated that he not own more than 9.9 percent of the overall stock.

The move cost the Prince millions in future profits. It was a public sign from the Fed that they were going to remain extremely vigilant. With his newly acquired shares of Citicorp, Alwaleed had also bought himself a very high profile in the United States. His moves would be scrutinized by regulators and investors alike. The rumors that Alwaleed was investing money on behalf of Middle Eastern investors that don't want their identities revealed continued to dog him.


The accusations were adamantly denied by Alwaleed—and are still denied to this day. (Those who know him say the Prince sees himself as a link between the Arab world and America—a Saudi with a soft spot for true capitalism.)

A Source Emerges

Then, in the Spring of 1991 shortly after the Citicorp investment, the Bank of Credit and Commerce International (BCCI) scandal ripped through the banking world like a missile. The fifth largest private bank in the world, as it turned out, was nothing but a fraud-ridden front, laundering money for drug lords and terrorists throughout the Middle East.


BCCI was also trying to gain control of American banks. It was a scandal of epic proportions that brought down dozens of high-profile members of the international banking community. It was the largest bank fraud case ever. And it didn't bode well for the Citicorp deal. After BCCI, the media speculated that Alwaleed might be up to the same thing.


In an interview with CNBC 10 years later, Alwaleed described the situation like this,

"We had Arabs involved with BCCI at that time. And they had a big scandal there, unfortunately. They (the Fed) looked at what I had there, we had a big discussion, long discussions, they could not find anything wrong with it at all. But I got the message that they were in a difficult position."

The Fed was indeed in a difficult position in trying to save Citicorp—the nation's largest bank. According to one person involved in the Citicorp negotiations, the Fed suspected that the money Alwaleed was investing was not his own, and officials there "looked the other way." The source says that the lack of due diligence in adhering to the rules that require transparency of foreign investors facilitated the Fed's goal of saving Citicorp.


A source close to Alwaleed now says that at least some of the money belonged to Prince Sultan bin Abdulaziz, Saudi Arabia's defense minister. The defense minister could not be reached for comment, and the Prince maintains that all of the money he invested was his. Since the Citicorp flap, Alwaleed has regularly, and voluntarily, disclosed selected investments to the public, even though he is under no obligation to do so. But he only discloses what he wants to.


Despite its controversial nature, the Citicorp deal put both Carlyle and Alwaleed on the map.


Many believed the deal was the financial embodiment of the political accord between the United States and Saudi Arabia. In a Washington Post article at the time of the deal, Shafiqul Islam, senior fellow at the Council on Foreign Relations in New York, said "here the profit motive and the political motive seem to coincide. Right now, the Saudis are our good friends, and Citicorp does need the money." Politically, it could be considered as a quid pro quo for the United States "helping them" in the Gulf War.


It was a rare time when the United States and Saudi Arabia were both politically and financially aligned, and it opened a brief window of opportunity for Carlyle and the Prince. But it wouldn't always be that way. Surprisingly, considering the magnitude of the deal, Norris and Carlyle walked away with a mere $50,000 of the Prince's money (they were paid more handsomely by Citicorp, though they won't disclose how much).


And the Prince?


After a nervous year during which the Prince's investments were underwater—a time when Rubenstein routinely fretted over Citicorp's languishing stock—today's estimates fall somewhere between an $8 billion and $12 billion profit on the deal. It made all the trouble seem worth it. And it set Carlyle up for a future with the Prince, including another major bailout by Alwaleed of Euro Disney (an investment that hasn't turned out so well). But more importantly, the deal gave Carlyle access to Saudi Arabia, a country of unimaginable wealth if one knew where to look.

"The deal gave us an enormously high profile in Saudi Arabia," recalls Norris.

And with the Prince on its side, Carlyle had the world's best tour guide to pry open the treasures of Saudi Arabia.


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