Led by major pension funds, investors in a limited partnership took the rare step of ousting the general partner for misusing almost $12 million collected in transaction fees.
Davenport Group MG L.P., New Haven, Conn., used the fees to pay bonuses and salaries to its staff, breaching contractual and fiduciary obligations of the partnership, a judge noted in a ruling on the removal.
The partnership, Madison Group L.P., has performed poorly since it was formed in late 1990 to invest in private equity deals; it was last valued at under $59 million, less than half of the $120 million in capital contributed by the limited partners, according to some of the partners.
"The performance was horrendous," said John Nolan, an attorney at Day Berry & Howard, a Hartford law firm that represented some of the limited partners.
Madison limited partners include the pension funds of United Technologies Corp., Hartford, Conn.; the Massachusetts Pensions Reserve Investment Management Board, Boston; Aluminum Co. of America, Pittsburgh; International Paper Co., Purchase, N.Y.; the State of Wisconsin Investment Board, Madison; the World Bank, Washington; National Fuel Gas Co., Buffalo, N.Y.; Household International, Prospect Heights, Ill.; Mars Inc., McLean, Va.; and IBM Corp.'s United Kingdom unit.
Among other limited partners are: Getty Family Trust; Project Capital, which has ties to Skadden, Arps, Slate, Meagher & Flom, New York; and Montague & Co., which was connected to Davenport.
Strategic Investment Partners Inc., an Arlington, Va.-based investment manager, serves as adviser to the World Bank, Mars and Getty on the investment, but it wasn't a partner in Madison. Officials at Strategic declined to comment.
All of the pension fund investors interviewed termed the removal of a general partner rare; none knows of any other instances where it has happened.
United Technologies' James Moody, manager-pension investments, and Neil Hassett, assistant general counsel, said the limited partners first learned of problems with the transaction fees last year from John E. Mullen III, after he left Davenport, where he was a manager. United Technologies then engaged Day Berry & Howard, which in turn contracted with Coopers & Lybrand to audit Madison.
That was the first audit the partners conducted on Madison. Messrs. Moody and Hassett said the limited partners - as is typical in limited partnerships - relied on the annual audits, provided by Davenport and prepared by independent auditors.
The Coopers & Lybrand audit turned up the misappropriation of the transaction fees.
The pension executives interviewed described the transaction fees as similar to investment banking fees and common in such private equity partnerships. They said the fees typically are paid to the partnership by the seller of the equity, or an agent trying to close the deal.
The partnership voted last summer to remove Davenport, citing its misuse of transaction fees. According to the partnership agreement, Davenport could be removed by a vote of two-thirds of the partners for, among other causes, a breach of fiduciary duty. Investment performance is excluded as a cause for removal.
Alcoa was the only pension fund not to vote for the removal of Davenport. Donna S. Barr, manager-trust investment for Alcoa, declined to comment.
Montague also didn't vote for removal.
Davenport filed suit in Delaware, where the partnership is registered, against the limited partners that voted for its dismissal. It asked the Chancery Court to invalidate its removal and restore its position.
The judge, Vice Chancellor Myron T. Steele, ruled Jan. 23 in favor of the limited partners, confirming their removal of Davenport, based on the misuse of the transaction fees. The limited partners sued by Davenport also submitted documents to the court contending serious conflicts of interest by Davenport in making investments in which it stood to receive gains outside the Madison partnership. The judge, however, didn't rule on these contentions, noting the misuse of transaction fees was sufficient cause to remove Davenport.
Some limited partners, led by United Technologies, formed a new general partner, Madison Group Management L.L.C., which in turn will hire a management company to manage the partnership's investment portfolio.
Messrs. Moody and Hassett said the ownership of the new general partner will be decided in a few days. They said it will be owned by several of the limited partners.
The United Technologies officials and Scott Henderson, general counsel, Massachusetts PRIM, said the partners are discussing whether to seek recovery of misappropriated fees from Davenport.
"We would expect we would pursue options to get the transaction fees back," Mr. Hassett added.
Robert B. Milligan Jr., chairman of Davenport Management Inc., which owns the general partner, said his firm plans to appeal the decision. He denied Davenport did anything wrong. He said the limited partners and the judge misinterpreted the agreement, and that it allowed Davenport to use part of the transaction fees for salaries and bonuses. He said Davenport used only 20% of the fees for compensation and the rest for other expenses, such as taxes.
Mr. Milligan said Madison was Davenport's only source of income.
The pension executives interviewed said they expect no problems in obtaining the records of the partnership from Davenport.
Davenport was to get only a quarterly management fee, which was $2,150,000 a year, plus expenses, plus it was to get 20% of profits above a certain level.
Madison was supposed to invest in buy-out situations. Madison's investments were:
$30 million in Gale Group Inc., a manufacturer and distributor of lawn and garden products;
$28.8 million in Wyatt Inc., a wholesaler of heating oil;
$20 million in Consolidated Hydro Inc., company engaged in the acquisition, development and operation of hydroelectric plants;
$6.5 million in Kiowa Resources Inc., a water management and development company;
$3.9 million in Fountainhead Technologies Inc., a maker of purification systems for swimming pools and spas;
$3.6 million in Radiant Industries Inc., a distributor of specialty petroleum products;
$2.4 million in Verigen Inc., a biotechnology company; and
$1.2 million in Aqua Clear Industries Inc., a maker and distributor of swimming pool and spa chemicals.