The sincerest form of flattery

Private equity firms follow in Carlyle Group's footsteps

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 Updated:

Following the extraordinary success of the Washington-based Carlyle Group, which has built a private equity empire that's earned billions for its investors, a number of firms have lined up rosters of former government officials and high ranking military officers as they pursue companies that are in the national security business.

Carlyle, which ranked as the ninth largest Pentagon contractor from 1998 to 2003, has made billions of dollars by investing in the defense sector. A team of high-powered former Washington insiders, including Frank Carlucci, who served as secretary of defense in the Reagan administration, and James Baker, who served as George H. W. Bush's secretary of state, led its pursuit of defense deals. (See related report, "Investing in War.")

More than a half dozen companies are now following in the footsteps of Carlyle by signing up former high-ranking government and military officials as they try to make inroads into the Pentagon and the newly-created Homeland Security contracting business.

The blue-chip political talent these private equity firms have lured include five of the past nine defense secretaries, two secretaries of state, two national security chiefs, two CIA directors and dozens of distinguished retired military officials.

Veritas Capital Management is the 41st largest defense contractor and second only to the Carlyle Group among private equity firms. Though Veritas doesn't have any marquee former politicians in its ranks, its roster includes Adm. Joseph W. Prueher, ex-commander-in-chief of the U.S. Pacific Command and former U.S. ambassador to China; Gulf War I veteran and former U.S. Southern Command chief Gen. Barry R. McCaffrey; former commander-in-chief of Allied Forces in Southern Europe Admiral Leighton W. ("Snuffy") Smith; former commander-in-chief of the U.S. Central Command Gen. Anthony C. Zinni; and Gen. Richard E. Hawley, former commander of Air Combat Command at Langley Air Force Base, Va.

The companies it has invested in have been very successful in bagging defense contracts, with nine of them winning Pentagon deals since 1998. More than 70 percent of the firm's contracts were brought in by Vertex Aerospace (formerly Raytheon Aerospace, part of the Raytheon Corp.), which provides aviation and aerospace technical services to the Pentagon and other branches of the U.S. government. Veritas sold Vertex in December 2003.

Unlike the Carlyle Group, which has reduced its investments in the defense sector, Veritas is still investing heavily. Last July it bought a majority stake in Springfield, Va.-based McNeil Technologies, which provides translation services to the Defense Department and intelligence agencies, among others. Primarily catering to the national security market, the bulk of McNeil's more than 1,000 employees have security clearances.

New entrants

In the past three months alone, two new venture partnerships have been formed, with hundreds of millions in funds, to invest in the national security market. Former Pentagon leaders, both civilian and uniformed, are at the center of both efforts.

Last August, former Defense Secretary William Cohen disclosed his plan to form a merchant banking firm, TCG Financial Partners, to invest in defense companies. Cohen, who heads The Cohen Group, a consultancy in Washington, D.C., hired a top investment banker from Bank of America to head the new private equity firm, which aims to raise $300 million. According to news reports, the ex-Pentagon chief will also employ Gen. Joseph Ralston, Supreme Allied Commander in Europe until last year, and former NATO Secretary General George Robertson.

In September, Bear Stearns Merchant Banking, the private equity arm of investment banking and securities trader Bear Stearns, entered into an alliance with GlobeSecNine, a little-known private equity group headquartered just a few miles from the Pentagon in Arlington, Va.

Bear Stearns Merchant Banking, which manages $1.5 billion, has earmarked $300 million to invest in national security-related companies, while GlobeSecNine has connections to the country's defense and national security establishment. David C. Miller Jr., one of GlobeSecNine's founders, was a special assistant to President George H.W. Bush for counter-terrorism and counter-narcotics. Gregory S. Newbold, another founding member of the firm, served as director of operations for the Joint Chiefs of Staff before he retired in 2002.

GlobeSecNine's board of directors includes John Lawn, Drug Enforcement Administration chief under Presidents Reagan and the first Bush, and Gen. Al Gray, a former commandant of the Marine Corps and former member of the Joint Chiefs of Staff. And Brent Scowcroft, who served as national security advisor for Presidents Gerald Ford and George H.W. Bush, is the chairman of GlobeSecNine's advisory board.

In announcing their deal, GlobeSecNine and Bear Stearns Merchant Banking drew attention to another partnership the latter had formed for investing in the defense sector. In July 2003, Bear Stearns Merchant Banking teamed up with Giuliani Partners LLC, a consulting firm founded by former New York City Mayor Rudy Giuliani, along with his ex-police, fire and emergency management commissioners.

Growth industry

The homeland security industry is currently the fastest growing sector of the U.S. economy, predicted to grow from a $5 billion industry in 2000 to $130 billion in 2010, according to the Homeland Security Research Corporation, a private California think tank.

"[T]he war on terrorism and possible confrontation with Iraq have focused investors' attention on defense and homeland defense," Bob Grady and Jay Koh, members of Carlyle Venture Partners, wrote in a February 2003 article in the Venture Capital Journal. "The events of Sept. 11 have drawn many new investors into the sector, spawned a host of new companies and redefined some old companies."

Among the private equities that have focused their efforts on the emerging homeland security contracting, trying to replicate Carlyle's success with defense contracting, are Paladin Capital Partners, Arlington Capital Partners, and Behrman Capital.

Like Carlyle, Paladin and Arlington Capital Partners have enlisted several former political and military leaders.

"The advantage of having former politicians is that they give you perspective, they give you potential access to getting additional business," Bob Knibb, a partner of Arlington Capital, told the Center.

Paladin's roster of ex-officials includes former CIA Director James Woolsey and former National Security Agency director Kenneth A. Minihan, both principals of the Washington-based firm. Last December, Paladin entered into an alliance with homeland security consultancy Civitas Group LLC, also in Washington, D.C. President Clinton's National Security Advisor Samuel R. Berger and Republican strategist Charles R. Black, Jr. work for Civitas.

Paladin created a "Homeland Security Fund" immediately after 9/11 to invest in homeland security firms. Boeing Co., the second largest Pentagon contractor, was an early investor in the firm.

Paladin has made at least three investments in companies that do business with the Department of Homeland Security. It invested more than $10 million in AgION Technologies Inc., a Wakefield, Mass.-based company that makes anti-bioterrorism products. Paladin also bought stakes in ClearCube Technology Inc., which developed a computer-security system, and SafeView Inc., a Santa Clara, Calif.-based firm that provides personnel screening technology.

Arlington Capital Partners, a $450 million private equity, acquired two top federal contractors, ITS Services in April 2003 and Science & Engineering Associates Inc. in January 2004. The firm combined the two, and named the new company Apogen Technologies, which provides "technology solutions" to the departments of Defense and the Homeland Security, as well as other branches of the government. Apogen ranks among the top 10 Department of Homeland Security contractors.

The chairman of Apogen's board of directors is Phil Odeen, who served as an aide to Henry Kissinger when the latter was national security advisor. Odeen also served as chairman of the National Defense Panel and vice president of the Defense Science Board. Vice Admiral Daniel T. Oliver, a former chief of naval personnel and deputy chief of naval operations for manpower and personnel, heads the national security sector division.

Another major investor in the national security market is Behrman Capital, which acquired two defense and homeland security contractors in the past two years. The New York and San Francisco-based firm bought Hunter Defense Technologies, Inc., last January. It acquired majority stakes in ILC Industries, Inc., a defense, aerospace and industrial products provider, last year. The firm owned Condor Systems, Inc., a defense electronic firm, in the late 1990s.

Behrman, however, does not presently feature any prominent former civilian or military officials.

That's an exception among those private equity firms vying for companies in the national security market—where having political and military insiders for their boardrooms and executive suites is the norm.

Career opportunities

Five of the past nine defense secretaries, excluding those who are in the current administration, have ties to private equities. Of the remaining four, two are serving in the current administration (Donald Rumsfeld was the defense secretary in the Ford administration; Dick Cheney served George H.W. Bush's administration), one (Les Aspin) is deceased, and the other, Caspar W. Weinberger, is the chairman of the company that owns Forbes magazine. Every other defense secretary since Elliot Richardson held the post in 1973 has ties to a private equity firm:

  • Bill Cohen, the last defense secretary, entered the private equity market with his own firm, TCG Financial Partners.
     
  • Cohen's immediate predecessor at the Pentagon, William Perry, founded Global Technology Partners to help equity firms invest in defense, aerospace and technology companies, after he left office. The group advises Donaldson, Lufkin and Jenrette's Merchant Banking Partners.
     
  • James R. Schlesinger, defense secretary in the Nixon and Ford administrations, is an advisor to the Lehman Brothers investment banking firm.
     
  • Harold Brown, defense secretary in the Carter administration, is a partner at Warburg Pincus, an investment firm with holdings in approximately 490 companies worldwide.
     
  • Frank Carlucci, defense secretary during Ronald Reagan's second term, was the first Pentagon chief to make his mark as an investment banker.

A number of senior Pentagon officials who served these secretaries also work for private equities. Perry has three of his former deputies as his partners at Global Technology Partners. John White was a deputy secretary of defense under Perry, Paul Kaminski supervised Pentagon's acquisitions as an undersecretary at Defense, and Ashton Carter was an assistant secretary of Defense. Perry's founding partner was former CIA director John Deutch.

John F. Lehman, who served as Secretary of the Navy from 1981 to 1987 and was also a member of the 9/11 Commission, runs his own eponymous private equity firm, J.F. Lehman and Company. The firm's targeted markets include aerospace and defense. Gen. Paul X. Kelley, who served as a member of the Joint Chiefs of Staff, is a limited partner of the firm.

Also doing their parts in helping private equity firms to invest in the national security market are some members of the Defense Policy Board, an influential body that advises the defense secretary. Schlesinger and Woolsey are members of the board. Another member, Gerald Hillman, founded Trireme Partners along with Richard Perle, who once headed the board and was a member until he resigned in February.

Kissinger, another Defense Policy Board member who served as secretary of state and national security advisor to Presidents Nixon and Ford, is an advisor to the private equity firm Hicks, Muse, Tate & Furst. His firm, Kissinger McLarty Associates, also had a private equity unit, the Kissinger McLarty Capital Group. A spokesman from the company told the Center that the capital firm did not invest in any companies and has since folded.

Letter of the law

Watchdogs have long criticized the "revolving-door" between government and the private sector, particularly when former officials join businesses that they regulated while in office.

Ex-officials are subject to federal regulations enacted in the 1970s that require a one-year "cooling off" period before they can lobby their old agency; these former officials can, however, register to lobby immediately, provided they refrain from contacting their old colleagues.

Carlyle spokesman Chris Ullman says all former government officials working with the firm meticulously follow the regulations. "If someone serves their government and then leaves, and then abides by all of the conflict of interests rules related to lobbying former colleagues for a year," he said, "they abide by all those rules, and then they join a private sector job and don't lobby those officials, but share the expertise that they have and it happens to be the same as within the sector, the area they worked in, defense for example, that's a conflict?"

Some are more troubled by the revolving door.

"I think that this is a much more important issue than what has been legislated," says Dan Briody, an outspoken critic of Carlyle's business practices. "I think it is very detrimental to public's confidence in both the political structure and the business structure in the country."

On the other hand, those in the private equity business, such as Arlington Capital Partners' Knibb, see nothing wrong in the collaboration of private investment firms and former public officials. "Private equity as an entity is not necessarily a wrong one," he said. "There's a lot of credibility a gentleman like Odeen [who chairs the board of Arlington-owned Apogen] would bring to businesses."

Some Washington observers say that there's nothing "inherently unethical" about retired Defense Department officials working for private equities. "I wouldn't assume because someone is coming out of a revolving door-type situation, therefore, it's unseemly," said Michael Levy, a professor of public policy and business ethics at Georgetown University's McDonough School of Business. "It is not necessarily in any way shape or form wrong. There are pretty strict rules about speaking to your former agencies… It may be troubling, but it is not in itself a form of corruption."

According to Briody, author of The Iron Triangle: Inside the Secret World of the Carlyle Group, there's something ominous about Carlyle's success. "What's dangerous about the success of Carlyle is that other companies are beginning to understand that this is the way to make a killing," he told the Center. "These former politicians are coming out of office and they are in heavy demand. How far this goes is what I fear. I already feel that it has gone too far."

Researcher Sheetal Doshi contributed to this report.

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