(MENAFN - Arab Times) A Kuwaiti investment firm is alleging that private equity giant Carlyle Group LP sold it a fixed income fund in 2006 without the necessary licence, and is seeking approval for its lawsuit against the US firm to be heard in Kuwait rather than the United States.
The case illustrates some of the potential legal pitfalls which US and European private equity firms operating in the Gulf face. Over the last several years they have flocked to the region, attracting hundreds of millions of dollars of investment from the Gulf's wealthy sovereign funds and family-owned firms.
National Industries Group (NIG), a company controlled by one of Kuwait's biggest merchant families, invested 25 million in Carlyle Capital Corp (CCC), a fixed income fund launched by Carlyle in 2006. The fund, which raised over 1 billion, collapsed during the credit crisis in 2008 after defaulting on about 16.6 billion in debt.
Investors in the fund, an early victim of the credit crisis and an example of the flaws associated with using excessive leverage, included Carlyle's co-founder David Ruben-stein and other Gulf Arab funds.
In 2009, NIG filed a fraud suit against Carlyle in Kuwait seeking to recover its investment and alleging that the private equity firm had misrepresented facts while marketing the fund.
Carlyle says that as part of the contract with NIG, any disputes arising from the investment should be resolved in the court system of the US state of Delaware. But in a statement issued on Sunday, NIG claimed its investment contract with Carlyle was void because the US firm did not have a securities licence to offer investment products in Kuwait.
NIG therefore sought approval from the Delaware court system to dismiss litigation there and allow the Kuwait suit to go forward, moving the case to the jurisdiction of its own national court system.
"Carlyle was more than happy to conduct its sales presentations in Kuwait and close its deals in Kuwait," Ahmed Hassan, general manager of NIG, said in the statement.
"But now that the moment has come to deal with the ugly aftermath and the firm's attempts to mislead and deceive its own investors, Carlyle would prefer to try its luck in Delaware."
Rory MacMillan, a spokesman for Carlyle in London, declined to comment.
Along with marketing its global funds, Carlyle also runs a 500 million Middle East and North Africa fund and has made investments in Saudi Arabia and Turkey. Its key shareholders include Mubadala Development Co, a state-owned investment firm of Abu Dhabi.
NIG, controlled by the powerful Kharafi family, was itself hit hard by the 2008 financial crisis. Investment firms such as NIG borrowed cheap short-term cash in the boom years to fund an asset-buying spree, both in Kuwait and overseas, but found they couldn't refinance the debt once borrowing costs rose.
Earlier in August, NIG said it would repay its 475 million Islamic bond, or sukuk, at maturity, dropping earlier plans to obtain a four-year extension from creditors.
Under Kuwaiti law, selling securities without a license nullifies a transaction, meaning that NIG should be entitled to rescission of its entire 25-million investment. Facing such rescission, Carlyle has fought to avoid Kuwaiti jurisdiction.
The case may have ramifications throughout the Middle East, which was one of Carlyle's main targets in 2006 when it was rolling out its international sales pitch for private investments in the fixed income fund, Carlyle Capital Corporation Ltd, or CCC.
David M. Rubenstein has his own credibility on the line. Rubenstein personally marketed the CCC fund to Middle East investors and, after it failed, personally offered NIG representatives the opportunity to invest in other Carlyle deals as a means to recoup their losses.
Carlyle raised 600 million in private investments - much of it in the Middle East - before offering the fund to the public and raising another 340 million. It is uncertain how many of the sales would be subject to rescission if Carlyle was also unlicensed in other Middle Eastern countries besides Kuwait.
CCC leveraged its clients' money to an extraordinary 32-to-1 debt-to-equity ratio and collapsed in March 2008 when banks refused to issue it any more credit after its underlying portfolio of mortgage securities declined in value during the US housing plunge.
The collapse exposed the falsity of both main elements of the Carlyle sales pitch:
That the underlying investments would be safe. Rather than perform its own due diligence, Carlyle appears to have blindly followed the suspect analysis of ratings agencies, which gave premium ratings to the bulk of the securities.
That the fund would be managed conservatively, with 20 percent liquidity cushion set aside as a buffer against "margin calls" if the underlying portfolio declined in value. In fact, the liquidity cushion was not maintained, and this lack of liquidity was the main cause of the fund's shocking collapse.
Carlyle did not immediately respond to a request for comment about the case Sunday. Its Dubai office said employees there were not authorized to speak to the media and referred requests for comment to its London office. There was no immediate response to messages left in London outside of business hours.
Carlyle has repeatedly said it will fight NIG's suit.
"We believe these claims are without merit and intend to vigorously contest all such allegations and are currently unable to anticipate what impact they may have on us," Carlyle said in its most recent quarterly report, filed on Aug 14.
Private equity firms such as Carlyle raise money from big investors and then use that money to invest in companies or other investments. The industry is under close scrutiny because of the US presidential election and presumed Republican nominee Mitt Romney's former role as an executive at another private equity firm, Bain Capital.
Kuwait's NIG started out in the 1960s as a building materials company and later began investing across a range of industries.