Steven Rattner's next headache

(Fortune) -- Steven Rattner, the New York banker-turned-Obama Administration car czar, has been much in the news lately. Riding high in early April thanks to laudatory profiles in the Wall Street Journal and the New York Times, Rattner's name has been in the press this week in connection with a scandal involving a New York State retirement fund.

What's gotten short shrift in all the coverage, though, is the complicated situation that Rattner left behind for his former partners and himself at Quadrangle Group, a New York-based private equity firm that Rattner co-founded.

On this Friday, April 24, Quadrangle's investors are scheduled to vote on whether they want to keep funneling money into a Rattner-free Quadrangle. Rattner's departure from the firm on February 23 came at a precarious moment for Quadrangle thanks to less than stellar returns and some high-profile flops like an investment in Alpha Media, the parent company that brings you Maxim and the recently shuttered music magazine Blender.

A 'key man clause'
The catalyst for the vote is that Rattner's departure triggered what on Wall Street is known as a "key man clause." The way the provision works is that if the key man (in this case Rattner) decides to leave the firm, Quadrangle's investors have the opportunity to block any further investments that can be made with capital they had previously committed. So a "nay" vote effectively terminates the funds' ability to do new deals from scratch (although some capital still could be invested in existing portfolio companies.)

The recent barrage of publicity about Rattner, 56, has the remaining partners of Quadrangle concerned about the vote's outcome. There was a meeting March 31 so that Quadrangle executives could answer investors' questions about the management and performance of the fund and to get "candid input on changes you thought were necessary to reflect the changed circumstances at our firm and the world more generally," is how Quadrangle's leadership phrased their position in a subsequent letter to investors.

Rattner started the firm in March 2000, shortly after he left his position as Deputy CEO of Lazard Frères in New York. He was joined by three of his former Lazard partners: Josh Steiner, a Clinton-era Treasury Department chief-of-staff; Peter Ezersky, Rattner's longtime number two in Lazard's hugely successful media banking group; and David Tanner, a former partner at Warburg Pincus and the only one of the four men with actual experience making private equity investments (including achieving an IRR of 145% in six investments at Lazard Capital Partners), a fact touted by the group to raise money.

With a lot of hard work by the Monument Group, a private equity fundraising firm, and a few phone calls by Rattner to his former Lazard media clients -- such as Comcast CEO Brian Roberts, Craig McCaw, the billionaire telecom investor, and IAC Interactive CEO Barry Diller -- Quadrangle was able to relatively quickly raise a $1 billion first fund (in which I am an investor). As it was on its way to being fully invested in 2004, the Quadrangle team hit the road to raise money for a second fund, which closed with $2 billion in March 2005. (It was Rattner's efforts to raise capital for this fund that have landed him in a recent SEC complaint about a "pay-to-play" scandal in New York State. Rattner is not a defendant in the SEC case that focuses on the kickbacks that a former deputy comptroller and a prominent political advisor allegedly received from investment management firms seeking to manage investment assets held by the New York State Common Retirement Fund.)

Quadrangle offers to take a haircut
For the first fund, Rattner's departure and the tripping of the "Key Man" provision is moot (the fund was fully invested). The key man event is very much operative, though, for the second fund, which still has around $500 million to invest and to call from its investors. In a letter to Quadrangle's investors, Rattner wrote that he hoped they would decide not to block the balance of the money in the second fund from being invested because of his departure. He added, "My family will enthusiastically fulfill its capital commitment to QCP II and looks forward to participating in the continuing investments and portfolio value creation of the firm." The Rattners, as well as the other members of the general partners of Quadrangle, had $55 million invested in the first Quadrangle fund and have another $120 million in capital commitments to the second fund.

On April 17, as an inducement to convince investors to stay the course, Quadrangle's remaining partners decided to take what in Wall Street parlance is known as a "haircut" following their discussions with limited partners. Quadrangle leaders voluntarily agreed to take a reduction of the fund's management fees from 1.75% of the $2 billion -- $35 million a year -- to 1.7% for the remainder of 2009, 1.65% for the first half of 2010 and 1.55% for the second half of 2010. Quadrangle also agreed to decrease to 15% the amount of the fund that could be put in any one fund investment and agreed to escrow 25% of all after-tax carry proceeds.

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