It seemed like a smart bet at the time for Carlyle/Riverstone Global Energy & Power Fund II LP. The sponsors, Carlyle Group and Riverstone Holdings LLC, bought a joint 30% stake in SemGroup LP in 2004 for $75 million, drawn by the prospect of SemGroup capitalizing on cheap assets in the midstream part of the oil and gas sector, which includes transportation, processing and storage. Tulsa, Okla.-based SemGroup put together an impressive portfolio in the U.S. and Canada purchased from distressed sellers like Dynegy Inc. and Williams Cos.

Tom Kivisto, SemGroup's founder, was also a dynamic -- and storied -- leader. The former captain of the University of Kansas' Jayhawks basketball team shepherded his fellow players to the NCAA Final Four in 1974. After graduating from KU with degrees in pre-med and psychology, Kivisto spent 15 years at Wichita, Kan., energy trading giant Koch Industries Inc. before founding his own crude oil marketing company in 1993 and the predecessor to SemGroup in 2000. Over time SemGroup became the fifth-largest privately held company in the U.S.

At the time of the private capital infusion, Andrew Ward, a principal at Riverstone Holdings LLC, crowed, "The company is growing rapidly and has a strong management."

On July 22, 2008, SemGroup LP, the parent of the various SemGroup subsidiaries, filed for Chapter 11 in U.S. Bankruptcy Court for the District of Delaware. The company's trading operation bet the wrong way on oil prices -- that they would go down to historic levels from their dizzying highs -- and then buckled under margin calls that resulted in $2.4 billion in losses from trading accounts on the New York Mercantile Exchange.

"They acquired too large a position in too volatile a market and got burned by it," says Stephen Schork, a former Nymex trader and editor of commodities newsletter The Schork Report. "We've seen this movie over and over again. It's indicative of how scary a market this can be."

So how did Carlyle/Riverstone find itself in this situation? Blind faith. According to a report by court examiner and former FBI Director Louis Freeh, Kivisto misled investors and lenders about SemGroup's liquidity in the months before its Chapter 11 filing while paying himself and co-founder Gregory Wallace millions of dollars in bonuses without proper oversight. "SemGroup's virtually blind deferral to Kivisto on trading matters, and its failure to develop or implement a suitable risk management policy, was central to its problems," the report said.

The report found SemGroup's risk-management policy "toothless." Trading violations were reported to Kivisto, who personally ran the trading operation, rather than to a separate oversight component. The report also found that the risk-management committee, led by Kivisto, chief operating officer Kevin Foxx and chief financial officer Greg Wallace, didn't hold monthly meetings as required by the policy.

Riverstone's Ward declined to comment for this story. But in comments he provided the examiner, Ward admitted there were no formal mechanisms in place to ensure that the management committee monitored SemGroup's compliance with its risk-management policy.

While Ward said he and others had frequent contact with SemGroup management, he said no one ever raised any problems regarding its trading activity. He said he frequently asked whether all of SemGroup's trading positions were "back-to-back," or supported by physical inventory, and he was consistently told that they were.

"Ward believes that he was misled regarding this issue by all members of SemGroup's senior management, including Kivisto," the report said.

Ward also said he received the same weekly position reports as SemGroup's bank syndicate, but the company's management committee did not independently verify the reports, which he believed were accurate at the time. Ward was a member of SemGroup's management committee, along with Riverstone colleague Bartow Jones, and Thane Ritchie from Ritchie Capital Management LLC, 25.2% owner.

Under the proposed reorganization plan, senior secured lenders will exchange roughly $2.93 billion in claims for substantially all of SemGroup's equity, depending on how unsecured noteholders and general unsecured creditors vote. If the unsecured creditors accept the plan, 4.1% of the new common stock would be carved out for their claims. If not, the senior lenders, led by Bank of America Corp., will walk away with 99.9% of reorganized SemGroup.

Grocery store billionaire John Catsimatidis, who gained control of a majority of SemGroup's management seats late last year, is working on his own reorganization plan that may include acquiring the company.

Meanwhile, the sponsors, which pumped additional equity into the highly levered parent, will walk away with nothing. In the examiner's report, Kivisto's trading practices were compared with "a game of chance," like roulette.

Unfortunately for the investors, it was a lethal turn.

Car chase
Second time around
The risks of derisking
Road to perdition
Crossover appeal
Go shop till you drop
Transactions from hell
Hard-won from start to finish
Bright light
The cheers, the groans