Are you the sort of person who believes in conspiracies--the Trilateral Commission secretly runs the world, that sort of thing? Well, then, here's a company for you. The Carlyle Group, a Washington, D.C., buyout firm, is one of the nation's largest defense contractors. It has billions of dollars at its disposal and employs a few important people. Maybe you've heard of them: former Secretary of State Jim Baker, former Secretary of Defense Frank Carlucci, and former White House budget director Dick Darman. Wait, we're just getting warmed up. William Kennard, who recently headed the FCC, and Arthur Levitt, who just left the SEC, also work for Carlyle. As do former British Prime Minister John Major and former Philippines President Fidel Ramos. Let's see, are we forgetting anyone? Oh, right, former President George Herbert Walker Bush is on the payroll too.

The firm also has about a dozen investors from Saudi Arabia, including, until recently, the bin Laden family. Yes, those bin Ladens. Is it any wonder that Internet sites with names like paranoiamagazine.com are rife with stories about Carlyle's shadowy, corrupt global network? And it's not just wackos. "Be careful," a tech entrepreneur in Silicon Valley wrote in an e-mail when he learned I was doing a story on Carlyle. "The rabbit hole runs really deep on this one.''

Leaving aside the conspiracies for a moment, what exactly does the Carlyle Group do? Start with the basics: It's one of the world's largest and most powerful private-equity investment firms, meaning it buys and sells privately held companies and divisions of large public companies for big profits. Founded in 1987 (and named after the favorite New York hotel of the firm's first investors, the Mellon family), Carlyle has raised a total of $14 billion from investors in just the past five years--more than any other private-equity firm has attracted in the same period, except the Blackstone Group and CSFB Private Equity. Profits, too, have been pretty terrific. Not counting the standard 20% cut that goes to Carlyle's partners and managing directors, the firm's average annual rate of return has been 36%.

It's quite a success story, and to understand how Carlyle pulled it off, FORTUNE spent a month and a half peeking down that rabbit hole. One conclusion seems clear: While most of the conspiracy theories are amusingly overblown, this is a firm that's been built on the backs of Bush and other big shots who have lent Carlyle their names, their golden networks of friends in high places, and their insights into how government works. It wasn't until Carlucci joined, for instance, that Carlyle really took off. Founded by David Rubenstein, a lawyer who worked as an aide in the Carter White House, Bill Conway, a former CFO at MCI, and Dan D'Aniello, a former finance executive for Marriott, Carlyle early on invested in a motley assortment of deals--buying an airline-catering business, a health-food chain, and a biotech firm, for example. In 1990, Carlucci got the trio interested in the $150-billion-a-year U.S. defense industry, making introductions to companies that would turn into some of Carlyle's most lucrative investments. Rubenstein quickly realized the wisdom of recruiting a former Secretary of Defense and followed it up with a former Secretary of State, then a former White House budget director, and on and on.

The revolving door has long been a fact of life in Washington, but Carlyle has given it a new spin. Instead of toiling away for a trade organization or consulting firm for a measly $250,000 a year, former government officials can rake in serious cash by getting equity cuts on corporate deals. Several of the onetime government officials who have hooked up with Carlyle--Carlucci, Baker, and Darman, in particular--have made millions. Carlyle isn't the only organization doing it: Metropolitan West Financial in Los Angeles recently hired Al Gore to help with tech deals and make introductions overseas, for example. But Carlyle, which pioneered the idea, seems more adept at it than any other firm.

Unlike other private-equity groups, Carlyle concentrates on companies funded by the government, such as defense contractors, or those affected by government regulation, such as telecommunications firms, and then hires people with relevant government experience. As the company once put it in a brochure, "We invest in niche opportunities created in industries heavily affected by changes in governmental policies." Doing so, of course, raises the ultimate rabbit-hole question: Is Carlyle's approach just a smart twist on good old business networking or a step over the line into an ethical twilight zone in which the public trust is broken?

Half a mile from the White House, inside nondescript offices sparsely adorned with generic depictions of ships and ducks, co-founder Rubenstein sits with his hands folded on a table so shiny you can see your reflection. Next to him sits Chris Ullman, Carlyle's first-ever full-time PR person. Habitually wary of media attention, Rubenstein and his partners agreed to rare interviews with FORTUNE. That's because since Sept. 11 the firm has been under unusual fire. First there was the bin Laden thing. Shafig bin Laden, one of Osama's many brothers and a Carlyle investor, was in attendance at a Carlyle conference at a Washington hotel on that infamous day. As the media were quick to point out, this meant that George H.W. Bush was working for a firm that was helping to make the bin Ladens money. Even though the wealthy Saudi family has reportedly cut all ties to Osama, the press lambasted Carlyle.

The firm has since given the bin Ladens back their money, some $2 million, but controversy lingers. Sept. 11 and its aftermath also created the appearance of further conflicts of interest--namely, that while his son is in the Oval Office directing the war effort and proposing the largest increase in defense spending since Ronald Reagan, Bush is working for a firm that, through various investments, has become the nation's 14th-largest defense contractor. "It destroys the office of the presidency no less, in my view, than having sex with an intern," says Larry Klayman, director of the watchdog group Judicial Watch. On top of all that, there's the unfolding Enron saga and the likely passage of the campaign-finance-reform bill, which suddenly make it look bad for businesses to have too many friends in Washington.

It's no surprise, then, that Rubenstein is anxious to downplay the roles of Carlyle's famous people and to dispel the aura of mystery surrounding the firm. "The word I hate most is 'secretive,' " says Rubenstein, whose wry countenance and shock of white hair suggest a less rubbery version of Steve Martin. Rubenstein insists that all Bush does for Carlyle is give speeches to investors and that it is silly to think of him whispering in his son's ear about how to help Carlyle's companies.

On the whole, Rubenstein says, the big names at Carlyle do a lot less than most people think. "We don't lobby the government," he says, echoing a claim made by other partners interviewed by FORTUNE. He insists that if Carlyle is at all remarkable, it's because of the firm's innovative approach to private equity, its great returns, and its global ambitions--not because it happens to employ a few famous people. "Out of the 500 people at the firm, we have maybe eight or nine who served in government. The rest are your typical Harvard, Stanford, or Wharton MBAs, who do all the same things they do at other firms,'' says Rubenstein. (In fact, the number of former government big shots is 12, but who's counting?)

The conspiracy theorists like to imagine that Bush, Baker, and Major are jetting around the world cutting deals and making money for companies owned by Carlyle, but after nearly two dozen interviews with CEOs of current and former Carlyle companies and people familiar with Carlyle's business, it seems clear that this really isn't happening. What Bush & Co. actually do is far less pernicious but clearly valuable to Carlyle--they help raise money. Every year Rubenstein sets up scores of lunches and dinners around the world intended to woo new investors and gratify existing ones. As you might imagine, people like Bush, Baker, and Major are a huge draw. "If you call and say you're doing a dinner with Jim Baker or with George Bush, and could they please attend, chances are people are going to show up," explains a former employee, who, like all ex-Carlyle staffers I talked to, didn't want his name used. In the mid-'90s, for instance, Baker introduced Rubenstein to members of the royal family in Saudi Arabia and Kuwait; since he left Parliament last year, Major has been opening doors to big money in Europe and Canada. The allure of a former President is particularly irresistible. At Carlyle's annual investor meetings, CEOs and money managers line up to have their pictures taken with Bush.

For his camera mugging and speech giving, Bush is paid "in line with market rates,'' says Rubenstein. That would mean about $100,000 per speech, so if Bush makes five or six speeches a year, as Rubenstein claims, then the former President is earning at least $500,000 annually from Carlyle, not including the money he makes investing in deals. Rubenstein declines to specify which companies Bush has put money into, except to say that as a rule, they have nothing to do with the U.S. government.

There's no doubt that without these stars Carlyle would not have been able to raise as much money as it has. The firm's impressive returns and Rubenstein's seemingly inexhaustible energy and willingness to spend 300 days a year traveling have certainly played a role, but it's the bigwigs who draw crowds and really leave an impression. Their names on Carlyle brochures and their faces at Carlyle events give the firm a patina of power and credibility. "David's a brilliant fundraiser," says a source formerly associated with Carlyle. "What he's done so masterfully is traffic on the impression that the connections they have from these guys can bring them many valuable deals."

In the case of Carlucci, that impression happens to be true. The deals he's brought in total close to $2 billion in profits. There were Magnavox and GDE, makers of top-secret electronics gear, and Vought, an aircraft-parts manufacturer, all of which Carlyle bought and sold within two years, netting $300 million, $109 million, and $140 million, respectively.

Carlyle today is mostly associated with the defense industry, and one of the things Rubenstein and his partners would like to get across is that they invest in other things too. In fact, the firm owns stakes in everything from European automotive-parts manufacturers to Silicon Valley startups and Japanese DSL companies; roughly 25% of its profits last year came from real estate. But if you follow the money, it leads straight back to defense, which is where the greatest chunk of Carlyle's profits have come from. Today defense accounts for about 10% of the firm's total investments, but in the early days it was 60%.

The firm's biggest score to date also involved a military contractor--United Defense, which went public in November, turning Carlyle's $130 million investment into $900 million. But the story of United Defense's latest coup also shows why Carlyle will probably never be seen as just another shrewd investment firm.

Last spring, when United Defense was feverishly pitching the Crusader, one of its new products, to the Department of Defense, Jacques Gansler, then in charge of acquisitions at the Pentagon, got a call from across the Potomac. It was Frank Carlucci, and according to Gansler, he wanted to know how Gansler felt about the Crusader, a controversial self-propelled artillery system that many inside the Pentagon felt was out of sync with plans for a lighter, more mobile Army. "I think he [Carlucci] wanted to make sure I was personally involved and that it wasn't going to be one of these things that got pushed down the bowels of the system,'' says Gansler, who has known Carlucci since the Reagan Administration and occasionally sees him at D.C. social events. As it turned out, Gansler was no fan of the Crusader and told Carlucci as much, ending that conversation. But Gansler thinks that had he been a fan, Carlucci "definitely would have wanted to make sure I was involved.'' It wasn't the first time Carlucci had had a conversation with a member of the Pentagon brass on behalf of a Carlyle company. In the early '90s, when Carlyle owned GDE, Carlucci drove over to Bethesda, Md., and met with, among others, Major General Raymund O'Mara, who was head of the Defense Department's Defense Mapping Agency, then a big GDE customer.

Carlucci acknowledges both conversations but asserts that neither constitutes lobbying. In O'Mara's case, he points out that GDE already had business from the mapping agency; in the case of Gansler, Carlucci says his call did nothing to advance the Crusader's cause. Nor, he says, did any of his interactions with Secretary of Defense Donald Rumsfeld during that time. The two men have known each other since their days on Princeton's wrestling team. The Rumsfelds have been to the Carluccis' for dinner and on several occasions have offered their ski house in Taos, N.M., to Carlucci and his wife, Marsha. It certainly would be easy for Carlucci to strike up a conversation over cocktails about the Crusader or some other Carlyle-related matter, but Carlucci says he never does that. "In light of our friendship, I'm particularly cautious about not discussing Carlyle business with him. In fact, I have never mentioned the word 'Crusader' in his presence," he says. All this may well be true. Yet it certainly can't hurt if it's known throughout the Pentagon that you are good friends with the Secretary of Defense. The Crusader, incidentally, is on the 2003 defense budget, making it likely that the Pentagon will ultimately buy 480 of the artillery systems for $5 billion.

There's no question that Carlyle does occasionally make calls to the government on behalf of its companies. They may not be hard-sell lobbying calls, but making introductions to influential people is often just as effective. One company Carlyle funded recently through its venture fund hopes to tap into the firm's government connections. Indigo Systems, a maker of infrared-camera technology in Santa Barbara, has an interest in seeing the laws restricting exports of U.S.-made infrared technology lifted or amended. Indigo's technology goes into tiny cameras that manufacturers are starting to place in cars. These cameras "see'' objects out of the range of the headlights and display them on a digital monitor. "The automotive industry is not centered on the U.S. today, and if our product is going to become a standard item on cars, I've got to have access to a global marketplace,'' says CEO Tim Fitzgibbons. During the five months it took Indigo and Carlyle to put together a deal, the two sides talked about ways Carlyle could help open doors within the government. "If somebody at Carlyle says to whoever is chairing a committee, 'We wish you would listen to these guys, we're invested in them, and they've got a good point,' then that says a lot. As opposed to me landing in D.C. and trying to get appointments, which is damn near impossible,'' says Fitzgibbons. Indigo's camera technology also has lots of security applications, and the company would like to get a slice of next year's $38 billion federal budget allocated for homeland security. "Carlyle certainly can't influence the outcome, but they can at least get us an audience,'' says Fitzgibbons.

Besides opening doors, fundraising, and marketing, there is another advantage to getting ex-government honchos to join your firm, and that's investment insight. Carlucci didn't help companies like Magnavox, GDE, and Vought win any defense business, but he brought these firms to Carlyle because of connections he'd made with defense contractors while at the Pentagon. And as a former Defense Secretary just a few years out of the job, he knew how to evaluate the companies. It was the end of the Cold War and Pentagon budgets were way down, but Carlucci knew big money was still going to be spent on certain programs. He figured that highly classified electronic equipment--such as the boxes for analyzing radar imagery and the battlefield radios made by Magnavox, as well as the digital mapping technology for cruise missiles made by GDE--was going to be very valuable as the Pentagon tried to make the Armed Forces smarter. Later, when Carlyle invested in Elgar Electronics in 1996, Carlucci looked favorably on something that scared off other investors. Says Elgar CEO Ken Kilpatrick: "Other people questioned what would happen if our business of selling automatic testing equipment to the Navy would go away. But Carlyle understood that the Navy was committed to this program and that it was just in the middle of it." Carlyle sold Elgar in 1998 for a profit of $100 million.

Carlucci downplays the extent of his insight by saying that top analysts like Loren Thompson at the Lexington Institute know just as much as he does about defense spending, and maybe more. Certainly people like Thompson are quite knowledgeable and have networks of contacts at the Pentagon, but they don't belong to the same high-level coterie that a former Secretary of Defense does. They don't, for instance, go to lunches like the one Rumsfeld gave a little over a year ago where former Pentagon heavyweights like Carlucci, William Cohen, Caspar Weinberger, William Perry, and Dick Cheney all chatted and mingled. "Cabinet-level people are a small fraternity who all stay in touch,'' says a former Carlyle staffer. "Once they've reached that global 50,000-foot view, they tend to stay there.''

Though defense has been Carlyle's most fruitful area to date, Carlucci and the firm's current head of defense investing, Alan Holt, don't have plans to do many deals this year. Wars are such an obvious bonanza for defense contractors that prices get bid up, and Carlyle thinks they're too high now. Fortunately, there are lots of other opportunities on the horizon. Carlyle recently launched its first energy fund in partnership with Riverstone Holdings; it is also in the process of putting together an asset-management group, headed by the former treasurer of the World Bank, that will invest in other private-equity funds. With the help of former SEC chief Levitt, Rubenstein is setting up a financial services fund. There's also telecom, which has the biggest team of people devoted to it of any area at Carlyle. "There are dramatic restructurings in the telecom and media business going on right now, and the one thing they have in common is that they're all driven at some point by government action,'' says former FCC boss Kennard--who, like Levitt, is a Democrat, which shows that Carlyle can be bipartisan.

Rubenstein started recruiting Kennard to be a managing director in Carlyle's telecom group as soon as he left the commission last year, and ultimately won out over lots of other bidders. He was quite a catch. Kennard knows everyone who's anyone in telecom and has extensive contacts at regulatory agencies around the world. Could telecom be Carlyle's new defense? Rubenstein doesn't like to put in it those terms, but he's hoping for big returns. Looking at what Carlyle and its star-studded team have been able to do in the past, would you bet against him?

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