FORTUNE — Jan. 20, 2009, was a day of proud and joyous reflection for Alphonse “Buddy” Fletcher Jr. The New York hedge fund manager had come to Washington, D.C., to witness Barack Obama making history and also to host a pre-gala cocktail party. One of the honored guests was inaugural poet Elizabeth Alexander, a professor at Yale and a recipient of a fellowship Fletcher had established to promote race relations.
As evening fell Fletcher gave a toast that acknowledged the significance of the moment, for the nation and for himself. While some of the most important people in his life looked on — Harvard scholar Henry Louis Gates Jr.; Fletcher’s mother, Bettye; and his brother, Geoffrey, whose screenplay for the film Precious would later win an Oscar — Fletcher delivered a speech built around the theme “What are the chances?” What are the chances, he mused, that the nation would elect its first black President or that a Fletcher Fellow would read her poem at the Inauguration? He acknowledged his wife, the venture capitalist Ellen Pao, and their 6-month-old daughter, Matilda. What are the chances, he asked, that he’d be there that day with his beautiful wife and child?
This last note elicited warm laughter. His friends all knew that Fletcher had for years openly dated a man, Hobart “Bo” Fowlkes, an employee of his investment firm, who helped plan the party but was not in attendance. But in the span of a year beginning in the summer of 2007, Fletcher and Pao had met, married, and started a family. The event was infused with a powerful dose of “hope and change.”
Nearly four years later much has changed for Fletcher and Pao — though not for the better. After achieving coveted positions in the rarefied world of finance, Fletcher and Pao each filed sensational lawsuits that now jeopardize their careers, no matter the outcome. Fletcher, 46, sued the iconic Dakota apartment building, located on Manhattan’s Upper West Side, accusing the board of racial discrimination after it questioned his ability to pay for an additional unit in the complex. The lawsuit triggered a series of events that ultimately led to the bankruptcy of one of Fletcher’s funds and investigations by the Justice Department and the Securities and Exchange Commission. Then, just as Fletcher’s predicament was intensifying, Pao, 43, sued her employer, the venerable venture capital firm Kleiner Perkins, for sexual discrimination, alleging that her superiors ignored her complaints of maltreatment by some male colleagues — and curtailed her career for raising the issues.
The unfolding drama has been the buzz of Wall Street and Silicon Valley, in part because the elite of those communities surely see glimpses of themselves and their values in the Pao-Fletchers: With five Ivy League degrees between them and access to some of the most influential people in business and academic circles, the attractive interracial couple embodies the sort of bicoastal, nerdy-cool success that so many smart young people aspire to.
But they were an odd couple from the start. Fletcher for years was attracted to the limelight and courted high-profile patrons. (Steven Rattner, a former neighbor at the Dakota, is a past investor in Fletcher’s firm; Tribeca Film Festival co-founders Craig Hatkoff and Jane Rosenthal befriended him.) Pao, consistently described above all else as “quiet,” faded into the woodwork; mentors adopted her because of her potential and work ethic. Fletcher thrust himself into the national debate on race relations with his fellowship program, and he has twice sued others for racial discrimination. Despite her pedigree and accomplishments, Pao achieved no notoriety at all until her explosive allegations came to light.
Their story picks at the societal scabs of sexism and racism that many like to think healed long ago. When the daughter of Chinese immigrants and the son of a middle-class black family achieve great success, they are held up as proof that the American dream works for everyone. Yet Pao and Fletcher say they have been victimized by dynamics that supposedly no longer exist.
It would be easy to dismiss their lawsuits, as many in their social cohort have, as the desperate actions of two individuals going through major professional crises — troubles that Fortune has pieced together by speaking with dozens of former colleagues, friends, neighbors, and associates and by reviewing hundreds of pages of court documents. (Pao and Fletcher declined to comment for this article.) But what if some or all of their allegations prove to be true? What would that say about the enlightened worlds of Silicon Valley and the Upper West Side? What would it say about the American dream in 2012?
In the spring of 2005 Ellen Pao applied for a job at Kleiner Perkins. John Doerr, the firm’s famed leader, sought a technical chief of staff who met precise job specifications: an engineering degree from a prestigious university, degrees in law and business, and a background in enterprise software. “I met everything in the spec,” Pao said in a 2008 interview with Fortune.
Pao was accustomed to meeting high expectations. The middle child of three girls, Pao grew up in suburban New Jersey. Her father, Young-Ping Pao, was a professor at New York University’s Courant Institute of Mathematical Sciences. The elder Pao, who died in 1987 when Ellen was a senior in high school, instilled in his children a commitment to academics, and each fulfilled his dreams. Ellen majored in electrical engineering at Princeton, where both her sisters studied as well.
Pao kept racking up the Ivy League degrees. From Princeton she went straight to law school at Harvard; then, after a stint at Cravath Swaine & Moore, she earned another Harvard degree, this time from the business school. “She is one of the least objectionable people on earth,” says Rebecca Eisenberg, a law school classmate. “She doesn’t stand out. She’s the type of person who just goes about her business.”
After graduating from business school in 1998, Pao moved through a progression of business-development jobs in Silicon Valley. She was also briefly married to her HBS boyfriend, Roger Kuo, now a mutual fund executive in San Francisco. The relationship ended quietly and, like so much in Pao’s life, without controversy. It was during her time at software maker BEA Systems that the Kleiner opportunity surfaced. Her boss at BEA, Adam Bosworth, encouraged her to take the job. “She was smart and underutilized and underchallenged,” he recalls. “She wasn’t setting her standards high enough.”
At Kleiner, Pao settled into a position that gave her access to some of the most glamorous and challenging opportunities in technology. As Doerr’s top aide she enjoyed an enviable position: Her office was next to his, and she sat in on his meetings. Yet her tasks could be menial. Doerr travels with a printer, the better to quickly produce a term sheet for entrepreneurs. Pao was known to carry it for him; Doerr says that didn’t happen.
Her proximity to Doerr thrust her into two areas outside her expertise: pandemics and clean tech. Both proved to be bad bets for Kleiner Perkins, and that was a setback for Pao.
A diligent worker, Pao stood apart in the schmoozy — and overwhelmingly male — world of venture capital. Numerous former colleagues noted that Pao rarely mentioned her personal life at work. “She’s not a good ol’ boy,” says Bosworth, her boss at BEA. “She crosses every t and dots every i before going to bed,” he says. She exuded an attitude of “Tell me what is expected, and I’ll do it.”
Kleiner Perkins quickly became an unhappy place for Pao. A year or so after joining the firm, she briefly had a relationship with a peer, Ajit Nazre. When Pao ended the relationship, she would later allege, she began to suffer retaliation in the form of being omitted from business meetings and being undermined with her portfolio companies. She also later claimed that she wasn’t the only woman at Kleiner Perkins to suffer from gender discrimination, and in the middle of 2007, she claims, she discussed her concerns with several senior partners, including Doerr. The firm denies this.
Her time at Kleiner may not have been all she had hoped it would be, but her connection to Doerr produced one tangible perk. Doerr, a trustee of the Aspen Institute, recommended Pao for the Crown Fellows program, a leadership seminar for outstanding young professionals. In August 2007 she traveled to Colorado for the weeklong session. There she would meet Buddy Fletcher.
Buddy Fletcher’s early adulthood is a swirl of successes marred by brief episodes of unpleasantness. “The popularity Buddy had was almost unmatched,” says Roy Niederhoffer, a New York hedge fund manager who was Fletcher’s freshman roommate at Harvard. Fletcher, who played varsity football at Harvard, was voted a class marshal, a kind of prom king meets social chairman. He was a member of the Harvard Republican Club and the exclusive Phoenix SK club made famous in the film The Social Network because Mark Zuckerberg couldn’t get in the door. Fletcher became club president. At one point, according to three former club members, including close friend Stephen Cass, Fletcher was impeached over concerns he had improperly used club funds. Some members resigned in support of Fletcher. Fletcher was later reinstated, and he and the two friends resumed their relationship with the club.
Fletcher moved to Wall Street after graduation, excelling at equities trading at Bear Stearns, then Kidder Peabody. He quit Kidder in 1991, dissatisfied with his bonus, and set up his own firm, Fletcher Asset Management. He also sued Kidder for racial discrimination, alleging that the firm decided that the amount he was owed “was simply too much money to pay a young black man.” An arbitration panel dismissed the racism charge but ordered Kidder to pay Fletcher an additional $1.3 million in bonus money.
At his new firm Fletcher boasted triple-digit returns and frequently told reporters he had never had a losing quarter. He also developed expensive tastes: a multimillion-dollar apartment in the Dakota, an 1,100-acre estate in Connecticut, and a chauffeured Bentley. While still in his twenties, Fletcher also gave generously to charity, setting up a personal foundation in 1994 and donating to cultural institutions that celebrated African Americans. He pledged a large, undisclosed sum to Harvard; legal documents reviewed by Fortune later revealed the amount to be about $9 million, by Fletcher’s estimations. The pledge came in the form of three securities, including a “contractual right” to buy shares in the biotech company Calgene.
Those donations, his apparent financial wizardry, and his straitlaced, dorky persona (think Clark Kent meets Steve Urkel) burnished Fletcher’s reputation as a bright young thing — The New Yorker wrote a glowing profile in 1996, and he was a patron of the arts and academia. All this gave him an aura of unassailability. Within the well-appointed walls of his firm, however, Fletcher developed a reputation for brutal behavior. Five former employees say he would scream when angered. He would talk about how he was surrounded by incompetent people. He would disappear from the firm for long periods, sometimes days, ex-employees say.
Fletcher’s mom, Bettye, who kept an office at Fletcher Asset Management, tried to explain away her son’s absences and smoothed things over with the staff. Says an employee who logged four years under Buddy Fletcher: “It’s not a pleasant place or a good culture. There was a lot of turnover as it dawned on people that they had left good jobs only to be abused.”
Even those who were once close to Fletcher say they were pressured. Michael Meade, a college friend and Fletcher Asset Management cofounder, and Cass, his SK club friend and later an employee, both alleged sexual harassment in the mid-1990s after being fired. They claimed Fletcher had retaliated when they rejected his advances. (Ironic, then, that some 15 years later Pao would accuse her employers of retaliating against her for making claims of discrimination.) While neither man would comment on their cases, Meade tells Fortune that he and Fletcher have reconciled. In 2003 and 2006 two caretakers at Fletcher’s Connecticut manse sued for sexual harassment, according to a 2011 article in the New York Times, which says that they settled as well.
Yet Fletcher never seemed to grasp the gravity of the accusations. He flirted with the idea of running for New York State controller, according to a person with knowledge of meetings with New York Democratic leaders. It seems never to have occurred to him, this person says, that the sexual-harassment claims would hurt his chances.
Legal issues also clouded Fletcher’s Harvard donation, according to court documents. Harvard announced in 1996 that Fletcher had generously donated at least $3 million to fund the Alphonse Fletcher University Professorship. (The first holder of the chair was the noted scholar Cornel West.) Exactly one year later the school sued Calgene in an attempt to redeem a contract to buy shares worth $3.8 million, by Fletcher’s estimate. Calgene said it had voided the contract before Fletcher had even given it to Harvard, legal documents say. Harvard and Calgene settled in December 1999. Harvard declined to comment.
Since 2006 the endowed chair has been held by Henry Louis Gates Jr., the influential scholar. Gates became an important fixture in Fletcher’s life: Gates says he introduced Bettye Fletcher to James Comer, a prominent Yale professor she married in 2004. He also unwittingly played matchmaker for Buddy Fletcher. As a trustee of the Aspen Institute, Gates often nominates potential Crown Fellows. In 2007 he recommended Fletcher.
The prestigious Crown Fellows program typically attracts the best and the brightest, and the class of 2007 was no exception. It included Chris Sacca, a Google (GOOG) executive at the time; John Wood, the founder of the nonprofit Room to Read; and Goldman Sachs (GS) banker Brooks Entwistle. One hallmark of the fellowship each year is an evening spent singing around a campfire, capping a week of shared experiences among the fellows. Fletcher and Pao bonded in the rare air of Aspen, where they came to be aware of their shared associations with Harvard, the financial world, and their respective experiences in the clubby, white, male worlds each encountered daily.
But it was difficult to see from the outside what more they had in common. When their relationship began, few if any of their Crown colleagues knew about it. “Ellen struck me as very quiet and reserved,” said one participant. “Buddy struck me as masked — not someone I would ever get to know.”
Their romance was a whirlwind. They wed that December in San Francisco, then repeated their vows in a civil-union ceremony at the Memorial Church of Harvard in April 2008, when Pao was six months pregnant. (Yes, the once openly gay Fletcher married a woman after a four-month courtship.) Fletcher began spending considerable time in San Francisco at the couple’s apartment in the Residences at the St. Regis. They avoided the regular Bay Area social scene, confining themselves to family-oriented and low-key activities: birthday parties for friends of their daughter’s and gatherings of Pao’s business school classmates. They were often spotted in the restaurant at the St. Regis with their infant in tow. Like others in Pao’s San Francisco social circle who have come into contact with Fletcher, BEA’s Adam Bosworth found him “hard to read.” And formal as well. “She told us to call him Buddy, but after a while I switched to Alphonse,” says Bosworth.
Despite his constant presence in San Francisco, Fletcher had New York on his mind, specifically his home at the Dakota. Already the owner of four units there, Fletcher applied to buy a two-bedroom apartment in the tony building in April 2010. The following month the Dakota board denied his application, prompting Fletcher to sue for racial discrimination. The board fired back with affidavits suggesting that Fletcher couldn’t afford his maintenance fees and mortgage payments. Most damaging, however, were the Dakota’s allegations that it didn’t trust the financial statements of Fletcher Asset Management, his firm. The board questioned the independence of Fletcher’s auditors and suggested that he had exaggerated the amount of money he managed. In his 2012 SEC registration, Fletcher says he has $555 million under management, a relatively modest amount for a fund boasting a two-decade record of outstanding returns and that was also actively looking to raise funds.
Following the Dakota’s incendiary allegations, three Louisiana pension funds requested money from their investment in a Fletcher vehicle called the FIA Leveraged Fund, which was registered in the Cayman Islands. At first they wanted to take some profits off the table. Eventually they redeemed their entire investments. Fletcher issued an IOU, saying that the assets weren’t liquid. The funds rejected the note. By the end of 2011, neither Fletcher nor the Louisiana pension funds could agree on an acceptable payment. The relationship between them deteriorated, and after an unsatisfactory meeting with Fletcher in December, the investors filed a petition in the Cayman Islands to liquidate the Leveraged Fund and get their money back.
Back in California, Pao was miserable at work. Friends say she made allusions to how beleaguered and overlooked she felt. She complained further to various Kleiner managers about her treatment, according to her suit. She also claimed to have been excluded from a high-level Kleiner dinner that took place at the St. Regis in San Francisco, where she had an apartment. (In its response to Pao’s suit, Kleiner denied that women were excluded from the dinner.) Ajit Nazre, the partner Pao had been involved with, quietly left Kleiner earlier this year.
In early 2012, shortly after Fletcher’s dispute with his investors was reaching a boiling point, Pao began to prepare a suit of her own, retaining lawyers who began interviewing potential witnesses. In March three male colleagues at Kleiner were promoted from the junior-partner role they shared with Pao; the staffing changes only aggravated her sense of grievance as she was not promoted.
At the same time, Fletcher’s situation with his Cayman Islands-based fund turned grim. A Feb. 27 affidavit by a Fletcher employee revealed that the FIA Leveraged Fund hadn’t filed an audited financial report since 2008, and that Fletcher’s main fund hadn’t filed audited financials since 2009. What’s more, Fletcher attempted to repay the Louisiana pension funds in a manner reminiscent of his Calgene maneuver with Harvard years earlier. Instead of cash, Fletcher offered the pension funds warrants to buy shares in United Community Bank, according to court documents. But Fletcher and United Community disagreed about the value of the warrants; a judge in the Cayman Islands in April ruled that the stock warrants were an unacceptable payment — in fact they could be less than worthless. When Judge Anthony Smellie used United Community’s assumptions, the warrants would actually create a $22.6 million loss for the pension funds. He ordered the liquidation of the Cayman-based fund.
Amid this embarrassing turn of events for Fletcher, Pao dropped a bombshell that would introduce even more scrutiny into their family life. On May 10, three weeks after the judge ordered her husband to liquidate one of his funds, Pao filed her jaw-dropping lawsuit against Kleiner, which became public 12 days later. Salacious tidbits in Pao’s complaint included her acknowledgment that she had “succumbed” to Ajit Nazre’s sexual advances “on two or three occasions” and that Pao had knowledge of “another female junior partner” who had been harassed by Nazre. (Efforts to reach Nazre for comment were unsuccessful.)
She also claimed that Book of Longing, given to her by Randy Komisar, a senior Kleiner partner, contained “many sexual drawings and poems with strong sexual content.” In its response to Pao’s allegations, Kleiner said she had “twisted facts and events” to make a harmless gift seem menacing. The suit grabbed headlines and provoked a statement from Doerr himself. In denouncing his former aide, he said the firm was going through a “difficult time” because of Pao’s “false allegations.” He also encouraged observers to consider Kleiner’s record on diversity.
Pao’s bold act flew in the face of past criticisms levied against her by Kleiner partners — that she was passive, that she waited for orders, and that she was risk-averse. She had turned their expectations on their head. She also showed astonishing backbone by continuing to come to work at Kleiner for five months after filing her suit, before Kleiner began the formal process of firing her. The situation was awkward, to say the least, as Pao continued to participate on the boards of the companies in which she had invested on Kleiner’s behalf and to attempt to make new investments. During the summer after she filed suit, Adam Bosworth asked Pao why she hadn’t simply left Kleiner. Her response, he said: “Why should I leave? I haven’t done anything wrong.”
In early October Kleiner ended Pao’s odd employment situation by telling her she would be paid for an additional six months and receive a severance payment but not be required to report to work any longer. As well, it informed Pao that the firm would begin the process of replacing her on her boards. (Venture capitalists who leave their firms on good terms will often continue to look after their investments so that current partners can focus on new efforts.) Pao took the unusual step of announcing on the website Quora that she had been fired.
Kleiner and Pao, of course, remain inextricably bound — and will be regardless of the outcome of her suit, which could yet yield her an enormous settlement or judgment should it go to trial. Pao’s allegations will be attached to the names of many partners for years to come, and her filing, along with the dismal number of woman executives at the highest levels of Silicon Valley venture firms and startups, is prompting a candid conversation about the role of women in technology.
Pao’s stubbornness may have surprised her peers, but it may not have surprised the one person who has been fighting his own battles in parallel. Fletcher has settled lawsuits filed against him, but he’s never lost one yet. Emboldened by his early Kidder Peabody victory, perhaps Fletcher is someone who doesn’t shy away from a challenge, who refuses to cede ground.
But can he fight his way out of his current predicament? The team appointed by the court to liquidate Fletcher’s Cayman Islands fund has raised questions about the handling of investors’ money, saying the fund’s complicated structure “allowed fees to be drawn … at multiple levels, without any benefit to investors.” The liquidators also noted that a firm affiliated with Fletcher had been paid $3.3 million in fees by the Leveraged Fund, unbeknown to the investors. On June 29, Fletcher halted the liquidation process by having part of his firm file for voluntary bankruptcy. Fletcher hoped to maintain control of the process, but the court had other ideas. Over Fletcher’s wishes, the bankruptcy judge appointed Richard J. Davis as the trustee overseeing the process. Davis, who specializes in white-collar crime, is best known for his work as an assistant special prosecutor in the Watergate trials. “The central issue in this case concerns corporate governance,” Tracy Davis, the U.S. Trustee overseeing the district bankruptcy courts, says in a filing.
After the revelations of the past year it seems Fletcher may have great difficulty attracting new investors for future funds. His wife’s professional prospects are equally uncertain. Her accusations have reversed her reputation such that even her friends don’t quite know what to make of her: Is she the diligent immigrants’ kid, or is she a defiant nonconformist? Whistleblower or troublemaker?
The couple are now on parallel paths of litigation and have crises enough for a 50-year marriage, never mind one that will be just five years old this December. It’s easily enough to drive even the most rock-solid pair apart. For Buddy Fletcher and Ellen Pao, it seems to have brought them together for now. Oddly enough.
–Additional reporting by Doris Burke
This story is from the November 12, 2012 issue of Fortune.