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SBC Private Equity Hearing

Senate Committee on Banking, Housing, and Urban Affairs

Protecting Consumers and Communities from Private Equity Abuse

Wednesday, October 20, 2021

Witnesses

Opening Statements
Chair Elizabeth Warren (D-Mass.)
Warren discussed the consequences of private equity firms buying up a range of companies in different industries, allowing firms to profit at the expense of those companies. She also discussed the costs to people’s health and students when private equity firms buy up medical centers and for-profit colleges. Warren recapped her bill, the Stop Wall Street Looting Act (WSLA) and said it would address private equity failures.

Ranking Member John Kennedy (R-La.)
In his opening statement, Kennedy described private equity (PE) as a decision of one willing buyer and seller and believes it to be an essential part of the free enterprise system. He added that he is pro private equity.

Testimony
Shirley Smith, Former Sales Manager, Art Van Furniture
In her testimony, Smith discussed her experience when a PE firm, T.H. Lee, took over the company she worked at. She saw workers being hired who did not know the business, orders began coming in slower, staff was being cut, and the company racked up millions of dollars in debt. Smith urged Congress to stop PE firms from coming in and taking over companies, driving them into bankruptcy, leaving employees with nothing, and gutting local economies.

Peggy Malone, Registered Nurse, Crozer-Chester Medical Center
In her testimony, Malone described the issues she has experienced while working at the Crozer-Chester Medical Center which is owned by Leonard Green & Partners, a major PE firm. She said the tax system should not be creating incentives for bad business practices, and PE firms should not be able to extract huge dividends while failing to fund employee pensions and supports Senator Warren’s Stop Wall Street Looting Act.

Michael Frerichs, Illinois State Treasurer
In his testimony, Frerichs said that although there is strong value in PE investment, there are many examples of firms that have profited off a business model that allows them to buy companies, load them up with debt, pay themselves massive and opaque fees with that borrowed money, and then leave the company bankrupt. Frerichs said he has seen hundreds of thousands of workers lose their jobs in PE owned corporate bankruptcies, tearing families and neighborhoods apart. He urged Congress to consider reforms that prioritize worker pay in the bankruptcy process, create incentives for job retention so that workers can benefit from a company’s second chance, and incentivize value-generating management and investment over asset-stripping.

Dr. Eileen Appelbaum, Co-Director, Center for Economic and Policy Research
In her testimony, Abbelbaum said Main Street is being “pillaged” by Wall Street’s largest private investment firms, and that PE firms view the companies their funds acquire for their portfolios as financial assets whose purpose is to provide returns to the fund and its private equity investors, not as operating companies that employ workers, produce valuable products for customers, and foster sustainable growth. She said the WSLA would provide incentives to PE funds sitting on many billions of dollars to use them in ways that create good jobs, high-quality goods and services, and help build a sustainable economy that supports the planet.

Dr. Doug Holtz-Eakin, President, American Action Forum
In his testimony, Holtz-Eakin expressed concerns that the WSLA would strongly discriminate against PE firms and damage the outlook for the industry and economy as a whole. He added that the impacts of this bill include: a 100 percent surtax on fees received from portfolio companies, a tax increase on carried interest capital gains, limitations on interest deductibility, restrictions on dividends, joint and several liability on holders of economic interests in a private fund for all liabilities of a portfolio companies, and alternative rules for the treatment of worker claims in bankruptcy. He urged that legislation should not disrupt the level playing field.

David R. Burton, Senior Fellow in Economic Policy, The Heritage Foundation
In his testimony, Burton said PE funds are the primary means for holding incompetent management accountable, and the means by which troubled companies are acquired, management replaced, and companies turned around. He said the WSLA would “erect a moat and high walls” around failing companies so that it would become virtually impossible to take over failing companies and replace their management. Burton said this may be attractive to corporate elites and their lobbyists, but is not in the interests of shareholders, workers, or consumers. He added that it is poorly drafted because the 100 percent tax in the WSLA on payments to private funds would be imposed on a host of businesses and payments far beyond what legislators intend. Also, he noted that there is no limitation on this tax to private equity funds acquiring targets within the statutory definitions.

Question & Answer
Fee Expense Arrangements
Kennedy asked Frerichs if he invests in PE without understanding the fees. Frerichs said no, but they have to spend a lot of time and effort understanding the fees and thinks there would be improvements in fees with greater transparency.

Sen. Jack Reed (D-R.I.) asked Frerichs to share his experience with private equity fee expense arrangements. Frerichs said that as private equity evolves, there is a need for disclosure around direct and indirect fees, expenses, and performance-based fees.

Warren said Frerichs manages a pension fund that invests in PE on behalf of public employees and asked if he is satisfied with the current rules governing PE. Frerichs said standard reporting would ensure transparency for all investors. He said their office does their due diligence but for many others there is difficulty receiving proper disclosure and transparency around direct and indirect fees in a clear and consistent manner. He explained that the opaqueness makes it difficult to “shop around” and ensure they are getting a competitive rate.

Regulation Gaps
Reed asked Appelbaum what she believes to be the gaps in regulation and supervision of private equity. Appelbaum said there is little recognition that firms have developed many avenues beyond leveraged buyouts for their work and gave multiple examples like real estate trusts.

Impact from Restricting Private Equity Markets
Kennedy said the WSLA would “gut private equity like a fish” and asked what impact this would have on workers in America. Holtz-Eakin said PE markets are large and an important source of capital for firms to invest in their workers, and the elimination of PE could cause layoffs. Burton said if private capital markets are restricted, it would destroy the U.S. economy because they are the most important means of raising capital for businesses and entrepreneurship.

Underperforming Firms
Warren asked if private equity outperforms the market. Appelbaum said no, that since 2006, the median or typical private equity firm has not outperformed the market, and at least half of the firms are underperforming. Warren asked what the investors are paying for. Appelbaum said they are paying billions of dollars in fees, and she pointed to a study that called PE funds “billionaire factories” for producing little for investors, yet turn PE firm partners into trillionaires.

Private Equity Abuse
Warren asked Smith how Art Van went under. Smith said Art Van was profitable before the private equity firm T.H.L. came in who then sold off all of Art Van’s real estate, made back the money spent buying the company, fired leadership, hired a bad CEO, and ran the company out of business. She added that T.H.L. took money out of the company without putting anything back in and denied workers benefits like severance pay when the company went out of business. Warren asked Malone if she noticed a change when private equity took over her medical center. Malone said yes, describing immediate staffing and supply cuts and other aspects of the private equity deal and said it is not surprising that private equity ownership has shown to cause deaths in nursing homes.

For more information on this hearing, please click here.