[Senate Hearing 117-666]
[From the U.S. Government Publishing Office]
S. Hrg. 117-666
PROTECTING COMPANIES AND COMMUNITIES
FROM PRIVATE EQUITY ABUSE
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
ECONOMIC POLICY
OF THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING WHAT PRIVATE EQUITY FIRMS ARE DOING TO OUR
ECONOMY AND TO OUR COMMUNITIES
__________
OCTOBER 20, 2021
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Available at: https: //www.govinfo.gov /
__________
U.S. GOVERNMENT PUBLISHING OFFICE
52-184 PDF WASHINGTON : 2023
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
SHERROD BROWN, Ohio, Chairman
JACK REED, Rhode Island PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey RICHARD C. SHELBY, Alabama
JON TESTER, Montana MIKE CRAPO, Idaho
MARK R. WARNER, Virginia TIM SCOTT, South Carolina
ELIZABETH WARREN, Massachusetts MIKE ROUNDS, South Dakota
CHRIS VAN HOLLEN, Maryland THOM TILLIS, North Carolina
CATHERINE CORTEZ MASTO, Nevada JOHN KENNEDY, Louisiana
TINA SMITH, Minnesota BILL HAGERTY, Tennessee
KYRSTEN SINEMA, Arizona CYNTHIA LUMMIS, Wyoming
JON OSSOFF, Georgia JERRY MORAN, Kansas
RAPHAEL WARNOCK, Georgia KEVIN CRAMER, North Dakota
STEVE DAINES, Montana
Laura Swanson, Staff Director
Brad Grantz, Republican Staff Director
Cameron Ricker, Chief Clerk
Shelvin Simmons, IT Director
Charles J. Moffat, Hearing Clerk
______
Subcommittee on Economic Policy
ELIZABETH WARREN, Massachusetts, Chair
JOHN KENNEDY, Louisiana, Ranking Republican Member
JACK REED, Rhode Island TIM SCOTT, South Carolina
CHRIS VAN HOLLEN, Maryland THOM TILLIS, North Carolina
TINA SMITH, Minnesota KEVIN CRAMER, North Dakota
JON OSSOFF, Georgia STEVE DAINES, Montana
Gabrielle Elul, Subcommittee Staff Director
Natalia Riggin, Republican Subcommittee Staff Director
(ii)
C O N T E N T S
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WEDNESDAY, OCTOBER 20, 2021
Page
Opening statement of Chair Warren................................ 1
Prepared statement........................................... 25
Opening statements, comments, or prepared statements of:
Senator Kennedy.............................................. 1
WITNESSES
David R. Burton, Senior Fellow in Economic Policy, Roe Institute
for Economic Policy Studies, Institute for Economic Freedom and
Opportunity, The Heritage Foundation........................... 2
Prepared statement........................................... 26
Doug Holtz-Eakin, President, American Action Forum............... 4
Prepared statement........................................... 41
Michael Frerichs, Illinois State Treasurer....................... 5
Prepared statement........................................... 42
Shirley Smith, former Sales Manager at Art Van Furniture and
Leader with United for Respect................................. 6
Prepared statement........................................... 45
Peggy Malone, Registered Nurse, Crozer-Chester Medical Center.... 8
Prepared statement........................................... 47
Eileen Appelbaum, Codirector, Center for Economic and Policy
Research....................................................... 10
Prepared statement........................................... 48
Responses to written questions of:
Senator Reed............................................. 60
Senator Van Hollen....................................... 65
Additional Material Supplied for the Record
Statements submitted in support of the Stop Wall Street Looting
Act............................................................ 68
Letters submitted in opposition to the Stop Wall Street Looting
Act............................................................ 146
(iii)
PROTECTING COMPANIES AND COMMUNITIES FROM PRIVATE EQUITY ABUSE
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WEDNESDAY, OCTOBER 20, 2021
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Subcommittee on Economic Policy,
Washington, DC.
The Subcommittee met at 2:14 p.m., via Webex and in room
538, Dirksen Senate Office Building, Hon. Elizabeth Warren,
Chair of the Subcommittee, presiding.
OPENING STATEMENT OF CHAIR ELIZABETH WARREN
Chair Warren. This hearing will come to order. This hearing
is in a hybrid format. A few reminders. As you begin, for our
guests who are joining us virtually, once you start speaking
there is a slight delay before you are displayed on the screen.
To minimize background noise please click the Mute button until
it is your turn to speak or to ask questions.
You should all have one box on your screen labeled
``Clock'' that will show you how much time is remaining. For
witnesses, you will have 5 minutes for your opening statements.
For all Senators, the 5-minute clock still applies for your
questions. At 30 seconds remaining for your statements and
questions you are going to hear a bell ring to remind you that
your time is almost expired. It will ring again when your time
has actually expired.
And to simplify the speaking order process, Senator Kennedy
and I have just decided we will go by seniority as people come
in.
What we are going to do is we are also in the middle of
votes, just to add an extra layer of complication to all of
this. So I am going to hand the gavel over to Senator Kennedy,
who is going to get us started. I am going to run, and then I
will come back and he can do the same.
So thank you all for being with us. Thank you. Thank you,
Senator Kennedy. All yours.
OPENING STATEMENT OF SENATOR JOHN KENNEDY
Senator Kennedy [presiding]. I do not have a very elaborate
opening statement. I want to thank all of you for being here.
If there are problems in our private equity markets I would
like to hear about them. I consider private equity--and we can
talk about the definition today if you would like--to be an
essential part of the free enterprise system. I mean, stripped
to its bare essential, all private equity investment is is a
decision by one willing buyer and one willing seller, and that
happens every day, billions of times every minute in the
American economy.
Private equity, as we know it, as I know it, of course, is
limited to accredited investors, very sophisticated investors.
I am a former State Treasurer and sat on the boards of a number
of retirement systems. I know, in the retirement systems with
which I am familiar, private equity is a huge part of those
retirements systems' investments. So put me in the corner of
pro-private equity, and I say that because I am pro free
enterprise. I am not real fond of neosocialism. I think
neosocialism is just trickle-down poverty. And it bothers me
that our store shelves are starting to look like the store
shelves in Cuba and Venezuela. That concerns me a great deal.
So let us get started. I cannot see, without my glasses,
and even with my glasses I cannot see that far.
OK. I am not going to introduce the panel. That will just
take away from their time. I am just going to introduce the
speaker. Well, maybe I should. I do not know. I do not want to
get put on double secret probation here.
OK, first, I am going to read this. Joining us virtually we
have Ms. Shirley Smith. Ms. Smith is a former employee of Art
Van Furniture in Detroit, Michigan, and is a Leader with United
For Respect. Next here, in person, we have Ms. Peggy Malone.
Ms. Malone is a registered nurse at Crozer--did I say that
right?--Chester Medical Center in Upland, Pennsylvania.
Joining us virtually we have also the Honorable Michael
Frerichs. Did I say that, Mr. Treasurer, correctly?
Mr. Frerichs. Senator, former treasurer, close enough.
Michael Frerichs.
Senator Kennedy. Yes, sir. Mr. Treasurer, welcome.
We also have Dr. Eileen Appelbaum here, who is the
Codirector of the Center for Economic Policy and Research. And
we have Dr. Doug Holtz-Eakin, President of American Action
Forum, and last we have Mr. David Burton, Senior Fellow at The
Heritage Foundation.
Let us start--well, let us start with our panel here.
How about Mr. Burton.
STATEMENT OF DAVID R. BURTON, SENIOR FELLOW IN ECONOMIC POLICY,
ROE INSTITUTE FOR ECONOMIC POLICY STUDIES, INSTITUTE FOR
ECONOMIC FREEDOM AND OPPORTUNITY, THE HERITAGE FOUNDATION
Mr. Burton. Thank you. My name is David Burton. I am Senior
Fellow in Economic Policy at The Heritage Foundation. I would
like to thank you, Senator Kennedy, Senator Warren, and the
other Members of the Committee for the opportunity to be here.
Entrepreneurship is vital to innovation, improved
productivity, better products, better wages, and prosperity
throughout the country. Private capital markets are, by far,
the primary means by which entrepreneurs raise capital to
launch and grow their business. Private equity, broadly
defined, is absolutely vital to the economic future of the
United States. Private offerings account for at least $2.9
trillion annually in capital raised. In contrast, registered or
public offerings raise less than half of that amount, $1.4
trillion. Regulation D is the most important means of raising
private capital and accounts for approximately $1.7 trillion as
of 2018.
Public capital markets are in decline due to regulatory
overreach. Firms go public much later in their life cycle,
fewer firms go public at all, and ordinary investors typically
do not receive the returns from successful startups and
entrepreneurial ventures because they go public so much later.
Being a public company has become extraordinarily
expensive, both in terms of the initial public offering costs,
the amount of money you have to spend on lawyers, investment
bankers, accountants, and so on, but also the continuing
compliance costs and the annual regulatory costs, not to
mention regulatory risk, the threat of being sued.
The number of public companies has declined almost by half
over the past quarter century, despite the real GDP growing by
80 percent and the population increasing by almost a quarter.
There is a major effort underway now to apply the policies
that have harmed the public market to the private market, on a
whole host of fronts, including ESG and what have you, and the
legislation that is part of this hearing today would be part of
that, the Stop Wall Street Looting Act.
Private equity funds, narrowly defined, are also an
important aspect of our capital markets. They are one of the
primary means of keeping incompetent management accountable.
They also are one of the primary means by which companies are
turned around, by an infusion of new equity capital.
The Stop Wall Street Looting Act would be more aptly named
the Protecting Incompetent Management Act. It basically would
erect a high wall and a moat around management of companies
that are failing, to make it virtually impossible to mount a
takeover that would be able to change the management and
protect the continued existence of the company by replacing the
management and also protecting the employees' jobs, who work
there and will lose their jobs in the event the company fails.
Now this may be attractive to corporate elites and
corporate management and their lobbyists but it certainly is
not in the interest of shareholders, workers, or consumers.
One thing I wanted to bring to the attention of the
Committee, if you read section by section there is a provision
that imposes a 100 percent tax on fees paid by targeted
companies to private equity funds, but the actual statutory
language in that would, in effect, impose the 100 percent tax,
which is really including State taxes, more than 100 percent,
on all payments by firms to any fund. It is very poorly drafted
language and not only would shut down, in effect, the private
equity fund market but have much broader and extraordinarily
adverse effects. I think that is a drafting error, but it is a
really important drafting error.
Other things in the act that I think are deeply
problematic, Title V would impose disclosure requirements on
private equity funds that are roughly comparable to what
Regulation SK and other aspects of securities law impose on
publicly traded funds, and I think that is more or less by
design. It would impose disclosure requirements on private
equity firms that are roughly analogous to public companies, so
no one would actually choose to be a private equity fund
anymore. Shutting down these private equity funds would have an
adverse impact on millions of people.
And last, in my written remarks I include 14 specific
suggestions on how to improve our private equity markets.
Thank you very much.
Senator Kennedy. Thank you, sir. Dr. Holtz-Eakin.
STATEMENT OF DOUG HOLTZ-EAKIN, PRESIDENT, AMERICAN ACTION FORUM
Mr. Holtz-Eakin. Thank you, Senator Kennedy, Senator Reed,
Members of the Subcommittee for the chance to be here today. I
also do not have an elaborate opening statement. Let me say a
few things and then I would be happy to answer your questions.
Clearly, financial markets are an important part of the
U.S. economy. They serve to provide many essential economic
functions, channeling funds from savers to investors,
allocating that capital as efficiently as possible, pricing
risk and return, allowing individuals to diversify away from
risk as they desire, and the list goes on. And in looking at
those financial markets you like to have all sorts of business
models compete to provide those services to the economy. We
have insurance companies and banks and all sorts of things,
including private equity.
My concern today is about the proposed legislation, and I
am concerned not because I am a big fan of private equity. I am
not. I also have no particular animus toward private equity. I
am concerned because the legislation would tilt the legal,
regulatory, and tax playing field quite strongly against
private equity, and I think that the objective of policy should
be that those legal, regulatory, and tax policies be as neutral
as possible. This is clearly an attempt to tilt the playing
field against private equity. And if there are problems with
private equity I think those should be dealt with in other
ways, identifying the harms and correcting the behaviors.
So its success in finding undervalued companies, reforming
their operations, has delivered an enormous footprint. There
are 11.7 million workers in private equity, earning about $900
billion in compensation. These are good-paying jobs. The
average employee is getting $73,000 in 2020, and the private
equity sector has produced $1.4 trillion in gross domestic
product, our about 6.5 percent of GDP. That footprint is a
testament to the success it has had in providing valuable
economic function.
The flip side is that this legislation would undo that, and
that would come at a tremendous cost. The Chamber of Commerce
estimates that the loss would range from somewhere between 6.9
to 26.3 million jobs in the U.S. economy, and returns that are
up to $3.5 billion a year for investors.
And so my hope is that the discussion can focus on what is
good policy for private equity and others and where there are,
in fact, identifiable hard to find remedies that are not so
sweeping as to disrupt the level playing field from a policy
perspective. Thank you.
Senator Kennedy. I am going to turn the gavel back over to
our Chairperson.
Chair Warren [presiding]. So it looks like we have the
Illinois State Treasurer next, the Honorable Michael Frerichs.
Michael, are you there?
Mr. Frerichs. I am. Can you hear me?
Chair Warren. Thank you. Yes, we can.
STATEMENT OF MICHAEL FRERICHS, ILLINOIS STATE TREASURER
Mr. Frerichs. Great. Well, good afternoon, Madam Chair and
Ranking Member Kennedy, Members of the Subcommittee, and
distinguished guests.
Now the clock I am looking at shows me a minute and 30
seconds.
Chair Warren. No.
Mr. Frerichs. Oh, there we go.
Chair Warren. There you go.
Mr. Frerichs. My name is Michael Frerichs. I am the
Illinois State Treasurer, elected by the great people of the
State of Illinois, and as Senator Kennedy knows from his time
as State Treasurer, and my colleague in the National
Association of State Treasurers, it is truly an honor being
trusted with the people's money. It is an honor to be invited
to speak with this Subcommittee today.
The Illinois State Treasurer performs many roles. I am the
State's Chief Investment and Banking Officer. In that role, my
team and I actually manage approximately $50 billion. This
portfolio includes roughly $25 billion in State funds, $16
billion in retirement account savings plans, and $9 billion on
behalf of local and State governments. Among those investments
are $500 million in private equity and venture capital.
But I also serve as a trustee on the Illinois State Board
of Investment, which manages approximately $31 billion in
pension assets on behalf of over 226,000 beneficiaries. ISBI
maintains approximately $1.7 billion of private equity
investments.
My job is to prudently invest public funds and pension
funds, a portion of which are managed by private equity firms.
I also have responsibility to the long-term fiscal health of
our State and local government institutions, which rely on a
vibrant and sustainable economy. And I also have a duty to tend
to the well-being of the communities I represent, including the
economic security and dignity of millions of workers.
Unfortunately, some private equity firms engage in
practices that harm these objectives. From my experience as an
institutional investor there are several important challenges
relating to private equity investments, in particular, the need
for increased transparency and the need for reforms to ensure
that workers, communities, and investors are protected from
predatory practices.
Before I go into further details I want to say that private
equity is an essential part of our capitalist system. The idea
of the industry is simple: sometimes a company has room to grow
and become more productive, but its current ownership is not in
a position to capitalize on that opportunity.
In this situation, it makes sense for an investment
vehicle, run by experts, to pool private capital, to buy the
firm and take it to the next level, and then to sell it. This
generates a profit for private equity firms and their
investors, it helps the company to grow, and it creates more
economic opportunity for society at large.
For investors like the Illinois Treasury, private equity
provides an opportunity to further diversify our portfolios, to
help drive economic development, to support small businesses,
to expand the circle of opportunity to underutilized investment
firms like those in downstate Illinois or those that are
minority and women-owned, and to provide a competitive return
within our overall portfolio.
Unfortunately, as private equity has continued to evolve
and become a larger and larger portion of the economy it has
continued to be regulated as though it was a boutique
investment that only affected the ultra-wealthy. That means
that predatory activities, like opaque fees and pillaging
assets and strategically using bankruptcy without regard for
the well-being of workers and their communities and their
pensions remains perfectly legal. And as long as these
practices are allowed, they will happen, and as long as they
happen, our communities are at risk, and that is why sensible
reforms are needed to rein in harmful behavior by bad actors in
this space.
Let me talk for a little bit about fee transparency before
I run out of time. There has been a significant increase in
demand from public pensions to invest in private equity. It's
no wonder. The asset class has had historic levels of
fundraising and record amounts of distribution to investors.
Private equity is unique in that it is rooted in a sense of
long-term partnership where investments are designed to mature
in 10 to 15 years, if not longer.
Fiduciary duty is the foundation of an effective
partnership between general partners and limited partners in
private equity funds, and this is especially important given
that these investments are illiquid and currently require less
transparency than other investment vehicles.
And that brings me to a crucial point. There is a dire need
for increased transparency and disclosure to help provide
investors the necessary information to make informed decisions,
including data on fees, to make clear, complete, consistent,
and in a not misleading manner, so that institutional
investors, like myself, can better fill our fiduciary duties.
I see my 5 minutes is coming to an end, so I look forward
to any questions you might have.
Chair Warren. So thank you very much, Mr. Treasurer. I
appreciate your comments here today.
And next we have joining us virtually Ms. Shirley Smith,
who is a former employee of Art Van Furniture in Detroit,
Michigan, and who is also a leader with United for Respect.
Ms. Smith, I would like to recognize you for 5 minutes,
please.
STATEMENT OF SHIRLEY SMITH, FORMER SALES MANAGER, AT ART VAN
FURNITURE, LEADER WITH UNITED FOR RESPECT
Ms. Smith. Thank you, Senators. Thank you so much for
having me here.
My name is Shirley Smith and I live in Detroit, Michigan.
For 23 years, I worked for Art Van Furniture, the last 9 as a
sales manager, and it was a job that I truly loved. Art Van was
a family owned business, and the company culture was centered
around family. Employees were tight-knit, we had each other's
backs, and there was a real sense of community.
I was a single mom and I am grateful for the support and
flexibility I had at work, so I could be there for my son while
juggling a successful career. I had the opportunity to build
relationships with my customers and earn a good living, making
it possible to buy my own home and provide a good education for
my son. Working at Art Van was like my own little slice of the
American Dream, until the private equity firm, T.H. Lee, came
in and broke up our family.
Before T.H. Lee took over in 2017, Art Van was a successful
company, reporting $800 million dollars in revenue that year.
Up to then, most of my colleagues would have told you it was a
company they loved working for, but those last 3 years were
hell.
It was not obvious right away, but a lot started changing.
We noticed our top company leaders were being pushed out the
door. T.H. Lee brought in people who did not know the furniture
business, and orders started coming in slower. In hindsight,
that was a big red flag. Sales associates work on straight
commission, which only gets paid when an order is delivered,
and customer orders were not being filled.
Art Van's reputation was being destroyed right before our
eyes. We had to start making up excuses to our customers, some
of whom grew violent when they learned they would not be
getting refunds. One of my colleagues even had a gun pulled on
her during closing weekend. T.H. Lee made us feel like liars
and thieves, taking people's hard-earned money when they knew
they were never going to get their orders.
We stopped paying our bills on time and started cutting
staff. For decades, Art Van had been a debt-free company that
paid all its bills. Under T.H. Lee's ownership, Art Van racked
up millions of dollars in debt to Wall Street banks and other
deep-pocketed creditors. T.H. Lee even sold off Art Van's real
estate to itself, forcing Art Van to pay rent on the same
properties it once owned. By the end of 2019, under T.H. Lee's
so-called leadership, Art Van was in the red, and it took just
three short years for T.H. Lee to strip our company for parts.
Then the pandemic hit. We first received WARN Act notices
about our layoffs before the COVID-19 emergency order was
issued in Michigan, so the bankruptcy and layoffs had nothing
to do with the pandemic. But then, a few weeks later, Art Van
changed their original WARN Act notice, citing COVID-19
instead. As a result, we did not get any severance pay or
benefits. Nothing. Robbing the American workforce like this,
hurting the same people on the front lines who have been
applauded as ``heroes'' for keeping our economy open, should be
a crime.
When we were told we would be losing our jobs, we were
promised a lot. We were promised health insurance after
closing. We never got it. The only insurance I could afford
charged me 10 times what I had been paying for prescriptions. I
was unemployed for 5 months, and many times I had to choose
between paying for my medication or paying other bills.
We were also promised a retention bonus that we never got.
Since my unemployment did not kick in for 2 months, I had to
take out money from my 401 to make ends meet, which I am still
paying taxes on today.
Sadly, my story is not unique. Private equity has quietly
taken over nearly every facet of life, from retail and grocery
store chains, to housing, health care, media, and more, turning
the American Dream into nothing more than a pipe dream for
millions of working families.
And T.H. Lee did not only destroy us, the individual
workers who lost their jobs. Every community that had an Art
Van store suffered too. We had a deep reach into our
communities. We were one of the largest taxpayers in the city
of Warren, where we were headquartered, and the biggest
contributor to our food banks. When the company went under,
there was a terrible ripple effect of harm felt throughout the
State of Michigan.
I am here today to show you the human toll of Wall Street's
greed. Our elected leaders, each of you here today, I have to
ask you why billionaires should be allowed to do this and
destroy the fiber of America. Why should this be legal? This is
a sin, it is unconscionable, and something needs to change.
Thank you for giving me the opportunity to speak with you
today.
With nearly 12 million people working for private equity-
owned companies in the United States, private equity is a major
employer. Given the industry's poor track record we must also
take a closer look at how their cost cutting and greed impacts
workers and the customers they serve across America.
Chair Warren. Ms. Smith, thank you very much for being with
us today. We really appreciate it.
And now we have, in person, Ms. Peggy Malone, who is a
registered nurse at the Crozer-Chester Medical Center in
Upland, Pennsylvania.
STATEMENT OF PEGGY MALONE, REGISTERED NURSE, CROZER-CHESTER
MEDICAL CENTER
Ms. Malone. Thank you, Senator Warren, and Members of the
Subcommittee for having me here today. I am the Vice President
of the Crozer-Chester Nurses Association, which is a local of
PASNAP, and I am also on the executive board. I have been a
registered nurse for 32 years at Crozer-Chester Medical Center.
Being a nurse, for me and my colleagues, is a calling. It
is a profession that we are very proud of, and private equity
has no business in health care. They have destroyed our
hospital. They have destroyed the fiber of what we are as
health care professionals.
Prospect Medical Holdings, which has 17 hospitals across
the country, I can go on and on about the owners, Leonard
Green, David Topper, Sam Lee, and what they have done. That is
all public knowledge. You can find that out. You can get that
information. You can see that it is wrong that our tax system
should not be creating incentives for business practices and
private equity firms. They should not be able to extract huge
dividends from hospitals. They were given $173 million of COVID
relief money, none of which we have seen in the hospitals. We
take care of patients every day, and I understand some of you
are very pro private equity. Well, I am going to tell you that
families were not allowed in the hospital. You did not see what
was going on in there during this pandemic.
We served patients moldy bread during that pandemic. We
were not able to give good-quality care to patients. Patients
were dying. They had no family. They had no one in the rooms
but us. It was the nurses. It was the respiratory therapists.
We were the ones that had to go in. We were scrambling for
iPads so that families could say goodbye to their loved ones,
without having anyone in the room. We were their families. We
were using poor-quality equipment. I would have to try to
straddle a urinal to collect urine from a patient's bag,
between my feet, with a gown and a mask and all the PPE. Number
one, we were wearing trash bags at a certain point because we
did not even have enough PPE.
And this is how we were taking care of patients, day in and
day out. I left my family. I stayed at a house that the local
college gave us, because I was afraid to take it home to my
family. I had my children at home who were having graduations
and everything taken away from them, as all of my colleagues.
And we went in and we did this job every day, to the best of
our ability, with no equipment, with no PPE. We were afraid for
our lives, and we did this job, and we did it every day. For
every single person in this country we thought we were doing
good. And you know what? Now we are the bad guys, because we
are speaking up, and we want to know where that money is, and
we want to know how these private equity firms cannot take care
of the patients that are in these hospitals.
We do not have enough staff. We do not have enough
equipment. We are fighting every day to give good-quality care
to patients, and we are not able to do it. We are not able to
do it, and nobody was in there watching. There were no families
in there. There was no one watching. It was just us, and we
were watching people die.
And so I can give you the statistics. I can talk about
Leonard Green, and I can talk about all the things that are
going on, and all the tax credits and things that these
companies are given. They were given pandemic money and we have
not seen one bit of it being spent on the patients. That is our
goal.
Private equity does not belong in health care. Our job. Our
job is to do no harm. It is to do no harm. It is to care for
our patients. That is why we got into this. And we will fight,
and every nurse I know will fight. But what I see now, we are
seeing the PTSD. We are seeing the nurses suffering. We are
seeing the doctors struggle. What we saw was a war zone, for
the last 20 months, and it is not over. And we have not gotten
support. We have not gotten support from our administration. We
have not gotten supplies that we need. We do not have the staff
that we need.
Private equity has no business in health care.
Chair Warren. So thank you, Ms. Malone, and thank you for
the work that you have done. I lost my brother early in the
pandemic, and he had no one with him except the nurses who
showed up to hold his hand. I appreciate all that you have done
and I know it has been hard.
We now have our final witness, and that is Dr. Appelbaum.
Dr. Appelbaum, could you please talk with us a bit.
STATEMENT OF EILEEN APPELBAUM, CODIRECTOR, CENTER FOR ECONOMIC
AND POLICY RESEARCH
Ms. Appelbaum. Yes. Thank you, Senator Warren, Senator
Kennedy, Members of the Subcommittee. I am very happy to be
here to testify today.
Private equity is a largely unregulated financial actor,
and it is playing a growing role in both the U.S. economy and
in global economies. In 2020, global assets under management
reached $4.5 trillion, and this is expected to double to $9
trillion by 2025, so it is a big and important player.
In the U.S., private equity owns or backs 8,000 companies
in every nook and cranny of the economy, ranging from health
care, as we just heard, to IT, to retail chains, to
supermarkets, single-family rental homes, and payday lenders.
They are in every part of the economy. The private equity
industry and its companies employ nearly 12 million workers.
Pension funds and other limited partners have been pouring
money into private equity funds, seemingly unaware that it is
really hard for any private equity fund to beat a booming U.S.
stock market, and they have not beaten it. Research has shown
that the median private equity fund in every vintage since
2006, has just tracked the stock market. It has not actually
beaten it.
Yet fundraising by the largest private equity firms has
reached stratospheric levels. It is not that investors in
private equity do not see a return on their money. They do see
it. However, the point is that they could have gotten the same
returns by investing in stock market index funds without all
the risk. So they are not beating the stock market. The point
is they could have done as well in the stock market.
The big private equity funds are just raking in money from
institutional investors. In the last 5 years, Blackstone and
KKR each raised more than $90 billion. This year, KKR was
launching an $18.5 billion for its North America Fund, and
Carlyle has announced plans to raise $27 billion for its next
fund, in what would be the biggest private equity fund.
It is not possible to take that kind of money, they have
just a few years to deploy it, and to invest it in small
companies. They invest in really big companies which do not
give you much opportunity for turning them around. We have just
seen the $38 billion purchase of Medline, a family owned
company, by private equity firms. You do not pay $38 billion
for a company you think you have to turn around.
With all that cash on hand, private equity is poised to buy
up large swaths of the U.S. economy, with no limit on how much
debt they can leverage on the companies, with no limit on how
much wealth they can take out, and no limit on how hard they
can squeeze the employees.
A study examining private equity buyouts of public
companies found that when private equity takes these public
companies private employment declines by 13 percent in just the
first 2 years. Another study that looked at private equity
buyouts that used a lot of debt found that the bankruptcy rates
were as high as 20 percent. For affected workers, their
families, and communities, this is devastating. But win or
lose, the private equity firms always walk away with a profit.
Thank you.
Senator Reed [presiding]. Well, I want to thank Chair
Warren and Ranking Member Kennedy for allowing me to go first
and ask question. Chair Warren will return promptly from the
vote.
Dr. Appelbaum, what do you believe to be the primary gaps
in the regulation and supervision of private equity?
Ms. Appelbaum. I think that there is little recognition
that while they once wanted to buy on leveraged buyouts,
private equity firms have now really developed many, many
avenues for making money and for participating in the economy.
So it is not just leveraged buyouts. It is also the credit
funds, which I think are playing a huge role in a shadow
economy.
Back in 2013, the regulators provided guidance that
essentially said to the banks, ``Really, you should not put
more debt on a company than six times earnings, because our
research shows that when you go beyond that point the company
is very likely to default on its debts, experience financial
distress, and to even go bankrupt.'' So they put that out
there.
And KKR came along, and it had difficulty raising the kind
of money it wanted to put debt on a company that it was buying.
And so it was not long before the private equity firms figured
out they needed their own credit funds. And these credit funds
act like investment bankers, but there is no banking regulation
of them. So I think that is really a huge gap in our knowledge
of what is going on.
Private equity now has real estate funds. These real estate
investment funds move back and forth. Sometimes they are
publicly traded. Sometimes they are privately held by the
private equity firm. They are playing a role that I think is
little understood in the economy .
I have been studying health care so I have seen their role
there. When you say that a chain like Steward sold its real
estate to a real estate investment trust, that would be
something that operates without much regulation, and provides a
lot of money to operators to go out and buy up, in this case,
more hospitals. So we have seen a buying spree of hospitals, by
private equity or formerly private equity-owned chains, funded
by the real estate investment trusts.
Real estate investment trusts are in many aspects of the
economy. We look to the SEC to say, shouldn't you be taking a
look at them? But, in fact, it is not just the SEC that needs
to be involved. Banking regulators regulate investment banks,
and I think if these credit funds want to operate as investment
banks, they should be regulated in the same way. And I think we
need to know a lot more about the role of real estate
investment trusts in the economy. They fly completely below the
radar, but they fund a lot of the expansion that we see going
on by private equity firms.
Senator Reed. Thank you very much, Dr. Appelbaum.
Now if the Treasurer is still on Webex or Zoom, Treasurer
Frerichs, I would like to ask if you could share your
experience with private equity in terms of fee-and-expense
arrangements, and do you believe these arrangements are
adequately disclosed and transparent?
Mr. Frerichs. OK. So my office experience is similar to
what other institutional investors are recognizing, and that is
as private equity continues to evolve there is a growing need
for improved disclosures around direct and indirect fees,
expenses, and performance-based fees, such as carried interest
in particular.
It is safe to say that investors such as ourselves or
public pension plans would be greatly benefited with increased
level of disclosure and transparency between general partners
of private equity firms and investors. Given the fees charged
by private equity managers are among the highest shouldered by
institutional investors, a lack of transparency represents a
meaningful risk factor.
It is necessary to ensure transparency for all investors
and ensure investors can validate fees but also understand if
there are any potential conflicts of interest around certain
fees that may be passed through to companies that may
negatively affect our investments.
Senator Reed. Well, thank you very much, Treasurer, and
thank you to the panel. I would happily yield back to my
colleague from Louisiana. Then I am going to vote.
Thank you, John.
Senator Kennedy [presiding]. Thank you. Thank you, Senator.
Mr. Treasurer, I am a little confused. As Treasurer you
invest in private equity, do you not?
Mr. Frerichs. That is correct.
Senator Kennedy. And your concern, and a concern we should
all share, is you say the fees are opaque and there is not
enough transparency.
Mr. Frerichs. Correct.
Senator Kennedy. Are you telling me that you make private
equity investments, as a fiduciary, without understanding the
fees, and if so, whose fault is that?
Mr. Frerichs. We put a lot of time and effort into
understanding these fees and working, but that adds increased
cost to us, and there are also smaller pension plans out there
who do not have the resources.
Senator Kennedy. Well, why don't you just do not make the
investment?
Mr. Frerichs. Oftentimes we do not, if they are not willing
to work with us.
Senator Kennedy. So what is the problem?
Mr. Frerichs. Just as in other fields, in other investment
classes, the transparency has been helpful in bringing down the
cost of fees, in things like mutual funds. We think we would
see improvements in fees with greater transparency.
Senator Kennedy. But if I go to buy a car and the car
salesman does not explain the details of the financing to me, I
just walk away. I do not call for the Federal Government to
take over every car salesman in America. What am I missing
here?
Mr. Frerichs. Well, I would say we are not----
Senator Kennedy. I mean this----
Mr. Frerichs. ----calling on the Federal Government to----
Senator Kennedy. ----this is--these are two players in the
financial market. You are not required to invest in private
equity. In fact, you breach your fiduciary duty to invest in
private equity if you do not understand the fees, do you not?
Mr. Frerichs. As I said, we put a lot of effort and time
into this. I am the first one to note that we at the Illinois
Treasury have significantly increased our allocation to the
private equity space, given the opportunities and our ability
to manage risks.
Senator Kennedy. Well, have you ever invested in private
equity when you did not understand the fees?
Mr. Frerichs. I never said we did not understand the fees.
We are advocating for the elimination--not advocating for
elimination of private equity. We are seeking reforms to make
it easier for us to do our jobs, to stop abuses, to increase
transparency, to help create more efficient markets, and
provide basic protections----
Senator Kennedy. I understand. Have you ever invested in a
private equity deal, as a fiduciary, as the State Treasurer,
without understanding the fees?
Mr. Frerichs. We put a lot of effort into this, but that
results in increased costs as well. And just as we saw public--
--
Senator Kennedy. I understand that. I heard you the first
time. But have you ever invested in a private equity deal
without understanding the fees?
Mr. Frerichs. No.
Senator Kennedy. OK. Let me ask Dr. Holtz-Eakin, I have
looked at this legislation. It will gut private equity like a
fish.
Mr. Holtz-Eakin. I think that is correct.
Senator Kennedy. Now what will that impact have on workers
of America?
Mr. Holtz-Eakin. We know that, you know, the private equity
markets are very large, as David Burton pointed out, that this
is an important source of capital. Capital is how firms invest
in skills for their workers, technologies, equipment, it raises
productivity, and that productivity flows into higher real
wages. So you are really affecting the standard of living----
Senator Kennedy. Is it going to cause layoffs?
Mr. Holtz-Eakin. Absolutely.
Senator Kennedy. You get rid of private equity, whether you
do it in the de facto or de jure way, you could abolish private
equity. You could also regulate it half to death. No, regulate
it completely to death. Now if you do that, I know it is in
vogue to talk about rich billionaires around here, but they
comprise a very small part of the American free enterprise
system. We are going to have massive layoffs, are we not?
Mr. Holtz-Eakin. Yes. I mean, you need the capital to run
the economy.
Senator Kennedy. In fact, is not that what free enterprise
is, a marriage of capital and labor?
Mr. Holtz-Eakin. Yes.
Senator Kennedy. Some of my colleagues think it is a zero-
sum game. They think that the American economy is like it was
back in primitive times. To take a Marxist approach, some of my
colleagues think that the only value in an economy is labor,
and if you make money in an economy you have to make money. If
you become wealthy, you do it by exploiting labor. That is not
an accurate description of the American economy today. Capital
joins with labor, and today they both improve their value. That
is how we grow our GDP, is it not?
Mr. Holtz-Eakin. That is correct.
Senator Kennedy. All right. Do you disagree with anything I
said, Mr. Burton?
Mr. Burton. No. The one thing that you did not really
mention is it is not just capital and labor. It is also
entrepreneurship and innovation, and it takes capital to
innovate, to acquire new technologies, and that is how
productivity improves, and that is how wages go up. If you do
not become more productive through technological innovation or
better management practices then you cannot see wages go up
over any extended period of time.
I also think everything you said is absolutely true with
respect to private capital markets. If we were to restrict
private capital markets we would destroy the United States
economy, because they are the most important means of raising
capital for businesses, and particularly for entrepreneurship.
There is a more narrow case of these private equity funds
that are basically engaged in acquiring failing public
companies----
Senator Kennedy. Can I stop you, because I am way over
time.
Mr. Burton. Yep. Yep. Yep.
Senator Kennedy. Since Senator Warren is coming back. Do
they have private equity in Cuba?
Mr. Burton. No.
Senator Kennedy. Do they have private equity in Venezuela?
Mr. Burton. No.
Senator Kennedy. If they have private equity in China it is
State-owned, right?
Mr. Burton. China is a little bit more ambiguous, but they
are certainly restricting private enterprise----
Senator Kennedy. So is that where we are headed here, to
have government-run private equity, like President Xi does in
China?
Mr. Burton. Yes.
Senator Kennedy. Would this bill move us toward that end?
Mr. Burton. This bill would make private equity funds,
narrowly defined, utterly uneconomic.
Senator Kennedy. Now my understanding of private equity is
that you have a company that goes out and says, ``We are really
good at investing money, and we ask you to invest your money,
private investor, with us, the venture capital company. And in
order to invest in that venture capital company you have got to
be an accredited investor.'' I mean, you have got to have a net
worth and show that you are a sophisticated investor.
Mr. Burton. Generally, yes.
Senator Kennedy. And then that private equity company goes
and buys a private business. When it buys that private
business, does it put a gun to the head of the owner of the
private business and say you have to sell?
Mr. Burton. No.
Senator Kennedy. So it is usually a voluntary transaction.
Mr. Burton. Yes.
Senator Kennedy. And so now you have got a new owner of the
business. Is that right?
Mr. Burton. Yes.
Senator Kennedy. And that new owner tries to increase the
value of that business, because that new owner wants to make
money. Am I right?
Mr. Burton. Yes.
Senator Kennedy. Does it always work?
Mr. Burton. No.
Senator Kennedy. If it does not work, who loses?
Mr. Burton. There can be a lot of losers--the shareholders,
the equity fund, the employees, customers, vendors.
Senator Kennedy. But if it does work it is a beautiful
thing.
Mr. Burton. Yes.
Senator Kennedy. And we call this free enterprise.
Mr. Burton. Yes.
Senator Kennedy. As opposed to the Government saying you
cannot invest there but you have to invest there.
Mr. Burton. Right.
Senator Kennedy. OK. I went way over.
Chair Warren [presiding]. That is OK.
Senator Kennedy. But I had to stall.
Chair Warren. Are you good?
Senator Kennedy. I am done.
Chair Warren. All right.
Senator Kennedy. I am going to go vote. Thank you all for
coming today.
Chair Warren. And thank you again. Sorry about the
confusion about all the things that are going on at once.
Let me start. I would like to talk about private equity and
its impact on workers and communities. Ms. Smith, I think you
are with us virtually. I want to thank you for being here
today. Since you experienced it firsthand I would like your
help in walking through how Art Van went under, so that we can
better understand the private equity model.
So could you tell me, was Art Van profitable before it was
acquired by THL in 2017?
Ms. Smith. We were. We had about $8 million in sales that
year, and we literally owned about 55 to 60 percent of the
market share in the furniture sales industry.
Chair Warren. OK. So this private equity company takes over
this successful, profitable, I think you said 58-year-old
company, saying they were going to make it more profitable.
Ms. Smith. Exactly.
Chair Warren. So let's talk about how they made it more
profitable. Ms. Smith, once THL came in, what did they do first
to supercharge Art Van's growth? Did they boost the marketing
budget? Did they invest in retaining management? Did they start
a staff training program? Did they build a new website? What
did they do to help boost the profits? What did they do,
straight out of the chalks?
Ms. Smith. Straight out of the gate, the first thing they
did was sell off all of the real estate. Art Van was a debt-
free company. They owned the land that every building was on.
The first thing they did was sold the real estate, made back
the money that they spent buying the company, and then they
started destroying the company.
They got rid of all of our top leadership and brought in,
as I said, people that did not know the furniture industry at
all. They hired the worst CEO, something that was rated the
worst CEO in the Nation, in 2016, to run the company, and some
could say he did not do his job, but I will say that he did his
job very well. He was hired to run his company out of business,
and that is what he did.
Chair Warren. OK. So let us talk through this. So this is a
standard play out of the private equity book. THL put out very
little of its own money. It took out a bunch of debt to buy Art
Van, and then made Art Van responsible for that debt.
Meanwhile, THL is collecting huge fees just for putting its own
deal together. And then before the ink dries on that deal, Art
Van, this once very profitable company, as you say, that had no
debt, gets hit with now two big expenses--the new debt that THL
put on the company and now, if they sell off all the real
estate, it is not that they move out and shut down their
business yet. It is that they have got to pay rent on all the
buildings that they used to own.
THL, however--so Art Van is a whole lot worse off. THL,
however, is a whole lot better off. They take some of that
money from the buildings, they pay themselves back they money
they had originally invested in the deal, and then they just
keep collecting fees on everything that is happening, including
managing the rental property here.
So now Art Van has its back against the wall. So let me ask
you, Ms. Smith, at this point then how did Art Van meet these
new expenses? Did these investments in the business help boost
revenue so they could offset these new debts?
Ms. Smith. There were no real investments into the company.
T.H. Lee took money out of the company and never put anything
back in. They started laying off workers. They kept
advertising. The one thing they did was they kept the
advertising budget up, but that was to keep customers coming
in, spending money. But where the money was going, we do not
know. They said that we were losing money. However, even though
our actual intake might have dropped in dollar-volume wise, our
profit margin went up.
Chair Warren. Mm-hmm.
Ms. Smith. So when you talk about $800 million, 6, 7
percent is a lot of money.
Chair Warren. All right. OK. But I take it what happens is
they keep cutting, they keep cutting the costs, and then Art
Van gets into a situation, because they no longer own their
real estate, they have now got to pay rent, they ultimately
cannot pay their bills. And so Art Van files for bankruptcy.
That destroys about 3,000 jobs. And you and your coworkers were
left without health care during a pandemic. Do I have that
about right?
Ms. Smith. You have that right. They told us that we would
have health care to the end of the month, and we did not. They
did not give us the severance pay they told us. They told us
that we did not get it because they did not close because they
were going out of business. They closed because of COVID so,
you know, let me use this as a shield to change my attitude and
change my dance so I do not have to pay.
Chair Warren. Right. So, you know----
Ms. Smith. Everything they did was to profit them and to
hurt the people, and they did not care.
Chair Warren. One of the things that we often hear about
from the private equity industry is that it is not in their
interest to drive companies into bankruptcy. I think that was
kind of the point that Senator Kennedy was making. And that
cases like yours are unfortunate, but they are just part of
doing business. They say that most businesses survive after
being taken over by private equity while only a few, like Art
Van, actually fail. Do you find that a persuasive argument, Ms.
Smith?
Ms. Smith. So I do not find it a persuasive argument. I
know that T.H. Lee did not intend for Art Van to go out of
business. They intended to take us into debt, because that is
the model. Let us take the company into debt. Let us suck
everything out of it we can, take it into debt, and then sell
it to somebody else.
However, Mr. Van's name was so golden that they were able
to borrow so much against this company that they could not sell
it. They took this company so deep into debt. And, you know, I
keep hearing the Senators talk about capitalism, and this
country was built on capitalism, and yes, it was. It was built
on capitalism. But this is cannibalism. It is not capitalism.
This is cannibalism. They are going in and they are stripping,
destroying, and they do not care. They are plundering and
leaving debt in their wake, and they do not care.
Chair Warren. Well what really troubles me here is that
private equity has worked out a business model that helps them
get rich at the expense of workers like you and your families.
You know, the model is pretty simple. They gamble with other
people's money, they squeeze out what they can, they cram their
pockets full, and then they bail, leaving workers and
communities to deal with the fallout.
So let me ask you, Dr. Appelbaum, how would the Stop Wall
Street Looting Act help address these market failures?
Ms. Appelbaum. Thank you. So it is very clear that the Stop
Wall Street Looting Act would play a role in these kinds of
situations. It would require that the private equity firm keep
some skin in the game. It would reduce incentives for them to
load portfolio companies with excessive amounts of debt.
Obviously reasonable amounts of debt are not a problem. As our
speaker just described, the amounts of debt that they put on
that company is what the problem was.
And so it protects companies from bankruptcy. The act
includes protections for workers in the case of bankruptcy,
severance pay and other protections. And it also increases
transparency. The institutional investors in these private
equity funds have little to no information about the companies
that the fund has acquired, and this would provide them with
some information, alter an asymmetrical information situation,
and, in my opinion, it would stop the worst abuses and
encourage private equity to do what it says it does and help
companies to grow and be successful.
Chair Warren. Thank you. Thank you very much, Dr.
Appelbaum.
I am just going to go to another round of questions, since,
like I said, we are in a little mix-and-match here.
What I would like to talk about now is what happens when
companies buckle under the weight of private equity debt and
mismanagement and go bankrupt and how workers and their
families and communities have to deal with that fallout. We
understand--and that is what happened in Art Van--that
particular version of the problem, but even when companies do
not go under, the consequences of the private equity playbook
can still be devastating. In the worst cases, as we have seen
with private equity's involvement in health care, people get
sick and they die.
So Ms. Malone, you have been a registered nurse at Crozer
for more than 30 years. Your hospital was acquired by Prospect
Medical, which was owned by the private equity firm Leonard
Green, in 2016. Did you notice a change when private equity
took over?
Ms. Malone. Yes, almost immediately. We immediately saw
staff were cut. We were unable to get supplies. We were told by
vendors that bills had not been paid and that is why we were
not able to get supplies. I work in the substance abuse
department. We were not able to have our acupuncturist come,
our music therapist. They had not been paid in several months
and they were going to be unable to continue to come and
provide their services to our patients. And we saw that happen
pretty quickly.
Staff was at a minimum, and the quality of the supplies--
which, when you have poor quality it takes several more
attempts to put an IV in, you are increasing your rate of
infection. When you have poor quality Foley catheters your
instance of infection goes up.
And so all of these things result in death. You have the
potential every time you make cuts in staff, when you are
giving nurses more patients than they are safely able to
handle. We are constantly putting patients at risk. These are
people's lives that we deal with. Workplace violence has
increased. People who are waiting. When you have 20 people over
and above what your emergency room holds, waiting to be seen,
the staff, we are abused. We are physically abused. We are
verbally abused.
I mean, the trickle-down of the cuts that this company made
almost immediately, we are still feeling. And unfortunately,
the pandemic happened, and so everything is being hidden under
the guise of this pandemic. These things were happening long
before the pandemic, and they are using the pandemic as an
excuse that there is a nursing shortage, that we cannot get
supplies, when the reality is they are not providing us with
what we can have. There is not a nursing shortage.
There is a shortage of nurses who are willing to work at
the bedside under these kinds of conditions. We take an oath to
do no harm, and we are no longer able to do that. Nurses are
fleeing. I can tell you of 20-plus nurses who have left Crozer
in the last 2 weeks.
Chair Warren. So you are saying here, just so I can get
this together, with private equity, so they cut staffing, cut
supplies. That reduces the quality of patient care, and, in
fact, increases infections, ultimately mortality rates.
Talk to me just a little bit, though, about other parts out
of the playbook. For example, what did they do with the real
estate, in your case?
Ms. Malone. So they did sell the real estate, and so, once
again, they made a large profit. Leonard Green took $400
million out of Prospect Medical.
Chair Warren. So they took how much money out of the----
Ms. Malone. $400 million.
Chair Warren. So they take $400 million out while they are
laying off people, shortchanging you on supplies.
Ms. Malone. Yes. Yes. They took all of that money, and they
had made a commitment. They had made a commitment to make a
$200 million investment in our hospital as part of the
acquisition deal, and none of that has happened.
Chair Warren. None of it happened. You know, this is not a
business model. This is looting.
Ms. Malone. It is.
Chair Warren. And unfortunately, we are seeing it all
around the health care sector, including, as COVID has made
painfully clear, at nursing homes. Private equity firms have
been buying up nursing homes, and the consequences have been
deadly. Researchers have found that private equity ownership,
quote, ``increases the short-term mortality of Medicaid
patients by 10 percent,'' end quote. That implies that more
than 200,000 people died between 2000 and 2017, simply because
they lived in a nursing home that was owned by a private equity
firm.
So, Ms. Malone, from what you have experienced with private
equity at your hospital, does the fact that private equity
ownership has been found to kill people in nursing homes
surprise you?
Ms. Malone. No, it does not. It does not at all. Private
equity firms are focused on making the biggest profit. They are
not focused on providing the best care. And I do not ever see
how their incentives could be aligned with patients and staff.
It just does not work that way. These are people's lives.
Chair Warren. I think I misspoke on the number of deaths. I
think I looked down and said 200,000 instead of 20,000. One
death is one death too many.
Ms. Malone. It is too many.
Chair Warren. Too many. So this is one of those things we
need to act, and this is why I have introduced the Stop Wall
Street Looting Act, so that we can better align incentives
between private equity and the companies they take over by
restricting the ability of private equity to buy a company and
profit from running it straight into the ground. This is a bill
that would ensure that private equity has skin in the game, as
Dr. Appelbaum was talking about. Because if private equity has
skin in the game, maybe they will think twice about their
actions, especially when their looting leads to increased
illness, suffering, and death among our most vulnerable people.
So thank you very much. Thank you for being here. I
appreciate it, Ms. Malone.
Should I do another round of questions? All right. Right
here. Here we go. This is what happens when you get out of
order here. You guys just have to take me straight through on
this.
So I want to talk about the returns. Let us talk about the
financial part of this now, the returns from private equity
investments. After all, private equity keeps scooping up money
because they promise super-high returns, higher than more
traditional investments like stocks and bonds. In fact, that is
why giant private equity firms get the big fees. They
supposedly deliver big returns.
Strong and steady returns are important. Public pension
funds and retirement security of teachers and firefighters and
local government employees across the country depend on these
returns. So it is no wonder that pension funds and other
institutional investors would find private equity's promises so
very attractive and why they might be willing to tolerate the
risks, and even the consequences that we have talked about
today.
So let us start with the data. Dr. Appelbaum, you have
studied market returns in detail. This is pretty much your
specialty. So let me ask you, does private equity outperform
the market?
Ms. Appelbaum. No, no, it does not, and there are quite a
few studies now that show that the returns basically--well, let
us be clear. Since 2006, it is the median private equity firm
in each vintage launched since then that has just about tracked
the market, using the metric that the finance professors would
use, which is the public market equivalent.
Nobody who studies private equity uses the internal rate of
return, which is what is used in the industry and which is
quite misleading. You never get the amount of money that the
internal rate of return suggests to take to the bank. That is
not money you can take to the bank. If we have time I can tell
you all about what is wrong with the IRR.
But what the researchers use is the public market
equivalent, and what they find is that since 2006, the median
fund, the typical fund has not outperformed the market. That
means half of the funds are underperforming the market. Right?
Chair Warren. Right. But that means for 15 years now----
Ms. Appelbaum. Yes.
Chair Warren. ----I just want to be crystal clear on this--
for 15 years the typical private equity fund has failed to
outperform the stock market, which sounds a lot like private
equity has been fooling everyone for the past 15 years.
So let me ask, Dr. Appelbaum, if the typical private equity
fund is not generating the returns that the private equity
industry claims it does, then what are the investors paying
for?
Ms. Appelbaum. Yes, that is a very good question, and, of
course, as you know, they are paying billions of dollars in
fees. I mean, those fees really add up. So I am just going to
point to a study by Oxford University finance professor,
Ludovic Phalippou. He calls private equity funds ``billionaire
factories.'' They produce little for investors but they make
private equity firm partners billionaires.
Chair Warren. Wow. So teachers and firefighters are being
asked to take money out of their retirements to pad the pockets
of private equity billionaires, and they are not even getting
the above-average market returns that they thought that they
were paying for. Is that a fair summary?
Ms. Appelbaum. It is definitely a fair summary. And you
have to remember that these are risky investments, and the idea
at the beginning was that they would get a return that was 3
percent above the market to reward them for the risk that they
are taking. And now they get no premium whatsoever.
Chair Warren. OK. So they are getting no premium but they
are taking on more risk.
So we have a chance here now to talk with the Treasurer of
the number one State employee pension fund, the fund that is
doing better than any other public employee pension fund. I
mean, hurrah, right? This is not the one in the middle. This is
the one way down on the top-performing end.
Treasurer Frerichs, you have been doing very well with
private equity. Is that a fair statement?
Mr. Frerichs. Yes. That is correct.
Chair Warren. Good. And you are an investor. That is, you
manage a pension fund on behalf of your office. You are a
trustee for a public pension plan that invests in private
equity on behalf of teachers and firefighters and other public
employees.
So the question I want to ask you, as an investor, you are
on the side that is trying to make money out of this, are you
satisfied with the current rules governing private equity or
would you like to see some new rules in place requiring
transparency about fees and aligning the interests of PE
managers with their investors?
Mr. Frerichs. I will say that PE has done well by us, but
it would be beneficial to see new rules and sensible reforms.
For example, standard reporting would ensure transparency for
all investors and ensure investors can validate all fees
charged by private equity to know that they conform with their
negotiated agreements. That would be one good reform.
Our office does due diligence. Senator Kennedy asked if I
had made any investments without that, no. We do our due
diligence, but for us, and many of our public fund peers, there
is difficulty receiving proper disclosure and transparency
around direct and indirect fees in a clear and consistent
manner. There has been characterization that we are heading
toward socialism here. I believe in the market here, and I
believe markets work well and efficiently with proper access to
information.
This opaqueness makes it difficult to shop around and
determine whether we are getting a competitive rate. He is
right, if we are buying a car and someone would not disclose to
us, we would not want to buy there, but sometimes they will
just flood you in information and bury things in that sale
document at that car dealer. You know, and we regulate car
dealers to make sure there is proper disclosure.
Without proper disclosures, tracking the fees and expenses
charged by a private equity firm is a cumbersome process, and
markets should not be cumbersome. This can then potentially
enable firms to hide and shift fees, potentially manipulate
returns reporting, and avoid disclosing certain deals.
Ultimately, I believe new rules would be valuable.
Chair Warren. Yeah. So as I understand this, you are saying
you like the market but it is very hard for you to be able to
see what you are paying in fees, and if that is hard, that
means it is very hard to make comparative judgments.
And I just want to emphasize here, you are not one of the
little funds. Am I right on this? You have a pretty big shop
there.
Mr. Frerichs. Correct. We oversee tens of billions of
dollars in investments, between ISBI and internal, billions of
dollars in private equity. So we have the resources here, but
still, in order to use those resources to try and sort through
all of this, it costs us extra money, and smaller pension funds
do not have the resources that we have.
Chair Warren. Yeah. I think there is just a really
important point about markets. If we want markets to work then
people have to have consistently reported information so you
can get comparisons across them, and the information has to be
made available.
You know, I appreciate your testimony on this. My Stop Wall
Street Looting Act would require private equity funds to
clearly disclose their fees and returns so that public pensions
and other investors have the information that they need in
order to make informed decisions.
America faces a retirement crisis, but the solution is not
to squeeze employees more or to cut retail jobs and wages or to
undermine the health and safety of people in hospitals and
nursing homes. The solution is to put stronger rules in place
that investors and retirees and families do not get gouged by
private equity firms that are trying to fleece them. So to me,
that is what this hearing is about today.
Since I did not get to do an opening statement at the
beginning I just want to do a kind of overview as we wrap this
up and say thank you to everyone who has been here. You know,
this is the first hearing that the Senate has held that has
focused entirely on private equity, and it is about time that
we do this. We need to get the facts on the table about what
private equity firms are doing to our economy and to our
communities.
Private equity firms have plenty of money to spend on
lobbyists and PR campaigns. They have their own trade
association, which I know has been making the rounds in
Congress ahead of this hearing. They have worked hard to
portray themselves as good actors that bring jobs and
investments to communities in need, and they have no problem
telling their version of the story.
But their version of the story glosses over a lot of what
happens to local workers, to local businesses, to local
communities when some private equity firm waltzes into town.
Once private equity starts buying up local stores or hospitals
or newspapers or prison commissaries or for-profit colleges or
nursing homes or hospitals or any of dozens of other
industries, the smiling private equity managers and their
secret investors profit hugely while workers and local
businesses and local communities too often come out as the
losers.
In 2019, I opened a broad investigation of the role of
private equity in the economy, and this investigation exposed
how the industry is fundamentally broken. Private equity relies
on a business model that pays managers to go after short-term
profits, charging huge fees even as they destroy the long-term
prospects of the businesses that they buy. It is bad for
workers and bad for consumers when local retailers, or even
large chains, are bought out by private equity. These firms
load up the target company with debt, as we have seen the
examples here today, they strip out assets, and the next thing
you know thousands of workers have lost their jobs and the
stores are shut down.
It is also bad for seniors and their families when private
equity firms buy up nursing homes and other health care
providers. It is the same pattern: assets are stripped out,
cost-cutting runs rampant, and the quality of care declines,
with real consequences for people's health and for their lives.
It is bad for students when private equity firms buy up
for-profit colleges. The industry already has a bad record of
ripping off students, and private equity just makes it worse.
It is bad for communities when private equity firms buy up
thousands of manufactured homes and the land that they sit on.
Costs skyrocket, forcing residents to choose between paying the
rent and paying for basic necessities like food and medicine,
and meanwhile the investments in these communities decline and
conditions get worse and worse.
And by the way, we will be hearing more about that
particular abuse of private equity in the housing sector
tomorrow at the Banking Committee hearing, and I am looking
forward to joining Senator Brown on that.
What I see here is across the board. In industry after
industry it is the same pattern. Private equity executives make
off with massive short-term gains and they leave workers,
consumers, communities, and ordinary investors with pretty much
nothing to show for it. And all of this has been magnified
during the COVID pandemic. The companies that are owned by
private equity firms have received over $5 billion in taxpayer
money from the CARES Act. I appreciate you pointing it out in
your case, Ms. Malone.
Their record has only gotten worse. Private equity-owned
nursing homes had a terrible safety record before the pandemic.
Private equity-owned retails were weighed down with debt and
shut their doors for good. Private equity landlords laid in
wait for the eviction moratorium to end so they could make more
money, even if meant kicking families out of their homes. What
almost every American experienced as a crisis, private equity
viewed as an opportunity.
And I know, we have heard from the private equity industry
in response to this hearing. They say this is all for the best.
We hear about the standard talking points that private equity
firms employ millions of people and create big returns for
pension funds for teachers and firefighters. But when you fact-
check those claims, it just turns out they are not true. In
fact, private equity investments often result in fewer jobs and
lower wages, and despite how hard they squeeze the businesses
they acquire, private equity does not offer an above-market
return to investors.
So what are we doing to do about this? Well, I want to set
some minds at ease. I do not want to eliminate private equity,
but I do want to fix it, and that is why I have introduced the
Stop Wall Street Looting Act, which is groundbreaking
legislation to clean up this industry. My legislation aims to
make the entire industry more transparent and to end the
misaligned incentives that create private equity's ``heads, I
win, tails, you lose'' business model.
So I appreciate all of the witnesses who joined us today. I
very much appreciate the first-hand accounts you have given us
about what it is like to live through this on the receiving
end, as an employee. I appreciate the academic perspective that
is going on, and I very much appreciate the Treasurer joining
us and telling us what it is like as an investor, even someone
who has done well with private equity, how we could make
improvements that make this market work better.
So thank you all for being here today. Thank you for
providing testimony. Before we go I would also like to submit a
statement for the record from the Private Equity Stakeholder
Project.
For Senators who wish to submit questions for the record,
those questions are due 1 week from today, which is Wednesday,
October 27.
I also want to enter into the record a statement from my
friend, Senator Baldwin, who has been a fighter for the workers
and the communities of Wisconsin in the face of predatory
private equity abuses. And so thank you, Senator Baldwin. We
will make sure that is entered into the record.
And for our witnesses, you will have 45 days to respond to
any questions.
Thank you all very much, and with that this hearing is
adjourned. Thank you.
[Whereupon, at 3:34 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIR ELIZABETH WARREN
Good afternoon, and welcome to today's hearing on ensuring that
companies and communities are not destroyed by private equity firms.
This is the first hearing that the Senate has held focused solely on
private equity, and it's about time. We need to get the facts on the
table about what private equity firms are doing to our economy and to
our communities.
Private equity firms have plenty of money to spend on lobbyists and
PR campaigns. They have their own trade association, which I know has
been making the rounds in Congress ahead of this hearing. They have
worked hard to portray themselves as good actors that bring jobs and
investments to communities in need, and they have no problem telling
their own version of the story.
But the industry version glosses over what happens to the local
workers, to the local businesses, and to the local communities when
some private equity firm waltzes into town. Once private equity starts
buying up local stores, or hospitals, or newspapers, or prison
commissaries, or for-profit colleges, or nursing homes, or any of the
dozens of industries, the smiling private equity managers and their
secret investors pocket huge profits while local workers, local
businesses, and local communities come out the losers.
In 2019, I opened a broad investigation of the role of private
equity in the economy. This investigation exposed how the industry is
fundamentally broken. Private equity relies on a business model that
pays managers to go after short-term profits, charging huge fees even
as they destroy the long-term prospects of the businesses they buy.
It's bad for workers and consumers when local retailers or even
large chains are bought out by private equity firms. These firms load
the target companies up with debt, strip out their assets, and next
thing you know, thousands of workers have lost their jobs, and the
stores are shut down.
It's bad for seniors and their families when private equity firms
buy up nursing homes and other health care providers. It's the same
pattern: assets are stripped out, cost-cutting runs rampant, and the
quality of care declines--with real consequences for people's health
and lives.
It's bad for students when private equity firms buy up for-profit
colleges. The industry already has a bad record of ripping off
students, and private equity makes it worse.
It's bad for communities when private equity firms buy up thousands
of manufactured homes or the land they sit on. Costs skyrocket, forcing
residents to choose between paying the rent and paying for basic
necessities like food and medicine, meanwhile investments in these
communities decline and conditions get worse and worse. By the way,
we'll be hearing more about the abuses of private equity in the housing
sector at tomorrow's Banking Committee hearing, and I'm looking forward
to joining Chairman Brown there.
Across the board, in industry after industry, we see the same
pattern: private equity executives make off with massive short-term
gains, and leave workers, consumers, communities, and ordinary
investors with nothing to show for it.
All of this has been magnified during the COVID pandemic. The
companies that are owned by private equity firms have received over $5
billion in taxpayer money from the CARES Act, and their record has only
gotten worse. Private equity-owned nursing homes had a terrible safety
record during the pandemic. Private equity-owned retailers were weighed
down with debt and shut their doors for good. Private equity landlords
laid in wait for the eviction moratorium to end so they could make more
money, even if it meant kicking families out of their homes. What
almost every American experienced as a crisis, private equity viewed as
an opportunity.
I know what we'll hear from the private equity industry in response
to this hearing. They'll say that all this is for the best. We'll hear
the standard talking points that private equity firms employ millions
of people and create big returns for pension funds for teachers and
firefighters. But it's time to fact-check those claims. In fact,
private equity investments often result in fewer jobs and lower wages.
And despite how hard they squeeze the businesses they acquire, private
equity doesn't always offer a good return to pension funds. In fact,
pension funds turn over millions in fees for these funds to manage,
then they end up with no better returns than index funds in the stock
market.
So what do we do about it? Well, let me set some minds at ease. I
don't want to eliminate private equity. But I do want to fix it. And
that's why I've introduced the Stop Wall Street Looting Act, my
groundbreaking legislation to clean up the industry. My legislation
aims to make the entire industry more transparent and to end misaligned
incentives that create private equity's ``heads I win, tails you lose''
business model.
I appreciate our witnesses joining us today--I'm looking forward to
hearing their first-hand accounts of what private equity meant for
their jobs and their communities. It's long past time to reform this
industry and end their most destructive practices.
______
PREPARED STATEMENT OF DAVID R. BURTON
Senior Fellow in Economic Policy, Roe Institute for Economic Policy
Studies, Institute for Economic Freedom and Opportunity, The Heritage
Foundation
October 20, 2021
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF DOUG HOLTZ-EAKIN
President, American Action Forum
October 20, 2021
Introduction
Chairman Warren, Ranking Member Kennedy, and Members of the
Subcommittee, thank you for the opportunity to discuss financial
markets, in general, and, in particular, the role of private equity
firms. In this testimony, I hope to make three main points:
Financial markets serve key economic functions such as
intermediation between savers and investors, allocation of
capital, diversification of risk, separation of ownership and
management, pricing return and risk, and others.
Participants in financial markets have myriad business
models--banks, insurance companies, pension funds, hedge funds,
private equity, etc.--to undertake these functions; legal,
regulatory, and tax policies should be as neutral as possible
with respect to the choice of business models.
The Stop Wall Street Looting Act violates this basic
dictum, discriminating against public equity firms, damaging
the outlook for the private equity industry and the economy as
a whole.
Let me discuss each of these in greater detail.
Financial markets are a crucial component of developed economies.
Well-functioning financial markets permit savers to provide their
pooled savings to firms for investment in skills, technologies, and
physical capital. They permit savers to diversify across risks and
provide important price signals regarding the expected returns and
risks of alternative investments. In the absence of financial markets,
owners would be forced to also manage each firm and hold
undiversifiable risk regarding its performance; financial markets
permit specialization of management functions as well as
diversification of risks.
These economic functions may be supplied by a variety of entities--
banks, pension funds, insurance companies, mutual funds, and others
offer various combinations of these desirable economic activities. In
developing the legal, regulatory, and tax frameworks within which they
operate, it is desirable to tilt the playing field as little as
possible, allowing financial market participants to compete on the
basis of performance. As noted by most economists and this
Administration, healthy market competition leads to lower prices,
higher quality goods and services, greater variety, and more
innovation.
Background on Private Equity
Private-equity (PE) firms are a crucial part of capital allocation
and the pricing of return and risk. PE firms invest in businesses they
see as undervalued, provide additional capital and management services,
and raising value. The vast majority (over 85 percent) of these
investments are in small businesses (under 500 employees).
PE has been very successful. For example, the American Investment
Council's 2021 Public Pension Study shows PE has the highest return of
any asset class public pension portfolios. In 2020, PE had a median
annualized return of 12.3 percent over a 10-year period.
Its success in raising value has resulted in a substantial economic
footprint. According to E&Y, the PE sector directly employed 11.7
million workers earning $900 billion in employee compensation. The
average employee earned roughly $73,000 in wages and fringe benefits in
2020, while the median worker received approximately $50,000 in wages
and benefits in 2020. These workers helped the private equity sector
produce $1.4 trillion of gross domestic product (GDP), or roughly 6.5
percent of total GDP.
The PE sector has substantial backward linkages. Suppliers
generated $900 billion in GDP, employing another 7.5 million workers,
and paying roughly $500 billion in wages and benefits.
In short, PE is a very successful sector of the economy and the
fruits of its success are widely shared by the investors in PE and the
economy as a whole. As a corollary, unwise policies that damage PE
would impose widespread harm in the economy.
Economic Implications of the Stop Wall Street Looting Act
The proposed Stop Wall Street Looting Act (SWSLA) is one such
potential policy misstep. The SWSLA would impose a separate set of tax,
regulatory, and legal frameworks on the PE industry. Among other
provisions, it would impose:
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.
As a matter of logic, the net result would be to make investments
in PE less attractive, pushing capital to less productive uses, and
imposing a loss on the economy. The only question is how large the
losses would be.
A 2019 study by the U.S. Chamber of Commerce found that the
``imposition of increased risk, taxes, and restrictions . . . would
likely cause some (and potentially all) of the private equity industry
to cease to exist.'' As a result, the SWSLA would result in a loss in
the range of 6.9 million to 26.3 million jobs, from $671 million to
$3.36 billion per year in investor earnings (about half of which would
be lost to pension fund retirees), and substantial tax revenue for
local governments, State governments, and the Federal Government.
Thank you. I look forward to answering your questions.
______
PREPARED STATEMENT OF MICHAEL FRERICHS
Illinois State Treasurer
October 20, 2021
Good afternoon Chair Warren, Ranking Member Kennedy, and other
distinguished Members of this Subcommittee and guests. My name is
Michael Frerichs. I am the Illinois State Treasurer, and it is an honor
to be invited to speak to you today to share my experience managing
investments on behalf of the people of Illinois.
The Illinois State Treasurer is a constitutionally established,
elected office in our State that performs a variety of roles. I am the
State's Chief Investment and Banking Officer. In that role, my office
manages approximately $50 billion, including $25 billion in State
funds, $16 billion in retirement and college savings plans, and $9
billion on behalf of State and local government entities. \1\ I also
serve as a trustee on the Illinois State Board of Investment (ISBI),
\2\ which manages approximately $31 billion in assets on behalf of over
226,000 beneficiaries of a number of State retirement plans. \3\
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\1\ Illinois State Treasurer, Investments, available at https://
illinoistreasurer.gov/Office-of-the-Treasurer/Investments.
\2\ I am testifying today in my capacity as the Illinois State
Treasurer and as an individual trustee of ISBI. These views are my own
and are not intended to represent the views of ISBI.
\3\ Illinois State Board of Investments, ``About Us'', available
at https://www.isbinvestment.com/.
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As an elected steward of public funds, I have a responsibility to
make prudent investment decisions, and I also have a responsibility to
the long-term fiscal health of our State, which relies on a vibrant and
sustainable economy. Furthermore, I have a responsibility to the
communities that I represent to tend to their well-being and to be
mindful of how the decisions that our office makes might impact the
livelihoods of workers and their families.
As an active investor in the space, I view private equity as an
essential part of our capitalist system. The idea of the industry is
simple and reasonable: sometimes a company has room to grow and become
more productive, but its current ownership is not in a position to
capitalize on that opportunity. In this situation, it makes sense for
an investment vehicle run by experts to pool private capital, buy the
firm, take it to the next level, and then sell it. This generates a
profit for private equity firms and their investors, it helps the
company grow, and it creates more economic opportunity for society at
large.
For investors like the Illinois Treasury and other institutional
investors, private equity investments provide an opportunity to further
diversify our portfolios, help drive economic development in Illinois
and beyond, support small businesses, invest in qualified minority- and
women-owned investment firms, and provide a competitive return that
complements our investments in other asset classes such as public
equities and fixed income.
The problem is that as private equity has continued to evolve as an
asset class, becoming a larger and larger portion of our economy, it
has remained dangerously under-regulated. That means that predatory and
destructive activities like pillaging assets, opaque fees, and
strategically using bankruptcy without regard for the well-being of
workers remain perfectly legal. As private equity continues to evolve,
there is a need for sensible reforms that will enhance long-term
outcomes for investors, including public pensions, and continue to
focus private equity on what it does best, helping companies to grow
and expanding economic opportunity for our communities.
As Treasurer, my office directly invests in private equity funds,
and we intend to continue to do so in the future. Through the Illinois
Growth and Innovation Fund (ILGIF), my office makes targeted
investments with venture capital, growth equity, and private venture
debt funds that invest in technology-enabled businesses that are either
based in Illinois or possess a significant workforce in Illinois with
the goal to attract, assist, and retain these quality technology-
enabled businesses in Illinois. \4\ As of March 31, 2021, we have $430
million invested in private equity and venture capital through this
program. To date, these investments have been our highest performing
asset class with a net internal rate of return of 21.3 percent since
the inception of the program in 2016. \5\ After evaluating this
program, I saw great potential in these investments for Illinois, both
in terms of the return on investment and the ability to stimulate
growth in our economy, and that led me to advocate for a change in the
State law to allow my office to increase the percentage of funds
invested in ILGIF from 2 percent of the State investment portfolio to 5
percent. \6\
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\4\ See Illinois Growth and Innovation Fund, Mission, available at
http://www.ilgif.com.
\5\ See Illinois Growth and Innovation Fund, Impact, available at
https://www.ilgif.com.
\6\ See the Technology Development Act, 30 ILCS 265, available at
https://ilga.gov/legislation/ilcs/ilcs3.asp?ActID=502&ChapterID=7; see
also ``Treasurer Frerichs Announces Increase in Venture Funding To Help
Grow Technology Businesses in Illinois'', Illinois Venture Capital
Association, Aug. 29, 2020, available at https://ivca.memberclicks.net/
treasurer-frerichs-announces-increase-in-venture-fundingto-help-grow-
technology-businesses-in-illinois.
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A core investment objective for ILGIF in addition to driving
performance and economic development, is fostering a more diverse and
inclusive manager and private equity ecosystem across Illinois. It is
my core belief that a more inclusive private equity ecosystem means
more opportunities for diverse founders which in the long term, has the
opportunity to build generational wealth and advance equity, diversity,
and inclusion in our communities. We know the importance of providing
individuals with traditional and nontraditional backgrounds necessary
opportunities to grow within the private equity space and the benefits
a greater level of diversity adds to the ecosystem overall.
As of March 31, 2021, of the $430 million committed to Illinois
venture capital firms under ILGIF, $183 million has been committed to
minority-, women-, veteran-, and disabled-operated (MWVD) venture
capital firms. That represents over 42 percent of committed capital to
date.
Investments from ILGIF fund managers have supported more than 110
diverse-owned portfolio companies to receive funding. Through ILGIF,
the Illinois Treasurer actively seeds and anchors new MWVD-operated
venture capital and private equity funds furthering the investment
objective to foster a more diverse and inclusive manager pool and
entrepreneurial community across Illinois.
For example, our office continues to push toward increasing
economic equity to broad swaths of Chicago, in which there has been
decades of disinvestment and undercapitalization that has left entire
communities vulnerable and marginalized. Entrepreneurship is a potent
tool in closing longstanding wealth gaps. That is why in partnership
with minority-owned and operated venture capital firm Cleveland Avenue,
ILGIF anchored and helped launch the Cleveland Avenue State Treasurer's
Urban Success Fund, a $70 million fund dedicated to investing in
underrepresented founders within underserved communities on Chicago's
South and West sides.
Likewise, as a trustee of ISBI, which maintains approximately 7
percent of its total portfolio in private equity investments, I have
also given considerable thought to the role that these investments play
in support of the long-term growth of our State pensions.
I have seen first-hand the benefits of private equity investment
for our State, but also the ways in which the current lack of
regulation allows for abuses that harm institutional investors,
workers, and businesses. Specifically, I want to underscore the need
for greater transparency to allow institutional investors, including
ILGIF and our State pension programs, to fairly evaluate the
prospective costs and benefits associated with a particular private
equity investment, as well as the need for reforms targeting bad actors
in this industry that allow workers and their families to become
collateral damages when an investment goes awry. I see these reforms as
a way to enhance this industry by aligning the goals of private equity
firms, institutional investors, and the people and communities that
work every day to make their businesses a success.
Lack of Transparency
Regulators have recognized that the lack of transparency in this
industry often operates to the detriment of institutional investors.
Since 2014, the SEC has brought to light many cases where fees and
expenses were improperly charged or insufficiently disclosed to
investors in private funds. \7\ In June 2020, the Office of Compliance
Inspections and Examinations (OCIE) at the U.S. Securities and Exchange
Commission (SEC) released a risk alert identifying numerous issues with
allocation and disclosure of fees and expenses by private fund advisors
that had arisen in recent compliance examinations. \8\ OCIE noted that
many of the deficiencies discussed in the Risk Alert may have caused
investors in private funds ``to pay more in fees and expenses than they
should have or resulted in investors not being informed of relevant
conflicts of interest concerning the private fund advisor and the
fund.'' \9\ Earlier this year, in testimony before the full Senate
Banking Committee, SEC Chairman Gary Gensler stated that
``[u]ltimately, every pension fund investing in these private funds
would benefit if there were greater transparency and competition in
this space.'' \10\
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\7\ See Andrew J. Bowden, Director of OCIE, ``Spreading Sunshine
in Private Equity'', May 4, 2014, available at https://www.sec.gov/
news/speech/2014-spch05062014ab.html; see also Marc Wyatt, Acting
Director of OCIE, ``Private Equity: A Look Back and a Glimpse Ahead'',
May 13, 2015, available at https://www.sec.gov/news/speech/private-
equity-look-back-and-glimpse-ahead.html.
\8\ See U.S. Securities and Exchange Commission, Office of
Compliance Inspections and Examinations, Risk Alert, dated June 23,
2020, available at https://www.sec.gov/files/
Private%20Fund%20Risk%20Alert-0.pdf.
\9\ See OCIE Risk Alert, supra.
\10\ Testimony of Gary Gensler before the United States Senate
Committee on Banking, Housing, and Urban Affairs, September 14, 2021,
available at https://www.banking.senate.gov/imo/media/doc/
Gensler%20Testimony%209-14-21.pdf.
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In my own experience, the lack of transparency surrounding private
equity investments, specifically related to fee arrangements and the
calculation of the internal rate of return creates significant
challenges for institutional investors like my office and our State
retirement plans. The fees and costs associated with a particular
investment can significantly affect the longterm return on these
investments. The fees charged by private equity managers are among the
highest in the investment industry, thus, any lack of transparency
represents a meaningful risk.
Private equity firms use different terms, different methodologies
around calculating asset values, and different metrics to report on
their performance, with some breaking out fees and expenses to
investors while others make fee and expense information much harder to
identify. This makes evaluation cumbersome and makes direct comparisons
between funds nearly impossible.
Additionally, private equity firms are increasingly using bridge
loans, known as subscription lines, to pay for assets, manage capital
calls, and boost returns, adding more debt to already leveraged
transactions without always accounting for their true impact on
returns. In order to assess the value of these investments,
institutional investors have to hire specialists who are expensive and
drive up costs, or risk paying more for an investment than we should.
Clear and standardized fee and expense disclosures, similar to the
template established by the Institutional Limited Partners Association,
would allow institutional investors to streamline their analysis and
will drive better decision making. These basic reforms would also
reduce the compliance burden and cost, not only on Limited Partners,
such as the programs my office manages, but also on General Partners
being asked to report against a range of varying templates from
investors. Investors would also be able to accurately understand and
account for general partner fees, fee offsets, and fund expenses in
order to verify what they are being charged against what was agreed
upon in investment contracts.
While some might argue that access to more granular reporting can
be achieved through negotiations between more sophisticated Limited
Partners like large institutional investors and the private equity
firms, this approach has yet to result in a change in market practice.
As a larger institutional investor, my office attempts to negotiate an
increased level of transparency by leveraging a reporting template that
is modeled off of the Institutional Limited Partners Association's
reporting template to ensure private equity firms demonstrate that they
are allocating costs appropriately. However, basic market transparency
should be available to all investors, including smaller institutional
investors such as city or county pension funds, not just those with the
buying power to negotiate a more favorable release of information.
Protection for Workers and Communities
In my role as an elected officer of the State of Illinois, I take
my responsibility towards the communities in my State very seriously.
As an investor of public funds, I also see it as my obligation to
integrate sustainability factors into our investment decisions,
including minimizing risks and negative impacts to what we call our
human capital--the workers who drive our economy. While I see strong
value in private equity 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 often
opaque fees with that borrowed money, and then leave the company in
bankruptcy. Hundreds of thousands of workers have lost their jobs in
private equity owned corporate bankruptcies, \11\ tearing families and
neighborhoods apart. To this end, Congress should 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.
---------------------------------------------------------------------------
\11\ The Center for Popular Democracy, ``Pirate Entity: How Wall
Street Firms Are Pillaging American Retail, The Center'', July 23,
2019, available at https://www.populardemocracy.org/pirateequity.
---------------------------------------------------------------------------
Conclusion
Madam Chair, Ranking Member Kennedy, and other distinguished
Members of this Subcommittee and guests, I ask for your help in
strengthening private equity markets, which will help ensure the long-
term success of the industry, establish market efficiencies, and lead
to better outcomes for all stakeholders. I firmly believe that private
equity can help unlock economic opportunity in ways that grow our
communities, expand the circle of possibility, and provide excellent,
long-term returns for investors like the Illinois Treasury. With your
support, I know that a reformed private equity market can accomplish
all this, and more.
______
PREPARED STATEMENT OF SHIRLEY SMITH
Former Sales Manager at Art Van Furniture and Leader with United for
Respect
October 20, 2021
Good afternoon, Senators. My name is Shirley Smith and I live in
Detroit, Michigan. For 23 years, I worked for Art Van Furniture as a
sales manager--a job I truly loved. Art Van was a family owned
business, and the company culture was centered around family. The
employees were tight-knit and we had each other's backs; there was a
real sense of community. I was a single mom and I'm grateful for the
support and flexibility I had at work, so I could be there for my son
while juggling a successful career. I had the opportunity to build
relationships with my customers and earn a good living, making it
possible to buy my own home and provide a good education for my son.
Working at Art Van was like my own little slice of the American Dream--
until the private equity firm Thomas H. Lee (THL) came in and broke up
our family.
Before T.H. Lee took over in 2017, Art Van had been a successful
company, reporting $800 million dollars in revenue \1\ that year. Up to
then, most of my colleagues would have told you it was a company they
loved working for, but those last 3 years were hell.
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\1\ https://www.crainsdetroit.com/awards/40-art-van-furniture-inc
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It wasn't obvious right away, but a lot started changing. We
noticed our top company leaders were being pushed out the door. T.H.
Lee brought in people who didn't know the furniture business, and our
orders started coming in slower. In hindsight, that was a big red
flag--sales associates work on commission which only gets paid when an
order is delivered--and customer orders weren't being filled. Art Van's
reputation was being destroyed right before our eyes, and we had to
start making up excuses to our customers, some of whom grew violent
when they learned they wouldn't be getting refunds. One of my
colleagues even had a gun pulled on her during closing weekend. T.H.
Lee made us feel like liars and thieves, taking people's hard-earned
money when they were never going to receive their orders.
We stopped paying our bills on time, and started cutting staff. For
decades, Art Van had been a debt-free company that paid all its bills.
Under T.H. Lee's ownership, Art Van racked up millions of dollars in
debt to Wall Street banks and other deep-pocketed creditors. T.H. Lee
even sold off Art Van's real estate to itself, forcing Art Van to pay
rent on the same properties it once owned. By the end of 2019, under
T.H. Lee's so-called leadership, Art Van was in the red. It took just 3
short years for T.H. Lee to strip our company for parts. Then the
pandemic hit.
We first received WARN Act notices about our layoffs before the
COVID-19 emergency order was issued in Michigan, so the bankruptcy and
layoffs had nothing to do with the pandemic. But then, a few weeks
later, Art Van changed their original WARN Act notice, citing COVID-19.
As a result, we didn't get any severance pay or benefits. Nothing.
Robbing the American workforce like this--hurting the same people on
the front lines who've been applauded as ``heroes'' for keeping our
economy open--should be a crime.
When we were told we'd be losing our jobs, we were promised a lot.
We were promised health insurance after closing. We never got it. The
only insurance I could afford charged me 10 times what I had been
paying for prescriptions. I was unemployed for 5 months, and many times
I had to choose between paying for my medication or paying other bills.
We were also promised a retention bonus that we never got. Since my
unemployment didn't kick in for 2 months, I had to take out money from
my 401K to make ends meet, which I'm still paying taxes on today.
Sadly, my story is not unique--private equity has quietly taken
over nearly every facet of life--from retail and grocery store chains,
to housing, health care, media, and more--turning the American Dream
into nothing more than a pipe dream for millions of working families.
And T.H. Lee didn't only destroy us, the individual workers who lost
their jobs; every community that had an Art Van store suffered too. We
had a deep reach in our communities--we were the largest taxpayer in
the city of Warren where we were headquartered, and the biggest
contributor to the Food Bank. When the company went under, there was a
terrible ripple effect of harm felt throughout the State of Michigan.
Art Van is not the only bankruptcy in T.H. Lee's portfolio. Between
2009 and 2019, T.H. Lee drove three other companies into bankruptcy. In
each instance, T.H. Lee attempted to profit while paying down creditor
interest by steadily decreasing the operational quality of these
companies, destabilizing their real estate holdings, extracting their
resources, and cutting jobs. While under T.H. Lee's ownership, over
6,000 people lost their jobs at four companies, including Art Van, that
filed for bankruptcy in sectors spanning food processing, media,
retail, and manufacturing. You can find more information about these
bankruptcies in the attached research brief, Thomas H. Lee Partners
Creates ESG Risk for Investors (Appendix III).
I'm here today to show you the human toll of Wall Street's greed.
Our elected leaders--each of you here today--have the power to stop
private equity firms from coming in and taking over our companies,
leaving employees with nothing and gutting our local economies.
Billionaires shouldn't be allowed to gamble with our livelihoods,
driving thriving companies into bankruptcy just to make another buck.
When faced with private equity's abuses, we fought back. More than
500 of my former coworkers and I teamed up with United for Respect to
demand that T.H. Lee create a hardship relief fund. We called, wrote
letters and told our story of what happened at Art Van, and after a
year, T.H. Lee relented and ultimately provided nearly $2 million
dollars to the relief fund, with eligible employees who signed up
receiving about $1,200 dollars each. Make no mistake, we're proud of
this hard-fought victory--but $1,200 dollars falls far short of the
fair severance each of us deserved.
With nearly 12 million people working for private equity-owned
companies in the United States, private equity is a major employer.
Given the industry's poor track record we must also take a closer look
at how their cost cutting and greed impacts workers and the customers
they serve across America.
One example I'd like to share with you is the ongoing efforts of
PetSmart employees to sound the alarm about unsafe conditions in stores
that hurt both workers and pets under their care. With 56,000 employers
and 1,650 stores across the U.S. and Canada, PetSmart is the largest
pet retailer in North America. PetSmart is also owned by London-based
private equity firm BC Partners.
When BC Partners acquired PetSmart for $8.7 billion in March 2015,
it was the largest private equity buyout of the year. In true private
equity form, BC Partners took an $800 million dividend from PetSmart
less than a year after taking over. \2\
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\2\ Forbes, Feb 18, 2016, ``PetSmart's $8.7 Billion LBO Is Already
Paying Off for Consortium Led by BC Partners''.
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Like me and my former Art Van coworkers, the people who worked at
PetSmart before BC Partners took over started noticing alarming changes
to store practices and policies after private equity took over.
PetSmart workers who started after the 2015 acquisition report having
to struggle to provide quality pet care while dealing with
understaffing, stagnant wages, lack of supplies, and broken equipment.
In July 2020, over 500 current and former PetSmart employees wrote
to BC Partners alerting them to these serious problems. It has been
over a year since PetSmart employees reached out to BC Partners and
workers are still waiting for a response. You can read more about BC
Partners mismanagement of PetSmart in a recently published report,
``Greed Unleashed: PetSmart, BC Partners, and what happens when private
equity preys on workers and pets'' (Appendix IV [In Additional Material
section of this Hearing]).
Imagine the victories we could win for working families with the
power of Congress behind us. I'm asking you, Senators, to summon the
same courage we found to stand up to these Wall Street executives and
corporate billionaires, because essential workers can no longer be
treated as collateral damage. The Stop Wall Street Looting Act will
finally close regulatory loopholes and change the rules that have only
served the billionaire class while wreaking havoc in our communities.
It's way past time to protect essential workers over wealthy corporate
executives--Congress must pass the Stop Wall Street Looting Act and
finally put essential workers first.
Thank you for inviting me to testify today, Senator Warren. I hope
all the Senators on this Committee will join me in standing up to Wall
Street.
______
PREPARED STATEMENT OF PEGGY MALONE
Registered Nurse, Crozer-Chester Medical Center
October 20, 2021
Thank you Senator Warren and Members of the Subcommittee for having
me here today. My name is Peggy Malone, RN, and I have provided care at
the Crozer-Chester Medical Center for 32 years. I am the Vice President
of the Crozer-Chester Nurses Association, which is a local of the
Pennsylvania Association of Staff Nurses and Allied Professionals, or
PASNAP. I am also a member of the PASNAP Board of Directors.
Being a nurse for me and my colleagues is more than a job. It is a
calling. We are first and foremost, fierce patient advocates. That is
why I am here today. Our patients are suffering due to the greed of a
major private equity firm that has enriched itself and its owners at
the expense of our patients.
Prospect Medical Holdings, which owns 17 hospitals across the
country including mine, was majority-owned until June 2021 \1\ by the
major private equity firm Leonard Green & Partners. Leonard Green and
Prospect's founders and current owners, Sam Lee and David Topper,
extracted over $400 million from Prospect since taking ownership just a
few short years ago. \2\ Simply put, we were looted.
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\1\ ``Rhode Island Regulator Approves Hospital Sale''. Laura
Cooper, Wall Street Journal. June 1, 2021.
\2\ ``Investors Extracted $400 Million From a Hospital Chain That
Sometimes Couldn't Pay for Medical Supplies or Gas for Ambulances'',
Peter Elkind with Doris Burke, Propublica. September 30, 2020.
---------------------------------------------------------------------------
I am here to testify in support of Senator Warren's Stop Wall
Street Looting Act, because Congress needs to take action now. We
cannot have a health care system in this country that allows, even
enables, this to happen.
Eighteen months ago, we were called upon to face a global pandemic
head on. We had no idea what we were up against. We did not have enough
PPE. We did not have enough staff. We were away from our families. It
was the hardest work of our careers. But we showed up at every shift
and took care of our patients. We took care of them like they were our
own family. We had one goal: to do no harm and help save as many lives
as we could. Were we scared? Sure. But we hid it behind our masks.
Eighteen long months later, we are still wearing masks, but we
can't hide what we feel now. We are sad, frustrated, overworked and
disrespected, but we still show up to work to take care of our patients
every day.
We have done our jobs. Prospect has not done theirs. In fact,
things have gotten progressively worse since our community hospital
system was converted to for-profit status under Prospect's ownership in
2016. The quality of care has gone downhill, and our hospital is only
kept from collapsing by the sheer will of the nurses and health care
workers that keep the ball rolling.
We are now at a crisis point. Due to Prospect's misguided efforts
to save money, we are now severely understaffed and without the
supplies we need to do our job. There are many shifts when our nurses
are overwhelmed with the number of patients they have to care for--
significantly higher than the safe maximum number of patients per
nurse.
This decline comes as Prospect has received $173.8 million in COVID
grants from the Federal Government. \3\ Where has that money gone? We
don't know. It certainly hasn't prevented conditions from getting worse
at the bedside.
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\3\ Covidstimuluswatch.org Query. October 18, 2021.
---------------------------------------------------------------------------
Senator Warren's Stop Wall Street Looting Act would have helped to
prevent the worst abuses by Leonard Green, Sam Lee, and David Topper.
The bill would ``[p]rohibit interest on excessive debt obligations from
being tax deductible by target companies,'' as pointed out by Senator
Warren's office. \4\ The increased interest rates that Prospect was
charged for issuing the debt lowered the tax payments made by Prospect.
---------------------------------------------------------------------------
\4\ ``The Stop Wall Street Looting Act of 2019 Section-by-
Section''.
---------------------------------------------------------------------------
What was most of the debt issued for? Not to provide care at the
bedside. Instead, the debt was issued to pay $400 million in dividends
to Leonard Green, Sam Lee, and David Topper.
They took this money while leaving our patients at risk. At the
same time they failed to fully fund our pension, leaving our families
and retirement at risk as well.
This is wrong. Our tax system should not be creating incentives for
bad business practices, and private equity firms should not be able to
extract huge dividends while failing to fund employee pensions. Senator
Warren's Stop Wall Street Looting Act would put an end to it.
Our calls to Prospect and its owners over the years have fallen on
deaf ears. We now turn to you. The 1,300 nurses and health care
professionals represented by PASNAP at Prospect are in full support of
Senator Warren's bill, and we call on you, our elected officials, to
support us, and support this bill.
Thank you so much.
______
PREPARED STATEMENT OF EILEEN APPELBAUM
Codirector, Center for Economic and Policy Research
October 20, 2021
Thank you, Senator Warren, Ranking Member Kennedy, and
distinguished Members of the Subcommittee. I am pleased to be here
today, at this important hearing, to discuss how the Stop Wall Street
Looting Act will rein in excesses and end abuses by private equity
firms, keep American companies strong, and protect the economic
vitality of communities.
By way of background, I am currently the Codirector of the Center
for Economic and Policy Research. Prior to joining CEPR, I held
academic positions as Distinguished Professor of Labor Studies and
Employment Relations in the School of Management and Labor Relations at
Rutgers, the State University of New Jersey, and as Professor of
Economics at Temple University. I earned a Ph.D. in economics at the
University of Pennsylvania.
My coauthored book with Cornell University Professor Rosemary Batt,
``Private Equity at Work: When Wall Street Manages Main Street'', is a
balanced account of private equity that was selected by the Academy of
Management--the premier professional association of business school
faculty--as one of the four best books published in 2014 and 2015. The
book was a finalist in 2016 for the prestigious George R. Terry Book
Award. \1\ More recently, Professor Batt and I have studied the role of
private equity in health care. Our publication, ``Private Equity
Buyouts in Health Care--Who Wins, Who Loses?'' examines the private
equity business model in health care. It focuses, among other topics,
PE's acquisitions of physician practices and its growing role in the
collection of medical debt--so-called revenue cycle management. \2\
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\1\ http://aom.org/Meetings/awards/George-R-Terry-Book-Award-
(2016).aspx
\2\ https://www.ineteconomics.org/research/research-papers/
private-equity-buyouts-in-healthcare-who-wins-who-loses
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Private Equity, Largely Unregulated, Plays a Growing Role in the U.S.
Economy
By net asset value, global private equity assets under management
have grown ten-fold since 2000. In 2020, global assets under management
by private equity firms reached $4.5 trillion--and growing. There are
about 5,000 private equity firms worldwide. \3\ More than half of
assets under management are held by U.S. PE firms.
---------------------------------------------------------------------------
\3\ https://www.mckinsey.com/media/mckinsey/industries/
private%20equity%20and
%20principal%20investors/our%20insights/
mckinseys%20private%20markets%20annual%20review/2021/mckinsey-global-
private-markets-review-2021-v3.pdf, p.11, 12, and 18.
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About 8,000 companies in the U.S. are currently owned by or have
financial backing from private equity firms. \4\ The cumulative number
would be far larger. According to the website of the American
Investment Council (AIC), the U.S. PE lobbying arm, employment in the
private equity industry and private equity-backed companies combined
numbers more than 11.7 million U.S. workers. \5\ In the year 2019, AIC
reports that PE firms in the U.S. invested $700 billion in 4,841
businesses (latest year). \6\
---------------------------------------------------------------------------
\4\ https://www.mckinsey.com/-/media/McKinsey/Industries/
Private%20Equity%20and
%20Principal%20Investors/Our%20Insights/Private%20markets%20come%20of
%20age/Private-markets-come-of-age-McKinsey-Global-Private-Markets-
Review-2019-vF.ashx
\5\ https://www.investmentcouncil.org/
\6\ https://www.investmentcouncil.org/aic-announces-top-states-
and-districts-by-private-equity-investment/
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The industry is a sizable and growing financial player in the U.S.
economy. Yet, it is largely unregulated. It is famous for loading
companies with excessive amounts of debt, for selling off the real
estate of companies it acquires, for its lack of transparency about
fees it collects or the performance of the companies it owns, and
fiercely protective of tax loopholes that allow PE partners to line
their pockets with billions that should have gone to the Treasury.
Private equity provides a newly acquired company with a game plan for
its first 100 days and the metrics it is expected to meet. It selects
the company's board members and freely fires its CEO if he doesn't get
with the program. The ``Stop Wall Street Looting Act'' will establish
guardrails that rein in behavior that undermines the viability of
companies it owns to the detriment of workers, vendors, suppliers,
creditors, and the communities where they are located.
The PE industry claims that it provides access to financing and to
expertise on organizational improvements--upgrading accounting and IT
systems, improving the company's digital and social media presence--and
advising on business strategy. This is often the case when smaller PE
firms buy out small to mid-sized companies for its portfolio and
provides this support. The PE firm ``turns these companies around'' and
sells them at a profit. Small and mid-sized companies have relatively
few assets to be used as collateral for loans, so the amount of debt
loaded on them is not excessive. By the same token, they have
relatively few assets that could be stripped, and their cash flow will
not support further borrowing in the junk bond market to pay their PE
owners dividends. In this case, the PE firm relies on operational
improvements to create value for the company and the economy in order
to achieve a successful exit at a price much higher than it paid to
acquire the company, often via a sale to a strategic buyer who sees
value in the company's products or services.
Most private equity deals, by deal count, fall into this category
and PE firms are able to provide small and mid-sized portfolio
companies with operational and strategic improvements. The Stop Wall
Street Looting Act will have little effect on the operations of these
PE firms.
However, most of the capital committed to private equity by pension
funds, endowments, sovereign wealth funds, and other institutional
investors flows to PE firms that sponsor large PE funds. Mega funds--
those with capital commitments of $5 billion or more--used to be rare.
Now they are becoming increasingly common. Mature, successful companies
with predictable cash flow make attractive acquisition targets for the
portfolios of large funds. But the companies provide few, if any,
opportunities for organizational or strategic improvements. They do,
however, present many opportunities for the PE firm to make money for
itself and its investors through financial engineering--that is, by
using the assets of the company as collateral for the high levels of
debt loaded onto it to finance its acquisition by the PE fund;
restructuring the organization not for a productive purposes but to
reduce the taxes it pays; using the revenue it generates to have the
company take out junk bond loans in order to pay dividends to its PE
owners; charging its portfolio companies monitoring and transaction
fees that go straight to the coffers of the PE firm; and stripping the
company of valuable assets and using the sale proceeds to line the
pockets of the PE investors. The Stop Wall Street Looting Act will end
the most extreme and abusive of these practices.
PE firms are playing with other people's money--capital committed
by PE investors to the PE fund it sponsors and the loans advanced to it
by creditors as it loads debt on the companies it acquires. Keeping up
with payments on the debt often means the company must squeeze its
workforce, cutting pay and benefits and even laying off workers. If
despite these efforts, the company faces financial distress, it is the
creditors who will lose money and, in extreme but not uncommon cases,
force the liquidation of the company in order to recover as much of the
money they lent as possible.
A veil of secrecy hides much of what private equity firms do, the
fees and expenses they charge to their investors for managing their
money, or the monitoring fees and transaction costs they charge to
their portfolio companies. In particular, there is virtually no
information about the financial condition or performance of portfolio
companies available to the public or even to the PE investors that own
the companies. Private equity is famously ``private,'' requiring
nondisclosure agreements and preventing even the investors in its funds
from speaking to each other about the deal they cut with the PE firm.
The Stop Wall Street Looting Act will establish guard rails that
will protect the interests of investors in PE funds and the creditors
that provide the financing for leveraged buyouts. It will not mandate
the level of debt that can be levered on portfolio companies, but it
will discourage the excessive use of debt by holding the decisionmaking
General Partner of the PE fund and the private equity firm jointly
responsible with the portfolio company for repaying the debt in case of
financial distress. It will tear back the veil of secrecy that
surrounds the actions of private equity and hides the financial health
of portfolio companies from public view. We--and the PE firm's
investors and creditors--have to take the word of the PE firms for the
value of companies in their portfolios.
The PE industry promotes the myth that if PE firms are making
money, they must be creating value for the companies they own, the
companies' investors and creditors, and for the economy. In my
testimony today, I want to address that myth by describing how large PE
firms can make money without creating value and even when they destroy
it.
Leveraged Buyout Model
Private equity firms recruit institutional investors--pension
funds, insurance companies, foundations, endowment, sovereign wealth
funds--for funds that they sponsor. A committee consisting of partners
and principals in the PE firm is called the General Partner (GP) of the
fund and makes all the decisions. Investors in the fund include
institutional investors (pension funds, sovereign wealth funds,
endowments, and so on) as well as wealthy individuals. These investors
are Limited Partners (LPs) and have no say in decisions about the
fund's financial activities. The LPs put up most of the equity in these
funds, with the General Partner typically putting in one to two cents
(occasionally as much as 10 cents) for every dollar the Limited
Partners contribute. The LPs pay a management fee to the GP (the
private equity firm), typically 2 percent annually of the money they
have committed to the fund. The larger the fund, the larger are these
no-risk payments to the GP (and thus the private investment firm). The
GP also collects a lion's share of any profits, typically 20 percent
(but may be as high as 30 percent) of the fund's returns. And the PE
firm typically contracts separately with the portfolio company for
payment of monitoring fees and transaction expenses to the PE firm.
Large companies that are attractive targets for a private equity
buyout possess considerable assets that can be used as collateral to
finance the takeover of the company. A large amount of debt (referred
to as leverage) is used to acquire the company for the fund's
portfolio, and it is the company, not the PE fund that owns it, that is
obligated to repay this debt. Debt is a double-edged sword. For the PE
fund, high debt and little equity used to acquire the portfolio company
means that even a small increase in the enterprise value of the
portfolio company translates into a large return to the PE fund. For
the portfolio company, however, high debt increases the risk of
financial distress or even bankruptcy and liquidation. Private equity
is gambling with the future viability of the company when it loads it
with debt. It is assuming that the company will be able to service the
debt and refinance it as it matures. In the case of an unanticipated
development, however, the portfolio company may find its margin of
safety has been eroded by debt payments. It may be forced into
bankruptcy. The private equity firm will lose at most its equity
investment in the portfolio company, and often this has already been
repaid via monitoring fees the PE firm collects directly from the
portfolio company or from the proceeds of the sale of the portfolio
company's assets. The PE firm has little skin in the game; it's the
company, its workers, suppliers, creditors, and customers whose
livelihoods have been put at risk.
The Case of Retail Chains
Investments in large retail store chains provide private equity
with rich opportunities for asset stripping, dividend payments, and
monitoring fees; and for many years, retail was the sweet spot for
private equity. Retail is a cyclical business that can be undermined by
a change in customer tastes or a downturn in the economy. To weather
the inevitable bad times, retail chains typically have low debt burdens
and own their own real estate. This protects them from having to pay
rent or make high interest payments when things get tough. Retail is
also a high cash flow business. These characteristics made retail an
attractive target for private equity. There is room to load retail
companies with lots of debt in the buyout. The real estate opens up the
possibility of sale-leaseback transactions that benefit PE investors
but leave the chain paying rent. And the high cash flow means the
retail company is able to make payments directly to the PE firm for
advisory services and transaction fees pursuant to an advisory
agreement between the chain and the firm. It also facilitates the
payment of dividends to the company's PE owners.
Overloading retail chains with debt or selling off their real
estate and burdening them with rent payments has made them financially
fragile. Any change in the company's prospects could lead to financial
distress, bankruptcy, and even, in extreme cases, to liquidation and
the shuttering of stores. Toys `R Us, owned by KKR, Bain Capital and
Vornado Realty Trust, is the poster child for this. But there are many
other well-known examples of private equity-owned retail chains that
closed all stores and laid off thousands of workers, left vendors with
unpaid invoices, and creditors facing steep haircuts. They include Sun
Capital-owned ShopKo, Alden Global Capital and Invesco-owned Payless
ShoeSource, Bain Capital-owned Gymboree, Sun Capital-owned The Limited,
Leonard Green-owned Sports Authority, Cerberus Capital Management-owned
Mervyns Department Store and, most recently, the Michigan-based Art Van
furniture store chain owned by Thomas H. Lee Partners.
Toys `R Us was still profitable at the time of its takeover in 2005
by the KKR, Bain and Vornado consortium, though its sales were flat and
its profit and share price had fallen substantially compared with a
decade earlier. At the time it was acquired, the toy store chain was
valued at about $7.5 billion, including nearly $1 billion in debt. Its
capital structure was 87 percent equity and a very manageable 13
percent debt. This was turned on its head when the chain was acquired
by the financial firms for $6.6 billion--$1.3 billion in equity
contributed equally by funds sponsored by those firms and $5.5 billion
in debt. With the almost $1 billion in debt the chain was already
carrying, its debt burden increased to $6.2 billion--a capital
structure of 17 percent equity and 83 percent debt. Toys `R Us now had
to make interest payments on this debt that exceeded $400 million in
every year and $500 million in some (see Appendix A for details and
sources). But for the investment funds that owned the chain, the low
amount of equity they paid in would mean a very rich payoff if they
exited the company at a profit in three to five years as planned. In
2010, five years after acquiring the company, KKR, Bain and Vornado
attempted to return the company to the public market via an IPO. The
effort failed however on concerns about the toy chain's ability to
refinance its high debt load.
It is this reckless loading of debt onto companies that the Stop
Wall Street Looting Act would end by requiring the PE fund's General
Partner and the PE firm to be jointly liable with the company for
repaying the company's debts.
Toys `R Us would have been broadly profitable in the years
following its takeover if not for the interest payments, which largely
ate up the company's profits. The chain struggled and ultimately
collapsed under its massive debt load as creditors reasoned that their
best chance to recoup some of their money was to liquidate the business
and sell off its assets. Nine-hundred communities lost an important
retail anchor as the stores closed, 33,000 workers lost their jobs,
vendors and landlords went unpaid, and creditors lost money they had
loaned to the retail chain. The limited partners in the PE funds had
their investment in Toys wiped out. But KKR, Bain and Vornado managed
to make money despite not creating--and, in fact, destroying--value.
The bankruptcy protections for workers in the Stop Wall Street
Looting Acy include mandatory severance payments for workers who lost
their jobs in the bankruptcy, which would provide further protection
not just for workers but for businesses that have a stake in the
survival of companies like Toys. We cannot know whether Toys' creditors
would have made a different decision if seniority-based severance
payments to 33,000 workers, some with decades of service, had to be
paid out in the case of liquidation. But it would definitely have
altered the calculus.
As for the funds that owned the chain, they each put in $433
million in equity when Toys was purchased. Bain contributed 10 percent
of the equity in its fund or $43 million. KKR put up $10 million (2.3
percent of the equity in its fund). Vornado's contribution is unclear.
At the time of its acquisition, Toys `R Us had entered into an advisory
agreement with each of the three sponsoring firms (not the funds) that
specified payments that Toys `R Us would make to KKR, Bain and Vornado
for advisory services. Over the life of the agreement, Toys `R Us paid
Bain, KKR and Vornado a total of $185 million for these services, or
$61 million each. Bain did not agree to share these payments with its
limited partners so net of its equity contribution, it had a gain of
$17 million. KKR had agreed to share 58 percent of its advisory fees
with its limited partners, leaving it with $24 million. Net of its $10
million contribution to its PE fund, KKR had a gain of $14 million.
It's not clear how much of Vornado's $61 million was a net gain. In
addition to the advisory fees, the three companies collected a total of
$8 million in expense fees, $128 million in transaction fees, and $143
million in interest on loans they had made to Toys `R Us. In total,
Toys `R Us paid the firms that owned it $464 million. In addition, some
of the chain's real estate was sold to Vornado and leased back by the
stores, resulting in a total of $73 million paid to Vornado in rent
(details and sources in Appendix A). Toys' PE firm owners made a profit
despite recklessly endangering the toy store chain.
Buy and Build PE Model
``Buy and build'' is another strategy that private equity uses to
make money. In this strategy, the private equity firm acquires a
company in a leveraged buyout and then expands the company--now called
a platform company--through a series of debt-fueled horizontal mergers
with its smaller rivals. The strategy has several advantages for the PE
firm. It enables the PE firm to establish local monopolies and reduce
competition. Its portfolio company can exploit its dominance in the
market to increase its profits by raising prices and/or degrading the
quality of its services without fear of competition for its customers.
And adding-on smaller rivals is a faster path to revenue growth than
investing in the original company. A growth strategy of using leveraged
buyouts to add-on smaller competitors to the original portfolio company
is more lucrative than investing in the original company and taking the
time to allow it to grow organically.
The use of add-ons by PE firms has become a popular strategy. It
has grown as a proportion of leveraged buyout activity across all
segments of the economy, from 56.5 percent of buyouts in 2009 to 70.5
percent in 2020 and is on a path to reach 73.2 percent, an all-time
high, in 2021. \7\ The key to the strategy is to pursue healthy add-on
acquisitions in highly fragmented markets and utilize the platform
company's access to leveraged loans to expand into hundreds of smaller,
local territories through multiple add-on acquisitions.
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\7\ https://files.pitchbook.com/website/files/pdf/PitchBook-Q3-
2021-US-PE-Breakdown.pdf#page=1
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Physician Staffing Firms
A familiar example of how PE firms extract wealth and make money
using the buy and build strategy comes from the world of physician
staffing firms. Private equity-owned emergency room physician practices
and the use of surprise billing to collect sometimes astronomical
payments from patients who are treated by these doctors have raised
concerns among consumers and patient advocates. These are patients who
are treated at hospitals that are in their insurance networks by out of
network emergency doctors on private equity-owned company payrolls.
Private equity firms have been actively acquiring doctors' practices
through leveraged buyouts and rolling them up into large, debt-burdened
physician staffing firms, a form of Managed Services Provider (MSP). PE
firms have consolidated these previously fragmented markets, and are
now dominant players able to exploit the market power of their MSPs to
increase prices paid by patients and private insurance payers. Many of
the acquisitions have been too small to trigger antitrust oversight.
But cumulatively, they have led to large, national consolidated
doctors' practices able to exercise monopoly pricing power in local
health markets.
In addition to increased market power in pricing emergency room
procedures, the takeover of doctors' practices affects the practice of
emergency medicine. Physicians are shielded from dealing with billing
and collections. But on the flip side of this, the PE-owned staffing
firms often inflate prices for treatment of patients, while doctors on
PE payrolls do not have a right to see invoices sent out in their
names. They are, thus, unable to serve as a check on fraud or
exploitation of patients. From the point of view of the private equity
firm, physicians are the major expense, and they would like to see
revenue per physician increase or the cost of employing these doctors
reduced. Pressure is on these emergency medicine doctors to use
charting and documentation to maximize payments to the staffing firm,
and to increase the number of patients they see per hour. PE firms also
decrease the number of emergency medicine physicians on staff and
increase the number of lower cost nonphysician practitioners (NPPS) in
emergency rooms, increasing the length of time that patients in ERs
wait to see a doctor. Not only do these practices reduce the employment
of trained physicians in emergency rooms, but the number of NPPs that
each physician is tasked with overseeing is increased. There are few
complaints about working conditions or patient care from doctors on
private equity payrolls. Doctors employed by PE-owned physician
staffing firms put their jobs on the line if they speak up about their
concerns. They can be fired on short notice and given no opportunity to
contest the termination. When the focus is on making money, doctor
staffing levels decline, the pressure on emergency medicine doctors
increases, and the quality of patient care suffers. \8\
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\8\ Robert M. McNamara, MD, and Professor of Emergency Medicine at
Temple University's Medical School power point presentation at Take EM
Back Summit, https://www.youtube.com/channel/UCQqx7Ajl6uAudQAJTARcjew;
https://www.medpagetoday.com/special-reports/exclusives/95022.
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Most States require that physician practices be owned by doctors
and make the corporate practice of medicine illegal. Private equity
firms get around this requirement by having the physician practices
nominally owned by a medical practitioner. In recent legal proceedings
against an emergency medicine staffing firm, it was revealed that a
single physician was on record as owning and managing 270 to 300
physician practices across 20 States. \9\ This was clearly a sham
arrangement to hide PE's role in the illegal corporate practice of
medicine. While a physician nominally owns the doctor practices. all of
the assets of the practices, from the chairs in the waiting room to
accounts receivable, are owned by the physician staffing firm. The Stop
Wall Street Looting Act would require that all entities receiving
Federal money--so nearly all entities in health care--to reveal their
ultimate owners.
---------------------------------------------------------------------------
\9\ Ibid.
---------------------------------------------------------------------------
The initial focus of private equity acquisitions was on hospital-
based specialties like emergency medicine and anesthesiology. The
largest physician staffing companies in these specialties are Envision
Healthcare and TeamHealth, MSPs acquired respectively by funds of
private equity firms KKR in 2018 for $9.9 billion and the Blackstone
Group in 2016 for $6.1 billion. The two staffing companies have
cornered 30 percent of the market \10\ for outsourced emergency
medicine doctors, and collectively employ almost 90,000 health care
employees that fill a variety of roles. Debt-financed consolidation of
emergency medicine practices has enabled these PE firms and their MSPs
to dominate the physician staffing industry. Multiple rounds of private
equity ownership, punctuated by IPOs and a return to public markets,
have left these companies with high debt loads. Envision's $5.45
billion loan is due in October 2025; TeamHealth's loan is due in
January 2024. The companies have relied on high fees for doctor
services and surprise medical bills to provide sufficient revenue to
meet debt obligations.
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\10\ https://isps.yale.edu/sites/default/files/publication/2017/
07/surpriseoutofnetwrokbilling-isps17-22.pdf
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Envision came under heavy scrutiny for the huge out-of-network
surprise medical bills it sent to ER patients. A team of Yale
University health economists \11\ examined the billing practices of
EmCare, Envision's physician staffing arm. They found that when EmCare
took over the management of hospital emergency departments, it nearly
doubled its charges compared to the charges billed by previous
physician groups. TeamHealth, the Yale University economists found,
took a somewhat different tack. It used the threat of surprise billing
to gain high reimbursements from insurance companies to keep its
doctors in-network.
---------------------------------------------------------------------------
\11\ https://isps.yale.edu/sites/default/files/publication/2017/
07/surpriseoutofnetwrokbillin-isps17-22.pdf
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In a victory for patients and the health care system, Congress
passed the No Surprises Act in December 2020. The act bans the practice
of sending surprise medical bills to patients beginning on January 1,
2022. In a concession to the private equity-owned staffing companies,
such bills can still be sent to insurance companies, and disputes over
payment are subject to arbitration. But arbitrators are instructed to
begin from what innetwork doctors are paid for procedures rather than
from the often massively inflated charges from the PE-owned doctors'
practices. PE-owned practices may still receive somewhat higher
payments than other doctors, but the expectation is that these payments
will be much more in line with what others receive, and a great savings
to the health care system. The effects of these measures on the massive
amounts of debt owed by TeamHealth and Envision coming due in 2024 and
2025 are currently not known. But default would surely throw the health
care system into chaos.
More recently, the corporate practice of medicine has grown as
private equity has turned its attention to specialties that are not
hospital-based. Dermatology is the bleeding edge of this development,
having been among the earliest to attract private equity's attention.
But dermatology has been quickly followed by gastroenterology,
orthopedics, ophthalmology, women's health, and other specialties that
cater to patients with private insurance, assuring a more lucrative
payer mix. The effects of COVID-19 proposed spending in President
Biden's Build Back Better bill have further fueled private equity's
already considerable interest in home health care, hospice services,
and behavioral health--the latter to treat both victims of the opioid
crisis and those suffering mental health problems caused by the
isolation and disruption of the pandemic. Patient care is likely to
suffer as the PE owners hold the medical specialists, now their
employees, to metrics that increase revenue per patient and reduce
costs. The substitution of less expensive Nonphysician Practitioners
for physicians and an increase in the number of NPPs a physician is
required to supervise are likely to affect patient care. Requiring
these practices to identify private equity firms as their owners, as
the Stop Wall Street Looting Act requires, will enable patients to make
informed decisions about where they want to be treated.
A similar situation is emerging in the accounting industry. Like
physician practices, accounting firms have legal requirements that
require that certified public accounting firms be owned by certified
public accountants (CPAs). An ``attest'' service--in which a CPA
conducts an independent review of a company's financial statements and
attests to their accuracy--can only be conducted by a CPA-owned firm.
As with health care, the accounting business is largely recession
proof. It's a predictable business with high cash flow and little
volatility. So, it is not surprising that PE is looking for a work
around that will let it take over large, successful accounting firms.
In mid-September 2021, PE firm Lightyear Capital announced that it
is buying a large stake in Schellman & Co., a top CPA firm, ranked 65th
in the country in the Accounting Today 2021 list. Schellman is being
split into two entities--a CPA firm that will perform attest services
and a new company, in which the PE firm is the majority owner, that
that will provide tax and consulting services. A month later, PE firm
TowerBrook Capital Partners announced it would take an ownership stake
in top 20 accounting firm EisnerAmper. It again split the company into
two entities and took a majority stake in the consulting business. \12\
These large accounting firms with high cash flow can be loaded with
debt that will be used to acquire smaller competitors. This has the
potential to crush competition and establish the dominance of these
accounting firms in local and national markets. Main Street businesses
are likely to suffer from a lack of alternatives when it comes to
having tax and auditing work done. They might want to be informed about
whether private equity has a stake in an accounting firm with which
they do business.
---------------------------------------------------------------------------
\12\ https://www.journalofaccountancy.com/news/2021/oct/private-
equity-push-into-accounting.html
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The Paradox of Private Equity
The ``paradox of private equity'' \13\ refers to the finding that
smaller private equity funds often outperform mega funds and tend to
deliver the best returns to investors, while the bulk of the money
invested in private equity flows to large funds and mega funds. Better
performance of smaller funds is actually not surprising. In our
research, Rosemary Batt and I found that smaller PE funds typically
acquire small and medium-sized enterprises that can benefit from the
access to financing and improvements in operations and business
strategy that private equity firms can provide. These enterprises have
relatively little in the way of assets that can be mortgaged, which
rules out the excessive use of debt to acquire them. In addition to
lower levels of debt, these PE funds provide access to financing to
upgrade operations, advise on implementation of modern IT, accounting,
and management systems, and appoint board members that can assist with
business strategy.
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\13\ https://www.institutionalinvestor.com/article/b1hx33sxljv1r0/
The-Private-Equity-Paradox
---------------------------------------------------------------------------
These improvements in governance, operations, and strategy create
value for the companies and the economy. But while the large majority
of PE deals are carried out by smallish funds buying out smallish
companies, large or mega funds receive he lion's share of funds from PE
investors. Limited partner investors have committed billions of dollars
to massive funds sponsored by a relative handful of PE firms. In the 5
years ending in April of 2021, the top 300 PE firms worldwide raised a
total of $2.25 trillion. This is an increase of 13 percent from the
previous 5-year period. Blackstone retained its position as top fund
raiser--its funds raised $93.2 billion over the 5 years, with KKR not
far behind. \14\ Eight of the top 10 (out of 300) funds are U.S. firms.
\15\ The flow of capital to the largest PE firms in the aftermath of
the pandemic is even more extreme than when the Stop Wall Street
Looting Act was first introduced, making its passage all the more
urgent. Capital raised by individual funds in the first three-quarters
of 2021 make clear that mega funds dominate fund raising. PE firm
Hellman & Friedman raised $24.4 billion for its 10th fund while KKR is
closing in on $18.5 billion for its North America fund and the Carlyle
Group has announced plans to raise $27 billion for its next fund--the
largest private equity fund ever if, as expected, they reach their
goal. Silver Lake Partners whose latest fund closed this year at $20
billion, Clayton, Dubilier & Rice at $16 billion, and Bain Capital at
nearly $12 billion are also among the mega funds at the top of the
fund-raising pyramid. Twelve mega funds have closed through August,
with a quarter of the year still left. \16\ All of this money needs to
be deployed in just a few years.
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\14\ https://www.privateequityinternational.com/pei-300/
\15\ They are Blackstone, KKR, Carlyle, Thomas Bravo, Vista Equity
Partners, TPG, Warburg Pincus, and Neuberger Berman Private Markets
https://www.privateequityinternational.com/database/#/pei-300.
\16\ https://pitchbook.com/news/articles/mega-funds-private-
equity-investing
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Mega funds have incentives to acquire large companies even if the
returns are mediocre compared with smaller companies. A mega fund has a
huge amount of capital it needs to deploy in a relatively short period
of time. This is more easily done if the fund acquires a few very large
companies. (The exception, as noted earlier, is when a PE fund buys up
small competitors and adds them onto a large company it already owns,
flying below the radar of antitrust regulators as it creates a national
powerhouse.) PE funds plan to exit their acquisitions in 3 to 5 years.
This is too short a time horizon to ``turn around'' a struggling
company. In contrast to the myth that PE funds buy troubled companies,
it turns out that attractive acquisition targets tend to be successful
businesses. Medline Industries, a family owned medical supply company,
sold for $34 billion in June of 2021 in a club deal in which
Blackstone, Carlyle, Hellman & Friedman, and GIC participating.
Clearly, a company that sells for $34 billion to some of the biggest
names in private equity offers few opportunities for improvement.
Large, successful companies present few opportunities for creating
value by improving operations or business strategy. They nevertheless
present opportunities for PE funds to load them with debt, extract
wealth via financial engineering, and make PE partners rich.
Millionaire and billionaire partners in private equity firms make money
even when the funds they sponsor do not create value and even when they
destroy it. Good jobs have been lost and inequality has worsened.
Meanwhile, private equity firms contend that their freewheeling
behavior results in returns that beat the stock market by a wide margin
and help fund retirees' pensions. They caution against killing the
goose that lays the golden eggs. This is an argument that might once
have made sense, but no longer. Studies by finance professors find that
since 2006, the median private equity fund has just tracked the market.
\17\
---------------------------------------------------------------------------
\17\ Eileen Appelbaum and Rosemary Batt. 2018. ``Are Lower Private
Equity Returns the New Normal?'' in Michael Wright, et al. (editors),
``The Routledge Companion to Management Buyouts'', Routledge. Robert S.
Harris, Tim Jenkinson, and Steven N. Kaplan. 2015. ``How Do Private
Equity Investments Perform Compared to Public Equity?'' Journal of
Investment Management. Darden Business School Working Paper No.
2597259, June 15. Available at http://ssrn.com/abstract=2597259; Jean-
Francois L'Her, Rossitsa Stoyanova, Kathryn Shaw, William Scott, and
Charissa Lai. 2016. ``A Bottom-Up Approach to the Risk-Adjusted
Performance of the Buyout Fund Market''. Financial Analysis Journal,
73(4), July/August. https://www.cfainstitute.org/en/research/financial-
analysts-journal/2016/a-bottom-up-approach-to-the-risk-
adjustedperformance-of-the-buyout-fund-market; Ludovic Phalippou. 2020.
``An Inconvenient Truth: Private Equity Returns and the Billionaire
Factory''. Journal of Investing, Volume 29, December. Available at
https://papers.ssrn.com/sol3/papers.cfm?abstract-id=3623820.
---------------------------------------------------------------------------
Conclusion
In ways large and small, Main Street is being pillaged by Wall
Street's largest private investment firms. Factories and stores have
closed as wealth has been extracted, hollowing them out and leaving
them bereft of the resources they need to invest in the technologies
and worker skills required for success in the 21st century. 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.
Private equity is poised to buy up key segments of the U.S.
economy. The rising tide of capital flowing into PE funds has left them
sitting on piles of dry powder. They are now ins a better position than
ever to buy up and hollow out large parts of the U.S. and global
economies. Estimates of how much global dry powder PE firms are sitting
on varied from $1.5 to $2 trillion in August with 4 months to go in
2021. In September 2020, U.S. buyout funds had $746 billion in dry
powder. \18\ The figure below shows the amounts of dry powder that some
of the largest PE firms are getting ready to deploy.
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\18\ https://www.investmentcouncil.org/wp-content/uploads/trends-
2021q1.pdf Figure 4.
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In the U.S. PE firms have set their eyes on everything from health
care to single family homes, and are even trying to figure out how to
make money from the chaos in fossil fuels as attention turns to
combatting climate change. \19\ We need the Stop Wall Street Looting
Act now to 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. No one will object if they also make an honest profit.
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\19\ https://www.nytimes.com/2021/10/13/climate/private-equity-
funds-oil-gas-fossil-fuels.html?smid=tw-share
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM EILEEN APPELBAUM
Q.1. Several private equity firms have recently announced
acquisitions of life insurance companies. Please explain the
primary conflicts of interest for investors and sources of harm
to policyholders caused by these acquisitions.
A.1. Thank you, Senator Reed, for shining a light on private
equity industry activities that are flying under the radar.
Private equity firms have had their eye on individual
retirement savings since 2013, when they were first allowed to
market directly to people. Pension funds already allocate
workers' retirement savings to private equity firms that use
these assets to fund a range of risky equity and debt
investments. Access to personal retirement savings would open
up a huge new source of capital for PE.
PE firms first attempted, unsuccessfully, to get a piece of
the very large direct contribution assets (IRAs and 401(k)s)
that individuals use to save for their own old age. More
recently, they have succeeded in gaining control of life
insurance and annuity assets. They use these assets to invest
in high fee alternative investments, including in the PE firm's
own buyout, real estate investment, and debt funds. These
insurance assets provide PE firms with a form of ``permanent
capital.'' A private equity firm typically raises capital by
recruiting investors and launching an investment fund with a
life span of 10 years, after which all the capital in the fund
is paid out and the fund is liquidated. PE firms launch these
funds every few years. Individual retirement savings, unlike
these sources of capital, do not need to be paid out at the end
of 10 years and don't require the PE firm to recruit investors
every couple of years.
For the public that owns these insurance and annuity
policies, there is the danger that investments in risky assets
may not provide them with the peace of mind and the assurance
that the benefits will be there when they are needed.
Investments in private debt and equity pay higher rates of
interest than plain vanilla bonds and stocks of publicly traded
companies. But they are illiquid, meaning that they will be
difficult to sell in case cash is required to satisfy a spike
in payouts on these insurance policies. In addition, the
possibilities for corruption and self-dealing are very real as
PE firms can use these insurance assets to bolster the
performance of their own struggling funds. Even in the absence
of patently illegal actions, PE control of life insurance
assets raises basic conflict of interest questions: are PE
firms looking out for the interests of insurance beneficiaries
or are they more concerned with making a profit for themselves
and their investors? Moreover, the claim that investing life
insurance assets in risky alternative strategies increases
benefits for policy holders may fail, either because the
investment fails or because the high fees charged for managing
complex investments eat up the higher performance associated
with greater risk. For consumers who bought life insurance and
annuity policies from stodgy insurance companies making plain
vanilla investments, it may be disconcerting to learn that
their policy has been sold to a private equity firm that will
be making risky investments with their retirement savings.
There is a clear need for regulations to protect the
retirement savings of holders of life insurance and annuity
policies. The opaqueness of private equity and the lack of
transparency regarding its activities makes regulation
difficult. Federal regulation to cap the fees that policy
holders pay and to assure that PE firms that control insurance
assets hold adequate reserves for their risky investments is
important. Moving the headquarters of PE-owned insurance
companies to Bermuda raises red flags because of the low
reserve requirements in that country when insurance companies
invest retirement savings of annuity holders in risky assets.
In what follows, I examine the size of retirement savings
in the U.S; briefly review earlier, largely unsuccessful,
attempts by PE firms to gain access to the savings of
individuals; and discuss PE's foray into life insurance and
annuities in recent years. Private equity's control of life
insurance assets has greatly increased, with little to no
regulatory oversight or protections for beneficiaries.
U.S. Retirement Assets
U.S. retirement savings have exploded in the last 30 years,
reaching $35 trillion in 2020, nine times as much as in 1990.
Pensions (direct benefit plans) have declined as a share of
retirement savings, most dramatically in the private sector.
Direct contribution plans (IRAs and 41(k)s) have grown in
volume and importance. IRAs have seen the most dramatic growth,
but 401(k) plans account for a large share of retirement
assets. (see figures below) \1\
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\1\ SEI Investment Manager Services. 2021. ``Evolving Forces:
Convergence in the U.S. Retirement Market Place''. SEI. https://
seic.com/sites/default/files/SEI-IMS-Evolving-Forces-Retirement-2021-
Whitepaper-US.pdf
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
PE Tries (Unsuccessfully) To Tap Individual Retirement Savings of
Workers' Pensions
Workers' pensions have been at the center of the equity
contributions to private equity investment funds. Public
pension funds have provided about a quarter of the equity in PE
investment funds and private pension funds have provided about
10 percent. But pension funds' share of retirement savings has
been declining over the last decade and longer. Private Equity
firms have had their eye on workers' individual retirement nest
eggs--401(k) and IRA accounts--since late 2013 when rules on
advertising to individuals were relaxed. But PE firms have had
only limited success tapping into IRA and 401(k) accounts. They
were stymied by the Obama Labor Department, which held the line
against letting risky private equity and hedge fund products
into workers' individual retirement accounts. \2\ Private
equity had some success during the Trump administration as the
Labor Department approved some private equity and hedge fund
products for these accounts. \3\ But brokers who manage
workers' defined contribution accounts were slow to include
them, because they lacked the experience and the confidence to
recommend them and because of the high fees attached to these
products. They were concerned that poor performance of these
assets could expose them to litigation and liability claims.
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\2\ Eileen Appelbaum. 2015. ``As Public Pensions Shift From Hedge
Funds, Hedge Funds Look to Main Street''. The Hill, November 30.
https://thehill.com/blogs/pundits-blog/finance/261455-as-public-
pensions-shift-from-hedge-funds-hedge-funds-look-to-main
\3\ Eileen Appelbaum. 2020. ``CEPR Statement on New Labor
Department Guidance Allowing Risky Private Equity Investments in
Workers' 401(k) Accounts''. Center for Economic and Policy Research,
June 4. https://cepr.net/cepr-statement-on-new-labor-department-
guidance-allowing-risky-private-equity-investments-in-workers-401k-
accounts/
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Private equity firms have long included very wealthy
individuals among the investors in their funds. But since 2015
have tried to develop new products for the merely very rich.
\4\ These efforts continue to the present time, but with only
limited success. Most of these ``retail'' investors are
effectively excluded from private equity and hedge fund
investments. The Trump administration's SEC chair, Jay Clayton,
pushed to open these funds to more investors. And in September
2021, an SEC panel formed in 2019--the Asset Management
Advisory Committee--recommended letting ordinary investors into
these funds. \5\ But current SEC chair Gary Gensler's remarks
indicating that the agency will take a tougher stance for
greater transparency on fees and expenses and against conflicts
of interest may undermine PE's efforts to attract money from
retail investors. \6\
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\4\ Eileen Appelbaum. 2015. ``Private Equity Is Going Retail''.
Huffington Post, March 11, https://www.huffpost.com/entry/private-
equity-is-going-r-b-6842394.
\5\ Chris Cumming. 2021. ``SEC Panel Backs Letting Ordinary
Investors Into Private Equity'', WSJ, September 28. https://
www.wsj.com/articles/sec-panel-backs-letting-ordinary-investors-into-
private-equity-11632778962
\6\ Paul J. Davies. 2021. ``Gary Gensler's Everything Crackdown
Reaches Privat Equity''. Bloomberg, November 17. https://
www.washingtonpost.com/business/gary-genslerseverything-crackdown-
reachesprivate-equity/2021/11/16/591d740a-46d1-11ec-beca-3cc7103bd814-
story.html
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PE Is Eating up Life Insurance and Annuities Companies
Recruiting limited partner investors for the PE funds that
private equity firms raise every few years has become
increasingly burdensome. Tapping into retirement savings
creates a source of ``permanent capital'' as savings flow into
retirement assets, creating a pool of assets that can fund PE
investment activities. Despite the lack of success penetrating
workers' IRAs and 401(k)s, retirement savings remain an
enticing source of capital for PE investment funds. And PE
firms have found another way to get their hands on people's
retirement savings. Private equity firms are taking a leaf out
of Warren Buffet's playbook. For decades Buffett has funded
investments in publicly traded companies from his $360 billion
insurance arm. \7\ Accumulated life insurance and retirement
assets and ongoing premium payments for annuities and death
benefits are an attractive, permanent source of investment
capital. In the last few years, private equity firms have
looked to the management or acquisition of life insurance
assets as a source of permanent capital that can fund a wide
range of activities and reduce the need to raise new investment
funds every couple of years. Private equity firms have found a
way to get rich from the retirement savings and bequests of
individuals. In just a few years, insurance assets have become
a major component of assets under management of PE firms.
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\7\ Paul J. Davies. 2021. ``Apollo Wants To Be a Bit Like Buffett,
But It's Complicated''. Bloomberg, October 29. https://
www.bloomberg.com/opinion/articles/2021-10-29/apollo-wants-to-be-a-bit-
like-warren-buffett-but-it-s-complicated
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Some PE firms are buying up entire life insurance companies
and annuity businesses. Others are taking a minority stake in
them and then managing all of their assets. Only the largest PE
firms have the financial wherewithal to afford deals to manage
or own the life insurance and annuity businesses of major, old
line insurance companies. But even smaller PE firms have gotten
into the game, buying up smaller life insurance businesses and
selling indexed annuities, a line of business they view as an
extension of their investment experience. At the end of 2020,
aggregate holdings of cash and invested assets of U.S. life
insurance companies was $4.9 trillion. Private equity firms
controlled 9.6 percent of these assets--a total of $471
billion. Of the slightly more than 400 U.S. life insurance
companies, 50 are owned or controlled by more than 24 private
equity firms. These include well-known PE firms such as
Blackstone, Apollo, and KKR. But also, many that most people
have never heard of. \8\
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\8\ Allison Best. 2021. ``Private Equity Firms Keep Eating U.S.
Life Insurers''. ThinkAdvisor, July 20. https://www.thinkadvisor.com/
2021/07/20/private-equity-firms-keep-eating-u-s-life-insurers/
?slreturn=20211028142207; Leslie Scism. 2021. ``Who Owns Your Life
Insurance Policy? It Might Be a Private Equity Firm''. WSJ, September
21. https://www.wsj.com/articles/insurance-policy-private-equity-
11632236526.
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Apollo is probably the most advanced. It has had a stake in
life insurance company Athene since 2015; in 2021, it acquired
the entire company and now owns Athene's insurance assets worth
about $194 billion. Apollo says it plans to invest about 5
percent of Athene's funds in riskier, fee-paying alternative
assets, including its own private equity and debt funds. \9\
This kind of self-dealing is rife with conflicts of interest.
Will Apollo's insurance units look out for its beneficiaries or
for its investors and shareholders?
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\9\ Paul J. Davies. 2021. ``Apollo Wants To Be a Bit Like Buffett,
But It's Complicated''. Bloomberg, October 29. https://
www.bloomberg.com/opinion/articles/2021-10-29/apollo-wants-to-be-a-bit-
like-warren-buffett-but-it-s-complicated
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Unlike Apollo, Blackstone prefers to take minority stakes
in life insurance companies and take over management and
control of most or all of their assets. It invests them in
alternative strategies in search of higher yield. In 2021,
Blackstone paid $2.2 billion to American International Group
(AIG) for a 9.9 percent stake in its life insurance and
annuities unit. Initially, Blackstone will manage $50 billion
of AIG's life insurance assets. In the coming years, this will
rise to nearly $100 billion. Blackstone also struck a deal in
2021 to buy a life insurance unit of Allstate Corporation. With
these transactions, Blackstone's insurance assets under
management will reach $150 million by the end of 2021. The
insurance assets it controls account for a third of
Blackstone's overall assets. \10\
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\10\ Miriam Gottfried and Leslie Scism. 2021. ``Blackstone Enters
Deal To Manage AIG Life and Retirement Assets''. WSJ, July 14. https://
www.wsj.com/articles/blackstone-near-deal-to-manage-aig-life-and-
retirement-assets-11626294156?mod=markets-lead-pos2; Antoine Gara.
2021. ``Blackstone Braces for Higher Inflation as Earnings Hit
Record''. Financial Times, October 21. https://www.ft.com/content/
10de97da-30e9-4c92-a3a7-5da251706c3e
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In July 2020, KKR announced it was buying life insurance
and retirement income company Global Atlantic Financial Group
for $4.4 billion and taking over management of about $70
billion of Global Atlantic's assets. The deal raised KKR's
assets managed on behalf of insurance companies from about $26
billion to more than $96 billion. It increased KKR's total
assets under management by 30 percent, from $207 billion to
more than $277 billion. And it increased the share of permanent
capital--capital that does not need to be replenished by fund
raising--from 9 percent to 33 percent. \11\
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\11\ Miriam Gottfried and Dave Sebastien. 2020. ``KKR To Buy
Global Atlantic Financial Group for $4.4 Billion''. WSJ, July 8.
https://www.wsj.com/articles/kkr-to-buy-global-atlantic-financial-
group-for-around-4-billion-11594207178?mod=article-inline
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Dangers Facing Policy Holders and the Challenges of Regulating PE
Control of Insurance Assets
Regulating private equity investments is difficult because
there is little public information on how these firms invest
insurance assets, making it difficult to gauge risk. But
clearly, they are moving some of the assets out of plain
vanilla corporate bonds and into private debt and asset-backed
securities where they can earn high fees for managing the
assets. Returns on private debt are usually higher than for the
plain vanilla bonds. However, investments in private debt are
riskier--they are less transparent and more difficult to trade,
making them difficult to sell to meet death benefit and annuity
obligations in case of an economic slowdown and cash crunch.
This may endanger policy holders. The Fed has expressed concern
that investments in difficult-to-sell debt and equity holdings
may mean that insurers will lack cash in an economic crisis to
pay a surge of claims. Not only do the assets lack liquidity,
they may also go down in value in these circumstances. \12\
Insurance regulators should require PE firms to hold higher
reserves against these riskier investments. But assessing
whether they are doing so will be hampered by the secrecy that
shrouds PE firm activities.
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\12\ Alwin Scott. 2021. ``Chasing Yield, U.S. Private Equity Firms
Nudge Up Risk on Insurers''. Reuters, June 1. https://www.reuters.com/
business/finance/chasing-yield-us-private-equity-firms-nudge-up-risk-
insurers-2021-06-01/
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Opportunities for corrupt self-dealing are widely available
as PE firms can use the insurance assets to shore up the
finances of failing or struggling funds they own. Such
activities are difficult to detect, since there is no
requirement for public disclosure of transactions. Banning the
practice of PE firms investing insurance assets they control in
their own debt and buyout funds would prohibit this activity.
At a minimum, rules to prevent corrupt self-dealing by PE firms
need to be put in place. Recent statements by SEC Chair Gensler
indicating that the SEC will act to increase transparency of
PE's financial dealings are welcome in this context as well.
Caps on fees paid for investment in alternatives such as
buyout or debt funds should be put in place so that fees paid
to PE firms do not eat up higher earnings on these risky
assets.
National standards for reserves against more risky
investments for any company managing life insurance and
retirement benefits in the U.S. regardless of where the company
is headquartered are needed to thwart moves to jurisdictions
with lax reserve requirements.
In general, steps need to be taken to prevent the
possibility that billionaire PE firm partners will further
enrich themselves at the expense of holders of life insurance
and annuity policies.
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR VAN HOLLEN FROM EILEEN APPELBAUM
Q.1. The Atlantic recently published an article on October 14th
that examines Alden Global Capital and its handling of the news
outlets it owns. The author, McKay Coppins, summarizes Alden's
corporate model as: ``Gut the staff, sell the real estate, jack
up subscription prices, and wring as much cash as possible out
of the enterprise until eventually enough readers cancel their
subscriptions that the paper folds, or is reduced to a
desiccated husk of its former self.''
Are you familiar with Alden's corporate model and, if so,
do you agree with McKay Coppins's characterization of it?
What kind of conditions can be set to prevent private
equity from engaging in such predatory ownership?
Dr. Appelbaum, your testimony points to the size and
influence of private equity in the United States. Many of the
funds are registered offshore in the Cayman Islands, Bermuda,
and other countries.
What are the practical effects of foreign ownership in
terms of accountability for these funds, and do you anticipate
national security implications?
A.1. Thank you, Senator Van Hollen, for this very timely
question about Alden Global Capital's ownership of newspapers.
On Monday, September 22, Alden-owned Digital First/Tribune--the
second largest owner of newspapers in the U.S.--announced its
intention to acquire Lee/BH Media, the third largest. Gannett,
formerly backed by private equity firm Fortress Investment
Group which is thought to continue to have a stake in the
company since it became publicly traded, is the largest owner
of newspapers since its 2019 merger with Gatehouse. Gannett/
Gatehouse owns 613 newspapers, Digital Media/Tribune owns 207,
LEE/BH Media owns 170 for a total of just under 1,000
newspapers. The next seven largest newspaper companies together
own a total of 500 newspapers. When the deal goes through,
Gannett/Gatehouse and Alden will create a duopoly with an
ownership between them of two-thirds of U.S. newspapers. \1\
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\1\ Penelope Muse Abernathy. 2021. ``News Deserts and Ghost
Newspapers: Will Local News Survive''. University of North Carolina--
Chapel Hill, Center for Innovation and Sustainability in Local Media.
Cislm.org.
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This is very concerning from the point of view of workers
at the newspapers Alden Global Capital owns and from the
perspective of residents in the communities the papers serve.
McKay Coppins description of Alden's business model is correct.
Alden views the newspaper industry as already in decline with
many newspapers in distress. The investment firm sees an
opportunity in buying up newspapers and consolidating the
industry that will allow it to extract the still sizable ad
revenue while cutting positions and costs to maximize profits
in the short run before discarding what is left of the papers
over a longer time horizon.
At a general level, Congress may need to grapple with the
question of whether there are industries where it does not make
sense for investment funds to own companies. The key role that
newspapers play in a democracy suggests that ownership by
investment funds, with their short time horizons and single-
minded drive for profits, make them unsuitable owners.
Ownership of health care providers is another questionable
situation: the drive for profits by investment funds may
conflict with the health care mission of providers.
In the short-run, passage of legislation proposed by
Senator Ron Wyden to provided an economic lifeline to the
newspapers not already owned by Digital First/Tribune and LEE/
BH Media can be very useful in enabling some community
newspapers to resist the siren call of investment firms. But
this is not a permanent solution.
Perhaps the most promising answer is to rethink the current
application of antitrust regulations. Under the current
application of antitrust regulations, there is nothing to stop
Alden from acquiring LEE/BH Media. The newspapers acquired in
this way are likely to be approved by regulators because they
don't compete with other Alden-owned papers in local markets.
Current interpretation of antitrust has allowed private equity
and hedge fund investors to build national powerhouses in a
variety of fragmented industries because of the focus of
regulators on competition and prices in local markets. This
interpretation was established by antitrust regulators during
the Reagan administration, when they chose to abandon the
measure of market share as a red flag in mergers and
acquisitions. A new reinterpretation by the Biden
administration's Department of Justice might be able to restore
market share as a factor to be considered before approving a
merger such as the one Alden proposes between Digital First/
Tribune and LEE/BH Media. The merger will give the combined
company ownership of one-quarter of all newspapers and likely
would not pass muster if market share is a factor to be
considered.
Your second question about the implications of PE
investment funds locating their headquarters in the Cayman
Islands and similar offshore locations is also an important
one. You have put your finger on the main issue--lack of
transparency and accountability. They are tax havens that allow
PE firms and their investors to avoid some U.S. taxes.
Financial regulation also tends to be more lax. In the latest
twist, PE firms are buying up life insurance companies that
provide annuities. Insurance regulations in some offshore
locations have more lenient reserve requirements, making them a
preferred location for the headquarters of these investment
funds. But the implications beyond these observations, and
national security implications in particular, are not my area
of expertise.
Additional Material Supplied for the Record
STATEMENTS SUBMITTED IN SUPPORT OF THE STOP WALL STREET LOOTING ACT
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
LETTERS SUBMITTED IN OPPOSITION TO THE STOP WALL STREET LOOTING ACT
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
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