Private Equity Under the Hot Lights Today at House Financial Services Committee Hearing, “America for Sale?”

Private equity is finally getting some long overdue official scrutiny via a series of Congressional moves. One is the full House Financial Services Committee meeting today, at 10:00 AM, America for Sale? An Examination of the Practices of Private Funds. You will find the live webcast at that link, as well as links on that page to the written testimony of each of the witnesses. This is a meaty topic, plus AOC should be on deck, so I hope you can catch at least some of the hearings and comment here if you are so moved.

In addition to this hearing, other measures underway are the bipartisan bills in the House and Senate to prevent surprise billing (which as we’ve discussed, is in large measure the result of private equity buying, consolidating, and exploiting various physicians’ practices that provide outsourced services to hospitals). The hard-ball lobbying against the bill generated a backlash, with the Energy and Commerce committee as well as Senator Elizabeth Warren and Representatives Mark Pocan and Lloyd Doggett all seeking pricing information from the major private equity firms engaged in these practices.

The big question may be, “Why now?” We’ve been writing about private equity’s dodgy practices for years, and we are not alone. The testimony provides an answer. The short version is that it is finally becoming obvious to too many people that for the most part, private equity’s profits come at the expense of everyone else. (For convenience, we are referring to private equity, but bear in mind that some hedge funds also will buy companies)

Private equity firms also seem rattled by Elizabeth Warren’s “Stop Wall Street Looting Act,” which would make private equity general partners and their control persons jointly and severally liable for all liabilities of the companies they acquire, as well as of the investment fund. Georgetown law professor Adam Levitin explains why, contrary to what the industry would have you believe, this is not an outlandish idea (in fact, the “heads I win, tails you lose” arrangement that private equity firms have created is what ought to be regarded as outlandish).

In a post last week, Levitin shreds the “Chicken Little” claims of the damage that the Warren bill would supposedly do, seeing them as a measure of industry worry. Another indicator of the industry’s diminished stature: the number of critical articles, even within the normally deferential financial press. For instance, Mark Hulbert’s MarketWatch op-ed last week used the proposed KKR leveraged buyout of Walgreens as a point of departure for a broad-ranging critique of private equity’s underwhelming returns. The damning subhead: “No evidence that public companies perform better after being taken private”

The lead witness, Eileen Appelbaum, has with her research/writing partner Rosemary Batt, been dogging this industry for a very long time. Their publication of the seminal book Private Equity at Work meticulously documented numerous private equity practices that were not widely known, plus gave careful readings of academic research. Appelbaum and Batt painstakings demonstrated that findings that were presented in the papers themselves as favorable to the industry regularly didn’t hold up when you read the study methodology and results. It was revealing to see the efforts soi-disant scholars twist their own results to flatter private equity. But this should come as no surprise since the overwhelming majority of academics who study private equity earn far more from consulting to private equity firms than they do from their day jobs.1

Appelbaum’s written testimony gives a high level but well documented overview of how private equity operates and how many of its practices are destructive. She points out that while smaller deals normally do lead to fundamenal growth of the acquired business,2 the big transactions, which is where most of the private equity dollars go, rely on leverage and financial engineering. And to add insult to injury, the mega funds which make the big deals earn the considerable majority of their income from risk-free fees, as opposed to profit participations.

Appelbaum focuses on two hot topics. One is retail bankruptcies, exemplified by Toy ‘R” Us. Toy ‘R’ Us clearly failed as a result of excessive leverage, which included selling its real estate and then forcing the stores to lease the properties back. This “op co/prop co” strategy has wrecked many a retailer, since owning their real estate outright would lower their cost base and enable them to ride out downturns. Not only would the private equity firms strip them of this protection, but they would often saddle the retailer with high-cost leases so as to make the sale price of the real estate even higher and allowing them to pull even more cash out of the deal early.

The second focus is private equity’s role in surprise billing. Here Appelbaum deserves to take a star turn since she documented in gory detail how two major firms, KKR and Blackstone, have played major roles in driving up hospital costs (they aren’t alone, mind you; they are just the biggest perps), doing the heavy lifting that the mainstream media re-reported.

Interestingly, the committee is also hearing from a private equity industry limited partner, Wayne Moore, a trustee of the Los Angeles County Employees Retirement Association. And mirable dictu, not only is he not a cheerleader, but he confirms the concerns we’ve been raising for years over excessive fees, lack of transparency and badly aligned incentives. Giovanna De La Rosa, a United for Respect Leader and 20 year veteran of Toys ‘R’ Us, speaks about how much the closures have cost her and other employees.

Despite the lofty consulting fees that the private equity industry lavishes on academics, curiously none of them is coming to defend their meal tickets. The two witnesses making the case for private equity are both from astroturf groups, one the American Investment Council and the other, the Small Business Investor Alliance. Their written submissions are awfully lightweight.

So hope you have time to catch at least some of the proceedings. Again, the link to the webcast is here.


1 One of my colleagues, newly installed in a (believe it or not, non-tenured) chair named for a private equity kingpin was invited to his office and offered a consulting gig. It was pretty close to money for nothing: “Why don’t you come and observe what we do and tell us if you have any ideas for what we could do?” My colleague, who has managed to rise in academia despite his fierce independence, found a way to politely turn down this, erm, opportunity.

2 While Appelbaum’s and Batt’s research does show that smaller deals, of transaction sizes of $50 million or smaller, typically do result in growth of the operation, and Appelbaum may have decided not to argue over these deals because the big ones that consume the bulk of investment dollars are so clearly destructive, that does not necessarily mean the private equity firms are adding enough value to offset their fees. Some members of the industry concede that private equity companies may simply be good at finding “growth-y” companies. That is confirmed by investment strategies that engage in public market replication of private equity, as in buying public companies that have characteristics that would make them attractive to private equity firms. Those strategies deliver returns similar to private equity net returns.

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  1. Olga

    This was intended for the “links” section – but perhaps relevant here, too – since El Paso Electric (vert. integrated utility) is in the process of being bought by a “retirement’ fund (which some think may be JPM’s hedge fund, as they are trying to conceal their investors), and the old TXU was once (2008) bought by KKR (only to declare bankruptcy in 2014). But the lesson seems to be: WS rules over all…

    I had a thought for a general education lesson to start the morning (with or without coffee) to show at least one example of how regulation works in the USA, USA (part., the CA contingent may find this of interest):
    For fun, I’ve been tangentially watching CenterPoint’s rate case at the Texas PUC (publ utl commission); CNP is the second largest T&D utility in TX, in and around Houston, plus it owns nat-gas assets elsewhere in the country. (Rate cases used to be a regular feature of a utility’s life; today, in the deregulated TX el market, they come in on an as-needed basis).
    One thing to understand is that a rate can be massive (even more so for vertically integrated utilities that own generation, which in TX they do not), and can overwhelm staff; CNP’s filing clocked in at over 7,100 pp. In comparison, the proposal for decision (PFD), issued by an administrative-law judge at the end of the litigated case (and which the PUC must then review and approve/disapprove), came in at almost 500 pp.
    So, the PUC was recently reviewing the case, and making decision cuts, but CNP reps were not happy (even the CEO attends, typically). Unresolved issues included ROE (ret. on equity, proposed at 9.42%), capital structure, and ring-fencing (i.e., certain protective measures in case there’s a bankruptcy or other adverse event).
    Towards the end, CNP’s counsel stated that the three above issues are all inter-linked, and must be considered as such, lest the utility suffer irreparable harm (my sarc words) – or, the utility would be weakened and have hard time raising capital (in counsel’s words, although one Comm. helpfully pointed out that there is a lot of money sloshing about the world, which is just looking for an investment spot). The counsel interpreted PUC’s stance as too tough on the poo’ol li’l utility…
    The parties gasped because the issue of “inter-linking” had not been raised during the case (a kinda no-no). (In a rate case (litigated), it’s not just the commission and commission staff (who act separately), but also various intervenors (e.g., consumer reps, industrial consumers, cities, unions, etc.), who all squabble over the rates and spoils; TX has a particularly strong industrial consumer representation, which fights for advantageous deals and is more than happy to let the residential consumers pay a larger share)).
    Commissioners were tired and delayed final decisions until Dec.

    Well, lo and behold – the very next day, in unison, several WS firms started to downgrade CNP (one example –; coincidence, no doubt.
    It will be interesting to see what happens in Dec. – will the Comm. buckle under and go easy on CNP (e.g., by increasing its allowable ROE), or will it stick to its guns. Hard to know. (Funny fact, the Chair of PUC used to work at CNP, but some do not see her as a fan of the co.)
    If one were conspiratorially inclined, one could wonder how is it that so many WS firms initiated downgrades… panic, pressure…. who knows? Btw, the term is – helpfully – “negative regulatory impact.”
    (Oh – and the reason CNP came in for a rate case to begin with – is because they over-earned their previously approved ROE for several years. Happens all the time, btw.)

  2. chuck roast

    A short time ago I made a request to inspect the public records of my public pension fund. Pension fund staff responded accordingly to my specific requests regarding the increased roll of PE/Hedge Funds in my pension funds investment decisions. Staff did not overwhelm me with info on the fund activities of PE/HF, but they gave me enough data that I could make a three-cent evaluation of their role. As you would imagine, no contract was forthcoming because of the laughable “trade-secret” clause.

    By my estimation, my $15B pension fund will have paid PE/HF $500M in management fees and carried interest by the end of FY 2020. Although PE/HF beat their “benchmark” investment goal, they under-performed the passive-strategy Russell 3000. And I’m not even going to get into the method of “evaluation of illiquid assets”. If the Russell 3000 was employed over the six-year measurement period by pension fund staff, my guess is that the pension fund would have gained an additional $500M. Add it up…screwed by PE/HF to the tune of $1,000,000,000 (I love the zeros) over six years. And as a bonus, PE/HF involvement in my pension funds goes back a lot longer than six years.

    Well, I’m sure the dog-catchers and secretaries on the Board are enjoying foie-gras investment-seminar retreats.

  3. DJG

    Thanks for this: The gory details are indeed gory, as is the MarketWatch article. I live in the neighborhood of Chicago where Walgreens was founded, and I have some Walgreens stock in one of my IRAs (you quit a job, you roll over…). The current situation at Walgreens may not be ideal–I get a strong impression of some looting going on, especially by Stefano Pessina and friends (and there are several who are legally required to be listed in the proxy). Use of private jets and other such siphoning-off mechanisms. And that embarrassing problem with the “scrips” delivery and opioids.

    And yet: Yet a takeover by private equity would be looting and pillaging: Toys R Us will be the model. At this point, Walgreens is no longer just a pharmacy but something more like Target.

    1. susan the Other

      Not a “Target” store, but a vertical monopoly in the pharma and medical industry. Walgreens didn’t fit the profile because it had better frivolous retail possibilities.

  4. bassmule

    Right now I’m watching Gregory Meeks talk about how private equity needs to fund minority businesses. What?

  5. Iapetus

    Probably the dodgiest of Private Equity practices is the nature of their relationship to their portfolio companies, and why this relationship promotes looting. A Private Equity firm is simultaneously an investor-owner of a private company, and a seller of vendor services to it, and a supervisor of its management. This allows them to stand on both sides of many potentially valuable transactions by this private company.

    So technically a Private Equity firm can influence or authorize the payment of an extraordinarily high dividend in their capacity as management, which is then paid to themselves in their capacity as investor-owners. Or as management they can influence or authorize the sale of valuable company assets to themselves (asset stripping) at very attractive or below market prices. Or as management they can influence or authorize the payment of extraordinarily high fees to themselves, as compensation for services of considerably less or nonexistent economic value. Or as vendors they can submit an inflated invoice to the private company, and then influence or authorize its payment to themselves in their capacity as company management. Or as management they can influence or authorize the sale-leaseback of company real estate to themselves which gives them both a below market price asset, and a creditor position in the event of this companies bankruptcy. Or as management they can influence or authorize heavy company borrowing in order to pay for all the above, but only this private company is responsible for the repayment of these debts.

    In this way a Private Equity firm can siphon away the valuable assets of a private company, leaving its employees and creditors to contend with the liabilities that remain. Since Private Equity firms will only invest in private companies, which are not required to report their financial actives to the Securities and Exchange Commission (SEC), this means details of these conflicted activities require less disclosure and can be hidden from the public eye.

  6. John

    Someone please tell me any positive aspects of Private Equity. Are there any or are the negative stories I read all there is?

    1. Samuel Conner

      It may be that the sellers of an enterprise into PE hands are pleased with the price they get, which presumably is generally higher than what an investor who intended to operate the enterprise (rather than loot it) would be willing to offer. So a relatively small number of the original owners may benefit in a short-term sense (more money now rather than retained earnings over time). Everyone else (aside from the PE people) associated with the enterprise will not do so well.

  7. Susan the Other

    Eileen was much more detailed than the others. And accurate. The guy on the end who touted PE for providing health care in rural, isolated America was nonsense. That is, if the things I have been reading are true – rural America is closing down and PE is letting it happen. If they can’t make their profit they shut it down, it doesn’t matter how much the hospital is needed. And as profits dwindle everywhere this business model is no model at all. It’s just a question of time. And when M4A goes through, which it will, the medical industrial complex will no longer be a private for-profit monopoly. It will be supported by the government; doctors will be well paid but not profiteers; pharma will finally be contained and everybody getting kickbacks from insurance and pharma companies will be SOL. And all of the hot shot administrators and “managers” will be downgraded to computer jockeys. And not a moment too soon.

  8. Frank Little

    One of the most tiresome tropes in US politics was on full display in this hearing: the myopic focus on job numbers/”job creation.” Those trying to defend private equity would point to the number of jobs in their respective districts either in private equity or at companies owned by private equity. While basically every representative will talk about how many jobs X or Y will create/destroy, there’s almost no interrogation of what the jobs in question are like for the people who actually have to do them or how those industries contribute (or don’t) to positive economic development.

    Mass incarceration supports lots of jobs, but just because lots of people currently work in prisons doesn’t mean we shouldn’t drastically reduce the size of our prison population or address the systemic corruption at both the state and federal level. Bloated defense spending is much the same way. Setting aside the dubious notion of “job creation” itself, it’s a shame that hearings on important issues are reduced to this kind of job tallying.

  9. Ken Murphy

    This reminds me of one of the more noxious deals I looked at back when I worked in the financial industry. It serves as a microcosm of how private equity operates. I apologize for a lack of specifics, as there are of course NDAs associated with my work, but I can talk in general descriptives.

    So picture a resort with beach access, an aging hotel, a golf course and some other minor assets. Owner is ready to cash out. Private equity looks at the property and comes up with this big scheme where they will upgrade the hotel, build condos, more golf courses, and infrastructure improvements. According to an ‘appraisal’, the final value of that property will be One Billion Dollars! Private equity then arranges with a bank for a $400Mn loan to do the deal, and at a 40% LTV, who wouldn’t do that deal?

    Private equity buys the property from the former owner for $150Mn dollars and takes title to the property. Once they have title, Private Equity promptly dividends $200Mn to themselves, as owners, because, you know, they’ve earned it. This leaves $50Mn in the property to take care of the $850Mn in improvements proposed. I think you can see where this is going. We were looking at the deal at a steep discount, and I puked all over it. The price where it would have worked (for our investment benchmarks) was ridiculously low and the seller wasn’t willing to eat the loss.

    So where did the debt end up? In your mutual funds. In your pension funds. In your retirement accounts. This was but one deal. I looked at lots of stinky deals. Our country is being actively looted and pillaged, and after I was laid off from the bank (layoffs were about every six months or so. I had survived fifteen rounds, but got caught in the sixteenth) I decided that I was no longer willing to enable this kind of thing and have found work in a much different industry. I will also no longer do 401Ks or other financial market investments because I know what kind of crap is in them.

    We’re so hosed.

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