(2023-05-02) Private Equity Is Out Of Control And Looting America This Prosecutor Says We Can Fix It

Lynn Parramore: Private Equity is Out of Control and Looting America. This Prosecutor Says We Can Fix It.Price hikes, deteriorating conditions, and poor service — along with a certain slickness of marketing — could be signs that ownership of a business you count on has transferred to one or more firms in a rapidly-expanding Wall Street industry.

Federal prosecutor Brendan Ballou provides the scrutiny that an industry with this much economic and political power should invite in his provocative new book, “Plunder: Private Equity’s Plan To Pillage America.” (see 2023-04-28-BallouPrivateEquityIsGuttingAmericaAndGettingAwayWithIt)

Financier William Simon got the idea for private equity back in the seventies.

expanded following the 2008 credit crisis into many of the less regulated corners of finance – some previously occupied by the great investment banks

they’re doing it with the help of lavishly-funded political allies.

Advocates say private equity makes companies more efficient when they buy them, but Ballou finds that their real specialty isn’t managing companies – they often screw that up, big-time – but finding legal and regulatory holes that allow them to make profits quickly and shift the risks and costs to somebody else – somebody like you.

Ballou points out that many private equity firms now target healthy companies, leaving them gutted, unproductive, or even bankrupt

Not only do they influence the political system — increasingly, they are the political system. Just ask men like Timothy Geithner, Newt Gingrich, Paul Ryan, and David Petraeus, all now working in private equity.

In the following interview, the prosecutor shares with the Institute for New Economic Thinking his insights and prescriptions for getting this industry under control.

private equity firms tend not to be held legally responsible for the actions of their portfolio companies.

LP: This industry, known as “leveraged buyouts” in the eighties

A company can get a large loan without necessarily making the sort of disclosures that you would have on the public capital market.

private equity firms are vastly less regulated than investment banks, which are generally considered either banks or bank holding companies. What this means is that private equity firms are doing a lot of the work that these companies did prior to the financial crisis. but they’re doing it with even less oversight.

private equity firms are able to use strategic bankruptcies to slough off obligations they don’t want to pay — pension obligations in particular.

In 2007, Sun Capital bought up Friendly’s, the ice cream and diner chain

Sun Capital was both the owner and the largest lender,

they could slough off the pension obligations, which were eventually taken over by the quasi-government agency, the Pension Benefit Guarantee Corporation [PBGC].

The PBGC, which now has to pay down those pensions, is funded in large part by other pension plans. So it’s other, more responsible companies, that end up having to pay the cost of the private equity firm’s strategic move.

Often private equity firms make their money from the companies they buy through “management fees” that the company has to pay every quarter or every year for the privilege of being owned by them. They also charge transaction fees, so if the private equity firm directs the company to sell its own assets, a portion of the sale actually goes directly to the private equity firm – not even the firm’s investors

One of the things that was surprising to me about private equity firms is that they often target industries that are highly regulated or those where a big chunk of the money comes from the government.

part of the appeal of industries like nursing homes is that government funds are an extremely stable source of income. They can rely on the money coming in from Medicare and Medicaid every month

Carlyle Group’s acquisition of HCR ManorCare, which was the second-largest nursing home chain in America. In 2007, Carlyle bought the company, loaded it up with debt and forced it to sell its assets, making its investment back through various transactions and management fees. While all this was happening, ManorCare was forced to cut back on costs. Health code violations spiked. Eventually, the company went bankrupt, but when people tried to hold Carlyle accountable, they failed.

specific resident of a ManorCare facility... fell and hit her head. She ultimately died of a subdural hematoma – bleeding of the brain. When her family sued Carlyle for wrongful death, the firm managed to get the case dismissed by arguing that technically they were not the owner of ManorCare, but merely advised a series of funds

There has been a crucial study suggesting that private equity ownership is responsible for an estimated 20,000 premature deaths over a decade and a half. It’s just extraordinary.

Toys-“R”-Us was bought by private equity firms (Vornado, KKR, and Bain Capital] that loaded it up with debt and eventually forced it into bankruptcy. The situation for employees was heartbreaking, made more so by the fact that the executives the private equity firms installed in Toys-“R”-Us allegedly managed to give themselves multi-million dollar bonuses just days before pushing the company into bankruptcy

private equity firms often move to sue the customers of the companies they buy. And perversely, while they can sue the customers — often working class and poor people – those customers can’t sue them because of forced arbitration agreements.

the private equity business model has evolved, essentially because of legal incentives, to focus on the short term, to load companies up with debt, to extract fees, and to evade financial and legal liability for their actions

Whether it’s getting favorable contracts for prison health care and phone services, or getting tracts of foreclosed homes from Fannie Mae and Freddie Mac, or protecting the carried interest loophole in Congress, private equity has been enormously successful in achieving its legislative and legal agenda.

I think that the worst effects of the private equity business model can be constrained

You can align responsibilities so that private equity firms are responsible for their actions. That would fundamentally change incentives and make their business moves a lot less destructive in a whole range of industries. We can act through a bunch of different levers to get this done. States and local entities can make sure that the portfolio businesses that have their primary business in their jurisdiction are held responsible.