What does Elizabeth Warren’s proposed legislation mean for the future of private equity?
BY Yaelle Gang | July 30, 2019
Senator Elizabeth Warren, who is running to become the next presidential candidate for the Democratic Party, has introduced new legislation attacking the private equity industry and calling for major reforms.
The Stop Wall Street Looting Act of 2019 proposes stringent rules around private equity transactions, including making private equity companies share responsibility for the debt incurred by the target firm, including legal judgements and pension obligations.
The proposals also include closing the carried interest loophole, banning the payment of dividends to investors for two years after a firm is acquired, providing workers with further priority in cases of bankruptcy, ending legal immunity for private equity firms if a portfolio company breaks the law and increasing transparency for private equity fund managers around fee disclosure.
U.S. tax expert Robert Willens says the proposed legislation is problematic. “I think it would become untenable to function in the private equity industry with those sorts of potential liabilities on the horizon. And I don’t see where an investor would feel comfortable committing funds to a private equity firm that had those sorts of contingent liabilities associated with its investment strategy.”
On the other hand, Eileen Appelbaum, co-director of the Center for Economic and Policy Research, says the proposed changes are long overdue. “I think that private equity, it’s been like the Wild West.”
Pension funds that are limited partners in private equity have little access to the information they need, she notes. “For example, they do not get to see the management services agreement between the portfolio company and the private equity firm. They don’t get to see that agreement at all. And that agreement lays out things like monitoring fees that are going to be collected from the portfolio company, transaction fees that are going to be charged to the portfolio company. And this is really important information if you’re an investor.”
If the legislation is passed, it would be the end of the private equity industry, Willens says. “Without being too dramatic or melodramatic here, I don’t know that the industry could survive. It’s sort of a self-defeating proposal because there would be nothing left for her to regulate.”
Appelbaum disagrees, though she says the proposed legislation would end the practice of financial engineering. “It will certainly clamp down on financial engineering by private equity firms, but I don’t think it’s the end of the industry. The industry would have to adapt.”
Hugh O’Reilly, executive in residence at the Global Risk Institute, notes that while putting these issues on the table is important, Warren may be fighting the last war by tackling problems of yesterday.
“Increase in competition in the marketplace, scarcity of assets which has led to increasing prices along with competition, the increasing presence of institutional players, whether directly or through private equity funds — all of this leads to people having a much more long-term perspective. The desire to sort of ‘get in, get out,’ very quickly is not what it once was in my opinion.”
With regards to the proposal to make private equity companies share responsibility for the pension obligations of the companies they buy, Willens notes that while this change is aimed at protecting pensioners, it could have a negative impact on other pension funds with private equity allocations.
According to a statement by the American Investment Council, private equity is the highest performing asset class for public pension funds, with a median 10-year annualized return of 8.6 per cent.
If the private equity industry doesn’t survive this major legislative overhaul, pension funds would lose out, says Willens. “You’re giving with one hand by strengthening the protections of pensioners and you’re taking away with the other, and [Warren] may not have realized that.”
O’Reilly says the proposal may not be the best way to tackle the problem of retirement security. “I think, rather than trying to work out these issues on an investment or a case-by-case basis, what needs to happen is we need to make sure we have properly funded pension insurance schemes like [the pension benefits guarantee fund] or, in the U.S., the Pension Benefit Guaranty Corp., so that people are protected no matter what happens because I’m not sure that the approach that she’s prescribing will work.”
In the current political environment, both Applebaum and Willens note the legislation won’t pass.
Yet, this could change, with the potential for Warren becoming the Democratic Party’s presidential candidate and an election coming up.
“It wouldn’t even be considered in any way, shape or form by the Senate Finance Committee because the Republicans control the Senate,” Willens says. “But you could see where, if the stars were properly aligned, something like this could actually pass.”
UPDATE: July 31, 2019 at 8:30 a.m.