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Lawmakers Introduce Bill to Regulate Change in Control Transactions

Steven.Lofchie@cwt.com's picture
Commentary by Steven Lofchie

Senators Elizabeth Warren (D-MA), Tammy Baldwin (D-WI) and Sherrod Brown (D-OH), and Representatives Mark Pocan (D-WI) and Pramila Jayapal (D-WA) introduced a bill to govern the private funds that engage in change in control transactions.

According to the bill's sponsors, private equity funds, which claim to earn high returns for investors and make companies more efficient, often do not serve either's best interest. Highlighting high profile bankruptcies of Toys "R" Us, Sears and Payless, the sponsors stated that private equity funds often (i) put the companies they buy into debt, (ii) sell off assets and (iii) guarantee payouts for themselves through "exorbitant fees," regardless of how the investments perform.

"The Stop Wall Street Looting Act" would, among other things:

  • make private funds responsible for their portfolio companies' liabilities (e.g., debt, legal judgments and pension obligations);

  • bar dividends to investors for two years after a company is acquired;

  • impose a 100% surtax on fees paid by target companies to private fund managers;

  • close the "carried interest loophole";

  • limit deductions for the business interest of certain private fund-owned businesses;

  • increase the priority claim for unpaid wages, severance and employee benefit contributions from $10,000 to $20,000;

  • prioritize severance and pension payments during bankruptcy proceedings;

  • restrict executive compensation enhancements and prohibit special compensation payments; and

  • hold firms liable for unpaid wages, severance, employee benefit contributions and pensions.

Commentary

This is not a serious bill. To illustrate this, here is a sample transaction under the definitions in the bill.

Sample Transaction. Three unrelated middle class individuals form a vehicle, in which each owns a 1/3 interest to buy a 40% interest in another company that owns three corner grocery stores. The vehicle obtains the right to a board seat and to block certain decisions, such as the decision to start a new corner grocery store or to sell one.

​Definitions. The corner grocery stores are a "target firm." The vehicle is a "private "fund"; the three individuals are "affiliates" of a private fund; and the vehicle's purchase of the corner grocery store was a "change in control transaction."

Results. Not only is the vehicle now responsible for the debts of the corner grocery store, so are the three individuals. Also, they can't receive any dividends for two years. They can be sued by any employee or creditor of the corner grocery stores. If the 60% owner of the grocery stores declares a dividend, the vehicle pays 100% tax on that dividend.

Conclusion. Not sure exactly what this does to the U.S. economy, but it certainly does not look like a strategy for growth. It will make it extremely difficult to sell interests in small private businesses. If these Senators believe that there is a problem, or more than one, with the private equity business, they need to do a better job of defining the specifics of the problem and the specifics of a solution. This legislation is absurd on its face.

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