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House Financial Services Committee Considers New Requirements on Private Equity Funds

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

The U.S. House Committee on Financial Services considered testimony on several bills that would impose new requirements on investment advisors and private equity funds.

Legislative Proposals

The bills under consideration include:

  • H.R.3848, the "Stop Wall Street Looting Act of 2019," which would (i) require private equity funds and their investors to assume liability for debts incurred through acquired companies, (ii) ban capital distributions for two years after a leveraged buyout, (ii) require the SEC to promulgate private equity funds' annual marketing disclosure regulations and (iv) reduce a private equity's ability to be exempt from their fiduciary duty;

  • H.R. ____, the "Private Fund Board Disclosure Act of 2019," which would require (i) a private fund's investment advisers to report the board of directors' race, ethnicity and gender composition to the SEC, and (ii) the SEC to make the report public; and

  • H.R. ____, the "Investment Adviser Alignment Act," which would (i) define "private equity adviser" in addition to requiring certain report filings and (ii) impose a fiduciary duty on private equity funds.

Testimony on the "Stop Wall Street Looting Act of 2019"

Center for Economic and Policy Research Co-Director Eileen Appelbaum supported the bill, stating that it would end the "reckless loading of debt onto companies" by making the General Partner of a private equity fund and the firm itself jointly liable for such debts. She said that the majority of private equity acquisition deals involve smaller private equity funds acquiring small- or medium-sized companies that can benefit from the acquisition, such as improvements to governance, operations and strategy. Consequently, she argued that under the bill, this type of acquisition would not be affected.

Los Angeles County Employee Retirement Association Trustee Wayne Moore argued that under the bill, workers' savings would be protected through deferred wages and payroll deductions and, ultimately, secure retirement funds.

United for Respect leader Giovanna De La Rosa called for "real, deep change," explaining that under the bill, jobs would be protected by the regulation of private equity.

In his dissenting statement, Small Business Investor Alliance President Brett Palmer warned that the bill would "unintentionally cause serious harm" to small businesses' access to capital while lessening private equity funds' resources to invest in small- and medium-sized companies. He also argued that the bill is based on an "incorrect concept of investing."

Commentary

Center for Economic and Policy Research Co-Director Eileen Appelbaum appears to have strong objections to both the sale of stock to private investors and to public companies buying back their own stock. It should be apparent that no one will invest in a company unless they can eventually get money back out of the company; presumably, investors are looking to take out more money than they put in. Accordingly, Ms. Appelbaum may want to consider whether her proposals might have unintended consequences, such as materially discouraging productive investment.

Contrary to Ms. Appelbaum's statement, stock buybacks were not illegal prior to 1982. The 1982 SEC rulemaking that she cites established the process by which companies buying back their stock could do so without risk of being accused by the SEC of having manipulated the price; it did not legalize buybacks, as they were never illegal.

Ms. Appelbaum correctly points out that retail companies, in which private equity firms have invested, have not done well over the past decade. However, it is also likely that retail companies in which private equity firms have not invested have also done badly for the past decade. A pretty important unmentioned factor in the analysis of the downturn in retail business is the impact of the "internet," which provided a way for consumers to buy goods online without going to retail stores. A fairer analysis would consider whether private equity was the determining factor in the failure of retail companies, or whether there were other factors involved. Similarly, beyond pointing to situations in which companies failed and workers lost their jobs, Ms. Applebaum might consider that during the same period, other companies have been born, jobs have been created, unemployment is relatively low, and the U.S. economy is doing well.

Legislative solutions to perceived economic problems require a deep and broad perspective, one that acknowledges the strengths of the economy, as well as pointing to instances of failure. There is a reason why Joseph Schumpeter, a pretty good economist, referred to capitalism as the process of "creative destruction."

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