Elizabeth Warren’s Private Equity Plan Seeks to Strip Industry of Riches

(Bloomberg) -- Elizabeth Warren wants to force private equity executives to eat their own cooking.

Predictably, they aren’t thrilled.

The Democratic senator and candidate for president issued a proposal this week that would link the profits at private equity firms to the success -- or failure -- of the companies they buy and sell. She also proposed limiting certain tax breaks.

“It is more of an industry-destroying proposal,” said Steve Biggar, an Argus Research Corp. analyst who covers Blackstone Group Inc., Apollo Global Management LLC and KKR & Co. “If firms like Blackstone and KKR can’t do this, in a free market someone less regulated will pick up the slack.”

Warren’s plan seeks to rein in private equity firms, which she said often act like “vampires” in their acquisitions by “bleeding the company dry and walking away enriched even as the company succumbs.”

A former Harvard law professor, Warren consistently places in the top four in a crowded Democratic field, having enjoyed a boost in polls after the first presidential primary debate. The plan unveiled Thursday -- called the “Stop Wall Street Looting Act” -- has several Democratic co-sponsors, including her 2020 rival Kirsten Gillibrand of New York and House Democrats Ayanna Pressley of Massachusetts and Rashida Tlaib of Michigan.

Warren is taking aim at an industry that’s booming. Investors have committed about $4 trillion to private equity in the last decade, according to Preqin data, and the money is continuing to pour in. Blackstone alone raised $88 billion in the first six months of this year.

The plan drew a rebuke from the industry’s trade group. “Private equity is an engine for American growth and innovation -- especially in Senator Warren’s home state of Massachusetts,” said Drew Maloney, president of the American Investment Council. “Extreme political plans only hurt workers, investment, and our economy.”

Here’s a look at Warren’s proposal.

Carried Interest

• Proposal: Closing the carried interest loophole that lets firm managers pay low tax rates on the money they earn.
• The private equity industry distributed about $1.5 trillion in capital over the last five years to investors, giving firms an estimated $291 billion in carried interest, according to Bloomberg calculations based on Preqin data. The data assumes a 20% average carry for the industry.
• KKR took in $441.5 million in carried interest in 2018, accounting for 18% of revenue, according to regulatory filings. Over the past three years, the firm had carried interest about $3 billion.
• “It’s huge,” said Robert Kiernan, chief executive of Advanced Portfolio Management, of carried interest. “It would double their tax bill. Many firms might consider moving offshore to avoid this.” His firm oversees about $4 billion of assets for clients.

Debt

• Proposal: Putting private equity firms on the hook for the debts of companies they buy, making them responsible for the downside of their investments so that they only make money if the companies they control flourish.
• About $194 billion in loans to fund private equity transactions, such as leveraged and secondary buyouts, have been underwritten so far this year, according to data compiled by Bloomberg. That money provided financing for 553 deals. That’s well off of last year’s pace, which saw $608 billion in loans sold to finance 1,446 deals.
• Bain Capital LP, KKR and Vornado Realty Trust took over Toys “R” Us in a $7.5 billion leveraged buyout in 2005. The company was paying interest of $400 million on about $5 billion of debt every year for a decade. While Bain, KKR and Vornado together lost over a billion dollars, (they wrote off their investment), they collected $470 million in fees and interest payments over the years.

Fees

• Proposal: Eliminating the ability of private equity firms to pay themselves monitoring fees and limiting the pay out of dividends “to line their own pockets.”
• KKR earned $316.7 million in monitoring fees over the past three years. The firm shares some of those fees with fund investors.

Warren’s plan garnered the support of New York City Comptroller Scott Stringer, who serves as the investment adviser to the city’s five pension funds, with assets of $200 billion.

“We must increase transparency, close the carried interest loophole, curb runaway executive fees, and strengthen protections for workers,” Stringer wrote on Twitter Thursday.

Changing the private equity model could have consequences for state pension funds and university endowments, which rely on such investments to enhance returns for the benefit of retirees and students.

At the Texas Municipal Retirement System, private equity was the best performing asset class, returning 27% in the year through March 31. The system oversees about $29 billion.

“I think PE gets a bad reputation,” said Chris Schelling, private equity director at TMRS. Investors are focusing on growth-oriented, job creating strategies within private markets, “and I’m not sure additional regulation changes that,” he added.

There could be an upside to the senator’s plans, said David Webber, a law professor at Boston University.

“She’s right that there is a pernicious side to private equity that has killed a lot of jobs and dumped the obligation on the public while reaping enormous benefits,” he said. “It might sort out the private equity funds from the ones that are largely relying on these more toxic business models.”

--With assistance from Martin Z. Braun, Janet Lorin, Melissa Karsh and Adam Cataldo.

To contact the reporters on this story: Heather Perlberg in Washington at hperlberg@bloomberg.net;Sabrina Willmer in New York at swillmer2@bloomberg.net;Michael McDonald in Boston at mmcdonald10@bloomberg.net

To contact the editors responsible for this story: Alan Mirabella at amirabella@bloomberg.net, Vincent Bielski

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