October 20, 2021

ICYMI: Warren Calls for Reforms to Clean Up the Private Equity Industry and Put Workers and Communities First

Earlier today, Senator Warren reintroduced the Stop Wall Street Looting Act to fix the private equity industry and level the playing field

Washington, D.C. -  Today, during a hearing of the Senate Banking, Housing, and Urban Affairs Subcommittee on Economic Policy, United States Senator Elizabeth Warren (D-Mass.) questioned witnesses on predatory private equity practices and ways  to protect companies, communities, and investors as the industry’s growth continues to explode. 

During the hearing, Senator Warren spoke about private equity’s business model, which allows private equity firms to loot company assets and extract exorbitant fees. Senator Warren highlighted how this business model harms workers and communities, has deadly consequences in the health care sector, and fleeces investors.

Earlier today, Senator Warren reintroduced the Stop Wall Street Looting Act, legislation that would fundamentally reform the private equity industry and level the playing field by forcing private investment firms and their managers to take responsibility for the outcomes of companies they take over, empowering workers, and protecting investors.

Full transcripts on the three rounds of questions and videos below.

Transcript: Protecting Companies and Communities from Private Equity Abuse
U.S. Senate Committee on Banking, Housing, and Urban Affairs Subcommittee on Economic Policy
Wednesday, October 20, 2021

Round 1 of Questions below and video HERE:  

Senator Warren: I’d like to talk about private equity, and its impact on workers and communities. Ms. Smith, you are with us virtually, I want to thank you for being here today. Since you experienced it firsthand, I’d like your help in walking through how Art Van went under so we can better understand the private equity business model. So, could you tell me: was Art Van profitable before it was acquired by THL in 2017?

Ms. Smith: We were. We had about $800,000,000 in sales that year and we literally owned about 55% - 60% of the market share in the furniture sales industry. 

Senator Warren: Okay. So, this private equity company took over this successful, profitable, I think you said 58-year old company, saying they were going to make it more profitable. So, let’s talk about how they made it more profitable. Ms. Smith: once THL came in, what did they do first to supercharge Art Van’s growth? Did they boost the marketing budget? Did they invest in retaining management? Did they start a staff training program? Did they maybe build a new website? What did they do to help boost the profits? What did they do straight out of the- straight out of the chalks?

Ms. Smith: Straight out of the gates the first thing they did was sell off all of the real estate. Art Van was a debt-free company, they owned the land that every building was one. The first thing they did was sell the real estate, make back the money they spent buying the company and then they started destroying the company, they got rid of all of our top leadership and brought in, as I said, people who didn’t know the company, didn’t know the furniture industry at all, they hired the worst CEO. Someone that was rated the worst CEO in the nation in 2016 to run the company, and some could say he didn't do his job, but I'll say he did his job very well. He was hired to run his company out of business and that’s what he did. 

Senator Warren: Okay, so let’s talk through this. So, this is a standard play out of the private equity book. THL put up little of its own money.  It took out a bunch of debt to buy Art Van and then make Art Van responsible for that debt. Meanwhile, THL is collecting huge fees just for putting its own deal together. And then before the ink dries on that deal, Art Van, this once very profitable company as you say that had no debt, gets hit with now two big expenses: The new debt that THL and now if they sell off all the real estate, it’s not that they move out and shut down their business yet, it's that they have to pay rent on all the buildings that they used to own. THL, however, so Art Van is a whole lot worse off. THL, however, is a whole lot better off, they take from all that money they made off of the buildings, they pay themselves back the money they originally invested in the deal.  And they just keep on collecting fees on everything that’s happening, including managing the rental property here. So, now Art Van has its back against the wall so let me ask you Ms. Smith, at this point then, how did Art Van meet these new expenses? Did these investments in the business help boost revenue so they could offset these new debts?

Ms. Smith: There were no real investments into the company, THL took money out of the company and never took anything back, and they started laying off workers, they kept advertising the one thing they do, is that they kept the advertising budget up but that was to keep the customers coming in spending money but where the money was going we don't know. They said that we were losing money, however, even though our actual intake might of dropped dollar volume wise, our profit margin went up.

Senator Warren: Mhm.

Ms. Smith: So when you talk about $800 million, 6-7% of it is a lot of money.

Senator Warren: Alright. Okay, but I take it what happens is they keep cutting, they keep cutting the cost and then Art Van gets into the situation because they no longer have real estate, they now have to pay rent, they ultimately can’t pay their bills and so Art Van files for bankruptcy, that destroys about 3,000 jobs. And you and your coworkers were left without health care during a pandemic. Do I have that about right?

Ms. Smith: You have that about right. They took- they told us that we would have healthcare till the end of the month. We didn’t. They didn’t give us the severance pay they told us. They told us that we didn't get it because they didn't close because they were going out of business, they close because of COVID so, you know, let me use this as a shield to change my attitude to change my dance so I don’t have to pay. So everything was to profit them and to hurt the people and they didn’t care.

Senator Warren: Yeah. One of the things that we often hear from the private equity industry is that it’s not in their interest to drive companies in bankruptcy and I think that was kinda o the point that Senator Kennedy was making and cases like yours are unfortunate. But they are just art of doing. Most businesses survive after being taken over by private equity, while only a few, like Art Van, actually fail. Do you find that a persuasive argument Ms. Smith?

Ms. Smith: So, I don’t find it a persuasive argument, I know that THL didn’t intend for Art Van to go out of business. They intended to take us into debt because that’s the model. Let’s take the company into debt, let's suck out everything out of it we can out of the debt and sell it to somebody else. However, Mr. Van’s name was so golen that they were able to world so much against this company that they couldn’t sell it. They took this company so deep into debt, and you know, I keep hearing the Senators talk about capitalism, this country was built on capitalism. Yes, this country was built on capitalism, but this is cannibalism this is not capitalism.They are going in and they are stripping, destroying and they don't care, they are plundering and leaving  it in thor wak and they don't care. 

Senator Warren: What really troubles me here is private equity has worked out a business model that helps them get rich at the expense of workers like you and your families. You know, the model is pretty simple, they gamble with other people’s money, they squeeze out what they can, they cram their own pockets full, and then bail, leaving workers and communities to deal with the fallout. So, let me ask you Dr. Appelbaum, how would the Stop Wall Street Looting Act help address these market failures? Is your mic on?

Dr. Appelbaum: Yes, Thank you. So, it’s very clear that the Stop Wall Street Looting Act would play a role in these kinds of situations. It would require that the private equity firm keep some skin in the game. It would reduce incentives for them to load portfolio companies with excessive amounts of debt, obviously reasonable amounts of debt are not a problem, as our speaker just described; the amount of debt that they put on that company is what the problem was. And so it protects companies from bankruptcy. The act includes protections for workers in the case of bankruptcy, severance pay and other protections, and it also increases transparency. The institutional investors in these private equity funds have little to no information about the companies that the fund has acquired, and this would provide them with some information, break down that asymmetrical situation, and in my opinion, it would stop the worst abuses and encourage private equity to do what it says it does and help companies to grow and be successful.

Senator Warren: Thank you. Thank you very much, Dr. Appelbaum.

Round 2 of questions below and video HERE:

Senator Warren: What I’m going to talk about now is what happens when companies buckle under the weight of private equity debt and mismanagement and go bankrupt, and how workers and their families and communities have to deal with that fallout. We understand, and that’s what happened in Art Van, that particular version of the problem, but even when companies don’t go under, the consequences of the private equity playbook can still be devastating. In the worst cases, as we’ve seen with private equity’s involvement in health care, people get sick and they die. So, Ms. Malone, you have been a registered nurse at Crozer for more than 30 years. Your hospital was acquired by Prospect Medical, which was owned by the private equity firm Leonard Green, in 2016. Did you notice a change when private equity took over?

Ms. Malone: Yes, almost immediately. We immediately saw staff was cut, we were unable to get supplies, we were told by vendors that bills had not been paid and that's why we were not able to get supplies. I work in the substance abuse department. We were not able to have our acupuncturist come, our music therapists, they had not been paid in several months and they were going to be unable to continue to come and provide their services to our patients. We saw that happen pretty quickly. Staff was at a minimum, and the quality of the supplies, which, when you have poor quality, it takes several more attempts to put an IV in, you're increasing your rate of infection. When you have poor quality foley catheters, your instance of infection goes up. And so all these things result in death. You have the potential every time you, you make cuts in staff, when you're giving nurses more patients than they're safely able to handle. You’re just, increased -- we, we are constantly putting patients at risk. These are people's lives that we deal with. Workplace violence has increased. The people who are waiting - when you have 20 people over above what your emergency room holds waiting to be seen, the staff were abused, were physically abused, were verbally abused. I mean the trickle-down of the cuts that this company made almost immediately, we're still feeling, and, unfortunately, the pandemic happened, and so, everything is being hidden under the guise of this pandemic. These things were happening long before the pandemic, and they're using the pandemic as an excuse that there's a nursing shortage, that we can't get supplies, when the reality is, they're not providing us with what we can have. There isn't a nursing shortage, there is a shortage of nurses who are willing to work at the bedside under these kind of conditions. We take an oath to do no harm, and we are no longer able to do that. Nurses are fleeing. I can tell you of 20 plus nurses who have left Crozer in the last two weeks.

Senator Warren: So you’re saying, just so I can get this together, with private equity, so they cut staffing, cut supplies, that reduces the quality of patient care, and in fact increases infections, ultimately, mortality rates. Talk to me just a little bit, though, about other parts out of the playbook. For example, what did they do with real estate in your case? 

Ms. Malone: So they did sell the real estate. You know, that, and, so they, once again, they made a large profit. Leonard Green took $400 million dollars out of Prospect Medical-

Senator Warren: So they took how much money out of the-?

Ms. Malone: 400 million. 

Senator Warren: So they take 400 million out while they’re laying off people, short-changing you on supplies--

Ms. Malone: Yes, yes. They took all of that money. And they had made a commitment. They had made a commitment to make a $200 million dollar investment in our hospital as part of the acquisition deal. And none of that -- none of that has happened.

Senator Warren: None of it happened. This is not a business model, this is looting.

Ms. Malone: It is.

Senator Warren: And unfortunately, we're seeing it all around the health care sector, including, as COVID has made painfully clear, at nursing homes. Private equity firms have been buying up nursing homes, and the consequences have been deadly. Researchers have found that private equity ownership “increases the short term mortality of Medicare patients by 10%.” That implies that more than 200,000 people died between 2000 and 2017, simply because they lived in a nursing home that was owned by a private equity firm. So, Ms. Malone, from what you've experienced with private equity at your hospital, does the fact that private equity ownership has been found to kill people in nursing homes surprise you?

Ms. Malone: No, it doesn't. It doesn't at all. Private equity firms are focused on making the biggest profit, they're not focused on providing the best care, and I don't ever see how their incentives could be aligned with patients and staff. It just doesn't, it just doesn't work that way, these are people's lives.

Senator Warren: I think I misspoke on the number of deaths, I think I looked down and said 200,000 instead of 20,000, but one death is one death too many. So, this is one of these things we need to act. And this is why I've introduced the Stop Wall Street Looting Act so that we can better align incentives between private equity and the companies they take over by restricting the ability of private equity to buy a company, and profit from running it straight into the ground. This is a bill that would ensure that private equity has skin in the game as Dr. Applebaum was talking about, because if private equity has skin in the game, maybe they will think twice about their actions, especially when their looting leads to increased illness, suffering, and death among our most vulnerable people, so thank you very much and thank you for being here. I appreciate it, Ms. Malone.

Round 3 of questions below and video HERE:

Senator Warren: So I want to talk about the returns, let's talk about the financial part of this now that returns from private equity investments. After all, private equity keeps scooping up money because they promise super high returns. Higher than more traditional investments like stocks and bonds. In fact, that's why giant private equity firms get the big feats, they supposedly deliver big returns. Strong and steady returns are important public pension funds and retirement security of teachers and firefighters and local government employees across the country depend on these returns. So it's no wonder that pension funds and other institutional investors would find private equities’ promises so very attractive and why they might be willing to tolerate the risks, and even the consequences that we've talked about today. So let's start with the data. Dr. Applebaum, you've studied market returns in detail. This is pretty much your specialty. So let me ask you, does private equity outperform the market?

Dr. Applebaum: No, no it doesn't. And there are quite a few studies now that show that, that the returns, basically, let's be clear. Since 2006, it's the median private equity firm in each vintage launch since then, that has just about tracked the market, using the metric that the finance professors would use which is the public market equivalent. Nobody who studies private equity uses the internal rate of return, which is what is used in the industry, which is quite misleading. You never get the amount of money that the internal rate of return suggests to take to the bank, that's not money, you can take to the banker. If we have time, I can tell you all about what's wrong with the IRR but. But what the researchers used is the public market equivalent. And what they find is that since 2006 the median fund, the typical fund, has not outperformed the market. That means half of the funds are underperforming the market.

Senator Warren: Right. So that means for 15 years now - I just want to be crystal clear on this - for 15 years the typical private equity fund has failed to outperform the stock market, which sounds like private equity has been fooling everyone for the past 15 years. So let me ask, Dr. Appelbaum, if the typical private equity fund is not generating the returns the private equity industry claims it does, then what are investors paying for?

Dr. Appelbaum: Yeah, that's a very good question. And of course this you know, they are paying billions of dollars in fees, I mean those fees really add up. So I'm just going to point to a study by Oxford University finance professor Ludovic Phalippou. He calls private equity funds billionaire factories. They produce little for investors, but they make the private equity firm partners billionaires.

Senator Warren: Wow. So teachers and firefighters are being asked to take money out of their retirements to pad the pockets of private equity billionaires and they aren’t even getting the above-average market returns that they thought that they were paying for. Is that a fair summary?

Dr. Appelbaum: It is definitely a fair summary and you have to remember that these are risky investments, and the idea at the beginning was that they would get a return that was 3% above the market to reward them for the risk that they’re taking, and now they’re getting no premium whatsoever.

Senator Warren: Okay. So they’re getting no premium but they’re taking on more risk. So we have a chance here now to talk with the Treasurer of the number one state employee pension fund—the fund that is doing better than any other public employee pension fund. I mean, hurrah, right? This is not the one in the middle, this is the one way down on the top-performing end. Treasurer Frerichs, you have been doing very well with private equity.  Is that a fair statement? 

Treasurer Frerichs: Yes. That’s correct.

Senator Warren: Good. And you are an investor—that is, you manage a pension fund on behalf of your office, you are a trustee for a public pension plan that invests in private equity on behalf of teachers and firefighters and other public employees.  So the question I want to ask you, as an investor, you’re on the side that’s trying to make money out of this: Are you satisfied with the current rules governing private equity?  Or would you like to see some new rules in place requiring transparency about fees and aligning the interests of PE managers with their investors? 

Treasurer Frerichs: I’ll say that PE has done well by us, but it would be beneficial to see new rules and sensible reforms. For example, standard reporting would ensure transparency from all investors and ensure investors can validate all fees charged by private equity that conform with negotiated agreements. That would be one good reform. Our office does its due diligence: Senator Kennedy asked if I made any investments without that. No, we do our due diligence but for us and many of our public funders, there is difficulty receiving proper disclosure and transparency around direct and indirect fees in a clear and consistent manner. There’s been characterization that we’re heading towards socialism here. I believe in a market here and I believe markets work well and efficiently with proper access to information. This opaqueness makes it difficult to shop around and determine whether we’re getting a competitive rate. Now he’s right, if we’re buying a car, we wouldn’t disclose if we want to buy there, well sometimes they’ll just flood you in information, bury you in things in that sale document at that car dealer. You know, and we regulate car dealers to make sure there’s proper disclosure. Without proper disclosures, tracking of fees and expenses charged by a private equity firm is a cumbersome process, and markets shouldn’t be cumbersome. This can then potentially enable firms to hide and shift fees, potentially manipulate returns reporting, and avoid disclosing certain deals. Ultimately, I believe new rules would be valuable.

Senator Warren: Yeah. So, as I understand this, you’re saying you like the market, but it’s very hard for you to be able to see what you’re paying in fees, and if that’s hard, that means it’s very hard to make comparative judgments. And I just want to emphasize here, you’re not one of the little funds, am I right on this? You have a pretty big shop there.

Treasurer Frerichs: Correct. We oversee tens of billions of dollars in investments, and between ISBI and internal, billions of dollars in private equity. So we have the resources here, but still, in order to use those resources to try and sort through all this, it costs us extra money. And smaller pension funds don’t have the resources that we have.

Senator Warren: Yeah. I think that’s just a really important point about markets: if we want markets to work, then people have to have consistently reported information so you can get comparisons across them, and the information has to be made available. You know, I appreciate your testimony on this. My Stop Wall Street Looting Act would require private equity funds to clearly disclose their fees and returns, so that public pensions and other investors have the information that they need in order to make informed decisions. America faces a retirement crisis, but the solution is not to squeeze employees more, or to cut retail jobs and wages, or undermine the health and safety of people in the hospitals and nursing homes. The solution is to put stronger rules in place so that investors, retirees, and families don’t get gouged by private equity firms trying to fleece them. So to me, that’s what this hearing is about today.