5

The People’s Lobbyists versus Private Equity

Just over one hundred years ago, Louis Brandeis, lawyer and future Supreme Court justice, published Other People’s Money and How the Bankers Use It. Among the book’s many famous observations—which depressingly retains much of its century-old descriptive power—was the remark “sunlight is said to be the best of disinfectants; electric light the most efficient policeman.”¹ Today, echoing Brandeis’s argument, the principles of disclosure and transparency remain core to how we regulate finance. We rarely ban the sale of securities, though perhaps we should more frequently. Instead, we require full and complete disclosure about it, policed by antifraud provisions that govern the truthfulness and candor of that disclosure.² Failure to properly reveal required financial information, or disclosing false or misleading information, can result in extensive criminal and civil liability enforced by the Department of Justice, the SEC, state securities regulators, and shareholder lawsuits. We focus less on what financial products companies sell, more on how they sell them. It is perfectly acceptable for companies to offer highly risky securities to the public as long as those companies disclose all of the known risks.

There is a competing view to Brandeis’s notion that regulation equals sunshine. That view says that regulation mandating disclosure costs more than it’s worth, that it harms companies and shareholders, and that good companies have the right incentives to voluntarily disclose all of the relevant information investors need. Given these questions about the value of sunshine, of regulation, it’s worth considering what kind of financial creatures prefer to live in the dark, and how we might expect them to behave. In the past ten years, private equity funds have been some of the main occupants there. Most of what we could find out about them is what they chose to tell us about themselves. But since Dodd-Frank, a light has been switched on, a dim light, but just enough to get a look at some of these creatures.³ Working-class shareholders installed the light, the wiring, and the switch, and simply asked the SEC to turn it on. The SEC finally did.

The fight to install that lighting was led by Heather Slavkin Corzo, who pressured the SEC to issue the CEO-worker pay rule. Here, too, she played a key role, working in a coalition she helped create—Americans for Financial Reform (AFR)—to ensure that Dodd-Frank would empower the SEC to start shining its light on private equity. The way to do that was to require private equity funds for the first time to register and report on their holdings. That is no easy feat. As of 2015, private equity had $4.2 trillion in assets under management. Along with that comes massive lobbying power. Its leading lobbying arm in Washington used to call itself the Private Equity Council. It then changed its name to the Private Equity Capital Growth Council, and now it calls itself the American Investment Council, for reasons that are too obvious to mention.⁴

The private equity business model has long been controversial. Some view it as essentially a financing mechanism, one that sharply favors those who control the fund over its investors, over taxpayers, and over the employees of the companies purchased by these funds. The private equity general partner—comprising the people who run and set up the private equity fund itself—relies on capital furnished by its investors, the limited partners, to purchase public companies and “take them private,” just as both Kohlberg Kravis Roberts and Cerberus did with Safeway in Chapter 1. Private equity uses tax breaks, including the “carried-interest loophole,” to obtain lower tax rates for its partners than that paid by most Americans.⁵

Victor Fleischer is a law professor at the University of San Diego, formerly the author of the “Standard Deduction” column for the New York Times, and recently served as co-chief tax counsel for Senate Finance Committee ranking member Ron Wyden (D-Ore.). In one of the most consequential, most cited, and most widely read works of legal scholarship of the past decade, Fleischer argued that the private equity industry’s carried-interest loophole illegitimately enabled the industry to count profits made from their labor (which is taxed at the higher rate for income that most of us pay) into profits made from capital gains (which is taxed at a lower rate). This was “an untenable position as a matter of tax policy,” according to Fleischer, who argued, among other things, that private equity profits should be taxed as ordinary income.⁶ Fleischer’s argument has been picked up nationwide, with as yet unsuccessful efforts to close the loophole in Washington, accompanied by local efforts by the Hedge Clippers, a labor-affiliated activist group that has pushed against this dodge in twelve states and the District of Columbia.⁷

Fleischer’s appointment as Senator Wyden’s tax council prompted a fraught reaction in some quarters: “Senator Ron Wyden Endangers Tax Reform with Hire of Radical Partisan Victor Fleischer,” wrote Forbes. The article included the standard Alinsky reference: “[Fleischer’s] appointment was praised by the Alinsky-esque ‘Patriotic Millionaires’ group he has worked with over the years.”⁸

In addition to the controversial business model, the growing behind-the-scenes role of the private equity industry in virtually all aspects of American life has triggered widespread concern. The New York Times’ “Bottom Line Nation” series on private equity captures much of the worry. The financial crisis of 2008 left states and cities in mostly temporary financial straits. Private equity stepped into that void, taking over public services including ambulance companies, railroads, highways, 911 call centers, water utilities, public golf courses, even courthouses. It used to be that if a state wanted to build a road, it could do so as long as it went through the regular process and allocated the requisite funds. Today, a state might need permission from a private equity fund to build that road, if the fund owns another road nearby from which it has the right to collect tolls. This ownership stake has given the industry an outsized voice in Washington and in state capitals. It has also led to the displacement of public worker jobs, an issue I discuss below.⁹

Slavkin Corzo worked fulltime on Dodd-Frank when it was being drafted. She was registered as a lobbyist on behalf of the AFL-CIO Office of Investment, the office she now runs. When the House of Representatives initially took up Dodd-Frank, it included a provision in the bill requiring the registration of private funds, including private equity funds. That meant subjecting these funds for the first time to the kind of disclosure regime described above. But when the bill got to the Senate, the registration requirement had mysteriously—or perhaps not mysteriously—disappeared. (Maybe it was just a coincidence, but Banking Committee chairman and patron of Dodd-Frank, Democratic senator Chris Dodd, represented Connecticut, home to a significant segment of the private equity industry.) Slavkin Corzo lobbied Senators Jack Reed (D-R.I.), Ron Johnson (R-Wis.), Carl Levin (D-Mich.), Sherrod Brown (D-Ohio), and Charles Grassley (R-Iowa) to reinsert the private fund registration provision into the bill. She particularly credited Senator Reed’s efforts during the reconciliation process (reconciling separate bills passed in both the House and Senate) for restoring the registration requirement.¹⁰

This is but one small example of the obscure wrangling over obscure provisions buried deep inside a thousand-page piece of legislation that is the daily toil of the Washington lobbyist. The public can never hope to enter into this labyrinth; it can only hope it has sent in the right representatives. Private equity sent in hordes of extremely well-paid lobbyists. For the rest of us, there was Slavkin Corzo and AFR. This “national coalition of nearly 200 state and local organizations ranging from financial experts to community advocates” includes notable organizations like the Roosevelt Institute and the National Community Reinvestment Coalition. It was largely staffed by Slavkin Corzo and the AFL-CIO and set up to help institute the framework for financial reform that was laid out in the Special Report on Regulatory Reform, released on January 29, 2009, by the Congressional Oversight Panel. That panel was chaired by Elizabeth Warren, and her role in leading it is what made her a household name and laid the groundwork for her successful Senate run in Massachusetts. One of AFR’s first priorities was to create the Consumer Financial Protection Bureau, a recommendation that came right out of the report and that was Warren’s idea. When President Obama declined to appoint Warren to lead it, she returned north to run for Senate.¹¹

Of course, critics will predictably argue that Slavkin Corzo and AFR were no different than the private equity lobbyists—there to represent their own interests, in this case, the interests of their union sponsors and others. And so they were. What were these interests? That pension funds were investing worker retirement savings in private equity funds they knew little about. That pension funds could hardly figure out what they were being charged by private equity funds. That pension funds were investing their workers’ retirement savings in the surreptitious takeover of public schools, of firefighting companies, of police and ambulance services, of water treatment facilities, of toll roads, in short, in job losses for their own workers.¹² The experience of pensions directly contradicted the view that companies would automatically disclose all the information investors needed without mandated disclosure. Is this disclosure yet another special interest? Are fees, investment performance, and the private takeover of the public square only the concern of unions?

In my view, the interests of the people on whose behalf Slavkin Corzo and AFR advocated are far better aligned with the interests of most Americans than any other sector of finance. My confidence in the Slavkin Corzos of the world, in the activists portrayed in this book, is not that they selflessly martyr themselves on the altar of the public interest, though I do believe they are far more public-minded than any other financial actors. Instead, my confidence in them stems from the fact that the interests of their members coincide with the interests of a far greater percentage of the public than any other sector of finance. The tens of millions of Americans invested in these pension funds and union funds—and the many more who are dependent on them through family ties to fund participants and beneficiaries—are working- and middle-class people. They are increasingly marginalized in the halls of power. Their own elected representatives may show less interest in working for them than do the folks who run their pensions.¹³

Thanks to Slavkin Corzo, AFR, and others, Dodd-Frank included the requirement that private equity funds register and disclose their holdings, alongside many other financial reforms, including creation of the Consumer Financial Protection Bureau.¹⁴ This was how Slavkin Corzo and others installed the lighting. The question then became whether the SEC would flick the switch and turn it on. It did so almost four years later, on May 6, 2014, and it offered some direct evidence relevant to the debate over the value of mandated disclosure.

Andrew J. Bowden was the director for the Office of Compliance and Inspections and Examinations for the SEC in 2014. On that day in May, he delivered a speech at the Private Equity International Private Fund Forum in New York. Titled, not coincidentally, “Spreading Sunshine in Private Equity,” Bowden announced the results of the SEC’s examinations of private equity funds based on the SEC’s new power to conduct such reviews under the registration provision in Dodd-Frank. Bowden began with background about some of the conflicts inherent in the private equity industry. One is that private equity funds take over a company and then force that company to hire the private equity company as its adviser. He then described what the SEC found in its first 150 inspections since the registration requirement became effective:

By far, the most common observation our examiners have made when examining private equity firms has to do with the adviser’s collection of fees and allocation of expenses. When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50% of the time.

This is a remarkable statistic. Historically, the most frequently cited deficiencies in adviser exams involve inadequate policies and procedures or inadequate disclosure.… So for private equity firms to be cited for deficiencies involving their treatment of fees and expenses more than half the time we look at the area is significant.¹⁵

In short, when operating away from the sunshine, private equity funds were cheating on their fees and expense allocations “over 50% of the time.”¹⁶ We learned this lesson from Brandeis a hundred years ago. It’s a shame to have to learn it all over again. It is impossible to imagine how these revelations might have taken place absent Slavkin Corzo, the AFL-CIO, AFR, and the other organizations that lobbied for private fund registration, particularly given the power of the private equity industry.

Since Bowden’s speech, the SEC has pursued eleven enforcement actions against private equity funds for assorted securities law violations. One of these actions was brought against WL Ross LLC & Company, founded and run by Wilbur L. Ross, who today serves as secretary of commerce in the Trump administration. The SEC found that his fund failed to disclose its fee allocations to certain other funds it advised, resulting in them “paying higher management fees between 2001 and 2011.” In response, the company revised its billing practices, returned $11.8 million in fees, and paid a $2.3 million penalty.¹⁷

Important as such enforcement actions may be, and subject as they are to whoever sits in the White House and therefore controls the SEC, the highest value of this disclosure is to enable transparency about fees and to monitor private equity’s investment activities more generally. To offer a simple example, Leonard Green Partners, one of the largest and most successful private equity funds, disclosed in its Form ADV (a required disclosure form) that the firm was charging portfolio companies—the companies (like Safeway) purchased by the private equity fund with money furnished by its investors, including its pension and labor fund investors—for the first-class, private, and business-class air travel of its executives. That prompted an investigation by one of its investors, UNITE HERE, into how the firm was billing its travel expenses.¹⁸

UNITE HERE, a union representing workers in the hotel industry, created a private equity watch list similar to the one Pedrotty and Weingarten built for hedge funds.¹⁹ Since 2013, it has published this list, labeling eighteen private equity funds as “irresponsible” and thirteen “responsible.” Irresponsible private equity funds are those that have, among other things, repeatedly refused requests to meet with the union and “had a longstanding, unresolved dispute at a hospitality-related property or portfolio company.” UNITE HERE is able to apply its pressure as an investor to demand greater transparency and disclosure. But it also does so to advance the interests of its members, whose pension benefits are directly tied to their ability to work, and to their compensation, precisely the same issues the union may be negotiating “at a hospitality-related property or portfolio company.” Such unions have also taken to negotiating side deals with private equity funds that require the funds to use union labor whenever possible.²⁰

Unions have also turned to pension investors for aid when embarking on unionization efforts or negotiating wages and working conditions with private equity owners. For example, members of the Communications Workers of America successfully turned to the New York State Common Retirement Fund ($192 billion in assets), an investor in private equity fund Apollo Global Management LLC, for aid in beating back concessions sought by the company from workers. Los Angeles hotel workers have similarly turned to pensions to supply helpful pressure in the union’s efforts to organize the Terranea luxury resort, operated by Lowe Enterprises.²¹

The interface between public pension funds, labor union funds, and private equity funds is the most fraught relationship described in this book. Private equity would be a shadow of its current self were it not for public pension investments. Estimates vary, but somewhere between one-third and just under one-half of all private equity assets under management come from public pension funds.²² As with hedge funds, pension funds have only recently recognized the problem of fees charged by private equity—both the size of those fees and their transparency. CalPERS has become so alarmed by private equity fees and lack of transparency that it is actively considering funding and staffing its own private equity fund or, worse, outsourcing it entirely to BlackRock.²³

But the latest development in the relationship between public pensions and private equity is considerably more promising. In 2017, New York City comptroller Scott Stringer’s office negotiated an arrangement between the NYC funds and KKR in which the private equity fund would not collect any fee on investment gains until those gains exceeded 7 percent. With a $3 billion investment in KKR, the NYC funds had the leverage to impose such an arrangement, the purpose of which was to “at least match the public markets.”²⁴ That means the NYC funds won’t pay fees on investment gains until those gains exceed performance of an S&P 500 index fund. This is yet further illustration of the basic point. The substantial stake that pension and union funds have in private equity means that they can shape the funds’ investment strategies in more labor-friendly ways, if pension and union funds actually make use of that power. Nowhere is that power more important than when it comes to the question of jobs.

In many cases, public pension funds are directly funding their own job losses via private equity’s takeover of public activities. Public ambulance drivers, firefighters, teachers, prison guards, engineers, and others have their own retirement funds invested in companies that take away their jobs and give them to lower-paid, private equity–funded private-sector workers with no benefits. Such investments raise profound questions about whether the trustees who have made these decisions are truly fulfilling their legal duty of loyalty to the workers and their retirement savings.²⁵ Here, too, formidable resistance is emerging, with many funds beginning to boycott such investments, imposing restrictions on such investments to protect workers, and, better yet, using their investment power to create jobs. Such jobs lead to more contributions to the fund. Still, the meaning of the law that governs pension investments is itself a political football and has flipped back and forth between the administrations of Presidents Bill Clinton, George W. Bush, Barack Obama, and maybe Donald Trump too. But before addressing the legal and policy challenges facing working-class shareholders, there is one more crucial topic to be covered. In the next chapter, I describe how working-class shareholders have increasingly used their shareholder power to bring lawsuits against CEOs, bankers, accountants, and others on charges of securities fraud.