The Economist February 26th 2022 Special report Private markets 11measures; and gps’ discharging of fiduciary duties to clients. He
has ordered reviews in all three areas. The sechas already pro
posed new rules that would ban certain activities involving con
flicts of interest and force more disclosure of fees and perfor
mance. It is also working on a plan to force “unicorns” (private
startups worth over $1bn) to disclose more about their operations
and accounts. And it has increased scrutiny of spacs, adumbral ve
hicles used as an alternative way of listing shares.
This push marks a “massive shift” in the sec’s stance towards
private markets, says Igor Rozenblit, a former head of the commis
sion’s privatefunds unit, now with Iron Road Partners, a consul
tancy. Theilpahopes to take advantage of it to lobby regulators to
force funds to report fees in a clearer, more consistent format. The
trade group created just such a template in 2016 and has been try
ing to persuade pefunds to use it; over 60% of investors have re
ceived data in this format from funds launched in America since
2017, says Colmore, a data provider.
The Federal Trade Commission is also eyeing pemore scepti
cally. Its chair, Lina Khan, an appointee of Joe Biden’s, is “a red
blooded antiprivateequity crusader”, says one industry bigwig.
Ms Khan has made policing buyouts a priority. “We’re now seeing
information requests directed not just at the acquiring fund but at
its sponsors themselves. Some are even being asked to provide in
formation about their industry track record,” says Erica Weisger
ber of Debevoise & Plimpton, a law firm. Scrutiny is intensifying
even where there is no competitive overlap between seller and
buyer. The industry’s big fear is that regulators may take a stricter
approach to “common ownership”, meaning they would consider
all firms in a manager’s portfolio as part of the same entity.
Private markets face scrutiny from guardians of fiscal stability,
too. The bishas warned that nonbanks can “trigger or amplify
market stress” and called for a more “macroprudential” approach
to mitigate systemic risks. It highlighted hidden leverage, often at
multiple levels: not only the firms owned by leveragedbuyout
funds but also the funds themselves (which often borrow to delay
making capital calls) and their investors (Calpershas added lever
age for the first time, of 5%). The bisdid, however, acknowledge
that private markets involve less “liquidity transformation”
(shortterm liabilities funding longterm
assets) and that longterm investments
should make funding more resilient.
The industry is under assault over tax
ation as well. gps have faced repeated calls
to pay exchequers a bigger slice of their
carried interest, the share of profits made
on investments. This is taxed as a capital
gain at a lower rate than if it counted as in
come. pebillionaires have more to fear
from the end of what many see as an unfair
tax break than from heavier regulation.
One result is that the industry employs almost 200 lobbyists in
America alone, according to the New York Times. It has made con
gressionalcampaign contributions of over $630m in the past de
cade, calculates Open Secrets, a nonprofit. The investment ap
pears to have paid dividends. The Looting act is stuck in Congress
and a push to close the carriedinterest tax loophole has floun
dered. Nor has any other country closed it. The British govern
ment rejected a proposal to raise the tax. Even if governments did
act, the industry might find a way to convert carried interest into a
commonstock equivalent that still qualified as capital gain.Shark practice
Yet the industry has a huge image problem. It faces a negative
press despite insisting its reputation for stripping assets and kill
ing jobs is outdated. The British media feature stories of “sharks”
as pehas acquired such household names as Morrisons, a super
market chain. Failures to bag targets, such as Bain Capital’s abor
tive attempt to buy lv, a mutually owned insurer, are met with
glee. On both sides of the Atlantic the industry is seen as an em
blem of inequality—the more so since it emerged that kkr’s co
heads had stock awards potentially worth more than $1bn each.
The financial engineering of pe’s early days, when purchases
were mostly debtfinanced and firms were hollowed out, is less
usual now. The new charge is of antisocial behaviour. In 2020 five
academics in the privatecapital field, including Mr Brown and
Steven Kaplan of Chicago University, wrote an article on pe’s “Ac
complishments and Challenges”. Though broadly positive, it took
the industry to task for operating in “a profitmaximising way
that, although compliant with laws and regulation, is not always
what most of us would view as socially optimal”. pebacked for
profit college education is linked to worse outcomes for students.
Another stain is the carehome sector. peowned firms have
fewer nurses and worse health outcomes, partly because of “arbi
traging” of nursing regulations, the authors concluded. In Britain
private funds’ takeovers of care homes have raised pressure to
maximise revenue per bed. Many statefinanced places have been
reallocated to private payers, leading to bedblocking in hospitals
by those who could be better looked after in homes. Numbers of
selfpaying residents have risen even as supply has fallen.
Mr Brown and his coauthors say the onus should be on gov
ernments to design policy better, with fewer loopholes. Poor out
comes in education, they say, are largely down to the shoddy de
sign of studentloan schemes. But institutional investors think pe
must do more than just wait for better policy. In a survey of lps last
year, conducted by Coller Capital, a majority said that just staying
within the law was not enough and predicted that “societal pres
sure will force the industry to begin selfregulating.”
It would feel less pressure if it could persuade critics that it is a
force for good. The industry has a history of exaggerating its bene
fits and its returns, says Jeffrey Hooke, author of “The Myth of Priv
ate Equity”. Academic studies are less damning. Reports in 2014
and 2019 linked buyouts with productivity gains from exiting less
productive businesses and entering friskier ones, and from moreThe sechas
already proposed
new rules that
would force more
disclosure