Private Equity, the ‘Dynamic and Flexible’ Scam

So (apparently) says Warren Buffett.

Much of America’s slide into economic inequality dates back to 1980 and Ronald Reagan’s promise to ‘get big government out of the way.’ Perhaps artificial intelligence (AI) can referee our two-party system of government back into sensible decisions, but I doubt it. AI appears, at least for now, to be amazingly free of Democrat or Republican bias.

That would be a refreshing change at the congressional committee level

Because I have long complained about regulatory tools having been removed from the toolboxes that restrain corporate enthusiasm for earnings and executive compensation, I suggest that AI may be a tool for reclaiming those constraints. Certainly, it’s not going to happen by a sudden wave of altruism and bipartisanship overwhelming the greed and self-service Congress has carefully erected for its compensation.

Nor will it be accomplished so long as legislators prefer re-election over statesmanship (defined as wisdom and skill in the management of public affairs). The perpetrators of legislative crimes do not spend millions to win a position that pays thousands. There are other games afoot.

But the unrestricted growth of private equity is our subject at the moment

So, let’s try to agree with the terms of debate. First, unrestricted growth is the acknowledged definition of cancer. Second (and I will make the case for this), the decline of publicly listed stocks and consequent growth of private (unlisted) equity is a major move in the wrong direction regarding public disclosure.

Making my case, listed public companies are required by law to provide certain information such as

·        The Securities Act of 1933 (the “Securities Act”),

·        The Securities Exchange Act of 1934 (the “Exchange Act”),

·        The Dodd-Frank Wall Street Reform and Consumer Act (“Dodd-Frank”),

·        The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), and

·        The Nasdaq corporate governance requirements.

The Sarbanes-Oxley and the Dodd-Frank Acts implemented changes, either directly or through rules adopted by the national securities exchanges, to public company governance and disclosure requirements to enhance independent auditing, as well as make directors more independent, empower shareholders, and provide increased transparency, primarily as it relates to executive pay and accounting matters.

Some of these requirements that the company will be subject to include:

·        Audit committee requirements;

·        Nominating and governance committee requirements;

·        Compensation committee requirements;

·        Whistleblower protections; and

·        Code of ethics disclosures.

None of these are required once a public company has been taken private

While that may chill your blood a bit in the abstract, you (like me) may never have owned a share of public stock in your life. So why care?

The ‘why care’ comes down to the fact that as public companies are taken private, they disappear down a black-hole of doing whatever the hell they want, without any reporting restrictions whatsoever. Some recent examples include:

·        X (formerly Twitter), sold in April 2022, to Elon Musk for $44 billion.

·        H.J. Heinz, the producer of a famous ketchup brand, sold in 2013 for $28 billion.

·        Burger King, the fast-food restaurant chain took the company private in 2010, sold to 3G Capital for $4 billion.

·        Dell Computer, taken private for $24.4 billion in October 2013.

·        Alliance Boots PLC, the European health care and pharmacy chain, set a record as the biggest leveraged buyout in Europe when bought for $22.2 billion in 2007.

·        Equity Office Properties Trust, (now EQ Office) was the largest publicly listed owner of office and commercial properties in the U.S., acquired in 2006 for $36 billion.

·        Kinder Morgan, managed one of North America's largest energy pipelines and storage portfolios, went private in May 2007 for about $22 billion.

·        Reader’s Digest, acquired by Ripplewood Holdings LLC in March 2007 for $2.4 billion, filed for bankruptcy twice, in 2009 and 2013, rebranding itself as Trusted Media Brands.

Truth and/or consequences

According to Alyssa Giachino, research director at the Private Equity Stakeholder Project, “These companies basically get to write their own stories. They produce their own reports. They come up with their own numbers. And there’s no one making sure they are telling the truth.”

Those on the other (acquiring) side of the issue claim privatization allows longer term financial and business planning, freed from the tyranny of investor quarterly expectations. That makes a lot of sense as an argument, but it takes a lot of trust to accept. Trust or truth, there are always consequences.

Neither the corporate nor governmental worlds have a positive track-record for trust in these divided times

To quote a recent Atlantic article, “In the roaring ’20s, the lack of corporate disclosure allowed a massive financial crisis to build up without anyone noticing. A century later, the growth of a new shadow economy could pose similar risks.

“The hallmark of a private-equity deal is the so-called leveraged buyout. Funds take on massive amounts of debt to buy companies, with the goal of reselling in a few years at a profit. If all of that debt becomes hard to pay back—because of, say, an economic downturn or rising interest rates—a wave of defaults could ripple through the financial system.

“In fact, this has happened before: The original leveraged buyout mania of the 1980s helped spark the 1989 stock-market crash. Since then, private equity has grown into a $12 trillion industry and has begun raising much of its money from unregulated, nonbank lenders, many of which are owned by the same private-equity funds taking out loans in the first place.”

If it walks like a duck and quacks like a duck…make your own judgment.