[It’s an incentive system that encourages risky, even reckless
behavior but, insulated from liability, they face little consequence
if those plans fail. This explains why private equity firms often have
such sorry consequences for everyone except themselves.]
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PRIVATE EQUITY IS GUTTING AMERICA — AND GETTING AWAY WITH IT  
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Brendan Ballou
April 28, 2023
The New York Times
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_ It’s an incentive system that encourages risky, even reckless
behavior but, insulated from liability, they face little consequence
if those plans fail. This explains why private equity firms often have
such sorry consequences for everyone except themselves. _

, Tim Enthoven

 

“Private equity” is a term we’ve all heard but which, if we’re
honest, few of us understand. The basic idea is simple: Private equity
firms make their money by buying companies, transforming them and
selling them — hopefully for a profit. But what sounds simple often
leads to disaster.

Companies bought by private equity firms are far more likely
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go bankrupt than companies that aren’t. Over the last decade,
private equity firms were responsible for nearly 600,000 job losses
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alone. In nursing homes, where the firms have been particularly
active, private equity ownership is responsible for an estimated —
and astounding — 20,000 premature deaths
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to a recent working paper from the National Bureau of Economic
Research. Similar tales of woe abound in mobile homes
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health care
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medicine
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buildings
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elsewhere. Yet private equity and its leaders continue to prosper, and
executives of the top firms are billionaires many times over.

Why do private equity firms succeed when the companies they buy so
often fail? In part, it’s because firms are generally insulated from
the consequences of their actions, and benefit from hard-fought tax
benefits that allow many of their executives to often pay lower rates
than you and I do. Together, this means that firms enjoy
disproportionate benefits when their plans succeed, and suffer fewer
consequences when they fail.

Consider the case of the Carlyle Group and the nursing home chain HCR
ManorCare. In 2007, Carlyle — a private equity firm now with $373
billion [[link removed]] in assets under management
— bought HCR ManorCare
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a little over $6 billion, most of which was borrowed money that
ManorCare, not Carlyle, would have to pay back. As the new owner,
Carlyle sold nearly all of ManorCare’s real estate and quickly
recovered its initial investment. This meant, however, that ManorCare
was forced to pay nearly half a billion dollars a year in rent to
occupy buildings it once owned. Carlyle also extracted over $80
million in transaction and advisory fees from the company it had just
bought, draining ManorCare of money.

ManorCare soon instituted various cost-cutting programs and laid off
hundreds of workers. Health code violations spiked. People suffered.
The daughter of one resident told The Washington Post
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“my mom would call us every day crying when she was in there” and
that “it was dirty — like a run-down motel. Roaches and ants all
over the place.”

In 2018, ManorCare filed for bankruptcy, with over $7 billion in debt.
But that was, in a sense, immaterial to Carlyle, which had already
recovered the money it invested and made millions more in fees. (In
statements to The Washington Post, ManorCare denied that the quality
of its care had declined, while Carlyle claimed that changes in how
Medicare paid nursing homes, not its own actions, caused the chain’s
bankruptcy.)

Carlyle managed to avoid any legal liability for its actions. How it
did so explains why this industry often has such poor outcomes for the
businesses it buys.

The family of one ManorCare resident, Annie Salley, sued Carlyle
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she died in a facility that the family said was understaffed.
According to the lawsuit, despite needing assistance walking to the
bathroom, Ms. Salley was forced to do so alone, and hit her head on a
bathroom fixture. Afterward, nursing home staff reportedly failed to
order a head scan or refer her to a doctor, even though she exhibited
confusion, vomited and thrashed around. Ms. Salley eventually died
from bleeding around her brain.

Yet when Ms. Salley’s family sued for wrongful death, Carlyle
managed to get the case against it dismissed. As a private equity
firm, Carlyle claimed, it did not technically own ManorCare. Rather,
Carlyle merely advised a series of investment funds with obscure names
that did. In essence, Carlyle performed a legal disappearing act.

In this case, as in nearly every private equity acquisition, private
equity firms benefit from a legal double standard: They have effective
control over the companies their funds buy, but are rarely held
responsible for those companies’ actions. This mismatch helps to
explain why private equity firms often make such risky or shortsighted
moves that imperil their own businesses. When firms, through their
takeovers, load companies up with debt, extract onerous fees or cut
jobs or quality of care, they face big payouts when things go well,
but generally suffer no legal consequences when they go poorly. It’s
a “heads I win, tails you lose” sort of arrangement — one
that’s been enormously profitable.

But it isn’t just that firms benefit from the law: They take great
pains to shape it, too. Since 1990, private equity and investment
firms have given over $900 million
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federal candidates and have hired an untold number of senior
government officials to work on their behalf. These have included
cabinet members, speakers of the House, generals, a C.I.A. director, a
vice president and a smattering of senators. Congressional staff
members have found their way to private equity, too: Lobbying
disclosure forms for the largest firms are filled with the names of
former chiefs of staff, counsels and legislative directors. Carlyle,
for instance, at various times employed two former F.C.C. chairmen, a
former S.E.C. chair, a former NATO supreme allied commander, a former
secretary of state and a former British prime minister, among others.

Such investments have paid off, as firms have lobbied to protect
favored tax treatments, which in turn have given them disproportionate
benefits when their investments succeed. The most prominent of these
benefits is the carried interest loophole, which allows private equity
executives to pay such low tax rates. The issue has been on the
national agenda since at least 2006, and three presidents have tried
to close the loophole. All three have failed.

Most recently, in 2021, as part of his first budget, President Biden
proposed to end the benefit for people with very high incomes. But as
he made his pitch, private equity opposition surged, and the largest
firms each spent $3 million to $7 million on lobbying that year alone.
One firm, Apollo Global Management, employed the former general
counsel to the House Republican caucus, a former senior adviser to a
past speaker of the House, a former chief of staff to another speaker
and a former senator, plus more than a dozen other former officials.

As the plan wound its way through Congress, it grew weaker, and by the
fall of 2021, the proposal to end the benefit was no longer a part of
Mr. Biden’s budget negotiations. Instead, Congress approved an
amendment
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largely exempted small and midsize companies owned by private equity
firms from a new corporate minimum tax. It was an obscure but
important consideration, and with it, private equity firms managed not
just to protect a preferred tax advantage — the carried interest
loophole, which benefited people like Blackstone’s Stephen
Schwarzman, whose income in 2022 was 50 times that of the chief
executive of Goldman Sachs — but also to win a new one.

The story further explains why the actions of private equity firms
often have such sorry consequences for everyone except themselves. By
protecting favored tax benefits, firms receive disproportionate gains
when their strategies succeed. But, insulated from liability, they
face little consequence if those plans fail. It’s an incentive
system that encourages risky, even reckless behavior like that at
ManorCare, and is designed to work for private equity firms and no one
else.

But if private equity firms are powerful, so too are ordinary people,
who’ve had surprising success confronting firms regarding
unaffordable prison phone calls and surprise medical bills
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among other issues. Even if we’re unlikely to fix our tax code soon,
activists and others can still push to update our laws and hold
private equity responsible for its actions. Congress can clarify that
firms can be sued for wrongs committed by companies they effectively
control. States and cities can do the same when portfolio companies
are based in their jurisdictions. By making private equity firms
responsible for their own actions, we can build a better — and
fairer — economy, and make tragedies like that at ManorCare less
likely. All we need is the courage to act.

_Brendan Ballou (@brendanballou [[link removed]])
is a federal prosecutor and served as special counsel for private
equity at the Department of Justice. He is the author of the
forthcoming “Plunder: Private Equity’s Plan to Pillage America,”
from which this essay is adapted. The views in this essay do not
necessarily reflect those of the Department of Justice._

* private equity
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* corporate profits
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* Bankrupting America
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