It’s been a very public year for private markets. As sectors like private equity have become mainstream in recent years, populist sentiment – with its suspicion of globalization and corporate greed – has spread its tentacles globally.

Rising inequality and the legacy of the Great Recession have generated debate on the impact of business and finance on voters’ day-to-day lives – not just in the US, where anti-private equity political rhetoric has intensified ahead of the upcoming 2020 presidential election, but also abroad. As one COO at a private equity firm said: “Realistically, populist fervor is up around the world. That will impact private equity, whether in the US, Europe or anywhere else.”

The public finger-pointing began ramping up in 2017, when Toys ‘R’ Us filed for bankruptcy. Politicians cite the case as a manifestation of private equity avarice (despite conditions in traditional retail being infamously difficult). Then in 2018, The Washington Post alleged that the downfall of care provider HCR ManorCare was caused the Carlyle Group saddling the company with debt, adding further fuel to the fires of public debate.

Elizabeth Warren

Since then, politicians – namely, Democrats in the US – have publicly taken the industry to task on other PE-backed failures. Shopko’s bankruptcy filing in January led several party leaders to publicly denounce Sun Capital Partners. Senator Elizabeth Warren of Massachusetts and New York Rep Alexandria Ocasio-Cortez sent a joint letter to Sun’s co-chief executive officers in July, demanding severance pay for Shopko employees.

Also in July, Senator Bernie Sanders of Vermont singled out Paladin Healthcare Capital head Joel Freedman over the firm’s closing of Hahnemann University Hospital in Philadelphia. More recently, Sanders has attacked Great Hill Partners-owned G/O Media as an example of the supposed threat private capital represents to independent media. Warren, Ocasio-Cortez and Rep. Mark Pocan of Wisconsin have also written to five private equity firms accusing them of profiteering off privatized services to prison inmates.

The scope of the attack ranges from mid-market firms to the biggest players. And not just in the US. In October, the new left-wing parliament of Denmark indicated it would tighten regulation on single-family rentals, citing Blackstone as a cause of concern in rising rental prices.

And, of course, there’s the ‘Stop Wall Street Looting Act’, the legislative proposal from Warren, Pocan and three other Senators that aims to fundamentally alter the economics of private equity. The bill counts carried interest as regular income for tax purposes, and holds funds and their managers financially liable for failed investments, among other things.

Industry groups have been quick to respond. The American Investment Council has been active in pointing out how private equity benefits the real economy, seeking to familiarize the public with the day-to-day ways in which the industry has impacted their lives for the better.

AIC president and chief executive Drew Maloney penned an op-ed in Iowa’s Des Moines Register, highlighting the $14 billion in private equity investments in the state in recent years. In a piece published by Fox Business News, he praised the comeback of Popeyes’ spicy chicken sandwich, noting the food chain was owned by Freeman Spogli before being sold to 3G Capital in 2017.

AIC also released videos promoting private equity’s impact on the economies of Texas, Michigan and Florida before the primary debates in each state. And it partnered with EY for a report which, among other things, points out that the industry paid $174bn in federal, state and local taxes last year.

Unlimited liability

Warren’s proposal represents the most concrete threat to private equity. “The Warren legislation would punish an industry that’s an engine of growth,” the private equity firm COO said. It adds that the proposal to hold funds and fund managers financially liable “would violate a 300-year-old convention that when you put money into something, you can’t lose more than what you put in.”

That part of the bill even includes LPs in its scope; a fact not gone unnoticed by the Institutional Limited Partners Association. The legislation would have holders of economic interest in a fund be held jointly and severally liable for all the liabilities of each portfolio company. “There doesn’t seem to be a carve-out for investors in the fund,” says Chris Hayes, senior policy counsel at ILPA. “But even if we were carved out it would be problematic. This runs against years of case law that establishes the principal of limited liability.”

A report release by the US Chamber of Commerce — the largest lobby group in the US — on November 13 echoed that concern. It noted the provision “is the equivalent of requiring PE funds and their principals to guarantee the performance of their portfolio companies to all of their creditors, which would just end PE investing altogether and is contrary to the principle of American business, which is to respect the corporate form.”

The paper, written by USC Marshall professor Charles Swenson, claims that the bill could result in the loss of up to 26.3 million jobs, and as much as $475 billion in local, state and federal tax revenue, annually. In a modest-case scenario, Swenson wrote, the proposed expansion of liability would result in a 19 percent reduction of the PE industry. There would be up to a 19 percent failure rate for PE-backed companies and up to a 19 percent reduction in returns to investors in PE.

Hayes suggested that there’s nothing stopping GPs, if the legislation were passed as written, from taking out large insurance policies to protect themselves and charging them back to LPs as an expense – and by extension, their end investors. But perhaps even more fundamentally, it poses a risk to the very companies the industry often tries to turn around. “Companies who need capital the most, and therefore are already at a higher risk of failing, would not be able to access capital from private equity funds,” Hayes says, since they would present a higher personal risk for fund operators.

More scrutiny on the way

As we went to press, the House Financial Services Committee was holding a hearing entitled “America for Sale? An Examination of the Practices of Private Funds” – perhaps the first Congressional hearing on private funds since the Dodd-Frank Act, Hayes speculates.

While the hearing portends some of the inevitable political grandstanding private equity firms are wary of, Hayes welcomes the growing investor concerns in private equity. ILPA members are pushing for greater market transparency and raising their eyebrows at what they see as an ongoing erosion of fiduciary duties to LPs. “Given that some of these investor related issues are highlighted in the [Warren bill], we do expect that some of those issues will be raised and discussed at the hearing,” he says.

“Transparency and sunlight are generally bipartisan ideals that can be achieved,” Hayes adds. Those are issues that will need addressing if the Securities and Exchange Commission broadens access to private funds to retail investors – something the SEC has been officially considering since June. This could both produce another surge in private fund investment, as well as even more intense political scrutiny.

For the sponsors, the hearing underlines the unnerving potency of the Democratic party’s recent campaign against private equity: even if the bill is unlikely to pass, it has already impacted the broader political debate, and parts of it could find their ways into future legislation. But while the industry takes the threat seriously, few firms are ready to panic.

“People have their concerns with Warren’s rhetoric, but it’s relatively early,” says a CFO at a mid-market firm. “Around here, it’s a wait-and-see approach,” the executive adds, noting that, even with a Democrat in the White House, Republicans have a good chance of retaining a majority in the Senate. Such a result would significantly hamper a Democratic president’s ability to pass legislation hostile to private equity.