Private Equity: Rescuing Capitalism
Commentary
Running a publicly traded company in America in 2023 is torture. Breaking the federal government’s voluminous rules, even unintentionally, can land you in prison. If, for example, a judge or jury can be convinced one of the investors in your public shares knew things he shouldn’t have, and profited from the information, he will be tarred, feathered, and incarcerated as an insider trader, the moral classification of which in the present culture lies many notches beneath that of sexual deviate.
The disgraced stock trader Ivan Boesky’s use of information regarding various companies’ impending mergers and other proposed deals was an ill-defined offense seldom prosecuted, but the mega-broker had made hundreds of millions of dollars, and resentment of wealth was in the air in the mid-1980s. He ended up paying over $100 million in fines and spending three years behind bars, even though he agreed to rat out on others.
All-star Major League Baseball slugger Doug DeCinces’s crime essentially was to be a friendly next-door neighbor to the chief executive of a struggling publicly traded medical supply company. Instead of borrowing a cup of sugar, the home run-hitting third baseman got a tip about an impending merger and used it to make over a $1 million. The Securities and Exchange Commission (SEC) made him pay $2.5 million, he was convicted on 13 counts of insider trading, and in 2019 at age 68 sentenced to eight months of home detention. (It’s unclear if the sentence forbade fraternizing across the picket fence with others in DeCinces’s neighborhood.)
The real crime seems to be that someone did too well and ignited envy and resentment in others. The truth is that insider trading—legal until the presidency of Franklin D. Roosevelt—would make stock prices a truer measure of the value of a company by providing more information to the market sooner, benefiting all investors whatever their net worth might be.
According to Paul Mahoney, distinguished professor at the University of Virginia School of Law, the disclosure regulations imposed on public firms “may lead companies to remain private and therefore out of the reach of the mandatory disclosure system for public companies. Such decisions can impose indirect social costs by keeping private firms operating at a suboptimal scale and by depriving retail investors of investment opportunities.” The social consequences should disturb even those on the left because, as Mahoney notes, “The latter effect may exacerbate wealth inequalities because the regulatory system constrains the ability of typical retail investors to invest in privately held companies, but puts fewer constraints on high-income or high-net-worth households.”
When Republicans attain power, they’ve been known to provide some deregulatory relief in the investment sphere, most notably the case during the presidency of Donald Trump, but always in the face of heavy fire from the Democratic Party and the media, their artillery consisting of accusations that the party of business is helping their “rich friends.” Then the regulations all come back like gangbusters, plus new ones, when the ever-more socialist-friendly Democrats get back in the driver’s seat.
Providing a solution may require a new paradigm, and the way forward might come from the private equity industry. Slandered as heartless job destroyers, a charge that helped defeat 2012 GOP presidential nominee, retiring senator, and Bain Capital co-founder Mitt Romney, private equity firms actually do the opposite. They save troubled or defective publicly traded companies by executing the extremely complicated legal process of converting them into private companies, under which status the firms can be fixed. After such life-saving surgery, they can, if ownership chooses, return to public status, with all the access to capital that offers, leading to expansion of their workforce and the prospect of lots more profit.
What if there were a way for firms seeking outside capital to reach the many of thousands of modest investors out there without having to be a public company subject to suffocating over-regulation? This new derivative instrument would probably entail such small investors signing away some or most of the rights enjoyed by stockholders, such as a contract stating that they are not among the owners of the firm, have no vote as to who sits in management, and maybe even forfeiting any and all rights to sue management. But at the same time, they would share in the profits just as if they were shareholders in a public company. An honest, transparent design would have to be formulated for the valuation of their investments, hardly an impossible feat considering the complexities formulated to contract exotic investment instruments like puts, calls and hedges.
Unlike junk bonds, turned to initially to bypass SEC regulations designed to obstruct mergers and takeovers, this new paradigm of retail investing ideally would have its genesis in the passage of laws authorizing the described innovations—hopefully featuring the exclusion of the SEC and the rest of the government from oversight and penalty jurisdiction. It is extraordinary to consider that even the Department of Justice concedes that the figure most associated with junk bonds, Drexel Burnham Lambert financier Michael Milken, who made a billion dollars over four years absolutely legally, was convicted not for anything to do with selling high-risk instruments but for failing to disclose his tampering with the prices of securities. The governing principle is obvious: “Find some way—any way—to get the guy who made an obscene sum of money.”
The costs of operating a public company are hardly worth the high blood pressure, and unburdening oneself of the regulatory octopus via technical acrobatics has been tried again and again, and seems impossible. Congress must find a way for investors to swim in other waters, where the creature does not lurk. Otherwise, as government regulation forces capitalism gets more complicated and expensive, a pure socialist economic regime—letting government run everything—will become ever more seductive to voters.
How might the introduction of mini-bonds impact entrepreneurship and economic growth in the United States
All dividend or profit-sharing rights. In return, they would receive a periodic payment based on the company’s performance, similar to bondholders receiving interest payments.
This new instrument, let’s call it a “mini-bond” for simplicity, would allow companies to raise capital from a large pool of small investors without the burdensome regulations imposed on publicly traded companies. It would provide an alternative avenue for companies to access much-needed funding while avoiding the scrutiny and restrictions that come with being a public company.
Of course, there would need to be safeguards in place to protect investors. Companies issuing mini-bonds would still be required to provide transparent and accurate financial information, just like publicly traded companies. Independent auditors could verify the company’s financial statements to ensure compliance.
Additionally, there could be limitations on the amount of capital a company can raise through mini-bonds to prevent abuse or fraud. Regulators could monitor the market to ensure that companies are not exploiting small investors or engaging in unethical practices.
The introduction of mini-bonds would not eliminate the need for public companies. Large corporations that require substantial capital or prefer the advantages of being publicly traded would still have the option to pursue traditional IPOs. Mini-bonds would simply provide an additional avenue for smaller companies or startups to raise capital without the burdensome regulations of being publicly traded.
This new paradigm could stimulate entrepreneurship and economic growth by providing more opportunities for companies to access capital and expand their operations. It would democratize the investment landscape by allowing small investors to participate in the growth of private companies, potentially bridging the wealth gap by providing investment opportunities that were previously only available to high-net-worth individuals.
In conclusion, the current regulatory environment for publicly traded companies in America is stifling innovation and hindering economic growth. The obsession with insider trading has created a culture of fear and uncertainty for executives and investors alike. Introducing a new derivative instrument like mini-bonds could provide a solution by allowing companies to raise capital from small investors without the burdensome regulations of being publicly traded. This would not only benefit companies seeking funding but also provide investment opportunities for small investors and potentially foster economic growth. It’s time to reconsider the existing framework and explore new possibilities for corporate finance in America.
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