Legal Briefs

Congressional lawmakers are widening their newfound interest in the buyout business.

Rep. Barney Frank, D-Mass., who leads the House Financial Services Committee, has reportedly sicced Congress’s watchdog on LBO firms. The Government Accountability Office is launching an investigation into how private equity firms structure themselves and operate, according to the Private Equity Insider.

The under-the-hood look at private firms follows a similar study of hedge funds, released last month, and generally continues lawmakers’ scrutiny of what they consider to be opaque corners of the financial market. In addition to shining a light on whatever subject is under the microscope, GAO reports tend to set the stage for new regulations, although lawmakers didn’t immediately recommend legislation following the hedge fund report.

Nonetheless, the GAO’s report on hedge funds was not altogether favorable to that industry, and it got a lot of play in the press. The title of the report sums up its blend of even-handed-sounding assessment and call to action: “Regulators and Market Participants Are Taking Steps to Strengthen Market Discipline, but Continued Attention Is Needed.”

On the one hand, the hedge fund study concluded that since the collapse of Long Term Capital Management, the Securities and Exchange Commission and market participants have done much to prevent investment houses from assuming a potentially destabilizing amount of risk. On the other hand, the report found that hedge funds, because they’re so highly leveraged and because they still lack sufficient transparency, continue to pose a “systemic risk.”

Like hedge funds, buyout firms haven’t enjoyed the most favorable reception in Washington. LBO shops and professionals have been accused of paying too little in taxes and of slashing payroll at portfolio companies in order to enrich themselves. Like hedge funds, buyout firms have also been chided by lawmakers for not revealing enough—for operating with a certain amount of secrecy. That shroud of mystery is one reason why Congress has been so eager to pounce on the industry. No narrative is as much fun as an exposé.

Buyout firms have responded in the last year by forming a trade group and making a more vocal case for their role in expanding the economy. Still, the industry’s reputation, which hardly even existed in the public’s imagination two years ago, isn’t terribly strong.

Even if the GAO report doesn’t lead to new laws, it will undoubtedly lead every major news outlet—as happened with the hedge fund study—to publish a story about how LBO firms present a risk to the economy. That’s not going to help mend a sullied reputation.