Government investigations by the DOJ, FTC, and others, into private equity funds–both in the civil and the criminal space–are a recent trend that doesn’t show any signs of slowing down. 

In this episode of The Corner Series, McGuireWoods’ Geoff Cockrell speaks with fellow McGuireWoods partners, Jason Cowley and Ben O'Neil, both of whom are former federal prosecutors and current members of the firm’s Government Investigations and White Collar Litigation practice. 

Tune in to hear Jason and Ben talk about the government’s attempts to reach beyond the portfolio company to get at the investor and the private equity company itself, as well as the list of factors that the government will look at when deciding whether to extend liability up the chain. They also discuss what changes private equity funds should make, if any, in how they manage their investments.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Corner Series, a McGuireWoods series exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuireWoods partner, Geoff Cockrell, as he and specialists share real world insight to help enhance your knowledge.

Thank you for joining another episode of The Corner Series. I'm your host, Geoff Cockrell, partner at McGuireWoods. Here at The Corner Series, we bring together thought leaders and deal makers at the intersection of healthcare and private equity investing.

Today, I'm thrilled to be joined by two of my partners, Jason Cowley and Ben O'Neil. They both are partners in our government investigations group. We're going to talk some about how government investigations can touch the private equity funds. It's become a hot topic of recent. We'll jump right into it.

But Jason and Ben, can you give a quick introduction of yourselves?

Yeah, happy to. Thanks for having us today, Geoff. I'm Jason Cowley. As you mentioned, I'm on of the partners in McGuireWoods' government investigations and white collar practice. I joined the firm a few years ago, after spending about 13 years in the Department of Justice. For a big chunk of that, I was both in as a line assistant, and then ultimately ran the securities fraud unit for the US Attorney's office for the Southern District of New York. Which is known for doing a lot of interesting financial crimes cases, including in the private funds space involving hedge funds, private equity funds and the like. This is subject matter that I dealt with while I was in government, and now deal with it on the other side in private practice.

Yeah, hi. This is Ben O'Neil. Happy to be with you guys. I'm also a former Federal prosecutor. I was at the fraud section in Washington, DC. I bring some background in in particular healthcare fraud enforcement. I did a good bit of that while at DOJ, along with corporate securities fraud and foreign bribery. I joined McGuireWoods in March of last year.

So while interactions with DOJ is not something that any platform wants, from a private equity investor perspective, historically that's been viewed as a platform issue. It could be profound, but it's pretty separated from the private equity fund. Of recent, the hooks from the DOJ, and FTC, and other governmental arms have been reaching out more directly to the private equity funds.

Can you guys comment on that? Am I correct that that is a bit of a sea shift from where we were before?

Yeah. Ben, you want to have the first go at this?

Sure. Yeah. I think, really in the last three, four, five years, you've started to see the government both in civil, false claims act type cases, and then even in the criminal space, try to reach beyond the portfolio company to go at the investor itself, the private equity company itself, on the basis that that is the entity that's really profiting. There's a whole list of factors that the government will look at when making a determination about whether to extend liability up the chain. But I think it came as a bit of a surprise to people when this began, but I unfortunately don't see any signs of this slowing down.

Yeah, I'd have to agree with that. In fact, as recently as earlier this month, from the 7th, the White House made an announcement about launching a cross-government public inquiry is how they phrased it, into "corporate greed in healthcare." And actually, call out private equity firms. They refer to private equity firms specifically in talking about issues relating to antitrust and other issues. It's something that the government very specifically and explicitly is aiming its sights on these days.

In response to that, are there changes that private equity funds should make in how they think about managing their investments? What should a private equity fund do?

Great, great question. I think there's a lot of different aspects of best practices. One thing that's obviously relevant and critical is in the diligence phase. When you're thinking about acquiring a particular company, there's a lot of different lenses I think you need to employ when doing that work. So you want to do that work obviously from an antitrust perspective, from a perspective of how you're setting up your level of oversight and direct management of the entity. And, the level of diligence you want to employ in making sure there's no skeletons in the closet, so to speak, in the portfolio company that you're thinking about acquiring or investing in. That's some initial thoughts as an overview.

I know there's been some recent DOJ guidance on corporate acquisitions that's got some relevance into this space, that I know Ben knows well.

Yeah. I think this was a policy pronouncement by the DOJ that came out in October of this past year. This DOJ has been issuing policy announcements on a monthly basis, but this one in particular I think got a lot of attention, because it was really squarely directed at M&A transactions and leniency in that space.

At bottom, what it says is if a company identifies wrongdoing and in an acquired entity, and it discloses that wrongdoing to the Department within six months, it can get what's called a declination, which is the most favorable resolution, which basically says the government will not prosecute the company for the wrongdoing. And then the company, once its done that, it has a year to actually remediate or fix the conduct. I think this has a ton of potential to be an important program for DOJ and for private equity because it does provide some insulation from instances where, unbeknownst and really through no fault of an acquiring company, it comes across wrongdoing.

You speak of wrongdoing a bit like it's a binary assessment.

Right.

When I'm working on a deal, you find something and you realize that target, or something in the background of the target, they made a close call. We make lots of close calls in shades of gray. You're trying to look at the shades of gray and figure out, well how dark is this shade versus some other way of approaching that, how has the market approached this question. Do these pronouncements and pathways shift at all how either legal practitioners or private equity funds should think about how they assess shades of gray?

Yeah. I think that, if you look at the cases that have actually been brought and what was the focus, you can see that there's a level of intent, I think, behind the conduct. Purely innocent, this is a close call, we're documenting all the reasons we think it's okay, this seems to us something that, based on pronouncements, based on policy, based on other cases, we think is on the up-and-up, you can find yourself in decent shape down the road. I think it's a really fact based inquiry.

I share your concern. It's not perfect, and you're having to make tough calls about what does and doesn't cross the line. But I think there is enough out there that can guide you as to whether, all right, this is something where we really think the company being acquired, someone has stepped over the line or gone beyond innocent intent.

I would just add to that, I think has been referenced, a lot of these are just judgement calls. But as we often counsel clients, the question is, in particular in acquisitions, would you rather be dealing or addressing this issue now, and trying to put it to bed, or would you rather maintain the risk of a DOJ or the like knocking on your door a year from now, once the transaction's completed? That's a cost-benefit analysis I think that is specific to the facts, specific to the context, if there is an appetite to try to address any potential exposure that acquired or to-be-acquired company brings to to table. But some of these recent policy provisions provide a good formalized process, if you will, to provide some expectations and clarity as to what the outcome might be.

It's a little intimidating in the context of a transaction, especially if there was a shades of gray call by the target. It's difficult to insist that full out disclosure become a part of the solution. Every historic regulatory risk has a couple features. One is magnitude, the other is probability of something happening from it. Disclosure brings that probability to 100%, when it certainly wouldn't have before. How are you seeing buyers react to that calculus, and sellers?

Great question. From my end, it's a lot of discussion on some very relevant subject matter areas. How old is the conduct an issue? Do we think it crosses a line? Do we think it's something that the DOJ might have interest in? What the implications are for each road one might go down. For example, what would a penalty look like in a world where there was some sort of reporting of this, and how much bigger would a penalty be if there wasn't?

You see you have the ability to do some creative problem solving thinking, with respect to these issues. I've personally seen, for example, the nature of investments change. Where, instead of putting in an equity stake where you might be the majority equity holder, instead it might be some sort of debt-based investment, or something like that, to limit the investor's exposure to some of the risks there and being on the hook for some of the financial liability.

It's an assessment of the risk at issue, and then I think it's some upfront problem solving as to what's the best structure here, in addition to making a decision about whether or not to self-report any conduct. Is there a way to structuring a deal to mitigate risk as well.

And Geoff, I would just add I think that what makes this new policy unique is very clear as to a declination, a complete walk away by DOJ is the result. I think in the context of other self-disclosure discussions, it's really much more gray. Not only do you have the gray of the conduct, you have the gray as to, "Okay, if we report this, what is the likely outcome?" Because there are instances where companies have self-reported and then ended up with a really harsh penalty. I think the aim here at DOJ really seems to have been to provide a significant incentive for self-reporting. You get certainty that, as Jason said, that no one's going to show up knocking on your door a year from now. Certainly, not a situation anybody wants to be in, but it is, I think, the aim was to really give an outcome that is palatable to someone who, unfortunately, stumbles onto something once they've made the acquisition.

The posture of the government is not static over time. Meaning, there's degrees of how aggressively the government is pursuing things, and that can ebb and flow. From where we sit now, certainly the posture is more aggressive. Do you think that that is emanating from the civil servant side of the government? Meaning, the agency as a whole. Or, is that emanating more heavily from the political leadership and political appointees? And if your thought is the second, does changes in administration lend itself to rethinking that posture from the government?

It's a great question, Geoff. I think there's a lot to unpack there and think about there. Certainly, I think you see a really heightened enforcement emphasis in this administration compared to the last administration in this space. That can be driven by a lot of things.

One thing that I know, I think drives at least the SEC, and the DOJ is banking on this based on public statements of a lot of political appointees, is the financial reality of how much money flows in the private equity deal space. For example, I think private equity deals in healthcare exceed $1 trillion on 2021, is one metric that we've seen. You have an entire enforcement division within SEC, asset management division, that focuses a lot of its time and energy in the private funds space. You see an emphasis that I think is driven by the economic reality of how private equity is taking on an increasingly larger role in our economy. And certainly, you see that coupled in announcements that are being made as high up as the White House, in addition to DOJ, Department of Health and Human Services, FTC, you name it. It certainly is a time of great focus on private equity.

Yeah. I think, no question, you see this. Jason, you mentioned this pronouncement from the White House. It's hard to read that as anything other than political, given the environment.

It's interesting. In some ways, I think everyone had the impression that, under President Trump, enforcement would be down, corporate enforcement. But actually, 2016 to 2022, was a very active period in enforcement. I think, Geoff, it goes to the question you raise. It's often times, you can have words coming out of the mouth of a political appointee or someone at the very top of the Department of Justice, but that doesn't always line up with what the people on the ground are doing. The work's not going to stop if we have another President Trump administration in the fall of 2024 or the beginning of 2025. Enforcement activity that's ongoing will still be ongoing.

I think there will be some policy tweaks, and you probably might see some different types of pronouncements. I think that's for certain. But I don't think the actual nuts and bolts of prosecution is going to change all that much.

A lot of the pronouncements, whether from state officials or letter from Senators, they paint a picture of private equity investors that is very foreign to me. It paints incentives, and single-minded, aggressive approach that is inconsistent with what I actually see in private equity funds. Whom, in my experience, have a much more holistic view, especially in healthcare investing, of being very, very interested in controlling costs. And the macro level, very interested in patient care, patient access. And often, private equity gets portrayed dimly against those metrics. What do you think private equity funds and the industry can do to rehabilitate some of that, either in the macro sense as a industry, or in the particular context of a specific deal?

Great question. I think I'll maybe start with the latter, in terms of a particular deal. From our perspective, what we often try to do when we're involved is think about what is a potential interaction with a regulator or the DOJ going to look like in two years, if this particular acquisition, or the conduct, or the underlying company is ever going to be put under the microscope, how can we paint a picture of a very responsible investor?

There's a lot of different ways of doing that. Obviously, a very thorough and well-documented diligence process. I think a very thorough and well-documented commitment to compliance, commitment to motivating patient care, and high quality deliverables for the underlying customer, IE the patient, in a way that, two years later, you can present that to the Department or a regulator and say, "Look how careful and thoughtful we were, with respect to these hot button issues. We understand you're now around, looking into this, but we want to show you this evidence documenting what a responsible corporate citizen and investor that we've been throughout this transaction."

Yeah. I think it's also worth mentioning, when you look at instances where this has gone badly for a private equity holder, a lot of times it's about the incentives that have been set up for the portfolio company. Are the incentives aimed purely at increasing profits, or can there be other metrics? Can you look at patient care and some of the other things that you mentioned, Geoff.

So I think, to Jason's point, being able to point to, "Look, we weren't just focused entirely on profits. This acquisition, there were relevant factors that went far beyond that. We did what we could on our end to incentivize good conduct from the portfolio company's executives, as they were coming under our umbrella." A lot of times, these cases really do come down to what was the person in charge incentivized to focus on. Was it purely dollars and cents, or were there broader implications?

Yeah, that's consistent with the advice that I give platforms and private equity funds at every level. And I don't mean this cynically, I mean it holistically. At every level and every part of the process, make sure you know what your values are and make sure that shines through in how you talk, what you incent, everything. That improves a lot, both what you and your people will do, but also how it'll be reviewed later.

The second piece that I counsel platforms on is to really, in numerous arenas, really, really understand where your risk frontier is. If you're talking antitrust, maybe that's your managed care contracting team. If that's your risk frontier, then make sure that everyone that is engaged in those areas has a clear understanding of what the boundaries are, what the rules are, how they need to think about these topics, and just really engage in training and understanding by the people who are actively engaged in your business at that specific risk frontier.

Yeah. I think, no question. I think as you said, I think you used the word holistic, I think so much of what DOJ focuses on, it's in a little bit of a different context, but it's this notion of tone at the top. If you can point to all the ways in which you were setting the right tone for your portfolio companies, I think that serves you really well down the line.

One last question. As you look forward, are there areas that you anticipate will be heightened areas of inquiry in the next year, two years, that maybe have been less now? Or is it going to be more and further engagement in the same?

Yeah. I think there's a few different subject matter areas where you're going to see continued and enhanced scrutiny in the private equity space. Some are things that are already on the radar. I think both in the false claims act space and in the antitrust space, which it's no secret that those are areas where various government agencies are focusing on private equity. I think you're going to see a continued emphasis on that. I think that you see that playing out in a lot of the cases being brought, a lot of the resolutions being brought, that maybe five years ago might have been just against a portfolio company. And now, they're including the private equity investor with respect to those.

I think in addition to that, one other area that you'll see some interest in is representations around value of different positions held in portfolio companies. The DOJ and the SEC have been active in the past in the hedge fund space, with respect to over-valuation allegations about investments. You see that increasingly applied to the private equity space. For example, there was a major matter that came out of SDNY a few years ago, of the Abraaj entity, which was a huge private equity entity based in Dubai. There was a number of allegations of fraud by the DOJ there, including an over-valuation of its positions in particular companies. That's another area that I'm confident the SEC and the DOJ are out there trying to make cases and set examples with respect to.

Ben, I don't know if any others jump out at you as particular areas of enforcement?

I think the government and the DOJ has actually been remarkably transparent about what they're focused on. A lot of times, they enforce through fear because they feel they can't police everything after the fact. But, I think they've been clear about their priorities. I have no reason to think the focus, the really strict scrutiny on antitrust issues and really deep involvement by a private equity firm in the day-to-day of portfolio companies. We talked a little bit about incentives, but setting up systems that could lead to submission of false claims, that type of activity I think will continue to be pretty squarely within their crosshairs.

Jason, Ben, I think we'll wrap it there. Certainly, an interesting and timely topic. I really appreciate you guys joining me. Thanks a ton.

Our pleasure. This was a great conversation. We appreciate it.

Glad to do it.

Thank you for joining us on this installment of The Corner Series. To learn more about today's discussion, please email host Geoff Cockrell at gcockrell@mcguirewoods.com. We look forward to hearing from you.

This series was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this series, you acknowledge that McGuireWoods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information or opinions expressed are solely those of the individuals involved, and do not necessarily reflect those at McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state, and should not be construed as an offer to make or consider any investment or course of action.