“Small Smiles, a string of dental clinics preying on unsuspecting poor families. As a Wall Street executive, Glenn Youngkin took over this chain of dental clinics, increasing corporate profits through serious abuse and the performing of unnecessary procedures on children.”

— Voice-over of a Terry McAuliffe (D) campaign ad, released Sept. 24

We dealt briefly with this advertisement as part of a roundup of debate claims made by former Virginia governor Terry McAuliffe, who is vying to get his old job back, and the Republican candidate Glenn Youngkin.

During the debate, McAuliffe had claimed, “When [Youngkin] was the chief operating officer, he was running a company called Small Smiles, which actually was cited a huge fine from the inspector general because what they were doing was unnecessary medical procedures on children.”

This is part of a general attack by McAuliffe on Youngkin’s business career. The GOP candidate rose to be co-chief executive of the private equity firm Carlyle Group and, as Mitt Romney discovered in the 2012 presidential campaign, bad deals can become campaign fodder.

Based on information we had received from both campaigns, we were under the impression that a Carlyle fund had acquired the holding company of dental clinics that catered to poor families. After all, an old webpage of the Carlyle Group listed the holding company Forba as part of the “portfolio” of Carlyle Mezzanine Partners, acquired in September 2006. So in the debate fact check, we focused our reporting on whether there was an overlap of problems at the clinics during the period Youngkin was chief operating officer from March 2011 to June 2014. (The answer: about six months.)

In a previous life, The Fact Checker was editor of a newsletter called Corporate Financing Week, and the name of the Carlyle fund should have been a tip-off that something wasn’t right. Mezzanine financing generally involves issuing subordinated debt with an option to obtain equity — a share of ownership — if a company runs into financial trouble. It does not mean acquiring a company.

The McAuliffe ad briefly flashes an image of a 2013 Senate investigative report. We have now dug deep into that report and found a memo outlining the proposed deal. Our colleague Alice Crites located relevant documents in bankruptcy court. (We did not trust the contemporary reporting on the bankruptcy, which was often wrong.) The bottom line: When the problems highlighted in the ad emerged, Carlyle was not involved in the management of this company and did not own it.

The Facts

Small Smiles first opened in 1928 as a small dental clinic in Pueblo, Colo., according to an archived Web history of the company. In 1967, it became the first dental office to cater to children covered under Medicaid, the health-care program for the poor. By the end of 2006, it had opened dozens of clinics in 16 states — and that’s when it attracted the attention of private equity bankers.

But the buyer was not Carlyle; it was a Bahrain-based investment firm called Arcapita. This added a level of complexity because the financing needed to comply with sharia practices.

According to the deal memo prepared for Arcapita, the business was attractive because Medicaid is a quick and stable payer and nearly 75 percent of American children eligible for free dental care did not receive it. State regulations prevented Forba, the holding company, from owning the dental centers or employing the dentists. But it in effect owned and managed the clinics by providing management services — billing, leases, employment — that absorbed all of the Medicaid payments.

After completion of the deal, Arcapita would own 93.9 percent of the company in exchange for a cash investment of $211 million, the memo said. Senior management would own 1.1 percent, and another 5 percent would be owned by incentive plan for other employees. That adds up to 100 percent.

As the Senate report states, “Arcapita was the private equity firm that owned FORBA, LLC.”

Indeed, when the deal was announced, Arcapita was described as the owner. “Bahrain-based international investment firm Arcapita Bank yesterday said it has acquired Sanus Holdings, which operates as Forba, one of the leading dental practice management company that focuses on providing oral care to the underprivileged children in the United States,” reported the Gulf News.

“King & Spalding Represented Arcapita Inc. in its acquisition of FORBA, LLC, a dental practice management company, for $435 million,” said Dental Economics in a 2009 article on the growth of dental practice management companies.

Arcapita also reports the Small Smiles deal as a 2006 acquisition on its website.

So where was Carlyle? The Carlyle Mezzanine Partners fund was one of the firms supplying the loans underwriting the deal — second-tier debt worth $85.5 million and what are known as payment-in-kind notes worth $21 million. (The top-tier loan was supplied by another banker, CIT Group.) PIK notes are another type of mezzanine financing, in which interest on the debt is not paid at first but instead is added to the debt.

At the time, Youngkin was global head of the firm’s industrial-sector investment team, which focused on a different fund — Carlyle Partners IV. So he played no role in this transaction.

Carlyle Mezzanine Partners fund shared this financing assignment with another company called American Capital Strategies (ACAS), according to the deal memo and bankruptcy court documents. As far as we can tell, Carlyle never announced its participation. But ACAS issued a statement saying the “investment takes the form of senior subordinated debt, holding company PIK notes and common equity and supports the acquisition of Sanus by affiliates of Arcapita Inc. and the Company’s senior management.”

(This statement mentions an equity investment and there is a page in the deal memo displaying a financing structure that suggests Carlyle and ACAS might share in an 8.8 percent share of another company that would own the holding company. We were not able to reconcile the discrepancy with Arcapita’s ownership stake, but in any case, 4.4 percent would be a relatively small stake. Carlyle described its Mezzanine Partners fund as primarily investing in “senior subordinated notes with warrants, preferred stock, and minority common equity securities.”)

ACAS and Carlyle charged high interest rates on this debt, according to bankruptcy documents. The subordinated debt bore interest at 14.50 percent, which included cash interest of 12.25 percent and payment-in-kind interest of 2.25 percent. No principal payments were required. The PIK notes had an interest rate of 16.5 percent but did not require any payments of interest or principal.

The 2013 Senate report specifically faulted the impact of private equity investors, which resulted in a business model “to increase patient volume as much as possible” and the use of bonuses “to incentivize their employees, both dentists and non-dentists, to maximize volume and profit.”

The Arcapita deal document noted that 33 percent of Medicaid patients break their appointments. The company’s management claimed it had figured out a way to get around the problem by overbooking appointments. “Since FORBA employs a minimum of three to four dentists per clinic, FORBA can leverage its critical mass of dentists and over-schedule appointments by 25%,” the memo said.

Even so, the company began missing interest payments in 2008 after its business tanked following a 2007 investigation of poor dental practices by WJLA, a local ABC News affiliate in Washington, D.C. (Scenes from this report are shown in the McAuliffe ad.) A federal investigation soon followed, resulting in a $24 million settlement, and numerous class-action suits were filed.

In 2010, the company renegotiated its loans with Carlyle and ACAS, exchanging the subordinated debt, the PIK notes and accumulated interest for new loans and preferred shares that gave the two firms ownership interest worth 27.41 percent, bankruptcy documents say. As part of the new deal, ACAS was permitted to name two directors to the company’s nine-member board and Carlyle one director — suggesting their equity ownership was not equal. Representatives of Carlyle, ACAS and Arcapita were also added to a four-member committee “tasked to independently review the medical and regulatory compliance” of the company.

When the company filed for bankruptcy two years later, Arcapita still held the “vast majority” of the equity, according to John Tishler, the attorney who handled the bankruptcy for the holding company.

The McAuliffe campaign defended the ad by pointing to news reports that inaccurately or incompletely described the ownership of Small Smiles.

“Glenn Youngkin said he will own everything that happened at Carlyle and, according to public reporting, Carlyle owned a pediatric dental company with a history of horrific and inhumane practices,” said campaign spokesman Renzo Olivari. “They mistreated children to drive up their profits. Now that he is running for governor, Glenn is putting politics over kids’ health by advocating against covid vaccine requirements for teachers that would keep them safe. It’s clear that Glenn Youngkin’s agenda would be disastrous for Virginia’s kids.”

The Pinocchio Test

On just about every level, this campaign ad is flat-out false. It claims that Youngkin “took over” the dental clinics. Not only was he not part of the original transaction, but Carlyle did not own or manage the clinics; it merely helped fund the deal with loans.

After the problems were exposed and the company failed to make good on its loans, in 2010 (before Youngkin became chief operating officer), the loans were renegotiated to give Carlyle a relatively small equity stake. Only at that point did Carlyle even have the right to name a board director. But the company still was mostly owned by Arcapita, the Bahrain investment firm. One might fault the terms of the Arcapita purchase for increasing pressure on company executives to maximize profits — but again, Youngkin had no role in the original deal.

Given that the ad displays an image of the Senate report — which says that Arcapita owned the holding company of Small Smiles — there is no excuse for such flimflammery.

McAuliffe earns Four Pinocchios.

Four Pinocchios

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