Senate Bill Rattles Private-Equity Nerves

Industry Blindsided by Measure That Would Double Tax Bill for Going Public

Until this week, few private-equity firms expressed worries about what lawmakers in Washington could do to dampen the white-hot success of the buyout business.

Today, many are concerned.

A bill two influential senators introduced Thursday took many private-equity executives by surprise and sobered the mood of a sector that has had little bad news. The measure by Senate Finance Committee Chairman Max Baucus (D-Mont.) and ranking minority member Charles E. Grassley (R-Iowa) would thwart a major tax advantage private-equity firms had hoped to enjoy when they sold shares to the public.

"It's safe to say everybody in the industry was surprised," said a private-equity industry operative who has been talking to many firms and spoke on condition of anonymity because he was not authorized to speak for them.

How such sophisticated and wealthy financial firms could have been taken off guard by a bill in Congress might signal the sector's political awakening, analysts said.

The industry's lobbying group, the Private Equity Council, is only four months old and has three full-time staff members working in a temporary office near the White House.

Private-equity firms have not been major donors to political campaigns, although that is changing. In the first three months of this year, private-equity professionals gave about $530,000 to presidential candidates, with Republican Mitt Romney, the former head of the buyout shop Bain Capital, getting about half of that, according to Thomson Financial's Private Equity Hub.

Private buyout shops have had little reason to be concerned about public policy or politics, except for helping friends get elected, analysts said. But in the last few years, the firms' prominence on Wall Street has begun to attract attention from Washington.

In March, Blackstone Group became one of the first major private-equity firms to file for an IPO, taking advantage of a 20-year-old tax provision that would allow it to pay the 15 percent tax rate on capital gains as a limited partnership rather than the 35 percent corporate rate.

Publicly traded partnerships are rare, especially in the financial sector. After Senate Finance Committee aides read about the dangers of allowing such expansions in Tax Notes, a trade publication they call "the bible," they became concerned that Blackstone's offering could lead to a wave of financial firms reorganizing themselves to take advantage of the tax provision.

Going public is the primary way partners in private equity firms can place a dollar value on their companies and enrich themselves in the process. The Baucus-Grassley bill came just 10 days before Blackstone's IPO, which would generate billions of dollars worth of stock and hundreds of millions in cash for its top executives. Now, that offering could be delayed, analysts said.

Initially, the Senate Finance Committee staff focused on whether Congress could change the law on how private-equity firms are taxed on the profits from their funds, which are known as "carried interest." But by late May, they decided that legislation preventing investment companies from using partnerships to reduce taxes might be easier to pass than trying to change the tax code on carried interest.