Senate Bill Rattles Private-Equity Nerves
Industry Blindsided by Measure That Would Double Tax Bill for Going Public

By David Cho
Washington Post Staff Writer
Saturday, June 16, 2007

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.

Since the bill was announced Thursday, the authors "have not heard a single word of dissent," said a Republican aide on the Finance Committee who did not want to be identified because he was not authorized to speak to the press.

"I think the bill will move fast," the aide said. "We want to make sure to hear from folks, but we want to move expeditiously."

The bill's announcement has rankled the normally collegial ranks of the private-equity industry. Several firms, including the Carlyle Group of the District and Apollo Management, were considering IPOs. Now, their taxes could jump from 15 percent to 35 percent if they go public.

Yesterday, some private-equity officials pointed fingers at Blackstone and its chief executive, Stephen Schwarzman. They said that Schwarzman did not help the industry by structuring the IPO to enrich himself with a $7.5 billion stake and as much as $677 million in cash. His image, fostered by lavish birthday parties and flamboyant profiles in business publications, may have made him an easy target for politicians.

"I think there's wide perception that Mr. Schwarzman shot himself in the foot," said the private-equity industry operative who has been talking to many firms. Blackstone declined to comment.

The bill would directly affect Blackstone and Fortress Investment Group, a smaller firm that runs both hedge and private-equity funds. Since both firms have filed to go public, the bill would give them a five-year grace period at the lower tax rate. But analysts expect the value of their businesses would decline because their tax bills eventually would increase by hundreds of millions of dollars.

Stock in Fortress, which went public in February, fell 6.5 percent yesterday.

Analysts think the legislation is likely to be enacted and are adjusting the market values of Blackstone and Fortress .

"This bill is going to pass," said Scott Appleby, an analyst who follows Fortress for Deutsche Bank. "It's already got bipartisan sponsorship."

For its part, Blackstone executives were huddled in meetings yesterday to craft a strategy, said a source who has been in close contact with Blackstone but requested anonymity because he was not authorized to speak about the firm's internal discussions.

"They're trying to figure it out," he said.