Managers Of Funds May Face Stiff Taxes
House Democrats Offer Bill; Blackstone Shares Rise in IPO

By David Cho and Tomoeh Murakami Tse
Washington Post Staff Writers
Saturday, June 23, 2007

Top House Democrats yesterday proposed one of the most far-reaching changes to tax law in decades that would more than double what managers of private-equity and hedge funds are required to pay.

The bill could raise billions of dollars for the federal government from some of Wall Street's wealthiest and most powerful financiers at a time when Congress is considering cutting the taxes paid by middle-class Americans. It was announced the same day that the private-equity firm Blackstone Group completed one of the richest initial public offerings in Wall Street history.

Blackstone shares rose 13.1 percent from its opening price of $31, closing at $35.06. The closing price set the value of the stake held by chief executive Stephen A. Schwarzman at $8.8 billion and put almost $700 million in cash in his pockets. A whopping 113.1 million shares were traded.

The House bill goes much further than legislation the Senate Finance Committee proposed last week, which would force only private-equity firms that go public to pay higher taxes. The measure in the House would affect all private-equity firms as well as some hedge funds, venture-capital firms and real estate partnerships.

Opponents of the proposed bill worry that it could choke the success of these fast-growing sectors, which are an integral part of the financial markets and key funding sources for companies in many different industries.

Private-equity firms pool funds from super-wealthy investors, pension plans and other financial institutions. The firms combine this money with their own money and with loans to acquire entire companies, turn them around and sell them for a profit.

In recent years, with unprecedented sums in reserve, private-equity firms have been able to buy all but the biggest companies. Some of their prize catches include Dunkin' Donuts, Chrysler, Toys R Us, Clear Channel Communications and HCA, the nation's largest hospital company.

Hedge funds are similar in that they pool money from large investors. But they often trade in stocks and bonds that provide financing for corporations.

In general, 80 percent of the profit from these funds is returned to investors. The rest, which is called "carried interest," is paid to fund managers and is taxed at the 15 percent capital-gains rate.

The rate would increase to 35 percent under the bill authored by Rep. Sander M. Levin (D-Mich.), a senior member of the House Ways and Means Committee, and signed by 13 other Democrats, including Ways and Means Committee Chairman Charles B. Rangel (D-N.Y.) and Financial Services Committee Chairman Barney Frank (D-Mass).

"It's a matter of equity and tax fairness," Levin said in an interview. "How do I say to somebody who provides services or other kinds of work in an ordinary job that you pay an ordinary income tax, but someone who is running an investment management company pays a capital gains tax."

Rep. Eric Cantor (R-Va.), also on the House Ways and Means Committee, called the bill an "all-out assault" on a "successful growth industry that benefits not just people on Wall Street but all Americans."

"We are not here in Washington to cut off growth and innovation," Cantor said in an interview. "This bill just doesn't make sense. If you want to discourage long-term investment in this country, then this is the direction you take."

Doug Lowenstein, president of the Private-Equity Council, the sector's lobbying group, said the bill "would substantially undermine the private-equity industry, which has strengthened and made more competitive hundreds of companies."

He added that the sector has returned more than $430 billion in profits to pension funds, endowments, foundations and other investors since the early 1990s.

Victor Fleischer, a law professor at the University of Illinois, who has advised lawmakers on the issue, said the House bill would cause a "significant change in the private-equity world." But, he added, "it is not going cripple the industry as some people have suggested."

The move by the House Democrats did not surprise to Charles White, a senior portfolio manager at ThomasLloyd Funds. "There's been a lot of money made in [private equity], and the government will always look for sources of new revenue, particularly with an election year coming up," he said.

The private-equity and hedge fund boom has been so good that many fund managers have considered selling shares in their companies to the public to raise more money -- and to enrich themselves. The first major firm to do so was Blackstone. Its IPO generated enormous excitement on Wall Street, but also drew scrutiny from Congress over the low tax rates it pays.

Still, despite a flurry of bills sparked by Blackstone's IPO, Congress has not been able to shut down the private-equity party. Kohlberg Kravis Roberts, another private-equity firm, may soon follow in Blackstone's footsteps.

KKR yesterday hired several investment banks to explore going public, said a person with knowledge of the situation. Such a move would allow KKR's partners to reap hundreds of millions of dollars.

Tse reported from New York.

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