Mary, quite contrary

In working as a lobbyist for the National Venture Capital Association, Mary Kuusisto says she kept seeing a certain study in the hands of congressional aides. ?Two and Twenty: Taxing Partnership Profits in Private Equity Funds,? written by University of Illinois School of Law faculty member Victor Fleischer, has been used by proponents of increasing the tax on carried interest in the US. The study has been widely circulated on Capitol Hill.

Kuusisto, a tax partner at law firm Proskauer Rose, decided to create a similarly scholarly document that would act as a rebuttal to Fleischer's work and, she hoped, would place carried interest taxation in a context that would help lawmakers see its value, thereby keeping its rate in line with long-term capital gains.

The result, ?Beyond Two and Twenty,? was rushed to completion just as the two members of the US House of Representatives introduced legislation that would tax carried interest as ordinary income, which is taxed as high as 35 percent, as opposed to the 15 percent currently enjoyed by receivers of carry.

The otherwise highly technical, 33-page document begins by claiming that the Fleischer article ?confuses rather than illuminates tax policy? regarding carried interest. It also argues that much of the interest in the subject is due to recent ?sensationalism? surrounding private equity and the wealth it has created for some fund managers.

Kuusisto spends some time addressing the mechanics of how interests in carried interest are currently granted and taxed. Of greatest interest to GPs will be her section headed ?Sound Tax Policy Should Encourage and Reward Entrepreneurial Risk,? where Kuusisto argues that carried interest or ?compensatory partnership interests? are similar to other forms of equity compensation.

While much of the capital put at risk by private equity GPs are from their LPs, Kuusisto argues that US tax policy should take seriously the investment of ?human capital? in an endeavor, i.e. sweat equity. ?To deny [long-term capital gain rate] treatment to human capital?would encourage workers to strip profits out of their businesses in the form of guaranteed non-profit-based salaries rather than build capital value in those same companies,? she concludes.

If private equity lobbyists spot congressional aides carrying copies of Kuusisto's paper under their arms, they'll have greater reason for hope.

Lobbying bonanza in Washington
Lobbying firms in Washington, DC are seeing brisk business from large private equity firms, who want to defeat a proposal to raise the tax rate on carried interest, among other issues. In addition to backing the Private Equity Council, a new lobbying group created to advocate for private equity on Capitol Hill, many firms have hired veteran lobbying organizations to further counter a growing chorus of voices who say private equity GPs pay unfairly low taxes. According to public records, Apollo Management has hired Brownstein Hyatt Farber Schreck to lobby lawmakers on the tax issue. Kohlberg Kravis Roberts has hired the lobbying division of Akin, Gump, Strauss, Hauer & Field having previously hired Covington & Burling last March. The Private Equity Council, led by Douglas Lowenstein, has itself subcontracted out to several specialist lobbying firms, including Akin Gump, Brownstein Hyatt, Capitol Tax Partners and Johnson, Madigan, Peck, Boland & Stewart. A federal law enacted in 1995 requires lobbyists to disclose new clients within 45 days of being hired.

Delaware court adds to buyout furor
Two recent Delaware court opinions have questioned the role of the management teams of two companies that have agreed to be sold to private equity firms. The rulings, both authored by Delaware Court of Chancery Vice Chancellor Leo Strine, expressed concern that the management teams of Topps Co. and Lear Co. have breached their fiduciary duties by not disclosing enough information to shareholders about possible incentives they agreed to for the deals. As the information is important to shareholders to vote on the deal, the court ruled that both companies must disclose additional information. According to a client alert from law firm Latham & Watkins, Strine's rulings validate the use of go-shop provisions as a substitute for a pre-signing auction and allow for ?standstill? agreements to be used for legitimate purposes, as long as they are not abused. But the motives of key managers and independent directors continue to be scrutinized to assess the quality and independence of the sale process and to assure shareholders are given the information required to evaluate the deal.

Blackstone fires back in ?loophole? fray
The Blackstone Group has issued a press release to refute a New York Times cover story which concluded that the firm employed a loophole to avoid taxes on profits from its IPO. The newspaper suggested the partners would not have to pay tax on up to $3.7 billion of the $4.75 billion raised in the offering. The release argued that on the contrary, the partners face a $900 million tax bill as a result of the IPO, saying the article was ?filled with inaccuracies, myths and misrepresentations.? The Times reported that the partners transferred goodwill worth $3.7 billion to a new corporation before selling shares to the public and then paid a 15 percent tax on this figure, equivalent to about $553 million. The goodwill is then deducted at a 35 percent rate by the new corporation, so the paper valued the deduction at $1.3 billion over a 15 year period. The release countered that the partners would pay tax on every dollar they receive from the IPO at the normal capital gains rate and rather than taking advantage of loopholes, it was using the standard tax method employed widely by private and public companies when businesses are sold. Blackstone ended the response by charging that the paper mischaracterized the IPO in saying the partners sold goods from their ?left pocket to their right.? In fact, Blackstone claimed, it sold business interests to the public.