Created as part of the Dodd-Frank Act in wake of 2008 Financial Crisis, the Consumer Financial Protection Bureau has a unitary purpose: “watching out for American consumers in the market for consumer financial products and services.”1 Its tasks include monitoring financial markets for risks to consumers, rooting out unfair or deceptive practices, and providing financial…
Tag: Politicking
Citi Faces (a Very Minor) Slap on the Wrist
In response to the financial crisis of 2007-2008, Congress passed the Dodd-Frank Act to bolster financial regulations and monitor Wall Street behavior. Included in the Act were amendments to Rule 506 of the Securities Act of 1933.1 Rule 506 is part of the Regulation D exemption, which allows issuers to raise capital for private offerings….
Marijuana and Banks II
On August 29, 2013 Deputy Attorney General James Cole issued a memo concerning enforcement of the Controlled Substances Act “in light of state ballot initiatives that legalize under state law the possession of small amounts and provide for the regulation of marijuana production, processing, and sale.”1 The memo noted that “the federal government has traditionally…
Marijuana and Banks
On January 23, Attorney General Eric Holder announced that the federal government was taking steps towards making it easier for depository institutions to do business with marijuana sellers.1 Holder cited “public safety” concerns noting, “substantial amounts of cash just kind of lying around with no place for it to be appropriately deposited is something that…
Buy or Sell: Geithner’s New Gig
Timothy Geithner served as the United States Secretary of the Treasury until January of this year. During his past four years in office Mr. Geithner has been an extremely polarizing figure in the financial world. His tenure was defined mostly by his dealings with the fallout of the recession. He is the name, perhaps unfairly,…
What is in a Name? Private Equity Industry Considers Label Change
Entering 2012, expectations were high for the private equity industry. Firms were finally recovering from the 2008 financial meltdown and private equity executives were confident that transactions would only continue to increase.[1] To top it off, one of the field’s very own had a legitimate chance to become our nation’s next president. Despite this favorable outlook, 2012 resulted in such damage to private equity’s image that some are now insisting the industry needs a complete rebranding.[2]
While the private equity industry has shouldered the blame for economic problems in the past, public criticism rose to unprecedented levels in the past year. The most widespread vilification occurred during the presidential election, when both Democrat and Republican rivals of candidate Mitt Romney spent millions attacking his private equity background.[3] Around the same time, a federal class action was filed accusing some of the nation’s largest private equity firms of a wide conspiracy to rig deal prices.[4] Considering the very negative popular conception of private equity following these events, it was not surprising when the Security and Exchange Commission’s enforcement division continued the assault by announcing that a regulatory heavy-hand would soon be coming down on the industry.[5]
Historically, private equity firms have not found this type of publicity overly concerning. They have had little need or incentive to uphold their image because they have operated completely in the private sector.[6] However, with many of the big firms going public in recent years, high-level private equity executives now believe that the industry must be “widely trusted” and maintain a “pristine reputation.” [7]
Looking to save face, some private equity practitioners have proposed rethinking the name “private equity.”[8] Blackstone Group President Tony James dislikes the label’s clandestine connotation and feels that it “subliminally sends the wrong message.”[9] Others argue for change by citing the fact that the industry is no longer truly “private,” as it is now regulated by government agencies.[10]
The corporate world has seen this type of makeover before. In the 1980s, “corporate raiders” became symbols of Wall Street greed for their tendency to conduct hostile takeovers of large companies. When legal countermeasures were put into place to thwart these attacks, corporate raiders revised their approach and adopted a more politically correct name: “activist shareholders.”[11] Since the re-characterization, activist shareholders have enjoyed success despite continuing to shake up companies like the corporate raiders before them.[12]
But still, in order for a name change to work, the industry must settle on an appropriate moniker. Noting how Blackstone provides its limited partners with widespread access to its portfolio companies’ financials, James suggests that the name should be changed to “clarity equity.”[13] Other ideas such as “ long term capital providers” and “opportunity capital” suggest positivity and communicate an actual function of these firms.[14]
While altering a label has helped groups repair their image in the past, it is a difficult process that is by no means guaranteed to succeed. An effective approach would supplement the name change with an effort to better educate the public on the benefits of the industry. Regardless of what these investors call themselves, their increasingly important reputation is unlikely to improve significantly unless they first make some attempt to eliminate the negativity surrounding the term “private equity.”
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[1] Hillary Canada, Survey Says: Glass-Half-Full Outlook For 1H 2012, Wall Street Journal Private Equity Beat (May 1, 2012, 7:08 PM), http://blogs.wsj.com/privateequity/2012/05/01/survey-says-glass-half-full-outlook-for-1h-2012/.
[2] William Alden, Rethinking the Term ‘Private Equity’, New York Times Dealbook (Jan. 31, 2013, 1:41 PM), http://dealbook.nytimes.com/2013/01/31/rethinking-the-term-private-equity/; Shasha Dai, Should Private Equity Industry Change Its Name?, Wall Street Journal Private Equity Beat (Feb. 1, 2013, 3:35 PM), http://blogs.wsj.com/privateequity/2013/02/01/should-private-equity-industry-change-its-name/.
[3] Tomio Geron, The Mitt Romney Effect on Private Equity and Venture Capital, Forbes (Sept. 21, 2012), http://www.forbes.com/sites/tomiogeron/2012/09/21/the-mitt-romney-effect-on-private-equity-and-venture-capital/.
[4] Don Jeffrey & Devin Banerjee, Blackstone, KKR, Bain, Accused of Agreeing Not to Compete, Bloomberg (Oct. 11, 2012), http://www.bloomberg.com/news/2012-10-10/investors-claim-kkr-told-equity-firms-not-to-bid-for-hca.html.
[5] See Bruce Karpati, Chief, SEC Enforcement Division’s Asset Management Unit, Private Equity Enforcement Concerns at Private Equity International Conference (Jan. 23, 2013) (transcript available at http://www.sec.gov/news/speech/2013/spch012313bk.htm).
[6] D.M. Levine, Carlyle and Oaktree Are Latest Private Equity Firms Expected to Go Public, The Huffington Post (Apr. 11, 2012), http://www.huffingtonpost.com/2012/04/11/private-equity-firms-go-public_n_1417734.html public_n_1417734.html.
[7] Alden, supra note 2.
[8] Id.; Dai, supra note 2.
[9] Dai, supra note 2.
[10] See id.
[11] Bob Moon, Corporate Raiders Morph Into Nice(r) Guys, American Public Media Marketplace (Nov. 26, 2012), http://www.marketplace.org/topics/business/corporate-raiders-morph-nicer-guys.
[12] See id.
[13] Dai, supra note 2.
[14] See id.
Private Equity Shares the Spotlight with Tax Reform
Post-2012 Presidential Election, the private equity industry is in the public spotlight simultaneously with the tax reform proposals. Throughout the election, private equity was a constant topic of conversation – especially Bain Capital. Acknowledging the media attention received from the election, Bain Capital addressed its investors in a formal letter thanking them for their support despite the increased scrutiny.[1] In this letter, Bain Capital attempted to portray the positive aspects of the business outside of its profits by asserting its creation of hundreds of thousands of jobs and support of hundreds of charities in its 28-year history. [2] These reassurances acknowledge the added scrutiny to the private equity industry that may not disappear post-election.
Tax reform is one topic that has emerged in response to the perceived inequities in the tax code and the need to reduce the national deficit. Earlier this year, President Obama proposed changes to the tax code to end corporate tax breaks and decrease the corporate tax rate from 35% to 28%. [3] Similarly, the top House Republican tax writer, Dave Camp, has vowed to pass tax reform legislation in 2013.[4]
With the private equity industry comprising a significant amount of the U.S.’s economic activity, this industry is not likely to avoid the effects of tax reform. Venture capital, one subset of private equity, alone provides 21% of the U.S. GDP.[5] If these efforts to close the gaps in the tax code are successful, private equity’s increased media attention comes at an inopportune time in light of the industry’s favorable “carried interest” rates.
Under the “carried interest” rule, private equity firms, alongside real estate and mining partnership structures, could lose its favorable tax treatment. In this provision, private equity firms are able to pay the capital gains tax rate, 15%, on a third of its profits rather than the income tax rate, 35%, paid on the remaining two-thirds of payments made on the guaranteed annual management fees. [6] Supporters of the favorable tax treatment argue that the private equity firms should be viewed as entrepreneurs whose risk-taking should be encouraged by this favorable tax rate.[7] Yet, some critics of the favorable tax rate state argue that private equity funds should be treated like investment bankers who use individual investor funds in these risky investments and retain approximately a 2% management fee and a 20% profit if they reach their target.[8]
Congress estimates that eliminating this favorable tax rate could generate up to $2 billion in tax revenues, increasing the attraction to close this provision. [9] Despite objections from the industry that investors would not receive adequate returns on their investments in this risky industry, there are admissions of some industry members that the “carried interest” provisions are generous.[10]
As the public and Congress continue to look more closely into the private equity industry, the favorable tax provision in private equity will not likely avoid review following the election. Consequently, as the support for tax reforms increases in the upcoming year, the media attention provided to the private equity industry makes the industry a prime candidate for tax reform in 2013, decreasing or eliminating the “carried interest provision”.
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[1] Greg Roumeliotis, Bruised by Romney criticism, Bain Capital thanks investors, Reuters (Nov. 8, 2012, 8:31PM), http://www.reuters.com/article/2012/11/09/us-usa-campaign-bain-idUSBRE8A804220121109.
[2] Id.
[3] See, Kevin Drawbaugh & Patrick Temple-West, Top U.S. House tax writer vows tax reform in 2013, Reuters (Nov. 15, 2012, 8:26 PM), http://www.reuters.com/article/2012/11/16/us-usa-tax-camp-idUSBRE8AF00620121116; Zachary A. Goldfarb, Obama proposes lowering corporate tax rate to 28 percent, The Wash. Post (Feb. 22, 2012), http://www.washingtonpost.com/business/economy/obama-to-propose-lowering-corporate-tax-rate-to-28-percent/2012/02/22/gIQA1sjdSR_story.html.
[4] Id.
[5] Brian McCann, Private Equity Searches for its Public Identity After the US Election, Opalesque (Nov. 15, 2012), http://www.opalesque.com/private-equity-strategies/2/private-equity-searches-for-identity-after-the.html .
[6] An end to the carry on, Buy-out firms face the prospect of a bigger tax bill, The Economist (Nov. 17, 2012), available at http://www.economist.com/news/finance-and-economics/21566647-buy-out-firms-face-prospect-bigger-tax-bill-end-carry.
[7] Id.
[8] Id.
[9] Id.
[10] Id.
Should the Carried Interest Tax Loophole be Eliminated?
With the “fiscal cliff”[1] fast approaching and the federal budget taking center stage in national politics, legislators are under intense pressure to find politically feasible changes to the tax code that can be used to raise revenue. One feature of the tax code in particular – its treatment of the “carried interest” income earned by most private equity and hedge fund managers – has fallen squarely within these legislators’ crosshairs. It seems likely that this “loophole” will soon be eliminated, but current proposals for doing so miss the mark.
Most private equity firms’ fees are structured on the “2 and 20” model. The “2” refers to a baseline fee fixed at 2% of assets under management, which is taxed as ordinary income. The “20,” on the other hand, is the famous “carried interest:” fund managers also keep 20% of all gains realized by the fund. Because private equity funds typically enter relatively long-term investments, private equity fund managers can characterize their carried-interest income as long-term capital gains, which are taxed at 15%.[2] Thus, successful private equity fund managers – whose incomes routinely exceed seven figures – often have the bulk of their income taxed at the low rate of 15%.
Not surprisingly, this practice has drawn scrutiny from legislators in Washington. Congressman Sandler Levin has introduced a “Carried Interest Fairness Act” in the House of Representatives,[3] and President Obama’s 2013 budget specifically targets the loophole.[4] Both simply propose that carried interest be taxed as ordinary income. This is an enticing solution: it singles out these wealthy fund managers, a group many people find unsympathetic,[5] and it raises much-needed revenue.
However, resolving this issue may not be quite so simple. Whatever justifications exist for taxing other kinds of capital gains at rates lower than ordinary income may apply for carried interest income as well. For example, some argue that lowering capital gains taxes incentivizes risk-taking and investment; these incentives are certainly in play in the private equity world. The same is true of the “lock-in” rationale: some say lowering capital gains taxes prevents people from holding on to subpar investments simply for tax purposes, and the same considerations could affect the decision-making process of private equity fund managers deciding when to realize their gains.
A simpler solution would be to eliminate the distinction between capital gains and ordinary income altogether. Economic research has found little, if any, empirical evidence supporting the rationales described above.[6] More direct and effective methods can be used to achieve the purported benefits of low capital gains tax. Worst of all, this distinction encourages people to engage in inefficient rent-seeking. The time spent by accountants and tax lawyers thinking of ways to re-characterize income, and indeed the hours spent writing this very article, could be used for other pursuits. The most sensible solution, then, is to do away with this distinction and tax income of all types at one simple rate.
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[1] I.e., the large number of scheduled tax increases and spending cuts set to go into effect in early 2013. See Jonathan Weisman, Q&A: Understanding the Fiscal Cliff, N.Y. Times Economix Blog (Oct. 9, 2012, 6:28 PM), http://economix.blogs.nytimes.com/2012/10/09/qa-understanding-the-fiscal-cliff/.
[2] Janet Novack, Romney’s Taxes: It’s the Carried Interest, Stupid, Forbes (Aug. 24, 2012, 6:03 PM), http://www.forbes.com/sites/janetnovack/2012/08/24/romneys-taxes-its-the-carried-interest-stupid/.
[3] H.R. 4016, 112th Cong. (2012).
[4] Cutting Waste, Reducing The Deficit, And Asking All To Pay Their Fair Share (2012), available at http://www.whitehouse.gov/sites/default/files/omb/budget/fy2013/assets/cutting.pdf.
[5] (just ask Mitt Romney)
[6] See, e.g., Capital Gains and Dividends: What is the effect of a lower tax rate?, Tax Policy Center, available at http://www.taxpolicycenter.org/briefing-book/key-elements/capital-gains/lower-rate.cfm; Brendan Greeley, Study Finds Benefit is Elusive for Low Capital Gains Rate, Bloomberg (Oct. 4, 2012, 10:17 AM), http://www.bloomberg.com/news/2012-10-04/study-finds-benefit-is-elusive-for-low-capital-gains-rate.html
Private Equity in India
Since the enactment of economic reforms in the early 1990s, India has experienced a period of rapid economic growth.[1] On average, GDP has grown over 7% per year since 1997,[2] making India one of the world’s fastest growing economies. In 2004, investors began seeing opportunities for private equity investment,[3] and the market grew from $6.6 billion in 2005 to $55.8 billion in 2007.[4] Despite taking a major hit in response to the economic crisis, investment grew back steadily through early 2011,[5] at which point India had the fastest growing private equity market in Asia.[6] However, towards the end of 2011, investment began trending downward and has languished ever since.[7] Unfortunately, this is due at least in part to the Indian government’s inconsistent policies, which have created regulatory uncertainty among foreign investors.
In January of 2012, the Supreme Court of India held that the Indian government may not tax capital gains from indirect transfers of capital assets located in India, an issue over which there had been much confusion.[8] The suit began after Vodafone, a Netherlands company, had purchased CGP Investments Ltd. (CGP), a company based in the Cayman Islands.[9] CGP’s main asset was an interest in Hutchison Essar Limited (HEL), based in India.[10] Under Section 9 of India’s Income Tax Act, a non-resident must pay tax on income arising through “transfer of a capital asset situate[d] in India.”[11] India’s tax authorities contended that this section applied to Vodafone, claiming that Vodafone’s acquisition of CGP was equivalent to a transfer of shares of HEL to Vodafone. Therefore, the government insisted that Vodafone owed taxes on capital gains derived from the acquisition of HEL.[12] The Supreme Court disagreed, holding that Section 9 did not cover indirect transfers of capital assets situated in India.[13] The case set an important precedent for a number of foreign investors whose deals were structured similarly to Vodafone’s, and provided clarity for others who were hesitant to invest due to the legal uncertainty of the pending case.[14] Unfortunately, the issue was once again opened in March of 2012, thanks to the Indian Financial Minister’s proposal of new tax rules. The proposal would enact General Anti-Avoidance Rules (GAAR),[15] making transactions between international companies with Indian subsidiaries liable for a domestic capital gains tax.[16] GAAR would “effectively overturn[]” the Supreme Court’s decision in the Vodafone case.[17]
The Financial Ministry’s proposal sparked massive uncertainty. GAAR would be retroactive through April 1st, 1962, creating the potential for many cases, including Vodafone’s, to be re-examined.[18] In addition, the outcome of several pending cases regarding M&A deals between international companies that hold Indian subsidiaries is once again uncertain.[19] Moreover, GAAR created further uncertainty among those who might have been planning to invest in Indian companies through deals structured similarly to Vodafone’s.[20] To assuage investor concerns, India’s Prime Minister issued a statement in June of 2012 saying GAAR would not be finalized without his approval.[21] The Prime Minister is expected to soften GAAR’s impact on investors, but exactly how he will do so is still unclear.[22]
The recent actions of the Government of India are problematic for two reasons. First, they re-open the issue of whether the Indian government may tax capital gains from indirect transfers of capital assets situated in India. Hopefully, the Indian government will soon clarify what GAAR’s practical effects will be, and resolve the matter once and for all. Second, even if the Indian Government resolves the GAAR issue in favor of investors, they have now set an example to the world that the law of India is volatile. Private equity deals are carefully structured to gain benefits from whatever legal systems they are subject to, so the fact that India’s laws seem to be constantly in flux is highly discouraging to anyone looking to acquire Indian companies. If the country wants any sort of private equity market, it must find a way to rebuild investors’ confidence in the stability of India’s laws. At any rate, it will not be easy to do so before Indian private equity investment falls even further.
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[1] Central Intelligence Agency, Economy: INDIA, The World Factbook, https://www.cia.gov/library/publications/the-world-factbook/geos/in.html#Econ (last visited Oct. 27, 2012). See also T.C.A. Anant & N.L. Mitra, The Role of Law and Legal Institutions in Asian Economic Development: The Case of India 4, 57 (Harvard Institute for International Development 1998).
[2] Central Intelligence Agency, supra note 1.
[3] Malini Goyal, PE: The story of greed, boom and the fall of private equity in India, The Econ. Times (May 17, 2012), http://articles.economictimes.indiatimes.com/2012-05-17/news/31749390_1_pe-firms-pe-investments-subbu-subramaniam.
[4] Deloitte, Private Equity: Fueling India’s Growth 6 (2012), available at http://www.deloitte.com/assets/Dcom-India/Local%20Assets/Documents/Thoughtware/Private%20Equity.pdf.
[5] Id.
[6] Id. at 4.
[7] Id. at 6.
[8] Vodafone International Holdings B.V. v. Union of India & Anr., (2012) __ S.C.R. __ (India), available at http://judis.nic.in/supremecourt/imgs.aspx.
[9] Id. at ¶ 2 (India), available at http://judis.nic.in/supremecourt/imgs.aspx.
[10] Id.
[11] Id. at ¶70.
[12] Id. at ¶ 71.
[13] Id.
[14] Amol Sharma and R. Jai Krishna, Vodafone Overturns Tax Bill in India, Wall St. J. (Jan. 21, 2012), http://online.wsj.com/article/SB10001424052970204616504577172152700710334.html.
[15] 5 Facts About the General Anti-Avoidance Rule (GAAR), NDTV Profit, http://profit.ndtv.com/news/market/article-5-facts-about-the-general-anti-avoidance-rule-gaar-300693 (last updated May 14, 2012, 19:27 (IST)).
[16] James Crabtree, India to Change Tax Law After Vodafone Case, Fin. Times, http://www.ft.com/intl/cms/s/0/d9d96cde-6f59-11e1-9c57-00144feab49a.html#axzz2ASEttu4q (last. updated Mar. 16, 2012 8:32 PM). Language in the amendments seems to be specifically targeted at the Vodafone decision. One of the explanatory notes reads, “[A]n asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India.” Crabtree, supra.
[17] Crabtree, supra note 15.
[18] Crabtree, supra note 15.
[19] Crabtree, supra note 15.
[20] After Vodafone, GAAR; PM Takes Charge of Finance Ministry, The Times of India (June 30, 2012, 2:16 AM IST), http://timesofindia.indiatimes.com/business/india-business/After-Vodafone-GAAR-PM-takes-charge-of-finance-ministry/articleshow/14513903.cms.
[21] Id.
[22] FE Bureau, PM Moves to Soften GAAR, Vodafone Blow, Fin. Express (June 29, 2012, 32:00 IST), http://www.financialexpress.com/news/pm-moves-to-soften-gaar-vodafone-blow/968019/0 See .also FinMin May Amend GAAR Rules to Boost Investor Confidence, Firstpost (Oct. 2, 2012), http://www.firstpost.com/economy/finmin-may-amend-gaar-rules-to-boost-investor-confidence-476521.html
Presidential Politics and Private Equity
This election season there has been a good deal of discussion over Mitt Romney’s time spent at Bain Capital. The Romney Campaign has sought to highlight that experience as a qualification to lead the country to a better economic future. The Obama Campaign and other groups affiliated with it have made the argument that Romney eliminated and outsourced jobs during his time at Bain Capital. [1]
Concerns exist that this election could bring increased public attention to the Private Equity industry, and give politicians extra incentive to regulate the industry. [2] In a recent survey of Tech Industry executives, where the Tech executives were questioned on the Presidential election, “78% say that the campaign’s focus on Romney’s roots in private equity have “damaged” the reputation of private equity and venture capital”; [3] and, “65% worry that there could be new regulation of private equity and venture capital investing”. [4] However, there is little reason to be concerned that the election will give politicians an impetus to further regulate the private equity industry.
There is evidence that political advertisements based on Romney’s Bain record have been effective; a Super PAC running political advertisements attacking Romney’s Bain record claim that their internal polling shows that “a decisive plurality of voters said Mitt Romney’s record as Bain CEO makes them less likely to vote for him.”[5] These advertisements highlight negative consequences of pursuing a strategy of profit maximization with a special focus on outsourcing, downsizing, and reducing employee benefits.[6]
However, the persuasive thrust of these advertisements could be effectively applied to all profit-maximizing business, particularly large businesses. In a recent PEW Research poll over 50% of respondents said businesses make too much profit. [7] In the same poll slightly less than 50% of respondents said that Wall Street hurts the economy more than it helps it. [8] And perhaps most significant, 67% of respondents claimed that Wall Street only cares about making money for themselves. [9]
It is a well-known fact that manufacturing companies pursue strategies of profit maximization as a rule of thumb. To maximize profits manufacturing companies have outsourced jobs, downsized workforces and when possible reduced employee benefits. However, manufacturing companies are not facing the same negative press as private equity firms. Consider for a moment that instead of working at Bain Capital Mitt Romney had become the CEO of General Motors. I suspect in this hypothetical world where Mr. Romney was CEO of General Motors – never having worked in private equity – we would see almost all of the same political advertisements currently on the air criticizing Mr. Romney’s Bain record, but with the word’s GM in place of Bain Capital.
In short, I posit that the public does not hold a special grudge for the private equity industry. That while the election may have certainly put private equity in the spotlight nothing of consequence will come from it because criticisms of the private equity industry are both general in nature and very similar to criticisms made of profit maximizing institutions in general. Consequently, concerns that new private equity or venture capital regulations may be coming as a result of the Presidential election are likely overblown.
[1] See , Michael Shear, A Final Push in Swing States, in a Bid to Break the Stalemate, N.Y. Times (Oct. 23, 2012) http://www.nytimes.com/2012/10/24/us/politics/a-tight-focus-on-battleground-states-as-campaigning-time-dwindles.html (describing Priorities USA plan to spend several million dollars on adds that tell the stories of people who lost their jobs after Bain Capital acquired the companies which employed them).
[2] Eric Savitz, Tech Execs Mostly Back Romney, But Expect Obama to Win, Forbes (Oct. 8, 2012, 8:04 PM) http://www.forbes.com/sites/ericsavitz/2012/10/08/tech-execs-mostly-back-romney-but-expect-obama-to-win/
[3] Id.
[4] Id .
[5] Alex Pappas, Democratic Super PAC to Revive Attacks on Romney’s Bain Record, The Daily Caller (Oct. 20, 2012, 9:41 AM) http://dailycaller.com/2012/10/20/democratic-super-pac-to-revive-attacks-on-romneys-bain-record/
[6] Shear, supra note 1.
[7] ‘Staunch Conservatives’ Are Warry of Wall Street , Pew Research Center (May 26, 2011) http://pewresearch.org/pubs/2003/poll-wall-street-business-financial-crisis
[8] Id .
[9] Id .