Private-equity tax debate heats up

Democratic presidential candidate John Edwards and billionaire buyout king Henry Kravis last week staked out dramatically opposing…

Democratic presidential candidate John Edwards and billionaire buyout king Henry Kravis last week staked out dramatically opposing positions in the growing debate about how to tax managers of hedge funds and private-equity groups that go public.
Commenting on a proposed bill that effectively would tax the managers’ fees as ordinary income rather than as capital gains (and require them to pay much more than the 15% rate they currently pay), Mr. Edwards said the proposal is a splendid idea. Not surprisingly, Mr. Kravis argued that enacting the bill would be terrible.
Mr. Edwards, a former senator from North Carolina running on a populist platform, said while campaigning in New Hampshire that “carried interest” is clearly a “return on labor” and should therefore be taxed at higher ordinary income rates.
While roaming the hallways of Capitol Hill and buttonholing lawmakers in advance of this week’s first Senate Finance Committee hearing on the bill, Mr. Kravis, a
co-founder of New York-based Kohlberg Kravis Roberts & Co., which is planning an initial public offering, asserted that firms such as his are critical to the economy and that an increase in tax rates would hurt American competitiveness.

Goodwill hunting?
The private-equity and hedge fund cause wasn’t helped last week by a report from New York-based Moody’s Investors Service or a front-page story in The New York Times.
The Moody’s report sharply rebutted private-equity claims that public companies are better off in private hands. It also criticized the increasing use of debt by private-equity firms.
According to the report, private-equity firms aren’t necessarily investing “over a longer-term horizon than do public companies, despite not being driven by the pressure to publicly report quarterly earnings.”
Meanwhile, Times tax reporter David Cay Johnston may be in line for another Pulitzer Prize after uncovering that The Blackstone Group of New York “has devised a way for its partners to effectively avoid paying taxes on $3.7 billion, the bulk of what it raised last month from selling shares to the public.”
He reported that Blackstone’s maneuver hinges on clever use of “goodwill,” the accounting term for the value of intangible assets. By shifting goodwill to a new corporation, Blackstone partners appear able to save $198 million in taxes. And who says alchemy is dead?

Index battle
One of today’s hottest investing debates pits defenders of traditional capitalization-weighted index funds against proponents of the newer fundamental-index approach.
Last week, San Francisco-based Charles Schwab Corp. sponsored a webcast that allowed traditionalist Dr. Burton Malkiel to confront fundamentalist Robert Arnott.
Dr. Malkiel, a professor of economics at Princeton (N.J.) University and acclaimed author of “A Random Walk Down Wall Street” (W. W. Norton & Co., 1973), argued that the fundamental approach simply tilts a portfolio toward value and small-cap stocks. Mr. Arnott, chairman of Pasadena, Calif.-based Research Affiliates LLC, countered that fundamental indexing has the potential to outperform market cap indexes.
Sherman Doll, principal of Walnut Creek, Calif.-based Capital Performance Advisors, who tuned in to the webcast, remains a traditionalist. “Mr. Arnott is advocating some new undiscovered universe of inefficiencies. I’m not buying it,” he said.

On the prowl
Massachusetts regulators began an effort to examine the sale of structured products last week, sending letters requesting information to major brokerage firms, including Charlotte, N.C.-based Wachovia Securities LLC and Morgan Stanley of New York.
Brian Lantagne, director of Massachusetts’ securities division, said the move “is more of a prophylactic effort so we don’t end up with another situation like we had with variable annuities, where investors come in here and say, ‘I didn’t know what I got.’”