Private equity and hedge funds work both sides of the aisle

Date: Tuesday, September 2, 2008
Author: Nicholas Rummell, Financial Week.com

Donations flow to Dems and GOP in hopes of saving 15% carried-interest tax rate.

Hedge funds and private equity firms arguably have more to lose than any other businesses this election cycle, given the calls in Congress over the past year to end the longtime special tax treatment of their revenue. Yet the latest campaign finance data show that hedge funds and PE shops have contributed more to Democrats than to Republicans in the 2008 presidential and congressional elections, helping bankroll the political party that seems most intent on hiking their taxes.

Democrats are shooting for 60 seats in the Senate, which would offer a safe margin against filibusters. Polling suggests the goal is a long shot. Still, if Democrats secure even a few more seats than their current 51-seat majority, that could help key lawmakers push controversial tax legislation out of committee and onto the Senate floor for a vote, said Pat Heck, a partner with Kirkpatrick & Lockhart, who recently served as senior counsel to Senate Finance Committee chairman Max Baucus (D-Mont.).

PE firms and hedge funds got a five-alarm scare last year when Democratic lawmakers in the House targeted carried interest—the income derived from managing assets in private investment deals, which is taxed at the 15% capital-gains rate due to a legal exception—as a good way to raise additional tax revenue from a capitalist crowd that's not exactly vox populi. Various proposals last year, which would have taxed carried interest at the 35% corporate tax rate, were ultimately quashed, but the message was clear: The tax loophole must be closed.

A separate proposal pitched by Mr. Baucus would tax like a corporation any publicly traded partnership that derives income from investment advisory or asset management services, which would boost the PE firms' taxes. That legislation also failed, but many predict it could pass in 2009.

“I tell folks this will be the largest tax debate in a generation,” Mr. Heck said. “There's certainly an appetite [for the carried-interest and publicly traded partnership bills]. Anytime you open up the tax code, there will be winners and losers.”

And the private investment industry may end up among the biggest losers. “The coffee break, chat-room type of things I'm hearing is that if [Barack] Obama gets elected, we're going to have a higher carried-interest rate...but you need a Democratic Congress to enact it in the first place,” said Bob Kennedy, an attorney with Jones Day who represents several leading private equity firms.

The Private Equity Council, an industry group formed at about the same time carried interest came under attack, declined to comment for this story, although two of its lobbyists were schmoozing at the Democratic National Convention in Denver last week and may move on to St. Paul, Minn., this week for the Republican National Convention, a spokesman said. A source at a PE firm added: “I don't think [John] McCain likes our industry any more than [Mr.] Obama does.”

At the National Venture Capital Association, whose members also benefit from the carried-interest break, president Mark Heesen described the tax fight as a long-term battle. “We got through 2007, it looks like we'll get through 2008, and now we'll have to see about 2009,” he said. “[But] carried interest will be part of the overall tax reform debate regardless of who wins the White House or what gains the Democrats make in the House and Senate.”

Lobbying activity and campaign contributions by the firms and their various arms clearly reflect that growing concern.

According to recent filings, the Managed Funds Association spent nearly $1.3 million during the first half of this year lobbying Congress, the Internal Revenue Service, the Securities and Exchange Commission and other agencies. (It spent $1.6 million during all of 2007.) Just last week, the association hired Roger Hollingsworth as its new government relations managing director. Mr. Hollingsworth was formerly the deputy staff director for Senate Banking Committee chairman and former Democratic presidential contender Christopher Dodd of Connecticut.

During the first half of 2008 the Private Equity Council spent $1.7 million lobbying Congress, the Treasury Department and the White House exclusively on the publicly traded partnership and carried-interest bills, compared with nearly $1.5 million spent in all of 2007.

The National Venture Capital Association spent about $845,000 lobbying last year vs. about $630,000 so far this year.

During the Democratic primaries, the private investment business was an occasional whipping boy on the campaign stump. Democratic vice presidential candidate Joe Biden said at a 2007 debate when he was running for the party's presidential nomination: “We need more transparency, particularly with regard to hedge funds and private equity funds. They are the ones that are causing this thing to go under.... We don't know how deep this problem is.”

Despite the rhetoric, fund-raising data compiled by the Center for Responsive Politics show that leaders of the private equity, hedge fund and venture capital fields have tended to spend more on Democrats in recent years.

In the 2008 election cycle, for example, representatives of those businesses dropped 59%, 69% and 58% of their total contributions, respectively, on Democrats. While PE firms and hedge funds have spent similar percentages since the 2002 elections, the records show they supported Republicans about 60% of the time prior to 2002.

According to sources at several firms, many of the barbarians at the gate are Democratic-leaning in their personal politics, including many partners at Bain Capital, TPG Group and Carlyle.

For example, Jonathan Lavine from Bain bundled—gathered individual donations from other employees or friends—at least $500,000 and two Carlyle directors bundled $100,000 for the Obama campaign.

There are plenty of exceptions, of course, such as McCain supporter Henry Kravis of Kohlberg Kravis Roberts, whose firm donated three-quarters of its contributions to Republicans this cycle.

Mr. Kravis himself bundled $500,000 for Mr. McCain. Also, KKR earlier this year hired Ken Mehlman, former chairman of the Republican National Committee, to head up shareholder outreach and government affairs.

And like many businesses, PE firms and hedge funds often hedge their political bets. Ken Griffin, president at Chicago-based hedge fund Citadel Investment Group, last month held a fund-raiser for Mr. McCain, and has plans for another. Yet in April 2007, he invited home-state Senator Mr. Obama to his headquarters, after which employees reportedly donated a total of $150,000 to his primary campaign, including the maximum $4,600 from Mr. Griffin himself. Mr. Griffin has also served as a “bundler” for both candidates, raising at least $100,000 for each.