California, New York lawmakers tackle PE regulation

  • New York lawmakers target carried interest
  • California lawmakers consider mandatory disclosure of fees
  • Activists target multi-state approach to regulate PE industry

Regulation of the private equity industry is turning into a local fight. In recent weeks, state lawmakers in California and New York drafted bills to address fee transparency and the tax treatment of carried interest.

To date, efforts to raise federal taxes on private equity firms’ share of their funds investment profits (known as carried interest) failed in the absence of comprehensive tax reform. Similarly, while the Institutional Limited Partners Association successfully launched efforts to standardize the industry’s disclosure of fees and expenses, federal regulators have not acted on local officials’ calls to require standardization.

“When Congress is blocking action on something where there’s big demand for action, the states are the laboratories for democracy,” said Michael Kink of Hedge Clippers, an activist group that coordinated with lawmakers on the New York bill. “We are admittedly [just] getting started. [We’re] putting out something that I don’t know has been seriously considered before.”

On March 4, New York Assemblymen Jeffrion Aubry and Sean Ryan introduced a plan to tax carried interest as regular income at the state level, eliminating the tax benefit it currently receives as a federal capital gain. The bill could impact private equity powerhouses like Blackstone Group and Kohlberg Kravis Roberts, whose headquarters are in New York City.

If the proposal becomes law, New York would only change its tax code if Connecticut, New Jersey and Massachusetts enact identical legislation. In theory, this would eliminate firms’ incentive to relocate to neighboring states with industry-friendly treatment of carried interest.

Aubry and Ryan could not be reached for comment.

“We do think it does make sense to have a multi-state initiative,” Kink said. “We’ve got a coalition of community groups and labor unions to talk with lawmakers they work with.”

According to Kink, activists also hope to expand the effort to California, where Assemblyman Ken Cooley is pushing a bill requiring private equity firms to disclose all fees and expenses to state and local retirement systems.

California became ground zero for the fee transparency debate last year after the California Public Employees’ Retirement System and California State Teachers’ Retirement System, two of the industry’s most important public limited partners, said they were unable to track of the amount of carried interest taken by their fund managers.

Under Cooley’s bill, firms would provide the information on “a form prescribed” by the relevant retirement system. State and local systems would then make annual public disclosures of fees and expenses.

“I actually think the effect of this bill would be to force CalSTRS and CalPERS to think about how they would standardize this, and how they would format it,” Cooley said in an interview. “The legislature, with the State Treasurer’s support, is giving the state pensions a push to start putting this together.”

State Treasurer John Chiang, a CalSTRS and CalPERS board member, said in October that pension investment staff lacked the clout to obtain private equity fee data on their own.

Chiang’s office did not respond to requests for comment. Spokesmen for CalPERS and CalSTRS said the pensions had not reviewed or considered Cooley’s bill.

For California’s local retirement systems, requiring additional analysis of GP fees and expenses could strain the limited resources of public investment staffers, according to LP sources.

“Passage of the bill would require additional staff time on our part,” said Ray Ciranna of the Los Angeles Fire and Police Pensions. “Fortunately, we can draw upon Portfolio Advisors’ data to help out. However, one of our biggest concerns is whether the really good private managers/funds close their doors to California institutional pension funds [if Cooley’s bill passes].”

To that end, the PE industry’s lobbying arm plans to combat the efforts by emphasizing the returns private equity generated for public pensions in New York and California, said James Maloney of the Private Equity Growth Capital Council.

“Our first move will be to educate state lawmakers as needed,” Maloney said. “And if we feel as though there’s traction on this issue, we’ll move to spend more time, resources on educational efforts on statewide initiatives. For now, we’ll focus on the current legislation that’s been introduced.”

Action Item: See a copy of the California bill here and  a copy of the New York bill here:

Photo: Assemblymember Jerry Hill (L) speaks with State Controller John Chiang before California Governor Jerry Brown delivers his State of the State address in the Assembly Chambers at the State Capitol in Sacramento, California January 18, 2012. REUTERS/Max Whittaker