Sloan: Harpooning Blackstone Group

If you're wondering why people like me keep writing about Blackstone Group, the big private-equity player, there's a simple answer: The whale that comes to the surface gets harpooned. And whales don't get much bigger than Blackstone, which lately seems to be bidding on every asset in sight.

When private-equity firms and hedge funds kept low profiles, they were well out of harpoon range. They benefited from an enormous tax loophole that few but the cognoscenti knew about and a nice legal loophole that's familiar to people in the world of partnerships but that I'd never heard of until last week. These things have now emerged into public view, thanks largely to Blackstone's bid to become a publicly traded company. The harpoons are flying-as well they should be.

Let's start with the tax loophole. Hedge funds and private-equity funds charge substantial fees to their investors, but what's made some hedgies and private-equity folks into billionaires is that they get a "carried interest" in the profits earned by the funds they manage. This piece of the action-or "carry," as it's known-is typically 20 percent, sometimes even more.

But instead of being treated as a fee, which it is in substance, the carry has been treated as a long-term capital gain. At current rates, that means paying 15 percent to Uncle Sam, as opposed to a top rate of 35 percent.

What I've learned since writing last week's column is that people have been playing this tax game for many years. That doesn't make it any less outrageous, of course. I hope that Congress, which is making noise about this, actually does something instead of just talking.

Let me show you some numbers. The tax break saved Blackstone's partners $310 million in federal taxes last year by my math-that's the difference between 35 and 15 percent, multiplied by the $1.55 billion of carry that the firm earned last year. (My source for the carry number: "Net Gains from Investment Activities" on page F-29 of the filing.) Compare that with the $150 million charitable foundation the firm says it's setting up. That would cost the partners a bit less than $100 million, by my estimate, because the donations would be tax deductible at 35 percent. I'm not minimizing the foundation-I think it's a great idea. I'm a big fan of private giving, and the more the better. I just want to put Blackstone's planned donation into perspective, relative to its tax break.

Then there's the legal loophole we discussed last week. Blackstone, which is offering units in a limited partnership rather than shares of stock, says it's reducing or eliminating its fiduciary obligations to investors who buy these units. Fiduciary obligations are your duties to people who've entrusted assets to you. I've always considered those obligations as almost holy. Foolish me.

As in the case of the aforementioned tax game, it turns out that this limiting of fiduciary obligations has been going on for years at publicly traded partnerships. The difference, I suspect, is that Blackstone made this disclosure near the front of its filing. I suspect that if I'd read more public-limited-partnership documents I'd have found similar disclaimers, buried so deep you need a backhoe to dig them up.

I called the Securities and Exchange Commission to see what people there think about the concept of limiting fiduciary obligations. Alas, no one would discuss it with me, including Chairman Christopher Cox, who declined, through a spokesman, to take my call.

In the past, however, SEC folks have told me that their job is to enforce securities laws, and their duty is to make sure that risks are clearly disclosed so that potential investors can understand them. With 31 pages of risk factors listed in Blackstone's filing as well as other
caveats scattered throughout the document, there's no shortage of warnings.

Now, to the New York Stock Exchange, supposedly the investor's friend, where Blackstone's limited partnership units would trade. Unlike the SEC, which has to enforce the securities laws as written, the NYSE has latitude to decline listings if it considers them distasteful.

Guess what? No one at the NYSE would talk to me about this. A spokesman e-mailed me two computer screens of NYSE listing requirements, and Blackstone's offering seems to meet them all. Of course, the NYSE is now a for-profit, stockholder-owned outfit rather than the not-for-profit shop it once was. It's not going to turn down listing fees from Blackstone and the other private-equity firms that are waiting in the wings to see how Blackstone's offering fares.

Now that Blackstone's surfaced and its fellow whales may soon follow, we'll see where the harpoons land. Meanwhile, I'll try to remember that people call me Allan. Not Ahab.