Washington Ponders Wall Street

Wall Street was the talk of the day on Capitol Hill on Wednesday, as separate Congressional hearings examined the way taxes are collected and risk monitored at hedge funds and private equity firms.

The bad news first: a unanimous vote by the Securities and Exchange Commission to strengthen anti-fraud measures ought to make money managers even more guarded with their comments than they already are. Once adopted, the new legislation will protect investors from misleading or fraudulent statements made by financial advisors working within hedge funds, private equity funds, venture capital funds and mutual funds.

The S.E.C. first attempted to tighten the reins on the largely unregulated industry last year, but that effort was foiled when a federal court overturned a requirement that hedge fund advisors register with the S.E.C.

Today's ruling makes crystal clear the S.E.C.'s powers of enforcement over advisors who defraud investors, through actions such as false account statements, or misleading reports of fund activity.

And the S.E.C. will vote soon on a proposal even more irksome to hedge fund and private equity managers: legislation that would demand higher minimum investments for investors putting money in their funds in an effort to ensure that individuals have sufficient financial savvy to play in the high-stakes financial vehicle.

Meanwhile, both the House and Senate were abuzz today with discussions of private equity and hedge funds.

After a hearing before the House Financial Services Committee, Representative Barney Frank (Democrat, Massachusetts) unveiled another bill to help protect investors in the wild world of hedge funds and private equity. Frank announced plans to draft legislation that would require hedge funds to keep copies of documents including trading data and email exchanges for the purpose of insider trading enforcement. He also said he plans to examine more closely the role played by credit rating agencies in the collapse of funds linked to subprime mortgages.

But there was a bright spot for investment managers over on the Senate side of the Capitol. At a tax policy hearing held before the Senate Finance Committee, Eric Solomon, the Treasury Assistant Secretary for Tax Policy, cautioned the committee about the risks of proposed changes to the tax treatment of private equity funds and hedge funds.

While Solomon didn't go as far as to say that the Treasury was opposed to changes in tax law, he made it very clear that he considered the current system beneficial for business and the economy as a whole, and advised extreme caution in making changes to tax laws that were originally put in place to "promote and support entrepreneurship,"
Congressional Budget Office Director Peter Orszag and Kate Mitchell, managing director at Scale Venture Partners, also testified to the same effect.

Lately, lawmakers have been scrutinizing the tax structure in place for investment firms and their managers, who are currently able to count compensation paid in the form of carried interest as capital gains. That cuts their tax burden from the 35 percent levied on regular income to a much lower 15 percent rate.

Finance Committee Chairman Max Baucus (Democrat, Montana) and ranking member Charles Grassley (Republican, Iowa) introduced legislation last month which would subject publicly traded hedge funds and private equity firms to the higher tax rate, and lawmakers in the House have further proposals in the works.

by Liz Gunnison