National Round-up (Detroit bankruptcy, private equity carried interest)
Detroit – Extra Pension Payouts? : Who knew that Detroit had for years been taking money out of its pension fund when investment returns exceeded actuarial assumptions and paying it out to thousands of city employees and pensioners whose “base” pensions were deemed to be too small? Carried Interest – Double Trouble for Private Equity: Right after Mitt Romney bared his embarrassingly low (14%) effective tax rate during the 2012 presidential campaign and Warren Buffett then called for a flat 30% tax on millionaires, it really looked as if the preferential tax treatment of carried interest on private equity investments would not survive Obama’s second term. http://aroundwallstreet.com/2013/11/national-round-up/
Published on: Mar 3, 2016
Transcripts - National Round-up (Detroit bankruptcy, private equity carried interest)
By STEPHEN BORNSTEIN
NOVEMBER 1, 2013
Detroit–Extra Pension Payouts?: Who knew that Detroit had for years been taking money out
of its pension fund when investment returns exceeded actuarial assumptions and paying it out
to thousands of city employees and pensioners whose “base” pensions were deemed to be too
small? Detroit had also used some of the excess funds to reduce its own annual pension
fundcontributions, but, two years ago,discontinued all such extra paymentsin a vain effort to
stave off bankruptcy.
Numerous other cities and states across the country have also been issuing “13th checks” to
their retirees for many years. In fact, San Diego underwent a similar pension scandal in 2001
and barely avoided bankruptcy itself.
Detroit’s “bump-ups,” however, have now come home to roost. Not only did they deprive the
city’s pension plan of billions of dollars that could be earning income today, the suspended
payments must now be made to retirees retroactively and continue to be honored through
Detroit’s bankruptcy according to a recent ruling from a Michigan state judge (who likened his
order to “a ticket refund on the Titanic”).
While the Michigan constitution protects municipal pensions, Detroit has filed for federal
bankruptcy protection which could trump state law and invalidate the pension add-ons. Other
cities and states with severely underfunded pensions are therefore watching the Detroit case
closely to see whether a federal bankruptcy filing could actually free them from otherwise
unpayable pension liabilities.
Carried Interest– Double Trouble for Private Equity:Right after Mitt Romneybared his
embarrassingly low (14%) effective tax rateduring the 2012 presidential campaign andWarren
Buffett (http://aroundwallstreet.com/2012/08/zingers-from-buffett-welch-and-weill/) then called for
a flat 30% tax on millionaires, it really looked as if the preferential tax treatment of carried
interest (http://aroundwallstreet.com/2012/11/curtains-for-carried-interest/) on private equity
investments would not survive Obama’s second term.
Almost a year has gone by since then without a word about carried interest, but its tax
treatment recentlyresurfaced thanks toa seemingly unrelatedpension fund decisionagainst Sun
Capital Partners(http://media.ca1.uscourts.gov/pdf.opinions/12-2312P-01A.pdf), a PE fund that, in
2007, acquiredan electronics component manufacturer, Scott Brass, Inc., which went bankrupt
the following year.
Sun Capital brought the suit against Scottand its underfunded pension fund in order to avoid
liability for the underfunding,claiming that it was a mere passive investor in the company. The
First Circuit Court of Appeals, however,found that Sun Capital was actively involved in Scott’s
operations,controlled itsboard and management team and was paid a fee by Scott for its
management services, all of which led to itsrulingthat Sun Capital wasactually engaged in a
“trade or business” involving Scott and was therefore responsible for the company’s pension
obligations under US labor law (ERISA).
Since PE funds typically acquire controlling positions in their portfolio companies and oversee
their management and operations, the adverse holding in Sun Capitalnow also calls into
questionPE’sprincipal argument forthe preferential treatment of carried interest.
Under the US tax code, a carried interest in a portfolio company qualifies for capital gains
treatmentonly if thePE fundowning that interest does not actively operate the portfolio
company as a “trade or business.” If it does, as was found in Sun Capital,its carried interest
would bedeemed to becompensation for management services,and any profit earned by the
fund on the sale of the portfolio company would be characterized as a return on labor rather
thancapital, in which case the carried interest would be treated for tax purposes asordinary
Now let’s see if the Obama administration uses Sun Capital torenew its legislative assault on
PE’s sacred cow.