Hedge Fund Testimony

Well, five of the highest paid hedge fund managers testified in front of Congress today.

As is usually the case with these things, I thought there was only one Congressman who was qualified to ask questions. He was from California, not sure his name, but he had a limited understanding of the business. The rest of the people on the committee had no clue.

The annoying thing is they try to act like they are smart and do not let the panel finish answering questions. It is common for them to try to corner someone without hearing the full answer. After not hearing the full answer they decide to jump to conclusions that they are convinced are correct, but are completely wrong. Can we do something about getting qualified people on these committees? These committees are a waste of time for the panelists.

Here is one example from the meeting. I forget the Congressman that was involved but here is the story.

The question to Kenneth Griffin from Citadel was should the taxation of hedge fund managers change? Not sure if our readers know this but hedge fund managers, private equity mangers, etc. get taxed at the same rate as their investors on the performance based compensation. Typically the manager receives 20% of the profits, and obviously this profit is not guaranteed so it could be 0%. It's not like investment bankers get paid no matter if the deal is good or bad. Comparing investment banking compensation to hedge fund compensation is an apples to oranges comparison, but Congress thinks they are the same.

In answer to the question, Mr. Griffin says he does not think the tax treatment on performance based compensation should change. Currently, short-term capital gains are 35% for these guys (the highest tax bracket) and long-term capital gains are 15%. Mr. Griffin is a trader so 98% of his compensation is taxed at the 35% rate, which means he has nothing to lose from the tax change. The Congressman seems to want to attack Mr. Griffin. He is definitely under the most scrutiny of any of the panelists. Griffin gives an example of a chef and a restaurant and compares it to a hedge fund manager. What he was saying is the chef gets taxed normally on his salary for working at the restaurant and he gets taxes at long-term capital gains tax when he sells the restaurant for a profit (as long as he owned it for over 12 months), which is the same as the hedge fund manager. The hedge fund manager gets taxed at normal rates on the guaranteed management fee and capital gains rates on the carry or incentive fee. The Congressman cuts him off and says, "But the hedge fund manager is making money off of other people’s money." That is correct, but if you put up 100% of the cash for 80% of the equity of the restaurant and the chef gets 20% in sweat equity (meaning he gets 20% of the restaurant for free), then it is no different than the hedge fund manager. The chef didn’t put up any money for his stake in the restaurant, which is the same as the carry on a hedge fund. His sweat equity equals carry. They are not different. The Congressmen are too stupid to understand this example and they wouldn’t let him explain it in more detail because they just want to corner him. Just ridiculous.

Pay attention people.

Increasing taxes in these types of situations will reduce the amount of small businesses that are formed in this country. Many small businesses are formed using other people's money and sweat equity. These type of arrangements bring entrepreneurs and investors together, which in turn creates jobs that would not have been created. You increase the taxes and you reduce the incentive, which reduces the number of jobs. In the case of the hedge fund industry, more of these jobs will potentially go to London where the tax rates are more favorable. Thus, the U.S. will lose 100% of the tax revenue (these are mostly high tax payers by the way). Another genius recommendation by Congress. They try to operate in a static environment and say if we increase the tax rate, the tax revenue will increase. No, not really. If the jobs leave the country, the increased tax rate will actually lead to less revenue.