Thursday, April 24, 2014

The Non-Germane Accusation

The Non-Germane Accusation

Greg Polsky, a professor at my alma mater, the School of Law at the University of North Carolina, has written extensively on the business practices of private equity and their tax implications.  For example, he’s argued that the monitoring fees charged by many private equity firms are really dividends in disguise, not deductions, and should be appropriately taxed.  Professor Polsky makes a cameo appearance in Benchmark Financial’s report about the North Carolina pension system. 


As I noted yesterday, the report, North Carolina Pension’s Secretive Alternative Investment Gamble: A Sole Fiduciary’s Failed “Experiment” is so error-filled that it’s actually difficult to attack.  The report uses inflammatory language to create the appearance of massive hidden problems in the North Carolina pension system.  In the course of making all sorts of wild claims, Benchmark winds up burying a few legitimate issues that are actually worth debating and analyzing.

Yesterday I discussed Benchmark’s tactic of using scary-sounding language to create the appearance of a problem.  Today I want to discuss another tactic employed in the report: the non-germane accusation. 

Professor Polsky has written careful and thoughtful articles on the tax treatment of various aspects of private equity.  I’ve spent a bit of time talking to Professor Polsky, and his work deserves serious attention.  Moreover, he’s gotten the attention of many private equity managers and their trade association.  However, Professor Polsky’s work has nothing to do with the North Carolina pension or Treasurer Cowell.  Nonetheless, Benchmark’s report has a heading entitled “Private Equity Monitoring Fees Tax Law Violations.”  While Professor Polsky’s work may prove to be correct, the Internal Revenue Service hasn’t adopted his position.  Even if the IRS takes up Professor Polsky’s contentions, it will be years before this matter is resolved.

In an effort to conjure up an ominous accusation, Edward Siedle, the report’s author, didn’t pause long enough to consider the fact that North Carolina and its pension are in all likelihood immune from federal taxation.  The federal government doesn’t tax states.  Even if the monitoring fees become taxable dividends, public pension plans aren’t going to get a tax bill. They don’t pay taxes on a variety of sources of income that impact other investors.

Professor Polsky’s work is of interest to endowments, foundations, and taxable investors, but it is irrelevant to public pension plans, and doesn’t belong in any report making accusations about the North Carolina pension.  However, Mr. Siedle was able to come up with billions of dollars in potential tax liabilities, so the numbers made useful filler in his report.

If Mr. Siedle ever decides to properly edit his report, he might consider reading Professor Polsky’s complete law review article instead of relying on a brief Wall Street Journal article. It’s well written and worth the effort.  He might also revise the heading of this section of the report to read: “Private Equity Monitoring Fees Might One Day Be A Tax Law Violation Having No Relevance to the North Carolina Pension System.”

If Mr. Siedle wants to pursue the monitoring fee issue, he will have to find a client for whom it is germane.