May 16, 2007
AFL-CIO vs. Blackstone
Posted by Victor Fleischer

FT reports on the AFL-CIO's letter to the SEC.  The union argues that Blackstone is an investment company for purposes of the 40 Act and should be regulated as such. 

Partnership Equity under the 40 Act.  I'm not a 40 Act expert, but as I understand it, the doctrinal question is whether Blackstone's GP interests in its underlying funds (i.e. its profits interests in the partnerships) are "investment securities."  The statutory language of the Act doesn't speak specifically to this question, although its broad language suggests that the term was meant to be inclusive.  The AFL-CIO argues that because a carried interest functions economically like a call option, and a call option would clearly be an investment security under the Act, then the GP interests should be treated as investment securities.  In its prospectus, Blackstone doesn't explain its position, other than to say it doesn't believe that the partnership equity interests are investment securities. 

Doctrinally, this strikes me as a close question.  The 40 Act is meant to protect passive investors.  General partners aren't normally passive investors, so Blackstone starts off on solid ground.  But investors in Blackstone won't actually have any meaningful control over their GP interests, so that makes them look more passive.  Should the 40 Act apply?  If these are securities for purposes of the Securities Act of 1933, why not the 40 Act? 

From a policy perspective, though, I think Blackstone is probably right.  It's hard for me to see why the 40 Act would apply to Blackstone but not an investment bank.  Investors are buying a piece of a management company, not investing in a fund.  So I need to do some more 40 Act research here, but Blackstone sure feels like an active business to me, and probably should be able to skirt the 40 Act. 

Regulatory Arbitrage.  Of course, the fact that Blackstone is calling itself passive for tax purposes - so as to qualify for a "passive-type" income exception to the publicly-traded partnership rules - won't help its case with the SEC.  In my view, Blackstone's avoidance of the corporate tax is what's screwed up, not its avoidance of the 40 Act.  Any thoughts from the securities profs out there?  Should Blackstone be regulated as an investment company?

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