Carta Policy: Weekly Brief for July 29

The Topline

• Sen. Manchin surprises everyone, pivots on prior opposition to climate spending and tax bill

• Manchin/Schumer agreement to limit carried interest tax advantage, with significant implications for private equity and venture capital

• House passes modified DEAL Act, which could expand qualifying investments for venture capital funds 

• FTC sues Meta to block merger, while antitrust legislation addressing Big Tech lacks necessary support to move forward

Macro matters

Tax deal curtails carried interest, maintains QSBS

Senate Majority Leader Chuck Schumer and Senator Joe Manchin shocked the policy world Wednesday night by announcing a tax deal, the Inflation Reduction Act of 2022. The bill would: 

• Invest $433 billion in: 
  

  • Energy and climate tax credits  

  • Affordable Care Act extensions

  • Energy and climate tax credits  

  • Affordable Care Act extensions

• Raise revenues by $739 billion through:
  

  • 15% corporate minimum tax

  • Prescription drug pricing reform

  • IRS tax enforcement

  • Carried interest limitation

  • 15% corporate minimum tax

  • Prescription drug pricing reform

  • IRS tax enforcement

  • Carried interest limitation

• Reduce the deficit by $306 billion

The carried interest provision will directly affect our readers; find details below under Taxation.

QSBS and IRA private asset investment both remain intact—for now

The proposed legislation does not affect qualified small business stock tax treatment or restrict the ability of IRAs to invest in private assets. Carta worked with coalition partners over the last year on both of these issues and is pleased to report that our coalition efforts were successful. Thank you to all the partners who engaged to help make the case. 

Next steps & politics: Leader Schumer plans to put the bill on the Senate floor next week, while the House—assuming the Senate passes the bill—will return from August recess to vote on the bill in mid-August. That said, political dynamics are fluid. Senate Democrats need every Democratic vote, as well as the vice president’s tie-breaking vote, to pass the bill. House Democrats can only lose four votes, so the margins are thin. Sen. Kyrsten Sinema (D-AZ) has previously opposed curtailing carried interest tax treatment, and Sen. Bob Menendez (D-NJ), as well as moderate House Democrats, are frustrated that the bill does not raise the state and local tax (SALT) cap, a measure they had previously demanded be included in any tax reform bill. Meanwhile, Sen. Dick Durbin (D-IL) just tested positive for COVID and Sen. Leahy (D-VT) is recovering from surgery. Congressional Democratic leadership is working hard to secure passage. Although the timing is in flux, this is likely to become law. 

A few weeks back we noted that Sen. Manchin was playing the role of Lucy, taking away the football at the last minute, just when Leader Schumer was ready to kick it. Turns out it was a trick play that caught Senate Republicans on the back foot. Republican Leader McConnell announced in early July that if Democrats pursued tax reform through reconciliation, Republicans would not support CHIPS funding—legislation to invest in semiconductor and technology resources to bolster U.S. competitiveness. Senator Manchin announced there was no deal to be had on reconciliation, Republicans got behind CHIPS+ funding (which passed the Senate Wednesday), and then Manchin and Schumer announced the reconciliation deal on Wednesday night.

Economic outlook

The U.S. economy contracted for the second straight quarter as growth fell at a 0.9% annual rate during Q2. The IMF cut its global growth forecast by 0.4%, projecting it will fall from 6.1% last year to 3.2% in 2022. The Federal Reserve raised interest rates another 75 basis points, and Chairman Powell reiterated that the Fed would take the necessary measures to bring inflation to 2%, which may come at the cost of contraction. Even as President Biden points to declining gas prices and Democratic policymakers note decent employment numbers, the broader economic sentiment portends a challenging political environment for Democrats leading into the November election.

Carta & pay transparency

On Nov. 1, New York City will require employers to publish wage ranges for open roles. To help companies prepare, Carta released complete sets of NYC salary and equity bands for a few key job areas. This push towards pay transparency is a growing trend and one companies should be prepared for, as it has vast implications on the ability to attract, retain, and motivate teammates.

Capital markets

House passes DEAL Act to expand VC secondary investments

This week, the House unanimously passed the Developing and Empowering our Aspiring Leaders (DEAL) Act, which would ask the SEC to allow investments in qualifying portfolio companies acquired through secondary transactions to be considered “qualifying investments” under the venture capital fund rules. 

Under the current rules, to qualify as a VC fund and register as an exempt reporting adviser, 80% of fund investments must be “qualifying investments”—essentially direct investments in private companies. Expanding qualifications to include secondaries could stimulate the VC secondary market, providing a significant source of liquidity for founders, employees, and early-stage investors to exit and redeploy capital. It would also allow new investors to gain exposure to startups that have already shown maturation and scale. 

There are a couple major changes from the bill as originally introduced: 

• A provision that would have expanded qualifying investments to include investments in other VC funds was stripped out. 

• Most importantly, the SEC would not be required to expand qualifying investments to secondaries unless it finds that doing so would benefit capital formation without compromising investor protection. Given the negative sentiment toward an expansion of the private markets, the Commission could choose to not move forward. 

Despite some concerns with the revised language, this is a positive movement to broaden the ability of VC to unlock capital and support the entrepreneurial ecosystem. Carta will continue to work with our industry coalition partners to advance these efforts to expand VC fund investments.

SEC advisory committee to meet to discuss liquidity challenges for small business investors

Next week, the SEC’s Small Business Capital Formation Advisory Committee will meet to discuss liquidity challenges investors in small and emerging businesses are facing—both in the private and public markets—and whether policy changes could help facilitate secondary liquidity. The work of this advisory committee has served as the basis for much of the bipartisan capital formation proposals in Congress. The focus on capital formation challenges in the private markets is even more important given the posture from some in SEC leadership who have been critical of expanding private market secondary liquidity (and the use of exempt offerings more broadly). 

SEC launches educational resources to help navigate capital raising process

The SEC launched its Small Business Capital Raising Hub, which centralizes resources designed to help small businesses and their investors navigate the capital raising regulatory framework. 

Crypto & digital Assets

No agreement on stablecoin framework, though negotiations continue

House Financial Services Committee Chairwoman Maxine Waters and Ranking Member Patrick McHenry were unable to come to an agreement on a highly anticipated bill that would provide a regulatory framework for stablecoins before the Committee markup this week, though a deal is “close” and negotiations are expected to continue over the August recess. As we noted last week, the proposal is expected to mandate bank-like rules for bank- and nonbank-issued stablecoins overseen by the Federal Reserve. The traditional banking industry has raised concerns that the framework does not adequately address systemic risk with respect to non-bank stablecoin issuers, and the SEC has also raised concerns that the agency could be limited in its role to oversee platforms that trade stablecoins, and inserted itself into the debate despite Treasury’s engagement and support for primary oversight residing with the Fed. While a stablecoin framework is arguably the area where there is the most consensus in Congress, this delay and the competing interests involved underscore how difficult it will be for Congress to come to agreement on a comprehensive crypto framework. 

Congress continues its scrutiny on SEC enforcement-first approach to regulating digital assets

Sen. Pat Toomey, the lead Republican on the Senate Banking Committee, criticized the SEC’s approach to regulating digital assets through enforcement instead of providing regulatory clarity, which harms both investors and innovation, especially when combined with a “haphazard and apparently sluggish enforcement pace.” By providing sufficient clarity, Sen. Toomey argues the SEC could have prevented the collapse of several crypto companies and focused their efforts on the worst actors. Sen. Toomey also questioned the basis on which the SEC deemed nine out of 25 digital assets to be securities in recent insider trading charges filed against a former Coinbase employee. Separately, the SEC is allegedly scrutinizing whether Coinbase improperly allowed trading of unregistered securities on its platform, which led to a 21% drop in the company’s share price this week. Such a probe could have significant chilling effects on crypto platforms and token projects. Coinbase has been standing behind its rigorous diligence process and has formally petitioned the SEC to propose rules clarifying a regulatory framework for digital assets that addresses classification, issuance, trading, and custody.

Banking and financial products

Chopra focussed on BNPL, consumer data, and Section 1033

Consumer Financial Protection Bureau Director Rohit Chopra is pushing forward on an agenda that targets Big Tech’s expansion into financial services, evaluates downstream consumer impacts of higher interest rates, and prepares for the age of real-time payments. Specifically, Chopra raised concerns over Big Tech’s collection of consumer data and its payment services, classifying it as “the highest-stakes issue.” He also believes there could be competition concerns, arguing that “Big Tech’s ambitions when it comes to buy now, pay later are inextricably linked to the desire to dominate the digital wallet.” Chopra indicated a report on BNPL services and Big Tech is forthcoming and he also plans to convene a small business review panel to discuss the Section 1033 rulemaking which grants consumers the right to access their own bank account and transaction data.

OCC reviewing fintech’s impact

The Office of the Comptroller of the Currency is calling for new research on how fintechs are impacting the banking industry. The solicitation broadly asks for studies on the results of financial technology entities and nonbanks on banking and the markets for lending, deposit-taking, and payment services. Submissions are due by August 21, following which the office will select papers to be presented to OCC staff in November..

Taxation

Proposed change for carried interest tax

Included in the Inflation Reduction Act is a revived proposal to narrow the advantageous tax treatment for carried interest. Carried interest is a share of profits earned by general partners of private equity, venture capital, and hedge funds. As a performance fee, most funds pay a 20% share of profits to their investment managers in order to align the managers’ compensation with a fund’s returns. Fund managers are typically rewarded with carried interest if the fund achieves a minimum return, or hurdle rate, and any interest is preferentially taxed at the long-term capital gains rate rather than being subject to the ordinary income tax rate. For comparison, the top long-term capital gains rate is 20% while the top individual ordinary income rate is 37%, allowing carried interest to be taxed at a significantly lower rate—or what many Democrats are calling a “tax loophole.”

The changes, estimated to raise $14 billion over 10 years, would significantly expand the application and scope of carried interest rules. The proposal would increase the holding period requirement to benefit from long-term capital gains from three years to five years. It would provide new rules for measuring the holding period for carried interest, which will only begin after a taxpayer has “acquired substantially all of the applicable partnership interest” and the partnership has acquired “substantially all” of its assets. The provision also rewrites the rules to recognize gain on all transfers of carried interest, including to related persons. But two important carve-outs to note are that the current three-year holding period will continue to apply for taxpayers with an adjusted gross income of less than $400,000 and for any income related to real property trade or business (including construction, redevelopment, rental, leasing, brokerage, and others).

The next steps for this proposal remain tricky. The private equity industry is fighting back hard to defend an incentive that supports entrepreneurship and small business investment. All eyes are now on Sen. Sinema, who has previously raised concerns on changing the treatment of carried interest, and the bill will have to go through the complex process of passing the Senate parliamentarian and face a very tight timeline next week in order to pass before Congress leaves for recess.

Antitrust, privacy, and technology

Antitrust bill lacks necessary votes

Senate Majority Leader Schumer has indicated that the American Choice and Innovation Act, antitrust legislation that would prevent internet platforms from preferencing their own products and services, has stalled. Although Leader Schumer maintains the legislation is a high priority and the Senate Judiciary Committee advanced the legislation earlier this year, Leader Schumer cited the bill’s controversial nature in an election year making it difficult to find the votes.

DoJ partners with NLRB to protect workers

In a memorandum of understanding, the Justice Department’s antitrust department announced a partnership with the National Labor Relations Board to prevent collusion among employers in their competition for workers by coordinating on investigations and other enforcement actions. The head of the DOJ’s antitrust division, Jonathan Kanter, said the DOJ will apply “extraordinary vigilance” to protecting workers’ right to earn a fair wage. Last week, the NLRB entered into a similar agreement with the FTC, which has prioritized scrutinizing mergers that hurt competition in labor markets, and taking action against gig economy companies that lie to workers. This follows initiatives from the Biden Administration to strengthen the position of workers, with a focus on workers in the “gig economy” who lack many of the legal protections afforded to those hired as full-time employees.

FTC sues Meta to block acquisition of VR fitness app

In a 3-2 vote along party lines, the Federal Trade Commission voted to sue Meta to block it from acquiring virtual-reality company Within Unlimited. FTC Bureau of Competition Deputy Director John Newman argued that “instead of competing on the merits, Meta is trying to buy its way to the top. A Meta spokesperson said the lawsuit is “based on ideology and speculation, not evidence.” The new case represents a major milestone under FTC Chair Lina Khan’s leadership following the confirmation of Democratic Commissioner Alvaro Bedoya, who cast the tie-breaking vote. Both Khan and her counterpart at the Department of Justice Antitrust Division, Jonathan Kanter, have emphasized the importance of bringing risky cases to expand antitrust law and the FTC’s enforcement powers at the edges.

Upcoming events

• SEC Small Business Capital Formation Advisory Committee Meeting  – Aug. 2 at 10:00 a.m. (ET)

Notable SEC proposed rules and comment deadlines

*60-days after publication in the Federal Register, which has not occurred

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