As a public service, I’m pointing to an important post at Gawker on some Mitt Romney investments that he has until now managed to shield from scrutiny. I hope qualified NC readers will put some of the pieces together and share your conclusions with Gawker as well as with NC readers in comments. This is the overview:
Today, we are publishing more than 950 pages of internal audits, financial statements, and private investor letters for 21 cryptically named entities in which Romney had invested—at minimum—more than $10 million as of 2011 (that number is based on the low end of ranges he has disclosed—the true number is almost certainly significantly higher). Almost all of them are affiliated with Bain Capital, the secretive private equity firm Romney co-founded in 1984 and ran until his departure in 1999 (or 2002, depending on whom you ask). Many of them are offshore funds based in the Cayman Islands. Together, they reveal the mind-numbing, maze-like, and deeply opaque complexity with which Romney has handled his wealth, the exotic tax-avoidance schemes available only to the preposterously wealthy that benefit him, the unlikely (for a right-wing religious Mormon) places that his money has ended up, and the deeply hypocritical distance between his own criticisms of Obama’s fiscal approach and his money managers’ embrace of those same policies. They also show that some of the investments that Romney has always described as part of his retirement package at Bain weren’t made until years after he left the company…
When Romney left in 1999, he and his wife retained significant investments in many of those Bain vehicles—he claims they are “passive investments” and that they are managed in a blind trust (though the trustee isn’t blind enough to meet federal standards of independence). But aside from disparate snippets of information contained in his federal and Massachusetts financial disclosure forms, his 2010 tax returns, and SEC filings, the nature of those investments has been obfuscated by design.
Update 3:30 AM 8/24. As reader Willard Mitt Sutton pointed out in comments yesterday afternoon, law professor Victor Fleisher takes a dim view of the treatment of the management fee in some of the deals:
In the 2000s it became common for private equity fund managers to “convert” their management fees into carried interest. There are many variations on the theme, but here’s how many deals worked: each year, before the annual management fee comes due, the fund manager waives the management fee in exchange for a priority allocation of future profits. There is minimal economic risk involved; as long as the fund, at some point, has a profitable quarter, the managers get paid. (If the managers don’t foresee any future profits, they won’t waive the fees, and they will take cash instead.) In exchange for a minimal amount of economic risk, the tax benefit is enormous: the compensation is transformed from ordinary income (taxed at 35%) into capital gain (taxed at 15%). Because the management fees for a large private equity fund can be ten or twenty million per year, the tax dodge can literally save millions in taxes every year.
The problem is that it is not legal. Because the deals vary in their aggressiveness, there is some disagreement among practitioners about when it works and when it doesn’t. But in my opinion, and the opinion of many tax practitioners, the practices that were common in the private equity industry in the 2000s became very, very questionable, and it’s unlikely that they would have stood up in court.
Fund VII. Gawker today posted some Bain documents today showing that Bain, like many other PE firms, had engaged in this practice of converting management fees into capital gain. Unlike carried interest, which is unseemly but perfectly legal, Bain’s management fee conversions are not legal. If challenged in court, Bain would lose. The Bain partners, in my opinion, misreported their income if they reported these converted fees as capital gain instead of ordinary income.
Our PE insider and guest poster Nanea adds:
In order for these structures to have a prayer of passing IRS muster, the repayment of the waived fees must be from actual economic profits, which in every case I have ever seen (and I have seen many), they are not.
Floyd Norris of the New York Times has an article keying off the Fleisher discussion and also mentions:
A 2009 document concerning Bain Capital Asia, one of the firm’s overseas private equity funds, for example, refers to three “blocker” corporations used to invest in D&M Holdings, a Japanese electronics company.
Blocker corporations, typically set up in tax havens like the Cayman Islands, can help investors avoid a levy known as the unrelated business income tax, which was created to prevent nonprofit groups from undertaking profit-making ventures that compete with taxpaying companies.
The documents also showed that some of the funds owned equity swaps, which have been used to avoid taxes that would otherwise be owed on dividends paid by American companies to foreign-based investors, like funds based in the Caymans.
I had taken a discussion of blocker entities out of Nanea’s materials for NC’s inaugural PE post as being MEGO (My Eyes Glaze Over) inducing and relegated it to in one of our next pieces. Whoops.