August
2012
Where the Money Lives
For
all Mitt Romney’s touting of his business record, when it comes to his own
money the Republican nominee is remarkably shy about disclosing numbers and
investments. Nicholas Shaxson delves into the murky world of offshore finance,
revealing loopholes that allow the very wealthy to skirt tax laws, and
investigating just how much of Romney’s fortune (with $30 million in Bain
Capital funds in the Cayman Islands alone?) looks pretty strange for a
presidential candidate.
Mitt
Romney looking for his vacation home through the window of the campaign plane.
© RUTH
TOMLINSON/ROBERT HARDING WORLD IMAGERY/CORBIS (BEACH); BY JUSTIN SULLIVAN/GETTY
IMAGES (INSET).
BURIED TREASURE Grand
Cayman, where Bain Capital maintains at least 138 funds. Inset, Mitt Romney tries to spot his La Jolla home
from the campaign plane.
Aperson who worked for Mitt Romney at the consulting firm Bain
and Co. in 1977 remembers him with mixed feelings. “Mitt was … a really
wonderful boss,” the former employee says. “He was nice, he was fair, he was
logical, he said what he wanted … he was really encouraging.” But Bain and Co.,
the person recalls, pushed employees to find out secret revenue and sales data
on its clients’ competitors. Romney, the person says, suggested “falsifying”
who they were to get such information, by pretending to be a graduate student
working on a project at Harvard. (The person, in fact, was a Harvard student,
at Bain for the summer, but not working on any such projects.) “Mitt said to
me something like ‘We won’t ask you to lie. I am not going to tell you to do
this, but [it is] a really good way to get the information.’ … I would not have
had anything in my analysis if I had not pretended.
“It
was a strange atmosphere. It did leave a bad taste in your mouth,” the former
employee recalls.
This
unsettling account suggests the young Romney—at that point only two years out
of Harvard Business School—was willing to push into gray areas when it came to
business. More than three decades later, as he tried to nail down the
Republican nomination for president of the United States, Romney’s gray areas
were again an issue when he repeatedly resisted calls to release more details
of his net worth, his tax returns, and the large investments and assets held by
him and his wife, Ann. Finally the other Republican candidates forced him to do
so, but only highly selective disclosures were forthcoming.
Even
so, these provided a lavish smorgasbord for Romney’s critics. Particularly
jarring were the Romneys’ many offshore accounts. As Newt Gingrich put it
during the primary season, “I don’t know of any American president who has had
a Swiss bank account.” But Romney has, as well as other interests in such tax
havens as Bermuda and the Cayman Islands.
To
give but one example, there is a Bermuda-based entity called Sankaty High Yield
Asset Investors Ltd., which has been described in securities filings as “a
Bermuda corporation wholly owned by W. Mitt Romney.” It could be that Sankaty
is an old vehicle with little importance, but Romney appears to have treated it
rather carefully. He set it up in 1997, then transferred it to his wife’s newly
created blind trust on January 1, 2003, the day before he was inaugurated as
Massachusetts’s governor. The director and president of this entity is R.
Bradford Malt, the trustee of the blind trust and Romney’s personal lawyer.
Romney failed to list this entity on several financial disclosures, even though
such a closely held entity would not qualify as an “excepted investment fund”
that would not need to be on his disclosure forms. He finally included it on
his 2010 tax return. Even after examining that return, we have no idea what is
in this company, but it could be valuable, meaning that it is possible Romney’s
wealth is even greater than previous estimates. While the Romneys’ spokespeople
insist that the couple has paid all the taxes required by law, investments in
tax havens such as Bermuda raise many questions, because they are in
“jurisdictions where there is virtually no tax and virtually no compliance,” as
one Miami-based offshore lawyer put it.
That’s
not the only money Romney has in tax havens. Because of his retirement deal
with Bain Capital, his finances are still deeply entangled with the
private-equity firm that he founded and spun off from Bain and Co. in 1984.
Though he left the firm in 1999, Romney has continued to receive large payments
from it—in early June he revealed more than $2 million in new Bain income. The
firm today has at least 138 funds organized in the Cayman Islands, and Romney
himself has personal interests in at least 12, worth as much as $30 million,
hidden behind controversial confidentiality disclaimers. Again, the Romney
campaign insists he saves no tax by using them, but there is no way to check
this.
Bain
Capital is the heart of Romney’s fortune: it was the financial engine that created
it. The mantra of his campaign is that he was a businessman who created tens of
thousands of jobs, and Bain certainly did bring useful operational skills to
many companies it bought. But his critics point to several cases where Bain
bought companies, loaded them with debt, and paid itself extravagant fees,
thereby bankrupting the companies and destroying tens of thousands of jobs.
Come
August, Romney, with an estimated net worth as high as $250 million (he won’t
reveal the exact amount), will be one of the richest people ever to be
nominated for president. Given his reticence to discuss his wealth, it’s only
natural to wonder how he got it, how he invests it, and if he pays all his
taxes on it.
Ironically, it was Mitt’s father, George Romney, who released 12
years of tax returns, in November 1967, just ahead of his presidential
campaign, thereby setting a precedent that nearly every presidential candidate
since has either willingly or unwillingly been subject to. George, then the
governor of Michigan, explained why he was releasing so many years’ worth,
saying, “One year could be a fluke, perhaps done for show.”
But
his son declined to release any returns through one unsuccessful race for the
U.S. Senate, in 1994, one successful run for Massachusetts governor, in 2002,
and an aborted bid for the Republican Party presidential nomination, in 2008.
Just before the Iowa caucus last December, Mitt told MSNBC, “I don’t intend to
release the tax returns. I don’t,” but finally, on January 24, 2012—after intense
goading by fellow Republican candidates Newt Gingrich and Rick Perry—he
released his 2010 tax return and an estimate for 2011.
These,
plus the mandatory financial disclosures filed with the Office of Government
Ethics and released last August, raise many questions. A full 55 pages in his
2010 return are devoted to reporting his transactions with foreign entities.
“What Romney does not get,” says Jack Blum, a veteran Washington lawyer and
offshore expert, “is that this stuff is weird.”
The
media soon noticed Romney’s familiarity with foreign tax havens. A $3 million
Swiss bank account appeared in the 2010 returns, then winked out of existence
in 2011 after the trustee closed it, as if to remind us of George Romney’s
warning that one or two tax returns can provide a misleading picture. Ed
Kleinbard, a professor of tax law at the University of Southern California,
says the Swiss account “has political but not tax-policy resonance,” since
it—like many other Romney investments—constituted a bet against the U.S. dollar,
an odd thing for a presidential candidate to do. The Obama campaign provided a
helpful world map pointing to the tax havens Bermuda, Luxembourg, and the
Cayman Islands, where Romney and his family have assets, each with the tagline
“Value: not disclosed in tax returns.”
Romney’s personal tax rate is a particular point of interest. In
2010 and 2011, Mitt and Ann paid $6.2 million in federal tax on $42.5 million
in income, for an average tax rate just shy of 15 percent, substantially less
than what most middle-income Americans pay. Romney manages this low rate
because he takes his payments from Bain Capital as investment income, which is
taxed at a maximum 15 percent, instead of the 35 percent he would pay on
“ordinary” income, such as salaries and wages. Many tax experts argue that the
form of remuneration he receives, known as carried interest, is really just a
fee charged by investment managers, so it should instead be taxed at the 35
percent rate. Lee Sheppard, a contributing editor at the trade publication Tax Notes, whose often controversial articles are read
widely by tax professionals, is nonplussed that the Obama campaign has been so
listless on the issue of carried interest. “Romney is the poster boy, the best
argument, for taxing this profit share as ordinary income,” says Sheppard.
In
the face of such arguments, Romney’s defense is that he never broke the rules:
if there is a problem, it is in the laws, not in his behavior. “I pay all the
taxes that are legally required, not a dollar more,” he said. Even so. “When
you are running for president, you might want to err on the side of overpaying
your taxes, and not chase every tax gimmick that comes down the pike,” says
Sheppard. “It kind of looks tacky.”
Continued
(page 2 of 4)
The
assertion that he broke no laws is widely accepted. But it is worth asking if
it is actually true. The answer, in fact, isn’t straightforward. Romney, like
the superhero who whirls and backflips unscathed through a web of laser beams
while everyone else gets zapped, is certainly a remarkable financial acrobat.
But careful analysis of his financial and business affairs also reveals a man
who, like some other Wall Street titans, seems comfortable striding into some
fuzzy gray zones.
The
Caped Avoider!
One might perhaps accept an explanation by Romney’s campaign
spokeswoman, Andrea Saul, that the candidate’s failure to include his Swiss
account in earlier financial disclosures was merely a “trivial inadvertent
issue.” But deeper questions do emerge.
All
the assets on Mitt’s financial disclosures are in blind trusts or retirement
accounts held by him and Ann. Blind trusts are designed to avoid conflicts of
interest for those in public office by having politicians’ assets managed by
independent trustees. The Romneys’ blind trust was created when Mitt was
elected governor of Massachusetts. Curiously, the Romneys appointed Bradford
Malt as their trustee. It’s certainly true that under Malt the trusts don’t
appear to be as blind as they might be: for instance, in 2010 the Romneys
invested $10 million in the start-up of the Solamere Founders Fund, co-founded
by their eldest son, Tagg, and Spencer Zwick, Romney’s onetime top campaign
fund-raiser; Solamere is now in the Ann Romney blind trust. Malt has said he
invested in Solamere without consulting Mitt or Ann and explained he liked
Solamere because of its diversified approach and because he knew the founders
and had confidence in them.
Likewise, the Romneys were
reported to have invested at least $1 million in Elliott Associates, L.P., a
hedge fund specializing in “distressed assets.” Elliott buys up cheap debt,
often at cents on the dollar, from lenders to deeply troubled nations such as
Congo-Brazzaville, then attacks the debtor states with lawsuits to squeeze
maximum repayment. Elliott is run by the secretive hedge-fund billionaire and
G.O.P. super-donor Paul Singer, whom Fortune recently
dubbed Mitt Romney’s “Hedge Fund Kingmaker.” (Singer has given $1 million to
Romney’s super-pac Restore Our Future.)
It is hard to know the size of
these investments. Romney’s financial disclosure form lists 25 of them in an
open-ended category, “Over $1 million,” including Solamere and Elliott, and
they are not broken down further. Romney hides behind a disclaimer that the
fund managers “declined to provide such information” about their underlying
assets. Many of these funds are set up in tax havens such as the Cayman
Islands, where a confidentiality law states that you can be jailed for up to
four years just for asking about
such information.
Andrea Saul said of these
investments, “Everything … was reported correctly.” Joseph Sandler, a
Democratic lawyer who has worked with candidates on disclosures for more than
two decades, is skeptical. “The law is the law,” Sandler says. “[Romney] says,
‘Well, you know, they won’t tell me.’ But when you run for office in the U.S.
and are not prepared to comply with disclosure requirements, you should either
divest yourself of the assets or don’t run.” The Washington Post summarized
the opinions of experts across the political spectrum by saying Romney’s
disclosures were “the most opaque they have encountered.”
Mysteries also arise when one looks at Romney’s individual
retirement account at Bain Capital. When Romney was there, from 1984 to 1999,
taxpayers were allowed to put just $2,000 per year into an I.R.A., and $30,000
annually into a different kind of plan he may have used. Given these annual
contribution ceilings, how can his I.R.A. possibly contain up to $102 million,
as his financial disclosures now suggest?
The Romneys won’t say, but Mark
Maremont, writing in The Wall Street Journal,
uncovered a likely explanation. When Bain Capital bought companies, it would
create two classes of shares, named A and L. The A shares were risky common
shares, to which they would assign a very low value. The L shares were
preferred shares, paying a high dividend but with the payoff frozen, and most
of the value was assigned to them. Bain employees would then put the exciting A
shares in their I.R.A. accounts, where they grew tax-free. With all the risk of
the deal, the A shares stood to gain a lot or collapse. But if the deal
succeeded, the springing value could be stunning: Bain employees saw their A
shares from one particularly fruitful deal grow 583-fold, 16 times faster than
the underlying stock.
The
Romneys won’t tell us how, or even if, they assigned super-low values to the A
shares, but there are a couple of ways to do it. One is to use standard options
models to price the shares—then feed inappropriate assumptions into those
models. Romney could alternatively have used a model called liquidation
valuation, which Kleinbard says would have been “completely inappropriate.”
Without seeing the assumptions used on Romney’s tax returns from the years when
those lowball A shares were squirted into his I.R.A., we cannot know how he did
it. Whatever methods he used, however, the valuations were, according to Andrew
Smith, of Houlihan Capital in Chicago, “pushing the envelope.” (Andrea Saul
retorts, “Why should successful investments be criticized?”)
Mitt’s
and Ann’s I.R.A.’s have also been receiving profit interest from (mostly Cayman
Island–based) Bain Capital funds that were set up long after he had left the
company, in 1999. For example, the 2010 return reveals a profits interest in a
Cayman-based fund called Bain Capital Partners (AM) X LP, which was transferred
to the Ann D. Romney trust in October 2010. An attachment to the return says
the Ann D. Romney trust is “performing services” to the partnership, which is
boilerplate language for these kinds of filings. Her blind trust could receive
lightly taxed income from Bain Capital for years to come, well into the
presidential term her husband hopes to win.
But
administrative guidance says you can do this kind of thing only if the
compensation is in recognition of past services you have provided. “This should
not mean retired from the mother ship 10 years out and getting profits you had
nothing to do with,” Sheppard says, adding that Romney can get away with it
because of excessive “administrative indulgences” that have allowed a
“perversion of the law in favor of a small class of overcompensated investment
managers.”
Romney’s I.R.A. also appears to have invested in so-called
blocker corporations in the Cayman Islands and elsewhere. U.S. pension funds,
foundations, and even I.R.A.’s routinely use offshore blocker corporations to
avoid something called the Unrelated Business Income Tax, which was designed to
keep nonprofits from competing with ordinary companies in areas outside their
core purpose: if you invest directly you get hit with the tax, but if you
invest in a blocker, which then invests in the U.S. business, you escape it.
Romney’s I.R.A. appears to have employed this lawful escape route, and his
campaign has used language suggesting that it has. But that would mean the
Romney camp’s claim that Mitt’s tax consequences of investing via the Cayman
Islands is “the very same” as it would have been had he invested directly at
home is simply not true. (Romney spokesperson Andrea Saul says Romney “gets the
same benefit anyone would get from an I.R.A.,” but she did not respond to
questions on whether his I.R.A. had used blockers or avoided taxes by investing
via tax havens.)
ADeutsche Bank analysis of 68 Bain deals Romney was involved in
calculated an internal rate of return—a standard private-equity benchmark—at a
staggering 88 percent annually (though after fees and inflation, investor
performance may have been little more than half that). It is substantially on
this stellar record that Romney is now running for president. His work at Bain
was unquestionably good for himself and for Bain, but was it also good for the
businesses he acquired, for their workers, and for the economy, as he claims?
A report by Bain and Co. itself,
looking at the period from 2002 to 2007, concluded that there is “little
evidence that private equity owners, overall, added value” to the companies
they took over: nearly all their returns are explained by broad economic
growth, rising stock markets, and leverage. Josh Kosman, who researched the
subject of private equity for his book The Buyout of America,
singles out Bain Capital in particular. “They take pride in pushing the
leverage envelope [i.e., use of borrowed money, which magnifies returns, while
off-loading the risks onto others] more than their peers,” he says. “I have
heard that from limited partners in Bain’s funds. I have heard that from
bankers who lend money to finance their leveraged buyouts. Bain always prided
itself on ‘We’ll push leverage more than the others.’ They brag about that,
behind closed doors.”
Continued
(page 3 of 4)
Dade Behring is a cause célèbre for Romney’s and Bain’s critics,
and it illustrates the leverage problem clearly. In 1994, Bain bought Dade
International, a medical-diagnostics company, then added the
medical-diagnostics division of DuPont in 1996 and a German medical-testing
company called Behring in 1997. Former Dade president Bob Brightfelt says the
operation started well: the Bain managers were “pretty smart guys,” he recalls,
and they did well cutting out overlap, and exploiting synergies.
Then
brutal cost cutting began. Bain cut R&D spending to an average of 8 percent
of sales, a little more than half what its competitors were doing. Cindy
Hewitt, Dade’s human-resources manager, remembers how the firm closed a Puerto
Rico plant in 1998, a year after harvesting $7.1 million in local tax breaks
aimed at job creation, and relocated some staff to Miami, then the company’s
most profitable plant. Based on reassurances she had received from her
superiors, she told those uprooting themselves from Puerto Rico that their jobs
in Miami were safe for now—but then Bain closed the Miami plant. “Whether you
want to call it misled, or lied, or manipulated, I do not believe they provided
full information about what discussions were under way,” she says. “I would
never want to be part of even unintentionally treating people so poorly.”
Bain
engaged in startling penny-pinching with the laid-off employees. Their
contracts stipulated that if they left early they would have to pay back the
costs of relocating to Miami—but in spite of all that Dade had done to them, it
refused to release the employees from this clause. “They said they would go
after them for that money if they left before Bain was finished with them,”
Hewitt recalls. Not only that, but the company declined to give workers their
severance pay in lump sums to help them fund their return home.
In
1999, generous pensions were converted into less generous benefits, wages were
cut, and more staff members were laid off. Some employees contacted Norman
Stein, then the director of the pension-counseling clinic at the University of
Alabama law school, with a view to challenging the conversions. Stein says the
employees were “extraordinarily nervous,” so fearful, in fact, that they
refused to let lawyers even make copies of pension documents. “I have been
dealing with pensions issues for over 25 years and I never saw anything like
this,” recalls Stein. The spooked employees did not go to court. Stein says
that, while breaking pension contracts like this was not unheard of, the
practice at that time was “questionable,” adding that Dade may have saved $10
to $40 million from converting its pensions.
The
beauty—or savagery—of leverage is that it can magnify any and all cash-flow
boosts, such as this one. Take $10 to $40 million squeezed from a pension pot,
then use that to create new, rosier financial projections to borrow several
times that amount, and then pay yourself a big special dividend from the
borrowed funds, many times the size of the pension savings. That is just what
Bain Capital did: the same month it converted the pensions, it created new
financial projections as a basis to borrow an extra $421 million—from which
Bain, its co-investor Goldman Sachs, and top Dade management extracted $365
million in dividends. According to Kosman, “Bain and Goldman—after putting down
only $85 million … made out like bandits—a $280 million profit.” Dade’s debt
rose to more than $870 million. Romney had left operational management of Bain
that year, though his disclosures show that he owned 16.5 percent of the Bain
partnership responsible for the Dade investment until at least 2001.
Quite
soon, however, a fragile Dade faced adverse conditions in the currency markets,
and it had to start in effect cannibalizing itself, cutting into the core of
its business. It filed for bankruptcy in August 2002 and Bain Capital departed.
When Dade emerged from bankruptcy, its new owners invested in long-term
R&D, and it flourished again.
Nor was this an isolated incident:
Kosman lists five other “formerly healthy” companies—Stage Stores, Ampad, GS
Technologies, Details, and KB Toys—Bain helped drive into bankruptcy, while
making big profits. (Despite numerous entreaties from Vanity Fair to Bain Capital to address on the
record points in this article with which it might disagree, the firm refused to
do so and instead provided this statement: “When politics overwhelm fact, some
will distort or cherry-pick our record and launch unfounded allegations and
insinuations. The truth and the full record show that Bain Capital operates
with high standards of integrity and excellence in compliance with all laws.
Any suggestion to the contrary is baseless.”)
Tax
Haven U.S.A.
The term “financialization” describes two interlocking processes:
a disproportionate growth in a country’s deregulated financial sector, relative
to the rest of the economy, and the rising importance of financial activities
with a focus on financial returns among industrial and other non-financial
corporations, often at the expense of real innovation and productivity.
Some see the rising influence of
finance and financial models in epochal terms. Author of Financialization and the U.S. Economy Özgür
Orhangazi summarizes academic literature that sees financialization “as one of
the indicators of the decline of the hegemonic power”: imperial Venice,
Genoa, Holland, and Britain all saw their power rise on the back of productive
industrial capitalism, followed by domination by the financial sector, which
eventually began to cannibalize the productive sector in pursuit of financial
returns—a process that ended in weakness and collapse.
Little
noticed in the academic discussions of financialization is the role of offshore
tax havens, one of the big reasons the financial sector has become so powerful.
In 1966, Michael Hudson, a young Chase Manhattan balance-of-payments economist,
was in a company elevator when he was handed a memo by a former State
Department operative. The memo came from the U.S. government, and Hudson was
tasked with figuring out how much foreign money the U.S. might attract. “They
were saying, ‘We want to replace Switzerland,’ ” Hudson explains. “All this money
will come here if we make this the criminal center of the world. We wanted
foreign criminal money, which was patriotic, but not American criminal money.”
In the years since then, almost unknown to most Americans, the
United States has turned itself into a giant tax haven for foreigners, just as
the memo suggested. Federal and state tax laws have been deliberately shaped to
give foreigners special tax exemptions unavailable to Americans, plus financial
secrecy and exemptions from regulatory restraints. “We have criticized offshore
tax havens for their secrecy and lack of transparency,” said Senator Carl
Levin. “But look what is going on in our own backyard.”
In
this grand scenario, tax havens such as the Caymans serve as feeders of foreign
savings into Tax Haven U.S.A. from abroad, providing foreign investors with
additional ways to skip around tax, disclosure, and regulatory requirements
that they might trigger if they invested directly.
The
money sucked into Tax Haven U.S.A., often via the “feeder” tax havens, is
frequently tax-evading and other criminal foreign money, in the spirit of
Hudson’s 1966 memo, and it is predominantly channeled not into productive
investment but into real estate and financial business.
One
cannot properly understand Wall Street’s size and power without appreciating
the central role of offshore tax havens. There is absolutely no evidence that
Bain has done anything illegal, but private equity is one channel for this
secrecy-shrouded foreign money to enter the United States, and a filing for
Mitt Romney’s first $37 million Bain Capital Fund, of 1984, provides a rare
window into this. One foreign investor, of $2 million, was the newspaper
tycoon, tax evader, and fraudster Robert Maxwell, who fell from his yacht, and
drowned, off of the Canary Islands in 1991 in strange circumstances, after
looting his company’s pension fund. The Bain filing also names Eduardo Poma, a
member of one of the “14 families” oligarchy that has controlled most of El
Salvador’s wealth for decades; oddly, Poma is listed as sharing a Miami address
with two anonymous companies that invested $1.5 million between them. The
filings also show a Geneva-based trustee overseeing a trust that invested $2.5
million, a Bahamas corporation that put in $3 million, and three corporations
in the tax haven of Panama, historically a favored destination for
Latin-American dirty money—“one of the filthiest money-laundering sinks in the
world,” as a U.S. Customs official once put it.
Continued
(page 4 of 4)
Bain
Capital has said it did everything required by the U.S. government to check
that the investors were not associated with unsavory interests. U.S. law
doesn’t require Bain to enforce the tax laws of its investors’ home countries,
but the presence of Swiss trustees, Bahamas trusts, and Panama corporations
would raise red flags with any tax authority.
Many
Americans might react with a shrug to the idea of shady foreign money such as Robert
Maxwell’s being invested here. But, says Rebecca Wilkins, of the Washington,
D.C.–based nonprofit Citizens for Tax Justice, “It is shocking that a
presidential candidate should think that is O.K.”
The assertion that he broke no laws is widely accepted. But it
is worth asking if it is actually true. The answer, in fact, isn’t
straightforward. Romney, like the superhero who whirls and backflips unscathed
through a web of laser beams while everyone else gets zapped, is certainly a
remarkable financial acrobat. But careful analysis of his financial and
business affairs also reveals a man who, like some other Wall Street titans,
seems comfortable striding into some fuzzy gray zones.
The Caped Avoider!
One might perhaps accept an
explanation by Romney’s campaign spokeswoman, Andrea Saul, that the candidate’s
failure to include his Swiss account in earlier financial disclosures was
merely a “trivial inadvertent issue.” But deeper questions do emerge.
All the assets on Mitt’s financial disclosures are in blind
trusts or retirement accounts held by him and Ann. Blind trusts are designed to
avoid conflicts of interest for those in public office by having politicians’
assets managed by independent trustees. The Romneys’ blind trust was created
when Mitt was elected governor of Massachusetts. Curiously, the Romneys
appointed Bradford Malt as their trustee. It’s certainly true that under Malt
the trusts don’t appear to be as blind as they might be: for instance, in 2010
the Romneys invested $10 million in the start-up of the Solamere Founders Fund,
co-founded by their eldest son, Tagg, and Spencer Zwick, Romney’s onetime top
campaign fund-raiser; Solamere is now in the Ann Romney blind trust. Malt has
said he invested in Solamere without consulting Mitt or Ann and explained he
liked Solamere because of its diversified approach and because he knew the
founders and had confidence in them.
Likewise,
the Romneys were reported to have invested at least $1 million in Elliott
Associates, L.P., a hedge fund specializing in “distressed assets.” Elliott
buys up cheap debt, often at cents on the dollar, from lenders to deeply
troubled nations such as Congo-Brazzaville, then attacks the debtor states with
lawsuits to squeeze maximum repayment. Elliott is run by the secretive hedge-fund
billionaire and G.O.P. super-donor Paul Singer, whom Fortune recently dubbed Mitt Romney’s “Hedge Fund
Kingmaker.” (Singer has given $1 million to Romney’s super-pac Restore Our
Future.)
It is hard
to know the size of these investments. Romney’s financial disclosure form lists
25 of them in an open-ended category, “Over $1 million,” including Solamere
and Elliott, and they are not broken down further. Romney hides behind a
disclaimer that the fund managers “declined to provide such information” about their
underlying assets. Many of these funds are set up in tax havens such as the
Cayman Islands, where a confidentiality law states that you can be jailed for
up to four years just for asking about
such information.
Andrea
Saul said of these investments, “Everything … was reported correctly.” Joseph
Sandler, a Democratic lawyer who has worked with candidates on disclosures for
more than two decades, is skeptical. “The law is the law,” Sandler says.
“[Romney] says, ‘Well, you know, they won’t tell me.’ But when you run for
office in the U.S. and are not prepared to comply with disclosure requirements,
you should either divest yourself of the assets or don’t run.” The Washington Postsummarized the opinions of experts
across the political spectrum by saying Romney’s disclosures were “the most
opaque they have encountered.”
Mysteries also arise when one looks
at Romney’s individual retirement account at Bain Capital. When Romney was
there, from 1984 to 1999, taxpayers were allowed to put just $2,000 per year into
an I.R.A., and $30,000 annually into a different kind of plan he may have used.
Given these annual contribution ceilings, how can his I.R.A. possibly contain
up to $102 million, as his financial disclosures now suggest?
The
Romneys won’t say, but Mark Maremont, writing in The Wall Street Journal, uncovered a likely
explanation. When Bain Capital bought companies, it would create two classes of
shares, named A and L. The A shares were risky common shares, to which they
would assign a very low value. The L shares were preferred shares, paying a
high dividend but with the payoff frozen, and most of the value was assigned to
them. Bain employees would then put the exciting A shares in their I.R.A.
accounts, where they grew tax-free. With all the risk of the deal, the A shares
stood to gain a lot or collapse. But if the deal succeeded, the springing value
could be stunning: Bain employees saw their A shares from one particularly
fruitful deal grow 583-fold, 16 times faster than the underlying stock.
The Romneys won’t tell us how, or even if, they assigned
super-low values to the A shares, but there are a couple of ways to do it. One
is to use standard options models to price the shares—then feed inappropriate
assumptions into those models. Romney could alternatively have used a model
called liquidation valuation, which Kleinbard says would have been “completely
inappropriate.” Without seeing the assumptions used on Romney’s tax returns
from the years when those lowball A shares were squirted into his I.R.A., we cannot
know how he did it. Whatever methods he used, however, the valuations were,
according to Andrew Smith, of Houlihan Capital in Chicago, “pushing the
envelope.” (Andrea Saul retorts, “Why should successful investments be
criticized?”)
Mitt’s and Ann’s I.R.A.’s have also been receiving profit
interest from (mostly Cayman Island–based) Bain Capital funds that were set up
long after he had left the company, in 1999. For example, the 2010 return
reveals a profits interest in a Cayman-based fund called Bain Capital Partners
(AM) X LP, which was transferred to the Ann D. Romney trust in October 2010. An
attachment to the return says the Ann D. Romney trust is “performing services”
to the partnership, which is boilerplate language for these kinds of filings. Her
blind trust could receive lightly taxed income from Bain Capital for years to
come, well into the presidential term her husband hopes to win.
But administrative guidance says you can do this kind of thing only
if the compensation is in recognition of past services you have provided. “This
should not mean retired from the mother ship 10 years out and getting profits
you had nothing to do with,” Sheppard says, adding that Romney can get away
with it because of excessive “administrative indulgences” that have allowed a
“perversion of the law in favor of a small class of overcompensated investment
managers.”
Romney’s I.R.A. also appears to
have invested in so-called blocker corporations in the Cayman Islands and
elsewhere. U.S. pension funds, foundations, and even I.R.A.’s routinely use
offshore blocker corporations to avoid something called the Unrelated Business
Income Tax, which was designed to keep nonprofits from competing with ordinary
companies in areas outside their core purpose: if you invest directly you get
hit with the tax, but if you invest in a blocker, which then invests in the
U.S. business, you escape it. Romney’s I.R.A. appears to have employed this
lawful escape route, and his campaign has used language suggesting that it has.
But that would mean the Romney camp’s claim that Mitt’s tax consequences of
investing via the Cayman Islands is “the very same” as it would have been had
he invested directly at home is simply not true. (Romney spokesperson Andrea
Saul says Romney “gets the same benefit anyone would get from an I.R.A.,” but
she did not respond to questions on whether his I.R.A. had used blockers or
avoided taxes by investing via tax havens.)
ADeutsche Bank analysis of 68 Bain
deals Romney was involved in calculated an internal rate of return—a standard
private-equity benchmark—at a staggering 88 percent annually (though after fees
and inflation, investor performance may have been little more than half that).
It is substantially on this stellar record that Romney is now running for
president. His work at Bain was unquestionably good for himself and for Bain,
but was it also good for the businesses he acquired, for their workers, and for
the economy, as he claims?
A report
by Bain and Co. itself, looking at the period from 2002 to 2007, concluded that
there is “little evidence that private equity owners, overall, added value” to
the companies they took over: nearly all their returns are explained by broad
economic growth, rising stock markets, and leverage. Josh Kosman, who
researched the subject of private equity for his book The Buyout of America, singles out Bain Capital in
particular. “They take pride in pushing the leverage envelope [i.e., use of
borrowed money, which magnifies returns, while off-loading the risks onto
others] more than their peers,” he says. “I have heard that from limited
partners in Bain’s funds. I have heard that from bankers who lend money to
finance their leveraged buyouts. Bain always prided itself on ‘We’ll push leverage
more than the others.’ They brag about that, behind closed doors.”
Dade Behring is a cause célèbre for
Romney’s and Bain’s critics, and it illustrates the leverage problem clearly.
In 1994, Bain bought Dade International, a medical-diagnostics company, then
added the medical-diagnostics division of DuPont in 1996 and a German
medical-testing company called Behring in 1997. Former Dade president Bob
Brightfelt says the operation started well: the Bain managers were “pretty
smart guys,” he recalls, and they did well cutting out overlap, and exploiting
synergies.
Then brutal cost cutting began. Bain cut R&D spending to an
average of 8 percent of sales, a little more than half what its competitors were
doing. Cindy Hewitt, Dade’s human-resources manager, remembers how the firm
closed a Puerto Rico plant in 1998, a year after harvesting $7.1 million in
local tax breaks aimed at job creation, and relocated some staff to Miami, then
the company’s most profitable plant. Based on reassurances she had received
from her superiors, she told those uprooting themselves from Puerto Rico that
their jobs in Miami were safe for now—but then Bain closed the Miami plant.
“Whether you want to call it misled, or lied, or manipulated, I do not believe
they provided full information about what discussions were under way,” she
says. “I would never want to be part of even unintentionally treating people so
poorly.”
Bain engaged in startling penny-pinching with the laid-off
employees. Their contracts stipulated that if they left early they would have
to pay back the costs of relocating to Miami—but in spite of all that Dade had
done to them, it refused to release the employees from this clause. “They said
they would go after them for that money if they left before Bain was finished
with them,” Hewitt recalls. Not only that, but the company declined to give
workers their severance pay in lump sums to help them fund their return home.
In 1999, generous pensions were converted into less generous
benefits, wages were cut, and more staff members were laid off. Some employees
contacted Norman Stein, then the director of the pension-counseling clinic at
the University of Alabama law school, with a view to challenging the conversions.
Stein says the employees were “extraordinarily nervous,” so fearful, in fact,
that they refused to let lawyers even make copies of pension documents. “I have
been dealing with pensions issues for over 25 years and I never saw anything
like this,” recalls Stein. The spooked employees did not go to court. Stein
says that, while breaking pension contracts like this was not unheard of, the
practice at that time was “questionable,” adding that Dade may have saved $10
to $40 million from converting its pensions.
The beauty—or savagery—of leverage is that it can magnify any
and all cash-flow boosts, such as this one. Take $10 to $40 million squeezed
from a pension pot, then use that to create new, rosier financial projections
to borrow several times that amount, and then pay yourself a big special
dividend from the borrowed funds, many times the size of the pension savings.
That is just what Bain Capital did: the same month it converted the pensions,
it created new financial projections as a basis to borrow an extra $421
million—from which Bain, its co-investor Goldman Sachs, and top Dade management
extracted $365 million in dividends. According to Kosman, “Bain and
Goldman—after putting down only $85 million … made out like bandits—a $280
million profit.” Dade’s debt rose to more than $870 million. Romney had left
operational management of Bain that year, though his disclosures show that he
owned 16.5 percent of the Bain partnership responsible for the Dade investment
until at least 2001.
Quite soon, however, a fragile Dade faced adverse conditions in
the currency markets, and it had to start in effect cannibalizing itself,
cutting into the core of its business. It filed for bankruptcy in August 2002
and Bain Capital departed. When Dade emerged from bankruptcy, its new owners
invested in long-term R&D, and it flourished again.
Nor was
this an isolated incident: Kosman lists five other “formerly healthy”
companies—Stage Stores, Ampad, GS Technologies, Details, and KB Toys—Bain
helped drive into bankruptcy, while making big profits. (Despite numerous
entreaties from Vanity Fair to Bain Capital to
address on the record points in this article with which it might disagree, the
firm refused to do so and instead provided this statement: “When politics
overwhelm fact, some will distort or cherry-pick our record and launch
unfounded allegations and insinuations. The truth and the full record show that
Bain Capital operates with high standards of integrity and excellence in
compliance with all laws. Any suggestion to the contrary is baseless.”)
Tax Haven U.S.A.
The term “financialization”
describes two interlocking processes: a disproportionate growth in a country’s
deregulated financial sector, relative to the rest of the economy, and the
rising importance of financial activities with a focus on financial returns
among industrial and other non-financial corporations, often at the expense of
real innovation and productivity.
Some see
the rising influence of finance and financial models in epochal terms. Author
ofFinancialization and the U.S. Economy Özgür
Orhangazi summarizes academic literature that sees financialization “as one of
the indicators of the decline of the hegemonic power”: imperial Venice,
Genoa, Holland, and Britain all saw their power rise on the back of productive
industrial capitalism, followed by domination by the financial sector, which
eventually began to cannibalize the productive sector in pursuit of financial
returns—a process that ended in weakness and collapse.
Little noticed in the academic discussions of financialization
is the role of offshore tax havens, one of the big reasons the financial sector
has become so powerful. In 1966, Michael Hudson, a young Chase Manhattan
balance-of-payments economist, was in a company elevator when he was handed a memo
by a former State Department operative. The memo came from the U.S. government,
and Hudson was tasked with figuring out how much foreign money the U.S. might
attract. “They were saying, ‘We want to replace Switzerland,’ ” Hudson explains. “All this money
will come here if we make this the criminal center of the world. We wanted
foreign criminal money, which was patriotic, but not American criminal money.”
In the years since then, almost
unknown to most Americans, the United States has turned itself into a giant tax
haven for foreigners, just as the memo suggested. Federal and state tax laws
have been deliberately shaped to give foreigners special tax exemptions
unavailable to Americans, plus financial secrecy and exemptions from regulatory
restraints. “We have criticized offshore tax havens for their secrecy and lack
of transparency,” said Senator Carl Levin. “But look what is going on in our
own backyard.”
In this grand scenario, tax havens such as the Caymans serve as
feeders of foreign savings into Tax Haven U.S.A. from abroad, providing foreign
investors with additional ways to skip around tax, disclosure, and regulatory
requirements that they might trigger if they invested directly.
The money sucked into Tax Haven U.S.A., often via the “feeder”
tax havens, is frequently tax-evading and other criminal foreign money, in the
spirit of Hudson’s 1966 memo, and it is predominantly channeled not into
productive investment but into real estate and financial business.
One cannot properly understand Wall Street’s size and power
without appreciating the central role of offshore tax havens. There is
absolutely no evidence that Bain has done anything illegal, but private equity
is one channel for this secrecy-shrouded foreign money to enter the United
States, and a filing for Mitt Romney’s first $37 million Bain Capital Fund, of
1984, provides a rare window into this. One foreign investor, of $2 million,
was the newspaper tycoon, tax evader, and fraudster Robert Maxwell, who fell
from his yacht, and drowned, off of the Canary Islands in 1991 in strange
circumstances, after looting his company’s pension fund. The Bain filing also
names Eduardo Poma, a member of one of the “14 families” oligarchy that has
controlled most of El Salvador’s wealth for decades; oddly, Poma is listed as
sharing a Miami address with two anonymous companies that invested $1.5 million
between them. The filings also show a Geneva-based trustee overseeing a trust
that invested $2.5 million, a Bahamas corporation that put in $3 million, and
three corporations in the tax haven of Panama, historically a favored
destination for Latin-American dirty money—“one of the filthiest
money-laundering sinks in the world,” as a U.S. Customs official once put it.
