More on Private Equity, Carried Interest, Wealth, and Romney
by Linda Beale
More on Private Equity, Carried Interest, Wealth, and Romney
Those who’ve read much of this blog are aware of the various arguments against the notion that private equity firms are “do-gooders” that we should encourage and even subsidize (through the carried interest provision). On the whole, I believe they are part of a harmful trend towards consolidation of enterprises that weakens links to communities, makes caring for workers seem like too great a cost, and encourages over-leveraging and instability that ultimately is devastating to the economy. Add to that the egregiously inappropriate tax treatment of “carried interest” paid to managers, and you have a wealth-building machine for a small, elite group that does not pay its fair share of the tax burden and whose activities are likely a net social detriment.
Specifically, private equity firms historically have looked for good, stable businesses with decent cash flows, low leverage and decent but not high profits that they can take over, leverage highly (to pay for the acquisition and to provide quick funds to fuel their own ultra-high profit demands), with the cash flow from the ongoing business paying off the debt. The result in these leveraged buyout cases may be that a stable busienss with a profit of 5-6% that spent what was needed on maintenance and new investment, expanding gradually and paying its workers a decent wage and its owners a small but decent profit becomes an overleveraged company that is less stable and has to use more of its cash flow to pay off the debt.
One result of excessive debt is that expenditures for maintenance and investment in new equipment are deferred. and business stalls for the time it takes to pay off the debt. Sometimes that stall is merely a bad time for the business (and often its workers). Liquidity problems can result in proclaimed “efficiency” decisions to fire or lay off hundreds of workers and to reshape benefits like pensions and health care. That’s if the company stays in operation. Sometimes the debt service and resultant deferral of investments and change of focus of the business will be fatal. Costly leverage results in bankruptcy or in the business being broken up and sold in pieces, either way with many workers losing jobs (and benefits) and many communities suffering dire consequences. Whatever happens, the equity fund managers gets high fees and “carried interest” profits taxed at inappropriately low tax rates. Romney, for instance, continued to get a “carried interest” cut from Bain Capital’s activities in compensation for past work done, long after he retired from doing any work at the firm in 1999. See Romney using ethics exception to limit disclosure of Bain holdings, Washington Post (April 5, 2012).
And of course, private equity firms do not necessarily invest only in domestic companies. They may hold considerable assets offshore–possibly in some of those very companies that represent low-wage, low-benefits, and low-worker-rights havens for US multinationals that end US jobs here in order to hire more cheaply abroad….. Romney, for instance, has holdings in “a high-tech sensor control firm that has moved U.S. manufacturing jobs to China.” Id. (noting that these holdings were revealed through SEC filings).
One wonders if those realities of equity funds is a reason that Romney has used an ethics exception to limit his disclosure of Bain holdings. See Romney using ethics exception to limit disclosure of Bain holdings, Washington Post (April 5, 2012).
By offering a limited description of his assets, Romney has made it difficult to know precisely where his money is invested, whether it is offshore or in controversial companies, or whether those holdings could affect his policies or present any conflicts of interest.
In 48 accounts from Bain Capital, the private equity firm he founded in Boston, Romney declined on his financial disclosure forms to identify the underlying assets, including his holdings in a company that moved U.S. jobs to China and a California firm once owned by Bain that filed for bankruptcy years ago and laid off more than 1,000 workers.
***[M]ost of the underlying assets — the specific investments of Bain funds— are not known because Romney is covered by a confidentiality agreement with the company.
Several of Romney’s assets — including a large family trust valued at roughly $100 million, nine overseas holdings and 12 partnership interests— were not named initially on his disclosure forms, emerging months later when he agreed to release his tax returns.
***
Several outside experts across the political spectrum, however, say Romney’s disclosure is the most opaque they have encountered, with some suggesting the filing effectively defeats the spirit of disclosure requirements.
***
[Romney’s failure to disclose these assets, and the inapplicability of conflict-of-interest “must sell” requirements to a President, mean that we may never know and that Romney may continue to hold positions that would be inappropriate for a sitting president.] Although still subject to the disclosure requirements, a president cannot be compelled by OGE to sell undisclosed assets, according to an OGE official. Romney’s would be the first presidency to face this circumstance. Id.
As the article notes, one reason Romney doesn’t disclose Bain’s underlying assets is that Bain (a fund he created) requires its participants to enter into confidentiality agreements. Handy for a politician with considerable wealth that the institution he created “requires” him to keep its investments secret. But not so handy for the people whom a president is supposed to serve. As Democratic Party lawyer Joe Sandler noted, “Romney’s approach frustrates the very purpose of the ethics and disclosure laws.” Id. The disclosure is intended to “allow the public to identify potential conflicts of interest and the personal economic priorities of candidates and elected officials.” Id. (quoting Fred Wertheimer, an advocate who worked on getting the law passed after Watergate). The right answer to a refusal to disclose is that the candidate should divest or else not run for office. Id. (noting that various Washington lawyers provide this advice to candidates who cannot disclose underlying assets).
As the campaign progresses with continuing claims by GOP advocates that Romney’s “entrepreneurial” activity at Bain demonstrates that he has the business sense we purportedly need in a president, more scrutiny will fall on his current holdings as well as Bain’s past and present activities and just how well such an organization does (or does not) support the country’s economy.
crossposted with ataxingmatter
Nice. I guess Senator McCain could have learned something. If he had only thought to have his wife ask him to sign a non disclosure form about the number of houses they owned his ignorance would have turned out to be strategic and wilful rather than pathetic and tone deaf.
The only suspense I can see on the horizon for this tedious campaign cycle is whether or not any Democratic operative manages to do more to get BO reelected than Governor Etch A Sketch. If I was Plouffe I’d be worried for my job security.
Thanks Linda
I hope the lack of comments here just means that people were struck dumb by the idea of Romney for President. As you know I am no fan of Obama, but Romney’s “business sense” is exactly what’s wrong with this country. Not that a country is run anything like a business, but that Romney’s particular style of rapacious dishonesty is what brought on the current recession, and a country run under Romney-ethics will shortly begin to look like a Hollywood version of the Fall of Rome.
I agree, Coberly. We have for far too long allowed business to be run as a stand-alone enterprise with profits as the only goalpost. We need to put community back into the model. And that means eliminating most of the tax-free busienss reorganization provisions that encourage the development of ‘too big to fail’ enterprises and reconsidering the entire gamut of business tax provisions.
I find it disappointing that the author seems to imply that she understands the structure of private equity and how everything works within private equity. I won’t dispute that there are some private equity firms that do exactly what you describe (buy a stable, low growth company, leverage it up, and get out before it implodes on itself), but that is an over generalization, akin to saying that all tech entrepreneurs are flashy and immature. We here about these because they make good flashy news stories, but they are a fraction of the population. For each private equity investor that does that, there are at least as many that are investing in the growth of a company, and will profit best by creating long term growth prospects.
Also, it is completely standard for all private equity firms to require shareholders to not disclose information about holdings, hence the term “private” equity. There are no laws requiring disclosure and Romney would be acting unethically by disclosing private information. If this is a problem, securities law, not private equity investors, are to blame. I am not supporting Romney. I simply want the coverage of these issues to be done honestly, rather than someone claiming they know more than they do.
Coberly, I could not agree more. As disappointed I am with Obama, but romney scares the life out of me. He knows all about LBO but nothing about people, and he realy does not care to know.
Linda,
the nation needs a re-education, to learn again that the meaning of the words solidarity and community and social is good and are not four letter words.
For more than 30 years we have been learning that greed is the best motivator to make the economy grow. Ayn Rand was the provider of the best and greatest explantion why greed is so great and to be real wealthy is the only thing worth living for.
Who made and lobbied for the security laws anyway?