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