Bloomberg News

Romney’s Bain Funds Showcase Deals for Wealthy Only

August 24, 2012

Romney’s Bain Funds Showcase Deals Only the Wealthy Can Obtain

A protester carries a Mitt Romney puppet as he leaves a demonstration outside the offices of Bain Capital on August 21, 2012 in Evanston, Illinois. Photographer: Scott Olson/Getty Images

Mitt Romney, the presumptive Republican presidential nominee who became a millionaire running Bain Capital LLC, invested in funds run by his former firm that used investing and tax strategies beyond the reach of ordinary savers, a source of wealth underscored by documents released yesterday by the website Gawker.

More than 950 pages of confidential financial reports and investor correspondence, which Gawker obtained from a source it didn’t name, provide an investment-by-investment look at many deals that Boston-based Bain pursued for its clients, who include wealthy individuals and institutions such as public pensions and endowments. Romney, who co-founded Bain in 1984, was able to put money into the funds after he left in 1999 to oversee the Salt Lake City Olympics and later serve as governor of Massachusetts.

Bain, which manages $65 billion in assets, is known as a leveraged-buyout or private-equity firm, acquiring companies such as Toys R Us Inc. and Dunkin’ Brands Group Inc. with a combination of investor cash and debt. Like other LBO firms, Bain’s goal is to run the companies for three to five years and sell at a profit. It also has funds that invest in corporate debt, as well as collateralized-debt obligations and credit- default swaps, types of fixed-income securities whose decline in value contributed to the 2008 financial crisis.

“For wealthy individuals, this is not unusual,” said Steven Kaplan, a professor at the University of Chicago Booth School of Business.

LBO Scrutiny

Romney’s campaign has drawn scrutiny to the LBO business because firms sometimes cut workers to increase earnings and make companies more attractive to buyers. Opponents also have zeroed in on the tax treatment of buyout profits, which are treated as capital gains rather than ordinary income, qualifying for a lower rate.

Romney has countered the criticism in part by saying his business experience qualifies him to address problems in the U.S. economy, including unemployment. Andrea Saul, a Romney campaign spokeswoman, referred questions about the documents to Bain.

“The unauthorized disclosure of a number of confidential fund financial statements is unfortunate,” Bain said in an e- mailed statement that didn’t dispute the authenticity of the documents. “Our fund financials are routinely prepared by auditors and demonstrate a commitment to transparency with our investors and regulators, and compliance with all laws.”

Superior Returns

Bain discloses its current private-equity holdings on its website. The documents published by Gawker comprise quarterly and annual reports, letters to investors and presentation materials that aren’t usually made public.

Bain, like other private-equity firms such as Blackstone Group LP, KKR & Co. (KKR:US) and the Carlyle Group, seeks to provide its investors with returns beyond those available from public stocks or U.S. Treasuries.

The Bain documents published by Gawker also illustrate methods used to lower taxes. On the campaign trail, Romney has taken criticism for his 13.9 percent effective tax rate in 2010, a rate driven by the ability of private-equity firm managers to enjoy capital gains rates on their share of investment profits, known as “carried interest.”

The documents reveal another tactic used by Bain and other buyout firms to achieve the lower rate for other compensation as well, a practice known as management-fee conversions or fee waivers.

‘Priority Profit’

Bain Capital Fund VII LP disclosed in a 2009 report that the general partner in the fund had in the past waived management fees and converted those fees into an interest in the fund called a “priority profit share.” That had the effect of turning fees that would be taxed at ordinary income rates, as high as 35 percent, into capital gains, taxed at a rate of 15 percent.

By deferring the receipt of that cash they get a second benefit by deferring the tax. While the partners are well- positioned to know what investments may be winners, the waiver is irrevocable, meaning the fees disappear if the deals don’t generate profit.

“The documents confirm that Bain Capital converted some of its management fees into carried interest; there’s no reason they would do this other than to convert high-tax ordinary income into low-taxed capital gain,” said Victor Fleischer, a tax law professor at the University of Colorado. “It’s a strategy that is aggressive, and, while common in the industry, is difficult to justify as an appropriate reporting of tax obligation.”

Offshore Funds

According to the financial disclosure form Romney filed in June, Ann Romney’s blind trust owns more than $1 million in the Bain Capital Fund VII, and between $100,000 and $250,000 in the co-investment fund. The Romneys received between $200,000 and $2 million in income from those two funds in 2011. The documents published by Gawker don’t show whether the Romneys benefited from the fee waivers.

The documents also show how deeply embedded Bain has become in the offshore tax-haven world, with funds organized in the Cayman Islands. Private-equity firms organize funds in tax havens to prevent foreign investors -- and non-taxable U.S. investors, like university endowments -- from getting hit with U.S. income tax bills from the profits generated by their underlying portfolio companies. That provides an economic benefit to the funds and to the private-equity managers because it means that, by avoiding U.S. tax, the investors have more to invest.

The funds through which Bain invested during Romney’s 15- year tenure at the firm returned 3.5 times their invested capital in aggregate, according to 2010 data cited last week by Thomson Reuters Corp.’s PeHUB. Bain earned $6.75 billion on $1.91 billion invested in about 150 companies from 1984 to 1999, PeHUB said.

Through Bain’s credit funds, Romney held investments in a number of complex securities including structured investments and credit-default swaps which were used to protect against defaults of corporate issuers or to bet on or against the likelihood of a company’s default.

To contact the reporters on this story: Jason Kelly in New York at jkelly14@bloomberg.net; Jesse Drucker in New York at jdrucker4@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net


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