Here's One Of The Clever Financial Tricks Mitt Used To Become Dynastically Rich

Here's One Of The Clever Financial Tricks Mitt Romney Used To Become Dynastically Rich

Henry Blodget | Jul. 13, 2012 | Business Insider

While the world waits for Mitt Romney to stop being the only Presidential candidate in several decades to keep his tax returns secret, we're left to try to solve the Romney money mysteries with the information we have.

One of those mysteries is how Romney accumulated $21-$102 million in his Individual Retirement Account.
Yesterday, we speculated that part of the reason might be that Romney remained the "sole shareholder" of Bain Capital more than 15 years after the firm was founded--an ownership stake that would presumably have been worth a boatload of dough.

Importantly, if this stake did contribute to Romney's wealth explosion, he would have made the money in a way that most people will quickly understand and respect: Specifically, by founding and building a company that ended up being worth a lot.

That's the American dream, and you would have to be bitter and petty to take issue with it.
But our readers pointed out that the entities Romney was "sole shareholder" of might just have been some of Bain's individual investment funds, not the firm as a whole, and that there was another tool that Romney used to become rich that has nothing to do with founding and building companies--or, for that matter, just "making great investments."

This other tool is a financial engineering trick.

And it appears to have been designed and used at least in part to avoid taxes.
Here's the trick, which was explained in great detail by Mark Maremont in this excellent Wall Street Journal article:

When Bain bought companies, it changed the capital structure to create two classes of stock.
The first class, so-called "L" shares, were a form of preferred stock. These shares had less upside than standard common stock, but they were also safer. They earned interest, and they offered capital protection in the event that the investment did not work well. These preferred shares likely ensured that Romney and Bain would not lose money on investments unless everything went completely to hell.

The second class, so-called "A" shares, were common stock. These shares had a vastly higher risk/reward profile than the preferred shares. If the investment worked, they made much higher returns than the "L" shares. If the investment didn't work, they got wiped out.

So far so good. And now comes the tax-avoidance part of the trick.

In the days in which Romney was at Bain, capital gains taxes were 28%. If Bain made a killing on an investment, therefore, a big chunk of the partners' gains would go right to the government. And no one likes writing checks to the government.

So, Romney and other Bain employees, who were allowed to "co-invest" in the firm's deals (common in the industry, but also a potential conflict of interest), figured out a clever way to get around paying these taxes:
They put the safer preferred shares--the "L" shares--in their regular taxable investment accounts.
And they put the high-risk/high-reward shares--the "A" shares--in their tax-deferred retirement accounts.

Alex Wong/Getty Images
On another topic... you can't be CEO and not be responsible for what the company does. Click for more >
Because of the way the risk/return for the "A" shares worked, this was akin to placing stock options in a tax-sheltered account. If things went badly, the entire investment in the risky shares would be lost. (But the partner still might make money overall--through the return and interest on the "L" shares.)

But if things went well--bingo--Romney and his partners hit the jackpot. And they didn't have to pay taxes on their winnings. Rather, they could cash them out, keep them in their IRAs, and then use the proceeds of the bet to make much bigger bets next time.

And as Mark Maremont discovered, Bain's "A" shares often hit the jackpot.  In one Bain deal that Maremont describes, Bain increased the equity value of a company by an extraordinary 36-fold in 20 months. But the value of the "A" shares over that period--many of which had been placed into Bain employee IRAs--jumped 583-fold.

So, that was the first part of the trick: Dividing a company's stock into two classes of shares, with the aim of having the high-risk/high-reward class compound tax-free in individual retirement accounts.
The other part of the trick was the value that Bain assigned to the high-risk/high-reward shares during this period.

The lower the value Bain placed on these shares, the more of the shares Romney and other Bain employees could stuff in their retirement accounts without exceeding the annual contribution limit. And, therefore, the more explosive their tax-sheltered gains on these shares might end up being.

So Romney and Bain had a strong incentive to place a low value on the IRA-bound shares. Which they apparently did.

In the days in which Romney was running Bain, Maremont found, Bain valued the IRA-bound shares at about 1/10th of the value of the safer "L" shares.

Tax lawyers Maremont spoke to said that was a very low valuation to place on the risky shares, especially by today's standards. Most private-equity firms who use this technique these days, he reports, value such shares at 1/3rd or 1/4th of the value of the safer shares.

Now, in Romney's defense, valuing illiquid equity and options (which is essentially what these shares were) is a subjective craft, not a science, and there's a wide range of defensible conclusions. But suffice it to say that Romney & Co. appear to have placed very low valuations on the risky shares that went into their retirement accounts and that, if they had placed a higher value on these shares, they would have sheltered less money from taxes.

Such financial engineering and tax-avoidance tricks obviously require a high level of sophistication, both in terms of investing and tax-planning. As a result, for all intents and purposes, they're only available to a tiny minority of Americans.

Furthermore, these tricks illustrate that Romney's financial success is not, in fact, just about "making good investments" (although he certainly made many of them), but about taking advantage of loopholes and tricks that a handful of people with considerable financial means can exploit.

Lastly, although such tricks may well be perfectly legal within the letter of the tax code (it depends whether the value that Romney placed on the IRA-shares really was reasonable--a question that's worth looking into), they're clearly miles from the spirit of what IRA tax-deferral laws were designed to encourage:

Namely, providing a little tax help to help average Americans save modest amounts of money for retirement.
By limiting IRA contributions to a few thousand dollars a year, Congress clearly meant these vehicles merely to be tools with which Americans could save a bit each year on a tax-deferred basis--not to place high-risk/high-reward bets that could allow people to amass vast fortunes beyond the reach of the IRS.

Romney and his colleagues, obviously, never needed the tax help to save for retirement--because they quickly had more money than they would ever need to retire on. So for Romney and Bain, the IRAs were merely tools with which to allow returns to compound without paying taxes.

And it also likely explains, again, why Romney is so adamant about keeping his tax returns secret. Because the "L" shares and "A" shares tax trick was likely only the beginning. And, for obvious reasons, Romney doesn't want average Americans to discover any more details like this.

Read more: http://www.businessinsider.com/heres-one-of-the-clever-financial-tricks-that-mitt-romney-used-to-become-dynastically-rich-2012-7#ixzz20nTca7QW

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My Thoughts:

It is very obvious why Mitt wants to keep his tax returns secret. But you have to give him credit for the brilliant manipulation of the tax code and other unique and probably unforeseen use of the IRA structure to amass such a large sum of money. If you notice the chart below

Fig. 1 - Data from IRS

As you can see, it is nearly impossible to amass $102 million dollars in an IRA based on the maximum contribution limits shown above. I now tax accountant around the country would like to know how he was able to do amass so much given the law.

Now these millions of dollars are tax differed. That being that as he removes the money from the IRA, he will pay taxes on them at his tax rate at that time, which is usually much lower in retirement than in your working years. And if you pull it out in small chunks, then it also lowers your tax liability.

But on the other hand, his brilliant manipulation also shifted the money burden of running our government and paying for wars he strongly supported onto the middle-class at the same time his company was outsourcing jobs.

For me that brings to question his real loyalty to the nation and the middle-class. His willingness to manipulate the tax code and other tax avoidance strategies with off shore banking proves to me it is all about the money, personal wealth and power to obtain more and more wealth. He is part of the plutocrats that now control our government with their money and influence. If Mitt reaches the White House, then the plutocrats will have a trifecta in absolute control. The middle-class will be further decimated and as history has taught us, revolt and revolution will follow.

The Dark Side of Mitt Romney's Bain Days

New revelations about Mitt Romney and his Bain Capital company. Recent SEC documents disclosed shows that Mitt Romney retained 100% ownership and listed as CEO, Chairman and President of Bain Capital far beyond the 1999 date his campaign has said, it was as late as 2003.

Romney holds up Staples as his shining star of building a business. But there is a problem with this claim.

Let me explain how venture capital investments and private equity investments differ: The first venture capital investment deal for Mitt and Bain Capital was the Staples deal. It was a traditional Venture Capital investment that mean the investors are in it for the long haul and allowing the current management of the company to remain. Bain's and thus Mitt's position was a minority investor and had absolutely no control of Staples. The VC stays out of the management of the company and may only work with the management about improving operations and how to expand it's market to reap the profits the VC is looking for. So Staples is not a fair example of the overall operation of Bain Captial under Mitt. 


Bain shifted its focus to a new type of Private Equity model of finding under performing companies and instead of strengthening them for the long term, they bleed off cash by leveraging the companies assets with huge loans to use to purchase the company, thus not using any of their own money, and then part of the loan money they take as fees which turn to millions of dollars in profit for Mitt and his investors, if any. The business model is to then reduce costs, which means laying off workers, but still having inventory to sell to generate revenue. The balance sheet will then look fabulous; high revenue with very small expenses to produce that revenue. They will then sell the company on the value of that balance sheet. The new owners will then realize when inventory is depleted that they are unable to fulfill orders and lack labor to create more product. But they have no assets free from incombrances to use as collateral to borrow against to hire more employees to keep the company going. Now the loan payments on the loans Bain took out against its assets are now the responsibility of the new owners and lack of capability to produce the goods or service forces them into bankruptcy. It is a great legal con game Mitt created. So the closure of the company will occur far later than with Bain and Mitt own and operated it for that short period of time.

Why is this important?

Because Romney is making claims of creating hundreds of thousands of jobs and avoiding the huge loss of jobs and outsourcing of jobs by Bain Captial under his watch. So the truth is finally coming out. Both in when he actually left control of Bain and the companies that went bankrupt because of him.

Here are just a few of the companies that lost jobs under Mitt Romney:

– GS Industries – 750 Jobs Lost: In a series of ads earlier this year, the Obama campaign hit Romney over Bain Capital’s purchase of GS Industries, a steel company that closed its Kansas City plant and eliminated 750 jobs in February 2001. The Romney campaign responded by claiming that Romney had left Bain Capital well before 2001, and was therefore not tied to the collapse of the GS. Bain Capital and its executives, including Mitt Romney, earned at least $12 million on the initial investment.

– KB Toys – Up to 3,500 Jobs Lost: During the primary season, Newt Gingrich’s 30 minute documentary on Romney and Bain Capital spent a significant amount of time focused on KB Toys, a retail chain bought by Bain in 2000. At the time, the Romney campaign, with an assist from fact-checking groups like PolitiFact, pointed to the calendar. As these new filings show, Romney was still very much at Bain Capital when they purchased KB Toys, and profited mightily when the company took out crippling loans to pay Bain Capital an $83 million dividend.

– Dade International – 1,700 Jobs Lost: Months after Romney claims to have left the company, Bain Capital received a $242 million bounty for its stake in the medical supply company. Romney profited substantially from the deal. In 2002, Dade International filed for bankruptcy, costing more than 1,700 people their jobs. At the time, Romney was the 100 percent owner of Bain Capital, the new documents show.

–DDi Corporation – 275 Jobs Lost: In 1996, the circuit board manufacturer was bought by a group of investors, with Bain Capital in the lead, for more than $40 million. By December 1999, DDi closed a Colorado plant and fired 275 workers. Bain Capital, with Romney still listed as Chairman and CEO, then proceeded to take DDi public, raising $170 million during the company’s IPO in 2000. Over the next few months, Bain began selling off its stock, raising almost $100 million, more than doubling its investment. The stock plummeted shortly thereafter.

There are many more that lost jobs because Mitt outsource them to other countries, but kept the company going and then selling them off. 

It is not clear when, but about the time Mitt was handing over management of Bain to some of his pals at Bain, there was a modification in their investment focus by shifting more into traditional Venture Capital deals and into pull purchase of viable companies, like Clear Channel radio and television stations and many other companies that they are investors in. Some of these they manage, some they are a majority investor and others they are a minority investor.

From what I understand is that his pals who are now in charge of Bain Capital are paying Romney on contract for his 100% ownership. Thus he gets a fixed amount each year for payment of its value and he also has a deal that he still gets commissions of any deals they do. A very nice departure package. 

Now what is also interesting is that how they structured these investment deals is that the moneys that Bain and Romney received were considered capital gains, NOT ORDINARY REVENUE TO THE COMPANY like other businesses. There are and have been several types of capital gains which can reduce the tax liability considerably. Mitt would have paid at best 20% on his capital gains and since 2003 15% or less, depending on the type of investment the money is coming from.

Further, Bain placed these capital gains into off shore investment deals that avoids US taxes and can then be discounted as "Liquidated Value Capital Gains" when drawn out for personal use, thus reducing the amount of the capital gains he actually received. For example: If you have 10 million invested in one of the shelters and you are earning say 10%, the initial 10 million is considered capital gains, but deferred because it is off shore. The 10% additional gain is considered "Liquidated Value" from the original 10 million still sitting there. After time with each 1 million dollars received, it reduces the original capital gains value by the 1 million dollars. So over 10 years, it has zero capital gains value, even though the total 10 million is still in the investment and now no longer taxable at all. So he received 20 million dollars and paid only 5% tax on only 10 million, because it was taxed at the liquidated value tax rate. I'm not clear on what happens to the 1 million he would receive on the 11th year and thereafter, since the original value is now zero, on paper that is. He probably rolls it over into another similar investment off shore and pays the 5% tax on the return just as before.

Now under current tax laws all that he has done is legal and that is why he states that his "blind trust" has paid all the taxes he is required to pay. He is correct in that statement. But the other point is that when you have a country in an economic depression, do we want a president that worked the system so well that he reduce his tax liability that funds the very nation he wants to be the leader of and is desperate need of tax revenue to keep it going? What kind of moral example is that to the nation?

We have had many very wealthy presidents, none were so blantanly obvious and gross about shielding their income from taxes. Most took the normal deductions and business gains and losses as everyone else. But Romney has cross the line and exceeded that normalcy to an extreme which leaves a question of how loyal is he to his country?