Opinion

Felix Salmon

Did Romney put Bain Capital shares in his IRA?

By Felix Salmon
July 16, 2012

Bill Cohan is the latest columnist to wonder how on earth Mitt Romney’s retirement account got so incredibly large — as much as $102 million — given the limits on the amount of money employees can put in such things each year. Nicholas Shaxson asked similar questions in Vanity Fair this month, and both of them cited the work of the WSJ’s Mark Maremont to help explain what might be going on; Cohan might want to update his link, since the Maremont article he links to is not the one with the real juice.

Maremont explains that when Bain bought a company, it wouldn’t just create debt and equity. Instead, there would be debt, equity, which was known as A shares, and then a kind of preferred equity called L shares. As far as the debt holders were concerned, the A and L shares together were the equity holders. And anybody with equity in the company received the same ratio of A shares to L shares. But A shares were much riskier, and had much more upside than L shares: holders of equity in Sealy, for instance, got a total gain of roughly 4X, where the L shares doubled in value and and A shares wound up worth 34 times what they were originally valued at.

So up until now, the theory has been that Mitt Romney pumped his retirement accounts full of A shares, which often had aggressively low valuations when they were first issued. If those valuations turn out to have been unreasonably low, that could create issues in an IRS audit.

But the recent controversy over when exactly Romney left Bain raises another possibility, which is hinted at in a Maremont article from January:

Several estate-planning experts said they know of others with IRAs of more than $100 million, but they are rare. Typically, they said, that occurs when founders of companies invest in their own shares, which then take off.

We now know that Mitt Romney, individually, was the sole shareholder of Bain Capital when he took leave of all day-to-day responsibilities in 1999 to concentrate on running the Salt Lake City Olympics. And he remained the sole shareholder of Bain Capital through 2002. So here’s the thesis, taken directly from Henry Blodget: that Romney filled up his retirement account with shares of Bain Capital itself, rather than shares in its funds, or in its portfolio companies.

This would also help explain why it took Romney three years to disentangle himself from Bain Capital:

Romney legally remained the CEO and sole owner of Bain Capital until 2002, Conard added, because he was intensively negotiating his exit deal with the partners at the firm. Conard summed up Romney’s position this way: “‘I created an incredibly valuable firm that’s making all you guys rich. You owe me.’ That’s the negotiation”.

Blodget has some very good questions about how Romney managed to set things up so that he was the sole owner of the company: one would imagine that other Bain Capital partners would also have had an ownership stake, not to mention Bain Consulting. But it seems that Bain Capital was a Romney entity, and that he then just handed out fees and carry to various stakeholders, while retaining all of the equity in Bain Capital for himself. When he left, then, he wasn’t just retiring from Bain Capital, he was actually selling the company to its partners. And you can see how that negotiation might have taken a while, given that those partners were picked precisely for their skill in buying companies for a low price.

What’s more, Romney would have had every incentive to keep the official valuation of Bain Capital low for many years, since the lower Bain Capital was worth, the more of it he could put into his retirement accounts every year. Again, the IRS might well be interested in the valuation techniques Romney used for the purposes of his retirement account contributions. And then, of course, suddenly, when Romney left Bain, he would have switched from minimizing Bain Capital’s official value to maximizing it.

I wouldn’t be at all surprised were we to learn that a huge amount of the gain in Romney’s retirement accounts came in 2002, when he finally sold Bain Capital back to its partners. Of course, Romney doesn’t seem remotely inclined to tell us. But if he started Bain Capital from scratch, and put a bunch of the company into his retirement account, and it’s now worth some ten-digit sum, then maybe it makes sense that his retirement account now is ridiculously enormous.

Update: My colleague Lynnley Browning reminds me that she covered this issue in January as well, and had her own theory:

Romney may have made use of an Internal Revenue Service loophole that allows investors to undervalue interests in investment partnerships when first putting them into an IRA…

An investor could even set an initial value for a partnership interest at zero dollars, because under tax regulations an interest in a partnership represents future income, not current value.

This seems conceptually extremely dubious to me: all securities, after all, represent future income. But if Romney had an aggressive tax lawyer, anything is possible.

Comments
17 comments so far | RSS Comments RSS

Here’s a problem the American electorate should have with Mitt Romney: we don’t now what he stands for.

Mitt Romney has an IRA, the value of which stretches credulity without some reasonable explanation of how it attained that level — but Romney’s inclination for secrecy will prevent the American public from understanding how this happened.

Secrecy also surrounds the policies he would promote as President, and secrecy surrounds his tax returns and the compensation he may have received for his tenure at Bain Capital when he wasn’t in “any management capacity” (although he signed various documents certifying that he did exercise management responsibilities when he wasn’t in “any management capacity”), and secrecy surrounds what’s “really in [his] heart” (but he just can’t or won’t articulate it). Basically, the American electorate just doesn’t know who Mitt Romney is or what he stands for.

There are more concerns about who Mitt Romney really is — just go to “The View from the Middle of the Road” on blogspot and see the post “We Need a President We Can Trust”.

Posted by RGWilliams | Report as abusive
 

There might be a bright spot if Mitt became President: He knows exactly ALL THE LEGAL TAX LOOPHOLES that need closing.

Posted by GRRR | Report as abusive
 

It’s basically standard operating procedure these days for Alts managers starting up a GP /Management Company to inject a portion of their equity in the GP into some sort of tax deferred vehicle before the structure has any economic value. I.e. I have a sense that I am going to get committed capital to the degree that the two sets of lawyers are talking, but nothing has been agreed yet. So I put x% of my GP equity into a trust with a value of zero (because its worthless as a business pre-funding) – and there is no taxable income. I’m not sure if this is still the case but historically you could also do this with an IRA. Bain Capital the GP is worth a lot of money, so its completely plausible that Romney put X% of his equity into an IRA or something like that. Then the income that is generated is tax deferred as is the cap gain when he sells to his successor(s). There is no reason to believe he was continually injecting Bain equity into his IRA. You probably wouldn’t want to, because then you open up the doors to the IRS in terms of correctly valuing the shares.

Also generally its quite common for the founder of the GP to maintain 100% of the equity and dole out profit participations rather than dilute his/her voting rights.

Posted by topofeatureAM | Report as abusive
 

ETA: Reasonably the only part of that mooted transaction that is tax evasion/avoidance is the fact you know your firm is a go, but the docs aren’t signed yet so in the real world there was already economic value. But that’s going to be a fraction of what the IRA ended up being worth. Other than that its just like owning an IRA with absolutely tremendous investment performance. He was still taking risk on BC, he didn’t know it would be a success.

I’m an Obama voter. The IRA thing is just silly.

Posted by topofeatureAM | Report as abusive
 

@topofeatureAM – All great points, and I understand the idea of putting shares in a trust as a way to transfer shares to children without gift or inheritance tax. I’d be surprised if many people have been putting shares into IRA’s under current tax rates, however, as it seems like that strategy didn’t work out well for Romney and doesn’t work out well under current tax rates. Romney will ultimately pay ordinary income tax rates when he withdraws the money from his IRA. If Romney sold in 2002 or 2003, he would have paid either 20% (2002) or 15% (2003) in long-term capital gains taxes. With the assets in an IRA, he is benefiting from tax deferral, but will have to pay ordinary income taxes unpon withdrawal and would almost certainly be the maximum rate bracket, which is currently 35%. As long as ordinary income tax rates are meaningfully higher than long-term capital gains tax rates, Romney’s strategy is a net loser for tax purposes.

I’d bet that he put his Bain equity into the IRA when ordinary and capital gains rates were the same in the late ’80′s and early ’90′s, as what he did would have made sense under tax law at that time.

Posted by realist50 | Report as abusive
 

realist50 – That timing also makes sense for when the BC launched.

Posted by topofeatureAM | Report as abusive
 

Before the French Revolution, in ancien régime France, nobles were except from taxation. We seem to have replicated that system to a remarkable degree even as we proclaim our fealty to a supposed equality.

Posted by f.fursty | Report as abusive
 

There should clearly be a maximum value on IRAs as tax sheltered retirement plans. When the balance goes over the maximum, the increase is ordinary income.

Like most good things in the US tax code, this one has been twisted out of recognition. What is the public purpose in letting people accumulate Individual Retirement Arrangements (“IRA”) of such size? There is none. We should not subsidize tax shelter programs over, say, 40 years of median pay for salaried workers.

Posted by usagadfly | Report as abusive
 

Wouldn’t it be pretty obviously a sham if he claimed that he put millions into Bain, a wildly successful venture, but made contributions of substantial amounts of partnership equity that he valued in the low thousands?

If, just for example, $100 million goes in as contributions but somehow only $100,000 comes out as the total value of all equity, while Bain is incredibly successful, that’s not going to stand up to scrutiny. Especially if he turns around and puts this supposedly- worthless equity into his own IRA and then it makes millions.

What would’ve stopped him from using a SEP IRA to take much larger contribution limits? As long as he took enough of his Bain compensation as wages, he could’ve had huge contribution limits. Am I missing something?

Posted by NL_ | Report as abusive
 

I too have often wondered how Romney came to own 100% of Bain Capital, a PARTNERSHIP that was formed by Romney and TWO OTHER Bain Consulting partners while they were STILL WORKING for Bain Consulting and in which Bain Consulting originally had a STAKE. I still don’t understand.

Posted by RueTheDay | Report as abusive
 

This may be slightly off topic, but isn’t the fuss really about the fact that Bain did bad things after Romney left for the Olympics? As in outsourcing and bankruptcies where they made out very well? Now the assumption is that Romney wasn’t associated with this malfeasance. Yet it’s completely clear that he reaped the benefits and kept the money. So if a company, of which he was the _sole_ owner, did something crappy and ruined the lives of thousands, too bad – he still gets paid. Was he ignorant? Bad for him. Was he aware but did nothing? Bad for him. Was he deceived by his associates? Bad for him. So he seems like a weasel. Worse than a pirate.

Oh David Brooks, where art thou when America cries out for moral instruction?

Posted by frit | Report as abusive
 

RueTheDay, I had the same questions. I had them four years ago, I have them now, and I suspect and in fact fully expect that Romney will be elected and inaugurated that I’ll still have them five years from now.

Posted by Strych09 | Report as abusive
 

Is any of this related to his reluctance to declare ALL of his past years income? I understand he’s only released those very recent figures…

My initial reaction was to suspect his income had been so high that it was embarrassing, but with this IRA business, perhaps it is because his declared (and taxable) income was extremely low? After all, if he’s been squirreling away income in his IRA instead of paying tax on it, he will have saved embarrassingly large oodles of tax.

As for the point about current law going against him on this, if he wins the Presidency does anyone really think he won’t change the law to suit himself? The Republicans won’t vote against one of their own if he promises income tax cuts, even if it means increasing the deficit. After all, they’re only against deficits when a Democrat is in the White House; George Bush is famous for having turned a surplus into a deficit and being re-elected for doing so!

Posted by FifthDecade | Report as abusive
 

Has Romney ever said who was running Bain when he was not? If he has, I have never seen it. If he wasn’t running it someone certainly was. Why doesn’t he just tell us who that person was? Then we would have the mystery cleared up.

Posted by Chris08 | Report as abusive
 

I suspect the reason going public sucks right now is not, as you seem to think, that it is going PUBLIC. The real reason is that it is GOING public. The transition, the IPO, has become extraordinarily tricky for all but the few and the lucky.

Facebook and BATS have recently given us examples of what can go wrong even FOR the few and the lucky! But consider medium-soized busiess, of a size where going public used to be not such a big deal. It is a huge and tricky matter today.

SEC enforced decimalization and NMS had a lot to do with this, changing the dynamics of the world of trading into which an IPO plunges such a firm.

Look at the decade before those changes, the 1990s. The average annual number of IPOs was 520. Had the rate remained the same as the size of the economy grew, one would have expected that in 2011 the United States would have had 950 such offerings. In fact, it had roughly only about 1/6th of that. The average number of IPOs annually since 2000 has been only 129.

The dysfunction may, as Arnuk, Saluzzi, and a lot of other market-savvy people think, have a lot to do with HFT, black pools, and other games playing. Behind that, there is the encouragement given to the games by regulation (NOT by deregulation, which we definitely have not tried yet.)

Posted by Christofurio | Report as abusive
 

Oops. I meant to place that comment two entries up!

Posted by Christofurio | Report as abusive
 

I just can’t see how Romney has made people believe his etchasketch lies. People say that in his first debate that Romney proved that he was a worthy challenger. I don’t believe that all of the lies he told were worth the time to listen to him. If people google what he says on his stump speeches then they wouldn’t need a light to see through him and his lies. Then there are the people that know better like Elisabeth Hasselbsck, Michael sateel and Amy Holmes. They are always in the news and always have something to say. If you watch anything but Fox, you have to know that the man is a liar! He also shows nothing that remotly explains how what he is saying will work.
I wouldn’t be surprised to see him led away in handcuffs for tax evasion.
He says he will be tough on China while he is at this moment through Bain that he owns part of is sending a company from Freeport Illinois to China costing 170 jobs even though the company made its biggest net profit last year.
I can fill up page after page. All I can say is if Romney says anything, just google it and you will find that he has been on the other side of whatever he says now.

Posted by slowwalkwe | Report as abusive
 

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