Posts Tagged ‘Private Equity’

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Warren Buffett has announced his largest buyout in history, the $38 billion takeover of Portland, Oregon based Precision Castparts.  This is almost twice the size of the Heinz takeover, one of his largest prior takeovers.

Heinz and other Buffett enterprises, including Burlington Northern and Pacific Power, are having a strong negative impact on the Oregon economy.

This includes potato farmers in Eastern Oregon who had a win/win long term relationship with Heinz cancelled, and local communities battling to prevent oil and coal from being shipped by rail thru their communities without adequate safety guidelines.

Burlington Northern receives more than one-third of its gross revenues from the shipment of coal and also carries more than 80 percent of the oil transported by rail in the United States.  Pacific Power’s primary source of energy is coal.

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Below is the link to a press release by Parish & Company in October 2005 which was provided to Berkshire Hathaway’s David Sokol and Warren Buffet for review.

Warren Buffett Dupes Intel with Ingenious Tax Scheme

In typical Buffett fashion, he is providing assurances to “top management,” what some might call insider dealing,  with inevitable devastating cost cuts to follow in mid management along with significant outsourcing to related companies and aggressive use of tax havens. Not to mention erasing long-term oriented shareholder gains as investors are forced to sell the stock.  One can also expect Berkshire Hathaway to use a related subsidiary to loan Precision funds at a rate significantly higher than market rates, that’s the Buffett formula.

The legal team representing Precision Castparts and its shareholders consists of Portland based Stoel Rives, the state’s largest law firm that was also intimately involved in Enron’s affairs prior to its demise, and New York based Swain Cravath, Swaine & Moore LLP.

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SEC Chair Mary Jo White’s husband John White is a senior partner at Cravath, Swaine & Moore LLP. Most large law firms are now living off merger and acquisition fees and those that are doing straight up legal work have been decimated from a loss of clients due to such consolidations.

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SEC Chair Mary Jo White              John White, Cravath Partner

As a former CPA and auditor I can attest that independence must be achieved both in “appearance” and “in fact,”   the most fundamental principle of auditing. That is a standard question on the CPA exam yet sadly it is impossible  for SEC Chair White to meet.

This is not some small merger or takeover but rather the biggest deal in Berkshire Hathaway’s history and one that will greatly impact the tax base in Portland, Oregon as jobs are cut and outsourcing accelerated.   Police, fire and school budgets will be greatly impacted.

The question is, how on earth are such inside deals between top management and takeover artists like Buffett being tolerated by the SEC?  Put another way, who is advocating for ordinary investors in Precision Castparts?  Remarkably, there has been almost no public discussion of this “deal” between top management at Precision and Buffett, expected to close in early 2016.

And where  is the SEC, the “Investors Advocate,” whose job it is to protect ordinary investors interests.  Granted, the workload for the SEC is staggering, and made more difficult by Buffett’s control of the media.  News coverage has in fact ceased largely due to Buffett’s enormous media clout, which includes his ownership of Business Wire, numerous newspapers and other media channels, not to mention vast advertising budgets capacity to influence news decisions.

White’s job at the SEC is difficult indeed.  For example, last month the Oregonian ran a lead editorial against the “fiduciary standard,”  openly challenging an important SEC initiative White is advocating.  Former SEC Chair Arthur Levitt, on the boards of both Bloomberg and the Carlyle Group, has called failure to establish this standard a “national disgrace.”

Buffett is clearly a political genius.  Rarely discussed is that his father was an influential four term Republican Congressman from Nebraska, who also chaired Taft’s Presidential campaign in the 1950’s.  No one could have started their career more politically connected.

And here in Oregon the joke is that he owns the State Legislature along with taking control of the Governor’s office with the ascension of Kate Brown after popular four term Governor, John Kitzhaber, was run out of office over a scandal regarding his partner’s advocacy of “clean energy.”

Hayes was not a state employee yet emails indicated she was actively acting as if she were. Of course this is nothing new for spouses of public officials.  What really put Kitzhaber’s demise on overdrive was charges against Hayes of tax fraud, specifically, not reporting her consulting income on behalf of clean energy non-profits.

These charges were completely made up and a gross breach of journalistic ethics given that Hayes released her 1040 showing net consulting income yet never provided a schedule C, which would show gross consulting income along with all her various expenses.  Reporters essentially took the net income amount on the 1040, compared it to publicly disclosed gross revenues from consulting contracts, and claimed tax evasion in several major front page stories and editorials.

How do I know this?  I was asked the by key journalist involved, as often is the case, to review the tax returns for major public officials.  In this case I was provided the returns by Nigel Jaquiss of the Willamette Week, completed the review, and clearly indicated there was nothing there.  Nigel followed up with a thoughtful analysis, highlighting net business income.  Sadly, other reporters at major publications then took this “net” number and compared it to the publicly revealed gross consulting revenues and ran major front page stories and editorials, almost on a daily basis, essentially charging Hayes with criminal tax evasion.

What never came out is the Kitzhaber and Hayes filed separate returns in which he used a local CPA firm and Hayes returns were “self prepared.”  Rather than give Hayes the benefit of the doubt and let the IRS do their job, as should be the case with any citizen, public or private, she was crucified in the media and remarkably no one came to Kitzhaber’s defense.

And once the new Governor Kate Brown stepped in, her first major action was to try and bargain away the “clean energy” bill for a transportation funding package.  And who would be the single biggest beneficiary, that’s right, King Coal Warren Buffett.

Bravo Warren!  You are amazing?

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Investment advisors like myself who walk the walk with respect to long term oriented investment rely on the SEC to function as the “investor’s advocate.”  That is all investors, not just takeover artists like Buffett who have never created anything but rather specialize in inside deals with top management, appeasing shareholders with a short term spike in the stock price and then gutting companies, as was done with Heinz, Burlington Northern and Pacific Power.

One could argue that this takeover should be denied on national security grounds given Precision Castparts key role in the aerospace industry and Buffett’s inability to manage companies in which true innovation is required.  Similarly, if the national power grid is a strategic issue, how can we rely on Buffett to make the key decisions required for security when all he seems to know how to do is gut companies and then thrive on corporate welfare.   And while he boasts about the cash flow Burlington Northern is generated, businesses suffer from gross neglect and related bottlenecks in the rail system.

In 2015 Buffett boasted in a front page Barron’s story that he and his Brazilian private equity partners made $22 billion in the first two years after his $25 billion takeover of Heinz.  Long term Heinz shareholders were stuck with a tax bill and dedicated employees and vendors were betrayed.  Buffett creates one debacle after another yet the media never seems to provide coverage.

Meanwhile here in Oregon the $80 billion state pension fund managers have said nothing about the takeover of Precision Castparts.  They perceive their role as narrow and only related to returns on portfolio investments.  One could argue however that the PERS system needs a strong tax base, in addition to returns on the existing portfolio.   A tax base being decimated by such takeovers.

Oregon PERS was the original large outside investor in KKR and has large investments in both hedge and private equity funds, including KKR, TPG and Blackstone.  These firms make tax evasion a science by gaming residency via tax havens ranging from the Caymen Islands to the UK.

It is ironic that the chair of the Oregon Investment Council, Katy Durant, has not clarified if she is a full resident of the State of Oregon for tax purposes, not only for W-2 wages but also investment income.   Perhaps that is where tax reform should begin, that is, full disclosure regarding tax residency for public officials and for publicly traded companies a footnote that summarizes actual taxes paid, the specific type of tax whether state, federal, property, etc.  and the years to which the taxes paid apply.  This would be great information for investors, advisors like myself and other stakeholders.  In addition, it would meet the spirit of the SEC rules.

A likely impact would be fewer takeovers of companies vital to the economy, like Precision Castparts, leading to stronger local schools and services and better long term returns for investors as tax receipts stabilize.  Put another way, go home Warren.  Enough of the “big con.”

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Sondland is a major real estate developer with numerous points of intersection with real estate investments made by the Oregon Investment Council.   He was also the most ardent opponent of a convention center hotel in Portland,  fearful it would compete with his existing properties, yet when the city finally crossed a legal threshold making it a reality, Sondland proposed that his firm handle the contract.

Even though private equity and hedge funds have produced poor returns for years, the Oregon Investment Council under has dramatically increased investment in this area under Durant with TPG, KKR and Blackstone being three of the primary beneficiaries.



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Disclsoure and Media Development Background:  Parish & Company maintains no speculative investments in the health care companies discussed and does not collaborate with any private equity or hedge funds.  It’s goal is to identify high quality health care opportunities suitable for long term oriented investment.

This effort includes providing high quality news material to leading journalists including Gretchen Morgenson of the NY Times, Mark Maremont and Rich Rubin of the Wall Street Journal, Joseph Tanfani of the LA Times and Margaret Collins of Bloomberg.

In doing its research Parish & Company has revealed a massive price fixing scheme, both in medications and medical equipment, being orchestrated by private equity and hedge funds, often financed by public pensions including Oregon PERS.   These firms purchase drug and medical equipment royalty cash flows and, in conjunction with the use of various drug and medical procedure distribution systems, including hospitals, specialized clinics and pharmacies, are price gouging patients and fleecing taxpayers via Medicare and Medicaid reimbursements.

In addition to anti-competitive practices that would result in quick DOJ actions in most industries, these firms are also aggressively using tax evasion to embellish financial results.

The purpose of this post is to provide a conceptual overview of the scheme for leading journalists to further their work in this area.   A related goal is to demonstrate that indeed one person can make a dramatic positive difference by revealing such issues via collaborating with leading journalists.  Already Congressional hearings have been scheduled.

The original analysis was provided to a few key reporters in the fall of 2014 with the expectation a story would be completed by December 2014, yet this was complicated by Bloomberg dismissing most of its leading investigative reporting staff and my favorite reporter at the NY Times, Gretchen Morgenson, being weighted down by a backlog of story material.  In reference to the analysis of investment firms purchasing drug cash flows and price fixing generic drugs, she did note  ” Thanks Bill. And thanks again for an illuminating conversation…sorry that my head is always spinning after we talk. You’re always way ahead of me.”

In order to help facilitate the story,  I began to publicly discuss the scheme on December 3, 2014 at the monthly Oregon Investment Council meeting.  See link to minutes and related audio file involving public comment questioning whether it was appropriate for public pensions to invest in such drug cash flow resulting from the sale of royalty rights to private equity and hedge funds.

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OIC meeting 12/3/15 Parish comment (See public comment at end of 3 page document)

OIC meeting 12/3/15 Parish comment audio mp3 (Full audio of testimony, approx 2 minutes)

It is amazing that medical equipment representatives from leading firms like Stryker are regularly in the operating rooms during procedures and appear to be compensated on commission based upon the volume of product sales.   Technicians yes, but commissioned sales reps? Two key areas where this should be a major concern are oncology and spinal procedures.  Hopefully this post will stimulate a close look at this yet to be publicly revealed practice,

This was followed by a January 2015 interview on Kink Radio here in Portland, the leading morning radio show.  This interview was generally about the energy sector yet I also made comments about Enron like accounting practices and its role in price fixing of generic drugs, specifically claiming that drug prices could fall sharply if this scheme were addressed,

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Kink FM Interview January 8, 2015 audio mp3 (5 minutes of audio)

One could easily criticize the NY Times for waiting nearly 8 months to do the first major story on this analysis yet they still beat Bloomberg and the Wall Street Journal.  Of course they must also be especially careful given the enormous financial stakes.

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Gretchen Morgenson, Reporter/Editor New York Times

Since Andrew Pollack and Gretchen Morgenson of the NY Times superb original September 20, 2015 report on Daraprim, a drug purchased by a hedge fund for which the price was immediately raised from $13 to $750 a pill, leading generic drug maker, Valeant Pharmaceuticals, has declined almost 70 percent, erasing more than $50 billion in market value.

Valeant was indeed one of the top holdings in many large hedge funds.  This superb story on Daraprim finally motivated the financial analyst community to get to work and realize that revenue increases at firms like Valiant were mostly resulting from what some call “price gouging,” an unsustainable model.

Here is the link to the NY Times story on Turing, the hedge fund that purchased the rights to Daraprim. Remarkably, the fund manager agreed to a video interview in which he tried to defend his actions.

Drug Goes From $13.50 a Tablet to $750 Overnight, NY Times, by Andrew Pollack 

Later in October of 2015 the NY Times also reported that a competitor would start selling the same medication for $1 per pill for bottles of 100.  Patients might call this sweet justice.

Drug Compounder Offers $1 Alternative to $750 Pill, Associated Press

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And while Berkshire Hathaway’s Charles Munger and Warren Buffett (In photo at right) are calling Valeant’s practices immoral,  one of its defenders, Bill Ackman (photo on left), is similarly calling out Munger on Berkshire Hathaway’s investment in Coke, calling it a key contributor to obesity and diabetes.  Neither Ackman nor Munger talk about their sizable investments in transporting coal and crude oil by rail and the related environmental and health/safety consequences.

Ackman is one of Canadian Pacific’s largest shareholders while Buffett and Berkshire of course own Burlington Northern, which receives a third of its gross revenues from transporting coal, in addition to transporting 80 percent of all oil in the U.S. that goes by rail.  Interestingly,  Bill Gates and his foundation are together the largest holders of Canadian Pacific railway, and are clearly trying to corner rail traffic in North America together with Buffett.

Already Canada Pacific has attempted to purchase CSX railway and, having backed away due to anti-trust issues, is now making a play for Norfolk Southern.  It is almost ridiculous that Warren Buffett is making billion dollar transfers to the Gates Foundation and then the foundation is using these funds to create a monopoly on rail traffic in North America.   Put another way, they are clearly related parties and the SEC should treat them as such.

Tax exempt public pensions should similarly think about whether it is appropriate for them to participate in monopoly generating activities in the health care grid.  Especially when these investments are using inversions and other schemes to deplete the very same general tax base necessary to sustain the public pensions.

I did also attempt to get some major coverage on this health care grid price fixing scheme in the LA Times as part of a review done on Jeb Bush”s financial statement yet was unsuccessful.  And while the market is focused on Valeant’s relationship with a “specialty pharmacy,” the best example needing more disclosure, in my opinion,  is Blackstone’s development of Catalent, which it merged into Vanguard Health Systems, which was sold to Tenet Healthcare, the nations third largest for profit health care company, on whose board Jeb Bush sat until shortly after the story was printed.

Here is a link to the excellent story by Joe Tanfani.  Unfortunately, the drug and procedure price fixing concept was too big to fit into the scope of the story, even though Bush made a fortune in gains from Tenet stock options, gains largely created by the roll-up purchase of Vanguard Health from Blackstone.   Consolidations done with tax-exempt public pension investment dollars.

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Jeb Bush                           Joseph Tanfani, LA Times

Jeb Bush, shifting focus, quits firm that has profited from Obamacare – LA Times, by Joseph Tanfani

Basic Premise Regarding Private Equity and Hedge Funds in Health Care:  Just as Enron spiked energy prices by shutting down key generation facilities on the power grid for unnecessary maintenance, private equity and hedge funds are purchasing hospitals,  specialized clinics and various other health care distributions systems and limiting access points through “roll-up” consolidations.  This is moving patients to higher cost choices, both in medications and medical equipment, often from related companies.

In understanding Enron, one could always rely on Ken Lay’s own words. ” We are going to be the Microsoft of the energy field,” he would say.  In practical terms he meant that they were using “financial engineering” to raise its share price and leverage growth in their stock options.

One key strategy was to hide debt in offshore entities, thereby strengthening its balance sheet.   The major debt now being hidden is taxes and all investors should ask, what if these firms had to pay a modest rate upon their various schemes being successfully challenged by the IRS?

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Ken Lay, Former Enron CEO

Of course Key Lay was known as “Kenny Boy” in the Bush administration, as he masterfully manipulated regulators, including the SEC, to prevent any real regulatory scrutiny.  Today PE firms like KKR are similarly manipulating key regulatory agencies and hiring the best political muscle money can buy.

Not only is former CIA director General David Petraeus on board with KKR for millions yet former President Bill Clinton has also made a fortune working for KKR thru 2014, a year in which he made $4.5 million working for one of KKR’s key portfolio companies, Laureate Education, a controversial for profit college company living off student loans.  Laureate paid Clinton $16.5 million over a 4 year period ending in 2014.

The irony regarding Clinton is that student loans and drug costs are positioning to be key issues in the 2016 Presidential campaign.

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Henry Kravis              George Roberts

Two Top KKR Promoters:

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Bill Clinton                      David Petraeus

Still unreported in the business press is that 70 percent of all carried interest earned by most major PE firms is paid in the form of stock options, see PricewaterhouseCoopers study posted on this blog.  And similar to Enron and Microsoft prior to the .com bust, PE firms are excluding the cost of these options from the valuation of their portfolio firms, thus greatly inflating their values and legitimizing “deal specific” carry fees they would not otherwise be entitled to.

See slide with PricewaterhouseCoopers summary.

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Health Care should present some terrific investment opportunities, especially in the basic delivery area, yet the level of fraud is currently simply staggering.  Step one should be to allow the government, since their are 45 million people in Medicare, to negotiate volume discounts and other key terms.  Remarkably, this was prohibited by Congress when prescription coverage was added.

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Today Oregon PERS approved a $400 million investment in Stonepeak, a firm that invests in “infrastructure projects.”

In his presentation Stonepeak’s managing director Michael Dorrell noted their strategy is to invest in “essential infrastructure assets with an economic monopoly, much like an airport.”  This includes water, power plants, transportation and telecom with a focus “outside the auction process.”  They expect an annual return of 12 percent over 30 years.

One of their major projects he discussed is the largest desalination operation in the western hemisphere, in Southern California.  The key development partner is Poseidon Resources, “former GE guys.”  Dorrell noted they obtained the exclusive rights to such desalination projects.  They brought these rights over from their former employer Blackstone, who is entitled to 50 percent of the carried interest from this project. The expected return is 14 percent over 30 years and the City of San Diego could not do much about this high rate since Stonepeak has rights to the “only viable site near San Diego.”

In the old days government entities would issue municipal bonds for such improvements in order to make sure the public interest is served with respect to keeping costs down.  One might question why Oregon PERS is investing in such projects via private equity firms rather than directly funding them via a firm specializing in this area working with the municipality?

This also highlights why it is so important for Oregon PERS to fully disclose carried interest fees and partnership audit reports to the public.  Key questions regarding Blackstone’s participation in 50 percent of the carried interest from the desalination project were simply not asked.  They include noting whether Blackstone has other businesses independent of Stonepeak with a stake in the project,  etc.

Put another way, more disclosure of private equity and hedge fund fees is important, not only with respect to their own funds yet also in terms of how much these funds have allocated fees to outside supposedly independent firms like Blackstone, especially if they come in the form of stock options.  At a minimum, Stonepeak should update its SEC ADV filing noting that Blackstone has a material participation in its largest project.

Remarkably, one of Stonepeak’s principal equity owners, per SEC filings, is TIAA-CREF.  Given that TIAA-CREF is tax exempt, along with Oregon PERS and most of the other limited partners, its not hard to see why tax rates are going up for the rest of us.  The overall corporate tax base is simply vanishing behind tax exempt status.

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In late 2014 the tax exempt Oregon Historical Society sold the Sovereign Apartment building, after owning it more than 30 years.  The Society maintains an outstanding board of directors and this was clearly a difficult decision. As part of the sale the society negotiated a long-term lease for itself yet its 44 tenants were last month given six months to vacate.


The building’s new owner is the Randall Group, a prominent locally based owner of numerous residential and commercial buildings.  The stated reason for the forced eviction is to undertake a major remodel resulting in much higher rents.  The Randalls are prominent local philanthropists and make significant contributions to OHSU.


Rather than use its own property management subsidiary, CTL, the Randall Group has chosen instead to use Norris Beggs, Simpson.  Tenants were offered the last two months free rent if they stay until the eviction date, December 31, 2015.  At the same time Norris Beggs is advertising short term rental rates below current tenants rates.  Of course some of the long term tenants find this disappointing.

Ironically, the Randall Group receives a significant amount of financing from tax exempt public pensions via CBRE, what they call structured finance in the real estate industry.  In 2012 Oregon PERS invested $100 million in one such CBRE fund.

Unlike New York, there is no rent control in Portland, Oregon and therefore this type of forced eviction effective December 31, 2015 to pave the way for a significant rent increases is an accepted business strategy.

In New York prominent private equity firms regularly purchase rent control buildings, financed by public pension co-investors including Oregon PERS, with the stated strategy of forcing a certain percentage of renters out of their apartments by cutting off utilities, not making key repairs, etc, what could be considered suggested evictions.  By doing this, they can often raise the rent 500 percent for new occupants.

Where it gets interesting is that the Oregon Historical Society was playing by the rules in that it held its ownership of the apartment building in a taxable subsidiary C corporation.

Therefore, they paid full taxes on its income, including $1.3 million or a 40 percent overall tax rate on the gain at the time of sale.

The following footnote is from the 2014 annual audit report.  Note the taxes paid on the sale, again, the society is a tax exempt entity.


So while the Historical Society is playing by the rules, other prominent Oregon based foundations including the Meyer Trust, Oregon Community Foundation, Ford Foundation and others invest aggressively in private equity based real estate partnerships that use foreign blocker corporations based in the Cayman Islands and pay no tax on either their income from the investments nor from gains on sales.  This is similar to Goldman Sachs renting a Post Office box in the Caymans, claiming it as its main office, and averting billions in taxes.  Tax attorneys call this tax efficiency while other more simply minded might consider it criminal tax evasion.

The solution is simple and that is to make sure any tax reform plans also incorporate various tax-exempt entities.

My proposal would be to provide tax free treatment on investment gains for tax exempt entities only if an investment is held 5 years and standard capital gain treatment if held less.  The only exception would be investment in government issued securities, the gains of which would be tax free without exception.  Of course an added benefit would be to reduce the rampant speculations being made with tax exempt investment funds,  or as one prominent short-seller Jim Chanos says, only tax exempts should short sell due to “tax efficiency” reasons.

It will be interesting to see how long the Randall Group hangs on to the Sovereign building or whether it will be sold to a private equity real estate pool using an offshore blocker so that tax exempts can invest and pay no tax on income or gains from sales.

Even CPA firms better known for crafting tax strategies have moved aggressively into private equity.  One such firm, which began as the CPA firm Parrot and Associates, now calls itself Vergepoint Capital.  It recently sold a $52 million complex to the Randall Group with financing provided to Randall by CBRE.

The next chapter in the Sovereign’s life might simply be a takeover by another more “tax efficient” tax exempt.  Not only is this bad public policy yet it is also aggravating an acute shortage or reasonable housing in downtown Portland.

It is astonishing how leading Presidential Candidates banter about tax rates with no recognition that public pensions, foundations and endowments via investments in offshore based private equity and hedge funds now control trillions of the US economy, and since they pay no tax on either income or gains, no tax reform will work without bring a discussion of tax exempt to the table.

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Disclosure:  This post is the first of several regarding the 2016 Presidential candidates.  One post will be done on each major candidate and the focus will be their primary financial backers and their respective foundations.  Bill Parish maintains no ties to any candidate nor does he have knowledge of any client owning positions in private equity or hedge fund partnerships.  Parish & Company only recommends publicly traded securities.

With Hillary Clinton likely to win the Democratic nomination, barring a major mistake, her most influential financial backers will be analyzed first.  They are Tony James of Blackstone and Jim Simons of Renaissance, the world’s largest private equity and hedge funds respectively.

The purpose of this post is to present an inside look at both firms and how they might influence national economic policy.

Primary Backer 1.  Tony James, President and Chief Operating Officer, Blackstone


Bill Parish with Tony James, Blackstone President and COO, at the April 2015 Oregon Investment Council meeting.  At the meeting, James secured an additional investment of $500 million from Oregon PERS.   James is seen as a leading candidate for Treasury Secretary in a Clinton administration.   And although clearly able to do the job, the key question might be, does James have the capacity to turn his back on his natural constituency, private equity and hedge funds, as Teddy Roosevelt did, and represent the country.

His firm, Blackstone, is involved in what some might consider blatant tax evasion schemes resulting from its heavy use of tax-exempt fund sources for its various investment partnerships.  It has also become a job destruction machine as they aggressively acquire, consolidate and outsource good paying jobs.  For Blackstone it is a short term orientation and related “race” to earn carried interest fees.

Blackstone’s key tax evasion scheme involves realizing its “carried interest” fees in the form of stock options.  They are essentially taking a full tax deduction for these options issued in taxable subsidiaries not owned by its tax exempt limited partners, even though the options involve executives at companies owned by the same tax-exempt limited partners  Put another way, taxable general partners are using tax deductions that belong to tax-exempt limited partners and are by definition unusable.

Of course Blackstone can rightfully claim that everyone is doing it, as summarized in the following study by PricewaterhouseCoopers showing that industry wide indeed 70 percent of all carried interest fees are paid in stock options.  Even Warburg Pincus, where former Treasury Secretary Tim Geithner is now president,  pays more than 50 percent of all carried interest fees in the form of stock options.

And while many look back at the .com era and see accounting excesses, the reality is that the whole bust was driven by the excessive use of stock options.  It was the quest to inflate earnings and related share and option prices that drove the “creative accounting.”   The key factor was that the options resulted in massive tax deductions, even though not paid in cash but rather simply by printing up new shares.  Yet the value of these shares was not shown anywhere on the income statement as an expense.

What private equity firms have essentially done is reinvent the same scheme behind the private equity curtain by using “economic net income,” which excludes these carry related option costs.  Portfolio companies’ values are then inflated by being valued using economic net income times a multiple, for example 8.  This has triggered deal specific carry fees, essentially overcharging limited partners with respect to carried interest in the equivalent of a “pyramid scheme loop.”

When I introduced myself to James and noted I was the guy who took on Microsoft over stock options. James replied  “you changed the world since those deductions can no longer be taken.”  I then added, but isn’t the private equity industry doing the same thing since carried interest is mostly paid in stock options.  James replied, “well, that’s right.”   So essentially the private equity firms have reinvented the scheme behind the private equity curtain, which is exactly why they so aggressively fight any form of disclosure regarding their activities

Here is a key page from the PricewaterhouseCoopers study on carried interest and stock options.   Remarkably, neither the Wall Street Journal nor New York Times has reported this, what is clearly the biggest financial story in 10 years.  Private equity firms now control trillions of dollars of the US economy.


Note: A slide from a presentation by PricewaterhouseCoopers in July 2014 highlighting that “PE funds continue to avoid using restricted stock as the primary equity award due to US tax treatment and valuation constraints.”  A key detail is that approximately 70 percent of carried interest is paid in the form of stock options, per PricewaterhouseCoopers’ own study.

Given on average at least 75 percent of the limited partners in these partnerships are tax-exempt, by allocating internal carried interest as options to portfolio company executives as internal carry, they are essentially creating tax deductions that do not exist.  This is a clear violation of the fractions rule, in addition to having no substantial economic effect.

When I first provided this analysis to leading academics like Victor Fleischer and Gregg Polsky in 2010 they were  focused mostly on the debate between ordinary income and capital gain treatment, what Fleischer called the 2 and 20 debate in a well written analysis.  Leading portfolio managers, analysts and journalists were similarly focused on rates. Unfortunately, this debate is meaningless if taxable income is zero due to illegitimate carried interest deductions.

Back in the .com era the debate de jour was whether or not stock options were recognized as an expense, just as Fleischer and Polsky later focused the private equity debate over the tax rate assessed on income, that is, ordinary or capital gain.  Looking at how expenses were allocated, including tax deductions, was simply not seen as significant.

As with stock options back in the .com era, the debate should be on these expenses and related tax deductions, specifically, how much is being created in expenses and tax deductions and to whom they are being “allocated.”  This is especially important since most of the limited partners are tax-exempt and deductions allocated to them are by definition unusable.  To do so would create a double tax deduction.

If this idea seems a stretch, consider the following chart provided by Blackstone in its April 2015 presentation that netted $500 million of additional funds from the Oregon Investment Council (OIC).

Parish & Company has pushed the OIC to disclose the specifics of these fees and expenses and related partnership audit reports for its various private equity partnerships since 2003.  This includes making regular public comments at monthly OIC meetings.


Performances and Returns from a presentation by Blackstone to the Oregon Investment Council, prepared for the exclusive use of the Oregon Investment Council, April 2015. One need only compare the gross IRR to the net IRR to frame the discussion.

Parish & Company has written extensively about these allocations, in addition to highlighting one key effect of these practices, that being tax-exempt investors have been overcharged with respect to “deal specific” carried interest charges in the equivalent of an Enron like tax deduction pyramid scheme.   Oregon PERS was one of the biggest losers on Enron related investments.

Here is an example of one recent public comment, provided both in formal testimony and in writing via email, to Chief Investment Officer John Skjervem at the February 2015 OIC meeting.  Note that Skjervem deleted the final paragraph from the official record and when asked to have it reinserted both he and current Chair Katy Durant both noted they would not do so.  Whether or not this is an ethical or administrative breach of public records law is secondary to the reality that it is simply poor judgement.

As you read this comment keep in mind that I have approximately 20 clients who are participants in Oregon PERS.

“Bill Parish, an independent Registered Investment Advisor, addressed the Council regarding its private equity and hedge fund investments.  He specifically requested that the council post the refund OPERS will receive from KKR’s settlement with the SEC regarding limited partners being overcharged fees.

Parish also suggested that the recent expansion into investing more heavily into private equity led drug royalty investments raises important public policy questions given that these strategies’ revenue originates primarily from Medicare and Medicaid reimbursements.

Just as Enron price fixed the energy markets in California by artificially constricting supply, creating rolling brownouts in the late 1990’s, price fixing of generic drugs and key medical procedures being led by private equity investors constricting supply through takeovers and other means is raising important public policy questions.”

The following excellent story was done by Gretchen Morgensen of the New York Times on May 1, 2015 and further highlights issues regarding the allocation of expenses.


Another key tool Blackstone is using with respect to expense allocations is their large Group Purchasing Organizations or GPOs, in particular Healthtrust, a GPO which claims to serve 25 percent of the health care market.  It is these types of delivery organizations that are contributing to a rapid consolidation in purchasing activity and driving up health care costs, due to lack of competition, ranging from generic drugs to basic procedures.

James claims its GPO is a non-profit yet Blackstone does not provide any details whether it is a registered tax-exempt with non-profit status nor what percentage each underlying owner maintains.  SEC filed documents do however clearly indicate Blackstone has conducted fee sharing in this area.


The following article regarding stock options was written by Bill Parish for Barron’s in 2003 and Microsoft revamped its compensation practice within 30 days of its printing.


The speech referenced below also highlighted the dramatic impact of stock options and explained how they were indeed the root cause of the .com collapse.


Primary Backer 2.  Jim Simons, Chief Executive Officer, Renaissance Technologies

Simons is widely known as a brilliant financial engineer and many might also add a brilliant architect of tax evasion schemes.   Both Bloomberg and the Wall Street Journal have reported on some of theses strategies yet my personal favorite concerns Renaissance’s retirement plan and Simons’s foundation, both unreported to date.


It is important to note that Renaissance does nothing productive for the economy, other than siphon off massive fees from public pensions and other tax-exempt investors resulting from short term speculations on security movements.  However, the real secret sauce to its strategy may indeed be tax evasion.

As Warren Buffet notes, successful investment requires keeping a laser eye on cash flow and generally the second largest cash outflow, after wages and benefits, is taxes.  Eliminate the taxes and you have a colossal structural advantage, provided such strategies are sustainable.  This is Simons’s key strategy.

With Clinton and other Democrats promoting their credentials with respect to protecting and expanding jobs for the middle class and related benefits such as a reasonable retirement, an examination of Renaissance’s own retirement plan is telling.

And the Simons Foundation, to be reviewed following the retirement plan, is where we see the 1 percent becoming the 99 percent.

Let’s start with the retirement plan.  The following notice was posted in the Federal Register from the Department of Labor in April of 2012.  The notice essentially granted an exemption to Renaissance that allows it to circumvent a key DOL rule that prevents companies from putting more than a certain percent of its own company stock into employees’ retirement accounts.  Essentially avoiding what would be considered prohibited transactions.

What Renaissance did was terminate its 401K plan in 2010 and roll the balances into a new employee IRA plan.  This new employee IRA plan is invested exclusively in Renaissance’s own partnerships, which violates key DOL and IRS rules.  Even though they have an exemption from the DOL rules with respect to ERISA-prohibited transaction rules, they are clearly in violation of IRS rules, which are different.

Think of it like a barber shop putting his business in his IRA so that he doesn’t pay any income tax.  Brilliant, creative but also against the rules.

The real beauty of the new Employee IRA Plan (no, this is not a SEP, not a 401K, not a profit sharing but rather a spectacular piece of what some call strategic non-compliance to the rules) is that Renaissance says to the IRS, just trust us that the the total investment in our own partnerships is less than a certain percent of the total IRAs of all employees, so we are following the rules.  Again, bear in mind that 100 percent of the IRA balances in the new plan are in Renaissance’s own partnerships and the value of these is determined by Renaissance’s own “valuation committee.”

And yes they also did start a new 401K for employees, independent of the New Employee IRA Plan.  The new 401K had 3 percent overall growth in assets in 2013 while the New Employee IRA Plan balances grew 43 percent.


The following chart shows the sum of the balances for the year ending December 31, 2013 in the New Employee IRA plan in which 100 percent of the account balances are invested in Renaissance’s own partnerships.


And here is the footnote to accompany its annual filing in which Renaissance states it has obtained an exemption from the DOL allowing it to not comply with the prohibited transaction rule.  The final sentence is spectacular in its deception as it states the administrator (which is Renaissance) believes that it complies with requirements of the IRC or Internal Revenue Code.  Again, the DOL ERISA requirement is separate and independent of the IRS rules.


In a further testament to the financial magic performed by Renaissance, which elevates its strategies to high comedy, is the following reference from Jim Simons’s multi billion dollar tax-exempt foundation.

In plain English, Simons is running a billion dollar investment company through his foundation, claiming that the foundation’s 99 percent ownership stake is only that of a “limited partner.”   There you have it, how the one percent becomes the 99 percent and makes aggressive speculative investments through the tax-exempt shell of a charitable foundation, paying no tax on gains.  Even Romney, a top notch financial engineer himself, would likely be impressed by this.


Of course the key question becomes, does Clinton have the capacity to genuinely reform the tax code if she ends up relying on advice from James and Simons, especially if James becomes Treasury Secretary.

James knows full well that the problem with the tax code has nothing to do with rates but rather a simple lack of enforcement of the existing rules, which has allowed people like Simons to shift his tax burden to the rest of us.

And the key rule that CPAs like myself respect mightily is substance over form.  Put another way, structure it however you want yet in the end the underlying substance should determine its fate.

The message for investors is clear, avoid private equity and hedge funds and their related companies, whether spun off in IPOs or backing bonds, regardless of the posted results.

Quality publicly traded securities with robust SEC, DOL and IRS oversight should increase in value as the air comes out of this financial engineering bubble based upon tax evasion.

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Disclosure:  Intel is currently the largest single individual equity holding in both my personal and most of my clients’ portfolios.   No shares will be recommended for sale based upon this original research.


Intel CEO Brian Krzanich

The purpose of this post, which will be accompanied with an email directly to top management, is to effect positive change and help Intel avoid an inevitable class action lawsuit by employees over mismanagement of its retirement plan.   Already Fidelity Investments itself and Massachusetts Mutual are subject to such lawsuits in which employees are claiming excessive fees and poor choices.  In both cases, employees are absolutely correct.

To be clear, it should be stated that the employee directed portion of the Intel pension plan is superb, in large part due to its open nature in which employees can invest in virtually anything via a brokerage equivalent account.  The problem is specific to the profit sharing and “Target Funds” portion, both of which have been infiltrated by hedge funds.

What Intel and many other firms still do not seem to fully realize is that these are essentially employee assets, not company assets.  And even though the company is managing the profit sharing component of the plan on behalf of employees, these are still “employee assets.”  Put more directly, within this plan lies the average employee’s life savings and allowing someone to speculate with them is an absolute breach of the ERISA prudent fiduciary requirement, Section 404C.

The problem is simple and involves Intel’s decision in 2011 to allocate 25 percent of its profit sharing and target related retirement options to a basket of approximately 25 hedge funds, affecting billions in employee retirement assets.   “Target funds” are popular with many investors today. The hedge funds that have infiltrated the pension plan include buyout funds, funds speculating on commodities, etc.

Not only do the hedge funds charge annual management fees 10 times higher than standard wholesale level fees for such plans, 1.5 percent versus .15 percent,  they also take 20 percent of all future profits on top of the management fees.   If Intel executives want to make such investments in their personal portfolios, that is one thing yet this level of institutional gambling with employees assets makes no sense.

Returns on these hedge funds greatly lagged the market in 2013 and while some advocates, including Mark Gardiner of Intel Capital, who until recently chaired the Oregon Investment Council’s $70 billion PERS portfolio, claim hedge funds are designed to outperform in more difficult markets,  there is no escaping that this is an absolute mess.  Oregon PERS is similarly aggressively increasing investments in speculative hedge funds.

Further complicating this issue is that Intel labels the hedge funds A thru V, not even having the courage to state exactly who they are in disclosures to employees, thus eliminating an opportunity for participant oversight.  For example, Fund C is a “Directional Fund” that invests in forwards and future commodity markets” while fund F is a “Technology based long/short fund.  Performance metrics include “sharpe” and “sorption” ratios, an explanation of which is not worth your nor my time.

Government Filings Reveal Specific Hedge Funds in Intel Plan

Government filings, not provided to Intel employees, reveal that these hedge funds include  the following (see complete listing at the end of this post):

**  HBK Investment OFF FD LTD Limited Partnership

HBK, whose office is listed as being in Dallas, Texas,  does do the required SEC ADV filing yet in its disclosure it claims it does not manage assets for pensions.  In addition, in the required ADV Part 2 filing it does not directly disclose its fee structure.   This is a clear breach of the SEC requirement, apparently no one at the SEC has looked at the disclosure.

Another complication for Intel is that it has not filed the required 990-T tax form to disclose what it owes in UBIT or unrelated business income tax from these pension based partnership investments.  This is a special tax on tax exempt entities, like pensions, who invest directly in operating businesses via private equity and hedge fund partnerships.  The way to avoid UBIT complications is to invest in publicly traded equities.

This 990-T filing is also designed to prevent tax exempts from trading valuable unusable tax deductions they are allocated in the partnerships to taxable partners who can fully use them.  The IRS rule that specifically prevents this trading of deductions is the “fractions rule.”  Today 95 percent of the investments dollars made into partnerships managed by the largest private equity and hedge funds is composed of tax exempt investors including pensions and endowments.    It is not hard to see the potential for abuse when such a large percentage of these valuable tax deductions being allocated remain unusable because they belong to tax exempts like the Intel pension plan.

Hedge funds may argue that they allocate tax deductions based upon the “economics of the deal,” what they call target allocations, which is simply a euphemism for allocating based upon cash flow, that is, who gets the cash.    It is as if they have invented a separate tax system for themselves, one playing by a different set of rules.   I might say, well, that is fine but there is this thing called the tax code and it does not define profitability based upon who gets the most cash.  Hedge funds primary source of cash is often issuing debt under its portfolio companies name and paying themselves rather than reinvesting in the business.  A leading company like Intel should have no role in enabling such a scheme.

The UBIT’s overall purpose is to maintain a level playing field in commerce and prevent pensions from running active businesses via a partnership structure within the tax exempt structure and allow the business to avoid all tax.  While Intel might claim that there was no UBIT tax generated in any of its 25 hedge fund partnerships,  that is extremely unlikely, some might say ridiculous.

Why Fixing the Pension is More Important Than Quarterly Earnings

Intel is a great company, perhaps the most critical industrial firm based in the U.S.   Often forgotten is the scale of manufacturing Intel does at home and the remarkable peripheral benefits that occur, both in seeding new companies and supporting government services at all levels.

In contrast Google and Facebook are wholly structured based upon a desire to sell personal privacy, using ridiculous tax schemes to avoid tax and accumulate cash for acquiring companies and stifling both innovation and competition.  Some would argue these tax schemes should be considered criminal.  Apple engages in similar tax schemes and metes out punishment to any publication that dare disclose how it conducts its business, particularly in China.

In contrast to Google, Facebook and Apple,  Intel stands as a beacon of integrity and opportunity.

While most analysts will focus intently on Intel’s earnings, to be announced later today, of much greater interest to long term oriented investors like myself should be how the company responds to these observations and more specifically how long it takes to remove hedge funds from its employee owned pension plans.

List of Hedge Funds in Intel Pension Plans


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With all the stories on Romney’s finances, many of which resulted from my observations regarding his tax returns and investment accounts, in particular his IRA, and the interaction of the trusts, foundation and Bain Company filings, the most important story is still untold.

Here it is, the story that could likely open the Republican convention to draft a new candidate.  I have been unsuccessful in getting a major reporter to tell the story, so I guess I’ll just have to tell it myself.

I’ll lay it out in simple steps with no conclusions or opinions.  It is simply astonishing that the media has not told this story.

1)  While head of Bain Capital, Mitt Romney set up a SEP-IRA pension plan that allowed employees to invest in Bain deals.  Mark Maremont of the WSJ did a fine story on this.

2)  IRAs are tax exempt and like other tax exempts must file a special return, a 990-T, if they are invested in leveraged transactions.  This is as straightforward as requiring employers to pay unemployment insurance for employees as part of periodic payroll transactions.  The purpose of the 990-T is to recognize the UBIT or Unrelated Business Income Tax, the rate of which approximates the corporate rate of 35 percent.

Congress adopted this approach for obvious reasons in that if an investor was getting tax exempt income in an IRA, let’s say interest income on a leveraged debt offering, and on the other side of the fence the borrower was taking large interest expense deductions, the net impact would be a double deduction and a grossly dysfunctional tax system.

3) Bain Capital is a leveraged buyout firm in which employees invested in numerous “Bain Deals” via their IRA accounts.  These investments are leveraged and clearly subject to UBIT tax.  Other leading private equity firms do not allow employees to invest in their own deals via IRA accounts.

4)  All 990-T returns, including those relating to IRAs, are by law public.  One need only make a request to the IRS.  In April, I made such a request for Bain and 12 top executives, including Romney, for their SEP IRAs covering the period 1992-2007.  The IRS responded none had been filed.  In addition, I also confirmed no filings were made from 2008-2011 with respect to the new Bain Capital Pension Plan set up by Ropes and Gray in which the official retirement age is 23 (not a misprint).   Maremont of the WSJ also reported on this “unusually young” retirement age.

5)  The only way to escape the 990-T requirement and UBIT tax is to make the investment through a foreign blocker corporation.   Domestic corporations are fully subject to the UBIT and leading law firms are very careful in structuring partnerships to account for this, that is, making sure such investments go through a foreign blocker corporation.

6)  Edgar Online is a public corporation ticker, EDGR, effectively controlled by Bain Capital via a convertible bond issue.  SEC filings clearly indicate this control, summarized in Edgar Online’s executives own words.

Edgar Online is in the business of summarizing  SEC data in user friendly formats that are widely used in the financial and media world.  Many leading databases including Lexis Academic, which is available in most public libraries, use Edgar Online.  One need only search for Mitt Romney using the Lexis Academic database, while specifying a search database of “SEC Filings” from 1/1/2000-12/31/2003 to see a list of references.

7)  In but one example, on February 13, 2000, SMTC Corp, ticker SMTX, filed a 13G report on behalf of Bain Capital.  Under section Item 2a, Name of Filing Person, it specifically states that BCIP Trust Associates II is a Delaware partnership, not a foreign blocker corporation.   This form also states Romney is the sole shareholder of Bain Capital and the only “control person” capable of declaring a special dividend.

8)  ERISA rules require pension plans to be trusts.  For example, if I want to set up a pension plan for Joe’s Consulting with TD Ameritrade, the title for each participant’s account would be Joe’s Consulting Pension Trust FBO followed by the employee name.  For example, Joe’s Consulting Pension Trust FBO Jane Doe would be one employee and Joe’s Consulting Pension Trust FBO Mitt Romney would be another.  The reason is to make absolutely certain each employee’s assets are held in and protected by a separate trust, which is required by ERISA rules.

In Romney’s IRA, note that he is not invested in BCIP Associates II but rather BCIP “Trust ” Associates.  The key word “trust” is a calling card for the IRA.  This can be seen in his recently filed 2012 Personal Financial Disclosure Statement.  Note that the most recent filing shows BCIP Trust Associates III, not II.  Trust III is identified as a foreign blocker in SEC filings yet in previous filings Romney was in Trust II and its predecessor, both domestic Delaware Corporations.

9)  The 13G filing regarding SMTC Corporation on behalf of Bain, referred to in item 7 of this analysis, specifically says BCIP Trust Associates II is a Delaware Corporation, not a foreign blocker.

If this SEC filing is accurate, and it certainly is, then not only Romney, but many other Bain employees have failed to file the required 990-T returns and pay the necessary UBIT tax.   Other leading private equity firms, including KKR and Blackstone, do not allow employees to invest in company deals via retirement accounts for good reason.  Perhaps Bain just got too greedy, consistent with its fees being 50 percent higher than the industry average.

There is a whole cottage industry of law firms that advise tax exempt investors on how to avoid UBIT by using foreign blocker corporations.  These clients include leading endowments such as Harvard and Yale, foundations such as the Gates Foundation and public pensions.

Romney says he trusts his advisors, yet that was clearly a mistake.  They have failed him in not only setting up a valid blind trust, but also a credible investment approach for a Presidential candidate.  See February 22, 2012 blog post for related material and comparison to Bill Esrey, former CEO of Sprint.

More importantly, if these filings made by one of Bain Capital’s portfolio companies, SMTC, and summarized via another entity they effectively control, Edgar Online, are accurate, then Romney is indeed involved in a massive tax fraud and by nature disqualified from being a viable candidate for President.

This is not complicated and hopefully someone will elevate it from the obscurity of a blog to where it belongs, front page top right above the fold on a Sunday.

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