Posts Tagged ‘sec’

    Senator McConnell’s Dilemma:   To Serve Patients or Investors?

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When evaluating health care investments it is important to analyze the structure of leading drug and medical equipment companies.  A close look indeed reveals a derivative driven system in which private equity and hedge funds increase demand for drug payments by purchasing the rights to the cash flows from key drugs.  Patients are indeed unaware that many of the drugs they consume are now owned in part by private equity investors.


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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.


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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.”


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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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Michael Dell Hopes SEC and IRS Are Sleeping


What continually makes the United States the place to be with respect to investment is the expectation that, when all is said and done, the rule of law generally prevails.   One need only visit  China, Japan and Russia to see that markets are generally manipulated by insiders.

The big story regarding Michael Dell’s proposed private equity led buyout has yet to be told and it is all about gaming SEC rules designed to promote fairness toward all equity investors, not just a few insiders, and more importantly also gaming key IRS rules.  A few key points:

1)  Tech firms like Dell aggressively compete regarding strategic acquisitions and nothing speaks louder than “cash” or shares assumed to have the potential to appreciate.  For most tech firms the largest source of cash is remarkably non-payment of taxes.  This is due to the large stock option generated tax deductions with no corresponding outlay of cash, deductions associated with restricted stock, etc.  These firms do not generally purchase shares on the open market to fulfill such commitments but rather simply print up new stock.

Put another way, if you can generate a billion dollars of tax deductions, you can effectively reduce your tax bill by 350 million, which is nothing short of cold hard cash in the bank, if you are profitable.  The biggest such deductions come from the issuance of stock or large write-downs of assets, for which there is no cash cost to the company.

If one compares Dell to Apple and Google it doesn’t take long to see that Apple and Google have been veritable tax deduction making machines via the issuance of non-qualified stock options.  Consider the following analysis based upon each companies most recently released 10K reports.  Also consider that large exercises in options at Apple and Google in the last 5 years have generated staggering tax deductions while Dell has generated little.

One could even argue that the whole anti-trust action against Google was misdirected in that the focus should instead be on tax rules that have created a situation in which they are relatively immune to competition.  What tax paying publishing company could possible compete with a firm like Google that “coins” cash, to quote Henry Blodget,  in the form of non-payment of taxes.

Although Apple did not issue any options in 2012, it like Google and Dell, is aggressively issuing Restricted Stock to employees.  Again, there is no “cash” cost to this since it is simply new stock being printed up.  In the old days such stock would be purchased on the open market, resulting in a cash outlay,  yet now it is just printed up.  Consider the following:

Dell Apple Google
Stock Price 2/5/2013        13.5       457.8        765.7
Average Option Exercise Price 25.4 127.5 405.9
Potential Tax Deduction per Share -11.9 330.3 359.7
Options Outstanding 143M 6.5M 8.5M

The key point is that Dell is so underwater with its options that it can’t play the game any longer.  What they need to do is go private, take a massive write-down and revalue the shares lower to create lower strike prices.

Management can then issue two classes of options, not unlike what Bain Capital has done with respect to its own employees participation in deals.  One class will have a greatly reduced exercise price that will accordingly result in massive tax deductions when exercised in a subsequent IPO, when Dell is taken public again.

The beauty of this well worn scheme is that the amount expensed for the options is declared when granted, not when exercised.  This often results in a tax deduction upon exercise years later that are ten times as great as the expense recognized.

If Dell is taken private such deductions can then be allocated among Dell and other taxable private equity partners and result in effective tax rates of close to zero.  This is because many private equity firms have tax exempt limited partners who have no use for tax deductions, examples being public pensions and foundations.   Tax deductions are unusable for tax exempts.

Those private equity firms like Silver Lake, whose largest limited partners are tax exempt investors, including Calpers that owns 10 percent of Silver Lake outright, use well worn schemes to allocate these deductions away from tax exempts, contrary to IRS rules, in particular the “fractions rule.”  Remarkably, there is not only no discussion of this important rule but also no enforcement.

Other major tax exempt investors in Silver Lake include the New Jersey Public Pension System.   Is it not ironic that New Jersey Governor Chris Christie excoriated the Republican party leadership for its slow response in providing Hurricane Sandy relief while the State and other public pensions seek to profit at every turn from “buyout” funds?  Especially when these buyouts decimate the very tax base relied upon to support the public pension system.

In a perfect world Dell would  also take a massive writedown now, prior to the buyout, so that this important value could be captured and quantified, that is the future tax deduction resulting from the write down.  What Michael Dell wants to do is wait until after the buyout and pocket a larger share of any such deduction for himself.

Clear disclosure of all existing unused net operating losses able to be used in future years should also be prominently disclosed.

Overall, this is a brilliant plan and would be just another day at the office if this were Bejing, Moscow or Tokyo.   Let’s hope for the sake of long term shareholders that both the SEC and IRS give Mike a call and say,  “nice try.”

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One of the sacred tenets of good corporate governance is separating the roles of Chairman of the Board and Chief Executive Officer.   This provides a critical oversight function with respect to the activities of the CEO.  Exhibit one supporting this concept is perhaps JP Morgan CEO Jamie Dimon’s role in the current multi billion dollar scandal regarding trading losses in its risk management unit.

Meanwhile over at Intel the current Chairman of the Board is former Chief Financial Officer Andy Bryant.  The CEO is Paul Otellini.   Otellini can run the business as he wishes yet he is accountable to the board and specifically Bryant.

At JP Morgan, Jamie Dimon, in a spectacle of abject arrogance, assumes both roles and is accountable to no one.  Even more remarkable is that JP Morgan, as one of the nation’s largest FDIC insured institutions, is putting taxpayers at risk by this breach of good governance.  It is noteworthy that JP Morgan could well have gone under in the recent crisis if the FDIC had not allowed it to assume Washington Mutual’s large deposit base while only assuming minimal liability with respect to its loan portfolio.

Further degrading good corporate governance principles is Dimon’s role as a board member on the Federal Reserve Bank of New York, one of the banking industry’s primary regulators.  Clearly, Dimon should resign immediately and spend more time with his lawyers given the increasing scrutiny from the SEC, FBI and other regulatory agencies regarding the massive trading losses under his watch at JP Morgan.

Parish & Company has been a leading advocate of sound corporate governance for more than 15 years.

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In the world of chess being too aggressive at the outset, advancing too far, is perilous. For Romney, his refusal to acknowledge his aggressive financial engineering and tax avoidance strategies could indeed result in an open convention.  One in which the party is free to forward a higher quality candidate.

Here is a list of the facts surrounding the Reid Romney dispute:

1)  On July 20, 2012 I published a blog post noting for the first time that Mitt Romney has not filed the required 990-T form and paid the related UBIT tax with his 2010 tax return, nor has he made this required filing in prior years.   This filing is essential for tax exempt accounts, including IRAs, if they contain related business interests, what I call leveraged transactions in Romney’s case since Bain is an LBO firm.

Remarkably, these 990-T filings are all publicly available by law.  One need only write to the IRS, specify the taxpayer, and within 30 days you will receive a reply if these 990-T filings have been made.   My request regarding Romney applied from 1992-2011, 19 years, and the IRS confirmed none had been filed.

2)  On July 31, 2012 Harry Reid made a claim to the Huffington Post that Romney paid no taxes for more than 10 years.  While Romney may claim that he paid “lots of taxes,” Reid is technically correct in that he has failed to pay taxes on the largest share of his wealth, what is believed to be an IRA worth as much as $100 million, for more than 10 years.

3)  Romney’s only defense is to claim that all his Bain related IRA investments were through foreign blocker corporations, thereby using a loophole that eliminates the need to file the 990-T and pay the required UBIT tax.   Disclosing this of course proves Reid’s claim regarding him paying no taxes, even though he may have used a technically legal scheme.  It is unlikely the public will care that Romney paid other taxes when he has avoided significant required taxes on Bain deals in his largest asset, the IRA.

4)  Worse for Romney would be what is noted in the July 20, 2012 blog post, that being that many of his investments, in particular those in BCIP Trust Associates I and II, were via a Delaware Partnership, not availing him of the foreign blocker exemption.  SEC documents clearly indicate this is the case.  The most recent personal financial disclosure shows BCIP Trust Associates III in his IRA, a foreign blocker, yet previous filings show domestic partnerships.

Even more troubling for Romney would be any transfer of Bain interests from the Delaware based partnerships, non valid blockers, since domestic partnerships are fully subject to UBIT,  to foreign blocker corporations such as BCIP Trust Associates III, after the initial investment, that is re-characterizing the fundamental nature of the partnership.

5)  Prior to 2008 Bain Capital utilized a scheme involving SEP IRAs that allowed employees, including Romney, to invest in Bain deals.  My best guess is that Reid’s office asked someone at Bain to look at the July 20 blog post and they confirmed that while at Bain they also filed no 990-Ts.  What this means, since the SEP is a company sponsored plan,  is that no one likely made the required filing, including Romney.  This simply confirms my original analysis.

Reid therefore stands on sound footing with his claim and the Romney campaign is foolishly self destructing by not coming clean and clarifying the issue.

Romney should step up, say they have a problem and commit to fixing it, but this of course would cost his fellow associates at Bain a bundle in back taxes.

Observing this conflict between Reid and Romney,  Paul Volcker comes to mind.  In particular Volcker’s assertion that engineering belongs in product development, not finance.

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