Fact-Checking the Latest Bain Hysteria

By Avik Roy
Wednesday, July 25, 2012

Journalists have been eager to find something scandalous in Mitt Romney’s private-equity career. As a result, there’s been a fair share of confused reporting about Romney’s Bain Capital days. Such is the case with a set of breathless articles from the Associated Press and Mother Jones, regarding investments made by two of Bain Capital’s subsidiaries, Sankaty Advisors and Brookside Capital. As I used to work at Brookside, I thought it would be worth bringing some perspective to this discussion.

Much of the case against Romney’s business career involves whether or not Bain or its subsidiaries were involved in outsourcing. Now, I happen to think that free trade makes low-income Americans more prosperous by making goods and services less costly. I also think it’s great that people in developing countries can lift themselves up from poverty by selling stuff to us. My friends on the left oppose these things. Fine by me. That debate is outside the scope of this article. What I want to straighten out is another issue: Which of Bain Capital’s investments is it fair to hold Mitt Romney accountable for?

The answer: He is accountable for the investments in which he actually made the decisions. If I have my 401(k) invested in the Fidelity Select Health Care Fund, am I responsible for every decision made by the portfolio manager at Fidelity? Obviously not. The same goes for Mitt Romney.

Much hay has been made of the fact that Romney was the “sole shareholder” of a number of Bain Capital entities. But investment partnerships don’t work like normal corporations. The majority of the returns from Bain’s successful investments went not to Romney but to Bain’s investors, and also to other Bain partners and employees. In addition, as Bain grew, Romney was involved in less and less of the decision making regarding Bain’s investments.

Although Bain Capital is best known for its private-equity work, the firm has created several subsidiaries that work on other types of investments. These include Brookside, a public-equity hedge fund; Sankaty, a fund focused on credit (debt) securities; Bain Capital Ventures, a venture-capital fund (venture capital is, technically, a subtype of private equity); and Absolute Return Capital, a “macro” fund that invests based on global economic trends.

Investment decisions in these other funds were made by the people running those funds. In order to incentivize those individuals to make good decisions, they and their subordinates retained most of the internal compensation that accrued to those funds. Other Bain Capital employees retained a smaller “carried interest” in their returns. For example, gains in the Brookside funds that didn’t go to the fund’s investors were distributed among Brookside partners and employees, and, to a lesser degree, among other Bain partners. This structure is entirely unexceptional within the world of asset management, as anyone in the field will tell you if you bother to ask.

It’s certainly fair to hold Romney accountable for private-equity investments made by Bain prior to Romney’s 1999 departure. And there isn’t anything wrong with what Bain did after he left. But facts are facts.

David Corn’s “exclusive” report for Mother Jones details a 1998 investment that Brookside made in Global-Tech Appliances, a Hong Kong–based appliance manufacturer. This proves, according to Corn, that Mitt Romney was an outsourcer. But Mitt Romney didn’t run Brookside. Indeed, Brookside’s investment decisions were made without Romney’s participation. In the 1990s, Brookside was jointly run by two portfolio managers, Domenic Ferrante and Ed Brakeman. It would be appropriate to assign credit or blame to Ferrante and Brakeman for Brookside’s decisions, but not to Romney.

Similarly, Stephen Braun’s report for the AP and a related article by Adam Serwer et al. for Mother Jones express concern about Sankaty investments. The Mother Jones article harrumphs that a Sankaty fund is based in Bermuda, a “notorious tax haven.” But the desire of U.S. citizens such as Romney to avoid taxes is not the reason that these offshore entities exist. Indeed, U.S. citizens must and do pay taxes on income they receive, regardless of where the income is earned.

The reason asset managers use these offshore entities is that it allows tax-exempt institutions, such as universities and foundations, to avoid paying extra taxes on their investments. The same logic applies to foreign institutions, which have to pay capital-gains taxes in their home countries: They would get taxed twice in certain ways if they invested in a U.S.-domiciled fund.

Similarly, if the Ford Foundation makes a mint by directly owning shares of Apple, the foundation doesn’t pay taxes on its capital gains. But if the foundation invests in a U.S. fund, the foundation will be forced to pay “unrelated business income taxes” on its portfolio. For this reason, any investment fund that seeks the business of tax-exempt institutions must set up an offshore entity.

Sankaty also had a very small stake in Hong Kong’s Global-Tech Appliances — only 48,000 shares, compared with Brookside’s 1.05 million. But Sankaty’s chief investment officer was not Mitt Romney, but rather Jonathan Lavine. Whether you agree or disagree with Lavine’s investment in Global-Tech — nothing wrong with it from my standpoint — it was Lavine who was ultimately responsible for Sankaty’s investment  decision. And Lavine happens to be a top fundraiser for . . . President Obama.

That relevant fact, of course, was not considered newsworthy by either the Associated Press or Mother Jones. If they think Sankaty’s work is so terrible, they should demand that the Obama campaign return Lavine’s donations. To date, they have not.

In sum, here is what you need to know about Bain Capital. Bain sought to invest not only its capital but also its people in turning important American companies around and making them competitive in the global arena. Bain made lots of investments. Some jobs were created, and some were lost. Mitt Romney was involved with some, and not others. Some failed, but many more succeeded. Most important, as dozens of Democrats have averred, it was honorable work.