Rabid conservative ideologues believe that everything transacted in a free-market, i.e., unfettered by government involvement or regulation, is by definition a good thing. I presume this is why Newt Gingrich acted like he was between a rock and a hard place when going negative on Mitt Romney's wealth, which was gained largely out of the purview of government regulators.
Gingrich has been desperately trying to besmirch Romney's reputation by any means possible (and I do mean any), but either he has been too lazy to collect facts or he has been unwilling to risk offending too many of the politically conservative oligarchs. Gingrich's excuse for vague assertions and conjectures seems to be that Bain Capital's affairs have been impenetrable.
Before going on, I want to be clear about what this post is not: a direct criticism of Mitt Romney's business dealings. Other than reading one Wikipedia article, I do not have a single fact as to what Romney did or did not do while at the investment firm he co-founded, Bain Capital. My objective is to provide a roadmap to the others for acquiring facts (if they exist) for legitimately evaluating Romney's past dealings. The signposts along that road are mostly failures in corporate governance, but as you might expect coming from yours truly, financial reporting has a little something to do with the story.
Corporate Governance and LBOs
It is well-known that Romney became rich in large part through acquisitions of controlling interests in hundreds of companies. Some of those companies were start-ups, but others were mature; they were transformed in one way or another such that Romney, his partners and the investors in their private investment fund reaped large profits from buying them up.
Many of these companies had been publicly traded before Bain's investment; these are the ones I will be focusing on. Typically, firms like Bain Capital obtain their interest in public companies as part of a "leveraged buyout" transaction, or "LBO." Very simply, an LBO is the acquisition of a company financed by a lot of debt. Sometimes, an LBO is referred to as a "bootstrap" transaction, because the acquiree's future cash flows (either from operations or sale of operating assets) are expected to be sufficient to pay down the debt and provide a healthy return to investors. Very often, and critically so, the top management of the acquiree takes an equity interest in the LBO. That can create a conflict of interest between one's personal ambitions and one's duty to shareholders, and the history of LBOs since the 1980s is replete with shareholder fleecings. Here's my all-time favorite example:*
On Dec. 6, 1983, the senior management of Metromedia, offered shareholders $720 million in exchange for all of the outstanding shares. The offer was accompanied by a prospectus in which it was stated that by taking the company private, management could more effectively pursue a long-term growth strategy. The offer also followed a series of very negative press releases, which were clearly designed to drive down the share price, and consequently, the cost of the LBO.
Upon consummation of the LBO, John Kluge ended up holding 90% of Metromedia's equity, without having invested a single dollar. Within two years, Kluge realized over $4 billion from the outright sale of most of Metromedia's businesses (so much for that long-term growth strategy!).
In 1986, Forbes identified Kluge as the second richest American, behind only Sam Walton of Wal-Mart fame.
Not coincidentally, I believe, the shakedown of Metromedia's shareholders happened around the same time as Mitt Romney was offered the opportunity to become a venture capitalist – for Kluge's coup must certainly have whetted the appetites of many a high roller. LBOs began to lose their luster as a get-rich-quick scheme starting in the late 1980s, but the ethics still remained questionable. In a nutshell, here's why: If a public company could benefit from shouldering more debt, improving operations or selling assets, why should it take an LBO to get the job done?
The LBO Accounting Story
All of this would be a digression from the main theme of my blog – financial reporting – without this additional accounting twist. LBO accounting was controversial until FAS 141R, Business Combinations, became effective in 2009. Up until then, one school of thought was that if management continued to run the same company, and/or the LBO transaction was absorbed by a brand new legal entity and effected outside of the target company (i.e., through the purchase of shares from existing shareholders), the carrying amounts for the assets acquired in the LBO should not change. Under that view, companies that are taken private could do an IPO a few years later with the same basis for their assets; i.e., without the burden of additional depreciation or amortization expense, and with a higher return on assets.
Is window dressing important to LBO investors? Maybe not to all, but to some (perhaps Bain Capital) it must be. EITF 86-16, Carryover of Predecessor Cost in Leveraged Buyout Transactions and its successor, EITF 88-16, didn't just come from nothing. The special accounting for LBOs structured in just the right way must have been pushed by investors who really needed that type of accounting to make their deals work. Paul Kluge would not have been one (although Abe Briloff called him out for questionable accounting a few years earlier – and Metromedia's stock price dipped 25%), but as deals became more difficult (higher buyout prices and lower leverage), maybe Mitt Romney would have been willing to use an accounting trick to sweeten a deal. EITF 88-16 was finally nullified by FAS 141R, but that was not until 2009, ten years after Romney left Bain Capital for good to enter politics. In the meantime, aggressive use of EITF 88-16 clearly must have played a part in LBO transactions somewhere and somehow.
Whom Do You Trust: Mitt the Vulture or the Newt the Dodo Bird?
Maybe Bain Capital's LBO transactions were pure as the driven rain. I don't know, and all I'm doing is providing a line of inquiry for those like Newt who seem to need a roadmap to validly question whether some or all of Romney's considerable wealth was fairly or ill-gotten. At the very least, those looking to put Mitt Romney's business career under a microscope should be asking whether the equivalent of Bain's brains and money could have been had without: booting shareholders out first; or paying such princely sums to Romney and his partners; or by giving preferential accounting treatment for LBOs. Creative destruction may be essential to economic growth, but vulture capitalism is not.
I don't buy Gingrich's excuse for not having facts to support his claims. There are always two sides to every transaction. Surely, if they exist, disgruntled counterparties and abused former employees of LBO targets should be all too willing to "swift boat" Romney. Come to think of it, since no one has yet to come forward, then maybe he's clean.
I won't speculate any further whether there are skeletons in Romney's LBO closet, but keep in mind that LBO transactions are rife with potential for conflicts of interest. For example, management may sell its own shareholders down the river for a quick buck; board members don't want to become too obstructive to their friends in management; investment advisers with a stake in the transaction may offer bogus "fairness opinions"; and auditors may remain silent even with full knowledge that a fleecing is about to take place. All of this could be happening as an LBO investor writes checks to facilitators and gives them encouraging pats on the back.
If Romney is complicit in a Kluge-type scheme to any degree, then a part of his fortune would have been built not from taking a fair share of value added through creative destruction, but through vulture capitalism – shareholder fleecing and economically unjustified upheaval of the lives of employees, their families and other innocent bystanders.
Ultimately, voters have a right to know.
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*Adapted from two articles by Benjamin Stein in Barron's, "Where Are the Shareholders' Yachts: But John Kluge Pockets Billions from Metromedia's LBO" (August, 18, 1986); "Shooting Fish in a Barrel: Why Management Always Makes a Bundle in an LBO" (January 12, 1987).


There's No Process Like FASB Due Process
"Once again, you are exactly on the mark, although I would attribute FASB's woes to its being insufficiently a creature of the accounting profession, as a profession, not too much so (but I do not identify the profession of accountancy with the big firms).
Clearly accounting standards, as they are professional standards, need to be determined by expertise and good professional judgment, not by democratic vote. A doctor should stand by his best professional judgment as regards medical treatment, even if 1000 non-doctors disagree. So you are right that FASB's solicitation of comments should be construed solely as due-diligence, that is, to check whether it has overlooked crucial bits of evidence or arguments. (Stakeholder theory I believe is not the appropriate context with which to evaluate it, but rather the conception of profession in the strict sense.) The problem is, as FASB has been divorced from accountancy as a profession, its procedures have taken on something of the character of the political, not the professional, and hence 'due process.'" [italics supplied]
And, speaking of due diligence, here is an internal email that was forwarded to me from the Institute of Chartered Financial Analsysts (ICFA), an investor group that published a prescient fair value manifesto before the latest financial crisis hit:
"There other interesting observations to make about these form [comment] letters [on the fair value proposal]. For example, many of those sending letters don't prepare GAAP financials. The Bank of Montgomery (approximately comment letters 350ish-400ish) sent is 40 plus letters and they don't prepare GAAP financials – just bank call reports – as per my discussion with the bank's cashier. This is a case for many of those smaller institutions sending in letters…call a few in Iowa and you will see this to be true. Further, some of those sending in letters did not know they sent in letters. One guy told me I had the wrong phone number. Another said it did it because the ABA told him to and still another loan officer forwarded me to the accounting department as he couldn't explain the basis for sending in a letter.
It would be interesting to determine what due diligence was done on those sending in comment letters."
But, Denny Beresford, former FASB chair, took me to task on the AECM listserv for my opening swipes at the manner in which changes to the Board's composition appeared to have taken place:
"I was going to add a few of my own comments about due process and the FASB. However, after seeing your opening comments about 'the firing of the FASB Chairman' (nothing could possibly be farther from the truth) and the appointment of three new board members 'who could be reliably counted on to vote as FASF chair John Brennan clearly wished them to' (another silly contrivance), it's obvious that your mind is already made up and wouldn't be changed by any different perspectives. Bob Jensen's forwarded article 'In the Teeth of the Evidence' notes 'It turns out that people who have made up their minds are not receptive to information doesn't support their beliefs,' and your latest piece clearly demonstrates that statement. I actually enjoy reading your opinions about accounting issues but not when you couple them with such outrageous and unsupportable assertions."
In response to Denny's criticisms (whom like Edith, I venerate), I slightly revised my post to clarify that I was expressing personal opinions. But, since these opinions have personal connotations, I now feel compelled to explain them further.
Blogging Standards – Or Lack Thereof
I am not going to defend bloggers in general, or the lack of established standards for blogging, but this seems like a good time to tell you mine: simply to be truthful about what is on my mind.
It may be also be helpful to tell you something about what my blog is not: it is not journalism. I would expect a journalist to make a good faith attempt to represent at least two sides of an issue, and (perhaps most germane to Denny's comments) to corroborate evidence received from one's sources. I sometimes conduct research for a blog post, but it is much more common that I write about what I already learned or inferred from reading, studying and thinking. If I were to hold myself to the same standards as professional journalists are held to by their publishers, then my posts would take me a week to write instead of a day.
Why Do I Think As I Do?
When Denny makes his own unsupported statement that "nothing could be further from the truth" to describe Bob Herz's departure as a firing, he implies that he knows something I don't. He may indeed, but I don't what that would be; but more important, I do not believe I made unreasonable inferences regarding Herz and Brennan from the information that was available to me.
First, Herz's resignation came as a surprise. I had absolutely no inkling that Bob's goals were anything less than to serve out his full second term, or at minimum to shepherd the FASB through the SEC's momentous formal decision on the status of IFRS for public companies.
Second, Bob was a staunch supporter of fair value, and his opportunity to explain his principled views at a congressional hearing did not seem to go well. Third, the vastly divergent views on financial instruments accounting between the IFRS and the FASB (and even within the FASB) were looming as the biggest impediment to convergence. Fourth, the earlier questionable decision of the FAF to shrink the FASB to five members in the face of overwhelming opposition had all the earmarks of a political power play. Fifth, the rapidity after the announcement of Bob's resignation with which the FAF re-expanded the Board back to seven members with hardly a pretense of deliberation or valid explanation. And sixth, there was the appointment of board members with backgrounds leading highly predictable predispositions against fair value measurement.
I, Too, Am Outraged
Notwithstanding my earlier predictions that Bob Herz's departure (however characterized) and subsequent re-expansion of the Board would play out almost exactly as it has, the circumstantial evidence I enumerated above was adequate to convince me that devolution toward convergence was the FAF's unstated agenda. I did not explain the reasons for those views as fully in my earlier post as I have here, because I did not regard them to be central to the theme of due process.
I don't mind admitting that I, too, am outraged – by the politicization of much-needed financial reporting reforms – not just in regard to loan accounting, but in all the many cases where over-represented financial interests have prevailed in the name of "due process." This, more than anything else, explains why I chose to make an exception to my practice of avoiding personal references when discussing policy matters.
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