Wylys – What Were They Thinking?

sam_wylyI’m fascinated by the psychology of Dallas-based entrepreneur Sam Wyly, recently ordered to disgorge $1.1 Billion for maintaining an extensive offshore scheme that led to convictions and penalties for securities fraud and tax evasion.

I’m interested in knowing: What the heck was he thinking?

I mean, I gather Sam was motivated to not pay too much in taxes. And I’m sympathetic, to a point.

Mike’s First Immutable Law of Taxation is that “Every tax action causes a tax-avoidance reaction.” The government passes a tax law. We, the taxpayers, try to delay, defer, and minimize those taxes.

That’s not always a bad thing, since Individual Retirement Accounts (IRAs) for example are in part a tax avoidance reaction. Reducing our personal cigarette or gasoline consumption is another potentially positive response to increased taxes.

We should expect and even condone a degree of tax deferral and tax minimization. I would even agree that you have a duty to your own family and your potential future philanthropic agenda as you get wealthier to prudently pay to the government only what you owe, and not a penny more.

And then there’s the Wylys. I mean, come on, guys. I don’t mean to be overly moralistic about them. I’m puzzled by the unnecessary risks they took.

Self-sabotage

What makes me shake my head even is the needless self-sabotage involved. None of their tax evasion – if they’d sort of stopped to think about their true self-interest, properly understood – really helped them in the long run.

Picture yourself as Sam Wyly. You show an extraordinary and wide-ranging knack for building businesses and making money over the decades in computers, retail, restaurants, and insurance. You are rich beyond any reasonable expectation, especially considering where you started in life.

You are a Texas Miracle. A Man in Full. You and your brother Charles are the American Dream, personified.

Not only that, but you give generously, funding endowments to The University of Michigan, and Louisiana Tech. Your brother Charles funds a theater in the Dallas Arts Center.

This is not enough, apparently.

You listened in 1992 to a clever promoter of offshore schemes to minimize your tax bill in a variety of ways – reducing income taxes, capital gains taxes, future inheritance taxes, gift taxes – all the while shielding your financial empire from the prying eyes of US tax authorities.

The plan is a bit untested. All sides admit it is an “aggressive scheme” and will require an alert team of attorneys, family office managers, trustees, accountants, and heavy reporting requirements to stay on the safe side.

An independent tax expert in 1993 – after you’ve initiated the series of offshore trusts, corporations, and money transfers intended to obscure your assets – opines that the scheme as executed probably isn’t legal. Not deterred, you continue to create new offshore entities in 1996, neglecting to investigate the “grey areas” of the scheme and failing to file proper disclosures as recommended.

Maintaining the scheme requires you to engage in circular money transfers between onshore and offshore entities to hide the origin of your funds, to use made-up “friends” who create offshore trusts on your behalf, and to hide ownership of public shares behind shell corporations to evade securities laws on disclosures.

In 2003, ten years into the scheme, an independent, top-notch, offshore tax lawyer not only warns you that it’s all probably illegal, but even negotiates anonymously on your behalf with the IRS to find a solution to any penalties that might arise from your decade of operating an illegal offshore scheme.

This was your chance to make it right. No settlement is reached at that time. You continue for yet another decade to perpetuate the scheme, fail to file proper disclosures, ending up in cat-and-mouse litigation with the IRS.

The SEC finally wins a $300 million judgment in 2014 against you for federal securities fraud, as a result of your offshore accounts activity.

So that’s awkward. And is a teensy dent in your American Dream story. Undeterred – again, you’re a Wyly and presumably grit is your middle name – you declare bankruptcy in 2014 as a pre-negotiating tactic on the $300 million owed.

But things get worse. The IRS, unhappy at missing out on taxes for decades and very likely interested in making an example of your rise and fall, vows to sue you for back taxes and penalties.

The bankruptcy court in June 2016 declared $1.1 Billion in money now owed (80% of this is “penalties and interest” on the original taxes evaded) by Sam. This is not good.

My naïve thoughts

I feel like the Wylys made some poor choices here.

One of my personal uninformed theories is that if you have a lot of money or make a lot of money you should realize that the entire legal system – civil and criminal enforcement – is built to protect your money, private property, and personal safety.

I mean really, what does a destitute person have to gain from private property rights enforcement in the courts? A destitute person could arguably do better in a system of weak enforcement. So like, if you’re rich, then you really, really want a strong government to protect you from the destitute person who’s got nothing to lose if they decide some day to just basically take your stuff by force or fraud.

So one of my views is that if you have a lot to lose, then pay your damned taxes with extreme gratitude that the police and courts are there to protect what you have. But like I said, this is just my dumb theory.

Maybe no choice?

But then I wonder, psychologically, did they even have a choice? Were they wired to always seek their maximum advantage, to their own ultimate demise?

This is just armchair psychology stuff but part of me thinks that the same entrepreneurial drive that helped Sam and Charles Wyly conquer the business world also drove them to game the offshore tax system to the max, to their ultimate fraud, bankruptcy, and tax evasion convictions.

I hope naively that when I become a billionaire I’m going to pay my regular taxes right here onshore in the United States and just try to be happy.

Maybe that’s easy for me to say now, as I am not currently (temporarily, mind you) a billionaire. Also, while I’m pretty happy now, maybe the problem of having to pay tens of millions of dollars annually in taxes on my hard-earned money will really drive me crazy – like it must have the Wyly brothers – and I’ll decide to put everything at risk to avoid making those payments. Will I plunge desperately into a legal gray area, spending my final years giving court testimony, guilty of securities fraud, bankrupt, and liable for billions in taxes and penalties?

I hope to – some how, some way – have the opportunity to find out just how I’ll react.

 

A version of this post ran in the San Antonio Express News

 

Please see related post:

How To Evade Taxes Offshore

 

 

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Book Review: Plutocrats – The Rise of the New Global Super-Rich and the Fall of Everyone Else

A recovering banker should engage in conversation about the ongoing income and wealth disparity between the very top and the rest of US society – among the top 10 important economic topics[1] for all Americans.

Chrystia Freeland takes on this topic directly with her useful analysis in Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else.

Freeland’s proximity to plutocrats as a business journalist for the Financial Times and more recently at Thompson Reuters – she works among them but is not of them – allows her to be close enough to recognize their humanity and real strengths, but also to critique them – and the global forces at work that led to their rise.

The Rise of the Plutocrats

Freeland uses anecdotes, academic research, and data to explore the causes and consequences of the rise of an ultra-rich global cohort.  An early 21st Century phenomenon, they command the most impressive concentration of wealth at the top[2] of their respective societies since the late 19th Century Gilded Age in America.

Freeland does not concentrate on the so-called 1%, not even the top 0.1%. The plutocrats of her focus occupy an even higher Olympian perch of wealth than that.[3]

She describes how the plutocrats as a group are the “working rich,” often earning their wealth in their lifetime and typically continuing to work extraordinarily hard long after they’ve “made it,” far beyond any material requirements in their own lifetime.

Driven by ideals and ideas

The plutocrats in Freeland’s description – especially in the US – are people of ideas and ideals, motivated not by avarice but by the thrill of the big idea or the key innovation.  Their status derives from philanthropy or from attending TED Talks, The World Economic Forum at Davos, or the Council on Foreign relations, more than it derives from the traditional accumulation and display of yachts, castles, and polo teams.[4]

Freeland points to two powerful forces which have facilitated the rise of the new plutocrat class.  First, in what she labels the “Marshall Effect,”[5] a widespread increase in societal wealth often leads to an even great concentration of wealth among top performers.  Increased wealth outside of the traditionally richer Western World, for example, has benefitted not only newly developing countries but the capitalists of the older developed countries as well.

Second, in what Freeland labels the “Rosen Effect,”[6] certain newer technologies have allowed for scale-ability in markets and therefore even greater outsized compensation for superstars.  The very top performers in a given area can access a ‘personal market scale’ previously unimaginable in earlier eras.

These twin effects strike me as accurate explanations for the rise of global plutocrats, and Freeland provides myriad anecdotes from her research to flesh out the role of globalization and technology in the creation of a plutocrat class.

Freeland usefully describes the new billionaires of fast-changing Russia, China, India, and Mexico as well.  Their rise, in Freeland’s telling, owes relatively more to ‘rent-seeking’ behavior than to the idea-driven technological breakthroughs of Silicon Valley.  ‘Rent-seeking’ is economist-speak for capturing underserved economic advantages through non-productive and illegitimate activities such as bribing government officials or the indirect capture of regulatory bodies to achieve profitable, private monopolies.

The Russian Oligarchs

Freeland’s prose strengthens when she describes the rise of the Russian oligarchs over the last 20 years, previously profiled in her book Sale of the Century: The Inside Story of the Second Russian Revolution.  The similarities and differences between Russia’s plutocrats and plutocrats in, say, the United States bear exploring.

The Russian oligarchs represent a clear example of extraordinary wealth acquired by a tiny number of men through illegitimate means during the chaotic privatization of the 1990s.  Whatever the oligarchs come to represent for Russians in the future, for now, at least, they indelibly stamp Russian-style capitalism as fundamentally unfair.  Non-plutocratic Russians can’t help but feel the game to acquire wealth has been fundamentally rigged against the meritocratic, but unconnected, capitalist.

Later, Freeland describes quickly but convincingly how China’s financial elites owe much to their close ties to the ruling political elite,[7] the way India’s plutocrats engage in outright bribery with regularity, and why Mexico’s Carlos Slim – the world’s richest man – is the capitalist Mozart of rent-seeking behavior.

The US traditionally celebrates its plutocrats

Traditional US society has long legitimized and celebrated its plutocrats, from JP Morgan a century ago to Bill Gates over the past twenty years.  Even if we could not all create the next ‘killer app,’ mainstream Americans embraced the myth that almost anyone could, with enough pluck and luck, be the next Mark Zuckerberg.

More than any other culture in the modern age, US citizens traditionally believe that the game is not fundamentally rigged against the merely meritocratic, but unconnected capitalist.  Market-oriented capitalism, for all its failings, seems legitimate, to most people.

In the post-Great Recession environment of the United States, characterized by the Occupy Wall Street movement and a newfound distrust of the means of wealth acquisition among the 1% and above, however, I think Americans need to discuss the extent to which society in the United States continues to believe in the system’s legitimacy.

By anthropologically cataloguing the habits and habitats of Russia’s oligarchs, China’s new billionaires, and the US’s tycoons, Freeland suggests the question of legitimacy.

Not a conspiracy in the US, but cognitive capture

In the final two chapters Freeland offers a nuanced description of the way in which the US system, at least with respect to financial regulation, is rigged in favor of the very top.

While financial elites do not typically engage in outright bribery or transfer of wealth from public to private hands in the US, they don’t need to go that far to tilt the rules in their favor.

“Cognitive” or “systemic” capture – the way in which elites in government or regulatory roles adopted the Wall Street perspective as their own perspective – does the work in place of an outright conspiracy.

As Freeland writes:

“[T]he real story isn’t one of individual corruption.  It is…about systemic capture.  The vampire squid theory of the super-elite is entertaining and emotionally satisfying.  It can be fun to imagine the super-elites who went to Wall Street and their Harvard classmates who became economics professors and those who became US senators participating in a grand conspiracy (hatched ideally, at the Porcellian Club) to rip off the middle class.  But the impact of these networks is much less cynical, and much more subtle, though not necessarily of less consequence.”

During the 2008 Credit Crisis, the fact that then-Treasury Secretary Henry Paulson grew up professionally at Goldman Sachs, and personally knew very well all the heads of Wall Street firms as colleagues and competitors, drove the Wall Street-friendly bailouts.

You don’t need to be a conspiracy theorist, or even a believer in any outright corruption, to acknowledge that Paulson’s world view – that what was bad for Wall Street would be bad for Main Street – drove his very-few-strings-attached-just-save-them-at-all-costs generosity to the Too-Big-To-Fail Banks.

I think Freeland’s nuanced explanation of “cognitive capture” explanation goes a long way to explain the 2008 Credit Crisis and our inability to rein in the TBTF banks better than any conspiracy theory.

Some quibbles about the book

Chrystia Freeland’s Plutocrats toggles between several modes of business-writing, not all of which successfully interact.

Less usefully, but perhaps inevitably, Plutocrats offers up tidbits of voyeuristic gossip, as Freeland name-drops her elbow-rubbing and panel-facilitation with the ultra-rich in places such as Davos, Sun Valley, and Aspen.  I cringed a little at reading some of this, but then again, what was I expecting?  I suppose we all need to compare the contradictory clichés of “Stars! They’re just like us,” versus “The rich really are different from you and me.”

Worse, Plutocrats sometimes reads as a traditional, business-school-style “How to,” book, offering anecdotes and bromides from current plutocrats for aspiring plutocrats to emulate.  We learn in Chapter 4, “Responding to Revolution” that emerging markets offer opportunities for faster growth than the traditional Western ‘developed’ countries.  Further, successful wealthy entrepreneurs excel at exploiting opportunities, and the ability to guide their startups through a crucial business-direction “pivot.”

Groan.

A missing explanation for the rise of Plutocrats in the United States

Freeland leaves out an exploration of how changes in the tax code in the United States in the last 30 years – especially with respect to top marginal income tax rates, dividend taxes, capital gains taxes, carried interest taxes, and inheritance taxes – institutionally spur income and wealth inequality, especially at the 1%, level, 0.1% level, and above.[8]

Wealth at the highest level inevitably is wealth derived from equity ownership; that is to say, derived from business earnings rather than salaries.  When Congress dramatically lowers top marginal income, dividend, capital gains and inheritance taxes – as has happened in the US in comparison to 1980 – it increases personal incentives for highly unequal compensation.[9]

Reasonable people, from different places on the political and economic theory spectrum, could debate the relative merits of this trend in tax policy, but I think its absence from Freeland’s discussion of the rise of massive wealth and income disparities, at least in the US, weakens her explanation.

Please see related post: All Bankers Anonymous Book Reviews in one place.

 


[1] I’m still working out what the other Bankers Anonymous topics should be.  So far, in addition to massive income and wealth concentration at the top, I think they are: What to do about Too-Big-To-Fail banks in the US; What should every adult citizen understand about personal finance; What are the consequences of the finance industry attracting such a high proportion of elite talent (rather than technology, education, medicine, engineering, social services, etc); How not to invest; Is poverty in the US an inevitable consequence of relatively free markets, or a failure of societal empathy; and What the hell really happened in 2008?  That’s what I have so far.  I’m open to further suggestions from readers to round out my top 10.

[2] Freeland describes different layers of the plutocratic stratosphere, at times changing levels without prior notice.  Mostly she means to describe the extraordinarily wealthy, although she never defines her ‘cut-off’ level to qualify as a plutocrat.  She cites the existence in 2011 of 84,700 Ultra High New Worth Individuals (UHNWI, as coined by Credit Suisse Bank), in the world – defined as owning $50 million in assets.  One can infer from her descriptions that she means to start somewhere near the low-end of “Mitt Romney wealthy” of say, an estimated $200 million, and go up from there.  At times in Plutocrats, however, she downshifts to describe the habits and rise of the merely wealthy, entrepreneurs or Wall Street employees in the $50-100 million net worth range.

[3] Freeland makes the important point to distinguish gradations within the so-called 1%.  According to Freeland, the top 1% of earners in 2007 reported an average income of $486,395.  These, most decidedly, are not plutocrats.  Further up the mountain, there were 134,888 taxpayers in the top 0.1% in the United States in 2007.  Still too many.  The US has 35,400 UHNWI, boasting $50 million or more in assets.  Getting warmer.  A smaller number, 15,000 Americans, reported average annual incomes of $23.8 million, constituting the top 0.01%.  Only 412 US citizens were billionaires in 2007.  The number of plutocrats seems to be somewhere between 500 and 15,000 in the US.

[4] The three plutocrats I’ve known in my own life, each from the United States, all fit Freeland’s type.  They worked extraordinarily hard at creating wealth in their own lifetime.  Equally striking, they dedicate extraordinary passion and energy toward their educational and medical philanthropies respectively.  They are curious, generous, and personally modest in affect.

[5] 19th Century economist Alfred Marshall noted that while the 1st Industrial Revolution led to a rise of incomes broadly, certain individuals reaped outsized returns from the rising tide.

[6] 20th Century economist Sherwin Rosen pointed to technological gains to explain the concentrated success of superstars in a modern economy.

[7] One side note on China that I found (gruesomely) fascinating:  Freeland cites an article that Chinese authorities executed 14 billionaires between 2003 and 2011, presumably on corruption charges.  I cannot even fathom the kind of changes that would have to come about in US society to see 14 billionaires executed on corruption charges. In a related story, apparently Chinese billionaires keep a much lower public profile than their counterparts in Russia, India, Mexico, or the United States.

[8] Since you asked, here’s some more of my views on the tax code’s favoritism for those at the top.

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Interview Part II: A Member of the 1% on Mitt Romney and the Death of the American Dream

Please click above to listen to full interview.

I continue the conversation with Jim, a member of the 1% who made his career in advertising to the high-end consumer, and who has studied the stratification of America professionally.  We spoke about the problem Mitt Romney will have portraying himself as a “Job Creator,” the disappearance of the American Middle Class, and the implications of that disappearance for the publishing business.

Click here if you would like to listen to Part I of this interview.

Jim: My name is Jim, and I’m a former publisher of a major, national, luxury magazine.

Mike: Thank you for joining Bankers Anonymous this morning.

On Mitt Romney as a “Job Creator”

Mike: I liked what you said in an earlier conversation about the trouble that the nominee Mitt Romney is going to have in arguing that he is a job creator, and I just thought you summarized in a funny way basically what the Democratic argument is going to be against him as a Bain Capital guy, which has gotten some press – after you said it of course.  Do you mind telling me your thoughts on that – the problem of Mitt Romney as a job creator.

Jim: Sure.  I mean, when you’re an executive of any company – certainly I can speak for myself, in the publishing industry – whenever you have a good year, you aren’t looking to ‘create more jobs.’  You’re getting pressure from your investors, or your boss, or your corporation, or your partnership, to actually squeeze more profit out of whatever you’re doing.  And usually the fastest way to do that is to keep your head count down.  So this idea that given the chance to invest and spend you’re going to add a ton of people to your payroll is absurd.  In fact, you’re going to find ways to outsource all of that, to NOT hire that person.  So you don’t have to pay them health insurance, to have it done in Indonesia, or overseas, and to find ways to use technology to save costs.

So this idea of executives dying to create jobs is absolutely absurd, in fact there’s a tremendous amount of pressure from the top to, when you hit a certain profit level, to see if you can hit that same number, with less people.

Mike: Mitt Romney is the ultimate, he will become the symbol this Fall of the ultimate 1%er.  The difference between how he knows how things really work – which is like you just described: Investors need to cut jobs not add jobs – and what he needs to say to get elected…The gap is so wide that as you and I, [who] have been inside that world of the 1%ers…it’s extraordinary to hear what he knows must go on, and that he has done, and what he has to say in order to be elected.  It’s really an amazing gap.

Jim: Yeah, and I wonder sometimes this whole idea of repeating a mantra over and over and over again. He’ll give a speech in Iowa to a predominantly middle class group, and the language he uses over and over again I think you begin to believe your own press releases, and your own dialogue.

 

On the Disappearance of The Middle Class and the American Dream

Mike: One of the thoughts that has occurred to me in the Occupy Wall Street Movement and to some extent the Tea Party – mirroring them on the other side – is that as a country we have this idea of “everybody has a chance to make it” and we’re somewhat of an egalitarian society, and we don’t talk about severe income and wealth stratification as if it exists.  Everybody’s middle-class.  We have this illusion that everyone is middle-class.

And yet what’s changed is in fact these two movements are basically saying “No, there’s a group of elites who are permanent.  And we can’t access them, and they don’t care about us.”

And yet you were talking to elites about this idea long before it became part of the public dialogue.

Jim: I mean, what people don’t know is we have the most stratified income and wealth inequality of any democratic, industrialized country.

In the history of America the whole zeitgeist is “The land of opportunity, for everybody.”  The Horatio Alger myth: “If you work hard you can pull yourself up by the bootstraps and you become part of this top 10%.  I happen to not believe that that is as easy to do as it was before, for a lot of different factors which I can go into, or not go into.

Mike: the myth has gotten more mythical and less real over time.

Jim: very mythical.

Mike: it’s a very helpful myth.  It is a very good story that we tell ourselves.  But the question is: Is there a reality behind the myth?  And that’s unclear.

Jim: You know, you look at what the wealthy have done to drive up the cost of education at the University level.  I mean how many people can afford $35,000 per year minimally to go to these colleges, and end up in that top 1 to 10% unless your parents are already in that top 1 to 10%?  And remember, the number of jobs involving physical labor or simple mechanics and engineering just don’t exist.  That’s what drove the middle class in America.  And as corporations and executives try to cut costs, and thus to pay themselves more money, because most executives are paid on profits, they lay off the people, replace the people with technology, and then outsource everything else they can to another country.

So what do you do when you don’t create those big middle-class jobs that we used to have an America?  We have to educate the workers, and once again the system is rigged.  That unless you have enough money to educate your children, you’re at a serious disadvantage.  So, I think because of globalization and technology [I would say to] the people who continue to say “hey with a little hard work you too can do it,” that was true in almost every part of American history, but because of globalization it just simply is not a reality today.

 

On The Disappearance of the Middle Class As Seen in the Magazine Business

Mike: Yeah.  I want to ask you about the magazine business.  I think what you’re saying is that advertisers are saying, “No, we do care about at least the top 10%” – or at least people with access to credit – which is middle, and upper-middle [class] aspirational buyers.  But they rejected your idea of the stratification, not so much on this illusion of American equality but more just because they actually just believed [Middle-Class consumers] had money to spend, which was only based on credit.

Jim: Yes they believed they had money to spend.  And, yes they did have money to spend, but it wasn’t real money.  It was borrowed money.  And eventually, eventually the banks and credit card companies are no longer willing to lend it to them.  So they had no wealth creation, they had no income gains when adjusted for inflation, and once they didn’t have credit they felt their lifestyle change dramatically. And then they started to look at how unfair the system really was, and how bad the disparity has gotten.

Mike: You were appealing to luxury advertisers.  And your competition to some extent was trying to appeal to the middle-class, mass affluent, people with some disposable income.  Do you have any sense what happened to them?  Was that just an error they made, when we went into recession?   Are those magazines dead?  Hurting? Will come back? Do you know where they stand versus the magazines like yours that appealed only to the truly wealthy.  What’s the relative performance – do you know?

Jim: Yes, there’s definitely some evidence that the magazines that strayed from their original luxury mission – pure luxury with a pure editorial product that appealed to that top 1 to 10% – during the boom times when the aspirational consumer seemed to be spending as much on luxury as the affluent consumer a lot of these magazines chased that aspirational consumer.  Made their articles more accessible, dumbed down the editorial a little bit, and for a short period of time were very successful doing it.  They saw their circulations go up.  They saw their ad pages go up.  And unfortunately when it became clear that that aspirational consumer wasn’t going to be able to buy the products that were featured editorially, and featured by the advertisers in the magazines, a few of them actually went out of business.

You look at a magazine like Gourmet which had been exclusively for the high-end consumer, they became much more accessible: shortened the recipes, talked about value, talked about fast food, TV dinners.  I mean everything that would have been anathema 10, 15, 20 years ago.  And they’re actually out of business.  Another example would be House and Garden magazine which catered to the aspirational consumer – kind of just under the Architectural Digest super-affluent consumer – and they too went out of business because they got lost in the middle.

I think it’s very tough for any brand to target that middle-end consumer – whether it’s J.C.Penney or whomever else because it simply doesn’t exist.  You have two classes: the high-end and the low-end.

Mike: And that doesn’t seem to be changing anytime soon.  If you were to look what is the future of magazines or anybody appealing to the middle-class or the very cost-conscious consumer, it must be very tough times.

Jim: You know the magazines that cater to the Walmart consumer, or the CVS or the Target consumer, whether it’s Cosmopolitan magazine, Good Housekeeping, or Glamour , those magazines are doing very very well.  A lot of the editorial is the “Look for Less” or “How to Get that High-End Look For Less Money,” how to get that high end skin cream for less money.  “What are the products available at the lower end stores that still look like $1 Million Bucks.”  Those magazines are thriving, and at the very top-end magazines like Departures, and Robb Report and Architectural Digest are doing very well also.

 

Want to hear more from Jim?

Part I of the Interview with Jim is here.

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