Bruce Rauner and the Cayman Islands

On Friday, the Chicago Sun-Times ran an exposé on Illinois gubernatorial hopeful Bruce Rauner’s finances. Specifically, the Sun-Times informed its readership (and the world at large) that Rauner has at least a portion of his fortune in the Cayman Islands, a tax haven country.

To which I reply, Duh.

Seriously, I’m not entirely sure how this could be more of a non-story. But to explain why it’s a non-story, I should probably unpack what the Sun-Times says, what it doesn’t say, and what it probably should say. 

Let’s move into Explainer format:

Who is Bruce Rauner, anyway?

Great question. In spite of being an Illinois resident, today, listening to NPR discuss this faux-controversy, was the first time his name registered for me. For our purposes, here are the relevant details:

The Sun-Times says he “channeled” part of his fortune to the Cayman Islands. That sure sounds bad. But what does it mean?

This is probably the weakest part of the Sun-Times‘s story. Honestly, it doesn’t say. It could mean a number of things, from the terribly shady to the completely innocuous. On the one hand, “channelling” part of his fortune to the Cayman Islands could mean that he’s got a secret, untouchable account there, and is hiding his money from the IRS, from his spouse, or from creditors. 

On the other hand, it could mean that he purchased a share of stock of a company (say, Yahoo!) that has a Cayman subsidiary that holds some of its money.

Rauner’s Cayman money probably doesn’t fall at either pole. I assume he’s a smart man, smart enough not to run for important public office if he has money hidden from the government offshore. And an equity investment in a corporation with a Cayman subsidiary is probably too attenuated to justify writing that a candidate is channeling money through the Caymans.

His Cayman money is, more likely than not (and Sun-Times, though you hint at it, you really could have done a better job explaining this) the result of investing in private equity funds.

And, since he worked in private equity, it almost goes without saying that he has exposure to private equity.

But isn’t the private equity fund doing something shady if it channels money through the Caymans?

Probably not. I don’t know GTCR’s exact structure, but many private equity and hedge fund are organized in a master-feeder structure. In its most basic form, a master-feeder fund looks like this:

Slide1If that’s the structure, presumably Rauner’s investment is in the onshore feeder, a partnership for tax purposes. The offshore feeder is treated as a corporation and reserved for foreign investors and tax exempts, who would rather invest in a foreign corporation for tax, regulatory, or other purposes. At the end of the day, all of the money that’s in the offshore feeder and all of the money that’s in the onshore feeder gets passed to the master fund, which is often organized as a Cayman Islands partnership.[fn1] For tax purposes, the location of its organization is totally irrelevant; partnership tax principles say, in essence, that you ignore the entity for tax purposes.

That is, even though Rauner is (I assume) invested in a domestic partnership, which is invested in a foreign partnership, which is invested in various companies, the tax law sees Rauner as owning directly his share of the master fund’s investments. He’ll pay taxes on the master fund’s income, and he’ll pay those taxes whether or not the master fund or the feeder fund distribute any money to him.

So why is the master fund organized in the Caymans rather than the US?

Great question, and I really have no idea. I assume it’s partly inertia, though: funds have been organized like this for a long time, and they’ll continue to be organized like this for a long time unless there’s some sort of legal change.

Do the Cayman Islands save Rauner any money on his taxes?

No. At least, no, assuming I’m right about how he has money in the Caymans. He’ll pay the exact same amount in taxes as he would if the master fund were a US partnership.

Do Cayman Island investments require a minimum $500,000 or $1 million deposit?

See, I don’t even know what the Sun-Times means here, except that it’s probably mis-paraphrasing Professor Kaplan.

Basically, most hedge funds require a minimum investment of $1 million (or $2 million, or $10 million, depending on the fund) if someone wants to buy in.[fn2] Private equity funds generally have “committed capital” requirements, often (though undoubtedly not always) in the $1 to $10 million range. In a private equity fund, you don’t have to come up with the money all at once, but you have to be ready to pony up when the fund requests the money (which it does generally as it finds companies to buy).

So should I vote for Rauner?

No idea. I haven’t looked at his platforms, and I know almost nothing about him. I certainly don’t mean this blog post as an endorsement; still, I firmly believe that, if you’re going to vote against somebody, you should vote against them for a substantive reason. 

And waving your hands and saying “Cayman Islands” isn’t a substantive reason, unless and until you’re ready to demonstrate that the Cayman Islands money is somehow nefarious, rather than standard fare.[fn3]

[fn1] For the sake of complete honesty, I’m kind of fudging my diagram a little bit. The master fund is probably a Cayman Islands limited company (that is, “Ltd.” rather than “LP”) that has elected to be treated as a partnership for US tax purposes.

[fn2] It’s kind of like mutual funds, except they usually have a minimum investment of $500 or $2,000, or something more in that range. Which, come to think of, means it’s not really a lot like mutual funds.

[fn3] I mean, to the extent a private equity fund can be standard fare. Sure, it’s for the very wealthy, it’s rarified, but it’s hard to see something nefarious about a structure that is tremendously common in the industry, and is entirely well-known by the government, including all of the regulatory agencies.





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