How America’s Richest People Can Access Billions Without Selling Stocks

Photo by Sharon McCutcheon on Unsplash

Many of the country’s wealthiest citizens avoid paying capital gains taxes by borrowing against their stock.

In a tweet shared by Elon Musk on Saturday, 58% of his followers voted for him to sell 10% of Tesla. Musk fulfilled his promise yesterday by exercising roughly 2.15 million of Tesla stock options and selling shares to pay his taxes. He has only ever sold Tesla shares twice before this week, both times for $617 million in pretax proceeds (593 million went to pay taxes on options). Musk’s net worth has risen by over 281 billion dollars (based on Wednesday’s closing price) since Tesla’s last sale.

He can use his Tesla shares as collateral instead of selling shares and paying capital gains taxes when he needs cash, instead of selling shares and borrowing money. Musk can access cash anytime he needs it with these pledged shares, which act as an evergreen credit facility. As of Wednesday, Musk has pledged more than $94 billion worth of Tesla stock, about 36.2% of his stake (excluding options).

Musky is one of 32 billionaires listed as collateral by companies listed on the NYSE or Nasdaq exchanges in company filings for current or possible lines of credit in Forbes 400 ranking of the richest Americans. Among the pledges are Larry Ellison, Walmart heir Jim Walton, and Stephen Schwarzman, the wealthiest person in private equity.

There are currently more than 560 executive officers and directors pledged shares among the companies listed on the NYSE and Nasdaq exchanges. According to Audit Analytics, the value of these pledged shares is $239 billion, and the average contribution has been $427 million. Audit Analytics provides independent audit, regulatory, and disclosure intelligence. Members of the Forbes 400 make up the majority of this group when it comes to pledging — value-wise, anyway. Tesla shares pledged by Musk alone represent 47% of this total. When Musk is removed from the Forbes 400, the remaining 31 members account for 56% of the total. (Equities in Tesla are down nearly 13% since the report was calculated on Nov. 5).

According to current interest rates and tax rates, borrowing against the value of a company’s shares is a much cheaper alternative to selling them and paying taxes on their gains.”

Proxy statements provide a glimpse into the murky world of billionaire borrowing by offering information about companies’ pledge policies. Several of the richest people paid no federal income tax in some years, according to a Leaked IRS Data report published by ProPublica based on leaked IRS data in June. The Senate Democrat Ron Wyden’s wealth tax proposal failed to win political support last month. American’s richest individuals would have been taxed on their unrealized capital gains under that measure.

Details of billionaires’ borrowings are typically kept private. The Securities and Exchange Commission doesn’t collect stock ownership or pledge information from those with fewer than 5% stakes in a company, or who don’t work for the company. 232 of the 400 richest Americans held their fortunes mainly in private companies according to the Forbes 400 list. The company does not report any pledges against diversified baskets of stocks or private assets in its filings. In addition, disclosure requirements do not require individuals to disclose if they have borrowed against their pledged shares or how much. According to Forbes, few billionaires still owe their pledges.

According to proxy advisory firm Institutional Investors Service (ISS), the majority of large companies prohibit pledging: 68.4% ban pledging for all employees and shareholders, 22% bar it but with exceptions, and 3.4% fully permit it. In ISS’ corporate solutions group, which advises companies on corporate governance matters, Jun Frank, an executive director, says that executives or directors pledging a significant portion of their equity raises investor concerns.

Margins calls are one concern: forced sales of pledged shares that can sink a company’s stock price, which could lead to panic-induced market declines. To fund an increasingly extravagant lifestyle, Robert Stiller borrowed against the shares of Green Mountain Coffee Roasters rather than selling them. In May 2012, a short-seller questioned the company’s accounting, which worked fine when its stock price rose. To meet margin calls on his pledged Green Mountain stock, he was forced to sell 5 million shares, worth $126 million, in just one day. To meet margin calls on his pledged Green Mountain stock, he was deposed from his chairmanship.

Buying pledging shares can also create friction between directors and executive officers and external shareholders, says Frank: “If you can retain control over the company but you no longer own those rights, then there will no longer be alignment between your control of the company and your economic interest.”.

A total of 32 billionaires on the Forbes 400 list of America’s wealthiest hold shares of public companies listed on the NYSE or Nasdaq.

There are sometimes conflicts between what company founders want, in this case pledging shares, and what the board and shareholders want, which is to prohibit pledging. One of the biggest shareholders of Oracle, Larry Ellison, was exempt from the rule prohibiting directors and executive officers from pledging company stock. Ellison was the only Oracle director then to have pledged company shares, as he still is now. Since 2007, after the Securities and Exchange Commission mandated it, Ellison, who is worth over $100 billion, has pledged shares.

It follows that Oracle’s new pledge policy had no immediate effect on the pledging activity of its executives and directors-especially that of Ellison. As of 2018, he owns 317 million Oracle shares, worth $28 billion — or about 27% of his stake and 11% of the company’s outstanding stock. From December 2010 to June 2020, Ellison did not sell Oracle stock, a nearly decade-long streak of big purchases. The developer has invested more than $1 billion in Malibu’s glitzy Carbon Beach, including at least 10 properties on Hawaii’s Lanai island and luxurious mansions.

The undisclosed court documents from a shareholder lawsuit revealed Ellison’s penchant for borrowing against his shares, even though Oracle does not disclose the amount. Oracle did not respond to Forbes’ inquiries about its pledging policy or Ellison’s borrowing. (The San Francisco Chronicle’s article suggested that Ellison had outstanding loans of more than $1.2 billion in 2001.)

There are other companies that find ways to exempt billionaire founders from pledge bans. It is possible to pledge shares owned by Kinder Morgan, an oil and gas company, provided they are over the applicable minimum ownership guidelines. For directors, such as billionaire Richard Kinder, the minimum ownership requirement is three times their annual cash stipend. Kinder makes $1k annually, which is helpful. Therefore, the eponymous cofounder has the option of pledge as many shares as he wants.

In a company proxy statement, Kinder, whose fortune is $7.2 billion, is described as pledging 40 million shares in the company that he founded, amounting to 15.6% of his stake in the company, or $679 million, solely to purchase more of the stock. Amounts borrowed against Kinder Morgan’s pledged shares have financed the purchase of 10 million additional shares. According to a Kinder Morgan representative, the company’s pledge rules are consistent with Forbes’ interpretation, but further comment is not possible.

It is not uncommon for companies to declare they are exempt from regulation in advance without writing convincing arguments why. Steven and Mitchell Rales, who both served on Forbes 400, were exempt from Danaher’s pledge ban because their shares had been pledged for decades. Steven Rales has pledged more than 78% of his Danaher equity stake, and Mitchell Rales has pledged nearly 91%. This may be a red flag for margin calls: Steven Rales has pledged nearly 78% of his equity stake. They represent a combined 9.4% stake in Danaher.

George Kaiser, owner of the $10.7 billion oil giant, has the highest ratio of pledged shares to the company’s total outstanding common stock among the Forbes 400 billionaires — another indication of how vulnerable he may be to margin calls. His pledge of nearly 31% of the outstanding stock of BOK Financial Corporation, the holding company of Bank of Korea, is equivalent to 21 million shares. However, Kaiser says he needs to borrow as little as possible from those pledged shares. We have this low cost backup line and haven’t used it in a long time,” he told Forbes by email.

According to Tesla, pledgers and shareholders have a fiduciary relationship when they pledge. GM’s electric carmaker changed its loan-to-value limit on pledged shares in 2018, pointing out that pledging grants executive officers financial flexibility without relying on large cash compensations or selling shares of the company. Keeping the interests of our stockholders and the shareholders of Tesla aligned, and mitigating risk exposure to the company — a stance Tesla has reiterated in its proxy filings before.

According to ISS, Tesla’s corporate governance principles are in direct opposition to this argument. It is unlikely that increasing a shareholding from 15 or 20 percent to 25 or 30 percent would suffice to motivate an executive to act in the interests of shareholders, says the report. One unspoken factor, though, may be that it is significantly less expensive to borrow against a share’s value than to sell it and pay taxes on the gains.”

So how common is it for the ultra-wealthy to pledge assets in order to borrow? Asked about Boston Private’s most high-net-worth clients: those with over $500 million in assets, managing director Jason Cain replied, “Pretty high.” (Cain refused to provide a specific percentage). In Cain’s opinion, this is no different than families borrowing for home purchases and other life purchases. In recent years, clients have become more aware of how debt can be used and have seen the arbitrage opportunity that the rising interest rates provide.

A former Julius Bär banker and founder of the boutique wealth management firm Azura, Ali Jamal noted that 70% of Azura’s clients took on debt to buy more stock during the March 2020 market crash, including pledging shares, artwork, and car collections. Azura has helped 40 percent of its clients leverage their way into special purpose acquisition corporations in the past year. When Jamal talks about the appeal of leveraged investments into SPACs, he says, “you can borrow at 40 basis points, maximum 50 basis points, to have someone identify an investment opportunity, then if it doesn’t work out, you can pull your money out.”

These billionaires are willing to take risks, but the rewards seem to outweigh the risks when they borrow against their shares. There is nothing wrong with it, and it’s hard to call it immoral. Do you think owning growth stocks is immoral? It’s immoral to borrow money?money?money? That’s what tax law professor Edward McCaffrey of the USC Gould School of Law says when describing how the ultra rich borrow money to avoid paying taxes. “So why wouldn’t anyone do that?” he asks.

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