By Gregory Zuckerman
John Paulson won fame after he made one of the greatest financial bets of all time. What comes next? One of the largest-ever personal tax bills.
By April 17, the hedge-fund manager must make federal and state tax payments of about $1 billion, on top of roughly $500 million in taxes he paid late last year, said people close to the firm. That sum is so big it dwarfs the maximum amount the Internal Revenue Service will allow any single taxpayer to pay with a single check. (That's $99,999,999, in case you're wondering.)
Mr. Paulson bet big against subprime mortgages ahead of last decade's financial crisis, earning about $15 billion of profits for his funds and approximately $4 billion for himself. He deferred the bulk of the taxes on these profits, using a tax provision available at the time to hedge-fund managers, said the people close to the firm. Now the bill is due.
Mr. Paulson, 62, isn't exactly struggling to pay the $1.5 billion bill. But he's also not as flush as the heady days of 2008. In fact, after a string of poor results, a bad bet on pharmaceutical stocks and client defections, Mr. Paulson has been selling various investments to cover the bill. He's also in the process of cutting costs and shrinking his firm, including laying off senior traders.
Seven years ago, Mr. Paulson was managing $38 billion and was firmly among Wall Street's elite. Today, Paulson & Co. is managing under $9 billion -- most of it Mr. Paulson's own assets, said the people close to the firm. That's one reason this particular IRS deadline stings.
"It is safe to say it is one of the largest tax bills on earned income in history," said Henry Bregstein, co-global head of the financial services group at the law firm Katten Muchin Rosenman LLP. Billionaires in the technology and private-equity worlds usually achieved the bulk of their wealth through the appreciation of shares, he said, not from earned income. Mr. Paulson declined to be interviewed for this article.
As with most hedge funds, Paulson & Co. enjoys profits from fees amounting to 20% of gains generated for investors. For decades, tax authorities allowed managers of hedge funds to defer receipt of this income. The IRS generally permits businesses to let executives defer compensation because that tends to lower the firms' compensation costs, forcing them to pay higher taxes on profits. That offsets income taxes not immediately paid by the employees.
But in the case of offshore hedge funds that don't pay offsetting U.S. taxes, including some operated by Mr. Paulson, the Treasury lost out. A 2008 tax change mandated by Congress gave Mr. Paulson and other hedge-fund managers until tax day of this year to pay taxes on money accumulated before the law changed. Other hedge-fund managers facing enormous tax bills include Steven Cohen, David Einhorn and Daniel Loeb, the Journal previously reported, citing people familiar with the matter. Mr. Loeb didn't respond to a request for comment. Representatives for Mr. Cohen and Mr. Einhorn declined to comment.
Mr. Paulson has been turning to his Credit Opportunities fund -- one of several funds he operates -- for the money, the people close to the firm said. This fund held about $3.5 billion in assets late last year, the bulk represented by Mr. Paulson's own interests. He pulled about $500 million from the fund late last year to make an initial tax payment and will pay another $1 billion from the fund by April 17, the people said. Mr. Paulson is the largest investor in the fund, which gained 10% last year, one of these people said.
To generate enough cash to let Mr. Paulson withdraw his money, Paulson has been selling investments including shares of Caesars Entertainment Corp., people close to the firm said. Paulson held nearly 28 million shares late last year, making it one of Caesars's largest holders. Paulson sold almost nine million shares in the fourth quarter, according to filings, and sold millions more earlier this year, the people said. The stock has fallen to about $11 from about $13 since November, weakness that some investors attribute at least in part to Paulson's selling.
Paying the tax bill may itself be something of a chore for Mr. Paulson. He could wire the money but may wish to pay by check if he'll earn interest on the money until tax authorities cash the check. If so, the IRS only accepts checks or money orders of less than $100 million. He could submit multiple payments, though tax attorneys note that clients can have problems fitting such huge numbers onto the line on a check.
Reversal of fortune
It has been a remarkable reversal of fortune for Mr. Paulson. Before that trade of a lifetime, he hadn't made much of a mark. A native of the New York borough of Queens, Mr. Paulson grew up in a middle-class family and attended New York University and Harvard Business School. He later worked at Bear Stearns before launching his own firm in 1994, where he produced steady gains as an arbitrager investing in merger deals.
In 2006, he became concerned about rising housing prices and a shift to subprime mortgages. "This is crazy," he told Paolo Pellegrini, one of his analysts, as they pored over housing data at the time, The Wall Street Journal reported.
The pair bought up derivative investments that served as insurance on the riskiest types of mortgages. Most on Wall Street thought the Paulson team was out of its depth, but when the financial crisis hit the derivatives soared in value. Paulson added another $5 billion of profits in 2008 betting directly against financial firms.
By anticipating a financial crisis that caught most bankers, investors and regulators flat-footed, Mr. Paulson became one of Wall Street's hallowed names. Today, he lives in a Manhattan mansion and has given $20 million to New York University, $100 million to the Central Park Conservancy and $400 million to Harvard University's school of engineering.
After Mr. Paulson's 2008 success, new investors, including Donald Trump, flocked. Rather than return to merger investing or turn investors away, Mr. Paulson continued to make unorthodox and big moves, hoping to sustain his winning streak. He turned bullish on U.S. banks and the overall economy -- prematurely.
On the plus side, he shifted to gold well ahead of a surge in prices, leading to another $5 billion of personal gains in 2010. As with his winnings during the financial crisis, Mr. Paulson kept the bulk of his personal profits in his funds, said some of the people close to the firm. By 2011, his firm had become one of the largest hedge funds.
Then he went cold.
Gold-mining stocks were crushed when gold prices weakened, other holdings slumped and some investors exited. At one point that year, Paulson owned more than 14% of Sino-Forest Corp., before fraud accusations against the Chinese forestry company sent shares tumbling, costing Paulson more than $100 million, according to a person familiar with the loss. Canadian regulators later ruled that executives at Sino-Forest, which filed for bankruptcy 2012, had engaged in fraud.
By 2014, Mr. Paulson told clients he had found a new hit: Consolidation in the drug industry would accelerate and boost a number of pharmaceutical companies, some investors said he told them. Late that year, he told one of these investors one of his largest holdings, Valeant Pharmaceuticals International Inc., then trading at around $140 a share, would hit $250, the investor said.
By July 2015, Valeant had soared past his target. But it soon fell, along with other drug holdings, hurt in part by a tweet by Hillary Clinton, then the presumptive Democratic presidential candidate, about "price gouging" in the specialty-drug sector.
In October 2015, with Valeant under $100, Mr. Paulson held a special meeting with more than 40 investors in a conference room in his Midtown Manhattan office, many of whom were unhappy, according to some investors at the event. Speaking in a calm, confident monotone, Mr. Paulson reiterated his support for Valeant and other drug stocks. Many investors gave Mr. Paulson the benefit of the doubt, given his remarkable gains during the financial crisis.
By April 2016, Valeant's stock was under $36. That month, Mr. Paulson sent a letter to investors in his merger fund, Paulson Partners, reviewed by the Journal, promising to change its risk management and not put more than 35% of the fund's assets in a single industry group, among other changes.
Soon, he was adding still more Valeant shares. A person close to his firm said it complied with the new risk guidelines. In the second quarter of 2016, Paulson bought nearly 5.8 million shares of Valeant, taking the firm's ownership to 5.6% of all shares from 3.9% in the previous quarter. Other drug positions also grew. As drug stocks fell further, Mr. Paulson expressed confidence the slump wouldn't last.
Paulson Partners, Mr. Paulson's oldest fund, lost over 10% through the first two months this year after dropping 20% last year and 27% in 2016, according to documents shared with investors. Paulson Partners Enhanced fund, which uses borrowed money to invest in merger deals, is down over 20% this year, fell 35% last year and lost about 49% in 2016.
Compounding the losses, Mr. Paulson tried to protect his pharmaceutical positions by selling short, or betting against, about $1 billion of investments linked to the S&P 500, said some investors. As the market soared, that wager turned into a big loser in 2017 before rebounding a bit this year. Some of the people close to the firm said Mr. Paulson made final decisions on all investments and few colleagues felt comfortable challenging his strategy.
Recently, the firm wasn't particularly active in some areas, such as debt investing, including bond buying, and traders had little to do, said a person close to the firm.
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