US Economy
US Senate report says top hedge fund dodged $6.8bn in taxes
By Michael Hennigan, Finfacts founder and editor
Jul 22, 2014 - 7:28 AM

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The US Senate Permanent Subcommittee On Investigations said in a report issued Monday that Wall Street banks sold structured products known as basket options that enabled hedge funds to avoid taxes over a decade with Renaissance Technology, one of the biggest, savings as much as $6.8bn in taxes.

The report outlines how Deutsche Bank AG and Barclays Bank PLC, German and British banks, from 1998 to 2013 sold 199 basket options to hedge funds which used them to conduct more than $100bn in trades. The subcommittee focused on options involving two of the largest basket option users, Renaissance Technology Corp. LLC (RenTec) and George Weiss Associates.

The banks and hedge funds used the option structure to open proprietary trading accounts in the names of the banks and create the fiction that the banks owned the account assets, when in fact the hedge funds exercised total control over the assets, executed all the trades, and reaped all the trading profits.

The report says that had the hedge funds made their trades in a normal brokerage account, they would have been subject to a 2-to-1 leverage limit – that is, for every $2 in total holdings in the account, $1 could be borrowed from the broker. But because the option accounts were in the name of the bank, the option structure created the fiction that the bank was transferring its own money into its own proprietary trading accounts instead of lending to its hedge-fund clients.

Using this structure, hedge funds piled on exponentially more debt than leverage limits allow, in one case permitting a leverage ratio of 20-to-1. The banks pretended that the money placed into the accounts were not loans to its customers, even though the hedge funds paid financing fees for use of the money. While the two banks have stopped selling basket options as a way for clients to claim long-term capital gains, they continue to use the structures to avoid federal leverage limits.

Data provided by the participants indicates that basket options produced about $34bn in trading profits for RenTec alone, and more than $1bn in financing and trading fees for the two banks.

"The [basket] options offered by Deutsche Bank which were discussed in the committee's report were at all times fully compliant with applicable laws, regulations and guidance," said Renee Calabro, a Deutsche Bank spokeswoman, told The Wall Street Journal. "Moreover, they were a niche offering to a small number of clients over a discrete period of time which we completely ceased offering in 2010."

" Barclays has been fully compliant with the law…and looks forward to continuing that cooperation at the hearing," said a spokeswoman, Kerrie Cohen.

The subcommittee will hold hearings today.

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