‘Game’ Allowed Hedge Funds 10X Leverage, Says Senate

‘Game’ Allowed Hedge Funds 10X Leverage, Says Senate

Barclays Managing Director Martin Malloy, Deutsche Bank Securities Managing Director Satish Ramakrishna and Renaissance Technologies co-CEO and co-president Peter Brown are amongst the witnesses called upon to testify today at a hearing in the Hart Senate Office Building.

At issue are allegations that two global banks and over a dozen hedge funds improperly used “basket options,” a structured financial product, to “dodge billions in taxes and bypass federal leverage limits.”

An investigation by the US Senate Permanent Subcommittee focused on hedge funds Renaissance Technologies and George Weiss Associates, said to be the two largest users of basket options that were sold by Deutsche Bank AG (NYSE:DB) (ETR:DBK) and Barclays Plc (NYSE:BCS) (LON:BARC) between 1998 through 2013 to a number of hedge funds.

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The 93-page report on the investigation seeks to establish how the banks and hedge funds allegedly colluded “in a giant game of ‘let’s pretend’ costing the Treasury billions and bypassing safeguards that protect the economy from excessive bank lending for stock speculation.”

Modus operandi

The two banks sold 199 basket options to various hedge funds which used them to conduct trades worth over $ 100 billion.

The basket options were placed in proprietary trading accounts held in the name of the banks, but which were operated entirely by the hedge funds. By exercising the basket options after the expiry of a period of one year, the hedge funds were able to claim the trading profits generated on these accounts as ‘long-term capital gains,’ which qualify for a lower income tax rate compared to normal short-term trading profits.

“Renaissance Technologies claimed it could treat the trading profits as long-term gains, even though it executed an average of 26 to 39 million trades per year and held many positions for mere seconds,” reveals a press release out of the office of Carl Levin, US Senator Michigan.

According to the subcommittee’s estimates, the hedge fund avoided taxes amounting over $6 billion during the period from 2000 through 2013. The chart below, sourced from the report, gives the basis of estimation of this figure:

To enable the above mechanism, according to the report, Deutsche Bank AG (NYSE:DB) (ETR:DBK) and Barclays Plc (NYSE:BCS) (LON:BARC) routinely hired the option holder – the hedge funds – as the investment adviser for the accounts and ceded control of their accounts to the option holder, which traded the account for its own benefit.


The basket option mechanism offered by Deutsche Bank AG (NYSE:DB) (ETR:DBK) was styled MAPS (Managed Account Product Structure) and that by Barclays Plc (NYSE:BCS) (LON:BARC) as COLT.

map-and-colt-sales Hedge funds

Here is how these products worked.

maps-diag Hedge funds

colt-diag Hedge funds

Hedge funds obtained as much as 10 times the allowable leverage

The complex structuring of the basket options mechanism also enabled hedge funds to get around federal leverage regulations that placed a lowly limit of 2-to-1 leverage on a normal brokerage account. But this was no normal brokerage account – the basket option mechanism, which purportedly stood in the name of the bank, allowed these hedge funds is to pile on “exponentially more debt than leveraged 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 is paid financing fees for use of the money,” alleges the press release.

What the bank and hedge fund say

According to Deutsche Bank AG (NYSE:DB) (ETR:DBK), the option products it offered were “at all times fully compliant with applicable laws, regulations and guidance.”

“We believe that the tax treatment for the option transactions being reviewed by the (panel) is appropriate under current law. These options provide Renaissance with substantial business benefits,” said a Renaissance spokesman.

Congressional Hearing On Hedge Funds Tax Evasion now underway live feed (H/T ZeroHedge) and documents below








    Chief Administrative Officer, Americas, Barclays
    Chief Executive Officer, Barclays Capital Inc.
    New York, NY

    Download Testimony (87.3 KB)


    President and Managing Director, Deutsche Bank Securities Inc.
    Co-Head of Global Prime Finance
    New York, NY

    Download Testimony (131.5 KB)


    Co-Chief Executive Officer and Co-President
    Renaissance Technologies LLC
    East Setauket, NY

    Download Testimony (3.36 MB)

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