By Douwe Miedema
WASHINGTON, July 21 (Reuters) - The head of a powerful U.S.Senate panel has accused Deutsche Bank AG andBarclays Plc of helping hedge funds avoid taxes,calling for tougher action from the authorities.
The banks sold complex option products to RenaissanceTechnology Corp that saved it and other hedge fundsbillions of dollars in taxes, Democratic Senator Carl Levin, whoheads the U.S. Senate Permanent Subcommittee on Investigations,said on Monday.
"Ordinary Americans had to shoulder a tax burden of billionsof dollars, a burden that was shrugged off by these hedgefunds," Levin told a news conference.
"And those same Americans will pay the price as the excessrisk from massive over leveraging once again destabilizes oureconomy as it has in the past."
Levin's committee presented the findings of a year-longprobe into so-called basket options, which Levin said can bemisused to lower taxes, and plans to grill representatives fromthe banks and Renaissance in a public hearing on Tuesday.
The hearing by one of the Senate's most high-profile panelscomes less than a month after New York's attorney general fileda fraud lawsuit against Barclays, accusing the British bank ofgiving an unfair edge to high-frequency traders.
And Deutsche Bank, facing an array of investigations intothe conduct of its staff that includes the Libor benchmark ratescandal, has set aside another 1.8 billion euros ($2.43 billion)to pay fines after already paying more than 5 billion euros overthe past two years.
But Levin stopped short of accusing either bank or the hedgefunds of doing something illegal, and Deutsche said the optionproducts it offered were "at all times fully compliant withapplicable laws, regulations and guidance."
A Renaissance spokesman said: "We believe that the taxtreatment for the option transactions being reviewed by the(panel) is appropriate under current law. These options provideRenaissance with substantial business benefits."
Barclays also said it had been fully compliant with the law,and that it had cooperated with the committee.
FICTIONAL OPTIONS
The two banks enabled at least 13 hedge funds to conductover $100 billion in securities trades, the panel said. Theprofits were taxed as long-term capital gains, even though thepositions were often held for only seconds. In the case ofRenaissance alone, the fund paid an estimated $6.8 billion lessin taxes because short-term trading profits are taxed at a muchhigher rate, the report said.
The products offered by the banks were styled as options inan account that was nominally held by the bank, but was in factcontrolled by the hedge funds, which bought and sold the assets,and profited from the trading, the report said.
The hedge fund then paid the lower tax rate on long-termcapital gains, arguing that profits came from exercising theoption, rather than from the underlying trades. But the optionswere fictional, the panel found.
The U.S. tax authority, the Internal Revenue Service, saidin 2010 that basket options do not function like an option andshould not be treated as such, but that opinion has no status asan official rule, and the IRS has not pressed any cases.
Renaissance has been debating the issue with the IRS for sixyears, the spokesman said. The two banks have now stoppedoffering the products, the panel said.
Levin's panel issued a number of recommendations from thereport that were largely targeted at the IRS, urging it to audithedge funds that used basket options, and calling for a changein legislation to make it easier to look at large partnershipssuch as hedge funds, which go largely unaudited.
"The IRS hasn't completed their review. It's about time theydo. It's long overdue," Levin said.
Another problem with basket options was that they enabledfunds to take on more debt than otherwise possible, potentiallyposing a risk to the overall financial system, the report said.
Renaissance used basket options to borrow 20 times as muchmoney as was put in the accounts. The fund had been unable toachieve such so-called leverage levels in other settings underfederal rules, the report added.
($1 = 0.7397 Euro) (Reporting by Douwe Miedema. Editing by Andre Grenon)
Barclays (BARC)