ABUSE OF STRUCTURED FINANCIAL PRODUCTS- Misusing Basket Options to Avoid Taxes and Leverage Limits MAJORITY AND MINORITY STAFF REPORT

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D. Analysis of Basket Option Case Studies
A review of the basket option transactions involving Deutsche Bank, Barclays, RenTec,
and George Weiss Associates demonstrates that although those financial products were styled as
options, the terms, conditions, and day-to-day operation of the MAPS and COLT structures, the
locus of control in each case, and who realized the profits from those arrangements undercut the
structures’ status as options and, more generally, as financial derivatives. Instead of options, the
MAPS and COLT accounts functioned as highly leveraged prime brokerage accounts controlled
by the so-called “option holders” who directed the trading and took the profits. Those basket
option holders did not profit from a derivative activity, but directly from the trades they
executed.
Although the option accounts and assets were held in the name of the banks, as
investment advisors to the trading accounts, RenTec and George Weiss had the exclusive right
and discretion to determine what assets were purchased and sold from each account, subject to
basic risk reduction guidelines specified in the investment advisory agreements. The hedge
funds told the Subcommittee that they were passive option buyers making mere “suggestions” or
“recommendations” to assist the banks with their hedging activities, but, in reality, the hedge
funds fully controlled the trading accounts used to determine the option payoffs, executed the
trades made per day, and reaped the profits from those trades. Additionally, by characterizing
the funds lent by the banks as money that the banks were depositing into their own accounts, the
hedge funds used the basket option accounts to obtain leverage at far greater levels than
otherwise allowed under federal law for prime brokerage accounts.
When RenTec took control of the option accounts at Deutsche Bank and Barclays, it
employed a proprietary investment strategy that utilized a computer-based set of algorithms
which was managed by over 90 professionals and required continual adjustments. The trading
strategy used hundreds of thousands of short-term trades per day and produced an average of 26
to 39 million trades per year. In addition, that high-volume trading strategy caused rapid and
significant turnover in the assets in the option accounts. The resulting, ever-changing basket of
securities, controlled by RenTec as the investment advisor, continually modified the portfolio of
assets supposedly supporting the option contracts. The constant changes not only undermine the
notion of an option whose value was linked to a specific set of assets, but also could be seen as
having given rise to realization events for tax purposes, further exposing the option’s role as
window-dressing to disguise direct securities trading by the company purporting to serve as a
mere option holder.
In substance, the structures functioned as prime brokerage accounts with non-recourse
financing that enabled the hedge funds to far exceed federal leverage limits on margin accounts,
conduct non-stop, direct trades using the banks’ trade execution software, and reap the resulting
profits from their own trading activity. In the case of RenTec, the basket option contracts were
not even administered as distinct, independent legal contracts, but were instead woven into an
integrated trading strategy across multiple banks, multiple legal entities, and multiple accounts.
This integrated strategy conducted hundreds of thousands of trades each day, yet RenTec used
the basket option structure to characterize the resulting profits from the option related trades as
long-term gains, saving billions of dollars in taxes over more than a decade.