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

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Just as RenTec treated the management of the MAPS and COLT option accounts as
components of a larger investment strategy, so too did the banks view and treat the individual
option accounts as if they were part of a single large investment pool at each bank rather than
trading specific securities within each option contract. For years, neither RenTec nor the banks
tracked the basket option trading activity on an option-by-option basis, instead pooling the assets
and profits. It was not until 2008, that Deutsche Bank began tracking asset performance on a per
option basis, while Barclays has never tracked performance on a per option basis.
In late 2008, when Deutsche Bank revised the MAPS structure and limited the
transactions to European style options that could be executed only on a fixed date, RenTec made
clear its intention to use the MAPS accounts to maintain its access to cash on a short-term basis.
RenTec did so by scheduling the options it purchased to produce exercise dates periodically
throughout the year. RenTec then exercised those options on the pre-determined dates to obtain
cash payments at regular intervals, and used the cash to support its business operations. This
activity offers further evidence of the extent of the hedge fund’s control over the option trading
activities and profits to meet its financial needs, in contrast to a passive option holder waiting to
see how a capital investment might pan out.
Each of these factors, RenTec’s control over the trading strategy and related activities,
high-volume trading and account turnover, integration of the accounts into a larger investment
strategy, and use of the accounts to produce regular cash payments supporting its business
operations, contradict a depiction of RenTec as a passive option holder awaiting derivative gains.
The option structure functioned instead as a vehicle for RenTec to conduct direct trades with
leverage at much higher levels than available in normal margin accounts, to aggregate and defer
its gains, and to avoid billions of dollars in short-term capital gains taxes. The structure
functioned the same way for George Weiss Associates.
(1) RenTec Utilization of the Basket Option Structure
Because RenTec was the longest and largest user of basket options studied by the
Subcommittee, and entered into options with both Deutsche Bank and Barclays, its use of the
basket option structures will be analyzed first.
(a) Disguising Trading Activity As An Option
Although Deutsche Bank and Barclays established proprietary accounts for the basket
options, purportedly to hold assets that would serve as a hedge to cover the option payoffs, those
accounts actually functioned as if they were RenTec’s own prime brokerage trading accounts,
with RenTec acting in the role of trader rather than option holder. The facts show RenTec had
active and total control over the trading strategy and executions. Barclays, in an internal
memorandum to its auditors, described RenTec as having so much control over the accounts that
Barclays planned to remove from Barclays’ financial statements the shell entity, Palomino Ltd.,
in whose name the accounts and assets were held. Further evidence that the accounts did not
function as true options, or likely even as derivatives, is that RenTec managed the MAPS and
COLT basket option accounts as components of one large investment pool, journaling assets
between option accounts, rolling assets from expired to new option accounts, and shifting parts