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

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Removing Palomino, a shell corporation, from the balance sheet – an action called
deconsolidation – in in effect removed Palomino’s assets from the balance sheet as well. When
consulting with its auditor over making the change, Barclays justified taking that action by
explaining how RenTec controlled Palomino and Palomino’s accounts and received all of the
significant rewards and risks associated with the account activity, as explained below.
Barclays removed Palomino from its balance sheet for accounting purposes in 2009, as
part of a larger series of changes to its overall corporate structure. 301 Its action meant that the
accounts and assets held in Palomino’s name were no longer considered part of Barclays and no
longer included in Barclays’ financial statements, reducing Barclays’ total assets by more than
$4 billion. 302 This accounting approach mirrored the accounting treatment that the bank already
provided for standard prime brokerage accounts holding client assets; it also mirrored how Prime
Services, the Barclays division that dealt directly with RenTec, already handled the accounting
for the majority of its client accounts. 303
Barclays had begun considering the removal of the Palomino assets from its balance
sheet in 2008, noting in an early analysis: “Generally, Palomino and Barclays do not share in
any gains in the value of the account, because any such gains are paid away to Badger under the
Options.” 304 Badger was the shell entity established by RenTec to act as the official option
holder on behalf of the hedge fund.
In June 2009, to obtain approval for the proposed deconsolidation from its auditor,
PricewaterhouseCoopers (PWC), Barclays implemented several PWC recommendations to
clarify that Palomino was controlled by and operated for the benefit of RenTec. First, Barclays
amended the Palomino Articles of Association to “restrict the activities of Palomino to those it is
currently engaged in under the COLT transaction,” 305 including to continue to work with
RenTec. Secondly, Barclays entered into a side letter with RenTec in which its subsidiary,
BBPLC, the sole owner of Palomino, “covenant[ed] that it shall not make any amendments or
modifications to the Memorandum and Articles of Association of Palomino without … the prior
written consent thereto of Renaissance.” 306 According to Barclays and PWC, after taking those
actions, Palomino could be considered a special purpose entity “set up for the benefit of
Renaissance.” 307 In a contemporaneous email, PWC also observed that the risk to Barclays from
the Palomino option accounts was “remote,” citing several “critical features of the agreement”
related to the basket option accounts, including “trading parameters, the trigger points at which
Barclays can control a wind-down, the ability to adjust the call premium such that if losses are
301 5/2011 email exchange among Marty Malloy, John Feraca, Lansford Dyer, and others of Barclays, “Palomino
deconsolidates from Barclays Group,” BARCLAYS-PSI-036091-102.
302 See 6/24/2009 Barclays memorandum from “SCM” to “PwC,” meaning PricewaterhouseCoopers, Barclay’s
auditor, “Palomino Limited (‘Palomino’),” BARCLAYS-PSI-139757-766, at 764.
303 Id. at 765.
304 7/2/2008 email from Rafal Medak, Barclays, to Nidhi Bajaj, PricewaterhouseCoopers,“Palomino’s PB accounts,”
BARCLAYS-PSI-632060-063, at 061.
305 6/19/2009 email from Simon Constant to Paolo Mammola of Barclays, “Project COLT – articles amendment,”
BARCLAYS-PSI-577747.
306 6/26/2009 letter from RenTec to Barclays, New York Branch, “Palomino Limited,” signed by Mark Silber on
behalf of both RenTec and Badger Holdings, RT-PSI-00236651-655, at 652.
307 5/29/2009 email exchange among Abhinav Shah, Rob Konowalchuk, Louise McSweeney, and others of
Barclays, “Palamino to PwC 20/5/09,” BARCLAYS-PSI-328074-077.