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

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70 among existing options at the end of a trading day, even though it was allowed under the terms of the management agreement. 368 RenTec’s frequent usage of journaling exposed several features of the new MAPS structure that may not have been immediately clear. First, it demonstrated that, although the new MAPS structure purported to set up separate option subaccounts to separate the assets assigned to each option, journaling allowed RenTec to continue to transfer assets among the options. Second, exercising an option did not require RenTec to give up assets that it wanted to retain; instead, RenTec could use journaling to transfer the assets it wanted to keep from the option being exercised to a different option subaccount, thereby maintaining the underlying assets. Third, each option subaccount was not operated on an independent basis, but was used by RenTec to pursue trading strategies that reached across all of its options. Fourth, journaling allowed RenTec to transfer assets out of a particular option subaccount and then exercise that option to cash out only a percentage of what had been its overall portfolio, just as it had been able to do through the old MAPS structure. RenTec’s active journaling showed that the new MAPS structure did not stop the hedge fund from switching assets among options. To the contrary, it provided additional evidence of RenTec acting as if it were the owner of the option assets, as opposed to a passive option holder. RenTec’s journaling again raised the issue of whether the basket options operated as true options, when their reference assets could be and were so easily altered. (d) Withdrawing Cash at Regular Intervals After Deutsche Bank restructured the MAPS options in 2008, and began using European style options that required option exercise on a specific date, RenTec set up the options it purchased so that it could regularly withdraw cash throughout the year from the option accounts and use that cash to support its business operations. RenTec told the Subcommittee that it wanted to cash out its earnings from its basket option holdings on a regular basis in order to protect its gains from a significant market downturn. 369 RenTec also indicated that it wanted to regularly access the option earnings to cover employee salaries and bonuses, and to make distributions to shareholders in order to keep the Medallion funds at a specified size. 370 Peter Brown, RenTec’s Co-CEO, told the Subcommittee that RenTec explicitly designed its 2008 option purchases to facilitate cash flow from the basket option structures on at least a semiannual basis to run its business operations, including paying salaries. 371 368 Subcommittee interview of Peter Brown, RenTec (6/4/2014). See also 12/15/2008 “Master Investment Advisory Agreement: Execution Copy,” signed by Deutsche Bank London and RenTec, DB-PSI 00000001-047, at 001-002 (explaining that the advisor had discretion to conduct trades for all subaccounts without consulting the client). 369 Subcommittee interview of Peter Brown, RenTec (6/3/2014). 370 Subcommittee interviews of Peter Brown, RenTec (6/3/2014), James Rowen, RenTec (5/20/2014), and Mark Silber, RenTec (6/10/2014). But RenTec’s outside legal counsel to the Subcommittee stated that the cash withdrawals were not used for employee salaries or bonuses, but only for returns to investors. Subcommittee briefing by RenTec outside legal counsel (6/16/2014). 371 Subcommittee interview of Peter Brown, RenTec (6/3/2014).
71 The technique that RenTec used was to stagger the initiation of the options it purchased so that they reached the one-year mark at intervals that enabled RenTec to withdraw funds on a regular basis, either quarterly or semi-annually, past the one-year time frame. 372 When an option matured, RenTec typically cashed out the earnings it needed and rolled the remaining assets from the expired option’s subaccount into the subaccount of an existing or newly initiated option. RenTec referred to this practice as the “Steady State.” 373 RenTec apparently communicated its desire to maintain that steady state to Deutsche Bank, since a 2008 email from Satish Ramakrishna, head of risk for the Global Prime Finance division at Deutsche Bank, indicated that he understood that RenTec “wish[ed] to stagger options once every 3 months.” 374 The fact that that RenTec was able to orchestrate the timing of the options to guarantee itself regular access to the gains from short-term trades underscores how completely it controlled the transactions. In addition, RenTec’s ability to make routine cash withdrawals from the basket option accounts to support its business operations is additional evidence that RenTec acted in the role of an owner of the underlying account assets, rather than as an option holder awaiting final resolution of an option under the control of another party. 372 In addition to allowing cash withdrawals to support its business operations, RenTec described other benefits from using options with staggered start dates. A 2008 email suggested they could be helpful in preventing a large loss during a crisis by ensuring that no two options had the same starting values or maturing dates, preventing cascading effects. See 6/16/2008 email from Satish Ramakrishna of Deutsche Bank to James Rowen of RenTec, “Language,” RT-PSI-00054256; Subcommittee interview of James Rowen, RenTec (5/20/2014). In addition, by rolling assets from exercised options into new options, RenTec could ensure that it took only the funds it needed and avoid large changes in the overall leverage or other parameters of its investment pool at Deutsche Bank and Barclays. See, e.g., 12/8/2011 email exchange among Noor Islam, Jordan Friedman, Devasish Majumdar and others of Barclays, “COLT Option XXIV – GFRM,” BARCLAYS-PSI-013658 (explaining that as long as RenTec put on a new option in the right order, it could exercise three others without violating leverage guidelines). 373 See, e.g., 9/10/2008 email from Peter Brown to James Rowen, “Re-shuffle- Follow-up,” RT-PSI-00068362. 374 6/16/2008 email from Satish Ramakrishna of Deutsche Bank to James Rowen of RenTec, “Language,” RT-PSI- 00054256.
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United States Senate PERMANENT SUBC
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ABUSE OF STRUCTURED FINANCIAL PRODU
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ABUSE OF STRUCTURED FINANCIAL PRODU
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3 client entered into a contract wi
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5 Although the Subcommittee does no
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7 4. Ceding Control. Although the i
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9 II. BACKGROUND This chapter provi
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11 dealers and sets the margin requ
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13 exercising the option. 33 The fi
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15 Since the hedge fund’s gain or
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17 managed account which, in the ca
Page 23 and 24: 19 corporation, and are instead tre
Page 25 and 26: 21 The abusive derivatives used pri
Page 27 and 28: 23 over form doctrine is that the t
Page 29 and 30: 25 securities in the basket. 95 It
Page 31 and 32: 27 Jürgen Fitschen and Anshu Jain
Page 33 and 34: 29 as the consolidation point withi
Page 35 and 36: 31 Financial Officer, Chief Complia
Page 37 and 38: 33 as U.S. persons, among other typ
Page 39 and 40: 35 which was initially designed by
Page 41 and 42: 37 Barclays COLT Options. In 2002,
Page 43 and 44: 39 C. Development of MAPS and COLT
Page 45 and 46: 41 the trades were placed and execu
Page 47 and 48: 43 option accounts. 254 In other wo
Page 49 and 50: 45 Because the investment advisor,
Page 51 and 52: 47 changed the formula used to calc
Page 53 and 54: 49 D. Analysis of Basket Option Cas
Page 55 and 56: 51 of its investment portfolio betw
Page 57 and 58: 53 The financing charges and transa
Page 59 and 60: 55 Removing Palomino, a shell corpo
Page 61 and 62: 57 • RenTec is effectively entitl
Page 63 and 64: 59 Barclays’ SEC filing also incl
Page 65 and 66: 61 accounts established in the name
Page 67 and 68: 63 (ii) Constantly Changing Asset M
Page 69 and 70: 65 selection was at the discretion
Page 71 and 72: 67 Percentage Allocations. Because
Page 73: 69 protection. 357 He explained tha
Page 77 and 78: 73 In addition to moving assets fro
Page 79 and 80: 75 (a) Facilitating Tax Avoidance B
Page 81 and 82: 77 Mr. Haas’ description of the 2
Page 83 and 84: 79 legal opinion from outside couns
Page 85 and 86: 81 available to Renaissance pursuan
Page 87 and 88: 83 as their hedge fund clients - th
Page 89 and 90: 85 continuing with the Option Trans
Page 91 and 92: 87 Within the bank, some executives
Page 93 and 94: 89 Attempts to Develop New Structur
Page 95 and 96: 91 IV. SYSTEMIC CONCERNS In its Gen
Page 97: 93 as publicly traded partnerships,
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ABUSE OF STRUCTURED FINANCIAL PRODUCTS- Misusing Basket Options to Avoid Taxes and Leverage Limits MAJORITY AND MINORITY STAFF REPORT

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