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

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legal opinion from outside counsel that the basket option structure, as revised in 2008, “should”
withstand IRS scrutiny and the restructured options were different from those described in the
2010 IRS GLAM, the bank had not found it necessary to report the transactions to DOJ. 417
Deutsche Bank also indicated that, after the 2010 GLAM was issued, the bank had placed a
moratorium on underwriting any new options, because of reputational concerns for the bank. 418
Deutsche Bank advised the Subcommittee that it was being conservative by staying away from
anything that could be viewed as a listed transaction. 419
In 2012, the Federal Reserve Bank of New York (FRBNY) examiners learned of the
basket options being sold by Deutsche Bank to RenTec. 420 The FRBNY examiners raised
concerns about the tax implications of the basket option transactions and, at the Federal
Reserve’s insistence, Deutsche Bank reported the transactions in connection with the NPA to the
U.S. Attorney’s Office for the Southern District of New York in January 2013, two years after
signing the NPA. 421 The Subcommittee is unaware of what actions, if any, were taken by federal
prosecutors in response to the bank’s disclosure.
(b) Circumventing Leverage Requirements
The hedge funds told the Subcommittee that, rather than tax, a major motivating factor
behind their participation in the basket options was the opportunity to obtain high levels of
leverage, beyond the federal leverage limit of 2:1 normally applicable to brokerage accounts, an
assertion supported by the banks. Deutsche Bank used its MAP accounts to provide a leverage
level of up to 18:1, 422 while Barclays used its COLT accounts to provide a leverage level of up to
20:1. 423 As explained earlier, federal securities laws and financial regulations impose restrictions
on the use of credit to purchase securities. 424 Those restrictions were developed after highly
leveraged securities transactions led to the stock crash of 1929, which imposed losses, not only
on stock speculators, but also on the banks and broker-dealers that had lent them funds to buy
securities, and led to the years of the Great Depression, the country’s worst economic period. 425
To prevent future stock market shocks of a similar nature, Section 7 of the Securities Exchange
Act of 1934 required federal financial regulators to issue “margin rules” to limit the amount of
credit that a broker-dealer or other party may lend to a customer to buy securities, using those
417 6/2/2014 Deutsche Bank briefing to the Subcommittee.
418 Id.
419 1/24/2013 Deutsche Bank briefing to the Subcommittee.
420 8/2/2012 meetings notes, “MAPS Meetings Highlights,” prepared by the Federal Reserve Bank of New York,
FRBNY to PSI (MAPs) 000238. [Sealed Exhibit.]
421 Information provided by the Federal Reserve Bank of New York (6/17 and 18/2014). See also 1/24/2013
Deutsche Bank briefing to the Subcommittee.
422 See, e.g., 12/15/2008 “Master Investment Advisory Agreement: Execution Copy,” signed by Deutsche Bank and
RenTec, DB-PSI 00000001-047, at 021.
423 See, e.g., 12/6/2006 “Amended and Restated Investment Management Agreement,” signed by Barclays and
RenTec, RT-PSI-00134963-5013, at 4983.
424 See, e.g., Section 7 of the Securities Exchange Act of 1934 (codified at 15 U.S.C. § 78a); Regulations T, U, and
X, commonly referred to as the “margin rules,” 12 CFR 220.1(Regulation T); 12 CFR 221.1 (Regulation U); 12
CFR 224.1 (Regulation X).
425 See, e.g., 9/2000 “Margin Requirements, Margin Loans, and Margin Rates: Practice and Principles,” New
England Economic Review, Peter Fortune, at 25.