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

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financing, RenTec’s basket option securities portfolio reached an outstanding notional value of
more than $50 billion. 433
The banks and hedge funds claimed the option accounts could operate entirely outside of
the federal margin rules, even though those accounts operated in the same way as prime
brokerage accounts subject to margin rules. Circumventing margin rules by relabeling a prime
brokerage account as an “option” account is not, however, a legitimate business purpose.
Moreover, bypassing the leverage limits did not displace tax avoidance as a key motivating
factor for the basket option activity, as detailed above. Using the basket option structure as a
way to circumvent federal leverage limits is another example of how the attempt to classify this
transaction as a derivative was used to skirt laws and regulations in addition to tax.
(4) Restructuring the Basket Option Products
The final part of the basket options story involves the response of the banks and hedge
funds to IRS efforts to stop the basket options from being misused to avoid federal taxes.
Deutsche Bank has offered basket options to a shrinking number of clients since around
1998; Barclays has offered them to a single large client, RenTec, since 2002. From 1998 to
2013, Deutsche Bank issued a total of 156 MAPS options to 13 hedge funds, including 36 to
RenTec and 10 to George Weiss. 434 Barclays issued a total of 43 COLT options, all to RenTec.
The hedge funds used those basket options to conduct more than $100 billion in securities
transactions, presumably claiming that virtually all of the trading profits from options that lasted
more than one year could be treated as long-term capital gains subject to the lower tax rate.
In November 2010, the IRS issued the Generic Legal Advice Memorandum (GLAM)
advising that basket options cannot be used to turn short-term trading profits into long-term
capital gains. Both Deutsche Bank and Barclays acknowledged to the Subcommittee that the
banks were aware of the GLAM when it was issued, and that the IRS had determined that the
basket option structure did not function as an option and should not be respected as such for tax
purposes. Despite knowing of the GLAM, Barclays personnel continued issuing the same types
of basket options to RenTec for another two years. Deutsche Bank responded to the GLAM by
suspending its issuance of new basket options, while continuing to administer multiple basket
options already in existence. In 2012 for Deutsche Bank and 2013 for Barclays, the banks issued
revised basket option products, with terms lasting less than one year, so that the structures could
no longer be used to characterize short-term trading profits as long-term capital gains.
For years, Deutsche Bank and Barclays spent a great deal of time, energy, and money to
secure legal advice and opinions reaffirming the basket options as derivatives, in order to
maintain the benefits that such a characterization provided. While the banks have not changed
their position that the basket options are derivatives – a position which benefits the banks as well
433 See 6/25/2008 email exchange between Eamon McCooey and Michael Ginelli of Deutsche Bank, “Tentative:
MAPS Working Group – Wednesday Sessions @ 3PM – June Meetings,” DB-PSI 00025040-41. See also
6/25/2008 email from Michael Ginelli to Eamon McCooey of Deutsche Bank, “Re: Tentative: MAPS Working
Group-Wednesday Sessions @3 PM-JuneMeetings,” DB-PSI 0025040-041; 6/24/2009 memorandum, “Palomino
Limited (“Palomino”),” prepared by Barclays, BARCLAYS-PSI-139757-766, at 764.
434 See undated and untitled Deutsche Bank table prepared for Subcommittee, DB-PSI 00052577.