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

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88 member of Mr. Schwartz’s team raised the issue. 473 According to Deutsche Bank, Mr. Schwartz’s team was aware of the GLAM, was informed of the MAPS structure in one of the initial meetings with Deutsche Bank, and did not request any further information, despite the concerns expressed by the IRS. 474 In the spring of 2012, the Federal Reserve Bank of New York began examining the MAPS transactions and instructed Deutsche Bank to alert the U.S. Attorney’s Office for the Southern District of New York, which was overseeing the NPA, about the options. According to Deutsche Bank’s outside legal counsel, in August 2012, Deutsche Bank contacted the U.S. Attorney’s Office and then had followup conversations and meetings with the office in September and December 2012 and February 2013. 475 The Subcommittee is unaware of what actions, if any, were taken by the U.S. Attorney’s Office on the matter. Reaction to the GLAM. Due to the NPA and reputational concerns, after the issuance of the GLAM in 2010, Deutsche Bank determined not to issue any further MAPS options without evaluating the transaction. 476 However, when the GLAM came out, Deutsche Bank had coincidentally nearly finished issuing another option to RenTec and chose to finish that process, completing the option just two days after the GLAM was released. 477 In addition to the new option, at that time, Deutsche Bank had several other outstanding MAPS options with RenTec. 478 In connection with evaluating the GLAM, Deutsche Bank personnel noted that there was a “30d [day] right of termination for DB [Deutsche Bank] embedded in all these contracts” that did not require cause for termination. 479 That provision would have allowed Deutsche Bank to terminate the contracts, using a method that would have required it to terminate one account at a time with a gap of twenty exchange business days between each account. 480 Deutsche Bank declined to terminate the options, however, for several reasons. According to the bank, it declined to terminate the options, because the post-2008 MAPS structure differed from the options described in the GLAM; it had acquired a legal opinion stating the new MAPS complied with the tax law; liquidation of multiple options could have suppressed the option asset values; it was concerned about its client relationship; and it wanted to protect its reputation as a reliable counterparty. 481 However, the bank stopped issuing additional MAPS options pending a reevaluation of the product. 473 6/30/2014 briefing by Deutsche Bank attorneys to the Subcommittee. 474 Id. Officials of the Federal Reserve Bank of New York reviewing the MAPS structure questioned Deutsche Bank about whether the bank had disclosed MAPS to Bart Schwartz’s team. Deutsche Bank advised the examiners that it had informed Mr. Schwartz’s team that Deutsche Bank had on its books a transaction like the one reported in the GLAM, but noted that the conversation was “very short.“ 8/2/2012 meetings notes, “MAPS Meetings Highlights,” prepared by the Federal Reserve Bank of New York, FRBNY to PSI (MAPs) 000238. [Sealed Exhibit.] 475 6/30/2014 briefing by Deutsche Bank attorneys to the Subcommittee. 476 Id. 477 6/27/2014 letter from Deutsche Bank outside counsel to the Subcommittee, PSI-DeutscheBank-24-000001-003. 478 See “Details of Barrier Option Contracts between Renaissance Technologies LLP and Deutsche Bank from 2000- 2013,” document attachment from Deutsche Bank counsel to Subcommittee, DB-PSI 00052583-85. 479 1/6/2010 email from Axel Niemann to Giovanni Favretti of Deutsche Bank, “MAPS,” DB-PSI-00006875. 480 See 12/15/2008 “Master Investment Advisory Agreement: Execution Copy,” signed by Deutsche Bank and RenTec, DB-PSI 00000001-047, at 006. 481 6/27/2014 letter from Deutsche Bank outside counsel to the Subcommittee, PSI-DeutscheBank-24-000001-003.
89 Attempts to Develop New Structures. In 2010 and 2011, Deutsche Bank conducted a review of the MAPS options product. It also worked to develop a new product that would not raise the same tax problems. In October 2011, Deutsche Bank reviewed a product developed under what was called, Project Dawn, involving the writing of call options to Mosel, a Delaware partnership in which RenTec served as the general partner. 482 Under the proposal, each Project Dawn call option would be an outperformance option which, at expiration, would result in payment to the option holder of the difference in the performance of RenTec’s strategy and the performance of the S&P 500. 483 Each option would be a European style option with a 13-month term. 484 These outperformance options were intended to isolate the portion of RenTec’s trading strategy that performed above the S&P 500 and provide a payoff “attributable to [that] portion only of the Strategy.” 485 In November 2011, Deutsche Bank drafted preliminary terms and conditions of another proposed transaction. 486 This transaction involved a call option “outright on [RenTec’s] fund rather than the relative performance version.” 487 An email exchange concerning those proposals at the time indicates that senior Deutsche Bank officials recognized that it was difficult to characterize the MAPS transaction as a true derivative. In a discussion between Satish Ramakrishna, then Deutsche Bank’s risk management head, and Anthony Tuths, a former member of the Tax Structuring and Planning Division at Deutsche Bank, Mr. Ramakrishna raised the concern that under the new proposal, RenTec would not receive back any portion of its premium. 488 Mr. Tuths responded: “That’s the result of having a real option,” in contrast to the previous transactions between the parties. 489 In an interview with the Subcommittee, Mr. Ramakrishna said that RenTec had indicated that it was not interested in Deutsche Bank’s proposed transactions because they did not closely track the performance of the trading recommended by RenTec’s algorithm. 490 Ultimately, RenTec rejected both proposed transactions. 491 Resumption of MAPS in 2012. After RenTec rejected the proposed new structures in 2011, Deutsche Bank considered resuming MAPS. Ultimately, two years after issuance of the GLAM, Deutsche Bank decided to offer MAPS to RenTec on modified terms with a shorter duration that would not risk the misreporting of trading profits as long-term capital gains. 492 As part of the new terms, all post-2012 MAPS options had terms that lasted less than one year 482 10/27/2011 Approval Paper, “Project Dawn,” prepared by Deutsche Bank, DB-PSI 00020110-117, at 110. Mosel had served as the option holder for the MAPS basket options since 2007. 483 Id. 484 Id. 485 Id. at 112. 486 11/29/2011 Indicative Terms and Conditions, “[TBD] c/o Renaissance Technologies,” prepared by Deutsche Bank, DB-PSI 00009727-730, at 728. 487 9/19/2011 email from Greg Bunn to Satish Ramakrishna of Deutsche Bank, “Fund Option,” DB-PSI 00018723. 488 11/13/2011 email from Satish Ramakrishna to Anthony Tuths of Deutsche Bank, “Rentec,” DB-PSI 00112522. 489 Id. 490 Subcommittee interview of Satish Ramakrishna, Deutsche Bank (5/16/2014) and James Rowen, RenTec (5/20/2014). In his interview, Mr. Rowen, Chief Operating Officer of RenTec, echoed Mr. Ramakrishna’s description of why RenTec rejected both proposals. 491 Subcommittee interview of Satish Ramakrishna, Deutsche Bank (5/16/2014) and James Rowen, RenTec (5/20/2014). 492 6/30/2014 briefing by Deutsche Bank attorneys to the Subcommittee.
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United States Senate PERMANENT SUBC
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ABUSE OF STRUCTURED FINANCIAL PRODU
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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
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19 corporation, and are instead tre
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21 The abusive derivatives used pri
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23 over form doctrine is that the t
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25 securities in the basket. 95 It
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27 Jürgen Fitschen and Anshu Jain
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29 as the consolidation point withi
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31 Financial Officer, Chief Complia
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33 as U.S. persons, among other typ
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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 and 74: 69 protection. 357 He explained tha
Page 75 and 76: 71 The technique that RenTec used w
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: 87 Within the bank, some executives
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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