Brokerage Account

Economically, the trades were similar to a hedge fund holding the securities in a brokerage account, the subcommittee said.

Because the bank was designated as the legal owner of the underlying stocks, the hedge fund didn’t need to recognize a short-term gain when it sold a security. Instead, it would claim a long-term gain when it exercised the option, typically after more than a year.

Under current law, profits from short-term capital gains are taxed at marginal federal rates of as much as 44.4 percent, compared with a 23.8 percent top rate for long-term gains. For some earlier years, the rates were 35 percent and 15 percent.

Illustrating how rapidly the contents of the “baskets” were shuffled, one option reviewed by the committee had more than 129 million underlying trades in a single year, the subcommittee said. Many of Renaissance’s stock investments lasted mere minutes or seconds, it said.

Trade ‘Suggestions’

The hedge funds that used the options sought to portray their involvement in the trading of the underlying portfolio as mere “suggestions” or “recommendations,” the subcommittee said. The panel said in Renaissance’s case, the trades were ordered by the firm’s computers and automatically executed by its banks, a process that took milliseconds.

The panel said Deutsche Bank and Barclays together sold 199 basket options since 1999, including 127 that had the potential to generate long-term capital gains. The options produced $1.1 billion of revenue for the two banks, according to the report.

The 60 options with tenures of more than a year sold by the two banks to Renaissance’s Medallion Fund generated profits of about $34.2 billion, according to the report. Based on the difference between the short-term and long-term rates, the panel estimated the tax saved on those profits at $6.8 billion.

George Weiss

In addition to Renaissance, about a dozen other hedge funds are known to have used basket options sold by Deutsche Bank, according to the report. Among the biggest users was George Weiss Associates, run by the Hartford, Connecticut, philanthropist George A. Weiss, the report said.

In a statement, George Weiss Associates said its basket options, which it stopped using in 2010, were lawful and were used to increase the amount it could borrow. It said it cooperated with the subcommittee’s investigation.

Another user of Deutsche Bank basket options was SAC Capital Advisors LP, the hedge fund run by billionaire Steven A. Cohen, the report said. Once one of the country’s top hedge funds, SAC stopped managing money for outside investors and changed its name to Point72 Asset Management LP this year after pleading guilty to securities fraud in an unrelated matter.

In a statement, Point72 said it didn’t report income earned from its basket options as long-term capital gains.

Renaissance’s use of basket options originated in an effort in the late 1990s to obtain more borrowed money to bet on stocks than it could get through regular brokerage arrangements, the firm said in a statement today.

Risk Limited

The options also were attractive because they limited the risk of loss to the amount paid for each option, Renaissance said.

“No other investment structure of which we are aware provides both high leverage and loss protection,” Renaissance said.

IRS action on the Renaissance matter is “long overdue,” Levin said yesterday. “To say they haven’t moved swiftly is an understatement.”

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