Stock Portfolio
As described in the memo and by people with knowledge of the matter, the transaction worked as follows: Barclays bought a portfolio of stocks and other instruments that fund managers at Renaissance wanted to trade. The bank hired the fund managers to oversee the portfolio, paying them a nominal fee.
Then Medallion bought an option with a term of two years, whose value was linked to the worth of the portfolio. Renaissance had full discretion to trade the securities in the portfolio.
Medallion could claim it owned just one asset -- the option -- which it held for more than a year, allowing any gain to be treated as “long-term” when its investors reported the income on their personal tax returns.
“The profits are just being transmuted, through the alchemy of derivatives, to a preferenced return,” said Urban Institute’s Rosenthal.
IRS Memo
Although the memo describes a specific basket option contract provided by Barclays, Renaissance entered into similar contracts with Deutsche Bank AG, said the people with knowledge of the matter. After the IRS published the 2010 memo criticizing the technique, Deutsche Bank stopped offering Renaissance versions of the option trades that had tax-reducing benefits, two of the people said.
Deutsche Bank spokeswoman Renee Calabro declined to comment.
Some of the people with knowledge of the option trades said they had at least one purpose unrelated to tax savings: they allowed Medallion to borrow more money from its banks than it otherwise could.
Robert J. Frey, who worked at Renaissance from 1992 to 2004, said he has heard about the dispute from current employees. They told him the firm hasn’t done anything wrong.