S. Hrg. 113–422 

ABUSE OF STRUCTURED FINANCIAL PRODUCTS: 

MISUSING BASKET OPTIONS TO AVOID 

TAXES AND LEVERAGE LIMITS 

HEARING 

BEFORE THE

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS 

OF THE

COMMITTEE ON 

HOMELAND SECURITY AND 

GOVERNMENTAL AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

SECOND SESSION 

JULY 22, 2014 

Available via the World Wide Web: http://www.fdsys.gov 

Printed for the use of the 

Committee on Homeland Security and Governmental Affairs 

( 
ABUSE OF STRUCTURED FINANCIAL PRODUCTS: MISUSING BASKET OPTIONS 

TO AVOID TAXES AND LEVERAGE LIMITS 
U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

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89–882 PDF 2014

S. Hrg. 113–422 

ABUSE OF STRUCTURED FINANCIAL PRODUCTS: 

MISUSING BASKET OPTIONS TO AVOID 

TAXES AND LEVERAGE LIMITS 

HEARING 

BEFORE THE

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS 

OF THE

COMMITTEE ON 

HOMELAND SECURITY AND 

GOVERNMENTAL AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

SECOND SESSION 

JULY 22, 2014 

Available via the World Wide Web: http://www.fdsys.gov 

Printed for the use of the 

Committee on Homeland Security and Governmental Affairs 

( 
(II) 

COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS 

THOMAS R. CARPER, Delaware Chairman 

CARL LEVIN, Michigan 

MARK L. PRYOR, Arkansas 

MARY L. LANDRIEU, Louisiana 

CLAIRE MCCASKILL, Missouri 

JON TESTER, Montana 

MARK BEGICH, Alaska 

TAMMY BALDWIN, Wisconsin 

HEIDI HEITKAMP, North Dakota 

TOM COBURN, Oklahoma 

JOHN MCCAIN, Arizona 

RON JOHNSON, Wisconsin 

ROB PORTMAN, Ohio 

RAND PAUL, Kentucky 

MICHAEL B. ENZI, Wyoming 

KELLY AYOTTE, New Hampshire 

GABRIELLE A. BATKIN, Staff Director 

KEITH B. ASHDOWN, Minority Staff Director 

LAURA W. KILBRIDE, Chief Clerk 

LAUREN M. CORCORAN, Hearing Clerk 

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS 

CARL LEVIN, Michigan Chairman 

MARK L. PRYOR, Arkansas 

MARY L. LANDRIEU, Louisiana 

CLAIRE MCCASKILL, Missouri 

JON TESTER, Montana 

TAMMY BALDWIN, Wisconsin 

HEIDI HEITKAMP, North Dakota 

JOHN MCCAIN, Arizona 

RON JOHNSON, Wisconsin 

ROB PORTMAN, Ohio 

RAND PAUL, Kentucky 

KELLY AYOTTE, New Hampshire 

ELISE J. BEAN, Staff Director and Chief Counsel 

ROBERT L. ROACH, Counsel and Chief Investigator 

DAVID H. KATZ, Counsel 

AHMAD SARSOUR, Detailee 

HENRY J. KERNER, Minority Staff Director and Chief Counsel 

MICHAEL LUEPTOW, Counsel to the Minority 

BRAD M. PATOUT, Senior Advisor to the Minority 

MARY D. ROBERTSON, Chief Clerk 
(III) 

C O N T E N T S 

Opening statements: Page 

Senator Levin .................................................................................................... 1 

Senator McCain ................................................................................................ 5 

Senator Johnson ............................................................................................... 44 

Prepared statements: 

Senator Levin .................................................................................................... 77 

Senator McCain ................................................................................................ 81 

WITNESSES 

TUESDAY, JULY 22, 2014 

Steven M. Rosenthal, Senior Fellow, Urban-Brookings Tax Policy Center, 

Washington, DC ................................................................................................... 7 

James R. White, Director, Tax Issues, U.S. Government Accountability Office, 

Washington, DC ................................................................................................... 9 

Martin Malloy, Managing Director, Barclays, London, England ......................... 24 

Satish Ramakrishna, Managing Director, Deutsche Bank Securities Inc., 

Global Head of Risk and Pricing for Global Prime Finance, New York, 

New York .............................................................................................................. 25 

Mark Silber, Executive Vice President, Chief Financial Officer, Chief Compliance Officer, and Chief Legal Officer, Renaissance Technologies LLC, New 

York, New York; accompanied by Jonathan Mayers, Counsel, Renaissance 

Technologies LLC, New York, New York ........................................................... 27 

Gerard LaRocca, Chief Administrative Officer, Americas, Barclays, Chief Executive Officer, Barclays Capital Inc., New York, New York ........................... 54 

M. Barry Bausano, President and Managing Director, Deutsche Bank Securities Inc., Co-Head of Global Prime Finance, New York, New York ................. 55 

Peter F. Brown, Co-Chief Executive Officer, and Co-President, Renaissance 

Technologies LLC, East Setauket, New York .................................................... 57 

ALPHABETICAL LIST OF WITNESSES

Bausano, M. Barry: 

Testimony .......................................................................................................... 55 

Prepared statement .......................................................................................... 118 

Brown, Peter F.: 

Testimony .......................................................................................................... 57 

Prepared statement .......................................................................................... 129 

LaRocca, Gerard: 

Testimony .......................................................................................................... 54 

Prepared statement .......................................................................................... 114 

Malloy, Martin: 

Testimony .......................................................................................................... 24 

Prepared statement .......................................................................................... 111 

Mayers, Jonathan: 

Testimony .......................................................................................................... 27 

Prepared statement .......................................................................................... 129 

Ramakrishna, Satish: 

Testimony .......................................................................................................... 25 

Prepared statement .......................................................................................... 118 

Rosenthal, Steven M.: 

Testimony .......................................................................................................... 7 

Prepared statement .......................................................................................... 83 

Silber, Mark: 

Testimony .......................................................................................................... 27 

Prepared statement .......................................................................................... 129 
Page

IV 

White, James R.: 

Testimony .......................................................................................................... 9 

Prepared statement .......................................................................................... 91 

APPENDIX 

Report by the Permanent Subcommittee on Investigations Majority and Minority Staff entitled, ‘‘Abuse of Structured Financial Products: Misusing 

Basket Options to Avoid Taxes and Leverage Limits,’’ July 22, 2014. ............ 135 

EXHIBIT LIST 

1. a. The Fiction of Independence, charts prepared by the Permanent Subcommittee on Investigations. ...................................................................... 250 

b. Rentec Control of Palomino, excerpts taken from 6/24/2009 Barclays 

Memorandum to PwC. [BARCLAYS-PSI-139757-766, at 763-764, Exhibit #53, below.] ......................................................................................... 252 

c. Medallion Master Funds [RT-PSI-00363694] ............................................ 253 

d. Signatories to Franconia-Rentec Investment Advisory Agreement [RTPSI-00396355, Exhibit #6, below.] ............................................................. 254 

Signatories to Mosel Limited Partnership Agreement [RT-PSI00396411-412, Exhibit #8, below.] ............................................................ 255 

Signatories to Bass-Rentec Investment Advisory Agreement [RT-PSI00396321, Exhibit #35, below.] .................................................................. 256 

Signatories to Badger Holdings Ltd. Partnership Agreement [RT-PSI00396313-314, Exhibit #4, below.] ............................................................ 257 

2. Internal Revenue Service Generic Legal Advice Memorandum (GLAM), 

released November 12, 2010, re: Hedge Fund Basket Option Contracts 

(The contract does not function like an option, and should not be treated 

as such.). [BARCLAYS-PSI-748148-158] ........................................................ 258 

Documents Related to Renaissance Technologies (RenTec): 

3. RenTec email, dated September 2008, re: Re-shuffle- Follow-up (I confirmed that there is no prohibition against end-of-day transfers in our 

new MAPS documentation. We may reshuffle the constituents of the underlying options at the end of the day, at the current closing price. *** 

Mark Silber was going [to] discuss with you the ability to optimize the 

end of day re-shuffle process in order to keep the number of position 

re-shuffles to a manageable amount and below the radar of DB.). [RTPSI-00068362] ................................................................................................... 269 

4. RenTec/Deutsche Bank email, dated November 2008, re: DB counteroffer 

(Daniel Koranyi wrote: . . . Colin points out that the Optimal Execution 

paper supports our contention that any portfolio they would find themselves having to liquidate would be low-risk, and could be liquidated 

slowly if required. The portfolio would be well diversified, market-neutral, 

and with low liquidity imbalance . . .). [RT-PSI-00368695-697] ................... 270 

5. RenTec email, dated August 2011, re: US portfolio shift - overrides? 

(Management has decided to shift some portfolio from the Palomino lossprotected managed account to the Deutsche (DBAG) loss-protected managed accounts. The total amount of portfolio to shift, for now, is USD 

4e9.). [RT-PSI-00364418] .................................................................................. 273 

Documents Related to MAPS Transactions: 

6. Investment Advisory Agreement between Renaissance Technologies Corp. 

and Franconia Equities Ltd., dated March 30, 2000. (Advisor is authorized, without further approval by or notice to the Client, to make all 

investment decisions concerning the Account . . .). [RT-PSI-00396351-355] .. 274 

7. Barrier Option Transaction confirmation, dated March 14, 2012, between 

Deutsche Bank AG, London Branch and Franconia Equities Ltd. (The 

Buyer has made an independent judgment of the experience and expertise 

of the Investment Advisor. *** Other than as provided above, Buyer agrees 

that it shall not contact directly the Investment Advisor regarding the 

terms or subject matter of this Transaction.). [DB-PSI 00123196-208] ........ 279 
Page

V 

8. Mosel Equities L.P., Limited Partnership Agreement, dated October 26, 

2007. ([T]he General Partner shall have complete and exclusive responsibility for managing and administering the affairs of the Partnership, 

and shall have the power and authority to do all things necessary or 

proper to carry out its duties hereunder.). [RT-PSI-00396394-413] .............. 292 

9. Amended & Restated Investment Advisory Agreement, dated November 

16, 2007, between Deutsche Bank AG London and Renaissance Technologies LLC. [RT-PSI-00000914-931] ............................................................ 312 

10. RenTec/Deutsche Bank email, dated December 2007, re: Buy Back Request (We’ve been unable to maintain a borrow to fully cover your following short position. Please confirm your willingness to buy this position 

back as we’re exposed to being bought in (any cost/short sale fines will 

be passed on)[.] Due to the illiquidity of this stock at present I must 

also ask you not to short any more.). [RT-PSI-00004630-632] ....................... 330 

11. RenTec/Deutsche Bank email, dated February 2008, re: UK MAPS (However, what you describe faced some general objection where DB could 

be argued to have been effectively fronting for an unregulated fund . . . 

Not thought a good idea then and following the Soc. Gen, fiasco i imagine 

there would be even more twitching now.). [RT-PSI-00062957-959] ............. 333 

12. Deutsche Bank Maps: New Process/Procedures As of May 15, 2008 (Portfolio rebalancing due to Option Exercise *** Rentec Fund Operations 

group will reallocate the positions in the sub-account underlying the exercised option to the remaining options based on their relative cash settlement amounts . . .). [RT-PSI-00002319-322] ................................................... 336 

13. RenTec/Deutsche Bank email, dated June 2008, re: Language (Staggering 

options: You wish to stagger options once every 3 months. My suggestion 

is that you stagger options by NAV also, so there is at least 6 points 

in NAV difference between different options.). [RT-PSI-00054256-257] ........ 340 

14. Deutsche Bank email, dated June 2008, re: What we need coded on 

PEAS apart from guidelines (The anticipated leverage amt is not randomly chosen. It is chosen so that the funding cost (which we will call 

the ‘‘optionality value’’) on the long side . . . is between 20%-25% of the 

initial premium (100 in the above).). [DB-PSI 00010767-769] ...................... 342 

15. Managed Account Products, Option Account Profile, 94150051-DBAG 

MAPS Rentech Mosel Equities LP Option Account 1, As of June 24, 

2008. [DB-PSI 00001599] ................................................................................. 345 

16. Deutsche Bank email, dated June 2008, re: Tentative: MAPS Working 

Group . . . (. . . if one option is near breaching the barrier and they 

[RenTec] want to reallocate trades from that options to others that are 

at capacity while still being under the 33bn GMV [Gross Market Value] 

threshold. Based on prior conversations they want to keep their flexibility 

around allocations.). [DB-PSI 00025033-034] ................................................ 346 

17. GWA/Deutsche Bank email, dated July 2008, re: George Weiss MAPS 

Investment Guidelines - PLEASE READ (Please transfer all the positions 

mentioned in Rule 11 and Rule 12 to OGI account from the MAPS 

account. *** He will be able to do the crosses requested under Rule 

11 & Rule 12 in the AM . . .). [GWALLC-PSI-0002504-505] ......................... 348 

18. RenTec/Deutsche Bank email, dated July 2008, re: Optionality Value 

(While this formula will give a desired result at the current interest 

levels, as interest rates increase (and we could potentially require a longer 

dated option) the Optionality Value could get prohibitively high even 

to the point of exceeding the total amount of premium. I played around 

with other formulas but still came up against the same conundrum.). 

[RT-PSI-00046119-121] .................................................................................... 350 

19. Excerpt of Deutsche Bank, GPF Business Development, CTB Program 

Portfolio, September, 2008. (The object of this initiative is to provide 

a New Multiple MAPS structure that will more closely resemble a traditional options structure–premium risk.). [DB-PSI 00116157-160, 177] ........ 353 

20. GWA email, dated October 2008, re: db maps account inbalance (just 

got a call from db claiming we have too much net long exposure in 

maps and want just to bring the portfolio back within 5% exposure within 

a week . . . maybe we can cross some position over to ybs next week). 

[GWALLC-PSI-0002328] .................................................................................. 358 
Page

VI 

21. Deutsche Bank/RenTec email, dated October 2008, re: DB/Rentec – Response to Issues Discussed on 10/16 (In any event, expanding this to 

20 Exchange Business Days does not work from a tax standpoint. 20 

Exchange Business Days to make a termination decision under a 13- 

month option tilts the balance strongly in favor of viewing the accrual 

of this termination right into the effective conversion of the option into 

an American style option.). [DB-PSI 00079017-021] ...................................... 359 

22. a. Excerpt of transcript of telephone conversation on November 7, 2008, 

between Satish Ramakrishna and William Broeksmit (Mr. 

Ramakrishna: [S]o that’s the way option is supposed to work . . . 

this is structured as an option because Mr. Broeksmit: Yeah for tax 

reasons Mr. Ramakrishna: For tax reason but the . . . option makes 

it clear that the premium is only . . . commitment that the option 

holder has). [DB-PSI 00122458] ................................................................. 364 

b. Excerpt of transcript of telephone conversation on November 6, 2008, 

between Peter Brown and Satish Ramakrishna (Peter Brown: [T]he 

models don’t see the government intervention but we do, and we are 

nervous that something could happen. . . . So we have actually intervened and we do that from time to time when things like this happen.). 

[DB-PSI 00122457] ...................................................................................... 365 

23. RenTec/Deutsche Bank email, dated December 2008, re: Test of representations (It will be operationally feasible for DB to create Designated Positions, both by not executing transactions directed by the Advisor and 

by unwinding or liquidating Effected Positions without the direction of 

the Advisor.). [RT-PSI-00236253-258] ............................................................. 366 

24. Master Investment Advisory Agreement, dated December 15, 2008, between Deutsche Bank AG London and Renaissance Technologies LLC 

(. . . supervise and direct the investment and reinvestment of all assets 

in the Account, and engage in such transactions on behalf of the Client’s 

Account, in the Advisor’s discretion and without prior consultation with 

the Client, subject only to the terms of this Agreement, in any and all 

forms of securities or other property, . . .) [DB-PSI-00000001-047] ............... 372 

25. Deutsche Bank/GWA email, dated February 2009, re: MAPs comments 

(Loss of the cross collateralization (ability to borrow against the excess 

equity) of the option. Historically, we have been able to fund the operating 

expenses of our business by borrowing against the excess equity value 

of the option.). [DB-PSI 00033762-765] ........................................................... 419 

26. Deutsche Bank email, dated August 2009, re: RenTech MAPS (If client 

started the day with maximum leverage (it has never done so), longs 

would have to underperform shorts by 11% to burn through capital and 

put us into non-recourse loss territory. We have triggers in place that 

allow us to sieze control of the portfolio at any point during the day 

if half of the capital is depleted (ie, 5.5% long underperformance of 

shorts).). [DB-PSI 00006983-984] .................................................................... 423 

27. Barrier Option Transaction confirmation, October 8, 2009, between Deutsche Bank AG, London Branch and Mosel Equities L.P. (Buyer has made 

an independent judgment of the experience and expertise of the Investment 

Advisor. Buyer agrees that it shall not attempt to direct or influence 

the choice of investments in the Basket.). [DB-PSI 00000181-209] ............... 425 

28. Deutsche Bank/GWA email, dated October 2009, re: DB Options – possible new development (. . . codification of the economic substance doctrine 

which, if enacted, could have serious implications with respect to the 

DB option transaction.). [DB-PSI 00036241-244] ........................................... 454 

29. Deutsche Bank/GWA email, dated October 2009, re: DB/Weiss MAPS 

option (Cross selling: DB will not allow Weiss to cross sell positions 

held in the DB account to other prime brokers in connection with its 

routine rebalancing activities.). [DB-PSI 00036700-701] ............................... 458 

30. Deutsche Bank email, dated November 2009, re: Rentec Mosel EurOption 

#4 (Problem is they were targeting the 7X Init Leverage again but that 

only gets us to a 16.6% Optionality Val. We either need 8.45X Init Leverage or Libor + 133bps Term Rate?????). [DB-PSI 00008625-627] ................. 460 

31. Deutsche Bank email, dated February 2012, re: Two Sigma Follow-up 

(Non-recourse financing is one option (MAPS is just a name for that) 

. . . ). [DB-PSI 00045265-266] .......................................................................... 463 
Page

VII 

32. Deutsche Bank email, dated September 2011, re: quick summary on 

Rentec (Im hoping you have a rough idea of the situation re the MAPS 

trades. In order to resolve the question of[:] – Owner of option controlling 

the entire underlying – Option (really the earliest version) looks like a 

margin account[.] I was thinking of using a CPPI like structure[.]). [DBPSI 00112132-133] ............................................................................................ 465 

33. Deutsche Bank email, dated December 2011, re: Rentec (That’s the result 

of having a real option.). [DB-PSI 00112522-523] .......................................... 467 

34. Deutsche Bank email, dated December 2011, re: Rentec confirm and 

IMAs (Please see below the changes to the Rentec confirm suggested by 

U.S. tax. I note that some of these changes are in response to changes 

suggested by Rentecs counsel, Winston & Strawn. I have not been privy 

to such communications. I trust you have been involved.). [DB-PSI 

00020740-748] ................................................................................................... 469 

Documents Related to COLT Transactions: 

35. Investment Advisory Agreement between Renaissance Technologies Corp. 

and Bass Equities Ltd., dated September 1, 2002. (Advisor is authorized, 

without further approval by or notice to the Client, to make all investment 

decisions concerning the Account . . .) [RT-PSI-00396318-321] ...................... 478 

36. Barclays Project COLT, New Product Proposal, dated May 28, 2002, 

(COLT provides an after tax benefit to these investors through the conversion of their return from the fund from short term capital gains (taxed 

at 39.6%) to long term capital gains (taxed at 20%).). [BARCLAYS-PSI212544-557] ....................................................................................................... 482 

37. Correspondence between Barclays and Financial Services Authority re: 

PROJECT COLT, dated July 4, August 16, September 5, and September 

13, 2002. [BARCLAYS-PSI-005241-243, 255-257, 260-261, and 258-259] ... 496 

38. Barclays Memo, dated August 22, 2002, re: SCM [Structured Capital 

Markets] Approvals paper – Project COLT (COLT provides an after tax 

benefit to these investors [RenTec] through the conversion of their return 

from the fund from short term capital gains (taxed at 39.6%) to long 

term capital gains (taxed at 20%). This would be achieved by substituting 

the Fund’s direct execution of its trading strategy with a cash settled 

call option over a Barclays proprietary account whose performance substantially replicates the Fund’s trading strategy.). [BARCLAYS-PSI212590-598] ....................................................................................................... 506 

39. Letter Agreement, dated September 30, 2002, between Barclays Bank 

PLC and Bass Equities Ltd. (COLT Transaction). [BARCLAYS-PSI212918-932] ....................................................................................................... 515 

40. Barclays Memo, dated April 4, 2003, re: SCM Approvals paper – Project 

COLT (Renaissance II) (Palomino will not have any credit risk or market 

risk in the transaction, due to the fact that . . . its PB account is hedged 

by the Synthetic Call Option and Prime Brokerage effectively has taken 

the downside risk. The risk borne by Prime Brokerage is akin to the 

risks taken in a normal collateralised [sic] Prime Brokerage relationship 

. . .). [BARCLAYS-PSI-213947-953] .................................................................. 530 

41. Badger Holdings L.P., Limited Partnership Agreement, dated August 17, 

2004. ([T]he General Partner shall have complete and exclusive responsibility for managing and administering the affairs of the Partnership, 

and shall have the power and authority to do all things necessary or 

proper to carry out its duties hereunder.) [RT-PSI-00396296-315] ............... 537 

42. Barclays Capital Memo to SCM Approvals Committee, dated September 

3, 2004, re: Approvals paper–COLT V: Renaissance Restructuring (The 

risk borne by Prime Brokerage is akin to the risks taken in a normal 

collateralised [sic] Prime Brokerage relationship, where the risks generally 

are confined to catastrophic losses occurring over a short period of time.). 

[BARCLAYS-PSI-004161-165] ......................................................................... 557 

43. Indemnity Agreement, dated October 1, 2004, among Barclays Bank PLC, 

Palomino Limited, Badger Holdings L.P., Medallion International Limited, Medallion Capital Investments Ltd., Medallion Associates L.P., Medallion Fund L.P., Medallion USA L.P., and Medallion RMP Fund L.P. 

[BARCLAYS-PSI-632877-904] ......................................................................... 562 

44. Letter Agreement, dated December 21, 2005, between Barclays Bank 

PLC and Palomino Limited (COLT Transaction). [BARCLAYS-PSI002879-896] ....................................................................................................... 590 
Page

VIII 

45. Investment Management Agreement, effective October 1, 2004, between 

Palomino Limited and Renaissance Technologies Corporation ([T]he Manager shall have full discretion and authority, without obtaining the Client’s prior approval, to manage the investment and trading of the Accounts . . .). [BARCLAYS-PSI-574664-686] ..................................................... 608 

46. Barclays email, dated April 2009, re: June Balance sheet targets (Rentec 

wasn’t comfortable with directly signing off on the deconsolidation, as 

they didn’t view this to be their problem. They are now considering a 

proposal to include some new language in their investment management 

document which would require them to sign off should we seek to reconsolidate at a later date.). [BARCLAYS-PSI-025382-383] ......................... 631 

47. Barclays email, dated April 2009, re: Colt (Marty Malloy spoke with 

RenTec today and they have indicated that they are fine with the proposal 

in principle, although they apparently mentioned that their tax counsel 

would also be putting together a letter agreement of some kind for us 

to review in the next couple days.). [BARCLAYS-PSI-588643] ...................... 633 

48. Barclays email, dated April 2009, re: Palomino letter, attaching April 

29, 2009 letter from Renaissance Technologies to Barclays Bank re: Palomino Limited Investment Management Agreement. (Please find attached 

a letter highlighting our concerns and representations that Renaissance 

would like Barclays to make in connection with the changes you are 

contemplating for Palomino.). [BARCLAYS-PSI-326572-575] ...................... 634 

49. Barclays/RenTec email, dated May 2009 (My guys have some comments 

on the letter and would like to discuss with our lawyers and Ed.). 

[BARCLAYS-PSI-285585-586] ......................................................................... 638 

50. Barclays/PwC email, dated May 2009, re: Palomino to PwC 20/5/09 

(. . . set up for the benefit of Renaissance, who are exposed to the majority 

of risks and reward.). [BARCLAYS-PSI-328074-077] .................................... 640 

51. Barclays email, dated June 2009, re: Project COLT – articles amendment 

(. . .restrict the activities of Palomino to those it is currently engaged 

in under the COLT transaction.). [BARCLAYS-PSI-577747] ........................ 644 

52. Rentec/Barclays/Winston Strawn/OrrickHerrington/WalkersGlobal/ email, 

dated June 2009, re: Palomino Limited – side letter (with attachments). 

[RT-PSI-00361844-847, RT-PSI-00361879-881, RT-PSI-00235499-500] ....... 645 

53. Barclays Capital Memo, dated June 24, 2009, re: Palomino Limited 

(RenTec controls the major activities of Palomino and is exposed to substantially all significant risks and rewards arising from the activities 

carried out through the PB Accounts, being the only permitted activities 

of Palomino. Consequently, under IAS 27.13 and SIC 12, BBPLC should 

de-consolidate Palomino from the date these proposed amendments are 

effective because they give rise to a loss of control (IAS 27.32).). 

[BARCLAYS-PSI-139757-766] ......................................................................... 654 

54. Barclays email and Memo, dated June 2009, re: Project COLT – Orphan 

Note (It has been agreed with BarCap Finance and PricewaterhouseCoopers (‘‘PwC’’) that, following proposed amendments to Palomino’s 

memorandum and articles of association (the ‘‘Articles’’) and the giving 

of a covenant by Barclays, as sole shareholder of Palomino, that it will 

not seek to amend the Articles in the future without the consent of Renaissance Technologies LLC (‘‘RenTec’’), Barclays will cease to consolidate 

Palomino under IFRS.). [BARCLAYS-PSI-026163-165] ................................ 664 

55. Renaissance Technologies LLC letters, both dated June 26, 2009, re: 

Palomino Limited (Barclays hereby further covenants to Renaissance that 

it shall not make any amendments or modifications to the Memorandum 

and Articles of Association of Palomino after the date hereof without 

first obtaining the prior written consent thereto of Renaissance . . .). 

[RT-PSI-00236651-655 and 00236914-918] ..................................................... 667 

56. Letter Agreement, dated June 26, 2009, between Barclays Banks PLC, 

Badger Holdings L.P, Renaissance Technologies LLC and Palomino Limited. [BARCLAYS-PSI-730031-032] ................................................................. 677 

57. The Companies Law . . . Memorandum and Articles of Association of 

Palomino Limited, dated June 26, 2009. [RT-PSI-00234974-998] ................ 679 

58. Barclays email, dated June 2010, re: Renaissance, attaching Barclays 

Capital, Portfolio Analysis of Renaissance Portfolios, CRA, dated June 

2010. [BARCLAYS-PSI-330659-682] ............................................................... 704 
Page

IX 

59. Barclays email, dated May 2010, re: COLT XIX – Draft SCM Approvals 

Notification (The options reference the value of these PB [Prime Brokerage] accounts, which is equivalent to them referencing the assets directly, 

and therefore there is no leakage between the value of the assets . . . 

and the value of the options. Thus, the net effect is that Barclays is 

extending senior financing to RenTec.). [BARCLAYS-PSI-010082-083] ....... 728 

60. Barclays email, dated November 2010, re: Privileged – Colt (This [the 

GLAM] is a detailed write up of Colt concluding it doesn’t work. We 

can discuss on MDs [managing directors] call but I intend to reach out 

to RenTec and Ed Cohen this morning to make sure they are aware. 

We will also confirm it does not impact Barclays. The only issue for 

Barclays I could see is some deemed wht [withholding] agent issue as 

the memo concludes that RenTec are the legal owner of the stocks. To 

me this would signal that IRS is inevitably going to litigate Colt.). 

[BARCLAYS-PSI-748506-507] ......................................................................... 730 

61. Barclays Memo to SCM US Approvals Committee, dated October 3, 2012, 

re: COLT XXVII (The tax risk is assumed by the Client. . . . The New 

Option Transaction does not meaningfully increase Barclays’ reputation 

risk in relation to the Option Transactions, because writing a new option 

(or exercising an existing one) should be viewed as the maintenance of 

a longstanding structure.). [BARCLAYS-PSI-016946-947] ............................ 732 

62. Barclays Memo to Tax Risk Committee, dated October 3, 2012: re: COLT 

(There is a reputation risk for Barclays, especially if the matter proceeds 

to court and the IRS’s challenge and Barclays’ role become publicly disclosed.). [BARCLAYS-PSI-016951-952] ........................................................... 734 

63. Barclays email, dated October 2012, re: COLT SCM Transaction/Important (The SCM US Approvals Committee recently approved an option 

transaction in which US tax reputation risk is an issue, and the Committee has engaged in the Tax Risk Committee on the transaction.). 

[BARCLAYS-PSI-748590] ................................................................................ 736 

64. Barclays Memo to Tax Risk Committee, dated October 12, 2012, re: 

COLT (This memo explains the background to an investment structure 

which has been in place for 10 years and explains why, notwithstanding 

the publicity risk that Barclays is subject to as a witness to the case 

if the Client proceeds to litigate in court, we believe it remains an appropriate transaction for Barclays to be a party to.). [BARCLAYS-PSI018114-116] ....................................................................................................... 737 

65. Barclays Memo to SMC US Approvals Committee, dated November 2012, 

re: Project COLT XXVIII (Renaissance Technologies) – Approvals Notification (SCM has notified and received approval from the following in relation to proceeding with the proposed transaction: Tax, Finance, Credit 

Risk, Market Risk, Regulatory, Legal, Compliance, and Operations.). 

[BARCLAYS-PSI-017091-093] ......................................................................... 740 

66. Barclays email, dated November 2012, re: Palomino options (. . . it was 

agreed that any exit from this structure would not result in the 60 day 

notice would be given, rather there would be more notice meaning that 

Reny would not have to close out the option and suffer short term capital 

gains tax.). [BARCLAYS-PSI-322103] ............................................................. 743 

67. BARCLAYS, New COLT Transaction, Transaction Review Committee, December 2013 (A reputational risk may arise to Barclays if the Original 

COLT Transaction proceeds to court or is included in a public hearing. 

However, it is considered that the New COLT Transaction does not meaningfully increase Barclays’ reputation risk in relation to the COLT Transactions, especially as it eliminates the Rate Differential Benefit.). 

[BARCLAYS-PSI-748587-589] ......................................................................... 744 
Page

X 

68. Excerpts of Securities and Exchange Commission Form 20-F, Annual 

Reports for Barclays PLC, Barclays Bank PLC, reflecting that Palomino 

was not controlled by Barclays: 

a. Fiscal year ended December 31, 2009; ................................................... 747 

b. Fiscal year ended December 31, 2010; ................................................... 749 

c. Fiscal year ended December 31, 2011; ................................................... 751 

d. Fiscal year ended December 31, 2012; and ............................................ 753 

e. Fiscal year ended December 31, 2013. ................................................... 755 

(. . . they are excluded from consolidation because the Group either 

cannot direct the financial and operating policies of these entities, or 

on the grounds that another entity has a superior economic interest 

in them.). 

69. 7/22/2014 ‘‘Post-GLAM Basket Option Contracts,’’ Memorandum to File 

prepared by the Subcommittee (summarizing Deutsche Bank, Barclays, 

and RenTec involvement with basket options after the November 2010 

issuance of the IRS advisory memorandum on basket options). .................. 758 

70. Document Locator List and documents cited in footnotes to Abuse of 

Structured Financial Products: Misusing Basket Options to Avoid Taxes 

and Leverage Limits, the Report released in conjunction with the Subcommittee hearing on July 22, 2014. The Document Locator List provides 

the Bates numbers or description of the documents cited in the Report 

and the hearing record page number where the document can be located. 

Not included are documents related to Subcommittee interviews, which 

are not available to the public, and widely available public documents. ..... 760 
(1) 

ABUSE OF STRUCTURED FINANCIAL 

PRODUCTS: MISUSING BASKET OPTIONS TO 

AVOID TAXES AND LEVERAGE LIMITS 

TUESDAY, JULY 22, 2014 

U.S. SENATE,

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS,

OF THE COMMITTEE ON HOMELAND SECURITY

AND GOVERNMENTAL AFFAIRS, 

Washington, DC. 

The Subcommittee met, pursuant to notice, at 9:35 a.m., in room 

SD–342, Dirksen Senate Office Building, Hon. Carl Levin, Chairman of the Subcommittee, presiding. 

Present: Senators Levin, McCain, and Johnson. 

Staff present: Elise J. Bean, Staff Director and Chief Counsel; 

Mary D. Robertson, Chief Clerk; Robert L. Roach, Counsel and 

Chief Investigator; David H. Katz, Counsel; Ahmad Sarsour, 

Detailee (FDIC); Henry J. Kerner, Staff Director and Chief Counsel 

to the Minority; Michael Lueptow, Counsel to the Minority; Brad 

M. Patout, Senior Advisor to the Minority; Patrick Hartobey, Law 

Clerk to the Minority; Amy Dreisiger, Law Clerk; Michael AviYonah, Intern; Adam Henderson, Professional Staff Member; Angela Messenger, Detailee (GAO); Joel Churches, Detailee (IRS); Mohammad Aslami, Law Clerk; Owen Dunn, Law Clerk; and Ritika 

Rodrigues (Sen. Johnson). 

OPENING TESTIMONY OF SENATOR LEVIN 

Senator LEVIN. Good morning, everybody. 

In recent years, this Subcommittee has devoted significant time 

and effort to exposing complex financial arrangements that profitable corporations and wealthy individuals employ to avoid their obligations to pay all their U.S. taxes. We also have examined reckless behavior that has put the stability of the financial system— 

and by extension, the U.S. economy—at risk. Today’s hearing 

brings those two themes together. 

Our focus today is on how two banks and a handful of hedge 

funds developed a complex financial structure to engage in highly 

profitable trades while claiming an unjustified lower tax rate and 

avoiding limits on trading with borrowed money. This structure 

worked well for the banks, which earned hundreds of millions of 

dollars in fees. It worked well for the hedge funds, which made billions of dollars in profits. But it did not work for average taxpayers, who had to shoulder the tax burden these hedge funds 

shrugged off with the aid of the banks. And it did not work for the 
2 

financial system, which is still recovering from a devastating crisis 

brought on by excess risk and remains ill-equipped to withstand 

another shock from over leveraged financial institutions. 

In essence, today’s hearing is about a series of fictions, one piled 

on top of another, fictions that major banks and their hedge fund 

clients used to avoid taxes and Federal leverage limits. 

The key financial product involved in these fictions is called a 

‘‘basket option.’’ The basket options examined by the Subcommittee 

were developed and sold by two banks—Deutsche Bank AG and 

Barclays Bank PLC—to more than a dozen hedge funds. Together, 

the banks sold 199 basket options to hedge funds that used them 

to make over $100 billion in trades. Two of the largest basket option users were Renaissance Technologies, known as RenTec, and 

George Weiss Associates. 

Although there were minor differences in specifics, the basket option basics worked like this: The bank sold its hedge fund client a 

structured financial product, called an ‘‘option,’’ whose payoff 

equaled the profits generated by a ‘‘basket’’ of securities held in a 

designated account at the bank. The basket here is key. It was an 

open account with ever-changing contents. Technically, the account 

and the securities it contained were held in the name of the banks 

in its own trading account. The hedge fund put up 10 percent of 

the cash needed to buy the securities, and the bank lent the other 

90 percent. 

This arrangement included a number of fictions which defied reality, but resulted in big profits for the hedge funds and the banks. 

First, though the structure was designed to create the appearance that the bank owned the assets in the basket option account, 

the hedge fund made all the trading decisions for those accounts— 

and in fact, used the bank’s computerized trading system to execute trades in the account. RenTec estimates that its trading 

through basket options accounts averaged more than 100,000 

trades each day, or about 30 million trades a year. Also, the hedge 

fund reaped all of the trading profits, even though the financial 

structure created the illusion that the bank owned the assets. The 

beneficial owner, the real owner, was the hedge fund. 

Now, second, the hedge fund’s control of all the trading for the 

basket option account demolishes the fiction of a legitimate option. 

So the hedge funds set up new entities, which they controlled, to 

serve one function, and that was to act as the option holder. The 

hedge funds would then claim that their control of the option holder was totally independent of their role in making the trading decisions for the basket option account. Documents that we will explore 

today show the extraordinary lengths to which RenTec and the 

banks went to perpetuate the illusion that the option holder and 

trader were somehow independent, when in fact the hedge fund, 

RenTec, played both roles. 

The fictional option was structured so that it could be exercised 

more than 1 year after it was created. Under that structure, the 

hedge funds claimed that trading profits from the account were 

long-term capital gains and thereby qualified for the reduced longterm capital gains tax rate. 

The Tax Code gives long-term capital gains a reduced rate on the 

theory that it provides an incentive for investors to risk their cap-
3 

ital on the kind of long-term investments that grow the economy 

and create jobs. The high-volume trading that, for example, RenTec 

conducted through its basket options does not meet that test. When 

securities are held for weeks or days or even seconds, it is surreal 

to characterize those trading profits as long-term capital gains. 

But that is what the hedge funds did. The banks and hedge 

funds used the fictional option structure to collapse millions of individual trades into one transaction, the execution of an option. As 

if by magic, the option structure transforms what would be shortterm capital gains from an ordinary trading account into long-term 

capital gains subject to lower taxes. Subcommittee staff estimates, 

based on basket option profits that RenTec reported from 2000 to 

2013, that RenTec avoided paying more than $6 billion in taxes 

that way. 

Now, that is a lot of money even by Washington standards. It 

would, for example, pay for almost two-thirds of the cost to replenish the Highway Trust Fund so that it does not run out of money 

next month and create havoc in road projects around the country. 

This is not the first time options have been abused to try to convert short-term trading profits into long-term capital gains. And 

that is why, in 1999, Congress passed a law in part to stop that 

practice, and that is Section 1260 of the Tax Code. The basket options at issue here were written to skirt Section 1260’s prohibitions. But in 2010, the IRS warned that the type of basket options 

used here could not claim the lower long-term capital gains tax 

rate. Despite that IRS warning, Barclays continued to sell basket 

options to RenTec for another 2 years, before finally revising its option product in 2013 so that the options expired in less than a year 

and could not be used to game the Tax Code. Deutsche Bank suspended its issuance of new basket options after the 2010 IRS warning, but continued to administer multiple basket option accounts 

already in existence. It also resumed offering them in 2012, although with a term of less than 1 year and a requirement that the 

option holder treat the profits as short-term capital gains. 

Tax avoidance through financial engineering is not the only problematic element here. These banks and hedge funds also used basket option accounts to circumvent regulations designed to limit systemic risks to the banking system posed by excessive leverage— 

that is, excessive lending to finance stock trading. 

The stock market crash of 1929 devastated the U.S. economy, not 

just by the collapse of thousands of stock speculators, but also by 

the failure of thousands of banks that had lent them money and 

could not collect on the loans. In the aftermath of the Great Depression, Congress enacted laws limiting the use of borrowed 

money to trade securities. Those limits are included in a set of 

‘‘margin rules’’ that essentially prohibit U.S. broker-dealers from 

lending more than $1 to brokerage clients for each $1 of the client’s 

own money in the account—in other words, for every $2 in a brokerage account, only $1 of that $2 can be borrowed from the 

broker. 

Had the hedge funds involved in these transactions been using 

normal brokerage accounts, they would have been subject to the 2:1 

leverage limit. But because the basket option accounts were opened 

in the name of the banks in their own proprietary trading accounts, 
4 

it looked as though the money placed into those accounts was the 

banks’ own proprietary money rather than money they were loaning to a customer. And this is another fiction. The banks and hedge 

funds pretended the bank funds were not loans, even though the 

hedge funds paid financing fees and posted collateral. 

So instead of complying with the 2:1 leverage ratio, the banks offered their hedge fund clients leverage as high as 20:1. RenTec 

used the increased leverage to borrow billions of dollars for its 

trading strategies, which produced huge profits for RenTec, while 

the lending generated huge additional fees for the bank. 

But as we have learned over and over—in the Depression, in the 

1990’s collapse of the hedge fund Long Term Capital Management, 

and in the financial crisis from which we are still recovering—excessive leverage does not always produce profits. Sometimes it produces losses. And when huge losses happen, they can bring down 

not just a reckless borrower, but the financial institution that lent 

it money, and that failure can ripple through the entire financial 

system. While it appears the two banks the Subcommittee has examined have stopped selling basket options as a way to claim longterm capital gains rates, they are still selling these products as a 

way to avoid leverage limits—meaning our financial system and 

economy still face unnecessary risk. 

RenTec, through its Medallion Fund, used basket options to 

produce profits from 1999 to 2013 totaling more than $30 billion. 

The banks charged financing, trading, and other fees that, over the 

same period, produced revenues totaling about $570 million for 

Deutsche Bank and $655 million for Barclays. Basket options were 

clearly a lucrative line of business for the participants. 

But this money maker was built on interlocking series of fictions. 

The key fiction is the option itself: the idea that this structure was 

really an option when, in fact, what it did was give hedge funds 

the profits from buying and selling assets in accounts that the 

hedge funds themselves controlled. It was fiction to treat the banks 

as the true owners of the basket option assets, when the hedge 

funds controlled and executed all of the millions of trades in the 

accounts, when the hedge funds paid the daily trading costs, and 

when the hedge funds reaped the profits. It was fiction to suggest 

that the borrowed money that financed the trades was considered 

proprietary funds of the banks rather than loans to the hedge 

funds. It was fiction to treat the profits from trades lasting days 

or even seconds as long-term capital gains deserving a reduced tax 

rate. And it was a fiction to pretend that hedge funds were not acting both as option holder and as trade decisionmaker. These were 

all fictions, but fictions with real-world consequences: they shifted 

billions of dollars in tax burden onto the backs of ordinary taxpayers, and they added billions of dollars in hidden risks to our financial system. 

Congress and financial regulators can and should work together 

to stop these abuses. 

The IRS should seek to collect taxes owed on billions of dollars 

in basket option profits unjustifiably claimed as long-term capital 

gains. 
5 

Federal financial regulators should make clear to banks that participating in abusive structures designed to avoid leverage limits 

and taxes is unacceptable and penalize the banks that do. 

The Financial Stability Oversight Council, working with other 

agencies, should establish reporting and data collection requirements to detect and to stop abuse of structured financial products 

to circumvent leverage limits that safeguard our economy. 

And, finally, Treasury, and the IRS should remove impediments 

to audits of large partnerships, like hedge funds, 99 percent of 

which today escape IRS audits—meaning that we are largely blind 

to how many other hedge funds may be using structures of this 

type to avoid risk limits and taxes. 

These measures would help protect the interests of ordinary 

Americans who pay their taxes and who must pay the price for tax 

avoidance schemes. It is these same Americans who would bear the 

burden of economic devastation that unaddressed systemic risks 

can cause. 

I want to thank Senator McCain and his staff for their hard 

work in making today’s hearing and our bipartisan report possible. 

The staff of this Subcommittee, majority and minority, through the 

years have been able to work together as one team, and I am very 

proud of them. 

Senator McCain. 

OPENING TESTIMONY OF SENATOR McCAIN 

Senator MCCAIN. Well, thank you, Mr. Chairman, and one of the 

aspects of my term and tour here in the U.S. Senate is the relationship that you and I have developed over many years, and the work 

we do together, I think the people of Michigan and Arizona and the 

country are better off for it. I thank you for today’s hearing, and 

today’s hearing sheds light on how Renaissance Technologies was 

able to avoid paying more than $6 billion in taxes by disguising its 

day-to-day stock trades as long-term investments. 

To accomplish that, Renaissance set up a ‘‘basket option,’’ which 

is an artificial structure, not available to ordinary consumers, that 

allowed Renaissance to legally classify its short-term trading profits as long-term capital gains, subjecting those gains to a substantially lower tax rate. Renaissance profited from this tax treatment 

by insisting on the fiction that it did not really own the stocks it 

traded, that the banks that Renaissance dealt with did. 

But the fact is that Renaissance did all the trading, maintained 

full control over the account, bore all the real risk, and reaped all 

of its profits. This setup allowed Renaissance to claim that profits 

from its day-to-day trades were actually long-term investments, 

thereby avoiding payment of billions of dollars in taxes. 

In reaction to Renaissance’s use of this structure, the IRS opened 

an investigation and today is in the process of litigating the legal 

issues. It is not the Subcommittee’s place to weigh in on those proceedings and determine whether the behavior in question was illegal. But this basket option practice, available to hedge funds but 

inaccessible to the average investor, needs to be fully examined and 

addressed. The biggest reason why it should be examined is the 

tremendous amount of taxes Renaissance was able to avoid paying 

by using this structure. 
6 

In the course of its investigation, the Subcommittee learned that 

between the years 2000 and 2014, Renaissance exercised 60 longterm basket options with Deutsche Bank and Barclays, earning in 

the neighborhood of $34 billion in pre-tax profits and potentially 

avoiding over $6 billion in taxes. 

Mr. Chairman, those are very large amounts of money. 

Meanwhile, Deutsche Bank and Barclays happily took part in the 

basket options because they made hundreds of millions of dollars 

in fees from these transactions while incurring no actual risk—that 

is, until the IRS started to investigate. To protect themselves, 

Deutsche Bank in 2010 and Barclays in 2012 decided to only offer 

Renaissance options lasting less than 1 year so that all the profits 

from the options would have to be considered short-term capital 

gains. 

Large trading firms will always try to stay one step ahead of the 

game when it comes to pushing the envelope on the Tax Code to 

minimize paying taxes, and regulators will inevitably struggle to 

detect and stop new schemes as they arise. It is, therefore, critical 

that regulators use the resources they have in an efficient manner 

to target the most likely offenders. 

So whatever practical impediments currently disable the IRS 

from auditing large partnerships that use these sort of tax structures should be eased or eliminated. Doing so would allow the IRS 

to audit companies based on a careful assessment of the likelihood 

that a given company is engaging in activities that warrant an 

audit. This would differ from the current practice which focuses on 

the corporate form selected by that company, which has led to corporations being disproportionately audited. 

One thing is clear. Americans are tired of seeing Wall Street 

firms playing by a set of rules other than those that apply to ordinary citizens. Even as consumers worried about losing their savings in the 2008 financial crisis, Renaissance remained enormously 

profitable throughout by, among other things, utilizing the tax 

avoidance such detailed in today’s hearing. 

When ordinary citizens make short-term trades, they get taxed 

at the short-term rate. When financial firms like Renaissance make 

short-term trades, they should not be treated any differently. 

The perception that Wall Street self-deals or plays by its own 

rules engenders a deep-seated distrust and cynicism among Americans that is neither desirable nor healthy for the Nation. 

I want to thank the witnesses for appearing before the Subcommittee today, and I look forward to their testimony. Thank you, 

Mr. Chairman. 

Senator LEVIN. Thank you very much, Senator McCain. 

I would like to now call our first panel of witnesses for this morning’s hearing: Steven Rosenthal, Senior Fellow at the Urban-Brookings Tax Policy Center; and James R. White, Director of Tax Issues 

at the U.S. Government Accountability Office (GAO). 

I appreciate both of you being with us this morning. We look forward to your testimony. 

Pursuant to our Rule 6, all witnesses who testify before the Subcommittee are required to be sworn, so I would ask both of you to 

please stand and raise your right hand. Do you swear that the testimony you are about to give before this Subcommittee will be the 
7 

1The prepared statement of Mr. Rosenthal appears in the Appendix on page 83. 

truth, the whole truth, and nothing but the truth, so help you, 

God?, 

Mr. ROSENTHAL. I do. 

Mr. WHITE. I do. 

Senator LEVIN. Our timing system today will work as follows: 1 

minute before the red light comes on, you will see the lights change 

from green to yellow, giving you an opportunity to conclude your 

remarks. Your written testimony will be printed in the record in 

its entirety. We would appreciate your trying to limit your oral testimony to 7 minutes. And, Mr. Rosenthal, we will have you go first, 

followed by Mr. White, and then we will turn to questions. 

Mr. Rosenthal. 

TESTIMONY OF STEVEN M. ROSENTHAL,1 SENIOR FELLOW, 

URBAN-BROOKINGS TAX POLICY CENTER, WASHINGTON, DC 

Mr. ROSENTHAL. Thank you, Mr. Chairman, Ranking Member 

McCain, and the Subcommittee for the opportunity to testify on the 

abuse of structured financial products. My name is Steven Rosenthal. I am a Senior Fellow at the Urban-Brookings Tax Policy Center. I am presenting my own views and not those of the Urban Institute, the Brookings Institution, the Tax Policy Center, or any 

other person. 

I have practiced tax law in Washington, DC, for over 25 years. 

In private practice, I have regularly advised hedge funds and other 

investors on the tax treatment of derivatives. In the 1990’s, I was 

a legislation counsel with the Joint Committee on Taxation, where 

I helped draft tax rules for financial institutions, financial products, capital gains, and related areas. 

Almost a century ago, Congress reduced the tax rates for longterm capital gains. Then ‘‘long term’’ meant holding assets for 2 

years. Now it means holding assets for at least 1 year. But for a 

century, regular tax rates have applied to gains on the sale of assets that have been held for a short term. 

I have been asked to evaluate the character of the gains of the 

Renaissance hedge funds based on my review of materials provided 

by the Subcommittee staff. 

The Renaissance hedge funds traded often, more than 100,000 

trades a day, more than 30 million trades a year, and they traded 

quickly, turning over their portfolio almost completely every 3 

months. 

Because the hedge funds adopted a short-term trading strategy, 

we would expect their gains to be short term. But the hedge funds, 

with the help of Barclays and Deutsche Bank, wrapped derivatives 

around their trading strategy in order to transform their shortterm trading profits into long-term capital gains. 

This tax alchemy purported to reduce the tax rate on the gains 

from 35 percent to 15 percent and reduced taxes paid to the Treasury by approximately $6.8 billion. 

I believe the hedge funds stretched the derivatives beyond recognition for tax purposes and mischaracterized their profits as 

long-term gains. 
8 

Here is how it worked. The hedge funds did not buy, hold, and 

sell their stocks directly. Instead, the hedge funds arranged for the 

banks to buy, hold, and sell the stocks. There were two steps. 

First, a bank granted the hedge funds’ general partner, Renaissance, the exclusive authority to select stocks to buy and sell for 

an account, when to buy and sell, and how to size and route the 

orders. 

Second, the bank agreed to pay the hedge fund the net profits 

from the trading of the stocks in the account at the bank. I will 

label this arrangement ‘‘the basket contract.’’ To fund an account, a hedge fund might deposit, say, $10 million. The bank also might contribute $90 million, which permitted up to 

$100 million to trade. The basket contract typically had a term of 

2 or 3 years, but a hedge fund could demand the bank cash out a 

basket contract at any time. In fact, the hedge fund typically 

cashed out the basket contracts after more than a year in order to 

qualify their profits as long term. To protect against losses in excess of $10 million, the original deposit, a bank contract would automatically be knocked out—that is, 

liquidated—if the value of the account fell from $100 million to $90 

million. But the banks also put in place protections to prevent the 

account from falling that much. In practice, no basket contract was 

knocked out, none of the 60. 

The tax law characterizes an arrangement based on its substance, not its form. In substance, Mr. Chairman, I believe the 

hedge funds possessed tax ownership of the stock in the accounts. 

The hedge funds, through their general partner, Renaissance, directed the buying and selling of the stocks, and the hedge funds 

profited completely from the trading. 

To establish tax ownership, the party’s label does not matter. For 

example, the IRS treated a deep-in-the-money option as ownership 

of the underlying stock. That was because the option was so likely 

to be exercised the taxpayer effectively assumed the benefits and 

burdens of owning the stock. 

Similarly, I believe the benefits and burdens of the stock basket 

belong to the hedge funds. 

First, the hedge funds enjoyed the opportunities of gain from 

trading the stocks and incurred the burden of losses, at least until 

the bank stopped the trading. 

Second, the hedge funds earned the interest, dividends, and 

other income from the stocks, bonds, and cash in the account, and 

the hedge funds paid the financing, commissions, and other expenses from the trading. 

Finally, the hedge funds, through their general partner, Renaissance, selected the stocks to buy and sell for the designated accounts, when to buy and sell them, and how to size and route the 

orders. As a result, the investment arrangement simply rewarded 

the hedge funds for their own trading efforts. 

Moreover, even if the basket contracts were respected, the gains 

from the basket contracts must be recognized currently. The hedge 

funds changed the economics of the basket contracts when their 

agent, Renaissance, traded in the designated account. And modifying a contract materially is a taxable event. The deferral was inappropriate. 
9 

1The prepared statement of Mr. White appears in the Appendix on page 91. 

As a result, I believe the IRS can and should challenge these 

strategies. But the IRS has limited resources to challenge the wide 

variety of derivative-related strategies which often are complicated 

and abstruse. So, in my view, Congress should address the taxation 

of derivatives comprehensively to reflect the income of derivatives 

more clearly. 

I believe the tax accounting for derivatives ought to follow financial accounting, which requires companies to mark to market the 

derivatives at year-end—that is, to report any income from derivatives as ordinary as if the derivatives were sold at the end of each 

year. 

Last year, Chairman Camp of the House Ways and Means Committee proposed to mark to market derivatives for tax purposes. I 

believe this step is overdue. It would greatly reduce the amount of 

time and energy that taxpayers and the IRS devote to the taxation 

of derivatives, an enterprise that is demanding far too many efforts 

in the most recent tax years. 

Thank you, and I am happy to take any questions. 

Senator LEVIN. Thank you very much, Mr. Rosenthal. 

Mr. White. 

TESTIMONY OF JAMES R. WHITE,1 DIRECTOR, TAX ISSUES, U.S. 

GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, DC 

Mr. WHITE. Chairman Levin and Ranking Member McCain, I am 

pleased to be here for the hearing on structured financial products. 

A number of the entities offering these products are large partnerships, which we define as those with over 100 direct and indirect 

partners and over $100 million in assets. I will describe them and 

the challenges IRS faces in auditing them. 

First, some background. Partnerships are pass-through entities 

that do not pay taxes but instead pass income or losses through to 

their partners to include on their own tax returns. Partnerships 

can be partners in other partnerships; that is, partnerships can be 

tiered, making tracking income through the tiers complicated. The 

number of partnerships of all sizes is growing, with a big shift toward businesses organized as partnerships and away from corporations. Between 2002 and 2010, the number of all partnerships grew 

45 percent to over 3 million while the number of corporations liable 

for corporate income tax decreased 14 percent to 1.5 million. Large 

partnerships grew even faster, tripling to over 10,000. 

Now I will describe large partnerships. According to IRS, many 

of these are investment funds, such as hedge funds or private equity funds. These funds may have hundreds of thousands of investors who are legally partners. When investing, the funds may create other large partnerships. For example, if a fund with a million 

partners invests in a small operating partnership, say in oil and 

gas, then the oil and gas partnership would now be large. The 

original direct oil and gas partners would be joined by a million indirect partners. 

Figure 2 on page 8 of my statement shows the sizes of large partnerships with almost 3,000 having more than 10,000 direct and indirect partners in tax year 2011. 
10 

My next point is that IRS audits very few large partnerships and 

makes few changes when it does. For example, in 2012, the audit 

rate for large partnerships was eight-tenths of 1 percent, less than 

1 percent. For large corporations, the audit rate was 27 percent, or 

33 times higher. The few audits done of large partnerships were 

not very productive. Two-thirds resulted in no change to the partnerships’ reported income. When adjustments were made, positive 

and negative changes roughly canceled each other out. 

Now I turn to IRS’ audit challenges, which may explain the low 

audit rate and poor audit results. 

Tiers of partnerships create very complex income flows. An example is Figure 3 on page 9 of my statement. The audited partnership at the left earns income that passes through eight other partnerships before reaching the ultimate owner who is responsible for 

any tax. IRS has the challenge of tracking the income as it flows 

through the tiers and verifying that the amount and nature of the 

income is correctly reported. Are capital gains short or long term? 

Is income passive or non-passive? 

IRS officials told us they have difficulty in identifying the business purposes of large partnerships and the source of income. And 

Figure 3 is a simple example with only 50 partners and 10 tiers. 

IRS said some have over a million partners and some over 50 tiers. 

While such complicated business structures can be used for tax 

evasion, I want to emphasize that they can also have legitimate 

business purposes, such as isolating one part of the business from 

the liabilities of another part. 

In addition to this complexity, IRS auditors said administrative 

procedures can make it challenging to finish an audit within the 

3-year statute of limitations. The Tax Equity and Fiscal Responsibility Act of 1982, or TEFRA, was passed to correct problems with 

fragmented audits of multiple partners. However, auditors told us 

that TEFRA can hinder audits of large partnerships. One challenge 

is identifying the Tax Matters Partner, or TMP, who represents the 

partnership in an audit. IRS auditors told us that the process can 

sometimes take months with some partnerships using this as a delaying tactic to reduce the time available for the actual audit. 

Another TEFRA challenge is passing audit adjustments through 

to taxable partners. According to IRS, linking a large partnership 

to thousands of direct and indirect partners spread over many tiers 

is extremely burdensome and limits the number of audits that can 

be done. Furthermore, by the time an audit adjustment is spread 

over thousands of partners, the amount per partner may be so diluted that it is not worth passing through. 

To summarize, large partnerships are increasing in number. IRS 

audits very few and gets poor results when it does audit them. The 

complexity of both the partnerships and the audit procedures may 

explain this picture. We are still completing the review requested 

by this Committee and plan to issue a report this fall with more 

details and, if warranted, recommendations. 

Mr. Chairman, this ends my statement, and I would be pleased 

to respond to questions. 

Senator LEVIN. Thank you very much, Mr. White. 

Mr. Rosenthal, substance over form, a judicial doctrine permits 

the IRS to recharacterize a transaction according to its actual sub-
11 

stance. The purpose of the doctrine is to prevent a taxpayer from 

calling a transaction something that it is not in order to avoid tax 

liability. 

Renaissance has asserted that its characterization of the basket 

option should be respected for tax purposes and that it should be 

entitled to long-term capital gains treatment because the basket 

option, they claim, was held for more than a year. 

It has asserted in part that it is entitled to this treatment because the transaction had a business purpose, including the claim 

that the transaction provided it with more leverage than could be 

obtained in a margin account. 

Now, does the claim of Renaissance that it had a business purpose answer the question of whether the structure was properly 

characterized as an option for tax purposes? 

Mr. ROSENTHAL. No, in my view, Chairman Levin, I do not believe the mere existence of a business purpose demonstrates conclusively that the labels affixed to the arrangement will be respected 

by a court of law. 

The key question in considering economic substance is what is 

the substance of the arrangement, not merely the form or the labels affixed by the parties to the arrangement. And here, in substance, in my view, the basket of stocks which was directed by the 

hedge fund—buy and sells—and controlled by the hedge fund, the 

benefits and burdens and the true owner of that basket of stocks 

in substance belonged to the hedge fund. 

Senator LEVIN. Now, you have reviewed in your testimony and 

I have reviewed in my opening statement what some of those actual facts were that constituted beneficial ownership. Would you 

agree that the hedge fund was the beneficial owner here? 

Mr. ROSENTHAL. Yes, I would. 

Senator LEVIN. And it received all the dividends from the trades 

as part of the option profits. The profits were Renaissance’s. Renaissance executed tens of millions of trades in a year in that account. It was charged a financing fee on the amount that it borrowed for the account. It received the rebates for the orders that 

it sent to the stock exchange, and, again, it received all of the profits from its trading and was exposed to most of the risk, with the 

exception of catastrophic risk. And there were even safeguards in 

the agreements to limit that risk. 

Now, in connection with the transactions affected by the bank’s 

basket accounts, it retained certain indicia of ownership, such as 

the legal title apparently; the right to vote shares—it is kind of 

hard to imagine voting shares when there are 30 million trades 

during a year, but, nonetheless, that right was retained—the right 

to lend shares out of their accounts to customers for fees. 

Now, how significant is it that the banks retained those indicia 

of ownership for determining who is the beneficial owner of the 

real transactions and the items that were in the account? 

Mr. ROSENTHAL. Not very significant, in my view, Mr. Chairman. 

The right to vote a publicly traded stock, a minority interest that 

was bought and sold within a few weeks, not a long-term holding, 

in my view is economically meaningless. 

The question of ownership is broader than mere form of title, and 

the courts repeatedly dozens and dozens of times have admonished 
12 

taxpayers that mere semblance of title does not answer the question of true ownership of the property. To determine true ownership, you need to look broadly at benefits and burdens. Who benefited when the stocks went up? Who lost when the stocks went 

down? 

And you need to think about who actually receives the beneficial 

income, the income from the beneficial ownership of the stocks. 

And, most importantly, you need to think about control and when 

stocks were bought and when stocks were sold and who determined 

that. 

In practice, I must have reviewed dozens, if not hundreds, of derivatives for a variety of investors, and derivatives by their nature 

derive value from some other asset or some other indicium. But 

there are limits to when an arrangement reflects a derivative and 

when an arrangement reflects ownership. And here the hedge 

funds simply crashed through those limits. They undertook a direction of what to buy and what to sell. They picked up all expenses, 

including commissions. They effectively determined what the bank 

would hold. They purported—I read in the materials provided to 

me that the bank had discretion as to whether to follow the directions of the buys and sells or whether to maintain positions. But 

in 30 million trades a year, over 300 million trades, I did not hear 

of a single instance in which the bank simply followed through and 

recorded ownership of the stock in the account per the direction of 

the hedge fund acting through Renaissance, its general partner. 

So the question of ownership is a facts and circumstance question looking at all the facts. But here the key elements of ownership in my view point to the hedge fund owning the basket of 

stocks, not the banks, notwithstanding the nominal title that the 

banks purported to have of the stocks in the account. 

Senator LEVIN. Now, the banks gave Renaissance direct access to 

the market through their trading execution system so that Renaissance executed the trades as well as receiving the profits and the 

losses. They had the right under their contracts not to execute. But 

do you know of any circumstances, looking through these materials, 

where they did not follow the algorithm which was provided to it? 

Mr. ROSENTHAL. To my knowledge, the general partner, Renaissance, the hedge fund, would direct trades directly to the exchange. 

That direction would take milliseconds. There was no, as far as I 

could see, any practical way for the bank to intervene and stop that 

order from going to the market. And as a practical matter, there 

really was very little opportunity for the bank to take a position 

out of the account and sell it, understanding that the hedge fund 

might want to sell the position in a matter of weeks. 

The bank made a lot of fees merely accommodating the hedge 

funds. I do not think the bank had any interest in independently 

owning those securities in their account. 

Senator LEVIN. Now, one point, the banks suggest that the execution was simply—by Renaissance was simply a recommendation or 

a suggestion to the bank. Have you seen any evidence that this was 

a recommendation or a suggestion? 

Mr. ROSENTHAL. No, I have not seen any evidence of that. 

Senator LEVIN. Is there any practical way in which 30 million 

trades a year could be 30 million recommendations? I think 
13 

100,000 trades a day, or more. Is there any practical way that that 

could be a recommendation or suggestion to the banks? 

Mr. ROSENTHAL. I cannot see it. I think you would need to ask 

the banks what mechanisms they had in place to reject the recommendation to buy or sell stocks. 

Senator LEVIN. And how often in 30 million purchases a year 

they did that? 

Mr. ROSENTHAL. In the documents that I saw and in the information provided to me by staff, I do not think they ever refused the 

direction of the hedge fund to buy or sell stocks. 

Senator LEVIN. The banks and Renaissance claim that Renaissance is independent from the fund when it is acting as investment 

advisor to the banks. Did you see any evidence that they are independent from their own funds when they are acting as investment 

advisor, the label given to it? 

Mr. ROSENTHAL. No, I did not see any evidence that Renaissance, 

the general partner of the hedge funds, was independent when it 

bought—when it acted to buy and sell stocks for the banks. Renaissance was the general partner of the fund, and I should just say 

in our financial structure, investment funds themselves do not 

have employees or computers or office equipment. They act through 

the general partner, and they incent the general partner to make 

money for them. 

So when Renaissance was managing the stock in the accounts at 

the banks, Renaissance was concerned in buying and selling stocks 

in order to make a lot of money for their partnership. They were 

compensated for that arrangement through fees, directly or indirectly, and they participated in the profits of the fund, which were 

staggering. I did not see any sign that Renaissance was taking into 

account the interests of the bank in buying and selling stocks for 

the account. 

Senator LEVIN. Now, they had the authority to execute trades 

without prior approval. That was in the contract between Renaissance and the banks. They used the banks’ trading execution system to place and execute several hundred thousand trades a day 

to go into that so-called basket account. 

Now, why would it be important then for Renaissance to claim 

that these are recommendations rather than to acknowledge that 

they are actually executing trades in the banks’ so-called basket account? What is the reason they make that claim? 

Mr. ROSENTHAL. Well, a key factor in tax analysis to determine 

who owns an asset is who controls the asset. And to the extent that 

the banks could assert that the hedge funds were not in control of 

the stocks in the account or the buying and selling of stocks in the 

account, that would bolster the argument that the banks and not 

the hedge funds were the owners of those stocks. 

Senator LEVIN. And they put in the contract documents that the 

bank could reject the trades. And would you agree that the reason 

that they put that in there is to give the appearance that the activity is not Renaissance’s but the banks and that the bank is not a 

conduit for Renaissance’s activity? Is that the reason that they 

would put that in a contract document that they had the right to 

reject the trade? 
14 

Mr. ROSENTHAL. Senator, I did not understand that representation when I saw it in the documents. The representation is at odds 

with my understanding of both the facts and the law, including 

Delaware law of partnership. So I cannot say why they made that 

representation—perhaps wishful thinking. It is really hard for me 

to assess why the representation was there. But as a factual and 

a legal matter, I just do not see how Renaissance, the general partner of the hedge fund, was not directing, influencing, controlling 

the buying and selling of stocks in that portfolio. 

Senator LEVIN. Now, Renaissance is the general partner of the 

option holders, Mosel and Badger. These are entities that were 

stated to be the holders of the option. At the same time, Renaissance is the investment advisor to Deutsche Bank and Barclays to 

manage the basket account. The parties assert that Renaissance as 

investment advisor to the bank is independent when it is making 

investment decisions for the banks and is not influenced by the option holders, Mosel and Badger. 

Now, how can Renaissance be independent from the option holders when it is their general partner? 

Mr. ROSENTHAL. I cannot see that. Earlier in the year, the First 

Circuit examined a private equity fund that claimed its general 

partner, in managing its investments, was not acting on its behalf. 

And the private equity fund argued: Ignore the efforts of our general partner; we are not responsible for those efforts for tax purposes. And the First Circuit rejected that analysis, a very important decision, Sun Capital. 

I believe hedge funds, private equity funds, and others take a 

rosy view of what they are engaged in. When a characterization 

helps them, they advocate it. But as a legal matter, I just cannot 

see how when an agent of a fund furthers the fund’s efforts to 

make money and that is the only objective of the fund, how the 

agent can disassociate its responsibilities to the fund and make 

money and assert that it is merely representing the bank when it 

is buying and selling stocks. 

Senator LEVIN. And so it cannot then, as a practical and realworld matter, be independent from the option holders when Renaissance is the general partner for those option holders? 

Mr. ROSENTHAL. Not in my view, sir. 

Senator LEVIN. Why would Renaissance and the banks set up 

that fiction, that the investors in Mosel and Badger are independent of the investment advisor that is making the investment 

decisions for the basket account? Why would they make that claim 

of independence? 

Mr. ROSENTHAL. From a tax point, if that assertion were true, 

that might help the argument that the banks actually owned other 

securities; that is, the investment manager of those securities, 

those stocks, if that investment manager were independent of the 

hedge funds and acting at the direction of the banks, that would 

help the argument that the banks owned the stocks. Again, I do 

not see, either under the facts or the law, how that independence 

could be true. 
15 

1See Exhibit No. 53, which appears in the Appendix on page 654. 

Senator LEVIN. Mr. Rosenthal, would you take a look at Exhibit 

53? 1

Mr. ROSENTHAL. Yes, Senator, I have that exhibit in front of me. 

Senator LEVIN. OK. This is a June 2009 memorandum that 

Barclays wrote to its auditor, PricewaterhouseCoopers, PwC, concerning the deconsolidation of Palomino Limited. 

Now, Palomino is a Cayman Islands entity of Barclays which was 

created to—in my view, at least quite clearly create an appearance 

that Barclays is the owner of the basket account, where all the 

Renaissance trades were located and on which the option was 

based. This is also the same account where the profits that Renaissance earned on its trading done with Barclays was located. So 

that is Palomino. 

Now, this memorandum was written by Barclays Structured 

Capital Markets Group, which was responsible for developing the 

COLT basket option product, and it proposes to deconsolidate, to 

remove Palomino from Barclays financial statements. 

So did you review that document? 

Mr. ROSENTHAL. Yes, I did, Mr. Chairman. 

Senator LEVIN. The memorandum sets out a number of significant facts and conclusions about Palomino and its relationship to 

Barclays and to RenTec that I would like to review with you. First, 

take a look at page 7, starting with paragraph a. 

Mr. ROSENTHAL. Mr. Chairman, can you point—can you say the 

first few words? My document is not paginated. 

Senator LEVIN. Yes, mine is not either, and I do not know where 

the ‘‘page 7’’ came from, but let us—OK. It is the page that starts 

with the heading ‘‘Consolidation Analysis.’’ 

Mr. ROSENTHAL. Yes, I have that in front of me. 

Senator LEVIN. OK. Now, on that page, in paragraph a., it says, 

‘‘Palomino was created solely to enable RenTec . . . to benefit 

(through the Badger Options and the Barclays’ Options) from its 

long-short statistical arbitrage strategy in an efficient manner 

. . .’’ So it was created solely to enable RenTec to benefit. 

Now, if you look at paragraph b., under ‘‘Decision Making,’’ it 

says that, ‘‘As described in Section VII in relation to the IMA, the 

PB Accounts’’—PB, do you know what PB stands for? 

Mr. ROSENTHAL. Prime brokerage. 

Senator LEVIN. ‘‘. . . [prime brokerage] Accounts are controlled 

by RenTec,’’ the key words there being the ‘‘[prime brokerage] Accounts are controlled by Rentec.’’ 

The next paragraph I would like you to look to is under ‘‘Benefits,’’ c., near the bottom of that page: ‘‘RenTec is effectively entitled 

(through the Badger Options and the Barclays’ Options) to 100% of 

the benefits from Palomino’s trading activities less any prime brokerage fees paid to BCI and BCSL’’—those are Barclays—‘‘in respect to the . . . Accounts.’’ Did you follow me on that? 

Mr. ROSENTHAL. Yes, I did. 

Senator LEVIN. They are entitled to 100 percent of the benefits 

from Palomino’s trading activities, Palomino being a Barclays creation. 
16 

1See Exhibit No. 68, which appears in the Appendix on page 747. 

Then on the next page, near the bottom, where it says, ‘‘Conclusion: Following the proposed amendments to the Articles and the 

entry into the Side Letter, RenTec controls the major activities of 

Palomino and is exposed to substantially all significant risks and 

rewards arising from the activities carried out through the [prime 

brokerage] accounts, being the only permitted activities of Palomino.’’ And, again, Palomino is Barclays’ creation. 

Now, if these factual representations to Barclays’ auditors by 

Barclay are true, what does that say about whether the option basket is a true option? 

Mr. ROSENTHAL. If these representations were true, Renaissance, 

the general partner of the hedge fund, controls the basket of stocks, 

and as a consequence, the control is so large that I think one would 

need to conclude that the hedge funds, for which Renaissance is 

acting, own the stocks as opposed to Barclays. And that seems to 

be the point of this memo for accounting purposes. 

Senator LEVIN. And they would not have an option to acquire 

something they already own, presumably. 

Mr. ROSENTHAL. No. I am trying to wrap my mind around this 

fiction of having an option over something you already own. My 

view of the option is it reflects a contractual right to the basket of 

stocks in substance, and I think Pricewaterhouse, or at least 

Barclays in these representations to Pricewaterhouse, agrees with 

my intuition and my belief. And I believe that Pricewaterhouse 

itself ultimately allowed Palomino to be deconsolidated, which I believe signals that Pricewaterhouse thought that all vested control 

was in the hands of the hedge fund and not in the hands of 

Barclays. 

Senator LEVIN. And that it was not an option because they already controlled and owned it. 

Mr. ROSENTHAL. Yes, they, in effect, owned the stock, right. 

Senator LEVIN. Now, I would like you to take a look at Exhibit 

68,1 if you would. 

Mr. ROSENTHAL. OK, I have that exhibit in front of me, yes. 

Senator LEVIN. OK. Now, this is an excerpt from Barclays’ annual report contained in its public filings with the SEC. And if you 

look at Note 41—— 

Mr. ROSENTHAL. I am turning to the back of the document. I only 

see Note 38. 

Senator LEVIN. At the top of the page it says 230, then it says, 

‘‘41 Investments in subsidiaries.’’ It is for 2009. It is Form 20-F. Is 

that what you have? 

Mr. ROSENTHAL. I have a Form 20-F, yes. 

Senator LEVIN. For 2009 of Barclays PLC and Barclays Bank 

PLC. 

Mr. ROSENTHAL. I have that in front of me. Which page is that, 

and where does it start—— 

Senator LEVIN. No, I do not have a page number. We have a 

note. Is that 230 at the top? 

Mr. ROSENTHAL. Oh, here, I found it on the second page, ‘‘41 Investments in subsidiaries.’’ 

Senator LEVIN. And 230 is the page number at the top? 
17 

Mr. ROSENTHAL. I see that, yes. 

Senator LEVIN. Now, if you look down where it says ‘‘41’’ in small 

print there? 

Mr. ROSENTHAL. Yes, I see that. 

Senator LEVIN. It says, ‘‘Entities where the Group’s’’—now this 

is Barclays filing with the SEC, right? 

Mr. ROSENTHAL. It appears to be so, yes. 

Senator LEVIN. OK. And then it says, ‘‘Although the Group’s interest in the equity voting rights in certain entities exceeds 50%, 

or it may have the power to appoint a majority of their boards of 

Directors, they are excluded from consolidation because the Group 

either cannot direct the financial and operating policies of these entities, or on the grounds that another entity has a superior economic interest in them.’’ 

So then it says, ‘‘Consequently’’—and these are the key words: 

‘‘Consequently, these entities are not deemed to be controlled by 

Barclays.’’ And then it lists two entities: one, Palomino Limited. So 

it is representing to the SEC, it seems to me, that Palomino is not 

deemed to be controlled by Barclays. Is that what you read? 

Mr. ROSENTHAL. Yes. 

Senator LEVIN. Now, Barclays is claiming in its public filing that 

it does not control Palomino, which is what you have been testifying to this morning, because it either does not direct the financial 

and operating policies of Palomino or it does not have a superior 

economic interest in Palomino. Based on your review of the evidence that was gathered by this Subcommittee, who does control 

Palomino? 

Mr. ROSENTHAL. Well—— 

Senator LEVIN. I mean, they are representing they do not control 

it. Is that a serious representation? 

Mr. ROSENTHAL. I think the hedge funds through their general 

partner, Renaissance, control the accounts in Palomino, just like I 

believe the hedge funds through their general partner control the 

accounts held directly under Deutsche Bank. And I think that—— 

Senator LEVIN. Is this a serious representation when you tell the 

SEC that you do not control Palomino? 

Mr. ROSENTHAL. I believe so. I suspect it is true, too, but, I—— 

Senator LEVIN. But is it also—I suspect it is true as well. In fact, 

our report says it is true. 

Mr. ROSENTHAL. Yes. 

Senator LEVIN. It is also something they are representing to the 

SEC that they do not control it. 

Mr. ROSENTHAL. Yes. 

Senator LEVIN. Part of their argument is that they do control it. 

I think we may hear that argument this morning. 

But in any event, they claim here that they do not control it, and 

what they are saying is the reason they do not control it is because 

they do not, it says here, they do not direct the financial and operating policies of these entities. They do not control, they say—excuse me. They do not direct the financial and operating policies of 

Palomino and/or another entity has a controlling interest. So is this 

not an acknowledgment in a very significant way to a Federal regulatory body that they do not direct the financial and operating policies of Palomino? 
18 

1See Exhibit No. 68, which appears in the Appendix on page 747. 

Mr. ROSENTHAL. I would say yes, although there is the word ‘‘either’’ here, and I do not quite understand this formulation, ‘‘either 

cannot direct the financial and operating policies . . . or on the 

grounds’’—— 

Senator LEVIN. No, it does not direct. 

Mr. ROSENTHAL. Yes, it is—‘‘or on the grounds that another entity has a superior economic interest in them.’’ In either circumstance—— 

Senator LEVIN. That another entity has a controlling interest in 

them. So on either grounds. 

Mr. ROSENTHAL. That is correct. Barclays is not viewed as controlling Palomino under this disclosure to the SEC. 

Senator LEVIN. All right. And if you look at the next representation for the year—that was 2011. In 2012, are they telling the SEC, 

if you look at—it is the same exhibit,1 2012, do you see there the 

same—it is footnote 38 in this case. 

Mr. ROSENTHAL. Yes, I have footnote 38 in front of me. 

Senator LEVIN. And they say that they are excluded from consolidation. They are not even showing Palomino as being owned by 

them on their SEC form because they do not direct the financial 

and operating policies of these entities or another entity has controlling interest, for one or the other reasons, they are not even 

going to show ownership because another entity has a controlling 

interest or Barclays does not direct the financial and operating 

policies of Palomino. Right? 

Mr. ROSENTHAL. Correct, at the bottom—— 

Senator LEVIN. And that is something you would agree with, 

from what you know. 

Mr. ROSENTHAL. From what I saw independently of the documents, I think this representation to the SEC is correct that Palomino was not controlled by Barclays. If you look to the economic 

and financial activities of Palomino, it was set up as a special purpose entity and only maintained accounts to facilitate the trading 

for Renaissance. And I think that these assertions, quite logically 

so, suggest that Renaissance controls that trading and those accounts, and not Barclays. 

Senator LEVIN. Yes, but at least Barclays sure does not. And that 

is what they have represented to the SEC. The same thing in— 

take a look at the next year, 2013. Here again, Palomino; country 

of registration or incorporation, Cayman Islands again. Can you see 

that is Note 38, this year. Do you see that? 

Mr. ROSENTHAL. Yes, I see the same words there. 

Senator LEVIN. They actually—it is slightly different words. 

Mr. ROSENTHAL. Oh. 

Senator LEVIN. I mean, same impact. They are excluded from 

consolidation. They do not want to even show them as owning this 

because the group, Barclays, does not have exposure to their variable returns, and these entities—that is Palomino—are managed 

by external counterparties and, consequently, are not controlled by 

the group. Same effect, slightly different words. Is that correct? 

Mr. ROSENTHAL. Yes, thank you for highlighting those slightly 

different words. I actually think the only counterparty to Barclays 
19 

here would be the hedge fund. I do not believe that Renaissance, 

the advisor, would be viewed as a counterparty. Normally the term 

‘‘counterparty’’ is used in connection with a derivative, the ones 

who have the economic interest in the contract. So I think these 

words point more directly to the hedge funds. 

Senator LEVIN. Which is what you have testified to. 

Mr. ROSENTHAL. That is how I viewed the arrangement consistent with these descriptions, yes. 

Senator LEVIN. So they are representing to the SEC what you 

say is the real-world situation, that the beneficial owner of that account was Renaissance. 

Mr. ROSENTHAL. Yes, it appears to me that way, yes. 

Senator LEVIN. Year after year after year, that is what they say 

to the SEC. 

Now, the evidence shows that Renaissance on a daily basis made 

hundreds of thousands of these rapid-fire trades. That is an average, by the way, of three per second, using its trading discretion 

that it was given by contract in the banks’ basket accounts. And 

I think you have testified to this in your opening statement, but 

I want to just ask you to expand a bit on it. 

Do you have a view as to—and you talked about a turnover in 

6 months, I believe, was like 97—what was the turnover, do you 

remember? 

Mr. ROSENTHAL. The turnover in 3 months’ time was about 87 

percent. 

Senator LEVIN. And in 6 months, do you have the number? I 

think it was 97, but at any rate—— 

Mr. ROSENTHAL. Something like that. 

Senator LEVIN. Does that give rise to a fundamental or material 

change to the composition of the basket options so that these 

changes to the underlying positions should be deemed exchanges of 

property and, therefore, taxable events under the Code? 

Mr. ROSENTHAL. Yes, I believe so. I believe that that argument, 

though, only holds if the basket contract were respected. I think in 

the first instance, the basket contract combined with the investment management agreements reflect direct ownership of the underlying assets, and, therefore, gains and losses would be recognized at the time that the underlying assets were bought and sold. 

But on the chance that some court might disagree—that there is, 

in fact, a contractual right only to the return and not to the underlying assets—I think that contractual right has been fundamentally changed as the portfolio turns over. And so I think the hedge 

funds would have a very uphill battle to persuade either the IRS 

or a court of law that the gains that they reported as long term 

and deferred really were long term and deferred. 

Senator LEVIN. So this is a second reason why they would have 

a problem with—from a tax perspective—from what the claim of 

the long-term gain is. 

Mr. ROSENTHAL. Yes, a second and independent reason, yes. 

Senator LEVIN. I have a few questions for the GAO, but, we will 

now hear from Senator McCain. 

Senator MCCAIN. I want to thank the witnesses. Could I say that 

there are many people who are watching this hearing, and there 

are many people like me that are not as familiar as you are with 
20 

how this whole system works. So maybe for the record—and, by the 

way, we will have to proceed on the assumption there is no such 

thing as a dumb question in my questioning you. How does this 

thing work? What is the technologically advanced algorithm? They 

employ real smart people. Just for the record, how does this whole 

system work that they have invented which allows them now to 

have nothing but profits throughout the entire time, no matter 

what the rest of the Nation and the world’s economy does? Would 

you, for the record, Mr. Rosenthal or Mr. White, either one or both, 

explain exactly what is taking place here? 

Mr. ROSENTHAL. Well, we are at some handicap. These Renaissance funds were incredibly profitable—— 

Senator MCCAIN. This is a hedge fund? 

Mr. ROSENTHAL. A hedge fund, yes, that buys and sells stocks. 

Senator MCCAIN. Right. 

Mr. ROSENTHAL. It pursues a strategy which has been tremendously successful, and understandably so, the funds were reluctant 

to share exactly what they did. But I think what they did was described as statistical arbitrage, and I am familiar generally with 

what statistical arbitrage entails. Statistical arbitrage entails trying to determine relationships between a couple of different assets 

and determine whether or not the price of one of the assets is out 

of kilter. Too low, you might buy; too high, you might sell. 

And so for instance, you might buy Ford Motor and sell short 

Chrysler depending on the price of steel. Maybe Ford uses steel 

more intensively in its manufacturing process. 

Senator MCCAIN. And that decision is made by really smart people they hire that do—— 

Mr. ROSENTHAL. Really smart people. 

Senator MCCAIN [continuing]. Intensive study and investigation. 

Mr. ROSENTHAL. Really smart people. 

Senator MCCAIN. And what does the use of algorithms—where 

does that enter into it? 

Mr. ROSENTHAL. Well, as I understand the algorithm, in the 

1990’s one of these really smart people, a Ph.D. from Berkeley, created the algorithm which, as I understand it, is a collection of different strategies or pricing signals to determine what to buy and 

what to sell. And throughout, the Renaissance investment advisor, 

which has more than 200 to 250 employees, including 90 Ph.D.s, 

math and science Ph.D.s, continued to tweak the model, search for 

pricing relationships, look for good investment opportunities, and 

they are very successful. They can spot pricing—mispricing that 

may be fleeting, days and weeks, and profit by it. 

Senator MCCAIN. Now, is Renaissance one of the most successful 

of all hedge funds because of this? 

Mr. ROSENTHAL. I believe so, Senator, based on my Google of the 

company. They are tremendously successful, very profitable. 

Senator MCCAIN. So basically they are not fundamentally doing 

anything wrong; it is just they are smarter than a lot of other analysts and hedge funds, etc. 

Mr. ROSENTHAL. Well, at its core, statistical arbitrage is a perfectly sensible and fair strategy to pursue, yes. 
21 

Senator MCCAIN. But the question here is: Are they paying their 

taxes that would be appropriate for the transactions they are engaged in? 

Mr. ROSENTHAL. Not in my view, Senator. In my view, their 

strategies fundamentally are short-term strategies. And at the 

start, Senator, in your opening statement, you described how the 

average investor looks at some of these arrangements and says, 

‘‘That is not fair. I cannot do that.’’ And if you were to look to an 

analogy of what Renaissance funds did to what I, as an average investor might do, I cannot instruct my broker at the end of the year, 

after I have bought and sold stocks—IBM, AT&T and the like-— 

I cannot instruct my broker, ‘‘Please do not send me a 1099 listing 

the individual gains and sales from my stocks. Instead, please send 

me after a year and a day my net profits so that I can treat that 

net profit as a payoff of a long-term investment.’’ 

I cannot do that with my retail broker. My broker sends me 

statements that reflect short-term profits when I pursue a shortterm strategy and long-term gains when I pursue a long-term 

strategy, when I am fortunate enough to have a long-term gain. 

That is not what has happened here. 

Senator MCCAIN. That is not what has happened here. So what 

has happened here? 

Mr. ROSENTHAL. What has happened here, in my view, Senator 

McCain, is that the hedge funds wrapped a derivative around the 

short-term trading strategies, that rather than view the short-term 

trading strategies as being owned and the benefits passing through 

directly as sales occurred, those gains were simply accrued and reinvested in new positions and were only cashed out when the derivative that wrapped itself around the strategy was terminated and 

the gains passed through by the bank to the fund. 

And as I said, the funds took the view that by arranging the 

wrapper, this derivative, around the strategy, that the tax law 

would ignore the short-term nature of the trades underlying the derivative and look only to the longer-term contract. I do not think 

that would withstand judicial scrutiny, Senator. 

Senator MCCAIN. Mr. White, I noticed you want to make a comment on this exchange here. 

Mr. WHITE. Senator, yes, we did not at GAO review this particular transaction. I want to be clear about that. What we did review is IRS’ ability to audit large partnerships, and many of these 

hedge funds, as I said in my statement, are structured as large 

partnerships. What we found, is IRS is hindered in its ability to 

audit these kinds of entities. One of the problems is finding these 

kinds of transactions. If you have a tiered structure, IRS auditors 

have the problem of finding the ultimate source of the income because what they need to do is audit the transactions such as this 

particular transaction that is the example today. 

The other problem that IRS faces is if they do find the transaction and make an audit adjustment, they then have to find all 

the partners in the structure to pass the change through to. 

Senator MCCAIN. So what do we do? 

Mr. WHITE. There are a couple of things that we are looking at. 

We are not done with our work yet. We will be issuing the final 
22 

report in the fall. But there are some options here to simplify the 

audit process for IRS under the TEFRA rules. 

One problem that we cited, the auditors told us repeatedly they 

have problems finding the so-called Tax Matters Partner, the representative of the partnership with whom they deal with in an 

audit. Right now under the law, it is not required that that Tax 

Matters Partner be listed. The Tax Matters Partner, if it is listed, 

may not be a human being. It may be another partnership. And 

IRS auditors told us this can delay their audit work by months. 

And given the statute of limitations, they may run out of time to 

complete an audit. So that is one option. 

Another possibility is assessing the tax at the entity level, at the 

partnership level, and avoiding the problem of having to pass the 

tax through to the partners. 

Senator MCCAIN. But right now, according to you, the IRS is auditing 0.8 percent of the large partnerships in the United States. 

Mr. WHITE. Yes. 

Senator MCCAIN. That is not exactly a deterrent to misbehavior. 

Mr. WHITE. Especially when you compare it to the audit rate for 

large corporations, which is, as I said, 27 percent, 33 times higher 

than 0.8 percent. 

Senator MCCAIN. So, Mr. Rosenthal, we are really talking about 

de facto tax avoidance here. Is that correct? 

Mr. ROSENTHAL. I think that is correct, Senator. That is, we have 

a situation in which the hedge funds engage in very complicated 

transactions, and in this instance in ways that I do not think would 

withstand judicial scrutiny. But having the IRS find the transaction and having the IRS audit the transaction effectively is not 

going on. I believe from a prior GAO report the IRS stumbled 

across these transactions through a tip from the SEC. So there are 

real problems on the audit side from the IRS. 

I would say TEFRA was enacted in 1982, I believe, to simplify 

partnership taxation to make it easier for the IRS to conduct audits 

at the partnership level, yet to provide some information rights to 

the partners, to make sure the partners knew what was going on. 

The TEFRA rules, designed to simplify, in fact have created quite 

a mess. I worked on the reform of the TEFRA rules in 1993 when 

I was at the Joint Committee on Taxation. I think Mr. White is correct that further reform might be desirable. But my personal view 

is that is not the fundamental problem here. 

There are two fundamental problems, in my view: one is these 

derivatives are just so complicated and so opaque that to get the 

IRS to have the resources to sort them through—— 

Senator MCCAIN. Could I interrupt you there on the first one? 

Does that mean you rule out such transactions? 

Mr. ROSENTHAL. No. On the first one on how to view derivatives, 

I think they serve a valuable commercial purpose. Yet I believe 

what we ought to do is require derivatives to be accounted for as 

if they had been sold every year. Chairman Dave Camp of the 

House Ways and Means Committee examined derivatives closely 

and in his tax reform proposals recommended that derivatives simply be marked to market, that is, treated as if they are sold each 

year, and then that income or loss recognized each year. That 

would help immensely to try to neuter the complexity and the dif-
23 

ficulties of the IRS in unraveling these derivative arrangements 

and would, in effect, come very close to the true income from the 

derivatives. And that was the approach that Chairman Camp proposed and then reproposed. I think that was a sensible approach. 

Senator MCCAIN. Your second point? I interrupted you. 

Mr. ROSENTHAL. My second point is it is a question of resources, 

I think, in part to the IRS. As you suggest, Senator, a 1-percent 

audit rate for an increasingly large segment of our economy just invites the most aggressive behavior. And it is unfortunate—I have 

practiced for many years, and I have seen this scenario from so 

many different spots. You can find advisors who will write aggressive opinions; whereas, most advisors would not opine that a transaction works. You can find taxpayers which will take aggressive positions in circumstances in which many other taxpayers would not 

take advantage of a situation that they did not think was appropriate. And, in effect, what you have is the aggressive driving a 

race to the bottom, the competitive pressures amongst professionals 

and amongst taxpayers are only enhanced by the lack of enforcement and regulation by the IRS. And so the situation is very challenging. 

So, again, I would try to think of systemic ways to make the 

audit and the taxation of derivatives simpler, but then you also, in 

my view, need to give the IRS more resources to do their job. 

Senator MCCAIN. Thank you. 

Thank you, Mr. Chairman. 

Senator LEVIN. Thank you. We are near the end of a vote in the 

Senate now, the first of three votes. I am going to run over there 

now and try to catch two votes together, and then I will probably 

just have to miss the third vote, because we are going to come back 

and continue to work through these. But I just want to make it 

clear that you agree, Mr. White, that the IRS has recently experienced budget reductions that do constrain the resources that are 

potentially available for large partnership audits? 

Mr. WHITE. Yes. Its overall resources have been cut. Furthermore, what is going on here is you have this very rapid growth in 

large partnerships. C corporations are shrinking somewhat but not 

enough so that IRS could reallocate resources from those audits, 

which are productive audits. Audits of corporations bring in several 

tens of billions of dollars to IRS. So reallocating resources away 

from those audits to large partnerships does not seem to make 

sense. 

Senator LEVIN. All right. Thank you both. You two are excused. 

We are going to move to our next panel in probably 10 minutes, 

so we will recess for 10 minutes. 

[Recess.] 

Senator LEVIN. The Subcommittee will come back to order. Now 

we will call our second panel of witnesses: 

Martin Malloy, Managing Director of Barclays in London; Satish 

Ramakrishna, Managing Director of Deutsche Bank Securities Inc. 

and Global Head of Risk and Pricing for Global Prime Finance in 

New York; Mark Silber, Executive Vice President, Chief Financial 

Officer, Chief Compliance Officer, and Chief Legal Officer of Renaissance Technologies LLC in New York; and Jonathan Mayers, 

Counsel for Renaissance Technologies LLC in New York. 
24 

1The prepared statement of Mr. Malloy appears in the Appendix on page 111. 

Thank you all for being with us this morning, and thank you for 

the cooperation of the banks and of Renaissance. We appreciate 

that. 

Pursuant to Rule 6, all witnesses who testify before the Subcommittee are required to be sworn, so we would ask you to please 

stand and raise your right hands. Do you swear that the testimony 

you are about to give before this Subcommittee will be the truth, 

the whole truth, and nothing but the truth, so help you, God? 

Mr. MALLOY. I do. 

Mr. RAMAKRISHNA. I do. 

Mr. SILBER. I do. 

Mr. MAYERS. I do. 

Senator LEVIN. We will be using a timing system today. About 

a minute before the red light comes on, you will see the lights 

change from green to yellow, giving you an opportunity to conclude 

your remarks. Your written testimony will be made part of the 

record in its entirety, and please try to limit your oral testimony 

to no more than 7 minutes. 

Mr. Malloy, we will have you go first, followed by Mr. 

Ramakrishna, then Mr. Silber, and then Mr. Mayers. Thank you. 

Mr. Malloy. 

TESTIMONY OF MARTIN MALLOY,1 MANAGING DIRECTOR, 

BARCLAYS, LONDON, ENGLAND 

Mr. MALLOY. Good morning. 

Senator LEVIN. Good morning. 

Mr. MALLOY. I am Marty Malloy, and I currently serve as Managing Director and Head of Barclays’ European Prime Services 

unit. From 1998 to 2008, I headed the equity finance team of 

Barclays’ Prime Brokerage group. In this capacity, I oversaw the 

execution of the COLT transaction with Renaissance Technologies. 

In the last 18 months, I have met with the Subcommittee staff on 

several occasions in an effort to assist your review and analysis of 

the COLT transactions, and I am here today as a further continuation of my and Barclays’ cooperation. 

Barclays and Renaissance first entered into the COLT transaction in the fall of 2002, and they were already a customer of the 

bank at the time. Renaissance proposed aspects of a structure that 

ultimately became COLT in connection with ongoing discussions regarding potentially expanding its business relationship with 

Barclays. Over the past 12 years, Barclays and Renaissance have 

entered into a number of COLT transactions. 

This is a commercial transaction from which Barclays earns fees 

in a number of ways. On options trades like this one, the bank realizes income from the spread on our execution of our principal 

trades. Additionally, Barclays benefited from being able to both 

pledge as collateral and lend out the securities held by Palomino. 

Before putting on the first COLT option and when subsequent 

options were considered and approved, Barclays subjected the 

transaction to an extensive internal review process and consulted 

with both internal and external regulatory and tax experts. The 

COLT transaction, like any transaction, poses certain risks to the 
25 

1The prepared statement of Mr. Ramakrishna appears in the Appendix on page 118. 

bank. In particular, Barclays bears gap risk associated with being 

the holder of the basket of securities. 

For example, over a period of several days in August 2007, this 

portfolio, like others using a statistical arbitrage strategy, suffered 

higher than expected losses. The portfolio eventually rebounded, 

and the losses did not exceed the limit levels that would have triggered an automatic unwind of the transaction. These risks were 

mitigated by features of the transaction, including Barclays’ right 

to unilaterally unwind the transaction if losses exceeded the 

amount of the premium paid by Renaissance on any existing options. There is also a monitoring system to oversee performance of 

the reference portfolio and certain limitations such as concentration 

and skew limits. 

While Barclays had the risks and protections I just described, the 

COLT transaction was unique in at least one important way in 

that it was non-recourse. In other words, unlike other transactions 

in which the bank provides financing, with the COLT transaction 

we cannot pursue legal remedies from Renaissance in the event the 

portfolio suffers losses in excess of the amount of premium paid. 

An issue raised by this Subcommittee is whether historically 

Renaissance has applied the correct tax rate to its earnings from 

the COLT options. The IRS issued generic legal advice in 2010, but 

to my knowledge, the IRS has issued no further guidance or decisions on these transactions. 

Although Barclays feels strongly that this transaction was subject to sufficient and significant internal and external review to ensure it complied with applicable tax laws and regulations, ultimately the question of what tax rate should Renaissance pay is a 

question to be resolved between Renaissance, as the taxpayer, and 

the IRS. 

I hope my testimony has been helpful, and I will do my best to 

answer the Subcommittee’s questions. I should note that although 

I have been involved with many aspects of this transaction over the 

course of its execution at Barclays, I have not been responsible for 

the deal’s day-to-day operations since May 2008. To assist the Subcommittee, the bank has done its best to collect as much information as possible related to this transaction and, therefore, at times, 

my testimony and answers will reflect not my personal knowledge, 

but what I have been informed of by others working at the bank. 

Thank you. 

Senator LEVIN. Thank you very much, Mr. Malloy. 

Mr. Ramakrishna. 

TESTIMONY OF SATISH RAMAKRISHNA,1 MANAGING DIRECTOR, DEUTSCHE BANK SECURITIES INC., GLOBAL HEAD OF 

RISK AND PRICING FOR GLOBAL PRIME FINANCE, NEW 

YORK, NEW YORK 

Mr. RAMAKRISHNA. Chairman Levin, good morning. 

Senator LEVIN. Good morning. 

Mr. RAMAKRISHNA. My name is Satish Ramakrishna. I am Managing Director and Global Head of Risk and Pricing for Global 

Prime Finance in Deutsche Bank Securities. I am currently based 
26 

in the New York office of Deutsche Bank, and I have been at Deutsche Bank for approximately 16 years. 

Before I became a risk manager in 2007, the job that I do now, 

I was an equity derivatives trader. I ran the structured products 

derivatives desk for Deutsche Bank in New York and later ran a 

derivatives desk in London. As a result, I have extensive experience performing quantitative analysis of equity derivatives, including pricing and evaluating the risk profile of various options. My 

colleague Barry Bausano and I have submitted detailed written 

testimony. 

I want now to briefly describe some of the specific features of the 

MAPS product at Deutsche Bank and provide some background on 

how and why we developed what we call ‘‘New MAPS’’ in 2008. Mr. 

Bausano will then provide you with a brief overview of the MAPS 

product in Deutsche Bank. 

MAPS was an option on a trading strategy. The option buyer, a 

hedge fund, paid a premium to Deutsche Bank to purchase the option. If the strategy did not generate gains in excess of the initial 

premium, the buyer simply paid for the costs and benefits of the 

option and received the remaining value in the option at maturity. 

However, if the strategy generated positive returns, the buyer received the amount of those returns, less the costs and fees for the 

option paid to Deutsche Bank. The bank engaged an investment 

advisor affiliated with the option holder to run the trading strategy 

within strict parameters and to purchase in short in the bank’s 

own account the securities or positions that comprised the strategy 

as a hedge to the option. 

While the bank’s exposure under the option was hedged, MAPS 

was not without risk to the bank, particularly absent the controls 

which we put in place. If the value of the securities held in the account fell below the barrier price of the option, the bank bore all 

losses. 

The extent of this risk became clear to me in August 2007, a few 

months after I joined Prime Finance as a risk manager, when 

hedge funds employing a statistical arbitrage, market-neutral 

strategy experienced what has come to be known as the ‘‘quant 

quake.’’ The quant quake demonstrated that such funds were 

riskier than believed because of the high correlation in the positions held by different funds employing similar strategies. 

As a result, in late 2007, I began to consider ways to provide the 

Bank with better protection if the value of the portfolio of securities 

the Bank was holding relating to MAPS suddenly dropped. At the 

same time, those in the bank’s control functions, including legal, 

tax, and compliance, were assessing MAPS in light of ongoing dialog and observations concerning the regulations surrounding derivatives products. Those efforts were merged together as we at 

Deutsche Bank worked to restructure MAPS and develop ‘‘New 

MAPS’’ in 2007 and 2008. 

The MAPS restructuring included a number of changes. Let me 

highlight three of them. 

First, New MAPS included key risk reduction terms that provided the bank with certain rights at declining levels of account 

value and that required the investment advisor to follow a defined 

balanced and liquid investment strategy. 
27 

1The prepared statement of Mr. Silber appears in the Appendix on page 129. 

Second, the New MAPS agreements further provided that the securities traded for each option would be held in separate sub-accounts and the options staggered in maturity for risk purposes. 

Third, New MAPS was changed from an American style to a European style option, which could not be terminated early without 

forfeiting a significant part of the premium. 

In addition to these changes to the product, we took steps to improve internal controls and apply intra-day risk management, thus 

better managing the bank’s risk under New MAPS. I also ensured 

that the revised option price calculation accurately compensated 

the bank for its risks and costs. Pricing was done through the use 

of traditional option-pricing methods, and the strike price was adjusted so that the cost of the option and the financing cost of the 

portfolio were reflected in the strike price of the option. 

In sum, we priced New MAPS as an option, managed it as an 

option, and documented it as an option. We did so because MAPS 

was an option and the bank was compensated for and managed its 

risk accordingly. 

Thank you for this opportunity to speak to you today, and I look 

forward to answering your questions. 

Senator LEVIN. Thank you very much. 

Next will be Mr. Silber. 

TESTIMONY OF MARK SILBER,1 EXECUTIVE VICE PRESIDENT, 

CHIEF FINANCIAL OFFICER, CHIEF COMPLIANCE OFFICER, 

AND CHIEF LEGAL OFFICER, RENAISSANCE TECHNOLOGIES 

LLC, NEW YORK, NEW YORK, ACCOMPANIED BY JONATHAN 

MAYERS, COUNSEL, RENAISSANCE TECHNOLOGIES LLC, 

NEW YORK, NEW YORK 

Mr. SILBER. Thank you. Chairman Levin, and Members of the 

Subommittee, good morning. 

Senator LEVIN. Good morning. 

Mr. SILBER. My name is Mark Silber, and I appreciate the opportunity to present a brief opening statement on behalf of Renaissance. 

Renaissance’s mission is to produce superior financial results by 

adhering to mathematical and statistical models in the design and 

execution of trading strategies. Our equity trading and advisory activities add liquidity to the markets, reduce inefficiencies, and improve capital formation. We have invested billions in the research 

that supports our models, and we have been very successful, but 

we know that past success does not eliminate future risk. 

I want to be clear: Renaissance’s Medallion fund purchased barrier options from Deutsche Bank and Barclays for substantial nontax business reasons. We would have purchased these options regardless of their tax treatment. I can confidently speak to our motivations for buying these options because I have been a part of the 

Renaissance leadership team for over 30 years. 

When we exercised a barrier option held for more than a year, 

we reported any gains resulting as long-term capital gains in accordance with current tax law. We reported short-term capital 
28 

gains on options held for less than a year. If the tax law relating 

to barrier options changes in the future, we will, of course, comply. 

Under current law, derivative instruments permit higher leverage than many other forms of investments. Again, if the rules concerning leverage change, we will comply. 

Medallion purchases barrier options to obtain a combination of 

leverage and loss protection that we have been unable to obtain 

through any other means. This is entirely permissible under current law. The Joint Committee on Taxation has recognized that derivatives are critically important tools in the risk management 

process and that, compared to actually stock ownership, derivative 

contracts typically afford a party much higher leverage than would 

be commercially possible or permitted by relevant margin regulations. 

Our options are not prime brokerage accounts with more than 

normal benefits. They come with a different bundle of rights and 

obligations. Owners of stock in prime brokerage accounts receive 

customer protections in bankruptcy and other benefits that we do 

not. For example, if one of our counterparties were to collapse or 

default, as Lehman Brothers and other large institutions have recently done, we would be a general creditor at the back of the line 

with no guarantee of recovering any portion of the value of the option. We have accepted these trade-offs in order to obtain greater 

leverage and loss protection that is not available in prime brokerage. 

The way in which we have used the barrier options also demonstrates that we were driven by business imperatives. The average holding period of the Deutsche Bank options from 2000 

through 2009 was around 450 days. For Barclays, it was around 

400 days. After the August 2007 Quant Quake, we exercised a 

Barclays option after only a few months, and then did so again in 

2009 during the market turmoil surrounding the financial crisis. 

Today all of the new options that Medallion enters into have terms 

of less than 1 year. 

Like all prudent investors, we were also mindful of the tax consequences of our actions. This is entirely permissible and in no way 

negates the compelling business reasons that led us to enter into 

these transactions. 

As you know, the IRS has been reviewing these options for over 

6 years now. Renaissance has been cooperating fully with that review and is working through the issue within the IRS’s established 

process. Frankly, we wish things would move faster. Ultimately, we 

expect to prevail because we have complied with the law. 

We also note that Congress many years ago gave the IRS the authority, in Code Section 1260, to prospectively change the taxation 

of options like these, and it has not done so. 

We appreciate the opportunity to be here today to explain our 

transaction, and we look forward to your questions. 

Senator LEVIN. Thank you, Mr. Silber. 

Mr. Mayers. 

Mr. MAYERS. Senator Levin, Mr. Silber’s remarks were on behalf 

of Renaissance as a whole, and I will not be making a statement 

separately. 

Senator LEVIN. Thank you. 
29 

1See Exhibit No. 6, which appears in the Appendix on page 274. 

2See Exhibit No. 8, which appears in the Appendix on page 292. 

OK. Let me first ask you some questions, Mr. Silber. In the basket deals with Deutsche Bank, RenTec used two different entities 

to purchase the options: Franconia and then later on Mosel. Franconia was a Bermuda corporation, and it was used by Renaissance 

to be the option buyer in 20 basket deals between 2000 and 2007. 

How many employees did Franconia have? 

Mr. SILBER. None. 

Senator LEVIN. Who controlled Franconia? 

Mr. SILBER. Renaissance as the general partner. 

Senator LEVIN. Now, take a look at Exhibit 6,1 if you would. 

Mr. SILBER. I have that exhibit. 

Senator LEVIN. If you take a look at page 1, it is stated that 

RenTec was authorized without further approval by or notice to the 

client—that is Franconia—to make all investment decisions concerning the account. Is that correct? Do you see that? 

Mr. SILBER. I am looking for it, but I believe that is correct. 

Senator LEVIN. OK. Now, in terms of RenTec’s control over Franconia, if there were any doubt, take a look at the signature page. 

Who signed that agreement for Renaissance? 

Mr. SILBER. I did. 

Senator LEVIN. And who signed on behalf of Franconia? 

Mr. SILBER. I did. 

Senator LEVIN. So you are signing that deal with yourself. More 

significantly, Renaissance is signing a deal with itself, and the 

company is such a shell that you, as an executive officer of RenTec, 

sign all of the papers. 

Now, the next entity RenTec used in these basket deals was 

Mosel. Am I pronouncing that correctly? 

Mr. SILBER. Yes, Senator. 

Senator LEVIN. Mosel was a Delaware partnership and has been 

used by RenTec to be the option buyer in basket options between 

2007 and 2010. It has also entered into all of the short-term deals 

that RenTec and Deutsche Bank have entered into since 2012. How 

many employees does Mosel have? 

Mr. SILBER. None. 

Senator LEVIN. And who controls Mosel? 

Mr. SILBER. We do as general partner. 

Senator LEVIN. Take a look at Exhibit 8,2 if you would. 

Mr. SILBER. Yes, sir. 

Senator LEVIN. This is a copy of the Limited Partnership Agreement for Mosel. RenTec is Mosel’s general partner. According to 

page 6 of the agreement, the general partners, subject to the terms 

and conditions of the agreement, ‘‘shall have complete and exclusive responsibility for managing and administering the affairs of 

the Partnership, and shall have the power and authority to do all 

things necessary to carry out its duties hereunder.’’ Do you see that 

language? 

Mr. SILBER. Yes, Senator. 

Senator LEVIN. OK. Now, look at the signature pages 15 and 16. 

Who signs for RenTec? 

Mr. SILBER. I did. 
30 

1See Exhibit No. 7, which appears in the Appendix on page 129. 

Senator LEVIN. And who signs for all of the partnerships that are 

the limited partners? 

Mr. SILBER. I did. 

Senator LEVIN. Full control by RenTec. RenTec’s general partner 

Mosel is also the agent of Mosel. Is that correct? 

Mr. SILBER. We are the general partner of Mosel. 

Senator LEVIN. Are you the agent of Mosel? 

Mr. SILBER. As general partner, we had all the authority and responsibility for the activities. 

Senator LEVIN. Now, I want to explore some of the fictions that 

I have referred to in some detail, and we are going to do so by looking specifically at the option deals involving RenTec and Deutsche 

Bank. What the bank and the hedge fund want is to create a reality, an alternate reality, in which RenTec can borrow lots of 

money from Deutsche Bank to make millions of short-term trades 

while both avoiding leverage limits and RenTec also claiming longterm capital gains rates. And the vehicle to create that alternate 

reality is a basket option that derives its value from a basket of 

securities that sit in a Deutsche Bank account, but that RenTec 

can change the mix of the assets in the basket as it wishes. 

The idea, however, of a hedge fund holding an option whose 

value derives from an account that that same hedge fund controls 

would be absurd, to have an option on yourself. So to maintain the 

fiction of a real option, RenTec creates an entity that it owns, Franconia, to hold the option. RenTec controls the Deutsche Bank account. The created entity Franconia holds the option on the account. That supposedly sets up a wall between the entity controlling the trades and the entity controlling the option. But on even 

the most cursory examination, that wall crumbles. These two entities are one entity, as we can see from the chart in front of us. 

Now, Mr. Silber, take a look at Exhibit 7,1 if you would. It is a 

confirmation document for one of the basket deals between RenTec 

and Deutsche Bank in 2002. Do you see where the heading there 

is ‘‘Deutsche Bank,’’ and it says, Franconia, it is addressed to Franconia Equities. 

Mr. SILBER. Yes. 

Senator LEVIN. Care of Renaissance Technologies. 

Mr. SILBER. Yes. 

Senator LEVIN. OK. Franconia, again, the RenTec-controlled 

shell, is the option buyer. Deutsche Bank is the seller. 

Now, if you look at one of the representations made in this document on the bottom of page 10, Article (v), there is a representation 

in that article that the buyer—that is Franconia—has made an 

independent judgment of the experience and expertise of the investment advisor. The investment advisor to Deutsche Bank is 

RenTec, who we have already seen is the investment advisor for 

Franconia, wholly owned by RenTec, who owns it and controls it. 

Franconia has no employees. 

Now, how can Franconia be able to make an independent judgment of RenTec? 

Mr. SILBER. I am missing—I am sorry, Senator. I see where the 

seller—— 
31 

1See Exhibit No. 7, page 11, which appears in the Appendix on page 279. 

Senator LEVIN. At the last line, ‘‘The buyer has made an independent judgment of the experience’’—— 

Mr. SILBER. ‘‘. . . and expertise of the investment’’—that is correct. Franconia is an investment vehicle owned by ultimately the 

beneficial owners of the fund, Medallion fund, which was the owner 

of Franconia. RenTec is an individual—is an independent entity 

which acts as Investment Advisor to both Medallion and Franconia. 

Senator LEVIN. Right. So how can Franconia make an independent judgment of the experience and expertise of RenTec? It 

was created by RenTec. 

Mr. SILBER. It was. 

Senator LEVIN. It has no employees. 

Mr. SILBER. That is correct. 

Senator LEVIN. So how does it make an independent judgment? 

Mr. SILBER. We as the—— 

Senator LEVIN. Who makes the judgment at Mosel? 

Mr. SILBER. Renaissance—— 

Senator LEVIN. I am sorry. At Franconia. Who makes the judgment? 

Mr. SILBER. Renaissance acting as the general partner with duties to the—fiduciary duties to its investors, is speaking on behalf 

of those investors with regard to RenTec, the same entity, in its 

role as investment advisor. 

Senator LEVIN. So RenTec is making a judgment on RenTec. 

Mr. SILBER. It is. 

Senator LEVIN. OK. If that is your definition of ‘‘independence,’’ 

I would like to find a dictionary—send me a copy of the dictionary 

that has that kind of a definition of ‘‘independence,’’ making a judgment on yourself. 

So take a look, if you would, please, at page 111 of that same document. And then in the second paragraph there, under ‘‘Investment 

Advisor,’’ it says, ‘‘Other than as provided above, Buyer agrees’’— 

that is Franconia—‘‘that it shall not contact directly the Investment Advisor’’—that is RenTec—‘‘regarding the terms or subject 

matter of this Transaction.’’ 

How is it under any definition conceivable that the Buyer, Franconia, with no employees, will not contact directly the Investment 

Advisor that creates it regarding the terms or subject matter of 

this transaction? How is that possible? 

Mr. SILBER.I agree. I do not understand—that sentence may not 

have been relevant to this transaction. 

Senator LEVIN. But it is highly relevant, trying to create a fictional wall. I am just asking you: How is it conceivable, under what 

definition is it possible that Franconia, with no employees, agrees 

that it will not contact the investment advisor, which is RenTec, regarding the terms and subject matter of this transaction? Would 

you agree that is not feasible, physically? 

Mr. SILBER. In this circumstance, I think you are correct. 

Senator LEVIN. All right. Now, Deutsche Bank in 2008 revised its 

basket option product called ‘‘MAPS,’’ and Mosel then replaced 

Franconia as the option buyer on behalf of RenTec. Please take a 
32 

1See Exhibit No. 27, which appears in the Appendix on page 425. 

look at Exhibit 27.1 If you look at page 21, this is the agreement 

now between Deutsche Bank and Mosel Equities care of Renaissance. This is the confirmation, so-called, for a basket deal in 2009. 

This is after the restructuring of MAPS. There is a representation, 

if you would, on page 21 near the top, end of paragraph (v), the 

‘‘Buyer’’—so now it is Mosel—‘‘agrees that it shall not attempt to 

direct or influence the choice of investments in the Basket.’’ 

The investment advisor to the Deutsche Bank account, the entity 

making the decisions for the trading account, is RenTec. The company controlling Mosel is RenTec. RenTec is the agent of Mosel. So 

how can Mosel represent to Deutsche Bank that it will not attempt 

to direct or influence the choice of investments in the basket when 

Mosel and RenTec are really the same entity? How is that possible? 

Mr. SILBER. Senator, Renaissance is playing two different roles 

in this transaction. With regards to the option, it is recommending 

trades for the reference basket, and with regard to Deutsche Bank, 

we are recommending and initiating trades for their hedge portfolio. 

Senator LEVIN. Would you agree that Mosel and RenTec are the 

same entity? 

Mr. SILBER. They are not the same entity. They are both controlled by Renaissance, but they have different ownership. 

Senator LEVIN. Well, Renaissance controls Mosel. 

Mr. SILBER. Renaissance manages and has control of the activities of Mosel. 

Senator LEVIN. And so Mosel is controlled by Renaissance. 

Mr. SILBER. On an activities basis, that is correct. 

Senator LEVIN. So Mosel is now agreeing it will not attempt to 

direct or influence the choice of investments in the basket, but the 

entity that controls it will. 

Mr. SILBER. I think Renaissance is—— 

Senator LEVIN. Renaissance controls it. 

Mr. SILBER. Renaissance—— 

Senator LEVIN. They are going to make the decisions. 

Mr. SILBER. And when we make the decision—— 

Senator LEVIN. But then Mosel is saying, Mosel will not do it, the 

person that owns us, the entity that owns us is going to do it. The 

problem is it does not say that anywhere here, does it? 

Mr. SILBER. No, it does not. Renaissance does not own Mosel. It 

controls Mosel. 

Senator LEVIN. It controls Mosel. 

Mr. SILBER. So Renaissance—— 

Senator LEVIN. So Mosel is telling Deutsche Bank, we are not 

going to make a recommendation, but the entity, it does not say, 

that controls us is going to make the recommendation, right? 

Mr. SILBER. In its role as advisor to Deutsche Bank, that is correct. 

Senator LEVIN. OK. Now, Mr. Ramakrishna, you signed this document on behalf of Deutsche Bank. And you are familiar with the 

operation of the basket deals. 

Mr. RAMAKRISHNA. Yes, sir. 
33 

Senator LEVIN. Do you think it is possible that Mosel, totally controlled by RenTec, could not be influencing the—— 

Would you agree that RenTec not only influenced the choice of 

investments, it made the decision on investments. Would you agree 

to that? 

Mr. RAMAKRISHNA. I think we did realize that the option buyer 

and the investment advisor are affiliated. 

Senator LEVIN. Not affiliated. That RenTec controls Mosel. You 

knew that. 

Mr. RAMAKRISHNA. We knew there was a relationship. I cannot 

speak to the control feature. It is not something I am an expert on. 

Senator LEVIN. But now that you know that Mosel is owned by 

RenTec, does it make any sense for Mosel to represent to you that 

it is not going to be making any decisions relative to what is in 

that basket? It does not add parenthetically, but the entity that 

owns us is. RenTec controls Mosel. So Mosel is telling you, Deutsche Bank, we, Mosel, we are not going to make any recommendations to you. But what they do not add in that agreement is, the 

entity that owns us is going to make those decisions. Doesn’t that 

change the whole nature of the contract? If they said that, the facts 

are that RenTec owns Mosel. You are told in this contract Mosel 

represents to you, Deutsche Bank, that it is not going to make decisions relative to what is in that basket, right? That is what it is 

telling you. 

Mr. RAMAKRISHNA. Senator, I am not an attorney, and I am sure 

the word ‘‘control’’ means something special. 

Senator LEVIN. It means what it says. You signed the agreement, 

didn’t you? 

Mr. RAMAKRISHNA. Yes, I did, sir. 

Senator LEVIN. Did you understand what you were signing? 

Mr. RAMAKRISHNA. I think I did, yes. 

Senator LEVIN. And did you understand that Mosel, which signed 

the agreement with you, owned by RenTec, representing to you 

that it is not going to make decisions, did you understand that the 

entity that owned it, RenTec, that owned Mosel, was going to be 

making decisions? Did you know that when you signed it? 

Mr. RAMAKRISHNA. We definitely knew that the two were connected—— 

Senator LEVIN. No, but did you know that RenTec—when you 

were told in this agreement—was represented to you that Mosel 

was not going to be making the decisions. Did you realize and understand that RenTec, the party that was making the decisions in 

its agreement with you, owned Mosel? Did you know that? 

Mr. RAMAKRISHNA. I do not think I knew personally if RenTec 

owned Mosel, but I do know that the two were strongly connected. 

Senator LEVIN. Senator Johnson. 

Senator JOHNSON. Nothing right now, Mr. Chairman. 

Senator LEVIN. OK. Let me just ask you, Mr. Silber, the entities 

that were involved in the Barclays-RenTec basket deals were similar to the ones that were involved with the Deutsche Bank-RenTec 

deals. In the deal with Barclays, RenTec used two different entities 

to purchase the basket options. Bass Equities was a Cayman Island 

company that was used by RenTec to be the basket option buyer 

in eight basket deals between 2002 and 2004. Badger was a Dela-
34 

ware partnership and has been used by RenTec to be the option 

buyer in 31 basket options between 2007 and 2012. 

Now, Mr. Silber, you signed all the formation papers for all the 

parties. RenTec controlled Bass and Badger, and RenTec was the 

investment advisor for the Barclays option account, which was held 

in the name of a Barclays special purpose entity called ‘‘Palomino.’’ 

Is that correct? 

Mr. SILBER. Yes, Senator. 

Senator LEVIN. OK. And you were the investment advisor to 

Bass and Badger. Is that correct? 

Mr. SILBER. Yes. 

Senator LEVIN. By the way, Senator Johnson, whenever you are 

ready, let me know. I would be happy to yield to you, because I 

have been going on for some time. 

Senator JOHNSON. Unfortunately, I missed the first part. 

Senator LEVIN. OK. Mr. Mayers, a critical event regarding the 

question of who controlled the bank accounts occurred in 2009 

when there was a change in the Articles of Association of Palomino, 

which is the Bermuda entity that Barclays used to hold the account 

related to the basket transactions. And it was followed by a side 

letter that effectively gave Renaissance power to approve changes 

to Palomino’s Articles of Incorporation. 

So we have a situation here where Palomino’s activities were restricted to those that it was currently engaged in by that side letter. Basically Palomino was restricted to basket option transactions 

with Renaissance and could only use Renaissance as the investment advisor to the Palomino account. 

Mr. Mayers, I believe you told Subcommittee staff that RenTec 

wanted to make sure that it could mitigate as much as possible the 

chance that Barclays could unilaterally undertake some activity 

that could void the investment management agreement and possibly terminate the option because RenTec wanted to preserve the 

access that it had to the leverage financing. Is that correct? 

Mr. MAYERS. Senator, in the context of the discussion with your 

staff which you are referring to, I advised that by the time I got 

involved in the side letter discussions, the reason for them had 

been—it had already been decided that it was going to be done. My 

role at that time was to review the documentation to see how it affected the rights and obligations as far as the option transactions 

were concerned. 

In reviewing those documents, the first thing that I noticed was 

that it did not negatively affect these rights and obligations, and 

as you correctly refer—as you correctly state, I was thinking that 

there may be a benefit in that side letter. I have since gone back 

and can see no way where that benefit can accrue. 

Senator LEVIN. Now, back to Mr. Malloy, Barclays had discussions with Renaissance about changes to the Articles of Association. Is that correct? 

Mr. MALLOY. Yes. 

Senator LEVIN. And the problem was that since Barclays was the 

sole shareholder of Palomino, Barclays could always go back and 

eliminate the restrictions in Palomino’s Articles of Association. So 

in order to ensure that the restrictions on Palomino would stay in 
35 

1See Exhibit No. 55, which appears in the Appendix on page 667. 

2See Exhibit No. 53, which appears in the Appendix on page 654. 

place, RenTec and Barclays entered into a side letter. Would you 

take a look at Exhibit 55,1 please? 

Mr. MALLOY. Yes. 

Senator LEVIN. Now, this side letter, at the second from the last 

paragraph, addressed to you, Mr. Malloy, by Renaissance Technologies, signed by Mr. Silber, stipulated that the amendments to 

Palomino’s articles would not change the obligations and duties 

that Barclays and Palomino had to RenTec regarding the basket 

transactions. In addition, the side letter said the following, and this 

is what I am reading to you from that second from the last paragraph: ‘‘Barclays hereby further covenants to Renaissance that it 

shall not make any amendments or modifications to the Memorandum and Articles of Association of Palomino after the date hereof without first obtaining the prior written consent thereto of Renaissance; provided that the Investment Management Agreement 

has not been terminated by either Palomino or Renaissance.’’ 

So what you do is you give Renaissance veto authority over Palomino’s entire Articles of Association. That is a huge sign of 

RenTec’s control. Not only does it have contractual and functional 

control over the accounts of Palomino; it also now has veto authority over the details of the organization’s charter. 

Mr. Malloy, this was one of the factors that Barclays used to justify the deconsolidation of Palomino in its financial statements in 

2009. Is that right? 

Mr. MALLOY. Yes. 

Senator LEVIN. Now, when Barclays deconsolidated Palomino, 

which means it removed Palomino from its annual financial reports, and when it removed it from its financial statement in 2009, 

Barclays took the position that Palomino is controlled by RenTec. 

Barclays’ reasons for taking this position were laid out in a June 

2009 memorandum that it wrote, Barclays wrote, to its own auditor, Pricewaterhouse. So if you would take a look, please, at Exhibit 

53.2 This is a memorandum that was written by Barclays’ Structured Capital Markets Group, which was responsible for developing 

the basket transactions. 

Now, I reviewed the reasons in depth with the first panel, the 

reasons given, and the full list is, again, available here for all the 

reasons that it represented what it did. So I am just going to summarize the reasons that Barclays gave to its auditor for wanting to 

deconsolidate Palomino. Here are the reasons: 

The trading activities of Palomino are managed solely by RenTec 

such that RenTec can obtain the majority of the benefits from Palomino’s activities; 

The prime brokerage accounts are controlled by RenTec; 

RenTec effectively is entitled to 100 percent of the benefits from 

Palomino’s trading accounts; 

RenTec is exposed to 100 percent of the risks from Palomino’s 

trading accounts. 

And this is the conclusion which you can see to that document. 

It is on page 139764, so that is the Bates number there, do you see 

that? ‘‘Following the proposed amendments to the Articles and the 
36 

1See Exhibit No. 68, which appears in the Appendix on page 747. 

entry into the Side Letter, RenTec controls the major activities of 

Palomino and is exposed to substantially all significant risks and 

rewards arising from the activities carried out through the [prime 

brokerage] accounts, being the only permitted activities of Palomino.’’ 

‘‘Consequently,’’ Barclays—which is BBPLC—‘‘should de-consolidate Palomino from the date these proposed amendments are effective because they give rise to a loss of control.’’ 

So now you are representing—you, being Barclays—representing 

to your auditor that, from the date of those amendments, Barclays 

no longer controls Palomino. Is that correct? That was the representation in that letter to Barclays’ auditor. Is that correct? 

Mr. MALLOY. Mr. Chairman, I think there is a number of 

points—— 

Senator LEVIN. But did I read it correctly? 

Mr. MALLOY. You read the statement that is in there, but I think 

you actually have to look at different aspects of this particular documentation. 

Senator LEVIN. OK. 

Mr. MALLOY. To put it into context, this is a document between 

accountants going back and forth over European accounting standards, and if we take some of the components that you talk about 

where you mention the risks, there are several spots within this 

documentation that actually highlights that, as I mentioned in my 

opening statement, that Barclays is exposed to the gap risk. So this 

is, when we are looking at this particular language, it is from an 

accounting perspective, Mr. Chairman, that they are starting to 

talk about the control component. 

I would observe that control is more a conclusion. If we go back 

to the—— 

Senator LEVIN. Well, what was the conclusion that Barclays gave 

to its auditor? 

Mr. MALLOY. This is a conclusion from an accounting standards 

perspective. Palomino—— 

Senator LEVIN. You mean it did not control? You are saying that 

it controlled it for accounting purposes but not for tax purposes? Is 

that what it says in here? 

Mr. MALLOY. Palomino was deconsolidated for accounting purposes. It was still consolidated, though, for regulatory purposes. 

Senator LEVIN. Well, let us look at the regulatory purposes. Look 

at, if you would, Exhibit 68,1 the statement to the SEC. 

Mr. MALLOY. Yes. 

Senator LEVIN. Your annual report to the SEC in filings, you 

have excluded Palomino from consolidation because Barclays does 

not direct the financial and operating policies of these entities or 

does not have a superior economic interest in Palomino because 

Barclays either cannot direct the financial and operating policies 

or, on the grounds that another entity has a superior economic interest in Palomino. Now you are talking to the regulator, right? 

You are saying we are not going to consider Palomino part of us 

anymore, it is excluded from consolidation. This is what you are re-
37 

porting to the SEC. Is that correct? In Exhibit 68, do you read that, 

on page 230? 

Mr. MALLOY. Yes. 

Senator LEVIN. ‘‘. . . these entities are not deemed to be controlled by Barclays.’’ And what is one of the entities? Cayman Islands-owned Palomino. So now you are talking to the regulators. 

Was that statement true? 

Mr. MALLOY. As I understand it, Mr. Chairman, this is an outcome from the analysis that was done on the accounting, so for the 

accounting standards, under that definition of the accounting 

standards associated with it, yes. I would point out, though, 

that—— 

Senator LEVIN. Yes, what? That the statement was true. 

Mr. MALLOY. I do not know of any factual inaccuracies in the 

memo that was submitted to PwC. 

Senator LEVIN. Well, my question is: Is the representation to the 

SEC that the entities are not deemed to be controlled by Barclays, 

was that a true statement to the SEC? That is my question. 

Mr. MALLOY. Mr. Chairman, I am not an accountant—— 

Senator LEVIN. No, I am asking you whether or not this statement to the SEC was correct. That is all I am asking. It is not an 

accounting statement. It is a factual statement that you made to 

the regulator. ‘‘These entities’’-—now we are talking about Palomino—‘‘are not deemed to be controlled by Barclays.’’ That is a 

very direct question. 

Mr. MALLOY. I am sure the statements that we made to the SEC 

are accurate. I was just pointing out it is from an accounting standard, Mr. Chairman. 

Senator LEVIN. So it is accurate for an accounting purpose, but 

inaccurate for what other purpose? 

Mr. MALLOY. No, I am not suggesting that these are inaccurate 

statements going to our regulators. 

Senator LEVIN. Well, you are saying it was accurate here, but it 

was not accurate for some other purpose. So where was it inaccurate? 

Mr. MALLOY. What I am pointing out is when you are doing some 

of the analysis that are going back, when you start talking about 

some of the language that is associated with it, the language could 

mean different things to different aspects, one from an accounting 

perspective, one from a tax perspective. 

Senator LEVIN. So in other words, you did not tell the SEC that 

we do not control this for SEC purposes, but we are going to claim 

we control it for tax purposes? Did you tell that to the SEC? 

Mr. MALLOY. I am not aware of exactly—— 

Senator LEVIN. Did the SEC refer this to the IRS? 

Mr. MALLOY. I became aware later that it did, yes. 

Senator LEVIN. So take a look at Exhibit 68, 2010, same statement: ‘‘These entities,’’ including Palomino, ‘‘are not deemed to be 

controlled by Barclays.’’ 2011, same statement: ‘‘These entities,’’ 

again Palomino, ‘‘not . . . controlled by Barclays.’’ Year after year 

you are representing to the regulator these entities are not controlled by Barclays. 
38 

But then it is interesting. You say in Exhibit 68—take a look, if 

you would, at the 2013 representation to the SEC. You are saying, 

if you look on the third paragraph under Note 38—— 

Mr. MALLOY. I am sorry, Mr. Chairman? 

Senator LEVIN. Sure, Note 38, Exhibit 68. This is now the 

2013—— 

Mr. MALLOY. OK. 

Senator LEVIN [continuing]. Representation to the SEC, Fiscal 

Year ended December 31, 2013. 

Mr. MALLOY. OK. 

Senator LEVIN. The third paragraph, do you see that? It starts, 

‘‘An interest in equity voting rights,’’ do you see that paragraph? 

Mr. MALLOY. I do. 

Senator LEVIN. And at the end it says, ‘‘However, certain entities 

are excluded from consolidation because the Group does not have 

exposure to their variable returns.’’ And then it says the following: 

‘‘These entities are managed by external counterparties and consequently are not controlled by the Group.’’ Not controlled by 

Barclays. That is, again, Cayman Island-registered Palomino Limited. 

So, again, Barclays does not control it, you are representing, but 

someone else, an external counterparty, manages it. Who is that? 

Mr. MALLOY. I believe what we are referring to here is the structure of the overall option where Renaissance—— 

Senator LEVIN. No, but who is the external—— 

Mr. MALLOY [continuing]. Was the investment manager as part 

of that. But I think it is also worth pointing out, though, Mr. 

Chairman, that we talk about this whole concept, Barclays still 

was 100 percent owner of Palomino. 

Senator LEVIN. Yes, I know that—— 

Mr. MALLOY. We still did all of the capitalization of Palomino. 

We managed all of the financing. We took all of the collateral that 

we had the full rights to use that Renaissance was never even 

aware of. So I think it is important that you look at different aspects of the overall structure to see who is acting in which capacity. 

Senator LEVIN. Yes, I could not agree with you more as to who 

the beneficial owner was of this account, who got the profits and 

losses, who made the decisions on what to buy. All of the key indicators of ownership point right to RenTec. In fact, that is the purpose this account was set up, was to service RenTec. In fact, you 

can make a claim that you represented—that we did not control it 

to SEC, but really we still owned it legally. You claimed that you 

are the beneficial owner of Palomino? 

Mr. MALLOY. We are the beneficial owner of the reference accounts and the asset—— 

Senator LEVIN. No, not the reference accounts. Are you claiming 

that you are the beneficial owner of Palomino? 

Mr. MALLOY. Palomino is a 100 percent wholly owned subsidiary 

of Barclays. 

Senator LEVIN. Do you claim you are the beneficial owner of the 

account that Palomino ran, of that basket account? Do you claim 

to be the beneficial owner of that basket account? 

Mr. MALLOY. Yes, we are the beneficial owner of the assets in 

that account. 
39 

Senator LEVIN. OK. Now, for each of the options, for more than 

10 years, Renaissance used Barclays’ software system, right? 

Mr. MALLOY. Yes. 

Senator LEVIN. It gave direct access to the stock market. RenTec 

executed tens of millions of trades per year in Barclays’ Palomino 

accounts. Renaissance received the stock dividends from all those 

trades as part of the option profits. It was charged commissions 

and trading costs by Barclays for each of the transactions that it 

executed. It was charged finance fees by the bank to borrow shares 

for its short selling activity in the Palomino account. It was 

charged a financing fee by the bank on the amount that it used for 

leverage in the account. Renaissance even received the rebates 

from stock exchanges for the orders using Barclays’ execution system that it sent to the stock exchange. Is that true, what I just 

said? 

Mr. MALLOY. In general, yes. 

Senator LEVIN. Now, when Renaissance sends a marketable 

order using your software system to the stock market, 30 million— 

or, I guess—yes, 30 million a year between the two banks, about 

15 million per bank. It is executed in a microsecond, is it not? In 

a second or less? Orders are executed—— 

Mr. MALLOY. The order—— 

Senator LEVIN. In microseconds. 

Mr. MALLOY. Right, again, just to maybe back up and explain 

how it worked. 

Senator LEVIN. OK. And the same was true, Mr. Ramakrishna, 

for Renaissance activities at Deutsche Bank. Is that correct? 

Mr. RAMAKRISHNA. Did you say microseconds? 

Senator LEVIN. Yes, these orders were executed in microseconds. 

Mr. RAMAKRISHNA. Usually—I mean—— 

Senator LEVIN. There are 15 million of these orders a year at 

your bank, right? 

Mr. RAMAKRISHNA. Yes. The orders were sent through our slower 

system initially, which was in the range of a few milliseconds. 

Microseconds is a thousand times smaller, so not on that level. 

Senator LEVIN. And who placed the orders? 

Mr. RAMAKRISHNA. They were placed by RenTec. 

Senator LEVIN. Renaissance. 

Mr. RAMAKRISHNA. Yes in Deutsche Bank’s name. 

Senator LEVIN. In your name. And, Mr. Malloy, did Renaissance 

receive all the profits from the trading reflected in the Palomino accounts when it closed out the account? 

Mr. MALLOY. Renaissance via the option did get the performance 

of the overall portfolio, yes. 

Senator LEVIN. OK. Was the same true, Mr. Ramakrishna, for 

Deutsche Bank? 

Mr. RAMAKRISHNA. Sorry. I think I missed exactly what—— 

Senator LEVIN. OK. Let me repeat the question. Did Renaissance 

receive all the profits from the account which was run by Deutsche 

Bank? So here we are talking about Deutsche Bank’s account, 

which held the stocks which were directed and ordered by RenTec. 

Did RenTec have most of the risk for those stocks? 

Mr. RAMAKRISHNA. RenTec had the risk up to the premium that 

they paid for the option. 
40 

Senator LEVIN. Exactly. 

Mr. RAMAKRISHNA. Beyond that, Deutsche Bank took all the risk. 

Senator LEVIN. You never took a loss on any of these purchases, 

did you? 

Mr. RAMAKRISHNA. Honestly, Senator, we did not take a loss on 

any of these accounts owing to proactive risk management. 

Senator LEVIN. I understand—— 

Mr. RAMAKRISHNA. We had other trades—— 

Senator LEVIN. But there were 30 million buys in these two 

banks, and you guys did not take a loss on any of those buys, right? 

Mr. MALLOY. No, we did not take a loss on—— 

Senator LEVIN. So you have 15 million buys ran through you to 

this account, profits and losses all belong to RenTec, they did the 

ordering, and you guys did not lose a penny on any of 30 million 

buys, and that was all RenTec’s risk, right? 

Mr. RAMAKRISHNA. Senator, there was a lot of careful selection 

of—— 

Senator LEVIN. I know it is carefully done. I am asking you, did 

you lose a penny on any of 15 million buys? 

Mr. RAMAKRISHNA. No. 

Senator LEVIN. Did you lose a penny on any of 15 million buy? 

Mr. MALLOY. No. That is not to say we did not have risk, though, 

Mr. Chairman. 

Senator LEVIN. I understand the risk that you are claiming. I am 

just saying you did not—— 

Mr. MALLOY. No, we did not. 

Senator LEVIN. For 10 years, tens of millions of buys, you did not 

lose a penny on any of the buys. I understand the risk you took, 

which never panned out. You never lost on any of that risk. But, 

nonetheless, that is not my question. 

Now, Mr. Malloy, isn’t it the case that for the options, the COLT 

options, that were written on a basket of securities that were held 

by Palomino and that RenTec determined the composition of and 

the overall investment strategy, is that the case? They determined 

the composition of the basket and the overall investment strategy. 

Mr. MALLOY. Yes, they made the decisions of what to purchase 

and sell. 

Senator LEVIN. The options were written on the basket of the securities that were held by Palomino. Is that correct? 

Mr. MALLOY. Yes. 

Senator LEVIN. OK. To both you, Mr. Malloy and Mr. Ramakrishna, your banks’ profits from the options came from financing 

and transaction fees. Is that correct? 

Mr. RAMAKRISHNA. Senator, we charged in excess of what we 

would normally charge for financing and transaction fees. 

Senator LEVIN. But that is where your profits came from. 

Mr. RAMAKRISHNA. The revenues came from that, yes. 

Senator LEVIN. And, Mr. Malloy? 

Mr. MALLOY. Yes, we also were able to—in this particular transaction, we had profits that came from the ability of the use of the 

collateral. 

Senator LEVIN. Right. 

Mr. MALLOY. We could use that for securities lending, and that 

also was as part of the revenue stream. 
41 

Senator LEVIN. Right. Did the banks, either of your banks, from 

these tens of millions of trades that were executed every year in 

your accounts for the option basket and from the billions of dollars 

of profits earned in those accounts, did your banks receive any of 

the profits from the trading activity after you deducted what was 

owed to Renaissance? 

Mr. MALLOY. No. The trading activity that occurred, the account 

would be up or down, losses or gains on any individual day. But 

Barclays did not receive any of the performance, no. 

Senator LEVIN. Is that true, Mr. Ramakrishna, with your bank? 

Mr. RAMAKRISHNA. Mr. Chairman, the—— 

Senator LEVIN. Is what he said true with your bank? 

Mr. RAMAKRISHNA. The payoff of the option was indeed the—— 

Senator LEVIN. No. I am just asking you whether it’s true? If you 

cannot answer, it is OK. What he has just said, was that true with 

Deutsche Bank? 

Mr. RAMAKRISHNA. I would like to just qualify it with one extra 

statement, which is that, for instance, when you have a trade from 

a customer, you may have crossing profits because you are able to 

cross internally. That sort of profit would not be recognized as Renaissance’s profit. That would be Deutsche Bank’s profit. But, otherwise, the account determined what the option value was, which is 

what Renaissance got back. 

Senator LEVIN. Now, to both of you, Renaissance is using the 

bank’s trading execution system to place and execute by itself, several hundred thousands trades a day that go into the basket account. The banks do not even get involved. Renaissance has direct 

access to Barclays’ and Deutsche Bank’s trading platforms to place 

orders. These orders go out directly to the exchanges in microseconds or seconds. If they are marketable orders, they get executed 

immediately. 

Renaissance was purportedly your investment advisor, but they 

were given by contract discretionary authority to execute trades so 

they could execute trades, which they did, by the millions in the 

banks’ Palomino accounts and the banks’ account without prior approval of the bank. Is that correct, Mr. Malloy? They could execute 

the trades without prior approval? 

Mr. MALLOY. No. 

Senator LEVIN. They could not? 

Mr. MALLOY. No. 

Senator LEVIN. Did you approve 15 million trades during these 

years? 

Mr. MALLOY. No. What we did is you have to have a process that 

puts in place—— 

Senator LEVIN. You approve the process. 

Mr. MALLOY. No, if I could—— 

Senator LEVIN. Sure. 

Mr. MALLOY [continuing]. There is actually a process that actually goes in place. As you rightly pointed out, there are a lot of 

transactions that are going through there, so your ability to look 

at that, you look at the accession-based processes. So what we had 

in our particular systems is we had—in this particular transaction, 

there was a disproportion, and the majority of the trading activity 

had to be done through our infrastructure so we had control of 
42 

that. We have the ability to block that on a name-by-name basis. 

We have the ability to put that in a restriction as far as the overall 

notionals. And we monitor the basket as it is going intra-day. And 

that is not to say that on the next day, even though it is going from 

a—in a fashion of quick execution after the fact, and we have done 

that several times, where we did not like a particular security 

through restriction and the like and asked them to take it out. 

Senator LEVIN. All right. How many times did that happen? 

Mr. MALLOY. On the restrictions of names? That is on a daily 

basis. 

Senator LEVIN. No. How many times did you veto anything in 

their purchases? 

Mr. MALLOY. From an execution point of view, I do not recall. It 

was after the fact, Mr. Chairman. 

Senator LEVIN. All right. How about Deutsche Bank? 

Mr. RAMAKRISHNA. Senator, the way in which Renaissance traded through us, given that they are a technologically forward organization, we did not intercept every single trade and approve or disapprove it. We had very strict guidelines in place for portfolio composition, diversity and liquidity, and the concentrations in various 

names, plus we had a restricted list. All this was supplied to them 

at an updated point of time several times a day, and they would 

have to conform to those restrictions. So we did not at any point 

actually go back and revisit trades because we did not have to. 

Those trades would be banned by definition. 

Senator LEVIN. All right. You had already set what the conditions were, but 30 million trades went through without you stopping any of them from going through? 

Mr. RAMAKRISHNA. We had exception policies in places, which 

would basically make sure that trades that should not go through 

did not go through. 

Senator LEVIN. OK. And so you had about 15 million trades that 

went through without exception. Is that correct? 

Mr. RAMAKRISHNA. We had lots of trades that went through after 

they passed the vetting. 

Senator LEVIN. How many trades were stopped by your guidelines? 

Mr. RAMAKRISHNA. Given that the restrictions put in place prevented trades that should not have gone through, all I can tell you 

is that Renaissance took great pains to make sure that we had no 

exceptions, and we had very few exceptions. I cannot think of any 

in my own tenure there. 

Senator LEVIN. OK. So of the 15 million trades at your bank, the 

guidelines did not stop any of those trades. Within your guidelines, 

they made the decision, they made the purchases and sales. Is that 

correct? 

Mr. RAMAKRISHNA. Exactly. They never violated the guidelines, 

yes. 

Senator LEVIN. OK. So your guidelines never stopped any of 

these millions and millions of decisions that they made. Is that 

true also with Barclays, Mr. Malloy? 

Mr. MALLOY. What I would say, Mr. Chairman, is we actually 

stopped the transactions that did not fit into the guidelines ahead 

of time. 
43 

Senator LEVIN. Yes, well, in other words, you said guidelines—— 

Mr. MALLOY. No, but we restricted the names before they even 

got into execution. 

Senator LEVIN. And how many times did that happen over the 

years? 

Mr. MALLOY. Every day. 

Senator LEVIN. So you actually stopped them from making purchases every day. 

Mr. MALLOY. We would block in our system—— 

Senator LEVIN. Your system blocked, you said? 

Mr. MALLOY. Yes. 

Senator LEVIN. OK. If it was inside of the investment guidelines, 

all of the trades would go through. Is that correct? 

Mr. MALLOY. If it was inside the investment guidelines, yes. 

Senator LEVIN. OK. And you would agree—— 

Mr. MALLOY. As a normal course of business, because it reduced 

our risk associated with the hedge. 

Senator LEVIN. I understand. But you had agreed on what those 

guidelines were. 

Mr. MALLOY. Yes. 

Senator LEVIN. OK. So they had agreed to guidelines, and they 

lived by the guidelines. And if they did not, the purchase would 

have been caught. 

Mr. MALLOY. I am sorry? 

Senator LEVIN. The purchase would have been prevented, the 

transaction would have been prevented if it violated the guidelines. 

Mr. MALLOY. Yes. 

Senator LEVIN. And that would be by their own algorithm or 

something you put in place? 

Mr. MALLOY. It depends upon what aspect of the investment 

manager that they are referring to. 

Senator LEVIN. OK. Did they basically buy those 15 million 

shares that went through your system through an algorithm? 

Mr. MALLOY. As I understand it, yes. 

Senator LEVIN. Is that true with you, too, Mr. Ramakrishna? 

Mr. RAMAKRISHNA. I believe that they used an algorithm, yes. 

Senator LEVIN. Was that their algorithm? 

Mr. RAMAKRISHNA. The algorithm that they used decided what 

they wanted to buy and sell. 

Senator LEVIN. Whose algorithm was it? 

Mr. RAMAKRISHNA. It was presumably Renaissance’s algorithm. 

Senator LEVIN. Do you know whose algorithm it was? 

Mr. MALLOY. Renaissance, as I understand it, yes. 

Senator LEVIN. Did they share their algorithm with you, by the 

way? 

Mr. MALLOY. They have not. 

Mr. RAMAKRISHNA. Sadly, no. 

Senator LEVIN. Decidedly not. 

Mr. RAMAKRISHNA. No, they have not. 

Senator LEVIN. Senator Johnson. 

Senator JOHNSON. Thank you, Mr. Chairman. I apologize for 

missing the earlier panel and the testimony here. 

We are obviously drilling down to some fairly detailed levels, and 

I would kind of like to just pull back a little bit and try and get 
44 

a little bit simpler understanding of something that is probably 

pretty complex. 

But to followup on the Chairman’s questioning there in terms of 

basically hiring a manager to manage a portfolio within the banks, 

do you have examples of other managers that you use similarly to 

manage certain funds in your banks, Mr. Malloy? 

Mr. MALLOY. In this particular transaction, we only had one 

counterparty that we did this in, and within the prime brokerage 

space, no, I am not aware of another example of that. 

Senator JOHNSON. No, I am talking about just other managers do 

other mutual funds that your bank holds for your customers. Is 

there another—do you hire another manager to do something similar? I am not saying really high-frequency trading like this based 

on an algorithm, but just a manager to manage portfolio stocks for 

your customers. 

Mr. MALLOY. I really could not speak across the bank. I would 

not be surprised if there was one, but I am just not aware of one. 

Senator JOHNSON. Mr. Ramakrishna, does Deutsche Bank have 

something similar to that? 

Mr. RAMAKRISHNA. In the Asset Management Division, we definitely have external managers who are often hired to manage portfolios for customers. We have a couple of external managers on our 

own platform, which are going to be phased out very soon, which 

manage money for us. 

Senator JOHNSON. Other than the frequency of the trades and 

the number of stocks they buy and sell, is there any real difference 

between how your relationship is with those managers versus with 

Renaissance? 

Mr. RAMAKRISHNA. They also run portfolios of similar, maybe a 

little smaller size, with a large number of names. And they may 

not use the same algorithms or the same frequency of trading, but 

they do trade a lot. 

Senator JOHNSON. But, again, your guidelines in terms of how 

you deal with those managers, is it similar or identical? In other 

words, you hire them to manage a particular fund you make available to a potential customer, and you are selling a mutual fund 

that could be bought and sold with a capital gain attached to it? 

Mr. RAMAKRISHNA. I would characterize the rules they use for 

Renaissance as much tighter. We had constraints on liquidity, concentration, size of position, which stocks they could actually trade, 

sector concentrations, country concentrations, that we would never 

put on any other manager because at some level that is their strategy and if they want to run it, it is fine. The reason we ran these 

portfolios this way was because of the risk we ran in this portfolio. 

Senator JOHNSON. But, again, the guidelines in terms of how you 

manage your manager, the different guidelines, but is it similar— 

I mean, you have a similar—you have guidelines that you work 

with the manager to manage your portfolio of stocks or bonds or 

options or whatever type of investment vehicle there is? Again, I 

am just trying to find out if there is something similar to Renaissance in terms of structure, not necessarily in terms of frequency 

of trade? 

Mr. RAMAKRISHNA. Not really, no. 

Senator JOHNSON. So this is pretty unique? 
45 

Mr. RAMAKRISHNA. It is pretty unique, yes. 

Senator JOHNSON. As I was studying this and getting prepared 

for this, what this appears to be is a question of form over substance. Is that a basically true statement, Mr. Malloy? The form of 

how you structured this deal versus the actual substance of what 

is happening? 

Mr. MALLOY. Again, the way in which this was structured is as 

an option. It has those features in it. I do not know if I actually 

understand the question. 

Senator JOHNSON. Let me just ask: To what extent has this been 

adjudicated in any kind of tax court or through the IRS? I have 

some memorandums passed. Is this really being looked at? Do you 

think this is going to eventually go before a tax court? 

Mr. MALLOY. As I understand it, there is an ongoing—it is a better question, obviously, for probably Renaissance, but—— 

Senator JOHNSON. OK. 

Mr. SILBER. Thank you, Senator. Yes, as I said in my opening 

statement, the IRS has been—we have been in conversation with 

the IRS for about 6 years now on this. They have had full transparency. They understand the structure very well, and we are in 

the midst of that process. We are hopefully going into the appellate 

level of the IRS shortly. 

Senator JOHNSON. So has this gone before a tax court at all? You 

are saying the appellate level. You are still working through—— 

Mr. SILBER. Not yet, no. We are still working through the administrative process. 

Senator JOHNSON. OK. Mr. Malloy, an earlier question by the 

Chairman was really talking about control. And there are different 

levels of control based on tax versus accounting standards versus 

potentially SEC. How many different bodies do you have to comply 

with in terms of determining whether, for example, Barclays would 

control a particular entity? 

Mr. MALLOY. I think it really comes down to what aspect of the 

transaction you are going to. From my lens, when I think about 

control, it is who ultimately has—who is the beneficial owner of the 

assets and whether you can actually use the assets. 

Senator JOHNSON. The point I am trying to make is, grappling 

with some of the different issues, there are criteria to determine 

whether the IRS is going to take a look at this is a controlled entity 

or versus whether accounting standards determine that. 

Mr. MALLOY. Right. 

Senator JOHNSON. And they are not always the same, correct? 

Mr. MALLOY. Correct, although you have the advantage there— 

I am neither an attorney or a tax attorney, but as I understand it, 

yes. 

Senator JOHNSON. Mr. Ramakrishna, can you speak to that? How 

many different bodies do you report to that you have to try and 

comply with in terms of determining whether or not a particular 

group is under control of your bank? 

Mr. RAMAKRISHNA. Senator, as a risk manager and the person 

who would take the first hit if there were a loss in this portfolio, 

it was very clear to me that we had ultimate control because we 

were the ones who were going to bear the brunt of a catastrophic 

loss. We did give the investment manager permission to trade in 
46 

the account, and we had an option whose delta was essentially 

managed by this investment manager. But it was very clear to me 

that if there was a loss, it would be on my head and on Deutsche 

Bank’s head, not in the investor’s court. 

So in my mind at least, control was very settled. I do not know 

the legal ramifications of what control means for other organizations. I am sure there are accounting and tax standards. I do not 

know them, though. 

Senator JOHNSON. OK. Mr. Silber, do you know the point I am 

trying to make here? I am not trying to judge whether or not this 

was a controlled entity. I am just trying to point out, in trying to 

comply with whether it is the tax authority or whether it is the 

SEC, whether it is just basic accounting standards, how many different bodies provide different standards and different criteria for 

determining—to make these judgments whether something is truly 

an option or whether it is under your control? Do you understand 

the point I am making? 

Mr. SILBER. Yes, I understand, Senator. We are nowhere near as 

diverse an entity as either of the banks here, but we ourselves are 

subject to multiple levels of regulatory review and filings, many 

of—from the IRS, the SEC, we are regulated by the CFTC, we have 

ongoing filings, many of which have different definitions. You used 

the example of ‘‘control.’’ That is important in some of the filings 

and not in the others. Even something as simple as assets under 

management, under our U.S. general accounting statements filings 

versus Form PF, which we now file with the SEC regularly, definitions of similar words will differ across—for different purposes for 

different agencies. Tax standards usually are different than accounting standards. Those are the ones that I am most familiar 

with. But we have a variety of reporting regimes that we file 

under, and the definitions are not always consistent. 

Senator JOHNSON. So suffice it to say it is very difficult to comply—— 

Mr. SILBER. We do our best—— 

Senator JOHNSON [continuing]. With all the different standards, 

with all the people you report to? 

Mr. SILBER. I would not say it is difficult. We put a lot of time 

into it. We do comply. But sometimes it is very hard to compare 

two sets of filings and try and get them to reconcile. They may be 

using different definitions. So as I say, I use the example of assets 

under management, for example, should be fairly straightforward 

English. Different purposes will give different results, and both will 

be correct under the applicable rules. 

Senator JOHNSON. So I am really trying to drill down in terms 

of what is the appropriateness of these transactions of this relationship. Really you are going to have to—if it is a tax issue, you 

really have to go through the tax authorities and take a look at exactly their rules versus if we are going to go through accounting 

standards and reporting, you are going to have to go through the 

SEC and figure out—it is a little more difficult in a setting like this 

where we are talking sometimes at cross purposes about different 

standards between different agencies. Is that basically correct? 

Mr. SILBER. Yes, I believe so, Senator. 
47 

Senator JOHNSON. OK. I have no further questions, Mr. Chairman. 

Senator LEVIN. Mr. Ramakrishna, I think you just said that 

Deutsche Bank gave permission to Renaissance to trade in Deutsche Bank’s accounts. Is that correct? 

Mr. RAMAKRISHNA. Yes. 

Senator LEVIN. You just said that? You gave them the right to 

execute—— 

Mr. RAMAKRISHNA. In Deutsche Bank’s name, yes. 

Senator LEVIN. In your name. 

Mr. RAMAKRISHNA. In Deutsche Bank’s name, yes. 

Senator LEVIN. OK. And is it not true that they had discretionary—‘‘they’’ being RenTec—has total discretion, full discretion 

and authority without obtaining your prior approval to manage the 

investment in the trading of the accounts? Is that true? Both of 

you. 

Mr. RAMAKRISHNA. I will take it first, sir. Given the constraints 

we had placed on them, which were maintained on their systems 

electronically, under those constraints, yes. 

Senator LEVIN. All right. The constraints were agreed to, and 

then within those constraints, Deutsche Bank had the full discretion and authority without obtaining your prior approval to manage the investment and trading of the accounts. Is that correct? 

Mr. RAMAKRISHNA. Yes. Under those constraints, yes. 

Senator LEVIN. Is that also true for Barclays? 

Mr. MALLOY. Subject to the Investment Management Agreement, 

but—— 

Senator LEVIN. Of course. 

Mr. MALLOY. Yes. I would not characterize it, though, as ‘‘unfettered.’’ We looked at those transactions, we monitored it in real 

time. 

Senator LEVIN. How about full discretion? 

Mr. MALLOY. I would not say ‘‘full’’ because it was subject to restrictions under the Investment Management Agreement. 

Senator LEVIN. You would or would not? 

Mr. MALLOY. I would say it was restricted under the Investment 

Management—— 

Senator LEVIN. Would the words ‘‘full discretion’’ be accurate? 

Mr. MALLOY. Subject to the Investment Management Agreement, 

they had discretion. 

Senator LEVIN. Full discretion? 

Mr. MALLOY. Not unfettered discretion, Mr. Chairman. 

Senator LEVIN. I am just asking you, did they have full discretion 

or not within the agreement that you reached? 

Mr. MALLOY. If they stayed within the guidelines, they could 

make the transactions. They had full discretion to deploy the portfolio—— 

Senator LEVIN. I asked you three times did they have full discretion within those guidelines? 

Mr. MALLOY. Yes. 

Senator LEVIN. You hesitated to say ‘‘full discretion.’’ 

Mr. MALLOY. The only reason I hesitated is because we do have 

some restrictions within there and I can step in. That is my only 

hesitation—— 
48 

Senator LEVIN. OK. Other than they had to operate within the 

guidelines, they could buy and sell anything they wanted, right? 

Mr. MALLOY. Yes. 

Senator LEVIN. And they did 15 million times, right? 

Mr. MALLOY. There was a lot of activity that went through the 

accounts, yes. 

Senator LEVIN. OK. And that was within the guidelines they had 

full discretion and authority, is that right, without your prior approval, within those guidelines? 

Mr. MALLOY. Within the guidelines. 

Senator LEVIN. That you two had agreed to. 

Mr. MALLOY. Yes. 

Senator LEVIN. OK. Is that true with your bank, Mr. Ramakrishna? 

Mr. RAMAKRISHNA. Yes. 

Senator LEVIN. OK. Now, if they operated within those agreed 

upon guidelines that they had agreed to with you, since they had 

full discretion, the decisions as to what to buy and sell as theirs. 

Is that correct, Mr. Malloy? 

Mr. MALLOY. Yes. 

Senator LEVIN. Mr. Ramakrishna. 

Mr. RAMAKRISHNA. It is probably hundreds tens of thousands, 

hundreds of thousands [securities] that their algorithm could 

choose. Within those guidelines, that decision was theirs. Is that 

correct? 

Mr. RAMAKRISHNA. Yes, sir, about 6,000 securities. 

Senator LEVIN. Six thousand? 

Mr. RAMAKRISHNA. Securities, roughly, yes. 

Mr. MALLOY. Yes. 

Senator LEVIN. OK. So within those guidelines, among those 

6,000 securities, it was their discretion, and they were not making 

recommendations to you then, were they? Within those guidelines? 

Mr. MALLOY. They would make the recommendations and then 

execute on our behalf to hedge—— 

Senator LEVIN. Well, wait a minute. I thought they had full discretion within those guidelines. 

Mr. MALLOY. They had the full discretion to make the—— 

Senator LEVIN. Buy and sell within those guidelines. 

Mr. MALLOY. To buy and sell within the guidelines. 

Senator LEVIN. That they had agreed to. 

Mr. MALLOY. Yes. 

Senator LEVIN. OK. If they were not within those guidelines 

when they made those decisions, using your platform, that was not 

a recommendation to you. They made the decision within those 

guidelines, within that number of 6,000 securities or whatever it 

was, that was their discretion, their decision. Is that correct? 

Mr. MALLOY. Yes. We still had the legal right, although, as we 

discussed—— 

Senator LEVIN. You did not exercise it. 

Mr. MALLOY. We did not exercise it until after the fact in many 

instances, yes. 

Senator LEVIN. Mr. Silber, you have been listening to this testimony about when you operated within those guidelines, as you had 
49 

1See Exhibit No. 36, which appears in the Appendix on page 482. 

agreed to, that you had full discretion under the contracts. Is that 

correct? 

Mr. SILBER. Within the guidelines, yes. 

Senator LEVIN. All right. And if you operated within the guidelines, you considered that that decision as to what to buy and sell 

was yours. You had full discretion? 

Mr. SILBER. Yes. 

Senator LEVIN. And your algorithm that you put together would 

pick and choose. is that correct? 

Mr. SILBER. Was put together by our group. 

Senator LEVIN. By your group. 

Mr. SILBER. Yes. 

Senator LEVIN. The algorithm would pick and choose—— 

Mr. SILBER. That is correct. 

Senator LEVIN [continuing]. Among those 6,000 securities? Is 

that about what it was? 

Mr. SILBER. Approximately. 

Senator LEVIN. But within those guidelines, it was not for you to 

make a recommendation, it was for you to make a decision as to 

what to buy. Is that not true, your algorithm? 

Mr. SILBER. We had the authority to act—to make the decisions 

for the reference basket, which was the important criteria for options. At the same time, we were making the recommendations, 

which I referred to as almost always executed for the hedge account for the banks. 

Senator LEVIN. So if you operated within the guidelines—— 

Mr. SILBER. Yes, then it would be—— 

Senator LEVIN. Then it was your decision. 

Mr. SILBER. For the initial investment, yes. 

Senator LEVIN. The initial investment. What does that mean? 

Mr. SILBER. It meant that the banks in either case had the ability—I do not know if they ever exercised it—to have changed the— 

de-levered—I am sorry, excuse me, wrong language—to remove 

their hedge or to hedge in a different manner. The purpose of our 

exercise—— 

Senator LEVIN. They had the authority, but they never exercised 

it. Within those guidelines that you had agreed to, there may have 

been 6,000 securities that you had the right, the discretion to buy 

and sell, within those guidelines? 

Mr. SILBER. They were placed into the account. 

Senator LEVIN. And the decision was yours within those guidelines? 

Mr. SILBER. Our firm’s, yes. 

Senator LEVIN. Your firm’s, of course. 

Mr. SILBER. Yes. 

Senator LEVIN. So they are not a recommendation to them. Within those guidelines. Would you agree? 

Mr. SILBER. Correct. 

Senator LEVIN. OK. Mr. Malloy, take a look, please, at Exhibit 

36.1 This is a Product Proposal for Project COLT, which is the 

project we are talking about. That is the basket option project. This 

was dated May 28, 2002. Your name is on it, so I assume you are 
50 

familiar with it. And if you look at page 3, if you look at page with 

Bates number 2-1-2-546. 

Mr. MALLOY. Yes. 

Senator LEVIN. At the bottom. Let me read this to you: ‘‘COLT’’— 

that is what we are talking about here—‘‘is targeted’’—this is your 

product proposal, 2002. It is ‘‘targeted at those Funds with a high 

proportion of US individual investors, stable year-on-year returns 

and strategies involving short-term trading. This gives rise to significant short-term capital gains for the investors regardless of 

whether or not they are invested in the fund for the shorter or 

longer term.’’ 

Then it says on page 4, ‘‘COLT provides an after-tax benefit to 

these investors through the conversion of their return from the 

fund from short-term capital gains (taxed at 39.6%) to long-term 

capital gains (taxed at 20%).’’ Did I read that right? 

Mr. MALLOY. Yes, you did. 

Senator LEVIN. Now, was this a product being proposed for Renaissance? 

Mr. MALLOY. The initial structure for COLT, yes, the initial and 

subsequently only client was Renaissance. 

Senator LEVIN. All right. So what you were in your proposal saying is that this proposal had an after-tax benefit through a conversion of their return from the fund from short-term capital gains 

taxed at 39.6 percent to long-term capital gains taxed at 20 percent. That was obviously an important part of your proposal. 

Mr. Silber, back in 2002 this was a pretty important part of their 

proposal. Hey, this is for Renaissance, we can convert, short term 

into long term, it is like magic. Do you still say that was not something that crossed your mind back in 2002? 

Mr. SILBER. I am not saying that it did not cross our mind. Once 

we had initiated the structure with Deutsche Bank, we came to realize that they had the potential for a favorable tax treatment, so 

we certainly were aware of it. But I cannot speak to this internal 

Barclays document. 

Senator LEVIN. And wasn’t this part of the proposal that was 

made to you? 

Mr. SILBER. No, I have never seen this—— 

Senator LEVIN. No, I am not saying that this is written, but 

when you were discussing this with Barclays, are you saying that 

they never mentioned to you the tax benefits in 2002? 

Mr. SILBER. Actually, I believe we actually proposed a structure 

of this to Barclays. They did not market it to us. 

Senator LEVIN. OK. 

Mr. SILBER. Deutsche Bank did market the structure to us. It 

was a product that they had already used, and they had not used 

the tax benefits as a selling point at all. 

Senator LEVIN. Deutsche Bank never did. And Barclays was marketing this to you, weren’t they? 

Mr. SILBER. We actually had suggested it to them, so—— 

Senator LEVIN. After you suggested it to them, because you already had one with Deutsche Bank, where did they get this language from? 

Mr. SILBER. I do not know. 
51 

1See Exhibit No. 42, which appears in the Appendix on page 557. 

2See Exhibit No. 37, which appears in the Appendix on page 496. 

Senator LEVIN. You do not know. So this was never discussed 

with Barclays? 

Mr. SILBER. Not to my knowledge, no. 

Senator LEVIN. OK. Barclays, did you ever discuss this with Renaissance? It was in your proposal. Did you ever discuss the tax benefits with Renaissance in 2002? 

Mr. MALLOY. I will answer the question two ways, Mr. Chairman. I was not personally involved with covering the account at 

that particular time, but as you can—so I am not sure exactly what 

the first exchange was. I subsequently did cover the account from 

a relationship perspective. But it was clear within the bank, 

though, that there was a tax benefit along with other benefits in 

the structure. 

Senator LEVIN. So take a look, if you would now, at Exhibit 42.1

This is a product approval memorandum for the same basket option. We are looking at page 3. 

Under the term ‘‘Economics and Economics Drivers. Fund Benefit. US individual investors of the Fund would obtain a post-tax 

benefit if the Call Option is exercised after 12 months because all 

of the gain on the Call Option would be treated as a long-term gain 

for US tax purposes and would therefore be taxed at 15% as opposed to 35%.’’ 

Does that look familiar? 

Mr. MALLOY. I am not familiar with this particular document. 

Senator LEVIN. But is this a Barclays document? 

Mr. MALLOY. Yes. It appears to be, yes. 

Senator LEVIN. And take a look, please, at Exhibit 37,2 that 

Barclays wrote to its regulator, and this is on page 1, on ‘‘Background,’’ right in the middle of page 1: ‘‘This transaction is designed to provide hedge funds with a tax-effective means of undertaking the business and for Barclays it would generate both a 

structuring fee and additional volume for the prime brokerage business.’’ So you told your regulator back in 2002 this was designed 

to provide hedge funds with a tax-effective means. 

Mr. MALLOY. We were very transparent in this particular transaction—— 

Senator LEVIN. You were very aware of it. 

Mr. MALLOY. And very concerned as—and one of the advantages, 

there was a tax advantage along with others, yes. 

Senator LEVIN. Now, Mr. Ramakrishna, when MAPS was restructured in 2008, was Deutsche Bank concerned that the old 

structure, the MAPS structure, would not be respected as a derivative or more specifically as an option for tax purposes? Was that 

one of your concerns in 2008? 

Mr. RAMAKRISHNA. Mr. Chairman, my initial concern was purely 

devoted to risk issues. There was a parallel conversation going on 

between lawyers in tax and legal, which I was not privy to, which 

I gather developed around restructuring the transaction. It is probably a—— 

Senator LEVIN. Was there a question in these conversations with 

your tax people, that there was a concern that the old MAPS, the 
52 

old approach, might not be respected as a derivative or it might not 

be respected as an option for tax purposes? Was that a concern? 

Mr. RAMAKRISHNA. I have no idea, Mr. Chairman. 

Senator LEVIN. OK. But if it were not respected as a derivative, 

then it would lose the tax benefits that was offered. Is that correct? 

Mr. RAMAKRISHNA. I presume so, yes. 

Senator LEVIN. OK. And that benefit was turning short-term capital gains into long-term capital gains. Is that true? That is what 

the tax benefit was? 

Mr. RAMAKRISHNA. That was the tax benefit, yes, sir. 

Senator LEVIN. OK. And are you saying, again, to make sure I 

understand your answer, that one of the reasons that this was restructured was to address the concern over the tax benefit, that it 

was one of the reasons? Is that what you said? Or you do not 

know? 

Mr. RAMAKRISHNA. I do not know. The reason I was involved was 

because of a risk reason that I raised. 

Senator LEVIN. All right. You heard conversation about concerns 

as to whether or not there would be a tax benefit under the old 

structure, you heard conversations about that? 

Mr. RAMAKRISHNA. Certainly not, Senator. 

Senator LEVIN. Did you ever have conversations with a man 

named Brocksmit? 

Mr. RAMAKRISHNA. Yes, sir. 

Senator LEVIN. And in that conversation, did you indicate to him 

that tax reasons were one of the reasons for this structure? 

Mr. RAMAKRISHNA. Senator, I had several conversations—— 

Senator LEVIN. No, in one of the conversations. 

Mr. RAMAKRISHNA. Yes. The conversation I had was most about 

explaining the risk issues. 

Senator LEVIN. I understand. That is not my question. 

Mr. RAMAKRISHNA. Yes. In the course of the conversation—— 

Senator LEVIN. Did you tell him that one of the concerns was 

whether or not there would be a tax benefit under the old structure? Did you tell him that? 

Mr. RAMAKRISHNA. In the conversation he mentioned that as a 

benefit, and I agreed with him, and I said there were other reasons, too. 

Senator LEVIN. That is fine. You agreed with him in that conversation. 

Mr. RAMAKRISHNA. Yes, sir. It was one part of a large conversation. 

Senator LEVIN. A minute ago you said you had never heard of 

that. 

Mr. RAMAKRISHNA. I think you had asked me if I had heard anybody from tax and legal talk about it. I did not do that. This was 

also a conversation—— 

Senator LEVIN. Well, who is Mr. Broeksmit? 

Mr. RAMAKRISHNA. He was head of risk and optimization of—— 

Senator LEVIN. So you heard from someone in your own division 

that there was a concern about whether the tax benefit would really be there under the old structure. 

Mr. RAMAKRISHNA. Mr. Broeksmit was not in charge of—— 

Senator LEVIN. Not in charge of. What division was he with? 
53 

Mr. RAMAKRISHNA. He was at a central level head of risk across 

the bank. 

Senator LEVIN. Fine. 

Mr. RAMAKRISHNA. Across the corporate bank. 

Senator LEVIN. Fine. Did you hear from him that there was a 

concern about whether the tax benefit would be there under the old 

structure? 

Mr. RAMAKRISHNA. I did not hear it from him that he was concerned about tax risk. 

Senator LEVIN. You had a conversation, you said, with him in 

which the question as to whether the tax benefit would—is solid in 

the old structure. 

Mr. RAMAKRISHNA. No, that was not a conversation I had. It was 

a conversation which said what are the benefits of the transaction, 

at which point I gave him the benefits, and he mentioned tax benefit as one of them. 

Senator LEVIN. So you heard him say—— 

Mr. RAMAKRISHNA. He did say tax benefit was one of the benefits, yes. He knew as well as I did. 

Senator LEVIN. We thank you, all four of you. We appreciate your 

being here, and your cooperation with our Subcommittee, and this 

panel is excused. 

Let me now call our last panel of witnesses for today’s hearing: 

Gerard LaRocca, the Chief Administrative Officer, Americas, for 

Barclays, Chief Executive Officer for Barclays Capital Inc., in New 

York; Barry Bausano, President and Managing Director of Deutsche Bank Securities and Co-Head of Global Prime Finance, in 

New York; and Peter Brown, the Co-Chief Executive Officer and 

Co-President of Renaissance Technologies in East Setauket, New 

York. 

We thank you for being with us today, and we also thank you 

and those with whom you work for, for your cooperation with this 

Subcommittee. 

Pursuant to Rule 6, all the witnesses who testify must be sworn 

before this Subcommittee, so please stand and raise your right 

hand. Do you swear that the testimony you are about to give will 

be the truth, the whole truth, and nothing but the truth, so help 

you, God? 

Mr. LAROCCA. I do. 

Mr. BAUSANO. I do. 

Mr. BROWN. I do. 

Senator LEVIN. Were you here before? Are you familiar with our 

timing system we have been using? Well, if not, let me repeat it. 

About a minute before a red light comes on, you are going to see 

the lights change from green to yellow. That gives you a chance to 

conclude your remarks. Your written testimony is going to be printed in the record in its entirety. Please try to limit your oral testimony to no more than 7 minutes. 

Mr. LaRocca, let me call on you first. 
54 

1The prepared statement of Mr. LaRocca appears in the Appendix on page 114. 

TESTIMONY OF GERARD LaROCCA,1 CHIEF ADMINISTRATIVE 

OFFICER, AMERICAS, BARCLAYS, CHIEF EXECUTIVE OFFICER, BARCLAYS CAPITAL INC., NEW YORK, NEW YORK 

Mr. LAROCCA. Good afternoon, Senator. 

Senator LEVIN. Good afternoon. 

Mr. LAROCCA. I am Gerard LaRocca, and I serve as the Americas 

Chief Administrative Officer of Barclays Bank. You have asked us 

to assist the Subcommittee in its review of certain issues related 

to the COLT transaction. 

As with other complex transactions, from the outset of COLT, the 

bank undertook a comprehensive review and approvals process to 

ensure that the transaction received proper scrutiny. This included 

review by the bank’s tax, regulatory, risk, and legal departments, 

as well as a review by at least seven different law firms over the 

life of the transaction. Barclays disclosed its participation in the 

transaction to our auditors and regulators, here in the United 

States and the U.K. We did not take this matter lightly and were 

ultimately comfortable engaging in the transaction. 

The question raised by the Subcommittee seems to be: What is 

the proper tax rate to apply to profits earned by Renaissance 

through the exercise of its options?’’ This is a matter to be handled 

between Renaissance, as a taxpayer, and the IRS. It is my understanding that the question has not been answered definitively. 

You have asked me to discuss the impact of the 2010 IRS advisory memorandum known as a GLAM, including the bank’s decision last year to change the tenor of the options going forward. All 

of this did not occur in a vacuum. Like other financial institutions, 

Barclays has faced numerous challenges in recent years. Our bank 

has endeavored to meet these challenges head on, and at times resolving them has resulted in significant changes, both in process 

and in personnel at the bank. Today we have new leadership and 

feel strongly we are moving in the right direction, transforming the 

way we do business. 

In 2012, Barclays had launched Project Mango, an internal review of our investment banking operations, and also commissioned 

Sir Anthony Salz to conduct an independent review of Barclays. Finally, Barclays embarked on the TRANSFORM program, an internal review aimed at establishing the conditions necessary for the 

bank’s long-term success, including the implementation of the 34- 

point road map for change detailed in the Salz Report. 

As part of TRANSFORM, the bank adopted five overarching tax 

principles that we now apply to all transactions. These are: 

Transactions must support genuine commercial activity; 

Two, they must comply with generally accepted custom and practice; 

Three, they must be of a type that taxing authorities would expect; 

Four, they must only involve financially sophisticated customers; 

And, five, transactions must be consistent with our purpose and 

values. 
55 

1The prepared statement of Mr. Bausano appears in the Appendix on page 118. 

It is against this backdrop that we considered what impact, if 

any, the GLAM should have on our participation in the COLT 

transaction. 

In December 2010, Renaissance made a routine request to enter 

into a new option. In light of the GLAM’s recent publication and 

prior to moving forward, we consulted with Renaissance and again 

with our own legal advisors regarding the impact of the GLAM. 

After extensive internal consideration and consultation with external advisors, Barclays approved the issuance of a new option. We 

agreed to continue to monitor relevant IRS announcements going 

forward. 

In February 2013, the bank issued its new tax principles and undertook a review of all existing transactions, including COLT. As 

noted, one of the principles provides that Barclays will not structure transactions of a type different than tax authorities would expect. The end result of our review was a decision that, going forward, we would limit the tenor of any new COLT options to a period of 11 months. The IRS had not made a final determination as 

to the appropriate tax treatment. However, the bank made a 

proactive and voluntary choice to shorten these options to ensure 

we met the tax authorities’ expectations. This was a decision that 

brought the transaction into conformity with our newly adopted tax 

principles. By doing this, the bank committed not only to following 

specifically applicable laws, but also to refrain from engaging in 

transactions that, while legal, might not meet the expectations of 

the relevant tax authorities. 

Therefore, any questions the Subcommittee may have about 

these transactions do not relate to the Barclays of today or the 

Barclays of the future. These are transactions from the past, about 

which we are awaiting a final determination as to the proper tax 

treatment. 

Thank you for the opportunity to provide this testimony. I look 

forward to answering the Subcommittee’s questions. 

Senator LEVIN. Thank you very much. 

Mr. Bausano. 

TESTIMONY OF M. BARRY BAUSANO,1 PRESIDENT AND MANAGING DIRECTOR, DEUTSCHE BANK SECURITIES INC., COHEAD OF GLOBAL PRIME FINANCE, NEW YORK, NEW YORK 

Mr. BAUSANO. Good afternoon, Chairman Levin. 

Senator LEVIN. Good afternoon. 

Mr. BAUSANO. My name is Barry Bausano. I am currently President of Deutsche Bank Securities Inc. and Co-Head of Global Prime 

Finance Business. After growing up in a suburb of Detroit and 

coming east for college, I am now based in the New York office of 

Deutsche Bank and has worked there for approximately 12 years. 

My colleague Satish Ramakrishna has already discussed some of 

the specific features of our MAPS options. I want to provide you 

with an overview of the product and Deutsche Bank’s involvement 

with it. 

I would note that Mr. Ramakrishna and I have submitted written testimony, which I would request be entered into the record, 
56 

and you can find a more comprehensive discussion of these subjects 

in the written testimony. 

Senator LEVIN. It will be made part of the record. 

Mr. BAUSANO. Thank you. 

Derivative financial instruments are a critical component of global finance as they allow participants to alter risk and the distribution of returns relative to holding the underlying investments. 

Deutsche Bank strongly believes that it acted at all times responsibly, indeed proactively, in its ongoing consideration of MAPS in 

the light of evolving views regarding the regulatory landscape surrounding derivative products, and that its conduct demonstrates a 

strong commitment to be well within the bounds of the law. 

MAPS was not a tax-motivated product. It provided clients with 

significant non-tax advantages as compared with other products. 

Let me briefly discuss what I view as the three most significant of 

those advantages. 

First, Deutsche Bank was comfortable providing the option buyer 

with greater leverage at the fund level than it would have allowed 

in a traditional prime brokerage relationship. 

Second, the MAPS option limited the client’s downside risk to the 

premium it paid to purchase the option. 

Third, the client could pursue its trading strategy anonymously 

because any market transactions associated with the trading strategy were made in Deutsche Bank’s own name. 

On the bank side of the equation, MAPS provided the bank with 

greater visibility, risk controls, and operational protections relating 

to the underlying trading activity than existed for a prime brokerage account. The bank imposed significant constraints on the investment advisor strategy, required the advisor follow a defined 

and balanced investment strategy. 

The bank also had specific contractual rights to require the investment advisor to reduce its leverage and for DB to take over the 

management of the portfolio and to assume control and liquidate 

the positions being traded by the investment advisor if the value 

of the portfolio fell beneath certain benchmarks. The bank owned 

the securities in its own account and had complete visibility, ownership rights and controls over that account, and the bank earned 

a premium for selling the option. 

The MAPS product does involve symmetric and economic exchange of risks and benefit for both the bank and its client. 

I understand the IRS expressed concerns with a particular type 

of barrier option contract and the potential for associated long-term 

capital gain treatment as set forth in an IRS Generic Legal Advice 

Memorandum, or GLAM, issued November 12, 2010. Importantly, 

in 2010, Deutsche Bank was not entering into any barrier option 

contracts as described in the GLAM. Indeed, the bank had ceased 

offering a product based on agreements similar to the ones described in 2008, when, in consultation with outside counsel, we 

independently restructured our MAPS product. Despite having no 

knowledge of any IRS intention to release the GLAM, Deutsche 

Bank proactively addressed virtually every factor considered in the 

GLAM approximately 2 years before its issuance. The restructured 

Deutsche Bank product is now referred to as ‘‘New MAPS.’’ 
57 

1The prepared statement of Mr. Brown appears in the Appendix on page 129. 

It is important to note the limited scope and use of New MAPS 

at Deutsche Bank. From 2008 through today, Deutsche Bank has 

entered into New MAPS options with only one client, Mosel LP, a 

RenTec affiliate. And even with that one client, Deutsche Bank entered into only one long-term option following the IRS’ issuance of 

the GLAM. That option was negotiated prior to the GLAM and entered into on the business day following its issuance, and only after 

Deutsche Bank conferred with outside counsel to confirm that New 

MAPS was not the same structure as the product described. Indeed, and importantly, shortly after issuance of the GLAM, Deutsche Bank reassessed its participation in barrier option contracts. 

Despite its belief that New MAPS was in compliance with applicable laws and regulations, Deutsche Bank decided that it did not 

wish to risk being associated with any controversy over the tax 

treatment of MAPS. Therefore, it decided to cease entering into any 

New MAPS transactions with a duration of more than 1 year. 

Deutsche Bank has affirmatively and proactively undertaken 

steps to ensure compliance with applicable tax and securities laws 

and regulations. While the Subcommittee has raised important 

questions about tax policy in this area, we did our best at all times 

to ensure compliance with the laws and regulations as written and 

understood by the subject matter experts at the time. I do note that 

it is a widely accepted principle, one that the Subcommittee report 

acknowledges, that tax consequences differ among various financial 

instruments. New MAPS, which was an option, was treated by 

Deutsche Bank in accordance with the tax rules relating to financial derivatives at all times. 

In sum, with respect to MAPS, Deutsche Bank initiated steps to 

ensure that its conduct was well within the boundaries set by applicable legal requirements. As of today, neither the IRS nor any 

court or regulator has found that a New MAPS option or, indeed, 

any Deutsche Bank MAPS option, did not qualify as a derivative 

for tax, securities, or any other purpose. Deutsche Bank believes 

strongly that it acted appropriately in entering the New MAPS options when it did and that it acted conservatively and responsibly 

when it decided to stop entering them for business reasons after 

the issuance of the GLAM. 

Thank you for this opportunity to speak to you today, and I look 

forward to answering your questions. 

Senator LEVIN. Thank you very much. 

Mr. Brown. 

TESTIMONY OF PETER F. BROWN,1 CO-CHIEF EXECUTIVE OFFICER, AND CO-PRESIDENT, RENAISSANCE TECHNOLOGIES 

LLC, EAST SETAUKET, NEW YORK 

Mr. BROWN. Good afternoon, Chairman Levin. 

Senator LEVIN. Good afternoon. 

Mr. BROWN. My name is Peter Brown. I am the co-CEO of Renaissance Technologies, a company that manages investment portfolios with computer programs that are based on complex models 

of the financial markets. 
58 

As my colleague Mark Silber discussed in his testimony, barrier 

options have been extremely important to Renaissance’s business 

objectives by providing our fund with both leverage and loss protection. These go hand-in-hand, because when trading with leverage, 

a single mistake can be disastrous for our firm. 

On an unlevered basis, our models would produce modest returns 

with very low volatility. Therefore, we can responsibly increase our 

leverage to produce stronger returns. But in so doing, we must protect ourselves from the catastrophic losses that might occur should 

we encounter a Black Swan event outside of our previous experience. The world is littered with financial institutions that have 

failed after putting too much trust in their models—institutions 

that did not account for the unknown unknowns. 

We are determined that Renaissance not suffer such a demise. 

The barrier options we use provide precisely the protection we 

need. 

While we have been well aware of Black Swan risks since Long 

Term Capital Management collapsed in 1998, for me personally the 

wake-up call came on March 13, 2000. Up to that point, our models 

had been performing exceptionally well. Then the dot-com bubble 

burst, and in a very short period we took very large losses. We 

worked non-stop for days trying to understand where things had 

gone wrong. 

It turned out that we had positions in Nasdaq stocks which our 

models thought were hedged by positions in NYSE stocks. It just 

never occurred to us or to our models that these markets could diverge so rapidly. Not having slept for days and being incredibly distraught by the losses, I offered to resign, but my boss at the time 

rejected my offer, telling me, ‘‘You are now far more valuable because you now know never to put your full faith in a model.’’ 

Six months later, we entered into our first barrier option. Not 

only do these options protect us from model failures, they also protect us from programming errors like the one that led to the demise of Knight Capital in 2012. If we did not have loss protection, 

then with over a million lines of code in our system, we too could 

face the risk of massive losses from a simple software bug. 

I have not yet had the opportunity to review your staff’s report 

as closely as I would like. I appreciate the time it has taken to prepare and the policy issues it raises. But I will note that I was surprised to see the report characterize the risk from which these options protect us as ‘‘small,’’ apparently because of our historical 

track record. 

I have worked with extraordinary scientists my entire career, 

building large and complicated models that are embedded in large 

and complicated computer programs. If there is one lesson I have 

learned, it is that models and computer programs can go horribly 

wrong. Mortgage models at Fannie Mae and investment banks had 

spectacular 50-year track records until the 2008 subprime crisis. 

For 35 years, money market funds were considered risk-free, until 

the Reserve Primary Fund broke the buck. The list goes on and on. 

The single biggest mistake we can make is to be so confident in 

our models that we have no fear of the risks we did not see coming. 

That is why loss protection is so important to us. 
59 

1See Exhibit No. 53, which appears in the Appendix on page 654. 

We understand there is an active debate on how best to reform 

the Tax Code and that proposals are being made to mark all derivatives to market and to tax all capital gains at the same rate. 

I will only point out that if there were no rate differential between 

long-term and short-term capital gains, the Tax Code would be far 

simpler, far more certain, and far more fair. 

I want to thank you for the opportunity to speak on behalf of 

Renaissance, and I am happy to answer any questions you may 

have. 

Senator LEVIN. Thank you very much, Mr. Brown. 

Mr. LaRocca, will you please take a look at Exhibit 53? 1

Mr. LAROCCA. I have it in front of me, Senator. 

Senator LEVIN. Thank you. This is the document we have been 

talking about this morning. It is the representation that Barclays 

made in 2009 to PricewaterhouseCoopers, PwC, its independent 

auditor. And the representation was here, if you look near the bottom of page 64—those are the last two letters in the Bates numbers—the conclusion is that, ‘‘RenTec controls the major activities 

of Palomino and is exposed to substantially all significant risks and 

rewards . . .’’ Was that statement true? 

Mr. LAROCCA. I see the language, Senator. There is qualifying 

language in the PwC memo. 

Senator LEVIN. I mean, it does not change that conclusion. This 

is the conclusion. You have got all the qualifiers in advance, ahead 

of the conclusion, and then it says here, ‘‘RenTec controls the major 

activities of Palomino . . .’’ Palomino is the entity that you guys 

created. 

Mr. LAROCCA. It controls the trading activities, Senator. 

Senator LEVIN. It says it ‘‘controls the major activities.’’ 

Mr. LAROCCA. I know what it says, Senator, but it controls the 

trading activities. The securities lending is controlled by Barclays. 

The financing is controlled by Barclays. So they control—— 

Senator LEVIN. But the major—— 

Mr. LAROCCA. They did control a major activity. That was their 

role, investment manager, Senator. 

Senator LEVIN. Right. So they controlled the major activities. 

This is what was represented to PwC. It is exposed to substantially 

all significant risks. Was that true? 

Mr. LAROCCA. Up to the premium, Senator. 

Senator LEVIN. I am just saying it is exposed to substantially all 

significant risks. I know there was a risk after the premium was 

used. We know that. It never was reached, but we know what the 

risk was. Ten years it never was reached, but still, theoretically it 

could be reached, and you guys protected against even that possibility. That is OK. You have got a right to protect yourself. When 

you tell your auditor that—substantially all significant risks and 

rewards arising from the activities are RenTec’s, my question is: 

Was that true? That is my question. 

Mr. LAROCCA. Senator, it is true that RenTec controlled the trading activities and controlled the substantial risk. That is why we 

were able to deconsolidate Palomino, Senator. 
60 

1See Exhibit No. 68, which appears in the Appendix on page 747. 

Senator LEVIN. It was not control the substantial risk. It was exposed to substantially all significant risks. That is what was written. Was that true? 

Mr. LAROCCA. With the exception of gap risk, Senator, that is 

correct. 

Senator LEVIN. OK. So substantially all significant risks were 

taken by RenTec. 

Now, you then made a report—‘‘you’’ being Barclays—made a report annually to the SEC, and if you will take a look at Exhibit 

68,1 you will see those reports. They are the past 5 years. And in 

that report, you stated that Barclays does not control Palomino. 

Were you here this morning when we went through these? 

Mr. LAROCCA. Senator, I heard the discussion this morning. 

Senator LEVIN. Take a look at Exhibit 68, if you would, then, 

starting with page 230. This was a note to the account file with 

SEC for the year ending December 31, 2009. And what you told the 

SEC, if you will look at the end of the first paragraph in Note 41, 

‘‘these entities’’—you are referring to the Cayman Islands-incorporated Palomino, is one of the two entities you are referring to— 

‘‘are not deemed to be controlled by Barclays.’’ Was that true when 

you told that to the SEC? 

Mr. LAROCCA. Yes, Senator, for accounting purposes that is 100 

percent true. 

Senator LEVIN. And did you tell the SEC that you really do not 

mean it for other purposes? 

Mr. LAROCCA. Senator, I do not know what specifically was said 

to the SEC. It does not surprise me that these regulatory filings 

are consistent with the correspondence that we laid out in PwC. 

That should not surprise us, Senator. 

Senator LEVIN. It does not surprise me at all. What surprises me 

is that you are waffling on the question of whether or not Palomino 

was controlled by Barclays. You represented it was not. 

Mr. LAROCCA. Senator, I am not waffling on the question, Senator—— 

Senator LEVIN. Well, you are waffling because you are saying for 

some purposes it was controlled. For other purposes control means 

something totally different. If that is not a waffle, I do not know 

what is. 

Mr. LAROCCA. Senator, we own the entity. We con—the results 

are reflected in our annual report in the footnotes. We comprise the 

board. We have risk. We shared in some revenues, Senator. 

Senator LEVIN. I am talking about what you represented to a 

regulator at the SEC. 

Mr. LAROCCA. Senator, this representation to the SEC says that 

Barclays did not have control of the trading activities. 

Senator LEVIN. No, it does not. It says the entities-—you are 

talking about Palomino, is managed by external counterparties and 

consequently are not controlled by you. You do not say for trading 

activities. You just say they are not controlled. You did not qualify 

it here. 

Mr. LAROCCA. Senator, I will agree with you, Senator, that is 

what this says. 
61 

1See Exhibit No. 38, which appears in the Appendix on page 506. 

Senator LEVIN. You will agree with me that I read it correctly. 

Mr. LAROCCA. Correct, Senator. 

Senator LEVIN. And you will agree with me that it was not limiting what was meant by they are not controlled—— 

Mr. LAROCCA. I agree there is no qualifying in this report, Senator. 

Senator LEVIN. That is progress. That is year after year after 

year, right? I will not go through them all, but Exhibit 68, the 

same words essentially for 2010, 2011, 2012, 2013. There is a slight 

modification in the words, but it is essentially the same. 

So now, in your statement, you indicate that the question of the 

proper tax rate to apply to the profits earned through Barclays’ 

basket transaction is ‘‘a matter to be handled between Renaissance, 

as a taxpayer, and the IRS.’’ But now I would refer you to Exhibit 

38.1 This is a Barclays document, 2002, August 22. The third paragraph, it says, ‘‘COLT’’—that is what we are talking about here 

today—‘‘is targeted at those funds with a high proportion of US individual investors, stable year-on-year returns and strategies involving short-term trading. This gives rise to significant short-term 

capital gains for the investors regardless of whether or not they are 

invested in the fund for the shorter or longer term.’’ 

Then come the key words: ‘‘COLT provides an after-tax benefit 

to these investors through the conversion of their return from the 

fund from short-term capital gains (taxed at 39.6%) to long-term 

capital gains (taxed at 20%).’’ 

So this is what you are selling to Renaissance. This is what is 

in your project. 

Now, do you have any responsibility at all, to your clients in 

terms of representing that there are certain magic ways of converting short term into long term? Don’t you think that you have 

a responsibility to determine whether or not you are aiding and 

abetting a fiction? 

Mr. LAROCCA. Senator, I would not characterize this as ‘‘fiction.’’ 

Senator LEVIN. If it were a fiction, do you think that you should 

be responsible for avoiding it? 

Mr. LAROCCA. Senator, I would not characterize this as a ‘‘fiction.’’ We have a responsibility to our clients to assist them with 

transactions and ideally to do them in a tax-efficient way. 

Senator LEVIN. ‘‘Tax-efficient,’’ what does that mean? 

Mr. LAROCCA. Senator, we do not have clients who call up investment banks and tell us, ‘‘We would like to do a transaction, and 

we would like to pay the maximum amount possible.’’ 

Senator LEVIN. Of course. I would hope not. 

Mr. LAROCCA. The phone would never ring, Senator. 

Senator LEVIN. I agree. So now you are targeting funds, like 

RenTec—that is the target here—and you are saying that one of 

the major benefits is that you can convert, to use your words, 

short-term gains, which are taxed at 39 percent, to long-term gains, 

which are taxed at 20 percent. You are holding that out as an advantage. Is that correct? 

Mr. LAROCCA. Senator, we did not target Renaissance. They approached us with this structure. This is an internal approvals proc-
62 

ess where we are being very transparent to all the decisionmakers 

about the tax elements of the transaction, Senator. 

Senator LEVIN. But in your own words here, you are saying that 

Renaissance—who I believe is the only user, the only basket option 

that this was aimed at. Is that correct? That Palomino was aimed 

at? That was aimed at Renaissance. Is that correct? 

Mr. LAROCCA. Senator, this correspondence says we would target 

funds, but we only executed the transaction with Renaissance. 

Senator LEVIN. OK. And you say that it provides the benefit of 

converting something. And are you saying that that was never 

mentioned to Renaissance? 

Mr. LAROCCA. Senator, I do not cover the account, Senator. I am 

not aware of the dialog. I would—I believe both parties understood 

the tax benefits associated with these barrier options. 

Senator LEVIN. But it was targeted at funds that were involved 

in short-term trading. Is that correct? By your own document, it 

was targeted at those funds that involve short-term trading strategies. 

Mr. LAROCCA. Senator, I would not know if—— 

Senator LEVIN. That is your own words. 

Mr. LAROCCA. Senator, this is an internal approvals correspondence. 

Senator LEVIN. Does that make it less or more accurate? 

Mr. LAROCCA. It does not, Senator. 

Senator LEVIN. Is it accurate or not? 

Mr. LAROCCA. Let me respond, Senator. You asked me if we, in 

fact, targeted funds, right? 

Senator LEVIN. Right. 

Mr. LAROCCA. My response was I do not know. We only executed 

with Renaissance. This suggested that, if approved, we would target additional funds. Whether we, in fact, put this product in front 

of other clients, I do not know Senator. I am not a salesperson. I 

do not, in fact, know the answer to that question. 

Senator LEVIN. Was this targeted at funds such as Renaissance? 

Mr. LAROCCA. The structure was brought to us by Renaissance, 

Senator. 

Senator LEVIN. Is COLT targeted at funds such as Renaissance? 

Mr. LAROCCA. Not to my knowledge, Senator. 

Senator LEVIN. OK. Then I am reading from your document: 

‘‘COLT is targeted at those funds with a high proportion of U.S. individual investors . . . and strategies involving short-term trading.’’ You are saying that was not targeted at RenTec? 

Mr. LAROCCA. Senator, I have said that RenTec brought this 

structure—— 

Senator LEVIN. I understand. RenTec brought it to your attention. But I am asking you, was the structure which resulted after 

they came to you asking you to design a structure, which you then 

offered to them, I am asking you, was that structure targeted at 

those funds—I am reading your Barclays document. 

Mr. LAROCCA. Senator, it was targeted at RenTec. 

Senator LEVIN. That is what I am saying. And those funds involve short-term trading, have a strategy involving short-term 

trading, and this provides an after-tax benefit to magically convert 

short-term to long-term gains. But the point is this structure that 
63 

you created after RenTec asked you to offer them a structure, this 

was targeted at RenTec, and you were aware of the fact that it 

would provide an after-tax benefit like I described. 

Mr. LAROCCA. Yes, Senator, that is—— 

Senator LEVIN. All right. 

Mr. LAROCCA [continuing]. Absolutely correct. I was confused 

and thought you were asking if we had targeted other funds other 

than RenTec. 

Senator LEVIN. All right. 

Mr. LAROCCA. And I am not aware of that. 

Senator LEVIN. Now, in November 2010, the IRS issued a generic 

legal advice memorandum, a GLAM, advising that basket option 

transactions similar to what Barclays was using should not be 

treated as an option for tax purposes. That same day, an employee 

of Barclays sent an e-mail to his colleagues recognizing the GLAM 

was describing the Barclays basket transaction. That did not stop 

you, Barclays, from continuing with the transaction. Over the next 

2 years, from late 2010 to late 2012, Barclays entered into another 

nine basket option transactions with Renaissance. Renaissance 

gained about $4 billion from six of those transactions, and three 

are still ongoing. 

Now, in light of the GLAM, this seems to be a pretty aggressive 

position that Barclays took. Why is it that you dismissed the position that the IRS put out in the GLAM and continued to proceed 

with so many of those transactions? 

Mr. LAROCCA. Senator, we took the GLAM very seriously. At the 

time of the receipt of the GLAM, we again consulted with our external advisors as well as our internal experts and felt that the 

GLAM was not the law; it was an IRS view and perspective. We 

consulted with our accountants. In fact, I would point out, in a 

paper we submitted to the Committee, there is a document from 

PwC which is skeptical of the IRS analysis and conclusion, Senator. 

We continued to monitor for IRS bulletins, but we made a decision at that time that the transaction was appropriate and that we 

would continue. 

Senator LEVIN. OK. Now, that IRS GLAM says the following 

about hedge fund basket option contracts: ‘‘This memorandum addresses certain contracts styled as options in form but acting like 

direct ownership of the underlying property and substance. This 

memorandum should not be used or cited as precedent.’’ And here 

is what it says, its conclusion—I assume you take IRS conclusions 

seriously. Do you? 

Mr. LAROCCA. Absolutely, Senator. 

Senator LEVIN. Here is the conclusion: Let me read you what the 

issue is because it fits like a glove to what these banks, your two 

banks were doing. ‘‘Where a taxpayer, a partnership, entered into 

a contract styled as an option to purchase a basket of securities 

that the taxpayer’s general partner also actively managed and controlled while the contract remained open, and with respect to which 

the taxpayer had opportunity for full gain and income and substantially all risk of loss, one, whether the contract should be treated 

as an option for tax purposes; and, two, whether the taxpayer 

should be treated as the tax owner of the securities.’’ 
64 

1See Exhibit No. 61, which appears in the Appendix on page 732. 

Now, that is about as accurate a description of what was going 

on here as I can read. We tried very often to describe this in our 

report and in my opening statement, and I cannot do much better. 

Here is the conclusion: 

‘‘One, the contract does not function like an option and should 

not be treated as such.’’ 

‘‘Two, a contract that provides a taxpayer with dominion and control over a basket of securities the opportunity for full gain and income and substantially all of the risk of loss provides to the taxpayer beneficial ownership of the securities for tax purposes.’’ 

Were you aware of this? 

Mr. LAROCCA. Yes, Senator, I was. 

Senator LEVIN. All right. Now, I would hope that that would be 

taken seriously, but here is what happened: For 2 years, you continued to sell these basket options. 

And then in July 2012, following a number of investigations into 

Barclays’ business practices and its participation in tax avoidance 

structures, Barclays undertook an independent review, known as 

the ‘‘Salz review,’’ and the objective was to review Barclays’ business practices. The review was critical of the bank’s culture, describing it as ‘‘winning at all costs,’’ and finding that it took a ‘‘robust position with regulators and followed the letter rather than 

the spirit of the rules.’’ 

Were you in attendance at a meeting in October 2012, Mr. 

LaRocca, at which Barclays decided to approve another COLT 

transaction? 

Mr. LAROCCA. Yes, I was, Senator. 

Senator LEVIN. If you take a look, please, at Exhibit 61,1 this is 

the minutes of the Structured Capital Markets Approval Committee at Barclays, and the topic of the meeting was consideration 

of a new COLT transaction. Some of the key points that were made 

during the discussion that led to the approval of a new COLT option—this is now October 2012, after the Salz review was undertaken. This is what the key points of the discussion were, according 

to the notes: 

The option was recommended for approval, again, the same basket option. Why? ‘‘The tax risk is assumed by the client.’’ Right off 

the bat, tax risk is assumed by the client. 

‘‘There is a reputation risk for Barclays, especially if the matter 

proceeds to court.’’ 

‘‘The New Option Transaction does not meaningfully increase 

Barclays’ reputation risk in relation to the Option Transactions, because writing a new option (or exercising an existing one) should 

be viewed as the maintenance of a longstanding structure.’’ 

Now, you were the chairman of this meeting, Mr. LaRocca. You 

knew about the GLAM. You knew there was reputational risk. You 

knew that the Salz review had started and was reviewing the business practice because Barclays had been subject to tax investigations. But you still recommended that the transaction be approved. 

You were then and now are the most senior executive in the 

United States, Barclays. At a minimum, shouldn’t you have been 

concerned about the reputational risk to the bank, approving the 
65 

same option after the GLAM had been issued on this—the IRS 

could not be clearer in the GLAM. At any rate, you decided we are 

going to approve it anyway. Shouldn’t you have been more concerned about the reputational risk to your bank at that time? 

Mr. LAROCCA. Senator, I was very concerned about the 

reputational risk of the bank. 

Senator LEVIN. And should you have recommended continuing on 

that course? 

Mr. LAROCCA. Senator, looking at the same document, you will 

see the actions I took as chairman. Again, we look for reaffirmation 

of our legal opinions and our external advisors. We spent a considerable amount of time. I escalated this issue to members of our Executive Committee, Senator. I also recommended that this transaction be reviewed by our Reputational Risk Committee. I was very 

much aware that the Salz review was underway, and we concluded, 

Senator, at this point in time that we should continue the options. 

Senator LEVIN. I know you concluded it, but basically the IRS 

had spoken, and Barclays said, ‘‘So what?’’ Now, that is an aggressive—that is what we call an ‘‘aggressive tax position.’’ And it was 

taken after all of these events which we have described had occurred. When the IRS in a GLAM just describes it, it is precisely 

what you guys were doing, and says, as it did, that this is not an 

option and this is not going to be recognized as long-term capital 

gains for tax purposes, your committee—you are the chairman— 

still recommended that you go ahead with another one. Why? Because you are already at risk, what is a little more risk? I mean, 

just the fact that somebody has been used repeatedly and then 

challenging by the IRS, what kind of argument is it that, well, we 

have done it before, we will continue doing it? That is not a good 

argument in terms of reducing reputational risk. Quite the opposite, it seems to me. 

Mr. LAROCCA. Senator, the IRS has not yet made a decision on 

what the appropriate tax treatment is. When we have consulted 

with our external experts—legal, tax accounting—they raised serious questions regarding the analysis that underpins the GLAM. 

Senator LEVIN. The IRS describes GLAMs as ‘‘providing authoritative legal opinions on certain matters such as industry-wide 

issues.’’ 

Mr. LAROCCA. Senator, I hope the GLAM—— 

Senator LEVIN. I do not think you take it very seriously. I got 

to tell you, if you are really worried about reputation, given all the 

problems that Barclays has, and given the fact you got a GLAM 

from the IRS and it is right on point describing exactly what you 

are doing and it says this is not an option—— 

Mr. LAROCCA. Senator—— 

Senator LEVIN [continuing]. It would seem to me a caution, if you 

are worried about your reputation, you would say, ‘‘Whoa, let us 

hold off on this thing, folks.’’ That is what caution does. That is 

what concern about reputation does. It is not—we have been doing 

this for years. So what? We will continue to do it in the face of a 

GLAM. I do not consider that to be concern about a bank’s reputation. 

Barclays then in 2013 initiated a bank-wide effort called ‘‘Project 

Transform’’ to ensure that the bank no longer offered or partici-
66 

pated in abusive tax shelter products. Barclays’ counsel informed 

the Subcommittee that as a result of Project Transform, Barclays 

developed a number of principles, including in the tax area. One 

of these principles is that Barclays will not engage in transactions 

that will not meet expectations of the relevant tax authority. At 

that point, you revised the COLT, this option, to make sure it could 

not be used to argue that the gains are long-term capital gains. 

You changed that in 2013 after another project of yours adopted a 

principle saying do not engage in transactions that would not meet 

expectations of the relevant tax authority. If you had adopted that 

earlier, you would not have issued those later options. Is that correct? 

Mr. LAROCCA. That is correct, Senator. 

Senator LEVIN. OK. Now, you have got some existing basket 

transactions, do you not? 

Mr. LAROCCA. Yes, we do, Senator. 

Senator LEVIN. There are three of them, I believe, and they do 

not conform with the new policy, and the contract with Renaissance allows for the unwinding of those contracts. Why not unwind 

them? Under the policy you have adopted—as a result of Project 

Transform—new principles, we are not going to engage in transactions that will not meet the expectations of the relevant tax authority. But apparently you are going to continue to participate in 

transactions that do not meet that expectation because you have 

not unwound those three existing basket options. Why not unwind 

them? 

Mr. LAROCCA. Senator, we have made the decision to not enter 

into any new transactions, Senator. 

Senator LEVIN. I understand. But why not unwind existing 

transactions because they do not meet the expectations of the relevant tax authority? Why not unwind them? You are allowed to 

under the contract. 

Mr. LAROCCA. Senator, we are allowed to unwind them, and we 

have not looked at the historical transactions that we approved 

prior. So the decision—— 

Senator LEVIN. Maybe you ought to. What do you think? 

Mr. LAROCCA. We will take it under advisement, Senator. 

Senator LEVIN. Thank you. 

Let us see. Mr. Bausano, you have testified that Deutsche Bank 

engaged in a major restructuring of its MAPS product—that is this 

basket option transaction—and you engaged in a major restructuring in 2008. This ties in with what we had heard, our staff had 

heard from Mr. Haas, who was the global head of Deutsche Bank’s 

Prime Brokerage Division, and from your counsel who represented 

to staff that Deutsche Bank had concerns whether the old structure 

would be respected as an option for tax purposes. So in 2008, Deutsche Bank undertook an effort to make MAPS look more optionlike. I believe your Global Prime Finance Division described the 

MAPS restructuring project as an effort to ‘‘provide a new multiple 

MAPS structure that will more closely resemble a traditional options structure.’’ 

Now, I want to just explore one example of that concern that you 

had that caused you to engage in that restructuring. 
67 

Before the restructuring, Deutsche Bank paid Renaissance a flat 

advisory fee which was well below industry standard fees for an investment advisor. So did you make the change in the fee structure 

to make this transaction look more option-like? 

Mr. BAUSANO. We restructured the option on the basis of two 

parallel tracks: 

The first, as was described by Mr. Ramakrishna, was a concern 

about the risk profile and the higher risk associated with gaps in 

the cluster of statistical arbitrage strategies as evidenced in the 

summer of 2007, August 2007. 

The second parallel push was a combination of concerns in the 

evolving regulatory landscape as communicated to me through my 

internal control functions—legal, tax, compliance, et cetera. You 

know, our view is that this has a significant number of option features and it is clearly an option. The idea that you have an asymmetric payout where your risk is limited to the premium you have 

paid, you have an upside convexity to leverage and performance if 

you succeed is to me the key hallmarks—it is a contract with a duration and an expiry, are all things that are hallmarks of an option. 

Senator LEVIN. Did you offer the increase to Renaissance without 

being prompted by them? 

Mr. BAUSANO. I was not part of those negotiations. 

Senator LEVIN. Do you know whether or not Deutsche Bank—— 

Mr. BAUSANO. I do not know which side proposed that. 

Senator LEVIN. Well, then, let me ask you the question again. 

Was the shift, change in the fee done in part in order to make the 

transaction look more option-like? 

Mr. BAUSANO. I do not know what the negotiation went on. I was 

not part of it. 

Senator LEVIN. I am not asking you about what the negotiation. 

I am asking you whether the change in the fee from a flat fee was 

done in part to make the transaction look more option-like. That 

is what I am asking you. 

Mr. BAUSANO. I really do not think so. I think it reflected what 

the standard investment advisor agreement to a fund would have 

been. 

Senator LEVIN. OK. Prior to the 2008 restructuring, did Deutsche 

Bank have any indications that the old MAPS structure would not 

be respected as an option? Do you want me to repeat the question? 

Mr. BAUSANO. No. Before 2008. 

Senator LEVIN. Before the restructuring. 

Mr. BAUSANO. Before the restructuring. Not to my knowledge. 

Senator LEVIN. You had no indications that the old MAPS structure would not be respected as an option? 

Mr. BAUSANO. No. As a matter of fact, to this date no court or 

regulator or statute has disqualified it as an option, either old or 

new. 

Senator LEVIN. That is not what I am asking, whether a court 

or regulator has—I am asking you, was there an indication from 

any source that the old MAPS structure would not be respected. 

You answered it, we did not hear from a regulator or court. That 

is not my question. 
68 

Mr. BAUSANO. To my knowledge, no. However, I am aware that 

my control functions were in regular conversations with all of the 

external regulatory constituencies on an ongoing basis. 

Senator LEVIN. How about internally? 

Mr. BAUSANO. Internally we discussed—— 

Senator LEVIN. Was there any evidence internally, attorney discussion internally to that effect? 

Mr. BAUSANO. That it would not be respected? Not to my knowledge. 

Senator LEVIN. Was that question ever referred by you to a law 

firm for an opinion on it? 

Mr. BAUSANO. I am sorry. Repeat again? 

Senator LEVIN. Was that issue ever referred to a law firm to give 

you an opinion on that question? 

Mr. BAUSANO. I am aware we had a ‘‘should level’’ opinion on 

that. 

Senator LEVIN. Was that before or after the restructuring? 

Mr. BAUSANO. I do not have the specific date, but I know it was 

early in the life cycle of the trade. 

Senator LEVIN. Do you know whether it was before or after 

the—— 

Mr. BAUSANO. I do not know. 

Senator LEVIN. Deutsche Bank entered into a non-prosecution 

agreement with the Department of Justice stemming from its involvement with abusive tax structures, and under the non-prosecution agreement Deutsche Bank promised to stop participating in 

and implementing fraudulent tax shelters and agreed to bring to 

the attention of the Department of Justice ‘‘products or transactions that may run afoul of U.S. Federal income tax laws, rules, 

and regulations.’’ 

Now, Mr. Bausano, in your written testimony, you said that, ‘‘It 

bears noting that the bank discussed the MAPS product with the 

Department of Justice, the IRS, the SEC, and the independent expert Deutsche Bank retained as part of the NPA. All of the discussions took place well before this Committee began its investigation. 

Indeed, the bank communicated with the independent expert about 

MAPS at a meeting on February 3, 2011, and discussed the MAPS 

product with the Department of Justice and the IRS at several 

meetings in 2012 and 2013.’’ 

You stated in your testimony that Deutsche Bank discussed this 

matter with the SEC. My question to you is: Weren’t those discussions initiated by the SEC as part of an SEC examination of 

MAPS? 

Mr. BAUSANO. You know, I was not part of that conversation. My 

secondhand knowledge is it was part of an examination, but that 

is arm’s length. 

Senator LEVIN. Arm’s length or secondhand? 

Mr. BAUSANO. Secondhand. 

Senator LEVIN. So secondhand you say you heard that this discussion with the SEC came as part of an SEC examination. Is that 

correct? That is what you heard secondhand? 

Mr. BAUSANO. As part of my preparation for this conversation, I 

was made aware of that. 
69 

Senator LEVIN. OK. Are you aware of the fact that the SEC referred Deutsche Bank’s activities to the IRS because the basket option strategy was being used to turn short-term capital gains in the 

portfolio into long-term capital gains and the options were being 

exercised after 1 year, thus subjecting the returns to long-term capital gains tax? Were you aware of the fact that because of that 

claim that there was a long-term capital gain that the SEC referred this activity to the IRS? Were you aware of that? 

Mr. BAUSANO. I was made aware of it as part of my preparation. 

Senator LEVIN. The first time that Deutsche Bank communicated 

the MAPS program to the Department of Justice was in 2012. 

Deutsche Bank did not disclose its MAPS program to the Department of Justice when it was negotiating the non-prosecution agreement in 2010. Is that correct? 

Mr. BAUSANO. I was not part of that negotiation. I learned about 

the NPA upon its settlement. 

Senator LEVIN. OK. Were you aware of the fact, however, that 

Deutsche Bank did not disclose this MAPS program to the Department of Justice when it was negotiated the non-prosecution agreement in 2010? Even though you were not part of it, were you aware 

of that? 

Mr. BAUSANO. As part of my preparation, I have heard that. I 

have no knowledge. 

Senator LEVIN. No personal knowledge, but you were informed of 

that? As part of your preparation, that is what you were informed? 

Mr. BAUSANO. That prior to the-could you repeat what I—— 

Senator LEVIN. I will. Were you informed that the first time 

Deutsche Bank communicated the MAPS program to the Department of Justice was in 2012 and that it did not disclose the MAPS 

program to the Department of Justice when Deutsche Bank was 

negotiating the non-prosecution agreement with the Department of 

Justice in 2010? 

Mr. BAUSANO. I am not specific on the date of the conversation 

with the DOJ. I am aware that the judgment of the negotiators in 

the NPA was that it was not shared at that time. 

Senator LEVIN. OK. Are you aware that Deutsche Bank went to 

the Department of Justice with the MAPS matter, disclosed it to 

the Department of Justice, only after the Federal Reserve Bank of 

New York, which had been examining MAPS, expressed concerns 

and instructed the bank to go to the Department of Justice? 

Mr. BAUSANO. My understanding is that the independent expert 

that was in Deutsche Bank at the behest of the DOJ was informed 

of MAPS, and it was our presupposition that, as the direct conduit 

to the DOJ, that would have been passed through. When we 

learned that was not the case, we informed them directly. 

Senator LEVIN. And then when you informed them directly, was 

that after the Federal Reserve Bank, which had been examining 

MAPS, expressed concerns and instructed the bank to go to the Department of Justice? 

Mr. BAUSANO. I am not aware of the specifics of that. 

Senator LEVIN. OK. Was there any concern within Deutsche 

Bank that to continue with the New MAPS after signing the nonprosecution agreement might put the bank in violation if it continued with that transaction? 
70 

Mr. BAUSANO. With the New MAPS? 

Senator LEVIN. Yes. Was there any concern within Deutsche 

Bank that to continue with the New MAPS after signing the NPA 

would be a violation—or could be a violation? 

Mr. BAUSANO. Well, we had moved to a less than 1-year only posture by that point, I believe. 

Senator LEVIN. OK. Now, when Deutsche Bank put a temporary 

halt to MAPS transactions in late 2010, it still had three basket 

transactions outstanding in 2011. They all lasted a year or more 

after the GLAM. Why didn’t Deutsche Bank cancel those, unwind 

those? As I just asked Mr. LaRocca, you had the right to do so 

under the basket contracts. Why not do it? 

Mr. BAUSANO. We felt that in an abundance of caution to cease 

the product was appropriate and it was what we did. The ones that 

were extending we felt that they were at that point and continued 

to be legal and legitimate transactions and elected to honor the 

terms of those transactions to their conclusion while not pursuing 

any further. 

Senator LEVIN. I understand that, but you decided not to continue to issue these contracts because of various concerns which 

you had. Why not unwind the contracts which you had since you 

were allowed to do that? Under the contract you could have 

unwound these. These were obviously finally of concern to you. It 

took a whole lot of years to get there, but nonetheless, you finally 

reached that point. So why not do what you were allowed to do 

under the contract, and that is to unwind contracts which are problematic? And your answer is that you did not. But why didn’t you? 

Did you think about it? Did you consider it? 

Mr. BAUSANO. It was the business judgment that we were being 

sufficiently aware of and respectful of the guidance we had gotten 

both from the legal, regulatory, and guidance perspective by ceasing to go on, and that the balance of risks was we would be better 

served to keep the contract as we had originally negotiated it with 

the existing clients. So we were aware of it, and we thought we 

were being especially and deliberately respectful of the changing 

regulatory landscape already. 

Senator LEVIN. I think you may have been wrong in terms of the 

New MAPS as it related chronologically to the NPA. 

Mr. BAUSANO. OK. 

Senator LEVIN. The NPA was 2010, and I think you said that you 

had no concern there about whether the New MAPS would be compliant with the NPA. But wasn’t the NPA in existence before the 

New MAPS was put in existence? 

Mr. BAUSANO. I do not believe that is correct. I have a chronology 

that has been submitted to you—— 

Senator LEVIN. OK. Let me rephrase it because I was inaccurate, 

my phrasing. You moved to an 11-month term in 2012, I believe, 

to make sure that the option when exercised could not be claimed 

to be a long-term capital gain. Is that correct? That was 2012, I believe. 

Mr. BAUSANO. I have April 2012 as the first New MAPS shorter 

dated. 

Senator LEVIN. But the NPA was in existence in 2010. 

Mr. BAUSANO. Right. New MAPs was struck in 2008. 
71 

Senator LEVIN. In 2008. But your short options—your 11-month 

option was not put in place until 2012, and so the question is: Were 

you concerned after the NPA about that issue? And if so, why 

didn’t you change to the short option, the 11-month option, before 

2012? 

Why did it take you so long? 

Mr. BAUSANO. The New MAPS structure was fully—ready? 

Senator LEVIN. I am ready. 

Mr. BAUSANO. We were fully advised internally by our control 

functions—legal, credit, tax, compliance, and external advisors—at 

the time that it was compliant and well within the boundaries and 

well within the area of ambiguity and, therefore, thought it was 

safe to proceed. 

Senator LEVIN. All right. So, in other words, Mr. Brown, in your 

statement, you say that the reference portfolio for each option was 

generated by Renaissance’s trading algorithm, and you make it 

sound like the selections were made by a machine with no human 

intervention. Now, your scientists and your experts are continually 

looking for inefficiencies in the market, and when they find something new, as I understand you in your testimony, they try to adjust the computer model and incorporate that into the algorithm, 

and that will affect the decisions that are generated. It could also 

have an impact on what positions are bought and sold. So there is 

a lot of ongoing human involvement in this process. Is that correct? 

Mr. BROWN. That is correct. 

Senator LEVIN. And how many employees are there at RenTec? 

Mr. BROWN. I think roughly 300. 

Senator LEVIN. And of these employees, how many work parttime or full-time on the algorithm strategy that supports or supported RenTec’s basket option transaction? 

Mr. BROWN. Well, on the strategy, 50 or so. 

Senator LEVIN. OK. And these would be employees with backgrounds in mathematics, physics, and computer science? 

Mr. BROWN. That is correct. 

Senator LEVIN. The employees that worked on the overall strategy to identify market inefficiencies in order to take advantage of 

them I assume did this on an ongoing basis. is that correct? 

Mr. BROWN. Yes. 

Senator LEVIN. And how frequently were they identifying these 

inefficiencies and modifying the inputs that go into the overall 

strategy? Was that a frequent occasion? 

Mr. BROWN. Well, most of the modifications involved maintenance, changes to—the system has a million lines of computer code, 

and when you have a million lines of computer code, it has to be 

maintained. Interfaces change. I do not know if you are counting 

those kinds of changes. 

Senator LEVIN. No. Just when they tweak the algorithm. 

Mr. BROWN. I’m sorry. What was the question? How many people 

work on—— 

Senator LEVIN. No. How frequently were you doing that? Was 

that a daily change? 

Mr. BROWN. No. 

Senator LEVIN. Weekly? Monthly? 

Mr. BROWN. No, more like weekly. 
72 

Senator LEVIN. OK. So every week there would be roughly? 

Mr. BROWN. One or two changes, roughly, on average. 

Senator LEVIN. In the algorithm? 

Mr. BROWN. Yes. The algorithm has been developed over 25 

years. It probably has a thousand man-years of work into it. It is 

very mature at this point. It is very hard to make significant improvements. So these are minor changes typically. 

Senator LEVIN. But you have 50 people working on this. There 

is a lot of human involvement in RenTec in this—— 

Mr. BROWN. Oh, that is not all they do. We trade commodities, 

futures—— 

Senator LEVIN. I know that, but I specifically asked you the 

question for this particular process, this basket option process, how 

many were working full-time or part-time on the strategy that supported RenTec’s basket option transactions? 

Mr. BROWN. I think my answer is accurate. 

Senator LEVIN. OK. So we will stick with 50. That is fine. 

Mr. BROWN. I mean, roughly. I do not know—— 

Senator LEVIN. That is fine, about 50. That is a lot of people, a 

lot of human intervention. Wouldn’t you agree? Fifty people working on these basket options? OK. I will let it speak for itself. You 

do not have to agree with it. 

Mr. BROWN. OK. 

Senator LEVIN. That is a lot of expertise. 

Now, did RenTec personnel intervene in the strategic to respond 

to market events? 

Mr. BROWN. Well—— 

Senator LEVIN. You know, like during the Greek crisis. 

Mr. BROWN. Oh, sure. 

Senator LEVIN. RenTec—— 

Mr. BROWN. We made a strategy—what happened—about the 

Greek crisis, for example, if you like, what happened there is that 

we were concerned at that time that Barclays had a lot of exposure 

to Greece. 

Senator LEVIN. And so you could shift billions of dollars of its 

portfolio, for instance—— 

Mr. BROWN. No. That is not what happened. 

Senator LEVIN. Well, could you? 

Mr. BROWN. Could we have? 

Senator LEVIN. Did you shift any money from Barclays to Deutsche Bank? 

Mr. BROWN. Shift money? No. 

Senator LEVIN. OK. Did you direct more of the sales orders to 

one bank and more of the purchase orders to another—to the other 

bank? 

Mr. BROWN. Yes, we made a change to the process that distributes portfolio among the options, so the algorithm produces a 

bunch of trades and produces a portfolio, and more or less of it can 

go to different options. So prospectively going forward, we made a 

change so that we would tend to put more portfolio with Deutsche 

Bank and less with Barclays. 

Senator LEVIN. And that was some of the type of work that your 

50—— 

Mr. BROWN. That is correct. 
73 

Senator LEVIN [continuing]. Experts would do? And so with the 

human intervention in this process, this affects what positions are 

bought, sold, and how long they are held. Is that correct? 

Mr. BROWN. Yes. As I said, the changes are modest, but yes. 

Senator LEVIN. Who changes the models? Human beings? What 

did you just say? 

Mr. BROWN. Changes are modest. 

Senator LEVIN. Changes their Models? 

Mr. BROWN. Small. 

Senator LEVIN. You make changes in the models? 

Mr. BROWN. There are modest changes in the models. 

Senator LEVIN. Modest changes in the models by these human 

beings. 

Mr. BROWN. That is correct. 

Senator LEVIN. This algorithm was not just making changes by 

itself. It took human beings to make changes. 

Mr. BROWN. Sure. The human beings wrote the code. 

Senator LEVIN. Good. And changed the code? 

Mr. BROWN. That is correct. 

Senator LEVIN. Tweaked the code and once or twice every week 

changed—— 

Mr. BROWN. On average. 

Senator LEVIN. On average, OK. When you made these changes 

in the algorithm, did you consult with the banks? 

Mr. BROWN. No. 

Senator LEVIN. Is the algorithm RenTec’s proprietary strategy? 

Mr. BROWN. It is. 

Senator LEVIN. Do the banks ever change the algorithm? 

Mr. BROWN. No. 

Senator LEVIN. Now, you have about 300,000 transactions executed in the banks per day for RenTec’s basket contracts. Were 

these submitted in the form of recommendations or suggestions to 

the banks? 

Assuming they met the guidelines, of course, which you had already agreed upon. But were these submitted, 300,000, approximately, transactions in the banks each day for the basket of contracts, were they submitted in the form of recommendations or suggestions, but were they automatically sent to the market providing 

they met the guidelines which you had agreed to? 

Mr. BROWN. So they were most commonly sent to the banks’ 

trading systems. 

Senator LEVIN. All right. 

Mr. BROWN. And if they—sometimes they were rejected. Not very 

often. And, otherwise, they went to the market. That is correct. 

Senator LEVIN. And not very often would mean if they did not 

meet the guideline? 

Mr. BROWN. I think that is the only—the only ones I know of 

where, you know, the restricted list had been changed and we were 

not aware of it, that kind of thing. Those are the ones I know of. 

Senator LEVIN. All right. So there was an agreement, there were 

guidelines, a restricted list, whatever you want to call it. If it did 

not meet that, then it would not go to market. 

Mr. BROWN. That is my understanding, yes. 

Senator LEVIN. And that did not happen very often. 
74 

Mr. BROWN. No, it did not. 

Senator LEVIN. How many times? 

Mr. BROWN. I do not know how many times—— 

Senator LEVIN. How many times in a year? 

Mr. BROWN. A few. 

Senator LEVIN. A few in a year. 

Mr. BROWN. I would guess. You know, I am not—— 

Senator LEVIN. I know. 

Mr. BROWN. I am guessing there. 

Senator LEVIN. To the best of your ability, you are guessing a few 

times a year? 

Mr. BROWN. Yes. I mean, you know, if it is 20, it would not surprise me. If it is three, it would not surprise me. In that range. 

Senator LEVIN. All right. That is out of 30 million a year. 

Mr. BROWN. I have not done the multiplication, but that is probably correct. 

Senator LEVIN. That is not multiplication. That is a question of 

fact. 

Mr. BROWN. Well, I do not know if it is 30 million or 35 million 

or 40 million. It is millions, many millions. 

Senator LEVIN. Tens of millions. 

Mr. BROWN. Yes. 

Senator LEVIN. It could have been three or five or ten times it 

did not meet the guidelines. 

Mr. BROWN. That is correct. 

Senator LEVIN. I am going to conclude. We have a vote on here 

now, so let me just end with a few remarks here. 

The situation that we have looked at here over a year or more 

is where an armada of law firms and hedge funds and financial institutions have devised financial structures that in substance are 

far from what they pretend to be. A series of fictions is created to 

create one big fiction, and that is to gain advantages which otherwise could not be obtained. 

Now, the structure the Subcommittee has explored today is an 

example of what we have been doing for many, many years looking 

at these structured transactions just to see how tax avoidance 

works in this country. The companies that engaged in the basket 

options and the law firms that support them ignore the realities of 

the transactions that they are engaged in by employing a structure 

that seeks to portray the activities as something from what they 

really are, and they hope that those that are reviewing the transactions will not catch it. 

Now, those who complain about the complexity of the Tax Code 

should look at these examples of tax avoidance and tax abuse and 

realize that it is this kind of gamesmanship that drives the complexity in the Tax Code, because the IRS is always trying to catch 

up and clarify that the fictions that are concocted are not in compliance with the law. If the parties that use these fictions and these 

structures want the tax system to be more straightforward and 

clear, they should end the gamesmanship. That is the issue that 

underlies what the Subcommittee has been addressing. I hope the 

regulators and Federal agencies will take note and try to address 

the larger issue that has been posed here. I hope members of the 

financial and legal communities will do that as well. 
75 

The structures that we have examined today have real consequences because they offload billions of dollars in taxes that are 

shrugged off by hedge funds onto the backs of ordinary American 

taxpayers. They add billions of dollars in leverage to the U.S. financial system, and it does not have to be this way. The IRS can 

audit hedge funds and collect taxes that were not paid. The SEC 

can stop basket options from being used to circumvent leverage 

limits. The Financial Stability Oversight board, working with other 

agencies, can impose new reporting obligations to detect and stop 

hidden leverage through derivatives. Congress can amend TEFRA 

to remove obstacles to IRS audits of large partnerships like hedge 

funds. 

Congress could go further and adopt the proposal of my colleague 

from Michigan, Congressman Camp, and tax all derivatives at the 

end of the year on their market value. That would short-circuit a 

lot of the games. 

Option baskets are being misused and abused to dodge taxes and 

to circumvent leverage limits, and we are going to continue as long 

as I am here to do everything I can to stop these abuses. 

We end the hearing with thanks to our witnesses for their cooperation with our Subcommittee, and we stand adjourned. 

[Whereupon, at 2:55 p.m., the Subcommittee was adjourned.] 

(77) 

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Æ