"The facts indicate that the basket option structures examined in this investigation were devised by sophisticated financial firms to allow clients to circumvent federal taxes and leverage limits. The structures rested on two fictions. The first was that the bank, rather than the hedge fund, owned the assets being traded in the designated option accounts, even though the hedge fund bought and sold the assets, was exposed to all significant risks and rewards, and profited from the trading, with little input from the bank serving as the nominal owner of the assets. In
effect, the structure purported to enable the hedge fund to purchase an “option” on its own trading activity, an arrangement that makes no economic sense outside of an effort to bypass federal taxes and leverage limits. The second fiction was that the profits from the trades controlled by the hedge fund could be treated as long-term capital gains, even for trades lasting seconds. That fiction depended upon the hedge fund claiming that the profits came from exercising the “option” rather than from executing the underlying trades. In fact, the “option” functioned as little more than a fictional derivative, permitting the hedge fund to cast short-term capital gains as long-term gains and authorizing financing at levels otherwise legally barred for a customer’s U.S. brokerage account."
So the complaint is that this was fictional derivatives used to mask ownership of the underlying assets and thereby avoid taxes. I'm going to do some more research but it does sound shady.
Earlier, the complaint points out that the IRS has already identified this as abusive behavior but has not acted:
"While that type of option product was identified as abusive in a public memorandum by the Internal Revenue Service
(IRS) in 2010, taxes have yet to be collected on many of the basket option transactions and its use to circumvent federal leverage limits has yet to be analyzed or halted."
"The facts indicate that the basket option structures examined in this investigation were devised by sophisticated financial firms to allow clients to circumvent federal taxes and leverage limits. The structures rested on two fictions. The first was that the bank, rather than the hedge fund, owned the assets being traded in the designated option accounts, even though the hedge fund bought and sold the assets, was exposed to all significant risks and rewards, and profited from the trading, with little input from the bank serving as the nominal owner of the assets. In effect, the structure purported to enable the hedge fund to purchase an “option” on its own trading activity, an arrangement that makes no economic sense outside of an effort to bypass federal taxes and leverage limits. The second fiction was that the profits from the trades controlled by the hedge fund could be treated as long-term capital gains, even for trades lasting seconds. That fiction depended upon the hedge fund claiming that the profits came from exercising the “option” rather than from executing the underlying trades. In fact, the “option” functioned as little more than a fictional derivative, permitting the hedge fund to cast short-term capital gains as long-term gains and authorizing financing at levels otherwise legally barred for a customer’s U.S. brokerage account."
So the complaint is that this was fictional derivatives used to mask ownership of the underlying assets and thereby avoid taxes. I'm going to do some more research but it does sound shady.
Earlier, the complaint points out that the IRS has already identified this as abusive behavior but has not acted:
"While that type of option product was identified as abusive in a public memorandum by the Internal Revenue Service (IRS) in 2010, taxes have yet to be collected on many of the basket option transactions and its use to circumvent federal leverage limits has yet to be analyzed or halted."