By Pam Martens and Russ Martens: April 7, 2021 ~

It has become clear from the ongoing drip, drip, drip of new revelations of what was going on behind the scenes of hedge fund Archegos Capital Management, its wealthy owner, Sung Kook (Bill) Hwang, and Wall Street’s global banks, that the public has seen just the first act in what is certain to be a far more complex drama.

A summary of the basics of what the public has been told thus far sheds light on why the full Archegos story has yet to be revealed. According to major media reports, Archegos was obtaining leverage of more than 6 times the cash it was putting up as collateral to buy stocks that were held in accounts at a handful of Wall Street’s largest banks. Through a privately negotiated derivatives contract, the banks claimed to technically own the stocks but the hedge fund, Archegos, selected the stocks, directed the trading in the accounts and got the upside as well as the downside of trading returns. In exchange, the bank collected a fee.

A critical missing part of this story is this: if the Wall Street banks were claiming to technically own the stocks in the Archegos account, who was responsible for paying the billions in taxes that were owed to Uncle Sam on short-term and long-term capital gains on the stock sales? According to media reports, Hwang had amassed a fortune of $10 billion from his trading accounts between 2013 and early March 2021. Thus, there had to be billions in capital gains taxes owed along the way.

The structure of the Archegos account sounds uncannily similar to a jaw-dropping investigation conducted by the U.S. Senate’s Permanent Subcommittee on Investigations in 2014 that found that hedge funds had used a similar structure to “avoid taxes and leverage limits.” The Renaissance Technologies (RenTec or RenTech) hedge fund was a central focus of the Senate investigation, which concluded that it had avoided paying $6.8 billion in taxes to the IRS as a result of the scheme.

In a hearing held by the Subcommittee on July 22, 2014, Steven M. Rosenthal, a Senior Fellow at the Urban-Brookings Tax Policy Center in Washington, D.C., explained the scheme as follows:

“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 short- term 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.”

In fact, the brazen nature of the scheme was far worse than the above suggests. According to the Senate investigation and exhibits, the account structure worked as follows:

The hedge fund would make a deposit of cash into an account at the respective bank. The account was not in the hedge fund’s name but in the bank’s name. The bank would then deposit into the same account $9 for every one dollar the hedge fund deposited. At times, the leverage could reach as high as 20 to 1.

The hedge fund controlled the trading in the account and generated tens of thousands of trades a day using their own high frequency trading program and algorithms. Many of the trades lasted mere minutes. The bank charged the hedge fund fees for the trade executions and interest on the money loaned.

There was a written side agreement which was cleverly called a “basket option,” no doubt dreamed up by one of Wall Street’s highly paid tax attorneys at a powerhouse law firm. The side agreement specified that the hedge fund would collect all the profits made in the account in the bank’s name after a year or longer. This, according to the scheme, allowed the hedge fund to characterize millions of trades which were held for less than a year, many for just minutes, as long-term capital gains (which by law require a holding period of more than a year.). At the time of the Senate investigation, long term capital gains were taxed at less than half the top rate on short term gains. Today, the top tax rate on long-term capital gains is 20 percent while the top rate on short-term capital gains, which are taxed as ordinary income, is 37 percent.

All of the stock trades were executed in the name of the bank and held in the bank’s proprietary trading account. Profits or losses on the trades remained in the account until the so-called “basket option” was exercised. The hedge fund had discretion on when it could exercise the option.

According to the Senate’s investigation, losses in the account were handled as follows:

“The banks claimed that the hedge funds did not bear 100% of the risk of loss, because the banks provided so-called ‘gap’ protection in the event of a catastrophic market failure. That risk was so small, however, that despite, for example, hundreds of millions of trades that took place in the more than 60 basket options held by RenTec over a decade, including during the worst financial crisis in a generation, neither bank was ever required to satisfy a loss due to a market failure.

“To further minimize the gap risk, the option contract contained several provisions designed to limit trading losses in the account to the 10% premium provided by the hedge fund. The key provision accomplished that objective by specifying a loss threshold – sometimes called a ‘barrier’ or ‘knockout’ amount – which if reached would cause the option to cease to exist, or ‘knockout,’ and trigger the ability of the bank to liquidate the account assets.”

In 2015 the Internal Revenue Service released a memo indicating that the basket option was an improper maneuver to convert short term capital gains into long term gains.

One might have expected the Justice Department to charge Renaissance Technologies with tax fraud and the banks with aiding and abetting a tax avoidance scheme and providing illegal leverage to a customer. But that didn’t happen.

As far as the public knows, all that happened was that Renaissance Technologies hired aggressive lawyers to fight the matter out in tax court for endless years. To date, there has been no media story suggesting that the hedge fund has settled the case with the IRS.

Renaissance Technologies has spent millions over the past decade lobbying for tax reform that would be beneficial to its hedge funds. Since 2014, the lobbying forms have indicated the following topics have been lobbied: “taxation of derivatives”; “mark to market accounting for financial instruments”; “issues dealing with capital gains and losses.”

James (Jim) Simons founded Renaissance in 1982. It is headquartered in East Setauket, a quaint town at the east end of Long Island, New York. Robert Mercer worked at Renaissance for more than two decades, retiring as Co-CEO on January 1, 2018. Both men are billionaires as a result of money made at the hedge fund.

Robert Mercer donated at least $25 million to Republican campaigns in the 2016 election cycle and built a vast network of social media projects like Cambridge Analytica to digitally target voters “inner demons.” Simons worked the other side of the street, pumping $27 million into the coffers of Democratic candidates and related campaign committees. Included in that amount from Simons was $11 million that went into Priorities USA, a SuperPac supporting Hillary Clinton’s 2016 campaign for the presidency.

Mercer and Simons have the following in common: both are computer scientists with doctorates who previously worked on military projects; both men’s names turned up in the Paradise Papers, a trove of millions of leaked files from offshore tax havens.

According to a November 2017 article in the U.K.’s Guardian newspaper, Simons had squirreled away over $8 billion in the tax haven of Bermuda. The newspaper also separately reported that Robert Mercer shows up in the Paradise Papers “as a director of eight Bermuda companies” which it says were used to “legally avoid a little-known US tax of up to 39% on tens of millions of dollars in investment profits amassed by the Mercer family’s foundation” which were then used to fund conservative groups and a “$475m retirement fund for the staff of Mercer’s hedge fund, Renaissance Technologies.”

According to the Center for Responsive Politics, President Joe Biden’s presidential campaign received $7 million from Euclidean Capital, the family office that manages Jim Simons’ wealth.