Updated, 8:30 p.m. | Complex financial instruments that the government has said helped the hedge fund Renaissance Technologies claim billions of dollars in tax savings were “extremely important,” its co-chief executive said at a Senate hearing on Tuesday.
Peter Brown, co-chief executive of Renaissance Technologies, which was founded by James H. Simons, said the financial products had given the fund, one of the most successful on Wall Street, the ability to get stronger returns by borrowing more.
“On an unlevered basis, our models produce modest returns with very low volatility,” Mr. Brown testified at a hearing of the Senate Permanent Subcommittee on Investigations.
Members of the subcommittee came to the hearing armed with a 93-page report that found that more than a dozen hedge funds had used complex financial structures called “barrier” or “basket” options to claim tax savings and borrow more money to trade.
Representatives from Barclays and Deutsche Bank, the two banks that helped create these structures, were also called to the hearing. The subcommittee, led by Senator Carl Levin, Democrat of Michigan, has been investigating tax-avoidance strategies of several large companies.
Steven M. Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center and one of the government’s independent experts, called the options “tax alchemy” that helped the hedge funds mask what they were doing — in effect making millions of trades over a short period. When it came time to pay taxes, they claimed the trades were long term. This helped Renaissance claim more than $6 billion in tax savings, according to the report.
The banks created special accounts for their hedge fund clients in their own names, but the funds had full control of the assets, would determine each trade and reaped all of the profits, the investigation found.
Over one year, for example, Renaissance was able to execute, on average, 26 million to 39 million trades, many of them held for just a few seconds, and the majority of assets were held for less than six months, the report found. The fund would wait until just after one year to “exercise the options,” contending that the profits should be taxed at a long-term capital gains rate.
The options also allowed the hedge funds to borrow significantly more than they would otherwise have been able to. At one time, Renaissance was able to borrow from the banks as much as $17 for every $1 it put into a trade, the subcommittee found.
Mr. Brown countered assertions by Mr. Levin and Mr. Rosenthal that these complicated structures were used primarily to skirt higher tax rates and take on greater risk. He said that the options gave Renaissance the ability to protect against model and programming failures.
Throughout the hearing, Mr. Levin focused on the lucrative nature of the transactions, most of which took place using Renaissance employees’ money. Between 1999 and 2010, the fund used basket options to produce profits of more than $30 billion, Mr. Levin said. Barclays and Deutsche Bank together made more than $1 billion in revenue.
“Basket options were clearly a lucrative line of business for the participants,” Mr. Levin added.
M. Barry Bausano, the president of Deutsche Bank Securities, testified that Deutsche Bank “affirmatively and proactively undertook steps to ensure compliance with applicable tax and securities laws and regulations.” It stopped selling the options in 2010 after the I.R.S. published a criticism of the strategy.
Marty Malloy, managing director of Barclays, testified Barclays was “subject to sufficient and significant internal and external review to ensure it complied with applicable tax laws and regulations.” Barclays stopped selling its options in 2013.