Ramesh S Arunachalam
Hillary Clinton has been talking about overturning Citizens United and the like. However, if you look at the data of the Federal Election Commission (FEC[i]), it needs to be emphasized that Hillary Clinton is the only candidate who has received very large corporate donations to finance her electoral campaign. And this is why I doubt whether indeed she can reform campaign finance and overturn Citizens United, whatever be her promises.
Beginning today, I will in a series of blog posts attempt to give factual information on campaign financing for the American Public from the U.S. Presidential elections 2016 and people can judge for themselves!
I start my blogging with a post on James Harris Simon’s, a Wall Street veteran, who is one of Hillary Clinton’s strongest donors and let us understand how he has supported Hillary and what his antecedents are?
James Harris Simons is a well-known American mathematician, hedge fund manager, and philanthropist. The Forbes hedge fund list had his name listed against a company called Renaissance Technologies (RenTec), a New York-based hedge fund.
The reason I took up James Simons and RenTec as my first Wall Street case study was the fact that employees and executives of RenTec had made nearly $13.8 million in campaign contributions over the three cycles, more than any other high frequency trading company.[ii] As per this report, RenTec contributed $692,300 during the 2008 cycle and nearly $11.8 million during the 2012 cycle, a 1,600 percent increase. Incidentally, the net worth of James H. Simons stands at about $15.5 billion, according to the Bloomberg Billionaires Index.[iii]
Curious, I started digging deeper and came across a website[iv] that stated Dr. James H. Simons is President of Euclidean Capital, supposedly a “family office.” Such organizations that handle the financial wealth and affairs of a single family are not required[v] to disclose any details to the U.S. Securities and Exchange Commission (SEC). The website[vi] also mentioned that Dr. James Simons is the board chair of Renaissance Technologies LLC, a highly quantitative investment firm engaged in algorithmic trading from which he supposedly retired in 2009 after serving several years as CEO.[vii]
A look at the FEC data[viii] reveals that James Simons’ Euclidean Capital contributed $2,700 to Hillary Clinton for the 2016 presidential election cycle. Incidentally, his former wife, Barbara Simons, a computer scientist, has also made a $2,700 contribution to Hillary Clinton. I found two more names associated with Renaissance Technologies: Francesco Scattone and Vincent Dellapietra. Both have contributed $2,700 and $2,600 respectively to the Hillary Clinton campaign as per the FEC website. All of these are individual contributions.
A closer look at various political action committees (PACs) supporting Hillary Clinton led me to focus on a very interesting group called “Priorities USA Action.”[ix] Their website is in very clear support of Hillary Clinton for President and it argues that “Priorities USA Action” is supporting Hillary Clinton because they believe that, among other reasons, she is the candidate best suited to advance the interests and well being of the middle class.[x]
A quick check of the FEC website for the names of the donors to this super PAC was revealing to say the least. Data from Federal Election Commission, http://www.fec.gov/, showed that James Simons (Euclidean Capital) had contributed $7,000,000 ($ 7 Million) to Priorities USA Action (which is a pro Hillary Clinton Super PAC).
Throughout the current presidential campaign season, I have observed that hedge fund managers have increasingly contributed to Priorities USA Action, the super PAC supporting former Secretary of State Hillary Clinton. They have also contributed to the “Hillary Victory Fund.” Therefore, in some ways, it is not surprising that Dr. James Simons has donated large sums of money to the Hillary Clinton campaign. That said, Simons’ contributions have not been quite enough to put him past George Soros, another hedge fund manager, as Hillary Clinton’s leading supporter in terms of super PAC contributions.[xi]
At this point, I would like to reemphasize the fact that Dr. James H. Simons is not only President of Euclidean Capital, but is also still the Board Chair of Renaissance Technologies LLC (RenTec), from which he retired in 2009 after many years as CEO.[xii]
Given the fact that James Simons was close to being one of the largest donors to the Hillary Clinton campaign, I decided to delve deeper into his companies. I came across a very interesting and high profile report on RenTec[xiii] that included significant comments on the practices within the company with regard to long- and short-term capital gains and avoidance of taxes. The report that I refer to is called, “Abuse of Structured Financial Products: Misusing Basket Options to Avoid Taxes and Leverage Limits,[xiv]” by United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS (JULY 22, 2014).
What follows is an excerpt from the above report[xv] of the U.S. Senate Permanent Subcommittee on Investigations on Renaissance Technologies LLC (RenTec):
“For the last decade, the U.S. Senate Permanent Subcommittee on Investigations has presented case histories showing how financial institutions, law firms, accountants, and others have designed and implemented complex financial structures to take advantage of and, at times, abuse or violate U.S. tax statutes, securities regulations, and accounting rules.[xvi]”
The final phrase is the key, stating that they have attempted to “abuse or violate U.S. tax statutes, securities regulations, and accounting rules” and need to be carefully noted. The above report further states:
“This investigation offers yet another detailed case study of how two financial institutions — Deutsche Bank AG and Barclays Bank PLC — developed structured financial products called MAPS and COLT, two types of basket options, and sold them to one or more hedge funds, including Renaissance Technologies LLC (RenTec) and George Weiss Associates, that used them to avoid federal taxes and leverage limits on buying securities with borrowed funds. 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.”[xvii]
As the U.S. Senate report further observes:
“The basket option contracts examined by the Subcommittee investigation were used by at least 13 hedge funds to conduct over $100 billion in securities trades, most of which were short-term transactions and some of which lasted only seconds.”[xviii]
Please note that the U.S. Senate report clearly specifies that most of the transactions were short-term transactions that lasted a mere few seconds and as the report further notes,
“Yet the resulting short-term profits were frequently cast as long-term capital gains subject to a 20% tax rate (previously 15%) rather than the ordinary income tax rate (currently as high as 39%) that would otherwise apply to investors in hedge funds engaged in daily trading. ... specific data supplied by the banks with respect to RenTec, the largest basket option user, suggests that the basket options may have been used to treat short-term capital gains as long-term capital gains, resulting in estimated tax avoidance of more than $6 billion. ... Over a fourteen-year period from 1999 to 2013, one hedge fund, Renaissance Technologies LLC, held 60 basket option contracts... [and] ...used them to carry out an investment strategy utilizing hundreds of millions of trades, virtually all of which lasted less than 12 months, and characterized the vast majority of the resulting $34 billion in trading profits as long-term capital gains.”[xix]
This certainly needs serious consideration as this action perhaps caused a huge loss to the United States (tax) exchequer by the hedge funds concerned. As is clear, Renaissance Technologies LLC (RenTec) is one of the major hedge funds explored in the U.S. Senate report.
In fact, the aforementioned Senate report unequivocally argues and settles the debate as follows:
“While the banks styled the trading arrangement as an “option” under which profits from short-term trades would be treated as long-term capital gains, in essence, the banks loaned the hedge funds money to finance their trading and allowed them to trade for themselves in highly leveraged positions in the banks’ proprietary accounts and reap the resulting profits. The banks offering the “options” benefited from the financing, trading, and other fees charged to the hedge funds initiating the trades. In the end, the trading conducted by the hedge funds using the basket option accounts was virtually indistinguishable from the trading conducted by hedge funds using their own brokerage accounts, and provided no justification for treating the resulting short-term trading profits as long-term capital gains.” [xx]
The report also notes a second issue related to these events and it pertains to “circumventing Federal Leverage Limits.” As the report argues,
“In addition to using basket options to reduce taxes on their short-term capital gains, the hedge funds used them to obtain financing for securities trades far in excess of what federal leverage limits allow. Federal leverage limits were established in response to the stock market crash of 1929, when securities purchased on borrowed funds magnified stock market losses and caused failures of, not only the stock speculators, but also the banks and broker-dealers that lent them money. Federal “margin rules” were enacted to impose a leverage limit of 2:1 on brokerage accounts opened by U.S. broker dealers for their customers. In contrast, because the participating banks seemingly lent money to their own accounts, the basket option accounts examined by the Subcommittee provided the hedge fund option holders with leverage ratios as high as 20:1. RenTec indicated in one document that it had been unable to attain such high leverage levels in any other setting.”[xxi]
The seriousness of the issue has been underlined by the financial crisis of 2008 and I quote from the FCIC report,[xxii] in which it is argued that:
“We conclude a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis. …In the years leading up to the crisis, too many financial institutions, as well as too many households, borrowed to the hilt, leaving them vulnerable to financial distress or ruin if the value of their investments declined even modestly. For example, as of 2007, the five major investment banks—Bear Stearns[xxiii], Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley—were operating with extraordinarily thin capital. By one measure, their leverage ratios were as high as 40 to 1, meaning for every $40 in assets, there was only $1 in capital to cover losses. Less than a 3% drop in asset values could wipe out a firm. To make matters worse, much of their borrowing was short-term, in the overnight market—meaning the borrowing had to be renewed each and every day. For example, at the end of 2007, Bear Stearns had $11.8 billion in equity and $383.6 billion in liabilities and was borrowing as much as $70 billion in the overnight market. It was the equivalent of a small business with $50,000 in equity borrowing $1.6 million, with $296,750 of that due each and every day. One can’t really ask, “What were they thinking?” when it seems that too many of them were thinking alike.
And the leverage was often hidden—in derivatives positions, in off-balance-sheet entities, and through “window dressing” of financial reports available to the investing public.” (FCIC Report[xxiv])
Looks like history may repeat itself in terms of another financial crisis, if the above practice of “high leverage” through basket options is allowed to continue.
That said, in summary, the report of the U.S. Senate Permanent Subcommittee on Investigations notes the following:
- “Although Deutsche Bank and Barclays established proprietary accounts for the basket options, purportedly to hold assets that would serve as a hedge to cover the option payoffs, those accounts actually functioned as if they were RenTec’s own prime brokerage trading accounts, with RenTec acting in the role of trader rather than option holder. The facts show RenTec had active and total control over the trading strategy and executions. …
- The resulting rapid asset turnover in the various option accounts meant that the options purchased by RenTec had no fixed assets and did not function as true options. The accounts existed simply to carry out RenTec’s algorithmic trading strategy.
- In the end, for all practical purposes, the accounts functioned as over-leveraged prime brokerage accounts controlled by the hedge fund...to produce trading profits rather than as accounts controlled by the banks to provide a hedge against an option contract. …
- This “RenTec’s control over the trading strategy and related activities, high-volume trading and account turnover, integration of the accounts into a larger investment strategy, and use of the accounts to produce regular cash payments supporting its business operations, contradict a depiction of RenTec as a passive option holder awaiting derivative gains. The option structure functioned instead as a vehicle for RenTec to conduct direct trades with leverage at much higher levels than available in normal margin accounts, to aggregate and defer its gains, and to avoid billions of dollars in short-term capital gains taxes.”[xxv]
Consequent to the 2014 report by the Senate Permanent Subcommittee on Investigations, reportedly[xxvi] hedge funds like RenTec that used the basket option strategy to avoid billions of dollars in tax faced new scrutiny from the government, in accordance with guidelines issued by the Internal Revenue Service (I.R.S.).
According to the new I.R.S. guideline, basket options — that allowed companies like RenTec to bypass taxes on short-term trades — were to be labeled listed transactions. What this meant was that anyone using the options strategy had to declare them on their tax returns. Failure to do so meant they ran the risk of penalty.
What is even more interesting is the fact that the new I.R.S. guidance was made retroactive, applying to all transactions from Jan. 1, 2011. A fact that brought within its ambit transactions by companies like RenTec, which according to a 2014 report by the Senate Permanent Subcommittee on Investigations,[xxvii] was able to avoid more than $6 billion in taxes over a decade through the use of the basket option strategy.
In fact, commenting on the activities, two Democrats reportedly supported the I.R.S. action. Carl Levin, a Michigan Democrat, and chairman of the 2014 Senate Permanent Subcommittee on Investigations supposedly said that the investigations showed that banks and hedge funds used “dubious structured financial products, costing the Treasury billions and bypassing safeguards that protect the economy from excessive bank lending for stock speculation.” He further added that the amount of money that hedge funds like Renaissance Technology were able to keep back by strategizing and not paying the required taxes, was a very significant amount, even by Washington standards. Likewise, Senator Ron Wyden of Oregon, the ranking Democrat on the Finance Committee, said he was all for the I.R.S. action to crack down on these types of basket option products.[xxviii]
In light of all this, it is baffling how the presumptive Democratic nominee for the U.S. presidential elections, Hillary Clinton, who promises to reign in Wall Street and who has also vowed to penalize (corporate) tax evaders, has no qualms in accepting campaign money from a company like RenTec and its founder and current chairman, James Simons.[xxix]
This is because, as noted earlier, according to the 2014 report of the U.S. Senate Permanent Subcommittee on Investigations, RenTec used the basket option structure with hundreds of millions of trades (virtually all of which lasted less than 12 months) and characterized the vast majority of the resulting $34 billion in trading profits as long-term capital gains and thereby avoided (paying) billions of dollars in taxes — which the Senate Permanent Subcommittee has estimated as amounting to over $ 6 billion, a huge number by any standards.
I wonder what the American people think of this juxtaposed against Hillary Clinton’s promises with regard to reigning in Wall Street, penalizing tax evaders, reforming campaign finance, overturning Citizens United and bringing in a constitutional amendment for the same. Whether she can walk the talk on all of this is something that only time can answer but I doubt it very much...
[v] Private Investment Firms Win the Right to Keep Money in the Family — http://www.bloomberg.com/news/articles/2015-02-10/meryl-streep-money-stays-with-simon-family-as-sec-grants-in-laws
[xi] As of May 28th 2016, both Soros and James Simons have been surpassed by Haim Saban, the media mogul, whose family and institutions have provided more than $10 million to the Hillary Clinton campaign directly and through pro-Clinton PACs.
[xiii] Senate: Renaissance Hedge Fund Avoided $6 Billion in Taxes in Bogus Scheme With Banks — http://wallstreetonparade.com/2014/07/senate-renaissance-hedge-fund-avoided-6-billion-in-taxes-in-bogus-scheme-with-banks/
[xvi] Abuse of Structured Financial Products Report (Basket Options) (2014), Original Footnote 1: See, e.g., U.S. Senate Permanent Subcommittee on Investigations reports and hearings, “Fishtail, Bacchus, Sundance, and Slapshot: Four Enron Transactions Funded and Facilitated by U.S. Financial Institutions,” S. Prt. 107-82 (1/2/2003); “U.S. Tax Shelter Industry: The Role of Accountants, Lawyers, and Financial Professionals,” S. Hrg. 108-473 (11/18 and 20/2003); “Tax Haven Abuses: The Enablers, The Tools and Secrecy,” S. Hrg 109-797 (8/1/2006); “Repatriating Offshore Funds: 2004 Tax Windfall for Select Multinationals,” S. Prt. 112-27 (10/11/2011); “Offshore Profit Shifting and the U.S. Tax Code – Part 1 (Microsoft and Hewlett-Packard),” S. Hrg. 112-781 (9/20/2012); and “Offshore Profit Shifting and the U.S. Tax Code - Part 2 (Apple Inc.),” S. Hrg. 113-90 (5/13/2013).
[xxii] Final Report Of The National Commission On The Causes Of The Financial And Economic Crisis In The United States, Submitted by The Financial Crisis Inquiry Commission, Pursuant to Public Law 111-21, January 2011 — http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf
[xxiii] It must be noted that Bear Stearns and RenTec worked closely for several years.
[xxv] REPORT: ABUSE OF STRUCTURED FINANCIAL PRODUCTS: Misusing Basket Options to Avoid Taxes and Leverage Limits (July 22, 2014) (805.6 KB). http://www.hsgac.senate.gov/download/report-abuse-of-structured-financial-products-misusing-basket-options-to-avoid-taxes-and-leverage-limits
[xxvi] I.R.S. Cracks Down on Hedge Fund Tax Strategy — http://www.nytimes.com/2015/07/09/business/dealbook/irs-cracks-down-on-hedge-fund-tax-strategy.html?_r=0
[xxvii] Senate Inquiry Faults Hedge Funds’ Tax Strategy — http://dealbook.nytimes.com/2014/07/21/senate-inquiry-faults-hedge-funds-tax-strategy/
[xxviii] Summarized from I.R.S. Cracks Down on Hedge Fund Tax Strategy — http://www.nytimes.com/2015/07/09/business/dealbook/irs-cracks-down-on-hedge-fund-tax-strategy.html?_r=0
[xxix] It must be emphasized that James Simons is the founder of RenTec and serves as the current chairman of RenTec. Therefore, whether he donates from RenTec or another company that he runs – Euclidean Capital, which is a family office — is immaterial. In addition, it must be clearly noted that James Simons was CEO of RenTec for much of the period when RenTec used the basket option strategy with Deutsch Bank and Barclays Bank.