The Wall Street Journal-20080115-Wall Street Facing New Senate Probe- Subpoenas Seek Detail On Efforts to Sidestep Taxes on Dividends
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Wall Street Facing New Senate Probe; Subpoenas Seek Detail On Efforts to Sidestep Taxes on Dividends
Senate investigators, stepping up scrutiny of tax-cutting maneuvers, are examining whether Wall Street firms improperly structured transactions that helped hedge funds sidestep dividend taxes, say people familiar with the situation.
In recent weeks, banking giant Citigroup Inc., securities firms Lehman Brothers Holdings Inc. and Morgan Stanley as well as Swiss bank UBS AG have received subpoenas relating to the use of derivatives by offshore investors, including some big hedge funds, to help avoid withholding taxes on U.S. stock dividends, these people say.
Investigators also have contacted a number of hedge funds to ask about the use of these derivatives -- complex financial instruments whose values are tied to those of assets such as stocks, commodities or currencies, these people say.
The investigators are examining these transactions to determine whether the securities firms and banks acted improperly by failing to withhold taxes on U.S. stock dividends, these people say.
The probe, by the Senate's Permanent Subcommittee on Investigations, chaired by Carl Levin (D. Mich.), was sparked by a Wall Street Journal page-one article in September that reported on efforts by Lehman and other firms to pitch hedge funds with offshore operations on ways to avoid paying taxes on dividends paid on U.S. stocks. Federal tax authorities also are seeking information about these types of transactions.
The new Senate probe is significant because it lifts the scrutiny of the area to a higher and more public level. The Permanent Subcommittee on Investigations -- dubbed by some Beltway insiders as the "show- trial" committee -- in recent years has held public hearings on KPMG LLP's controversial tax shelters and on banks' questionable dealings with once-highflying energy giant Enron Corp.
The subcommittee could push for a change in policy in this area, or if it finds potential wrongdoing, could move to have public hearings on the matter. A spokeswoman for the subcommittee declined to comment on the investigation.
At stake is more than $1 billion in withholding taxes on U.S. stock dividends that are sidestepped by such trades, accountants say.
Already, finger-pointing about who is on the hook for the money has begun between banks and their big-ticket hedge fund clients, according to people in the industry. If the government ultimately determines that withholding taxes should have been paid, it will likely seek to recoup the money, plus interest and possible penalties, from the banks, who are the withholding agents. The banks may then try to recover the money from their clients.
The subpoenas are broad and seek information about derivatives trades where offshore-investment vehicles such as hedge funds enter into "swap" arrangements -- selling stocks to investment banks which, in return, pay the clients the return of the stocks and any dividends they generate. The transactions can help hedge funds save paying as much as 30% in taxes on U.S. stock dividends because the offshore fund technically doesn't hold the stock.
Investigators are seeking emails, marketing materials and any other documents dating back to Jan. 1, 2000, that are related to these transactions, say people familiar with the situation.
They are focusing on swaps executed for 21 days or less involving underlying securities where there was a scheduled dividend payment during that time, these people say.
In the case of Lehman, investigators are seeking information about a strategy called the "Cayman Islands Trade." This transaction offered institutional offshore entities -- mainly foreign mutual funds and pension funds -- a way to "enhance the yield" on dividend-paying U.S. stocks, people familiar with the situation say. The Cayman Islands trade, so named because part of the transaction involved Lehman's Cayman operations, was reported in the Journal story. With other banks, investigators have inquired generally about their Cayman operations, these people say.
Investigators also are asking securities firms for information about clients that executed these types of trades through them, say people familiar with the situation. As reported in September, a number of hedge funds entered into trades with Lehman, according to a Lehman document. They included Angelo, Gordon & Co.; Highbridge Capital Management, the big hedge fund majority-controlled by J.P. Morgan Chase & Co.; JMG Triton; and KBC Alternative Investment Management.
Angelo Gordon didn't return calls for comment. JMG Triton and Highbridge declined to comment. It isn't clear whether these hedge funds have been among the funds investigators have contacted. It also isn't known if the funds are among those investigators have sought information about from securities firms.
A KBC AIM official said: "We have not been contacted by any congressional committee. If we are, we will be happy to cooperate."
