Wall Street Firms Involved In Tax Dodge, Report Says

By Alison Fitzgerald
Bloomberg News
Friday, September 12, 2008

Wall Street firms have helped offshore hedge funds dodge hundreds of millions of dollars in U.S. taxes through concocted derivatives and stock-loan deals, according to a Senate report released yesterday.

The Internal Revenue Service looked the other way while securities firms sold complicated financial products designed to skirt a law requiring them to withhold U.S. taxes on stock dividends paid to offshore investors, said Sen. Carl M. Levin (D-Mich.), chairman of the permanent subcommittee on investigations.

Levin said he wants the IRS to pursue back taxes or penalties against Wall Street firms and their hedge-fund clients that got around a 30 percent dividend tax. Lehman Brothers Holdings, UBS and Merrill Lynch are among the firms that could be targeted.

"We are going to press the IRS to go after what is obviously a scheme," Levin said, while briefing reporters Wednesday about the committee's yearlong probe. "The IRS should be going after this. They are not. They have been pussyfooting around this."

Citigroup, Morgan Stanley and Deutsche Bank also profited by creating and selling "dividend-enhancement" products with no legitimate investment purpose besides letting investors avoid taxes, the committee report said.

Morgan Stanley's dividend-enhancement products generated $25 million of revenue for the company in 2004 alone, and cost the U.S. government more than $300 million in unpaid taxes from 2000 through 2007, the report said.

Lehman Brothers, in an internal document described in the Senate report, estimated that it helped clients avoid $115 million in taxes in 2004. Lehman spokeswoman Monique Wise declined to comment on the report.

Dividend-enhancement transactions earned about $5 million of profit for UBS in 2005, and $4 million for Deutsche Bank in 2007, the report said.

Levin said he plans to introduce legislation making it harder to structure swaps and stock loans for the sole purpose of avoiding taxes.

At a hearing yesterday, executives from three hedge funds, Highbridge Capital Management; Angelo, Gordon & Co. and Maverick Capital, said the investment firms in the report, and many others, marketed the products to their companies to win their business.

"Every major financial institution would come and try to convince us to buy these products," said Joseph Manogue, treasurer of Dallas-based Maverick Capital. He said the primary reason his firm bought the products was to boost dividend returns and that most swaps lasted 15 to 30 days.

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