Wall Street Blamed in Senate Report for Helping Foreign Hedge Funds Avoid U.S. Taxes

Wall Street megabanks, Lehman Brothers, Citigroup, Morgan Stanley, and Merrill Lynch, are all facing heavy scrutiny over some of their questionable business practices. A U.S. Senate committee investigation has revealed that several top firms are raking in millions of dollars in profits by using complex derivatives and stock schemes to help foreign hedge funds illegally avoid paying billions in U.S. taxes.

In its 77-page report, to be released Sept. 11, 2008 the Senate Permanent Subcommittee on Investigations calls the tax-avoidance schemes another example of a “privileged few” benefiting at the expense of millions of American taxpayers who are left to shoulder a disproportionate share of the tax base. The report says that $100 billion a year is lost to offshore tax abuses. The report names several hedge funds involved in the schemes, including Moore Capital, Highbridge and Maverick Capital.

Foreigners who invest in the United States are exempt from many U.S. taxes - they don’t pay taxes on interest earned on money deposited in a U.S. bank, nor do they pay taxes on capital gains. However, if they invest in a U.S. company and the stock pays a dividend, U.S. law requires them to pay a tax on the dividend. Dividends sent abroad are supposed to be taxed at a rate of 30% in most countries.

In reality, however, it’s a different story, and many non-U.S. stockholders never pay the dividend taxes that they owe. According to the Subcommittee’s report, the fault lies with U.S. financial institutions.

According to the report, each of the institutions investigated developed and marketed “dividend-dodging products” that disguised dividend payments to clients as nontaxable ones. The products involved complex equity swaps or loans that the banks described as offering a “dividend enhancement,” “yield enhancement,” or “dividend uplift.”

For the investment firms, the practice is a profitable one. The Senate investigation shows that from 2000-2007 Morgan Stanley helped clients avoid payments of U.S. dividend taxes of more than $300 million. Lehman Brothers estimated that in one year alone, it helped clients avoid U.S. dividend taxes amounting to $115 million. From 2004 to 2007, UBS enabled clients to dodge $62 million in dividend taxes.

As was seen in the FBI’s investigation of Bear Stearns’ executives Matthew Tannin and Ralph Cioffi, as well as in several other recent Wall Street scandals, emails are at the center of the Senate Committee’s probe over dividend tax dodging.

As reported Sept. 11, 2008 in The New York Times, the Committee’s report cites an internal e-mail message in which an employee from Lehman Brothers refers to Microsoft’s announcement of a special dividend as “the cash register is opening!” A senior Lehman official is then quoted as saying, “Outstanding. Let’s drain every last penny out of this [market] opportunity.”