A large but low-profile Seattle-based investment firm, Quellos Group, used a bewildering series of fake securities deals between offshore shell companies to help rich clients shelter more than $2 billion in capital gains from taxes, a Senate report released Tuesday alleges.
Senate investigators said the Quellos-created shelters ultimately cost the U.S. Treasury $300 million in tax payments.
The Senate's Permanent Subcommittee on Investigations concluded, after a yearlong inquiry, that offshore tax havens allow the wealthy to stash trillions of dollars, mostly beyond the reach of tax, regulatory and law-enforcement authorities, and avoid paying $40 billion to $70 billion in taxes each year.
Michigan Sen. Carl Levin, the senior Democrat on the subcommittee, said at a hearing yesterday that the report, which outlines the Quellos shelters and several others, "blows the lid off tax-haven abuses that make use of sham trusts, shell corporations and fake economic transactions to help people dodge taxes."
Addressing Quellos specifically, the report alleged the Seattle firm "concocted a tax shelter that was based upon the fabrication of billions of dollars worth of fake securities transactions that were used to generate billions of dollars in fake capital losses."
But in testimony before the panel, Quellos Chief Executive Jeffrey Greenstein called the report "unfair, one-sided and inaccurate," and said it "seems to have glossed over or omitted several basic facts."
Greenstein also described the unit that sold the tax shelters in 2000 and 2001, Quellos Custom Strategies, as "small and now dormant."
Quellos, founded in 1994 as Quadra Capital Management, is now one of the world's biggest players in the "funds of hedge funds" business. Such funds allow someone to buy, with a single investment, into several hedge funds — huge, lightly regulated investment pools that employ complex investment strategies and cater to wealthy individuals and big institutions.
From its headquarters on the top floor of Seattle's Two Union Square office tower, Quellos manages more than $15 billion in assets. Its client list, according to published reports, includes the Washington State University Foundation, Seattle City Employees' Retirement System, the Alaska State Pension Investment Board, and the Hong Kong Jockey Club.
An earlier Senate investigation found that Quellos was among several financial-services firms and law firms that in the mid- to late 1990s helped accounting giant KPMG structure and execute "unregistered and fraudulent tax shelters." KPMG avoided an indictment last August by agreeing to pay $456 million in penalties.
According to the subcommittee report issued yesterday, Greenstein and other Quellos executives devised the complex tax strategy, known as Personally Optimized Investment Transaction or POINT, in 1999.
POINT essentially combined a partnership that held a group of stocks expected to lose money and a long-dated warrant — similar to an option but with a longer term — giving investors the right to buy the same stocks.
A client — typically someone with large unrealized capital gains from stock that had risen in price — would buy one of the money-losing partnerships and add in his profitable stocks.
When the entire portfolio was sold, the report stated, the gains and losses would cancel each other out: "As long as the stock proceeds were kept in the [partnership], the theory was that the investor could avoid indefinitely all taxes on the profits on his original stock."
The warrant was included to create the possibility of making a profit, at least on paper; one criterion the IRS uses to judge whether a tax strategy is abusive is whether it has any legitimate business purpose other than reducing taxes.
In reality, according to the report, there was never an intent to sell the warrant.
One step of the complex series of POINT transactions involved two dummy corporations set up on the Isle of Man, a British dependency sandwiched between England and Ireland. The companies, called Barnville and Jackstones, were to swap cash and stock that neither in fact owned, says the report: "The entire transaction was a fiction."
Quellos sold POINT to five clients in 2000 and 2001. Two of them, Johnson & Johnson heir Robert Wood Johnson IV and television producer Haim Saban, also testified at Tuesday's hearing.
Johnson told investigators two weeks ago that when he needed to sell assets to buy the New York Jets football team in 1999, he asked his accountant at KPMG to look for ways to minimize his tax bill. Around the same time, the accountant left KPMG to join Quellos; shortly thereafter, he told Johnson that "he might have found an idea that would help."
Saban told investigators two weeks ago that he had been unaware of how the tax losses had been generated, adding: "You have before you a very disappointed person, who feels misled, lied to, cheated."
In his testimony, Greenstein denied that the POINT transactions had no real profit potential and stressed that both Quellos and its clients had consulted with tax lawyers and other professionals, who gave formal written opinions blessing the deals.
He noted Quellos had registered POINT with the IRS as a tax shelter, as required by law, and had not tried to hide information about it.
IRS Commissioner Mark Everson told the subcommittee his agency has a number of offshore-tax-shelter investigations finished or under way.
"Offshore tax shelters are robbing the American treasury of billions of dollars each year," he said in written testimony.
The Senate report recommended a series of reforms to U.S. tax and money-laundering laws, including:
• Offshore trusts and shell companies in designated tax havens should be treated as if they are controlled by whoever supplies their assets, even if on paper they're independent.
• Publicly traded companies should have to disclose any company stock in offshore trusts or shell companies related to officers, directors or large shareholders.
• Hedge funds should be required to establish anti-money laundering programs and report suspicious transactions to law enforcement.
Reuters contributed to this story.
Drew DeSilver: 206-464-3145 or email@example.com