Citigroup Receives Wrist Slap for Helping Hedge Funds Avoid Taxes

Date: Tuesday, October 13, 2009
Author: Seeking Alpha.com

Bloomberg reports Monday that Citigroup (C) agreed to pay $600,000 in fines related to a charge Finra brought against the bank. The regulator claimed that Citigroup didn’t properly supervise specific transactions of foreign clients to skirt paying taxes on dividend payments.

According to the Bloomberg article:

Investigators at the Financial Industry Regulatory Authority, which polices almost 4,800 U.S. firms, found Citigroup Global Markets failed to supervise the system of trades and swap contracts and inadequately monitored certain communications.

Well, not exactly innocuous. What Citigroup was doing — as was discovered by a U.S. Senate inquiry last year — was actually part of a larger trend towards Brokers/Dealers ('BDs') extending trading and derivatives to international hedge fund and institutional clients in an effort to avoid paying U.S. taxes.

Payment of dividends is clearly a taxable event for investors. What BDs did for their clients was to purchase client shares before dividends were to be paid. In return for this synthetic ownership, clients received a derivative contract that was to pay them the equivalent of the dividends they’d be owed if they still owned the stock.

BDs service their clients, provide their derivative desks some action, and avert taxes - and everyone is happy. Citibank even disclosed the transactions and paid — it appears in lieu of their clients having to pay — taxes in 2006 and 2008 on these transactions.

This move comes as the current U.S. administration is cracking down on all types of offshore companies sequestering funds out of reach of Uncle Sam. It also coincides with a little own introspection as Finra tries to wash the egg from its face in light of the massive frauds the regulator could have prevented.