Thursday, 31 July 2014
Last updated 15 hours ago
Mar 14 2012 | 1:06pm ET
The hedge funds accused by Fairfax Financial Holdings of market manipulation and insider-trading are seeking a measure of revenge against the Canadian insurer.
One of the hedge funds, Kynikos Associates, SAC Capital Advisors and Third Point, made a complaint about Fairfax to the Internal Revenue Services' whistleblower office. According to the hedge fund, relying on one of their expert witnesses in the Fairfax case, the insurer used trickery to claim $400 million in tax benefits from 2003 through 2006, The New York Times reports.
Fairfax offset its own losses against income from its reinsurance subsidy, Odyssey Re Holdings. The only problem was, Fairfax didn't own the necessary 80% of Odyssey in 2003. Rather than buying the $78 million in Odyssey shares it needed to reach that threshold, it borrowed them—and, according to the hedge fund, borrowing is not the same as owning, and is the difference between a legitimate $400 million benefit and fraud.
Certainly, tax law expert Edward Kleinbard, hired by the hedge funds, doesn't think it’s the same thing, and has produced a 60-page report to show—and testified that—the deal was a sham.
"Fairfax borrowed shares to no economic effect simply to create the impression that it owned them," he wrote. "Fairfax did not accomplish any business objective through this transaction, but rather simply paid a fee to [Bank of America] to acquire a false claim to file a consolidated federal income tax return with Odyssey Re."
Fairfax did get Ernst & Young to sign off on the deal, but, Kleinbard wrote, the auditor's decision was based solely on what Fairfax told it about the deal. And BofA seemed to question Fairfax's plans—although the executive who managed the deal later changed his mind.
Borrowing the shares "does not provide true economic ownership of the ORH shares to Fairfax," Robert Giammarco wrote in an e-mail at the time. But testifying in 2011, after a stint as executive vice president of Odyssey, Giammarco said, "I think I just got it wrong."
It is unclear whether the IRS has taken up the whistleblower complaint.
"Fairfax owned these shares and was properly consolidated," Michael Bowe, a lawyer for Fairfax, said. "Only defendants and their paid experts, like Mr. Kleinbard, argue Fairfax did not have an economic interest in these shares."
Fairfax has seen its lawsuit against those defendants slowly whittled away after more than five years of litigation. In fact, one of the defendants isn't a defendant anymore; last year, a judge dismissed Fairfax's case against SAC.
Jul 8 2014 | 10:48am ET
The surge in derivatives regulation is among the most complex challenges facing the financial services industry today. Northern Trust’s Joshua Satten recently spoke with FINalternatives to share insights into the challenges presented by new regulation and explore how the industry is responding. Read more…