E Perverse Incentives

JP Morgan Chase is using a new algorithmic software program which signals employees who might be “going rogue”. It collects data on whether or not they attend compliance classes or if they have a prior history of having violated trading rules. Then it predicts which bank employees might behave badly again.

A danger at huge banks comes because the top brass cannot check on what the rank and file are up to. Back in the old days bankers were supposed to know their customers, and of course it was inconceivable that they then didn't know their staff members. It is an argument for breaking up large global banks with insufficient personnel control.

The theme of today's newsletter is perverse incentives. Having this software is an example.

I made an error in my article two days ago about the Wisdom Tree one-stop exchange traded funds investing outside the US dollar using currency hedges. The yen-hedged fund investing in Japanese equities is a new one, Wisdom Tree Japan Hedged Dividend Growth Fund, ticker symbol JHDG. Its priority is yields, not capital gains.

More  follows from Britain, Israel, China, The Netherlands, Singapore, Hong Kong, India, Myanmar, Ireland, Canada, and Brazil.

Toxic Taxes

• Even an activist investor may be designated as a passive one under the US tax code administered by our Internal Revenue Service. Pershing Square Holdings Ltd yesterday issued press release notifying “self-identified” US shareholders about tax reporting under the Passive Foreign Investment Co. PFIC rules were crafted in 1986 by the Reagan Administration on behalf of the US Investment Company Institute, the fund industry lobby. The idea was to stop US investors buying foreign mutual funds.

PSHZF is a foreign-based closed-end fund, listed in Amsterdam and HQ'd in the Channel Islands, established by activist US investor Bill Ackman, bought for our portfolio last month. It will send to US filers who seek it information for the 2014 tax year allowing them to file paperwork to treat PSHZY as a qualified electing fund (QEF) under US tax rules for reporting PFICs. The material will be sent on a confidential basis to shareholders who apply, not to the IRS. Applications go to the investor relations contact: IR-pershingsquareholdings@stockwellgroup.com PSH listed over a year ago in London and its corporate registry is in St. Peter Port, Guernsey, in the Channel Islands but it is managed by Ackman, an American.

PFIC rules require that a shareholder annually mark to market any gains in a designated PFIC boosting the basis at which it was bought. A PFIC is a foreign investment corporation where 75% or more of the income for a taxable year is passive, based on US regs, or where at least 50% of the assets held by it are produced as passive income. To avoid dissuasive taxation US taxpayers should apply to have the fund treated as a QEF. That means you pay tax on earnings and profits as they grow. The shareholder's basis is increased to prevent double taxation. This is comparable to what happens with normal closed-end funds when they automatically reinvest payouts. Distributions are then only taxed if they are defined as “excess distributions” worth 125% over the distributions reported over the prior 3 years and may be taxed as ordinary income rather than dividends, unlikely with this fund.

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