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.

The PSHZY notification came after another newsletter first recommended and then withdrew its recommendation for PSHZY. The prospectus, as is often the case, warned that the fund may be treated as a PFIC by the IRS.

• The same newsletter also heralded the PFIC risk with Kennedy Wilson Europe Real Estate plc, a UK company formed by the listed US Kennedy Wilson group to invest in European property, KWERF. It is listed in London and run from St. Helier on a different Channel Island, Jersey.

The key fact about these two funds is that they are owned and managed by US companies or persons.

A PFIC hunt in our portfolio right now would turn up plenty of candidates, ranging from Investor of Sweden, IVSBF, a holding company; to Canadian General Investments, CGRIF, a closed-end fund; from Yoma Strategic Investment (YMAIF), a Singapore vehicle for investing in Myanmar, to Africa Opportunity Fund, AROFF, listed in London; from Deutsche Bank MSCI Pakistan Investment Fund, HK:3106 to Ascendas India Trust, ACNDF; from Canadian currency-hedge Horizon US Dollar, DLR-TSX to Mexican REIT Fibra Uno, FBASF. I have owned several for as long as a decade, and never had any questions raised after my dividends and capital gains are reported by the brokers to the IRS.

Perversely, the big difference is that PSHZY and KWERF are US-managed notionally pure foreign investment funds. The others have only a few US shareholders, and are managed outside the Land of the Free. In theory PFIC rules apply regardless of how many US shareholders own the fund; in practice only US-run funds are hit. And only US-run funds provide the QEF forms.

In addition, the PFIC definitions often apply to non-finance companies like biotech startups which have cash and little operations. The rules are just a mess and if in a year's time we get notifications on these two funds, we can simply sell them.

• Separately, PSHZF reported that it lost 3.5% in net asset value in March, closing with an NAV of $27.35. As long as it fails to earn a profit it will not produce a taxable distribution, not why we own it.

• The Wall St.Journal reports that Indians are being asked to pay 100 rupees in order to get the application form for a free bank account under the 10-mo old Narendra Modi “People Money Scheme” to widen access to financial services for the poor.

The Financial Times reports that about 100 foreign funds investing in Indian shares have been slapped with demands for payments of minimum alternative corporate taxes (MAT) that funds typically are not required to pay. This resulted from audits of 2011-2 returns. There are about 6000 global funds investing in India and only the largest have reported getting the tax bill so far.

The tax bills come after attempts to extract large sums in taxes, interest, and penalties on foreign firms like Cairn Energy, like our Sesa Sterlite (a sub of Vedanta), and Vodafone. SSLT and VOD are ultimately British. A London fund manager told the FT: “This seems like one more self-inflicted tax problem that India doesn't need at the moment.”

• A friend's daughter has just lost her young husband in Italy. As a result her joint check account is in violation of US FATCA rules which limit American holdings in foreign bank accounts to $50,000. His death meant she became the only owner. She is selling her home and moving with her two pre-teen children back home with her parents, who luckily have a large house. I am pretty sure she was not the intended target of this tax rule.

Now for some real news starting with mergers and acquisitions.

Oil & Gas

• The agreed $70 bn Shell acquisition of BG has naturally turned attention to the other cheap British oil company, BP plc. It may be a target of ExxonMobil according to the buzz among oil analysts. Kamkura Corp bond analysts warn that BP bond prices incorporate the highest risk of default in the past 10 years on the US market where its UK and US bonds are among the most heavily traded.

• Extended oilpatch optimism has boosted Schlumberger Ltd, (SLB) our Dutch wellhead services firm, which rose 2.5% today.

• ”Muddy Waters” issued a short sell on Singapore's Noble Group Ltd, which is not the same as Noble Energy, the US partner of Delek Group in Israeli offshore.

Drug Dealing

• Rumors that Teva was going to spring for either Mylan or Perrigo is less likely if the $29 bn Mylan offer is accepted. Both are former US companies now incorporated in Ireland and The Netherlands for tax inversion last year. PRGO specializes in OTC drugs while MYL is in the not very profitable business Teva dominates: generic drugs. Part of the Perrigo appeal might be its Tysabri multiple sclerosis drug which competes with TEVA's Copaxone. Teva is up 2.6% today in relief that it is not in the bidding. Frankly I doubt if it wants to be in OTC drugs and if it could get anti-trust okay to get deeper into generics for the US market.

Finance

• Fitch Ratings today said that Vale will not this year breach its loan covenants with Brazil's BNDES which require that it keep its gross debt below 4.5x gross adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA, or cash flow), and gross interest higher than twice EBIDTA. This concerns about $7.7 bn of debt accounting for about a fifth of the VALE total. The remaining 80% does not have loan covenants. The rater says that even if iron ore prices average below $50/metric tonne in 2015, which Fitch considers unlikely, Vale would have gross debt at 3.8% of EBITDA and net debt at 2.9% of EBITDA. Moreover, as I keep saying, Vale can scale down capital spending and exit or divest non-iron ore assets. An example cited by Fitch is the sale of its gold stream to Silver Wheaton (SLW) for $900 mn in Feb.

However, there is a negative. Fitch thinks if iron ore prices remain in the dumps, Vale may halve its dividend which otherwise would cost it $2 bn at current exchange rates.

• Simplification of the ordering process based on a cloud-based user interface which maintains security and records is on offer from Ariba Mobile, a sub of SAP for corporate sales and procurement. It will allow orders by cellphone or other devices outside the office to be tracked and recorded inside the office. Ariba also offers a consumer payment device for T-mobile phones. Both firms are German.

• Eduardo Garcia writes that HSBC's Mexican branch network may be acquired by Scotiabank. Bank of Nova Scotia, BNS, is a Canadian bank with a Latin American franchise. He quotes Gabriel Duchenne of Canaccord Genuity in today's www.sentidocomun.co.mx.

• CRH (CRH) rose 3.25% in London trading today (although it is incorporated in Ireland) thanks to the resolution of disagreements over the merger of Lafarge and Holcim which will let it buy cement assets on the cheap. The new chief to head Holcim-Lafarge is Franco-American Eric Olsen. I wonder if that makes it a PFIC? It is up only 2.3% here.

• Worries that China stocks are in a bubble (again) has led to outflows from Shanghai to Hong Kong shares using the pipeline, where a record flow exited today. Among the big gainers is Tencent Holdings, up 5.25% in Hong Kong and 5.62% here (TCEHY), a new high.

• Insurer AIA ordinary shares (HK:1299) are up 3.7% to HK$58, an all-time high, in the rush.

• Yoma Strategic Holdings, YMAIF, ran a 2nd shareholders' trip to Myanmar, where the Singapore firm invests, to show them what it is doing. They visited the Star City and other golf courses, retail centers, an auto showroom, and other sites for 3 days late in March. I was not invited to Yangon but there was at least one American in the party of 76 shareholders. Yoma last year issued rights which expired worthless in Feb. Lucky. They might have counted as a 125% distribution!

Neiges d'Antan

• More on why China Chaintek (LSE:CTEK) rose 20% yesterday to 32 British pence, about 48 cents. The Chinese logistics firm completed acquisition of a Fujian Province transit warehouse near its existing facility where about 45% of its operations are now in place. The new facility ran into regulatory issues but now has been bought outright for EMB 15.8 mn, about $2.5 mn. The new quarters allow CTEK to fill smaller trucks with loads carried during the daytime when traffic restriction rules apply, and use its older large trucks to feed the new site at night. The share fell back nearly 7% overnight to 28 pence. For the record the shares in my e-trade account do not show either price.

• Bombardier faces more misery because Moscow based Ilyushin Finance is reconsidering its order for the C-series single-aisle low-energy regional jet. BDRAF announced last month that commercial flights of the C-series would be delayed until 2016, 3 years late. I love the idea of Canadian competition to Boeing and Airbus, but it is up in the air. We sold.