Wall street is notorious for Dirty Little Secrets, so the title here is slightly misleading as it implies that there is just one dirty secret they are hiding away. However, this one has been largely unreported until recently, Bloomberg posted an article just a couple days ago entitled The ETF Tax Dodge is Wall Streets “Dirty Little Secret”, the article looks at what they are calling ‘Heartbeat’ transactions.
‘One day last September an unidentified trader pumped more than $3 billion into a tech fund run by State Street Corp. Two days later that trader pulled out a similar amount.’
This transaction raised alarm bells and so they began to dig a little deeper and what they found is basically a loop-hole being exploited by Wallstreet with help from their corporate banker friends to avoid Billions if not Trillions of dollars worth of taxes.
‘It turns out that transfusions like these are tax dodges, carried out by the world’s largest asset managers with help from investment banks. The beneficiaries are the long-term investors in exchange-traded funds. Such trades, nicknamed “heartbeats,” are rampant across the $4 trillion U.S. ETF market, with more than 500 made in the past year. One ETF manager calls them the industry’s “dirty little secret.”
How Does it Work?
When a Stock is sold at a profit, i.e you sell at a higher price than you purchased you are then automatically liable for tax on these profits, however thanks to a loop-hole in the Nixon-era Tax laws these taxes can be avoided if the profits are used to pay off a withdrawing fund investor.
The Heartbeat comes into play when there isn’t an exiting investor available. A fund manager then asks when of their banking buddies to create withdrawals by rapidly pumping the asset in and out.
‘Imagine that a grocer got a tax deduction every time someone returned a box of cornflakes to his store. Heartbeats are when the grocer asks a friend to buy all the boxes and return them, just to pocket more deductions.’
The process is entirely legal and at this point if new legislation was introduced to prevent such foul play occurring it would inevitably trigger a major crash in the ETF markets, so fixing the problem isn’t a simple task.
Regardless, its another thing to keep in mind. The Economy is fragile and with so foul play so rampant among Wall