Germany is bracing itself for a wave of cases involving the long-running cum-ex tax evasion scandal, as a 10-year statute of limitations on criminal investigations by prosecutors draws to an end this year.
There is pressure on BaFin, the German financial regulator, which has already been under fire this year following the Wirecard fraud. In a parallel with the Wirecard case, whistleblowers notified the regulator about the cum-ex scandal more than a decade before it acted.
Cum-ex fraud uses a form of dividend arbitrage between the date that the share was acquired and the date on which a dividend was paid to reclaim payment of withholding tax, sometimes on many occasions. It requires creating the impression of multiple owners of the same share at the same time, a concept of economic ownership which appears now to have been debunked.
Lost tax revenue
The cum-ex withholding tax reclaim system, which started in 1990s and lasted until at least 2011, is alleged to have cost European states some $55.2 billion in lost tax revenue. Some 31.8 billion euros was estimated to have been lost to Germany, 17 billion euros from France, 4.5 billion euros to Italy and 1.7 billion euros to Denmark. The UK exchequer escaped any financial exposure as it does not operate a withholding tax regime in respect of share dividend payments.
An investigation by the UK Financial Conduct Authority (FCA) into dividend arbitrage by City traders was highlighted by Mark Steward, the FCA's executive director of enforcement and market oversight, in a February 2020 speech.
"The FCA has been investigating substantial and suspected abusive share trading in London's markets that has allegedly supported these schemes. "
The UK was working with Germany, Italy and France, Steward said.
Banks, bankers on notice of criminal investigations
Political pressure from Bonn is intense. "State prosecutors need to investigate each and every single case. The closer we get to the 10-year statute of limitation, the greater the pressure on prosecutors," said Bastian Finkel, partner at law firm Bach Langheid Dallmayr in Cologne.
A dedicated team of state prosecution lawyers has been set up in Cologne to take these cases forward. It has put at least 100 banks and 400 individual bankers on notice of criminal investigations, a measure that enables it to bypass the German statute of limitation rule and continue their investigations.
Police are working with tax authorities to enforce repayment of the amounts made from the fraud, on the basis that they were obtained through crime.
"A few banks will receive repayment orders from the tax authorities, so their profits can be seized through criminal proceedings. In some cases, tax authorities can approach a bank and say, 'look, you were involved in that, taxes were refunded that shouldn't have been, and so here is your tax repayment order'," Finkel said.
Banks have proved reluctant to contest them.
"Banks won't really fancy going to court to fight the tax authorities," Finkel said.
Banks must establish extent of exposure
Executives who had responsibility for institutions where the fraud occurred have also been pursued by banks to obtain redress. These have largely been settled out of court.
"The banks will probably turn around and say, 'Who was on the board at that time, who screwed that up? You are liable for this and will need to compensate for the loss.'"
The extent to which senior bankers knew about the fraud varied between banks, Finkel said.
"In cases with which I am familiar, there was no proof that there was any positive knowledge on the top executive board about what was going on at the trading desk," he said.
The fraud was most widely practiced by dividend arbitrage departments between 2007 and 2012, said David Stern, a barrister with 5SAH. Stern has advised compliance departments to understand their exposure to cum-ex trading and to take significant steps to offset their risks, as well as to improve their regimes.
"A very large number have received letters from German investigators. We have no idea how many banks and bankers will end up being actively pursued, but you are well-advised to know the nature and extent of any involvement with cum-ex trading and what your exposure could be. This is likely to entail the need for significant internal investigations, with both UK and German legal teams with a detailed understanding of the trading methodologies," Stern said.
A series of recent events involving international financial institutions with cum-ex allegations will add to the pressure on prosecutors, banks and their advisers.
In February 2020 it was disclosed that liquidators for Canadian bank Maple Financial's German unit — which collapsed in 2016 a result of a massive claims arising from its involvement in the cum-ex scheme — had sued EY, Maple's auditors between 2006 and 2009, for 95 million euros, citing EY's "flawed advice".
A civil lawsuit was brought against a partner at Freshfields Bruckhaus Deringer in June 2020, citing his advisory role in the scheme that brought down Maple's German operations. In August 2019, Freshfields paid 50 million euros to settle a claim brought by Maple's liquidators, without admitting liability.
On September 23, 2020, MM Warburg lost its claim against Deutsche Bank for 166 million euros for losses it had experienced following cum-ex related claims. However, the Frankfurt judge said MM Warburg could try to bring a claim against ICAP, the UK-based Interdealer broker, which sold the shares involved in the deal.
In March 2020 a British banker working for German bank HypoVereinsbank in London was convicted of fraud in Bonn. This was the first conviction in a criminal case in a German court involving cum-ex fraud and a landmark decision.
Bankers from DZ Bank have also been investigated for their roles in the fraud.
"This is the tip of the iceberg. There's going to be a lot more criminal proceedings that will go to court, probably next year," Finkel said.
While many of these negotiations with executives were said to be occurring in private, UniCredit/HypoVereinsbank has sought to use the courts to recover damages of 140 million euros from three former board members.
Some 50 German and international banks have been investigated for their involvement in cum-ex fraud. HypoVereinsbank has paid multi-million-euro fines and restitution to the state.
"Virtually all the major banks in Germany have been implicated in one way or another. The list of those involved reads like a 'Who's Who' of the banking sector," according to a report from DAC Beachcroft, published in 2017.
The FCA declined to comment on this investigation.