Partner Bambos Tsiattalou discusses how a new EU tax scandal is sure to reach London, in Law360.
Bambos’ article was published in Law360, 12 December 2019, and can be found here.
A trading scandal is brewing on the continent which could yet envelop London. It may ultimately prove to be even more damaging than the Libor scandal. It is widely believed that a number of leading UK banks and advisors were involved – to one degree or another – in a questionable equity trading practice known as cum-ex trading.
Cum-ex trades were once relatively common. Their unusual name derives from the Latin words for “with” and “without”. In simple terms, these trades involve the rapid lending of shares as dividends fall due, so as to enable two parties to simultaneously claim ownership of the same shares. This meant that participants could exploit loopholes in tax legislation, which meant both parties could claim valuable tax rebates.
It is now estimated that cum-ex trading has resulted in losses to the treasuries of Europe of an incredible €55 billion. Le Monde, which was one of the newspapers to break the scandal in 2018, has called it the “robbery of the century”. Germany is the most severely affected EU state, with estimated losses above $36 billion. France is estimated to have lost over €17 billion, while Italy is believed to have lost around €4.5 billion. A number of other nations were also significantly affected, and robust investigations are underway. A parliamentary inquiry led by the German Finance Ministry has described cum-ex trading as “organised crime”.
Two former British investment bankers are now on trial for tax fraud in Germany in relation to cum-ex trading. Martin Shields and Nicholas Diable are being tried for their part in trades which allegedly defrauded the German treasury of over €400 million between 2006 and 2011. This is one of the first major European criminal trials relating to cum-ex trading and its outcome is likely to set expectations in terms of future enforcement actions, both in Germany and elsewhere. Large-scale investigations into cum-ex trading continue to unfold across Europe. Those being questioned by the authorities include some of the biggest players in the financial and legal world.
In recent months, the German authorities have raided the German offices of Commerzbank AG, Deutsche Bourse AG, ABN Amro NV, BlackRock Inc as well as advisors MM Warburg and Freshfields Bruckhaus Deringer. In the latter case, a former global head of tax at Freshfields was arrested by the German authorities in relation to the cum-ex scandal. He has now left the firm.
It is understood that some 100 banks are under investigation by the German authorities alone. Institutions such as Bank of New York Mellon Corp., Deutsche Bank AG, and Société Générale SA have all been caught up in the scandal. There are also rumours that questions about cum-ex trades are already being asked in London, although the Serious Fraud Office and the Financial Conduct Authority have refused to comment.
The extent of London’s involvement remains unclear. However, we do know that Londoner Sanjay Shah is being investigated by the Danish authorities in relation to cum-ex trades which, the Danish authorities say, cost their exchequer around €1.6 billion. Mr Shah is reported to have learned about cum-ex trades at Rabobank in London, before setting up his own London firm, Solo Capital, and personally relocating to Dubai. Solo Capital is reported to have been receiving up to US$3 million an hour in tax rebates from the Danish authorities by July 2015. In August 2015, the Danish authorities stopped payments after a tip-off from the British government.
The London offices of Solo Capital were later raided by the UK’s National Crime Agency. It’s therefore clear that the UK authorities have been aware of some issues surrounding cum-ex trades for a number of years. What is not known is what will happen next, or the total extent of the city of London’s involvement with European cum-ex trades.
Cum-ex trades are not new. They were known of in the US as far back as 1992 when whistle-blowers revealed the nature of such trades. However, Germany did not specifically ban them until 2012. The German authorities argue that cum-ex trades were always fraudulent and unlawful, and were so prior to the introduction of any specific legal measures designed to curtail them. However, their illegality may not have been readily apparent to all participants at the time the trades were made. In terms of criminal responsibility, much can depend on what a given participant knew at the time.
Cum-ex trades are complex and they involve the arcane detail of tax codes and the interplay of multiple actors. In such cases, the line between legitimate tax avoidance and unlawful tax evasion can become blurred. Some of those involved may have been unaware of the wider purposes of a specific transaction. Some may have been unaware of the existence of connected transactions. However, some senior actors do appear to have been orchestrating equity trades for the purposes of obtaining tax rebates that were not properly due. Such individuals will no doubt have fully understood the overall structure and its intended result.
Given the complex and international nature of such transactions, building a complete evidential picture will be a herculean task for investigators. The German Finance Ministry is currently investigating 500 cum-ex arrangements with a total estimated value of some €5.5 billion. Around €2.4 billion has already been recovered. Cum-ex trades involved bankers, lawyers and traders all across Europe.
So far, the focus of the cum-ex trading scandal has been on the European continent, since that is where the enormous losses involved were incurred. However, it already seems clear that there were many London-based participants in cum-ex trades and that many may have been orchestrated from the UK. Indeed, that position is all but inevitable, given the city’s role as Europe’s preeminent financial hub.
The cum-ex scandal has therefore already been justifiably described as being another potential Libor manipulation scandal in waiting. One point of similarity with the Libor manipulation scandal being that cum-ex trades were apparently so widespread as to be almost a common and accepted practice within the industry. Indeed, one of the British former bankers on trial in Germany, Martin Shields, told the court that cum-ex trades were not “clandestine” at all. Indeed, he said that they were the “clear and openly communicated expectation of most banks and their customers”.
Given the scale of the investigations ongoing across the continent, and the global banks and advisors being investigated, it seems all but inevitable that shared information may soon prompt very significant investigations by the UK authorities – if such investigations are not in fact already underway.
If the SFO really wants to sink its teeth into this issue, it should perhaps be mindful of the somewhat underwhelming statistic that it only secured five convictions in relation to its Libor manipulation investigation. Such a low conviction rate seems remarkable considering how widespread Libor manipulation once was. However, given the sheer volume of evidence being amassed about hundreds, if not thousands of separate cum-ex transactions, it may be some time before the extent of London’s involvement becomes clear.
If cum-ex trades were indeed as widespread as has been alleged, the repercussions for London’s financial and legal world may yet be profound. The financial services industry has not yet regained the public trust lost in the 2008 global financial crisis. The cum-ex scandal could prove to be yet another hammer blow to public confidence in that industry. However, the potential damage to the legal services sector could be very significant too.
Reports from the continent suggest that investment banks took part in cum-ex trades on the basis of legal advice that the practice was lawful. If that proves to be the case, the risks for law firms and lawyers could be very significant.
The German cum-ex scheme alone even appears to have originated with lawyers. A German tax lawyer, Hanno Berger, has been described as the mastermind of the German cum-ex scheme, as he was the first to identify the loophole that made it possible. He has now been prosecuted and has gained notoriety in Germany as “Mister Cum-ex”. A law firm which advised a bank that the German cum-ex trades were legal has also been sued by the bank in respect of that advice. Given that the investigations are ongoing, such reports could just be the tip of the iceberg in terms of risks for any law firms which advised on cum-ex trading.
An anonymous German lawyer who worked with Mr Berger on cum-ex transactions has said that Mr Berger told young lawyers at their Frankfurt law firm, “Whoever has a problem with the fact that because of our work there are fewer kindergartens being built, here’s the door”.
Needless to say, in the context of such cavalier comments – and with €55 billion allegedly missing from public funds – the full resources of some of the most powerful states in Europe are being used to investigate and prosecute those involved in unlawful cum-ex trades. As the investigations continue apace, the question is not if Europe’s cum-ex scandal will hit London – the only real questions are when, and how hard.