Cum-ex tax fraud court ruling (part two)
14 August 2020 London
Image: Sina Ettmer/Adobe.com
Part two of this series, first published in SLT 256 (July), breaks down the landmark decision handed down by a court in Bonn that marked the major step forward in the crackdown on cum-ex tax fraud
In my previous memo, I explained the mechanisms of an estimated €55 billion tax fraud (known as cum-ex) that has occurred in Europe exploiting the mechanics of delivery under a securities lending agreement.
In response, a number of individuals from lawyers to industry practitioners contacted me requesting further details. In the last week of June, a court in Bonn finally handed down its landmark decision. It found two defendants criminally liable. Defendant CA was guilty of tax evasion in 10 cases and aiding and abetting tax evasion in another case.
He was handed a suspended jail sentence of one year and 10 months. The second defendant was found guilty of aiding and abetting tax evasion and also given a suspended sentence.
He was “ordered to recover the value of the proceeds of the crime in the amount of €14 million”. The second defendant was found guilty of only tax evasion and will serve one year in jail; the other defendants were ordered to repay the proceeds of crime: €176.57 million.
The ruling comprises 334 pages of technical German but I discussed its implications with a leading tax professor in Germany who has testified in front of the European Parliament.
This ruling is the tip of the iceberg. It will pave the way for state prosecutors to pursue banks, traders, custodian banks, law firms and ancillary actors. It will also reactivate the insolvency case that the High Court stayed pending the Bonn ruling ([2019] EWHC 705 (Ch)).
NCA failure
In 2005 a Dutch employee was fired from a bank and disclosed cum-ex. In 2008, Switzerland tightened its laws to prevent cum-ex. Yet it was a full six years after the Dutch disclosure and three years after the Swiss state that the German Ministry of Finance finally decisively closed the programme – to the detriment of tens of billions of euro. The same actors then moved to Denmark and repeated the scheme there.
The national competent authorities’ (NCAs) performance and coordination have been woeful. BaFin, the German financial regulator, could easily have spotted the cum-ex fraud by noting the huge spike
in trading volumes in equities around their dividend record dates. The lack of such elementary analysis says little for NCA’s surveillance and detection abilities. To compound matters, a whistleblower first contacted BaFin in 2007 but was ignored.
We now learn that the German Ministry of Finance had been engaged in projects to prevent cum-ex, but had not involved BaFin. Thus, BaFin continued to authorise the establishment of entities set up expressly to commit cum-ex tax fraud. As Gerhard Schick, a German MP, put it: “BaFin could have stopped the criminals by preventing the purchase of the murder weapon.”
While the European Securities and Markets Authority (ESMA) was established after cum-ex came to an end, the cum-cum variant ended much later. ESMA too failed to detect the fraud notwithstanding its role to “protect public values such as the integrity and stability of the financial system…”.
Numerous funds were established in the EU with the sole purpose to facilitate criminal activity. NCAs and ESMA must engage in serious introspection to identify failures in culture, systems and processes that have allowed the theft of tens of billions of euros.
Securities lending often involves the borrowing of securities that are owned by insurance companies and pension funds. The European Insurance and Occupational Pensions Authority (EIOPA) should instigate an investigation and provide cogent reasons should it refuse to.
Liability
The entities that filed the false dividend tax rebate must be held liable – criminally if their state of mind can be proven. Custodian banks that wrongly issued dividend certificates must be held liable because the fraud is predicated on the issuance of this certificate.
There is a strong case for criminal liability as, without disclosing names, a large custodian bank was found to possess two separate bank accounts – one for genuine dividends and one for dividend compensation payments (manufactured payments).
The legal advisors should be liable under tort for negligence. If I can explain last week within the confines of a one-page memo how the scheme is obviously illegal, there is no defence for the issuance of shoddy advice that provided legal cover for this fraud.
Schick said: “Dealmakers have varied their approaches a lot over time adapting smoothly to changes in law and administration.” NCAs and ESMA must invest in state-of-the-art artificial intelligence and machine learning technologies to detect the next big fraud. In the meanwhile, criminal prosecutions must follow.
Return to part one.
In my previous memo, I explained the mechanisms of an estimated €55 billion tax fraud (known as cum-ex) that has occurred in Europe exploiting the mechanics of delivery under a securities lending agreement.
In response, a number of individuals from lawyers to industry practitioners contacted me requesting further details. In the last week of June, a court in Bonn finally handed down its landmark decision. It found two defendants criminally liable. Defendant CA was guilty of tax evasion in 10 cases and aiding and abetting tax evasion in another case.
He was handed a suspended jail sentence of one year and 10 months. The second defendant was found guilty of aiding and abetting tax evasion and also given a suspended sentence.
He was “ordered to recover the value of the proceeds of the crime in the amount of €14 million”. The second defendant was found guilty of only tax evasion and will serve one year in jail; the other defendants were ordered to repay the proceeds of crime: €176.57 million.
The ruling comprises 334 pages of technical German but I discussed its implications with a leading tax professor in Germany who has testified in front of the European Parliament.
This ruling is the tip of the iceberg. It will pave the way for state prosecutors to pursue banks, traders, custodian banks, law firms and ancillary actors. It will also reactivate the insolvency case that the High Court stayed pending the Bonn ruling ([2019] EWHC 705 (Ch)).
NCA failure
In 2005 a Dutch employee was fired from a bank and disclosed cum-ex. In 2008, Switzerland tightened its laws to prevent cum-ex. Yet it was a full six years after the Dutch disclosure and three years after the Swiss state that the German Ministry of Finance finally decisively closed the programme – to the detriment of tens of billions of euro. The same actors then moved to Denmark and repeated the scheme there.
The national competent authorities’ (NCAs) performance and coordination have been woeful. BaFin, the German financial regulator, could easily have spotted the cum-ex fraud by noting the huge spike
in trading volumes in equities around their dividend record dates. The lack of such elementary analysis says little for NCA’s surveillance and detection abilities. To compound matters, a whistleblower first contacted BaFin in 2007 but was ignored.
We now learn that the German Ministry of Finance had been engaged in projects to prevent cum-ex, but had not involved BaFin. Thus, BaFin continued to authorise the establishment of entities set up expressly to commit cum-ex tax fraud. As Gerhard Schick, a German MP, put it: “BaFin could have stopped the criminals by preventing the purchase of the murder weapon.”
While the European Securities and Markets Authority (ESMA) was established after cum-ex came to an end, the cum-cum variant ended much later. ESMA too failed to detect the fraud notwithstanding its role to “protect public values such as the integrity and stability of the financial system…”.
Numerous funds were established in the EU with the sole purpose to facilitate criminal activity. NCAs and ESMA must engage in serious introspection to identify failures in culture, systems and processes that have allowed the theft of tens of billions of euros.
Securities lending often involves the borrowing of securities that are owned by insurance companies and pension funds. The European Insurance and Occupational Pensions Authority (EIOPA) should instigate an investigation and provide cogent reasons should it refuse to.
Liability
The entities that filed the false dividend tax rebate must be held liable – criminally if their state of mind can be proven. Custodian banks that wrongly issued dividend certificates must be held liable because the fraud is predicated on the issuance of this certificate.
There is a strong case for criminal liability as, without disclosing names, a large custodian bank was found to possess two separate bank accounts – one for genuine dividends and one for dividend compensation payments (manufactured payments).
The legal advisors should be liable under tort for negligence. If I can explain last week within the confines of a one-page memo how the scheme is obviously illegal, there is no defence for the issuance of shoddy advice that provided legal cover for this fraud.
Schick said: “Dealmakers have varied their approaches a lot over time adapting smoothly to changes in law and administration.” NCAs and ESMA must invest in state-of-the-art artificial intelligence and machine learning technologies to detect the next big fraud. In the meanwhile, criminal prosecutions must follow.
Return to part one.
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