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March 2020
In this GT Alert, we provide an overview of Cum-Ex trading and the response of the authorities so far. We
consider the position in the UK as well as the implications for both firms and individuals and suggest
steps firms and individuals may now wish to consider.
While there has been little publicity in the UK, there is a strong UK connection. Many of the traders were
UK nationals and much trading will have taken place in the City of London.
While UK enforcement agencies have taken little action to date, despite the apparent involvement of
British banks, traders and fund managers, it is anticipated that this will change, particularly in light of the
convictions following the 44-day trial in Bonn, which was expedited in light of the unfolding COVID-19
pandemic.
The overall results of the German investigation may have a significant impact not only on the 130 or so
institutions that German prosecutors claim were involved, but on the financial services industry
What is Cum-Ex?
In summary, the activity involves the transfer and/or borrowing of a share between investors just prior to
the date on which a dividend is paid to the shareholder. The name ‘Cum-Ex’ is derived from the Latin
words ‘with’ (‘cum’) and ‘without’ (‘ex’), referring to a security traded with or without the right to a
dividend. The alleged tax scheme is based on the fact that in Germany (and some other European
countries) dividends are subject to a withholding tax (WHT) (broadly, tax on income from securities,
deducted at source), which in general is credited against the income tax liability of the shareholder. In
order to receive the credit it is necessary to have a withholding tax certificate, certifying that the tax has
been withheld.
Until 2012, when the German tax law was changed, these tax certificates could be issued by the company
paying the dividend and by the bank where the shares were deposited at the time when the dividend was
paid. Where shares were traded immediately prior to the date when the dividend was to be paid, there was
a risk that several tax certificates could have been issued, even though the tax was only paid once. In other
cases the transactions were structured in a way that made it unclear whether the seller or the buyer of the
shares should be considered the owner of the shares and thereby entitled to the tax credit. These cases
gave rise to a substantial risk that the certificate had been issued to the wrong person, who then claimed
the tax credit without having been entitled to it. This opened the door to multiple withholding tax
reclaims in respect of one withholding tax payment. Observers have likened Cum-Ex to having one child
while claiming child allowance for many children.
According to German tax authorities and criminal investigators, a large number of the Cum-Ex
transactions were structured with the intention that several withholding tax certificates were issued even
though the tax was actually only paid once. In other words, the transactions were structured to allow
investors to make a claim for a rebate to which they were not entitled. In the Bonn case, the judge ruled
that these trades were illegal and did not merely exploit a loophole in the law.
The two British traders convicted in Bonn on 18 March 2020 in connection with allegations that they
arranged deals costing German taxpayers over $400 million in unpaid tax received suspended sentences
of 22 and 12 months, respectively, due to their apparent co-operation with the German authorities, with
one also being ordered to repay EUR 14 million in compensation from the personal profits he made. In
contrast, a private bank also involved in the proceedings was ordered to repay around EUR 176 million
($187 million), a decision which it has stated it intends to appeal.
Given these allegedly fraudulent trades have purportedly cost treasuries upwards of EUR 55 billion
Europe-wide, enforcement may not stop with this one prosecution in Germany or elsewhere in Europe
where similar schemes are the subject of investigation.
Given the significant amounts presently being pledged by governments to bolster the global economy in
the present crisis, they may seek to recover what they perceive as significant losses to the taxation
authorities through so-called Cum-Ex trading.
In June 2017, the Financial Conduct Authority (FCA) conducted a review of the activities of firms involved
in so-called ‘dividend arbitrage’, concluding that ‘some firms may not have identified the risk posed by
contrived or fraudulent trading for the purpose of making illegitimate WHT reclaims’. The FCA
highlighted the need for firms to monitor existing business and assess new business and stressed the
importance of highlighting any concerns to the FCA in accordance with the Principles for Business.
Since then, and until recently, the FCA had remained silent on the issue of Cum-Ex. However, in a
February 2020 speech, FCA Executive Director of Enforcement and Market Oversight Mark Steward
confirmed that ‘the FCA has worked closely with European authorities for some time on a story that
appeared this week about the seizure of a property in London as part of proceedings against a trader
allegedly involved in dividend stripping tax avoidance schemes that have operated in Denmark, Germany,
France and Italy.’ He went on to confirm that ‘the FCA had been investigating substantial and suspected
abusive share trading in London’s markets that has allegedly supported these schemes. These
investigations are now very close to their conclusion and decisions about action are imminent.’
UK Firms
Given the FCA’s 2017 insight into how it will view such trading activity, how it expects firms to tackle the
associated issues, and its recent confirmation that it has been actively investigating conduct in the UK,
firms that have failed to tackle such conduct may find themselves subject to the full range of enforcement
powers available to the FCA, including public censure and potentially severe financial penalties.
With the recent convictions, increasing media coverage worldwide, and the investigations and litigation in
various jurisdictions expected to intensify, firms may wish to consider the following.
Individuals
If the UK authorities pursue individual traders, the FCA may do so under the civil regime available to it
which can lead to various sanctions including financial penalties and the removal of the trader’s
‘authorised’ status.
Alternatively, the FCA, HM Revenue and Customs (HMRC) or the Serious Fraud Office (SFO) may open
criminal investigations for offences of fraud which carry a maximum prison sentence of 10 years.
Such sentences are severe in comparison to those handed to the two UK traders in Germany. In the UK,
following a conviction for fraud involving a similar amount, the sentencing court would take a starting
point of between three and seven years immediate imprisonment, depending on an assessment of ‘harm’
caused by the conduct.
Convictions may lead to the application by the prosecuting authority for an order confiscating any benefit
from the criminal conduct. Such an application will necessarily involve the realisation of any available
assets of the convicted person. Such orders can impose a sentence in default of up to a further 14 years.
Whilst UK prosecutors may be encouraged by the result of the trial in Bonn, securing convictions may not
be straightforward. Those subject to investigation and litigation in Germany have advanced complex and
technical arguments about the lawfulness of Cum-Ex trading, the legislative history and the apparent
awareness of the authorities of the nature of the structures involved as well as the lack of intent on their
part.
In addition, UK authorities will face the usual challenges of bringing complex and technical allegations of
fraud to trial. Such challenges have been well publicised in the UK, particularly after a string of failed
prosecutions in the UK by the Serious Fraud Office (SFO) and others. The challenges include, but are not
limited to, the presentation of cases which may lack direct evidence of dishonesty as well as the
involvement of expert evidence in order to explain complex financial instruments and terminology to a
jury.
Summary
Although the implications of the Cum-Ex scandal have been seen almost exclusively in Germany, the
speech given by Mark Steward suggests that UK enforcement actions may be imminent.
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