Investigations into cum-ex trading, where traders exploited loophole to reclaim tax they never paid, are underway across the EU and more banks are likely to be under the spotlight.
The cum-ex scandal begin in 2017 when the German authorities opened fraud investigations into hundreds of banks and individuals over involvement in so-called cum-ex trading fraud between 2001 and 2011.
Cum-ex transactions allowed investors to exploit a legal loophole that allegedly enabled multiple parties to reclaim billions of euros of tax they never paid on share dividends.
A cum-ex deal involved a trader borrowing a block of shares to bet against them using short selling in the run-up to dividend day and then selling them on to another investor. A loophole in the German tax code meant parties on both sides of the trade could successfully claim a refund of withholding taxes paid on the dividend — even though authorities contend only a single rebate was due.
Investigations in alleged cum-ex trading are on the rise in Europe. Austrian and Luxembourg authorities have announced mutual legal assistance requests to gather evidence from other jurisdictions into alleged cum-ex trading fraud on their tax systems. Belgium and Denmark have begun their own extensive investigations.
London under scrutiny
A large amount of the cum-ex trading under suspicion is believed to have been conducted by traders based in London claiming dividend rebates in European states.
In March 2020, two London-based bankers, Martin Shields and Nicholas Diable – formally of Munich-based lender HypoVereinsbank – were found guilty in Germany of tax evasion and only avoided prison in exchange for co-operation with German authorities. The pair were given suspended sentences and Mr Shields was ordered to repay €14m.
In February 2021, Interpol added Paul Mora, a New Zealand citizen, to its most wanted list. Mr Mora was based in London and was Mr Shields’ boss at HypoVereinsbank. The German authorities recently obtained an arrest warrant for Mr Mora and his face has since been plastered on billboards in German train stations and shopping malls.
A large amount of the cum-ex trading under suspicion is believed to have been conducted by traders based in London claiming dividend rebates in European states
In a separate case, Vijaya Sankar, an operations manager for a hedge fund in London, lost his challenge against extradition to Germany last month. Mr Sankar was arrested at his home in June last year pursuant to a European arrest warrant.
This year, Belgian authorities have also brought extradition proceedings against another London-based individual.
Sitting targets
Obviously, anyone under criminal investigation over cum-ex trading by a foreign country while employed by the London office of a financial institution will not only vulnerable to proceedings brought by that foreign state, but also be at risk of regulatory and criminal enforcement by the Financial Conduct Authority (FCA), the UK regulator.
While the FCA has been slow off the mark, it has reportedly opened investigations into 14 firms and six individuals which operated cum-ex schemes in Europe. A recent FCA cum-ex disciplinary investigation into a London-based trader was only halted by the High Court in the UK on the grounds that a separate Danish tax authority case in the UK High Court should take precedence.
Nevertheless, FCA action appears to be slower than its foreign counterparts, heightening the risk of decisions taken by authorities abroad involving minimal input from the subject but still with significant consequences.
When an individual is considered a fugitive from justice, any data placed on Interpol’s system will inhibit the freedom to travel. Any published data of this kind is likely to find its way on to other data platforms for due diligence checks, which can lead to a de-risking refusal to provide banking facilities. Apart from the obvious strain of dealing with outstanding foreign criminal charges, the harm to reputation and the ability to carry out business can be catastrophic.
It remains to be seen in a post-Brexit world how the UK extradition court puts a member of the EU to the test. The concept of mutual trust and recognition of EU state court decisions leading to a request for extradition is no longer a stated principle, as it is notably absent from the UK-EU Trade and Co-operation Agreement.
So far, the UK court seems to be processing extradition requests with a business-as-usual approach. The grounds for challenge may be thin in circumstances where an equivalent criminal offence based on the conduct alleged can be established in the UK but where the UK authorities choose not to take the lead in any investigation, or to investigate at all.
Short of extradition, well-established channels of communication between cross-border law enforcement agencies and formal information-sharing agreements mean that an absent suspect based in the UK is not a great obstacle for foreign EU states. Mutual legal assistance mechanisms mean that UK individuals can be interviewed as suspects in a foreign criminal investigation.
An individual’s employer may also be served with an order to produce information and documents under compulsion. Such action can result in potential FCA or employer-related disciplinary issues for the individual where fitness and propriety are called into question.
Unfinished business
In any scenario, an individual facing scrutiny over their conduct or as potential witnesses should be aware of the wide-ranging powers available to foreign and domestic law enforcement agencies to investigate. The consequences may vary in seriousness. One consideration is whether early engagement in any investigative process can help mitigate risk. Such individuals and their corporate employers certainly have the right to challenge and will need to consider their strategy. Corporates will also need to consider the risk of one investigation into its operations spawning another.
As foreign cum-ex investigations continue, we may see UK authorities take a more active role in enforcement in this area. It may also be a phase of criminal enforcement that highlights another financial industry practice that was accepted until it was not. As with the Libor scandal, it may hog the spotlight for as long as it takes to effect change, before attention shifts elsewhere.
Jasvinder Nakhwal is a partner and Andrew Wallis is of counsel at Peters & Peters Solicitors.
