Reporting and Governance

The UK’s Financial Conduct Authority is likely to pursue parties who were involved in cum-ex trading, a process for reclaiming tax rebates across the EU, as it sees the activity as an abusive trading strategy. By Nick Barnard, senior associate at Corker Binning

Cum-ex trading has been the subject of much high-profile activity by investigators and prosecutors in Germany over the past 12 months, where market participants have been using the technique to claim tax rebates. 

In light of what is now known about the financial and geographical scale of cum-ex, it had been expected that equivalent action in other jurisdictions would follow in short order. Like all others, that expectation has had to be revised in response to Covid-19. However, it would be a mistake to conclude that the delay means that further enforcement action will not follow in the UK and elsewhere, or that it will be any less significant.   

Cum-ex was a system of share dealing that involved making reclaims of capital gains tax ostensibly withheld at source on dividends paid by Europe’s largest companies (sometimes known as withholding tax). Such reclaims were made in various European countries in the late 2000s and early 2010s, and most prevalently in Germany until 2012. The controversial aspect is that cum-ex involved multiple tax reclaims in respect of the same dividend payment. If all such claims were paid, the national tax authority involved paid out far more than it collected via the withholding tax. Some estimates put the losses to exchequers across Europe as high as $60bn.  

The extent of the losses in Germany was revealed by investigative journalists in 2017. However, it is only in 2020 that the country’s criminal and regulatory response has taken shape. The first criminal prosecution concerning cum-ex trading commenced in Bonn in September 2019 against two UK traders, Nicholas Diable and Martin Shields. The trial itself was unusual, in that neither man sought to deny his role in making tax reclaims, and in fact spent considerable time explaining the process to the court. The question for the judge was whether their conduct was, as they contended, a legitimate exploitation of a loophole in German tax legislation. Unfortunately for them, and the many other individuals and institutions previously involved in cum-ex trading, the judge concluded that the reclaims were not lawful, and that that their conduct was criminal. 

Firing the starting gun

Given the scale of the losses caused by Mr Diable and Mr Shields (the latter being ordered to pay some €14m in respect of his personal benefit), it may be surprising to learn that both received suspended sentences. This was partly due to their exceptional co-operation but also because, as one German prosecutor observed, harsher sentences would have “covered up the fact that the greatest tax robbery in German history was not conducted by two individuals but hundreds of people”. This neatly summarises why the Shields-Diable verdict is only the sound of the starting pistol for cum-ex enforcement. It should be understood that every tax reclaim was the end product of a long chain of transactions, each involving a facilitating institution, many of whom are household names. Having established that the eventual cum-ex reclaims were illegal, attention will now turn to what each of the individual and institutional participants knew or suspected about their role in the process.  

Even before the conclusion of the Shields-Diable trial, the German authorities had laid further charges against individuals, including two lawyers who reportedly advised on the legality of cum-ex trading while at a high-profile international firm. Since the verdict, there has been a steady stream of further charges, raids and extradition requests, as well as moves to extend the statutory limitation period to avoid any future prosecutions being time-barred. While it is full steam ahead for Germany, it remains to be seen whether investigators and regulators in other jurisdictions will be inspired by their progress.

In the UK, the Serious Fraud Office has given no hint that a criminal investigation is underway, while the National Crime Agency has confirmed that its own investigation, begun in 2016 following a referral by the Danish tax authorities, has been discontinued. 

However, the UK Financial Conduct Authority (FCA) is poised to act, with its director of enforcement having announced in a February 2020 speech that:

  • the FCA regards cum-ex trading itself as an abusive trading strategy;
  • the FCA has been collaborating with its counterpart European authorities; and
  • most significantly and unambiguously, his department was contemplating action against some of the London-based participants ‘imminently’. 

In this regard, there is no shortage of potential targets for the FCA. Although no contentious reclaims were made to the UK tax authorities, it is known that several well-known City institutions played a key role in facilitating cum-ex trading, for example, by providing access to shares in German public companies that were required to make withholding tax repayment claims. With regard to individuals, the Senior Managers and Certification Regime includes a specific requirement to act with honesty and integrity. As such, it is not necessarily an impediment to enforcement action if an individual claims, as Mr Shields and Mr Diable did, that he or she believed that cum-ex involved a legal loophole, albeit one which resulted in significant profits at public expense.

Although the pandemic will inevitably have slowed the pace, cum-ex will have remained a priority for the FCA. It is only in recent months that we have seen the conclusion of cases arising from the 2008 financial crisis and cum-ex is of comparable scale. As the immediate health crisis recedes, we should expect to see the promised FCA action, and perhaps similar move by its European counterparts.   

A Speakers’ Corner is an area where open-air public speaking, debate and discussion are allowed. The original and most noted is in the north-east of Hyde Park in London 

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