Is it time to address the increasing gap between the spirit and the letter of the law?
In recent weeks, stock traders in Europe, to include bankers, lawyers, and investors, are being accused of siphoning an estimated US$ 60 billion, from state coffers, between 2006 and 2011. An astonishing period of five years before being detected! While the bulk of the loss has been borne by Germany (US$ 30 billion) and France (US$ 17 billion) other European nations like Spain, Italy Belgium, Austria, Norway, Finland, and Poland have also been duped, for lesser amounts. Le Monde, the French newspaper has called the fraud, ‘the robbery of the century’; while, others have claimed it to be, ‘the biggest tax theft in the history of Europe’. A third, Dubai based UK citizen, Sanjay Shah is alleged to have copied their methods to defraud the Danish treasury of US$ 2 billion.
The procedure adopted by the alleged fraudsters is called, 'cum-ex', which is a Latin translation for, 'with – without'; and refers to the disappearing nature of fraudulent dividend payments. By adopting the procedure, investors were able to fool the financial system, so that investors could claim two refunds for dividend taxes, when, in fact, they may have been eligible for only one.
How was the Anomaly Detected?
In 2011, a clerk in the Bonn Central Tax Office came across a tax refund application that looked dubious. A single US Pension fund had bought and then sold US$ 7 billion, in German stocks. The Fund now claimed US$ 60 million, as a refund for just one beneficiary! Instead of just paying out the refund, the clerk started making inquiries. She soon received a letter from a German law firm that threatened to hold her personally accountable, under criminal, disciplinary, and liability law, for withholding the refund. The clerk reported all of this to prosecution authorities, which ultimately led to the trial in Bonn.
In the German trial, Oxford-educated Martin Shields (41) and New Zealander Paul Mora (52), two London-based investment bankers, have been charged with ‘aggravated tax evasion’, for a sum of US$ 500 million. In Dec 2019, the German Judge issued a preliminary ruling, declaring for the first time, that 'cum-ex' was a felony; calling it, 'a collective grab in the treasury'.
German authorities say, so far, from 56 investigations, they have identified over 400 suspects involved with ‘cum-ex’ transactions. Also, with the landmark ruling in the Bonn case, many law firms and lawyers may also face penalties, for having provided highly-priced legal opinions that are now untenable. Many in the legal fraternity had contended that since no law explicitly prohibits ‘cum-ex’, it was thus, a ‘perfectly legal’ system.
Where did the fraud Originate?
Outrage over the incident is focused on the City of London, wherein 2004 Martin Shields met Paul Mora, at the London Branch of Merrill Lynch. Though these two investment bankers are currently on trial, in Germany, there is a sprawling network of bankers, brokers, investors, asset managers, lawyers and consultants, who have actively participated in ‘cum-ex’ trading and are now liable for their actions.
Many lawyers will argue that that ‘cum-ex’, was the exploitation of a loophole in German law; and constitutes, ‘tax avoidance’ that is both legal and reasonable. However, the Bonn ruling clarifies that ‘cum ex’, violates the law and constitutes ‘tax evasion’, a felony that carries a 10-years prison sentence. Recently, one senior lawyer from the elite tax firm, Freshfields Bruckhaus Deringer was arrested, for ‘cum-ex’ transactions.
Are US Banks in Trouble?
In 2008, a US Senate investigation reported 'dividend abuse' that was depriving the US Treasury of US$ 100 billion, annually. Consequently, a ban was imposed on dividend arbitrage of stocks in US corporations. However, nothing prevented American banks from conducting such transactions with foreign companies, on foreign soil. Reportedly, German prosecutors have also opened investigations into transactions of Bank of America, JP Morgan, Chase, Morgan Stanley, and others. Unfortunately, many of the dubious transactions, involve US pension funds.
In 2008, the global financial crisis was in full swing. At that juncture, from the perspective of investment bankers, 'cum-ex' was one of few reliable money-makers, available. Financiers and bankers, who dared indulge in 'cum-ex', were able to boost trade in the suppressed financial market and received complimentary benefits in their careers.
The argument that investors exploited a ‘loophole' in German law is not sustainable either in the letter or in spirit. German law does not permit a double refund, on a single tax payment. What was perhaps exploited was the inadequacy of the software that allowed the double-refund. Does the inadequacy of software constitute a loophole in the law?
Now that the fraud has been established, European governments will be keen to press for both, recovery of funds and punishment for criminal liability. However, considering the sheer volumes of investors involved in ‘cum-ex’, it is unlikely all be prosecuted. While a civil settlement in most cases is more likely, it is hoped that authorities will show more determination in bringing criminal action against those who created the insidious practice of ‘cum-ex’, and many lawyers are believed to be in that group.
"Small men command the letter of the law. Great men serve their spirits. For the spirit of the law is justice, and justice is the spirit of God."
- JC Marino, Dante’s Journey