(Bloomberg) -- Prosecutors in Cologne are preparing their first indictments in a tax-evasion probe involving some of the biggest names in finance that cost the German treasury billions of euros, according to people familiar with the matter.
Investigators are looking at the role of dozens of banks, brokerages, accounting companies, and law firms in the deals, and the cases involve hundreds of individuals, said the people, who declined to be identified because they’re not authorized to discuss the probe. The investigations include transactions handled by lenders including Barclays, Goldman Sachs Group, Bank of America Corp., Macquarie, and BNP Paribas, and initial indictments are likely as soon as this year, the people said.
The probe, which has been underway for about a half-decade, is picking up speed as several witnesses have agreed to cooperate. The Cologne team is working in parallel with prosecutors in Munich and Frankfurt, who last month charged six people, including former investment bankers at UniCredit SpA’s HVB unit in London. The Cologne investigators are focused on bankers in London because the tax office for non-residents is located in nearby Bonn.
For about a decade starting roughly 15 years ago, big banks helped investors exploit an interpretation of the tax code that seemed to allow two parties to claim ownership of shares and -- crucially -- the right to a refund of withholding taxes paid on dividends.
Scores of banks across Europe and U.S. participated on some level--doing the deals themselves, arranging them for clients by acting as custodians, issuing tax certificates, or financing transactions in the practice, which has come to be known as “Cum-Ex”--a Latin phrase that means “with-without,” a reference to the vanishing dividend payments in the trades. The practice is believed to have cost German taxpayers more than 10 billion euros ($11.6 billion).
The transactions involved short sales just before dividend time. Companies withheld taxes on dividends and custodian banks issued certificates that shareholders could redeem at the tax office in the event of an overpayment. In the short sales, the buyer’s bank also issued a certificate that could be redeemed for a full refund. Prosecutors say that in some instances, several parties may have been issued tax-refund certificates, multiplying the damage.
Commerzbank, Deutsche Bank, German private lender M.M. Warburg & Co., and Clearstream Banking, the unit of Deutsche Boerse AG that settles trades, have acknowledged that transactions they were involved in are being investigated.
Deutsche Bank says it didn’t participate in cum-ex trades as a short seller or buyer, but was involved in some of its clients’ deals and that it’s cooperating with the authorities. Warburg says any trades it made were in line with the law. Goldman says it doesn’t know of any investigation against the bank or its employees. Clearstream says it’s cooperating with the prosecutors. The other banks declined to comment or didn’t respond to messages.
The Cologne team has settled cases with several banks and individuals, and others are seeking to cut deals with investigators on the current round of probes, but given the magnitude of the tax damage the prosecutors are reluctant to do so, one of the people said.
"Many banks have long started to explore the cum-ex subject internally," said Heiko Gemmel, a tax lawyer at Hogan Lovells in Dusseldorf, who advises client on the issue. "It’s high time now for those who haven’t to start. The noose is tightening."
Settlements, though, are inevitable because the justice system doesn’t have the capacity to try hundreds of suspects. While German law doesn’t allow for criminal charges against companies, prosecutors can add them as associated parties to probes of their employees and they can face substantial sanctions.
The Cum-Ex practice stopped after Germany reformed its tax code in 2012, and the debate centers on whether the trades were legal before that. Tax authorities accepted the tax certificates for years, and lawmakers did little to tighten the rules despite repeated warnings about abuse of the system. Once the tax authorities examined the matter more closely, they stopped paying out refunds and alerted prosecutors, triggering raids at banks and law firms, fights in tax court, and at least one bankruptcy.
The Cologne probe led to raids in 14 countries in 2014, and investigators have reviewed thousands of emails, voice mails and Bloomberg chat sessions used by traders. Their breakthrough came about last year when a handful of traders and advisers agreed to cooperate, giving details of how the deals were set up. This summer, the Bonn Regional Court is set to rule on whether the prosecutors can offer leniency to four key witnesses who are cooperating. The Bonn court, which will hear cases resulting from the probes, has beefed up capacity and added an extra chamber to handle an expected wave of charges.
Banks, funds and investors that participated in the trades relied on legal opinions from lawyers that said the transactions were allowed. But prosecutors say those documents oversimplified the matter, often leaving out key facts, and that it was clear that the transactions involved double-dipping on the refunds.
The prosecutors aim to look beyond the traders who handled the deals and go after higher-ups, who they say must have known what was happening and signed off on it. The transactions were huge, and banks typically require approval for deals of such magnitude.
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