Ex-London Bankers Cooperating With Cum-Ex Probe in Bid to Dodge Jail

(Bloomberg) -- Two former London investment bankers cooperating with a German probe of controversial tax deals that cost the nation billions of euros are wagering that their help will persuade judges to go easy on them, according to people familiar with the issue.

For more than a year, the men have helped prosecutors to understand complicated details about the so-called Cum-Ex deals, including the role of investment banks, brokers and other market players, said the people, who all asked not to be identified because the probe is confidential.

In return, the bankers hope to avoid lengthy jail terms, according to the people. Charges may be filed early this year, with a trial following swiftly, meaning a verdict could come in 2019, they said.

Prosecutors in Cologne, Frankfurt, Munich and other German cities are reviewing the involvement of investment banks, financial-service providers and law firms across Europe and the U.S. in relation to the trades that have come to be known as Cum-Ex -- a Latin phrase that means “with-without,” a reference to the vanishing dividend payments in the transactions. The practice is believed to have cost German taxpayers more than 10 billion euros ($11.4 billion).

Cologne prosecutors and lawyers for the two bankers declined to comment on the case.

Biggest Probe

The Cologne probe is by far the biggest and it targets some well-known financial institutions. Alongside the two ex-investment bankers, prosecutors are obtaining information from several former traders and a lawyer who handled deals. The information gleaned from these insiders is considered key to uncovering the structure of what they say was “a Cum-Ex industry,” enabling investigators to go after institutional targets, the people said.

The cooperating traders and the lawyer will appear as witnesses and disclose their knowledge in open court, according to the plan. The details will also include the involvement of companies acting as clearing agents, leverage providers and custodians.

When Cum-Ex deals were at their peak, the two ex-bankers worked for a company that had a role in many of these deals. Their trial may become the centerpiece of the Cologne probe that is looking at hundreds of people and key banks.

Under German law, schemes involving tax losses of more than 1 million euros must usually carry jail time with no suspension possible -- the higher the evaded amount, the longer the term. In Cum-Ex cases, the tax loss is more likely to be counted in hundreds of millions, if not billions, so sentences would generally be substantial.

Quid Pro Quo

While German law allows various ways to reduce a sentence, the ultimate decision will be up to the judges. The two are betting that by providing information the authorities couldn’t have obtained otherwise, they’ll win a lighter punishment even with a guilty verdict. But there’s no legally binding quid pro quo.

The two ex-bankers do not lose their right to appeal any sentence. Since the Cologne arrangement’s aim is also to get a fast final judgment saying that Cum-Ex deals were illegal and criminal, there is an incentive to have a verdict the two man will accept.

The first German Cum-Ex indictment was filed by Frankfurt prosecutors in 2017 in a separate probe. It took almost eight months to translate the 900-page indictment, and it’s unclear when a decision on the trial will come, but hearings are unlikely before 2020. At least two of the six accused are fighting the charges, which usually means a long trial and a lengthy appeals stage, delaying resolution of the case for years.

By contrast, under the Cologne scenario, a trial of the two ex-bankers and even a verdict in 2019 is likely. The case can give a boost to other probes pending in that city. The charges will be filed to a court in nearby Bonn, where a special chamber was added to hear the wave of further ones expected. Bonn is home to a special tax authority that’s handling tax-issues involving investors abroad. After a 2007 change in the law, Cum-Ex deals only worked if a lender based outside Germany was handling an element of the transaction.

The Frankfurt charges cover 61 short sales of shares of companies listed on the German benchmark DAX. The trades, done between 2006 and 2008, were valued at 15.8 billion euros, causing a tax loss of 106 million euros. That’s tiny in comparison to what will be at issue in the Cologne case, according to one of the people.

Cum-Ex transactions took advantage of how Germany once handled tax refunds on dividends. At the time, a company paying dividends automatically withheld the tax but the tax payment was certified by the custodian bank of the shareholder. The lender issued that tax certificate when the investor received an amount equaling the net dividend payment he could claim on a set of shares.

In Cum-Ex deals, short sales were set up around dividend day in a way that the owner of the shares and the buyer both received an amount equaling the net dividend payout -- the owner from the company and the buyer from his short seller. That was enough for their respective custodian banks to issue a certificate. While the tax was paid only once, both the stock owner and the buyer used their certificate to claim the refund.

The practice ended in 2012, when Germany revised its tax laws. It is still being contested that the tactic was illegal as tax authorities had been paying out refunds for years.

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