Tax Fraud Deals Were Easily Discernible, Banker on Trial Says

(Bloomberg) -- A former investment banker on trial in Germany said nearly everyone in the financial industry was able to spot the controversial tax-driven deals that cost taxpayers billions in lost revenue.

Addressing a court in Bonn, Martin Shields said the profit expectation, pricing and volumes of securities traded in so-called Cum-Ex deals allowed market participants to see these weren’t the arbitrage deals based on real dividend payments. Such profits couldn’t have been made without a refund claimed in Germany for tax payments that in reality never happened, he said.

“It must have been clear even to the inexperienced trader that the transactions weren’t based on real dividends,” the 41-year-old said at a hearing on Thursday.

Shields’ statement continues a theme he laid out on his first day of testimony: that Cum-Ex was a trading activity enacted on an industrial scale and required participation from multiple players. By saying that the practice was clearly separable from other transactions, Shields is contradicting the version of some other actors in the industry, who have claimed that Cum-Ex wasn’t easily distinguishable from normal dividend arbitrage.

Shields is a defendant in the first Cum-Ex trial in Germany, which seeks to understand how participants in the financial-services industry were able for years to get multiple tax refunds on dividend payouts, a practice the government has since sought to abolish. The court will have to determine whether the practice was legal and whether people participating can be convicted of crimes. That’s an issue because the government at the time was aware that double refunds could occur and stepped in only at a very late stage.

Because the complex practice required the interplay of many characters, the case has become a close examination of the wider financial industry. Facing charges that he helped orchestrate transactions that led to a tax loss of more than 400 million euros ($442 million), Shields has been cooperating with Cologne prosecutors. While there’s no formal deal that grants him leniency, he’s betting to avoid a lengthy prison term by helping uncover crucial elements of the transaction, as well as people and financial-industry players that were involved.

He worked at Unicredit SpA’s HVB unit until leaving in 2008 to co-found an asset management company that advised clients on Cum-Ex deals. He said he made 12 million euros from deals his company handled that are under review in the Bonn case.

Shields told the court that Cum-Ex transactions had several features that made them stand out: timing, volumes, structure, and settlement process, and most of all that the parties couldn’t change the trade day while the settlement needed to be after dividend day, he said.

“To overlook this pattern was the same as being surprised that you get presents and a cake at the same day each year,” the ex-trader said.

The banker reiterated that “dividend compensation payments,” a central element in Cum-Ex deals, were booked by Deutsche Boerse AG’s Clearstream unit, the main depository for German shares. Clearstream used a code -- KD 111 -- when transferring an amount that equaled that net dividend payments but didn’t come from the company that paid the dividend. When Clearstream instead transferred a real net dividend payment the code was KD 110, said Shields.

The compensation payment was crucial for the buyer in a Cum-Ex deal: it triggered his custody banks to give him a certificate stating the tax was paid, which the buyer could use to reclaim the tax amount.

A spokesman for Deutsche Boerse said the company is cooperating with the authorities and won’t comment beyond that. The Clearstream unit is among companies being investigated by Cologne prosecutors.

A lawyer for M.M. Warburg & Co, a German bank whose trades are being reviewed at as part of the Bonn trial, told the court that the lender disputes that the code KD111 meant what Shields is alleging. M.M. Warburg is among three financial institutions ordered to participate in the case as they may face fund seizures over the issue.

On Wednesday, Shields said an array of financial institutions took part at some level. He rattled off names including Barclays Plc, TP ICAP Plc, Commerzbank AG, Sweden’s SEB AB and more than half a dozen others.

At the end of the last decade, when Cum-Ex deals reached their peak, short sellers “flooded” the market, which also influenced the price difference between traditional dividend arbitrage and Cum-Ex deals, he said.

“The difference between transactions based on real dividends and those on a compensation payment was now totally evident for anyone in the equity finance market,” Shields said.

The pricing spread also skyrocketed. In 2005, Cum-Ex was five to six times more profitable than regular dividend arbitrage, known under the name Cum-Cum. In 2010 it was 20 times more profitable, the ex-banker said.

The next hearing is scheduled for Sept. 24.

To contact the reporter on this story: Karin Matussek in Berlin at kmatussek@bloomberg.net

To contact the editors responsible for this story: Anthony Aarons at aaarons@bloomberg.net, Benedikt Kammel

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