Short Sellers Started ‘Twisting’ Tax Trades to Dodge Scrutiny
Short Sellers Started ‘Twisting’ Tax Trades to Dodge Scrutiny
(Bloomberg) -- Banks and lawyers involved in Cum-Ex trades started to hide their ties to short selling as early as 2009 amid a government crackdown on the controversial tax practice.
A lawyer who was heavily involved in Cum-Ex deals told a Bonn court Tuesday that people involved started omitting the phrase short selling from communications to avoid scrutiny after Germany issued new rules in 2009 targeted that element in the transactions. Nevertheless, everyone involved knew what they had to do without spelling it out, he said.
“If was like in soccer: if two teams meet, no one explicitly needs to tell them to bring a ball,” the 48-year old witness told the court. “In Cum-Ex, everyone worked to keep the ball in the game.”
The testimony is part of the Bonn trial against former bankers Martin Shields and Nicholas Diable, who are charged with helping to organize deals that led to more than 400 million euros ($437 million) in lost taxes. German authorities say Cum-Ex, where investors collected multiple refunds on taxes withheld on stock dividends, may have cost taxpayers more than 10 billion euros.
“We as advisers and also the banks immediately switched and avoided the word short selling in written communication,” the lawyer, who is not being identified by German media, told the court.
Short selling, another controversial practice where traders bet that a company’s share price would drop, was a key element of Cum-Ex deals.
In Cum-Ex trades, short sellers sold a stock shortly before a dividend was due but only delivered after the payout date. The buyer was granted a substitute reimbursement in lieu of the dividend that made him eligible for a tax refund, even though no such tax had been paid, prosecutors claim. That refund made the Cum-Ex trade profitable, and the spoils were shared among all participants.
The windfalls made Cum-Ex a popular practice for a variety of bankers. Lawyers helped in the practice with written legal opinions that said the deals were legal or by finding new ways to operate once lawmakers revised rules.
“Of course we had a disturbing feeling,” according to the lawyer, who like Shields and Diable, is cooperating with prosecutors. “But we all also had a deep, common longing: we wanted it to continue, and we did everything to make it continue.”
The good times were threatened, however, in 2009 when the German Finance Ministry issued a letter saying that dividend tax refunds would no longer be granted for trades where buyers and short sellers cooperated.
The industry reacted by “twisting” communications and the overall set-up so that buyers would be able to claim they didn’t know who the seller was, the lawyer said. One of the changes was to add brokers to the trading chain to help veil who did what. The Cum-Ex market only needed three days before everyone found a way to dodge the new rules, he said.
“Bankers and traders saw to it that the machinery could go on,” he said.
The lawyer who testified Tuesday is also being investigated in Germany for his participation. He was the first witness to cooperate with Cologne prosecutors, and he also helped to convince other suspects, including several former traders, to change sides and share their knowledge with investigators. They all hope their cooperation will help them dodge jail time.
Cum-Ex exploited how Germany taxed dividend payments, and allowed multiple people to claim ownership of tax refunds, a maneuver named after a Latin term meaning “With-Without.” In 2012, Germany revised its tax laws in an effort to end it, but whether the tactic is illegal is still being contested.
Various roles were necessary for the transactions, including buyer, short-seller, custody bank and providers of leverage. According to a court document, investment banks often took several of these roles. The documents list more than 20 lenders. Among those active in Cum-Ex-related short selling were Macquarie Group, Morgan Stanley, JPMorgan Chase & Co. and Bank of America Merrill Lynch, Barclays Plc, Santander and Nomoura, according to the document.
--With assistance from Donal Griffin.
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, Christopher Elser, Benedikt Kammel
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