The German Tax-Dodge Probe That’s Roiling Banks

(Bloomberg) -- The investment seemed virtually risk-free, guaranteeing hefty returns after only a short period of trading. By exploiting how Germany once taxed dividend payments, dozens of bankers, brokers and lawyers helped investors snatch billions of euros from the national treasury. A decade later prosecutors won their first convictions for tax crimes, while more than 1,000 people face investigation in what’s come to be called the Cum-Ex affair.

1. What’s a cum-ex trade?

The trades exploited an interpretation of the tax code that appeared, at the time, to let multiple people claim ownership of the same stock and — crucially — the right to a refund of taxes withheld from dividends. The transactions relied on the sale of borrowed shares just before a company was scheduled to pay dividends. This enabled more than one investor to claim a refund on a tax that was paid only once, according to German authorities. The practice was named after the Latin terms cum/ex, meaning with/without, because the stock was sold with — but delivered without — a dividend payment.

2. Why is it controversial?

For years tax authorities granted the refunds, despite knowledge that the process could lead to multiple payouts. While there were several attempts to mend the practice, in 2007 lawmakers said tax officials had to tolerate occasional incidents. Law enforcement authorities, however, started to investigate a few years later, arguing that parliament focused on the unintended side effects of legitimate transactions — and not trades set up deliberately to generate tax refunds. Prosecutors argue that people involved in the transactions knew they were double-dipping on the refunds. The practice ended in 2012 when Germany revamped how it collects dividend tax. Similar deals are being reviewed in Denmark and Belgium.

3. Which banks and investors used it?

According to a parliamentary inquiry, the practice was first noticed by banks as early as the 1990s. A decade later, transactions were set up by traders at structured finance units of banks, mainly in London. Cum-Ex spread beyond the banking industry as some former bankers set up funds to allow wealthy individuals to take advantage of the loophole. Many investment banks across Europe and the U.S. participated at some level: buying or selling stock, lending shares to the short seller, providing capital or by acting as custodian banks.

4. How wide are the investigations?

There are half a dozen probes in Germany, with one in Cologne being the broadest. Prosecutors are targeting hundreds of bankers, lawyers and investors. At Deutsche Bank AG alone, about 80 former and current employees are under investigation, including five former board members. The Frankfurt-based lender says it never directly participated as a short seller or buyer in Cum-Ex deals, and it is cooperating with the authorities. Suspects are also being chased abroad. Authorities put Paul Mora, a former investment banker at UniCredit SpA’s HVB unit who lives New Zealand, on Interpol’s Most-Wanted list. Meanwhile Switzerland in August decided to extradite Hanno Berger, a German tax attorney who had been living in the country since police raided his Frankfurt-based law firm nine years ago over Cum-Ex. Berger is fighting the decision, and both he and Mora reject the allegations.

5. Has anyone been convicted?

Two former London bankers were convicted in 2020 but given suspended sentences after cooperating with Cologne investigators. Germany’s top criminal court in July backed these verdicts, dubbing the trades a ‘blatant money grab’. In June, a Bonn court sentenced a former high-ranking banker at M.M. Warburg & Co. to 5 1/2 years in prison. He appealed the conviction. Frankfurt judges were also trying five ex-Maple Bank employees and a Wiesbaden court was hearing charges against two former HVB bankers. The Bonn court started the trial of an ex-Warburg banker on Sept. 23. Others, including two former partners of law firm Freshfields, have been charged. Aggravated tax evasion in Germany carries a maximum sentenced of 10 years in prison.

6. How long will this go on?

The probes are likely to continue for another few years. A state justice minister said he expects a cascade of new indictments. While banks may be interested in reaching deals, Cologne prosecutors want to bring charges against high-profile suspects. The Bonn court hearing the Cologne cases has expanded its staff to handle the new wave of charges. Some settlements, though, seem inevitable because the justice system still won’t have the capacity to try hundreds of suspects.

The Reference Shelf

• A Bloomberg story on how a banker’s long prison sentence puts suspects on alert.
• Bloomberg articles on a star witness and the hunt for an investment banker.
• A Bloomberg story on a hedge fund, a Jewish school in New York and $1.1 billion in Cum-Ex trades.
• A July 2018 Businessweek story explained how the trades came to light.
• How the scandal reached Deutsche Bank.
• A 2017 report by German parliament (in German).

©2021 Bloomberg L.P.