Germany’s most convoluted tax case in recent memory gets a human face this week when two former investment bankers make their debut in court. But more than the duo’s dealings, it’s the role of the financial services industry at large that will come under scrutiny.
The two men, Martin S., 41, and Nicholas D., 38, are charged with helping orchestrate transactions in the latter part of last decade involving corporate shares and their dividends that resulted in more than 400 million euros ($443 million) in tax losses. Both are cooperating with authorities in a bid to avoid jail time.
The former bankers will be equal parts defendants and star witnesses in a trial starting Sept. 4 that’s been one year in the making. Their case is part of a previously widespread trading practice across the industry known as Cum-Ex. Lawmakers estimate the financial engineering cost the government more than 10 billion euros in lost revenue, a shortfall the treasury is keen to recoup from those involved.
“It’ll be a pilot case that’ll write legal history and break ground for others to come,” Gerhard Schick, a former German lawmaker who has followed the Cum-Ex case for years. “The criminal clean-up is finally entering its crucial phase.”
The charges were brought by Cologne prosecutors, who are leading the biggest of several Cum-Ex investigations in Germany. Hearing the case is a court in nearby Bonn, home to a special tax authority that’s handling issues involving foreign investors.
Cum-Ex transactions, spawned from various forms of dividend stripping, relied on the sale of borrowed shares just before a company was scheduled to pay dividends. This allowed more than one investor to claim a refund on a tax that was normally paid only once, effectively double-dipping at the expense of the state.
Given the complexity and high volumes involved, Cum-Ex required participation from many players. They all profited one way or the other from the deals, the cooperating suspects have told investigators, according to court documents viewed by Bloomberg News.
There’s potentially much to gain from helping authorities shed light on the dealings, given the outsize financial damages involved. Under German law, schemes with tax losses exceeding 1 million euros usually carry jail time with no suspension possible — the higher the amount, the longer the term. At the same time, cooperation can help reduce or even get a prison sentence waived altogether.
Representatives for the two men — who are both British citizens — declined to comment. They could only be identified by their first names due to German press law.
In one of the most closely followed German tax cases, FC Bayern Munich President Uli Hoeness was given a 3 1/2 year prison sentence in 2014 for evading evading 28.5 million euros in tax — a fraction of the sum involved in the Bonn case.
The indictment lists 34 cases that prosecutors pieced together, and the account reads like a who’s who of the financial services community. Cum-Ex transactions required the finely-tuned collaboration of an entire industry: a buyer taxable in Germany, as well as short sellers who borrowed the stock from pension or investment funds, along with trading desks at investment banks and brokers who facilitated the deals.
Martin S. told investigators that next to vehicles set up for the purpose of buying stock, some German lenders also fulfilled that role — among them private bank M.M. Warburg & Co. and some regional banks. The short sellers were often investments banks, including Macquarie Group Ltd., Barclays Plc, and Banco Santander SA, a role also taken by Royal Bank of Scotland Group Plc, Morgan Stanley and Merrill Lynch & Co, according to other witnesses.
Among investment banks that lent stock, cooperating witnesses cited Deutsche Bank AG, State Street Corp., and Sweden’s SEB AB. Brokers included Tullett Prebon Group Holdings Plc and ICAP. Banks were allegedly also among the investors funds in funds that did Cum-Ex transactions.
In some of the cases selected for the charges, Deutsche Bank and Merrill Lynch acted as prime brokers for funds that did trades. Deutsche Bank, BNP Paribas SA and BHF, a company later acquired by Bank of New York Mellon Corp, were among lenders which acted as custody banks, issuing crucial tax certificates.
In response to questions from Bloomberg, Deutsche Bank said that unlike many competitors, it didn’t do Cum-Ex trades on its own account. However, the bank was involved in clients’ Cum-Ex transactions, including typical banking services such as financing securities transactions
Warburg said it never sought double refunds and never intended do to transactions to that aim. Santander referred to its interim report stating it’s being investigated and is cooperating with authorities. SEB said it was a market participant in securities lending but has no information about lending to short sellers involved in Cum-Ex.
State Street said it’s cooperating with the authorities as part of an ongoing inquiry. TP ICAP PLC, the company formed after Tullett Prebon acquired ICAP, referred to its latest report that states Frankfurt prosecutors are investigating three former ICAP employees and have opened proceedings against the German ICAP unit. RBS, BNY Mellon, Merrill Lynch, Macquarie, BNP and Morgan Stanley declined to comment, while Barclays said it had no immediate comment.
For the trial scheduled to last into January, a handful of other cooperating traders and one lawyer have signaled their willingness to testify and disclose what they know to help authorities pick off the big names. One of the cooperating witness to be called is a former Macquarie employee. He told investigators that the Australian lender took on various roles, including buyer and short seller, according to the court documents.
A challenge in these types of cases is where to draw the line between providing legitimate help in transactions and complicity in tax crimes, said Heiko Gemmel, an attorney at Hogan Lovells in Dusseldorf who advises clients on the issue. Not everyone touched by the wide-ranging practice necessarily committed a crime, he said.
“A lot of people in the financial industry will follow the proceedings with bated breath,” said Gemmel. “The outcome of this trial will likely determine the trajectory of other cases.”