Former City Bankers Found Guilty in Germany’s First Cum-Ex Trading Trial

With the conviction of two former London bankers for their participation in such dividend arbitrage schemes in Germany from 2008 to 2011, the German authorities are the first ones to prosecute cum-ex trading as a fraudulent activity, an activity that was rendered illegal by the country’s authorities in 2012.

Martin Shields and Nicolas Diable, two former London-based employees at HypoVereinsbank (HVB), one of Germany’s leading financial institutions, were found guilty of tax evasion and aiding and abetting tax evasion respectively, by a court in Bonn (Germany) last week.
 

Both Shields and Diable were given suspended jail sentences, avoiding a harsher ruling by closely cooperating with the German authorities. Shields, who had already made a first payment of €3 million last February, was additionally ordered to pay back €14 million from the money he made with illegal cum-ex dealings. 

The judge further ordered Hamburg-based private bank MM Warburg to pay back over €176 million to the German tax authorities for its role. According to a spokesperson, leadership at MM Warburg is considering an appeal against the court’s verdict.

The Bonn case was the first ruling of its kind, to shed light on the complex tax evasion scheme that is cum-ex trading. A cum-ex scheme is an extreme form of dividend arbitrage, also referred to as dividend stripping, through which investors exploit legal loopholes in Germany’s (and other European countries) tax code, misleading tax authorities into refunding them a dividend for a tax they have never paid. Key to the scheme’s success is a strategy by which investors and stockbrokers trade shares with (“cum”) and without (“ex”) dividend rights right before dividend is scheduled to be paid out, in an effort to confuse tax authorities as to who is the actual owner of the shares. 

Below is a simplified example of how such a cum-ex scheme works:

• Investor A owns shares worth €2 million in listed firm X.

• Investor B buys shares worth €2 million in the same firm X from investor  C, just a few days prior to the firm paying out a dividend to shareholders. The shares bought by investor B are characterized as cum-dividend shares because these shares will provide the buyer with the dividend. Investor C does not yet own these shares, but promises to deliver the shares to Investor B at an agreed time. This is known as ‘short-selling’. 

• Firm X now pays out the dividend, worth €100,000 to investor A, who receives €75,000 directly from the firm and has to pay 25% (€25,000) to the German tax authorities. In return investor A receives a tax certificate refund of the same amount (€25,000). Investor A’s shares are now only worth €1.9 million (€2 million - €100,000 dividend).

• Investor A then sells these reduced-value shares, characterized as ex-dividend shares, to investor C, who has to deliver the promised shares to investor B. However, since they are now worth €100,000 less, investor C has to pay investor B a dividend compensation worth €75,000. Additionally, investor B also receives a tax certificate of €25,000 from the tax authorities.
   

• Finally, investor B sells his shares (worth €1.9 million) back to investor A. As a result, both investor A and investor B had a right to a refund on the dividend tax, even though the German tax authority collected the tax only once.

• The reimbursed dividend tax is shared between all three investors.  

This system allows multiple investors to claim back tax returns on the same shares even though only one party paid the dividend tax.


It is estimated that the practice cost Germany more than €7 billion in tax revenue between 2005 and 2012. In 2012 the country moved to close the loophole, changing its tax system to ensure that the dividend tax is directly collected by depository banks, the same entities issuing refund certificates, and no longer by the corporation issuing shares, which had led to an information vacuum between the two institutions, which was readily exploited.

While the scope of the scandal has been most significant in Germany, where more than 50 similar cases, concerning hundreds of suspects, including current and former Deutsche Bank and Macquarie employees, are currently still under investigation, other European states have been battling with cum-ex fiscal scandals as well, among them Denmark, Belgium, Austria, Switzerland and Norway.


Coline Choraine