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Regulatory Roundup: The €150 Billion Tax Fraud Scheme and Implications for Market Participants

Tony Sio
Tony Sio Head of Regulatory Strategy and Innovation

Commentary & Analysis

A key responsibility for those within the financial community is to ensure our company or firm is not being used to facilitate financial crime. A recent fine relating to cum-ex trading highlights the importance of that responsibility while also shedding light on one of history’s largest tax fraud schemes. In July of this year, the U.K. Financial Conduct Authority (FCA) issued a £2.5 million fine for a broker for its role in a cum-ex trading scheme, which helped generate over one billion dollars in fraudulent tax payments to their client. This is the fifth case brought by the FCA in relation to cum-ex trading, which has so far totaled more than £20 million in fines at the FCA. The scheme has been estimated to have cost €150 billion in lost tax revenue globally, primarily in the E.U. In Germany, it’s estimated that 1,800 individuals are currently under investigation. At the same time, French authorities raided the headquarters of five banks earlier this year concerning cum-ex and cum-cum dividend trading. The ramifications of the scheme continue to play out, and even parties that had been unwittingly used to facilitate the activity have faced legal consequences.

So, what is cum-ex trading, and what is the implication to market participants? Cum-ex trading generally refers to strategically timed trading of shares around the ex-dividend date, which allows two parties to claim withholding tax. This is done by a short sale before a dividend is paid and delivery after the dividend has been paid, which entitles the buyer of the short position to a withholding tax certificate. By working their trading activity across multiple parties, it was also not possible for tax authorities to determine beneficial ownership, thereby allowing two parties to claim withholding tax: the buyer of the short position and the holder of the shares. Like many types of financial fraud, these schemes use multiple third parties who are unaware of the scheme to help facilitate them as they require a mixture of activities to enact the trading, hide the beneficial owner, or mitigate risk exposure created by these complex movements. 

Similar and related to cum-ex trading is cum-cum trading, which is when shares are sold to an entity in a jurisdiction with more advantageous tax treatment or entitlement. After a short time, those shares are sold back, and the benefits are shared. The legality of dividend arbitrage has historically been a legal grey area; however, many countries have toughened their laws in light of recent scandals. Cum-cum trading has not had the same response as cum-ex trading, but a raid by French authorities in March could indicate a change.

There are existing case studies of the instigator party of cum-ex schemes but none of the facilitators, so to understand that perspective, we’ll examine a recent case by the FCA. In July, the FCA fined Bastion Capital, a now-defunct investment banking firm, £2,452,700. Let’s look at a few interesting aspects of the activity in this case.

Bastion executed £49.03 billion of trades for their client, Solo, in Danish and £22.48 billion of Belgian equities, and they purportedly traded an average of 14.98% of the shares outstanding in the market on major listed Danish stocks in circumstances where share ownership of over 5% required publication. The trades were:

  • Executed on a closed pool OTC platform affiliated with Solo Group and always filled within a matter of minutes. 
  • Represented 30% of the shares outstanding in the companies listed on the Danish exchange and up to 10% of the equivalent Belgian stocks. 
  • Transacted around the last day of cum-dividend. 
  • of a volume that equated to an average of 41 times the total number of all shares traded and 23 times the Belgian stocks traded on the relevant last cum dividend trading date.

The FCA also investigated the actions of the broader Solo Group (outside of Bastion), which they found to be characterized by “high-value OTC equity trading, back-to-back securities lending arrangements, and forward transactions, involving EU equities on or around the last day of cum-dividend.” Following the purported cum-dividend trading that took place on designated days, the same trades were subsequently purportedly reversed over several days or weeks to neutralize the apparent shareholding positions (the “Unwind Trading”). Through this activity, Solo Group was able to make withholding tax reclaims and was paid approximately £888.23 million by the Danish and Belgian tax authorities. Additionally, the FCA found no evidence of ownership of the shares by Solo Group. Altogether, this is highly indicative of the cum-ex strategies previously mentioned and that Bastion’s trading activity was one leg of a larger multi-legged scheme. 

While Solo Group instigated the scheme, what failings did the FCA hold Bastion accountable for? Overall, there were many red flags relating to the client and their activities that could have indicated financial fraud. Some of the failings that the FCA found were:

  • A lack of adequate risk assessment and risk management policies, procedures, and systems.
  • The scale and volume of the trades were highly suggestive of financial crime.
  • There was a failure to implement transaction monitoring processes and procedures.

Ultimately, in the eyes of the regulator, Bastion was found guilty of failing to identify clear red flags, which Steve Smart, Joint Executive Director of Enforcement and Market Oversight of the FCA, stated: “should have alerted them to the risk of being used for financial crime.” We all play a role in fighting financial crime; a key part is ensuring that we don’t facilitate it. Bad actors often rely on good actors to help facilitate their activities, but, unfortunately, when it comes to financial crime - and the prosecution of it - sometimes even those parties unknowingly involved can pay the price. The most effective way to prevent collateral responsibility is to learn and recognize what constitutes financial crime and market abuse and ensure surveillance and monitoring for such behaviors.

Regulatory Updates

19 October: The U.S. Securities and Exchange Commission (SEC) dropped charges against Ripple Labs’ CEO and Executive Chairman in a long-standing battle surrounding allegations of aiding and abetting federal securities law violations. This decision has led to the cancellation of a future trial set for the following year, marking a partial victory for Ripple. The SEC and Ripple will continue to address the legal issues related to institutional sales of XRP.

18 October: The SEC is considering a proposal to address exchanges’ volume-based rebates and fees. The U.S. Congress has mandated that the SEC work to promote competition in the capital markets, which has been amended in various instances since 1975. The commission has requested public comment regarding whether volume-based discounts should be prohibited to even the playing field upon which broker-dealers compete.

17 October: The European Securities and Markets Authority (ESMA) published a letter and a statement encouraging preparations for a smooth transition to MiCA. The letter calls on Member States to designate competent authorities responsible for carrying out the functions and duties provided under MiCA and to consider limiting the optional grand-fathering period to 12 months should they offer it in their jurisdictions. The statement addressed entities providing crypto-asset services and the national competent authorities responsible for their supervision, which lists expectations for each from now until the end of the MiCA transitional period.

16 October: The Hong Kong Monetary Authority (HKMA) issued an update on enhancements to combat digital fraud. The update covers expectations for authorized institutions to ensure their anti-fraud efforts are “adequately resourced and coordinated to ensure effective and efficient implementation and deliver stronger protection for customers.”

13 October: The SEC adopted a new rule, Rule 13f-2, to provide transparency to investors and market participants through increased public availability of short sale-related data. This rule will require institutional investment managers to meet or exceed thresholds to report short sale-related information for equity securities.

13 October: The SEC adopted a new rule, Rule 10c-1a, which will require certain individuals to report information about securities loans to a registered national securities association (RNSA) and require RNSAs to make publicly available information that they receive regarding those lending transactions. This rule is intended to increase the transparency and efficiency of the securities lending market.

11 October: The U.S. Financial Industry Regulatory Authority (FINRA) is being challenged by broker-dealer Alpine Securities Corp. Alpine claims that FINRA’s structure and operations violate the separation and delegation of powers and the appointments clause; FINRA claims it’s a private, not state, actor independent of the SEC, but is supervised by the SEC. The case is part of a broader trend of litigation challenging the authority of federal agencies.

11 October: The ESMA voiced concerns about the significant risks associated with decentralized finance (DeFi) despite its early stage of development. These concerns include speculation, operational vulnerabilities, security risks, and a lack of clear responsibility. ESMA is planning further investigations and annual reports to address these concerns.

9 October: The FCA issued 146 alerts on the first day of the new regulatory regime for crypto-asset promotions, emphasizing that businesses must be authorized, registered, or have their marketing approved by an authorized firm. The FCA urges consumers to check its Warning List for potential violations and emphasize the high risks associated with crypto-assets while vowing to take decisive action against non-compliance.

6 October: The Bank for International Settlements (BIS) of Switzerland, four central banks, and the Monetary Authority of Singapore (MAS) launched “Project Mandala” to explore encoding jurisdiction-specific policies into a common protocol for cross-border use cases like payments and foreign direct investment. The project aims to automate compliance procedures, enhance transparency, and facilitate efficient cross-border transfers of digital assets.

6 October: The Lithuanian Financial Markets Policymaking Advisory Commission discussed how to strengthen oversight of crypto market participants. To implement the requirements of the Crypto Asset Markets (MiCA) and Fund Transfer Regulations (TRF), the Ministry of Finance is preparing seven draft amendments to the laws. The Ministry of Finance proposes that the full licensing process in Lithuania be started earlier than the deadline proposed in the regulation.

5 October: The Canadian Securities Administrators (CSA) provided further clarification and guidance to crypto-asset trading platforms regarding their temporary approach to trading pegged crypto-assets (some commonly referred to as “stable cryptocurrencies”).

5 October: The ESMA published a second consultation package under the Markets in Crypto-Assets Regulation (MiCA). The ESMA is seeking input on five sets of proposed rules covering sustainability indicators for distributed ledgers, disclosures of inside information, technical requirements for white papers, trade transparency measures, and recordkeeping and business continuity requirements for crypto-asset service providers. Stakeholders shall provide their feedback to this consultation by 14 December 2023.

4 October: The Hong Kong Securities and Futures Commission (SFC) established a working group with the Hong Kong Police Force (HKPF) to enhance collaboration in monitoring and investigating illegal activities related to virtual asset trading platforms (VATPs). The working group is comprised of representatives from both parties, and it is set up to facilitate the sharing of information on suspicious activities and breaches of VATPS, implement a mechanism to assess the risk of suspicious VATPs, and enhance coordination and collaboration in related investigations.

4 October: The MAS revealed its use of artificial intelligence (AI) in the supervision of financial institutions. The regulator has utilized data analytics techniques to better identify the various risk signals in the large amounts of data it receives. With the introduction of AI and machine learning techniques, MAS has automated certain tasks to better identify outliers of suspicious networks.

3 October: The Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC) jointly published an information package to support the implementation of the Financial Accountability Regime (FAR). The FAR imposes a responsibility framework for entities in the financial sector, designed to improve the risk and governance cultures of Australia’s financial institutions.

29 September: The SEC closed out its fiscal year with a surge of civil enforcement actions totaling $218 million in fines. Though the government shutdown was averted, the SEC can’t hold onto penalties to fund its operations due to the potential appearance of a “financial incentive to impose penalties on people without regard to a balanced and objective enforcement policy,” said Andrew Vollmer, a former SEC deputy general counsel.

28 September: The CSA finalized regulations establishing a comprehensive regime for supervising the commercial conduct of brokers and advisors on over-the-counter derivatives markets.

28 September: The World Federation of Exchanges (WFE) published the report “Promoting Sound Marketplaces – DeFi/CeFi, Crypto Platforms & Exchanges,” with six principles to build trust and stability.

27 September: The SFC warns four Hong Kong crypto exchanges – Hong Kong Virtual Asset Exchange (HKVAX), Hong Kong Digital Asset Exchange (HKbitEX), Hong Kong BGE, and Victory Fintech – as they pursue virtual asset licenses. All the exchanges mention their commitment to operating in accordance with crypto regulations; however, the SFC has cautioned that applying for a license does not mean a company is already in compliance.

Enforcement Actions

The SEC charged ten firms with widespread recordkeeping failures. The SEC’s investigations uncovered unmaintained and unpreserved off-channel communications at all ten firms, violating the federal securities laws. The firms agreed to pay combined penalties of $79 million and have begun implementing improvements to their compliance policies and procedures.

The SEC charged the host of the podcast “The Cash Flow King” for fraudulently raising approximately $11 million from over 50 investors. The host deceived investors with promises of low-risk, high-return promissory notes supposedly backed by residential properties but instead misappropriated their funds for personal expenses and failed to secure the promised collateral. These actions led to charges including violations of securities laws and a seeking of penalties and injunctive relief.

The ASIC won a landmark disclosure case against Australia and New Zealand Banking Group Limited (ANZ). ANZ breached continuous disclosure laws when undertaking a $2.5 billion institutional share placement by failing to disclose material placement subscriptions allocated to underwriters. The decision in this case reaffirms ASIC’s expectation that an issuer of securities must disclose material shortfalls in capital raisings to the market.

The Financial Conduct Authority (FCA) fined Equifax Ltd £11,164,400 for failures to manage and monitor the security of U.K. consumer data it had outsourced to its parent company based in the U.S. Due to the security breach, hackers accessed the personal data of millions, exposing U.K. consumers to the risk of financial crime.

Following a criminal prosecution initiated by the Canadian Financial Markets Authority, a Judge in Montreal imposed fines totaling $830,000 against two individuals who were found guilty of market manipulation. The two defendants took part in a scheme to manipulate the securities of small capitalization companies listed on the American over-the-counter markets, namely HE-5 Resources Inc., UMining Resources Inc., and Neuro-Biotech Corp. The scheme was based, among other things, on fraudulent issuances of shares of these companies, on the production of false documents, and on the design and distribution of press releases containing false and exaggerated information about these companies.

The U.S. Commodity Futures Trading Commission (CFTC) fined three financial institutions, including Goldman Sachs, J.P. Morgan, and Bank of America, over alleged swaps reporting failures and other violations. Goldman Sachs has been ordered to pay a $30 million civil penalty; J.P. Morgan has been ordered to pay a $15 million civil penalty; Bank of America has been ordered to pay an $8 million civil penalty.

The CFTC filed a civil complaint against Technical Trading Team (TTT), alleging fraudulent solicitation of over $5 million for a commodity pool scheme. TTT solicited funds, lost over $3.13 million, and falsely claimed they could recoup losses using artificial intelligence-based trading. The CFTC seeks several actions, including but not limited to a civil monetary penalty, full restitution to defrauded pool participants, disgorgement of ill-gotten gains, and a permanent injunction against future violations of the Commodity Exchange Act (CEA) and CFTC regulations.

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