Analysis: Fraud in Germany propels new European AML plan

The plan arose out of a recent regulatory supervision review and controls that failed or facilitated a dividend arbitrage scheme, known as “cum-ex.” The scheme has also been the subject of a criminal prosecution in Germany, which saw two ex-British bankers found guilty of tax fraud. On March 18, right around the time many of us went into lockdown, the two ex-bankers avoided imprisonment because they cooperated and provided assistance to the authorities.

It has been reported that the cum-ex scheme, which operated for 10 years, may have taken in excess of €55 billion (U.S. $60 billion) from European governments. The Germans want their money back and are said to have 400 targets in their sights, meaning more trials will start soon. Within the cum-ex scheme, bankers took advantage of tax rebates, and some European countries offered upon-share dividends, so the bankers operated an arbitrage scheme to facilitate claims for the rebates.

At its most simple level, banks operated alongside other parties and loaned shares from fund managers before undertaking transactions, obfuscating the ownership of the shares and/or creating more than one owner of the shares on the day when dividends were paid. Subsequently, more than one party claimed a rebate upon the dividends, sometimes from two tax authorities. The proceeds of the scheme, including the rebates, were then shared among the participants, including the bank, the fund manager, and temporary owners of the shares.

The scheme has now been declared criminal tax evasion, but supervisors have been criticized for allowing it to go unchecked for 10 years. The EBA has determined weaknesses within AML controls and supervision contributed to its longevity; consequently; the agency has made a number of AML recommendations, which may help to stop a similar scam operating again.

The cum-ex scheme highlights AML failings within arbitrage trading, proprietary trading, and complex trading strategies within banks and other regulated financial service businesses. Specifically, the EBA has established some banks and supervisors failed to identify and tackle the criminal tax evasion risks within these trades. It follows that schemes that are designed to evade tax—or as in the cum-ex scheme, to steal tax rebates—will launder the proceeds of these crimes/trades through their banks.

Previously, compliance officers and financial crime professionals may have determined their own staff and internal trading desks were low risk. The EBA document challenges this and mandates the application of a logical AML risk assessment to these areas, with a focus upon tax evasion.

There is a wider issue here, which is the laundering of the proceeds of crimes committed in the securities markets. I previously wrote a training module for this subject and asserted there were seldom clear connections between common crime, drug trafficking, and laundering in the equities markets.

My friend and author Roberto Saviano supported this theory in his book “ZeroZeroZero,” wherein he stated, “If you had invested €1,000 [(U.S. $1,086)] in Apple stock in the beginning of 2012, you would have €1,670 [(U.S. $1,813)] in a year. Not bad. But if you had invested €1,000 in cocaine … after a year you would have €182,000 [(U.S. $197,591)].”

Drug dealers invest in drugs; securities market participants invest in securities, and some commit securities fraud as well as tax evasion.

Thus, as though compliance professionals did not have enough to do, they now need to apply additional controls, scrutiny, assessments, and resources to proprietary trading desks. Tax evasion is a crime, as is the laundering of the proceeds of the same. Given our governments are taking on huge debt to fight the coronavirus pandemic, there will be a lot of focus on fighting tax evasion.

The transactions in the cum-ex trades, including dividing up the proceeds and paying the participants, were essentially being undertaken to launder the proceeds. Thus, it will be necessary to monitor these transactions and the expenses of bankers/traders on these desks. On the other hand, you can stop looking for drug money in the markets, because as Saviano states, it is not there.