Cum/ex

by John Quiggin on September 24, 2019

Looking for a different story in the business pages of The Guardian, I happened across a headline stating The men who plundered Europe’: bankers on trial for defrauding €447m. That attracted my attention, but the standfirst, in smaller print, was even more startling

Martin Shields and Nick Diable are accused of tax fraud in ‘cum-ex’ scandal worth €60bn that exposes City’s pursuit of profit

I think of myself as someone who pays attention to the news, but I had missed this entirely. Google reveals essentially no coverage in the main English language media. There’s a short but helpful Wikipedia article and that’s about it. The scandal has been described as the ‘crime of the century’, but it’s just one of many multi-billion dollar/euro heists, with the GFC towering above them all.

It remains to be seen how the trial will turn out, but it’s already clear that, as usual, the banks have got away with it. The bank most closely involved in the scam, HypoVereinsBank in German has set aside €200 million euros to cover its potential liability. That’s less than 1 per cent of the tax avoided or evaded (the lawyers will be fighting out which, for some time, but the effect on ordinary citizens is the same).

The crucial point here isn’t the failure of the law to punish wrongdoing.

What matters is that crooked deals of this scale suffice for a complete explanation of the growth of the global financial sector since the 1970s. The point of the financial sector is not to allocate capital more efficiently, but to undermine the regulatory and tax systems that are supposed to make the economy work properly. Unsurprisingly the huge financial boom has been accompanied by miserable productivity growth, repeated business collapses and massive growth in inequality.

The only way to fix the problem is to shrink the financial sector to a tiny fraction of its current size, and tightly regulate what remains. The rational route to achieve this would start with the kinds of reforms being proposed by Elizabeth Warren. But we may be stuck with a messier path, in which courts tire of giving slaps on the wrist to recidivist banks and start shutting them down.

For those interested, the name cum/ex (Latin for with/without) refers to shares before and after dividends have been paid. The scam relied on making the same shares appear to be owned by different people, in such a way that each could claim favorable tax treatment.

{ 29 comments }

1

hix 09.24.19 at 9:56 am

Tax evasion sounds too nice in this case. It´s outright fraud like those many VAT return schemes, since they got a tax backpayment twice. The curious part here is how morals could deteriorate to the point where people would consider this a clever and legal gap in the tax law. Getting a tax return twice legal, seriously?

2

nastywoman 09.24.19 at 9:59 am

@
”Unsurprisingly the huge financial boom has been accompanied by miserable productivity growth, repeated business collapses and massive growth in inequality”.

Mainly in the two countries -(UK and US) which went ”all in” for ”Finance”.
Countries which still prefer the production of stuff – compared to the production of money – are doing a lot better.
(to say it all very simplistically)

But on some other -(and very ironic) hand – didn’t the financial boom and industry create such amazing and wonderful ”Molochs” like London and NYC?
I mean – sarcastically – if we pull the plugs on the Gamblers and the Casinos these cities are going down, down, down – and I post that from Karlsbad – where once not only the Financial Elite of this world used to relax the intestinal muscles in order to support regular bowel movements – and thusly improved the quality of life among lot and lots of constipation.

Or in other words:
Just look at the amazing Hotel Poop – I mean Pupp -(and the attached Casino) – to make you understand that rich gamblers are very necessary to further ”rich culture” and a pleasant environment – and what better way to tax -(and not regulate) – them – by
having them finance fancy Indian Restaurants and a Hotel like the Poop?

And only perhaps – joking?

3

Tim Worstall 09.24.19 at 12:22 pm

“For those interested, the name cum/ex (Latin for with/without) refers to shares before and after dividends have been paid. The scam relied on making the same shares appear to be owned by different people, in such a way that each could claim favorable tax treatment.”

Not quite.

One allegation is that by staging a short sale/transaction where the settlement period (say, T+3) ran over the ex-dividend date there could be more than one party recorded as owning the shares.

Given certain continental habits of the corporation paying tax on the dividend before distribution, to be reclaimed by those who shouldn’t be paying that dividend tax (say, other corporations) this could lead to two tax refunds being issued.

I found the story about the case (on Corectiv I think it was?) difficult to follow as there was lots about reporters talking to people etc and not a great deal of actual nuts and bolts of how it worked.

But the €60 billion and all that seemed to be about that. More than the one tax refund due being issued.

What you’re claiming is something much more akin to dividend washing. Which is now illegal in some places – or at least doesn’t gain tax advantages – and that’s rather less awful. Someone who doesn’t pay tax on dividend income owns the shares when dividends are paid. The people who did/will own them get a capital gain on the transaction. CGT is normally less than dividend taxation.

Two refunds being issued on the same share, that’s different from shuffling assets to reduce tax bills.

I do actually find it difficult to believe that the first was even possible. The taxation and regulatory system is so appallingly managed that it can happen?

4

Jerry Vinokurov 09.24.19 at 1:43 pm

But John, I have it on good authority from one “Dan Cooper” that any attempt at regulating the financial sector would result in the immediate deaths of up to half of humanity!

5

steven t johnson 09.24.19 at 2:19 pm

“What matters is that crooked deals of this scale suffice for a complete explanation of the growth of the global financial sector since the 1970s. The point of the financial sector is not to allocate capital more efficiently, but to undermine the regulatory and tax systems that are supposed to make the economy work properly.”

Can’t you lose your union card for denying that regulatory and tax systems make the economy work improperly? The next thing you’ll be saying unregulated monopolies (including intellectual property) are bad for the economy. At any rate, the discovery that fraud is the sole cause of financial overgrowth suggests that it is also the ultimate cause of financial crises. But how can this cause business cycles? (I’ve forgotten what von Hayek’s theory of business cycles was, but as I recall it too didn’t have any internal mechanism that I could see that would cause cycles.) Or do you deny there are business cycles?

6

R. Porrofatto 09.24.19 at 3:21 pm

I’m no economist, but I had a similar reaction to the Guardian article. 60 Billion Euros? And according to Google the American press barely mentioned it in the past several years beyond a few Bloomberg paragraphs? WTF?

If you or I claimed reimbursement for taxes that were never paid in the first place we’d be in jail. (The WAPO may not have reported the Cum-Ex scandal, but they did have an article about an American couple who spent most of the $100,000 deposited erroneously into their bank account: they’re being charged with theft and receiving stolen property.)

This story may not even be on the radar of U.S. business news, but it’s all over Germany’s. This Deutsche Welle article has one interesting comment:

Frederik Richter from the German research network Correctiv told DW that the German Finance Ministry got wind of dubious cum-ex deals as early as 2002, but didn’t act right away.
“There are people who said that following the global financial crisis, cum-ex deals were the only lucrative business left for the ailing banks,” Richter said. “That may have prompted the regulators to turn a blind eye to those kind of transactions so as not to harm the banking sector.”

(This is also a pretty good overview.)

7

BruceJ 09.24.19 at 3:35 pm

But we may be stuck with a messier path, in which courts tire of giving slaps on the wrist to recidivist banks and start shutting them down.

This will only ever happen if the people behind the prosecution actually care about punishing the banks. All too often they’re hand-in-pocket with those very same banks.

8

Jonathan Goldberg 09.24.19 at 6:33 pm

What is the basis for the statement that these activities are sufficient to account for the growth of the financial sector? That is a strong claim. I find it plausible, but would like to be able to cite evidence when I repeat it.

9

P.D. 09.24.19 at 7:05 pm

“the name cum/ex (Latin for with/without)” — Shouldn’t that be “with/from”?

I only took Latin one summer ages ago, so maybe it’s a fixed phrase I didn’t learn. It’s mostly striking that, among all the graft, it’s the Latin translation that caught my attention.

10

Dipper 09.24.19 at 7:36 pm

“What matters is that crooked deals of this scale suffice for a complete explanation of the growth of the global financial sector since the 1970s. The point of the financial sector is not to allocate capital more efficiently, but to undermine the regulatory and tax systems that are supposed to make the economy work properly. Unsurprisingly the huge financial boom has been accompanied by miserable productivity growth, repeated business collapses and massive growth in inequality.”

Putting aside the moral/legal aspect of tax evasion, this money isn’t just disappearing, it is being diverted from state toward (rich) individuals. From what I can see, this period of massive tax evasion (sic) coincides with a period of unprecedented global growth with significant uplift in most indices of well being across the world. The GFC was caused by western governments inflating a housing boom to generate growth when their underlying economies were stalling, and the period after the GFC when governments have constrained banking and fined banks billions of billions has ‘coincided’ with a period of flatlining productivity and growth. An observer might conclude that free markets and competition create economic growth and monolithic state regulation destroys it.

11

Chetan Murthy 09.25.19 at 3:58 am

When our host John Quiggin posted his OP, I thought to myself: “gee, I should post something to the effect that I couldn’t make up my mind until having seen Dipper’s comments, since he’s so trenchant and accurate in his observations”.

And along comes Dipper, to fulfill my every hope and desire. A boy couldn’t ask for more, than to be gaslighted by the best, can he?

What’ the point of addressing his points, when he so clearly doesn’t bother to argue in good faith? It would be so much spitting-in-the-wind.

12

notGoodenough 09.25.19 at 7:38 am

Dipper @ 8

It is interesting that you assume that “free markets” inherently lead to “competition” and “economic growth”.

In fact, what we seem to see is that without regulations companies become giant monolithic enterprises, engage in price fixing, etc., because having a monopoly is inherently more profitable for a company. Very often the driving force behind any competition at all is having regulations to prevent them from doing that.

So, in fact, an observer who actually pays even the slightest attention to the world around them would not conclude “that free markets and competition create economic growth and monolithic state regulation destroys it.”

13

John Quiggin 09.25.19 at 9:25 am

Dipper, you contradict yourself from one sentence to the next, and then again in the one after that.

14

SamChevre 09.25.19 at 11:38 am

I’m having some trouble making sense of this from the Wikipedia article.

If it was made illegal in 2012, does that mean it was legal (and not legally fraud) until 2012? Is this “tax fraud” like most claims for asylum are “immigration fraud”, or is it “tax fraud” in the “clearly illegal” sense?

Because tax law is odd–it often has unexpected consequences that don’t make logical sense, but that’s how it works. (For example, in the American case, the parent who counts a child as a dependent for tax purposes doesn’t necessarily have custody for other purposes.) And because a delay is as good as a win (another parallel with immigration law) most countries have standards intended to reduce delay, even at the cost of somewhat limited legal protections and somewhat arbitrary outcomes.

(Note that I agree that finance is over-focused on exploiting loopholes and if it focused only on useful activities would be much smaller.)

15

Dipper 09.25.19 at 8:34 pm

There’s a lot in the article and the OP that is getting conflated. It is going to take quite a time and several posts to unpick all this. But as I like you all so much here goes.

Equity derivatives seem to be mainly about avoiding tax on dividends. It is not overly surprising to see that a line has been crossed. Tax is a messy area for all sorts of reasons, but the first thing to understand about these kind of deals is they don’t happen in secret. Teams produce brochures, visit clients and put their ideas on display on the table and as one person says these deals were “approved by legal experts and undertaken in accordance with advice”. Furthermore regulators can pretty much walk into any bank and demand any information. So there isn’t any excuse for regulators not knowing about this kind of stuff.

The OP gives two numbers. The first is the fraud of €447 million. It’s a lot of money for individuals ideals or a group of people, but in terms of banking as an industry it is fairly insignificant. But the second number – €60 billion – is large. Sums of money that size make a big noise when they hit balance sheets and P/L accounts. So, where were all the regulators? Where were the accountants? There are literally thousands of people employed in banking whose job it is to ensure the propriety and accuracy of financial statements, so how come they all missed it? A €60 billion fraud is a massive systemic failure to provide any kind of financial oversight, in which case I wonder whether it really is that big or someone is just picking numbers out of thin air to big themselves up.

16

nastywoman 09.25.19 at 9:47 pm

but, but, but Dipper voted Brexit in order to punish the Finance Industry in London – and to destroy it – in order that he soon will be able to afford a flat in Mayfair?

17

eg 09.25.19 at 10:00 pm

Dipper wittering on about “free markets” as if such a thing ever existed or ever could.

It’s kind of amusing.

18

Dipper 09.26.19 at 6:07 am

In any area of human activity, when results matter people will cheat. This isn’t unique to finance. Evidence of cheating is not evidence that the entire system is built round cheating. I wouldn’t, for instance, maintain that Australian success in cricket is because Australian cricket is systemically riddled with cheats despite the fact that several prominent cricketers have been caught cheating. I suspect it is more a result of Australia having a strong tradition and culture of sporting excellence.

Similarly, just because there were crooks in banking and there was a Global Financial Crisis it doesn’t follow that the Global Financial Crisis was due to crooks. The best book I’ve found on this is All The Devils Are Here. It lays bare the relentless boom in the housing market which politicians used as a means of stimulating economic growth in the absence of underlying performance, a boom which carried on until there was no-one left to lend to at which point it came crashing down. This is a clear explanation, it has the evidence in that it has the size of activity to create the observed bust. People complaining about bankers bonuses and bankers cheating seem to have lost a few zeros in their trail of blame as whatever you think of the money they took it wasn’t sufficient to bring the worlds major economy crashing down and it is dwarfed by the size of the housing bubble. As a causative explanation, it is not sufficient to show there were greedy and crooked bankers, you have to show there was an increase in the scale of greed and crime sufficient to cause the crash and there is no evidence that there was an increase of the size required to create the boom.

People get highly paid in all sorts of competitive industries- sport, films, music. That doesn’t mean all these people are corrupt. I don’t hear too much complaining about greedy footballers, greedy musicians, greedy film stars.

Bank failings can happen to the best of people. Take The City of Glasgow Bank. An institution run by devout presbyterians with not a derivative in sight. It still went bust for the reason most failed banks fail; making loans to people who don’t pay them back.

19

Dipper 09.26.19 at 1:33 pm

The OP states ” Unsurprisingly the huge financial boom has been accompanied by miserable productivity growth, repeated business collapses and massive growth in inequality.”. The growth in international finance is often portrayed by the left as a spree of looting by a small but powerful section of society, but the data tells a very different story.

The charts on Our World In Data give a clear picture of significant increases in just about every aspect of well-being being delivered across the world. Declining child mortality, increasing life expectancy, increasing political rights, increasing education. I would contend that global financial markets enable investment and trade to be spread across the globe through the ability to spread risk and so enable significant investment. Hence, this period of financialisation drove huge improvements in well being across the globe.

The OP also talks about declining productivity. My view about the EU is that big businesses have in effect formed a cartel and have used an avalanche of regulations to prevent small businesses challenging them and stifle innovation. Their only source of increased profits is driving down labour costs through bringing more and more workers into the economy at low wages. If you want to increase productivity, enable competition and innovation.

Businesses collapsing is an essential part of capitalism. It is the mechanism for allowing good businesses to drive out bad businesses and enable productivity increases. Clearly there are instances which are significant for towns and regions which depend on industries but a business going bust is often not a sign capitalism isn’t working but that capitalism is working. The alternative is the economics of the former Soviet Union, where no enterprise went bust until the entire country went bust.

20

Bernard Yomtov 09.26.19 at 3:05 pm

Like Tim Worstall, I don’t find the explanations of how this worked clear at all. The wikipedia article says:

The participants in the network would lend each other shares in large companies, so that to tax authorities there would appear to be two owners of the shares, when there was only one. The bank that was used in stock trading would then issue a “confirmation” to the investor that tax on the dividend payment had been paid, without it being done.

That may be helpful to John Quiggin, but it’s not at all helpful to me. It just sounds like fraudulent reporting by the bank. Who needs a lot of stock transactions to do that? Don’t the tax collectors bother to check the totals actually paid against those “confirmed?”

What exactly is the relevance of the ex-dividend date?

Wikipedia links to a description of “dividend-stripping,” which can be used to convert dividends to capital gains. Is that what the scheme is all about?

21

Tim Worstall 09.27.19 at 8:02 am

“Wikipedia links to a description of “dividend-stripping,” which can be used to convert dividends to capital gains. Is that what the scheme is all about?”

If it were dividend stripping only then it would be something that was common, has been made illegal – or at least not tax effective – in some jurisdictions but not all as yet.

The idea of this being that people who get dividends tax free be the people who own shares at the time the dividend is paid. And the people who would pay dividend taxation, but can convert that to a lower taxed capital gain, do so by selling to the first lot just before the dividend, then buying back just after.

The morality of it all, well, have fun deciding upon that.

The confusing allegation here is that multiple tax refunds were gained on the same one lot of shares. If the system is stupid enough to allow that then, well, someone’s going to do it. Leaving your wallet on the table as you go to the bathroom isn’t recommended either.

The morality of doing this second – the legality even – gain of not due tax refunds is presumably rather different from the dividend washing.

22

Bernard Yomtov 09.27.19 at 10:01 pm

Tim Worstall,

Yes, I understand the dividend-stripping game. What I don’t understand is the set of transactions that created the fraudulent refunds, or how the ex-dividend date plays a role.

Further, I agree with you that, at least as described, it seems incredible that this was not caught immediately.

23

Bernard Yomtov 09.27.19 at 10:02 pm

Can I ask why my comments are routinely held for moderation?

All comments are routinely held for moderation. We made that change quite a while ago – JQ

24

nastywoman 09.28.19 at 5:07 am

@19 Dipper
”The growth in international finance is often portrayed by the left as a spree of looting by a small but powerful section of society, but the data tells a very different story”

My God?

I made a mistake Dipper didn’t vot for Brexit in order to punish the Finance Industry in London – and to destroy it – in order that he soon will be able to afford a flat in Mayfair.

He must have voted for Brexit in order to support his countries Financial Industry?

But how will that work – with so many of them already moving to Frankfurt and Paris?

And I thin we need to solve this whole contradiction with this ”Financial Industry” as everybody is so happy in Frankfurt – that all of these London Bankers are coming – and everybody in Frankfurt is hoping that ”all of these great international Financiers” will turn Frankfurt into a London mini-ME!

25

nastywoman 09.28.19 at 6:17 am

– and
Hey Dipper! –
I don’t want all of these London Bankers moving to Frankfurt – as I really don’t like Frankfurt – and then. were is this problem with my favourite Italian restaurant in London – my favourite waiters told me that if all of these bankers will move to Frankfurt and Paris – they might to have – either close their restaurant – or move too – and we can’t have that Dipper –

Right?

What would we do without our favourite Italian restaurants in London –
(as I know you must have one too) –
and the Finance Industry – you seem to like – just like me – sponsoring Italian Culture?

”Suicidarsi”?!

26

Tim Worstall 09.28.19 at 6:28 am

“What I don’t understand is the set of transactions that created the fraudulent refunds, or how the ex-dividend date plays a role.”

As I understand it – and this is incomplete as I’ve not really understood the journalists’ explanations, possibly on the grounds that they don’t quite understand the process themselves – during the settlement period the tax authorities are registering the two parties, seller and buyer, both as beneficial owners of the shares.

So, at T-1 there’s the seller as such beneficial owner, at T + 5 (in a T+4 settlement system) there’s the buyer registered. But in T to T+4 both are so registered. Sounds very weird to me, very weird indeed, but that’s the only way I can see the allegation working. I am working backwards I admit, from what must be happening for the allegation itself to make sense.

If the ex-div date is in the T to T +4 period then the tax authorities have two people listed as having received said dividend. The markets, or the company perhaps, do better than this, in that they only pay the dividend the once.

But if the tax authorities have two registered owners over that ex-div date then they’ve got two people who are eligible (assuming, in the German system at least, that they are corporations who shouldn’t be paying dividend tax at source) for a refund of the dividend tax paid at source. Both claim said tax refund.

It might be that this only works on short sales of borrowed stock. Possibly even only on naked shorts but that seems unlikely as I’m not sure stock markets allow that these days.

But if there’s that dual “ownership” during the settlement period then schemes can be constructed to gain the dual tax refund over that ex-div date. One rough description from the original reporting seems to be fund lends stock to short seller, who sells to third party. Ex-div third party delivers back to first. At the end of the tripartite process all three share any change in capital value of the stock plus the extra tax refund on the dividend.

Three parties involved because to use just the two would be straight dividend washing. Or perhaps wouldn’t create that dual ownership during the settlement period.

What does seem must be true is that in order to work the tax authority’s allocation of ownership must be different from the company registrar’s. For that’s the only way a dividend paid once could possibly lead to two tax refunds on a dividend.

If this is what was happening then I am astonished that the hole exists in the ownership registration at the tax authorities. But if so, well, it’s so.

My initial prejudice was to assume that the journos had simply misunderstood simple dividend washing but that seems to be what is referred to as the “cum/cum” idea, rather than the “cum/ex”.

I, for one, would greatly welcome an explanation from someone who really understands this. D2 would be great if he still frequents here.

27

Another Nick 09.28.19 at 11:50 am

http://www.europarl.europa.eu/cmsdata/158435/2018-11-26%20-%20Information%20paper%20on%20Cum-ex%20-%20Cum-cum.pdf

In general at least three parties are needed for a successful cum-ex scheme. Below a simplified example how the cum-ex scheme worked in Germany is shown.

Example:

– Investor A (e.g. an asset manager) owns shares worth 20m in listed company X.

– Investor B now buys shares worth 20m from company X as well, just a few days prior to company X paying out dividend to its shareholders. The shares bought by investor B are characterized as cum-dividend shares, because these shares will provide the buyer with dividend. Investor B buys these shares from investor C, who – critically – does not own these shares himself yet. Investor C is ‘short-selling’, and promises investor B to deliver the shares at an agreed time.

– Now company X pays out the dividend – worth 1m – to investor A, who receives €750.000, directly from company X and a certificate from his own bank to reimburse €250.000, worth of dividend tax which has been collected by the German tax authority. As a result, investor A’s shares are now worth 19m (20m – 1m dividend).

– Investor A now sells these reduced-value shares, characterized as ex-divided shares, to investor C.

– As agreed before, investor C now delivers these shares to investor B. However, because they are worth 1m less, investor C pays investor B a dividend compensation worth €750.000, and investor B’s bank provides him with a certificate to reimburse €250.000, of dividend tax.

– Finally, investor B sells his shares (worth 19m) back to investor A. As a result, both investor A and investor B now own a certificate to reimburse the dividend tax, even though the German tax authority collected the tax only once.

– The additional reimbursed dividend tax is shared between investors A, B and C.

28

John Quiggin 09.29.19 at 7:07 am

Thanks, Nick. That’s very helpful.

29

Dipper 09.29.19 at 12:47 pm

likewise thanks to Another Nick for that.

There’s a comment in the Guardian article about “… teaching them about the moral and legal consequences of their actions in return” re new graduates. I disagree almost entirely with this statement.

Nearly all banks, and many regulated industries, operate with three lines of defence. Hence the instruction to new employees is pretty much ‘know your three lines of defence. Always engage Legal/Compliance wherever appropriate. If you have any doubts, go to your representative in your business control unit.’ Sorted.

The moral issue is not so clear cut, but my view is that banks should not presume the morality of their customers and should do whatever is legal and in the interests of their customers. If you deviate from that you can get into a situation where people may reasonably claim banks are exercising censorship and persecution to prevent them going about their legal business.

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