The Biggest Tax Heist Ever? The Cum-Ex Scandal

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The “cum-ex”-scandal—based on a series of financial transactions that allegedly allowed its participants to obfuscate beneficial ownership of stock and capitalize on so-called “dividend arbitrage”—carries potential macroeconomic and legal implications for the financial services industry and beyond.  The New York Times reports that:

“Stock traders are accused of siphoning $60 billion from state coffers, in a scheme that one called “the devil’s machine.” Germany is the first country to try to get its money back.”

Two defendants “stand accused of participating in what Le Monde has called ‘the robbery of the century,’ and what one academic declared ‘the biggest tax theft in the history of Europe.’”  Id.

The alleged scheme was built on something known as “cum-ex trading”—a finance transaction that The Times likens to a “David Copperfield stage illusion.”  Put in perspective, the most successful diamond heist in history involved jewels worth 334 million euros.  Bernie Madoff’s Ponzi scheme—the largest in history—involved some $20 billion in value.  So the “cum-ex trading” scandal is—well, a fairly big deal.

The defendants in the case have been charged with “aggravated tax evasion,” allegedly costing the German government some $500 million.  German prosecutors have indicated that they intend to pursue at least 400 suspects.  It is unclear how far the investigations stretch, but the NYT hints that whistleblower leaks indicate that American banks conducted cum-ex trades overseas, citing a 2008 Senate investigation into “dividend tax abuse” that found a diversion of some $100 billion annually related to the practice.

Cum-Ex Trading

The “Cum-ex” descriptor derives from two Latin terms: cum, meaning “with,” and ex, meaning “without.”  And so the illusion begins.  The parties to the transaction trade stock “with” (cum) and “without” (ex) dividends in a series of transactions that obscure the beneficial ownership of the stock at the point in time when the stock gives rise to a dividend.  This ambiguity with respect to the beneficial ownership of the stock at this key point in time allows multiple parties to claim (and receive) a “refund” of dividend withheld tax (“WHT”).  In other words, the allegations maintain that the parties utilized a legal loophole that allowed them to simultaneously claim ownership of the shares and obtain a refund of the WHT based on that “ownership.”

How it works

The trading regime appears to have utilized a perceived tax treaty loophole.  Under certain tax treaties, investors are entitled to a refund of WHT on the sale of shares.

In somewhat simplified form, the transaction involves three parties.  We’ll call them Parties A, B, and C.

Party A owns shares in Company.  Company declares and issues a dividend.  Party A receives the dividend and a tax certificate to reimburse the WHT.

In the meantime, Party C short sells shares in Company to Party B.  The transaction occurs prior to the dividend record date (T1) but the transaction is settled after the dividend record date (T2).  The transaction provides for a dividend compensation payment to Party C that equates to the dividend payable on the shares.

In between T1 and T2, Party A sells the stock to Party C.  Party C then delivers the stock to Party B (to close the short sale) and provides for an additional payment equal to the dividend.

Party B then sells the shares to Party A.  Party B, however, also receives a tax certificate to be reimbursed for the WHT. Thus, two parties to the transactions receive tax certificates to be reimbursed for the WHT.

B and C then file WHT refund claims to recover the WHT.

In a nutshell, that’s how the alleged scam appears to work.


Given the magnitude of the dollars allegedly at issue, the cum-ex equity trading scheme has the potential to give rise to a ripple effect with macroeconomic implications for the financial services industry—and beyond.  Stay tuned for more on the fallout from the investigations and indictments.


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