Last week saw the culmination of the first of a series of cum-ex investigations by the UK regulator, the Financial Conduct Authority (FCA), with the imposition of a fine of £178,000 on a UK-based investment banking firm for failing to have in place adequate systems and controls to identify and mitigate the risk of being used to facilitate fraudulent trading and money laundering.

Cum-ex trading schemes explained

"Cum-ex" schemes involve shares being traded "cum" (with) dividend where the settlement date for the shares is "ex" (without) dividend. In cum-ex schemes, shares are typically traded rapidly across different tax jurisdictions with the intention of generating multiple refunds of withholding tax (WHT), with the result that tax authorities effectively pay the same tax rebate to multiple parties. Cum-ex trades have been the focus of a tax evasion scandal which has seen tax authorities across Europe lose billions of euros in fraudulent tax rebates. Investigations and prosecutions are underway in Germany, France, Belgium and the UK (amongst others).

While the UK does not impose WHT, UK financial institutions could nevertheless be implicated given the UK's position as a major trading hub. Against this background, UK institutions and individuals could be subject to enforcement action by the authorities in affected jurisdictions. For example, British individuals have been charged by prosecutors in Germany and Denmark in respect of concerns arising out of cum-ex trades which were conducted whilst working in London.

The basis for enforcement

Regulators and prosecuting authorities are grappling with how to distinguish legitimate, lawful trades from those which give rise to concerns of criminality. In theory, proof of collusion between multiple parties to claim the same tax refund would provide a clear basis for prosecution. The difficulty lies in proving such collusion given the complexity of these trades with multiple parties often spanning a number of jurisdictions. Nevertheless, given the potential scale of the scandal, it is clear that cum-ex investigations and prosecutions are a high enforcement priority.

The view from the FCA

The FCA has cautioned that cum-ex trades made without sufficiently detailed assessment could amount to market abuse as they may give "false or misleading signals about the supply of, or demand for the relevant security". In that capacity, it has launched a number of investigations both into regulated individuals and firms associated with cum-ex trades on the basis of market abuse concerns, often collaborating with international regulators to do so.

Any firm undertaking trades that appear to be linked to WHT reclaims should conduct a sufficiently detailed assessment of the purpose and nature of the transaction before accepting instruction. That means that firms must have effective processes for carrying out due diligence on new business proposals, on new clients and for monitoring ongoing business. As well as effective policies and procedures, firms must ensure that they have appropriate management oversight and controls in place to minimise the risk of the business being used for a purpose connected with financial crime and that they adhere to the requirements of the Senior Managers Regime. Firms are additionally reminded of their reporting obligations under the Proceeds of Crime Act 2002, the Market Abuse Regulation and Principle 11 of the FCA's PRIN principles for business.

If you would like to discuss strategies for managing the risks arising from cum-ex trades in your business, please do not hesitate to contact Paul Marshall, James Millward or Lisa Kinroy.