The great tax robbery?
How did a Kiwi banker become caught up in a financial scheme that may have cost European governments billions of dollars?
If German prosecutors have their way, a Christchurch investment banker looks set to become one of the main fall guys for a financial screwup that is estimated to have cost European governments about €55 billion (NZ$95b).
Paul Robert Mora, 51, was schooled at St Bede’s College and Canterbury University, but made his fortune in the City of London under what are now deeply controversial circumstances.
What remains to be seen is whether he broke any laws.
The cum/ex loophole
Over a period of several years starting in earnest in the early 2000s, financial institutions helped facilitate share trades that prosecutors say resulted in tax refunds that should never have been paid out.
While some of the transactions sailed closer to the wind than others, the figure includes a rump €12b of particularly problematic ‘‘cum/ex’’ tax refunds claimed from German tax authorities.
At their simplest, cum/ex transactions involved three parties – either banks or wealthy individuals – exploiting a supposed loophole in German law.
One would be a buyer of shares, another a ‘‘short seller’’ who sold shares they did not yet own, and the third a lender of shares.
By transferring shares between one another just before and after a dividend entitlement was due, the buyer and the lender both claimed to be the owner of the shares at dividend time.
Each then claimed a tax refund when only a single withholding tax payment had been made to German tax authorities.
Put plainly, a tax refund was claimed for a tax payment that had never been made.
What remains to be resolved is whether a crime was ever committed.
The glue in the middle
It was individuals such as Mora who were the glue in the middle, setting up some of these complex transactions.
In Mora’s case, that was initially in his job working for HypoVereinsBank (HvB) in London, which he joined as a manager in 2003.
Later, he did so on his own account at a company, Ballance Capital, that he set up with partners for the purpose of cum/ ex trading and dividend arbitrage in 2008.
One of those partners, British banker Martin Shields, is currently on trial in Bonn, along with fellow British banker Nicholas Diable, for his part in setting up cum/ex trades between 2006 and 2011.
The trades in question generated €447m in tax refunds and, according to Shields’ testimony, netted him €12m while he was at Ballance.
Shields worked under Mora at Merrill Lynch and HvB before joining him at Ballance. In 150 pages of testimony delivered to the court in Bonn, Shields has co-operated with prosecutors, spilling the beans on the cum/ex industry and his dealings with Mora and Swiss lawyer Hanno Berger.
Berger has been portrayed as perhaps the spiritual leader of the cum/ex industry, and Mora as one of its chief operating officers, a charismatic Kiwi who used his network of contacts in the City of London to recruit traders to the cum/ex party.
Sonke Iwersen, who heads the investigations team at Dusseldorf newspaper Handelsblatt, believes prosecutors in Frankfurt are waiting for a verdict in the judge-only trial in Bonn before pressing the trigger on a case they have been building against Berger, Mora and four other accused.
Frankfurt prosecutor’s office spokesman Alexander Badle told Stuff last year that ‘‘a 50-year-old New Zealand investment banker’’ – widely reported to be Mora – was among six people it had indicted for cum/ex trades that took place between 2006 and 2008 and which allegedly defrauded German tax authorities of €113m.
Mora, who has since built up a property empire in Christchurch, would not comment about his willingness to cooperate with German prosecutors, or to make himself available for trial if the indictment proceeds to that stage, ‘‘due to the ongoing proceedings in Germany’’.
But in a sign of the trouble he appears to be in, his lawyers said he was keeping the court in the state capital of Wiesbaden, 40km west of Frankfurt, informed as to his whereabouts.
A complicated ‘crime’
If cum/ex was a crime, it was no ordinary one.
Since mid-2007, HvB has been owned by Italy’s UniCredit, which is one of Europe’s largest banks, with 147,000 employees. So how come staff of a major bank were allegedly involved in setting up dubious tax deals as part of their day job?
And if large financial institutions and wealthy investors were involved, why are two ‘‘middlemen’’, Shields and Diable, the first to stand trial?
Above all, though, €55b, or even €12b, is a colossal sum of money.
The former is roughly equal to a third of the New Zealand economy and far exceeds the sum Inland Revenue collects in taxes each year. It seems unlikely the German government could lose even a fraction of that sum over several years without the secret getting out.
Embarrassingly for German authorities, Shields’ testimony was that there was little, if anything, secret about the cum/ex industry, or the broader set of dividend tax refunds troubling the tax department.
Shields said on his first day on the stand that he was asked to find ways to profitably exploit the impact of cum/ex trading as part of his role at HvB.
‘‘There was never anything hidden and it was certainly not something that was clandestinely worked up in backrooms,’’ he told the court, according to a rough transcript of his intended testimony provided by his representatives in Germany.
‘‘There was no black box. There was only an extremely profitable desk. For two of the four years we were at HvB, I was told we were the most profitable desk on the equity derivatives floor.
‘‘In 2007, cum/ex activity in Germany accounted for about €40m of earnings of our desk. This did not remain hidden within the bank, and generated respect and jealousy in equal measure. From my perspective, Paul Mora was lauded as a result of our profitability.’’
Shields’ evidence points to there being no criminal intent by either himself, or Mora, or any of his coaccused. Instead, it suggests they arranged cum/ex transactions carefully to exploit what they believed was a genuine loophole in German law.
German law firm Rudolph Rechtsanwalte Partnerschaft noted in a blog post on the cum/ex that, under German criminal law, offenders must have deliberately committed an offence in full knowledge of all its objective characteristics.
‘‘There is certainly defence potential here,’’ it said.
Paul Mora’s defence
In his most extensive statement to date, Mora told Stuff via his lawyers that an ‘‘undue prominence’’ had been given to his role in cum/ex industry and that he was neither its architect nor inventor.
Cum/ex transactions had instead been practised for many years before 2004, when he joined HvB, his statement said. ‘‘There is evidence that the German authorities, responsible for advising and steering legislation, were aware of cum/ ex transactions for more than a decade.
‘‘In hindsight, within the German Parliament some have criticised the passive attitude as a case of severe government failure. In fact . . . one official used the word ‘dulden’, meaning ‘to tolerate’, with respect to his view of the general attitude to cum/ex transactions at the time we are concerned with.
‘‘Even the belated and incomplete initiatives to regulate these transactions were deficient and could have been seen, as the authorities well knew, to leave a loophole.’’
It is a matter of record that the German government took several stabs between 2007 and 2012 before it finally addressed the apparent legal loophole that gave rise to cum/ex trades to its own satisfaction.
The range of the financial institutions that participated in cum/ex transactions might also seem to fly in the face of the idea that those participating in them thought them illegal.
More than 100 financial institutions have been linked to the transactions, according to The Financial Times.
Shields told the court in Bonn that he had advised prosecutors that he believed Merrill Lynch, Lehman Brothers, Banco Santander, Macquarie Bank and Barclays had all processed short sales, either for themselves or for clients.
Australia’s Macquarie has acknowledged helping to finance a failed cum/ex transaction even in the dying days of the trade and said last year that it was ‘‘cooperating fully’’ with German authorities.
Mora’s statement observed that a number of German state-owned Landesbanks participated in cum/ex transactions and said this must have been known to their governing boards.
Landesbanks are regional, stateowned banks unique to Germany that provide wholesale and investment services, rather than everyday banking for consumers.
‘‘The latest news about this concerns the former HSH Nordbank, the Hamburg Landesbank which received more than €100m cum/ex refunds at the time when the government supported this bank with a cash injection . . . very likely after a due diligence operation that must have shown cum/ex activity.’’
Big players dragged in
Germany’s second-largest bank, Commerzbank, is one of the latest to be dragged into the cum/ex investigations. It revealed in its latest annual report that the public prosecutor’s office in Frankfurt was investigating cum/ex transactions conducted by the bank and Dresdner Bank, which it acquired in 2008, and was ‘‘co-operating fully with the authorities’’.
Shields identified Clearstream – a share depository wholly owned by the German stock exchange Deutsche Borse – as a central player in the cum/ex system and the company that helped settle all the transactions in which he stands accused.
Clearstream was raided by prosecutors in August, according to Bloomberg. Shields said its involvement was one of the factors that persuaded him cum/ex was legal.
Shields also challenged media reports that proponents of cum/ex trading had ‘‘shopped around’’ for favourable legal opinions to provide a fig leaf for their activities. Instead, internationally respected ‘‘tier one’’ global law firms and many of the major international accountancy and advisory firms were active in the cum/ex market, he said.
The fact the cum/ex industry was allowed to thrive under the noses of the German government appears to have flummoxed German investigative journalists who have followed the scandal for years.
Handelsblatt was one of the European media organisations that collaborated to blow the lid on what it headlined ‘‘The Great Tax Robbery’’ in 2017.
But Iwersen has no ready explanation for what might best be described as a period of collective financial delusion.
‘‘Germans definitely think – and rightly so – that politicians and government oversight are to be faulted, because the first warnings started coming out in 2002 that these double refunds were possible and being paid out and it took a full decade for them to fix this.
‘‘There is no reason it should have taken €12b for the politicians to wake up, but unfortunately that is how it played out,’’ he says.
‘‘It is quite mind-boggling that so many bankers and tax lawyers and consultants – everybody was in on it and it was not a secret where the profits were coming from; doubledipping into public funds basically.’’
But now that the ‘‘non-secret’’ is well and truly out, ‘‘the German public are pretty angry that €12b could just go out of the tax coffers and into the pockets of rich people and banks that assisted them,’’ Iwersen says.
While the culpability of German authorities in the cum/ex scandal remains the elephant in the room, it is one that Germans appear willing to squeeze past in their search for restoration and retribution.
Certainly, there is no sign that any criminal proceedings are going to grind to a halt because of it.
‘‘We have kindergartens and schools not being rebuilt or repaired
. . . because all of this money was sucked out of the system,’’ Iwersen says. ‘‘People want the money back.
But they also want, simply put, ‘justice’ – for people who filled their pockets to stand trial and be punished. The expectation is that jail terms will be handed out.’’
Villains and heroes
Germans have their ‘‘villains’’ in individuals such as Berger, Mora and Shields who facilitated the trades.
They also have ‘‘heroines’’ in a 30-year-old female office clerk in the German tax department who, just six months into the job, became suspicious about a €53m refund claim and became instrumental in shutting down the industry, and in Cologne prosecutor Anne Brorhilker, who has been relentlessly pursuing the cases.
If a movie is ever made of cum/ex, expect their parts to be lead roles.
Shields, while not admitting breaking the law, has made it clear that he regrets his involvement in cum/ex.
‘‘With the benefit of age and experience, and as a father, with very different perspectives and priorities, I look differently on the role and responsibility of financial markets, and of cum/ex,’’ he said in a statement released by his lawyer in September.
‘‘I often ask myself whether if I had my time again I would do things differently. Knowing what I now know, the answer is obvious.
‘‘I would not have involved myself in the cum/ex industry in particular.’’
But if Mora feels the same way, it is not something he is yet able to admit.
Iwersen believes Mora would in any case have left it too late to join Shields in co-operating with prosecutors in a bid for leniency.
Asked if he also felt cum/ex was unethical, Mora responded through his lawyers that he had been advised that ‘‘it is not appropriate to comment on questions of this nature given the ongoing proceedings in Germany’’.
‘‘However, it is possible for Mr Mora to reiterate that he is of the firm view that these transactions were lawful at the time they were entered into,’’ his statement said.
In Mora’s view, would there be any possible underlying policy rationale for allowing multiple refunds on a single tax payment to be legal, or would it be fair to say the cum/ex trade was known to be built on a legal mistake?
‘‘It is not possible to comment on the German legislature’s intention,’’ was the response provided through his lawyers.
Implications for New Zealand
There may be postscripts to the cum/ex saga, once German prosecutors have done their dash.
Perhaps one of the most troubling aspects of cum/ex is the speed with which financial institutions around the world swooped on the ‘‘opportunity’’, and what that may say about the potential for further shenanigans.
Quasi-legal opportunities to doubledip on tax refunds may not come along in every country, every day. But the bulk of the €55b in losses commonly associated with cum/ex have actually come from a lesser rort that could be more internationally widespread. These were the so-called cum/cum trades that did not involve a double tax refund.
German tax law allowed German owners of shares to reclaim withholding tax on dividends because their income from dividends would be caught elsewhere in the tax system. But withholding tax was not universally refundable to foreign owners of German shares.
So an industry built up around ‘‘dividend arbitrage’’, whereby the ownership of shares was transferred temporarily to German owners who had the tax advantage in owning them at dividend time.
A similar situation could, in theory, exist with imputation credits that can be attached to dividends paid by Australian businesses, given that Australian share owners can claim a refund for those imputation credits, but New Zealand owners of Australian shares cannot.
So do we have anything to worry about?
A spokeswoman for the Australian Tax Office (ATO) says a market for dividend arbitrage may have existed in Australia in the late 1990s, when a practice that became known as ‘‘franking credit trading’’ started to proliferate.
But a law was implemented in 1998 to stop such schemes, she says.
‘‘This involved the introduction of a holding period rule, that requires recipients of imputation benefits to hold the underlying share at risk for a period of at least 45 days in order to be eligible for the imputation benefit.’’
At the same time, a ‘‘general imputation integrity rule’’ was also introduced that allowed the ATO to deny any imputation benefits derived from a scheme which had a more than ‘‘incidental purpose’’ of deriving an imputation benefit.
But the ATO said it was continuing to monitor taxpayer behaviour in the area and, when needed, draw attention to ‘‘risk areas’’. ‘‘With respect to the broader imputation system, we have issued two public guidance [statements] in recent times.’’
One of them, published just last year, warned that dealing in ‘‘particular structured arrangements’’ risked breaching the holding period rule or the general imputation integrity rule.
Inland Revenue spokeswoman Gay Cavill said it was watching developments in Germany to assess whether there was any risk to the New Zealand tax base, and whether existing laws were adequate.
‘‘So far our assessment of these schemes is that New Zealand is not at risk. But we continue to watch and assess.’’
Suddenly, Germany’s tax debacle doesn’t seem quite so far away.
‘‘There is evidence that the German authorities, responsible for advising and steering legislation, were aware of cum/ex transactions for more than a decade.’’ Paul Mora