Tags: CFTC | Royal Bank of Canada

CFTC Accuses Royal Bank of Canada of Sham Trades

Monday, 02 April 2012 06:35 PM

U.S. regulators are accusing one of Canada's largest banks of engaging in hundreds of millions of dollars in sham futures trades to reap tax benefits on its holdings of company stocks.

The Commodity Futures Trading Commission on Monday sued Royal Bank of Canada, saying the bank also concealed the true nature of the trades and made false statements to a futures trading exchange. The agency said it is the largest case it has brought against so-called wash trades, which cancel each other out.

The CFTC alleged that Royal Bank of Canada made the trades in stock futures contracts from 2007 to 2010 with two foreign subsidiaries. The transactions weren't "at arm's length," as required by law, and reported by the bank to the exchange, the agency said.

An arm's length transaction is one done at a price that would prevail if the buyer and seller were unrelated. The federal rules allow futures trades between companies and subsidiaries, but only if they are done on an arm's length basis.

The CFTC is seeking unspecified fines and damages in its civil lawsuit filed in federal court in Manhattan.

The CFTC said the bank's trading strategy was devised to gain Canadian tax credits on its holdings of U.S. and Canadian company stocks. The strategy was created and carried out by a group of executives at the bank. However, the agency's suit didn't name any individuals.

CFTC Enforcement Director David Meister wouldn't say whether related suits could be filed against individuals in the future or if the alleged misconduct by Royal Bank of Canada also occurred at other banks.

The buyer or seller of a futures contract commits to purchase or sell something at a specified date and price.

There were two types of futures trades the bank engaged in that corresponded to two different Canadian tax benefits, the CFTC said. One benefit allows Canadian companies that hold U.S. stocks that pay dividends to get a tax credit for the U.S. dividend tax they pay. The bank bought stocks in U.S. companies that it expected to pay dividends on certain dates.

As a hedge against risk, the CFTC said, the bank sold single-stock futures contracts at the same time to a foreign subsidiary. The subsidiary sold the stock short, meaning it bet against the stock — borrowing shares, selling them and then buying them when the stock price falls and returning them to the lender, while pocketing the difference.

The net effect was a "wash," but the bank got a tax credit as a result, the CFTC said.

The other tax benefit allows Canadian companies that hold Canadian company stocks for more than a year to get tax-free dividends for a year from the companies. In this case, Royal Bank of Canada bought baskets of Canadian stocks that it held for more than a year and also sold stock-index futures contracts as a hedge to another foreign subsidiary, the CFTC said.

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