Royal Bank defends 'wash trades'
U.S. regulators have picked an epic fight with RBC. But has Royal Bank actually done anything wrong?
Photo: Norm Betts/Landov
A U.S. lawsuit alleges senior RBC executives orchestrated an elaborate trading scheme for the sole purpose of generating tax credits.(Photo: Norm Betts/Landov)
The celebrated American jurist Learned Hand once said:"There is nothing sinister in so arranging one's affairs as to keep taxes as low as possible." Doing so nevertheless often gets people and corporations into trouble. In early April, the U.S. Commodity Futures Trading Commissions lapped a lawsuit on Royal Bank of Canada. Filed in federal court in New York, it alleges senior executives orchestrated an elaborate trading scheme that generated no real gains or losses; rather, its sole purpose was to generate tax credits.
The CFTC's allegations have not been tested in any court.RBC dismisses them as "baseless" and maintains the trading was permissible. "These trades were fully documented, transparent and reviewed by both the CFTC and the exchange," said spokesman Kevin Foster. The regulator is unaccustomed to such intransigence; nearly all its targets negotiate settlements rather than fight.
The CFTC's account of the alleged scheme is tediously arcane. It involved two esoteric instruments that didn't exist until a decade ago. The first are called single stock futures (SSF). These are contracts under which two parties exchange company shares at an agreed price at a future date. The second type, narrow-based stock index futures (NBI), are similar but involve sector indexes. Both are traded exclusively on One Chicago, an electronic futures exchange. The Institute for Financial Markets, a Washington-based non-profit, says SSFs and NBIs can be used for speculation, hedging, short selling and other purposes.
Precisely what RBC was doing is unclear. (The bank didn't respond to questions about the purpose and nature of its trading.)According to the CFTC, between June 2007 and May 2010 various RBC units traded these instruments between one another. So extensive was this activity, the CFTC claims, that hundreds of millions of dollars' worth changed hands. Because RBC was on both sides of the transaction, the trading "was conducted in a riskless manner which ensured that the positions of each counterparty washed to zero."
The commission contends this amounted to "wash trading," an illegal practice. The CFTC claims the bank intended to (and did) "generate tax credits that RBC would apply against its Canadian taxes."It provided no estimate of how much those tax credits were worth. BMO Capital Markets analyst John Reucassel guessed it amounted to $20-$30million a year-chump change for an institution of RBC's size. RBC, for its part, says it contacted One Chicago for guidance "before we made a single trade."And the CFTC itself knew about the transactions since 2005 but raised no objection until now. "Itis absurd to now claim these trades were either fictitious or wash sales," the bank said in a statement. The CFTC, though, asserts RBC falsified or concealed information about the transactions.
Both the CFTC and RBC have a lot riding on this showdown. It's been described as the CFTC's biggest wash-trading case to date. RBC says that while the matter is not financially material, it will defend its reputation. The Canada Revenue Agency will doubtless watch with interest.
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