CFTC Accuses Royal Bank of Canada of Sham Trades

By MARCY GORDON AP Business Writer The Associated Press, April 2, 2012

WASHINGTON (AP) — U.S. regulators are accusing one of Canada’s largest banks of engaging in hundreds of millions of dollars in illegal futures trades to reap tax benefits on its holdings of company stocks.

The Commodity Futures Trading Commission filed civil charges Monday against Royal Bank of Canada, saying the bank made the sham trades with itself. The agency said it is the largest case it has brought against so-called wash trades, which cancel each other out. Royal Bank of Canada engaged in “a wash-trading scheme of massive proportion,” the CFTC said.

In addition, the agency alleged that the bank concealed the true nature of the trades and made false statements to a futures trading exchange, OneChicago.

The CFTC alleged that Royal Bank of Canada made the trades in stock futures contracts from June 2007 to May 2010 at non-competitive prices with two foreign subsidiaries. The transactions weren’t “at arm’s length,” as required by law, and as reported by the bank to the exchange, the agency said.

An arm’s length transaction either is one in which the buyer and seller aren’t directly related or one done at a price that would prevail if they were unrelated. The federal rules allow futures trades between companies and subsidiaries, but only if they are done on an arm’s length basis.1

Toronto-based Royal Bank of Canada called the CFTC’s allegations “baseless” and said it will contest them in court. The bank said the trades had been vetted in advance by the CFTC and futures exchanges back in 2005 with no objections being lodged against them, and they were monitored for several years.

The CFTC is seeking a permanent injunction against the bank committing further violations of the federal commodities laws and rules, and unspecified monetary penalties 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.

“Today’s action should make clear that the CFTC will not hesitate to bring charges against even the most sophisticated market participants who unlawfully exploit the futures markets for their own gain,” SEC Enforcement Director David Meister said in a statement.

Meister, questioned by reporters, 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 also 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.

Another Canadian tax benefit allows Canadian companies that hold shares of other Canadian companies for more than a year to receive dividends tax-free for a year. In that 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.

“Before we made a single trade, we proactively contacted the exchange to seek its guidance,” Royal Bank of Canada said in a statement. “These trades were fully documented, transparent and reviewed by both the CFTC and the exchanges, and for the next several years were monitored by them. RBC’s trading was permissible in 2005, and it is permissible today under the CFTC’s published guidance.”

The bank said that since there was no objection in 2005, it is “absurd” for the CFTC to claim now that the trades were fictitious or wash sales.

The trades were engaged in by independent RBC entities with the intention of taking genuine market positions, in accordance with CFTC guidelines, the bank said. “They were executed at competitive market pricing and no market participants suffered any negative impact.”

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