European Banking Authority Publishes Results of Inquiry into Dividend Arbitrage Trading Schemes, Announces Ten-Point Action Plan

On May 12, the European Banking Authority (EBA) published the results of its inquiry into dividend arbitrage trading schemes, sometimes called “Cum-Ex” or “Cum-Cum” schemes.  Cum-Ex/Cum-Cum trading has been defined as “a form of dividend arbitrage where trading and lending of securities and derivatives are constructed around dividend dates in order to generate multiple withholding tax (WHT) reclaims for the same stock.”  It typically involves rapid exchanges, in as many as a dozen transactions, of exchanging stock “with” and then “without” dividends between three parties, where at least two of the parties then claim tax rebates on taxes only paid once.

Background

Since the mid-2000s, Cum-Ex trading became a means of conducting tax evasion on a massive scale.  From 2006 to 2011, according to the New York Times, hundreds of bankers, lawyers, and investors “made off with a staggering $60 billion, all of it siphoned from the state coffers of European countries.”  Because of a gap in its tax code, Germany was most heavily affected, losing an estimated $30 billion.  Ultimately, German prosecutors charged and successfully prosecuted two key figures in Cum-Ex trading, Martin Shields and Paul Mora, for tax fraud that involved double tax reclaims totaling $486 million.

In response to the extensive reporting about Cum-Ex’s role in tax evasion, the European Parliament asked the European Securities and Markets Authority (ESMA) and the EBA to

conduct an inquiry into dividend arbitrage trading schemes such as cum-ex or cum-cum in order to assess potential threats to the integrity of financial markets and to national budgets; to establish the nature and magnitude of actors in these schemes; to assess whether there were breaches of either national or Union law; to assess the actions taken by financial supervisors in Member States; and to make appropriate recommendations for reform and for action to the competent authorities concerned.

The EBA Report

The EBA Report included a number of important findings, based in part on EBA surveys, with regard to Cum-Ex schemes:

  • National-Level Laws Prohibiting Cum-Ex Schemes: In eight European Union (EU) Member States,  dividend arbitrage trading schemes such as Cum-Ex schemes are tax crimes and therefore constitute a “criminal activity” within the meaning of the EU’s Fourth Money Laundering Directive.  One EU Member State indicated that such schemes were not a tax crime under its national law.  In some other Member States, such schemes were not tax crimes under national law, but “were treated as tax crimes on the basis of case law.”
  • Money Laundering/Terrorist Financing (ML/TF) Risk: For five Member States, dividend arbitrage schemes were being assessed as part of those States’ national ML/TF risk assessment under Article 7 of the Fourth Money Laundering Directive.  In addition, for nine States AML/CFT supervisors indicated “that these schemes gave rise to the risk that a financial institutions’ governance and internal control framework would be insufficient to adequately manage the risk of the financial institution, or someone acting on the financial institution’s behalf, committing or facilitating tax crimes.”
  • Supervisory Action Regarding Cum-Ex Schemes: Survey responses indicated that “most competent authorities have not considered the relevance that dividend arbitrage trading schemes may have for financial institutions’ sound and prudent management and for ML/TF risks due to weaknesses within the internal control framework and, consequently, few have taken supervisory actions.”
  • Cooperation: Notably, most competent authorities (whether prudential and/or AML/CFT supervisors) in Member States indicated that they “had not cooperated with other public authorities in their jurisdiction (such as tax authorities) or other competent authorities in their jurisdiction or in other Member States because they believed that there were no dividend arbitrage trading schemes in their Member State.”

The Report concluded that because facilitating tax crimes, or handling proceeds from tax crimes, “undermines the integrity of the EU’s financial system,” the EBA “expects institutions and competent AML/CFT and prudential authorities to take a holistic view of the risks highlighted by dividend arbitrage trading cases, . . . which may give rise to questions about the adequacy of financial institutions’ anti-money laundering systems, internal controls and internal governance arrangements.”  The Report recommended a number of measures to address the problem with regard to the current regulatory framework.  Those included AML/CFT supervisors’ outreach to local tax authorities, cooperation arrangements for information exchange between relevant competent authorities (including tax authorities) with regard to financial institutions’ involvement in Cum-Ex schemes, and competent authorities’ taking mitigating measures that are commensurate with the risks that such schemes pose.

The EBA Action Plan

Consistent with the Report’s findings and recommendations, the EBA’s Action Plan addresses ten specific actions that the EBA will take – with deadlines specified for each action — “to enhance the future regulatory requirements applicable to dividend arbitrage trading schemes”:

  1. Amend its prudential Guidelines on Internal Governance, “in order to ensure that the management body develop, adopt, adhere to and promote high ethical and professional standards”;
  2. Amend its prudential Guidelines on the Assessment of the Suitability of Members of the Management Body and Key Function Holders, “in order to ensure that tax offences, including where committed through dividend arbitrage schemes, are considered in the assessment”;
  3. Amend its prudential Guidelines on Supervisory Review and Evaluation Process (SREP) with regard to the section on governance, in order to include an appropriate reference to tax crimes, such as dividend arbitrage schemes”;
  4. Monitor “how prudential colleges have followed up, in a risk-based approach, on guidance” with regard to Cum-Ex schemes;
  5. With regard to the EBA’s ongoing consultation on its Guidelines on ML/TF risk factors, assess the responses that the EBA will receive “to identify whether the existing references to tax crimes contained in the draft Guidelines are sufficient to address the risks arising from dividend arbitrage trading schemes”;
  6. Amend its Guidelines on Risk-Based AML/CFT Supervision “to include additional requirements on how AML/CFT competent authorities should, in a risk-based approach, identify, assess and address ML/TF risks associated with tax crimes such as illicit dividend arbitrage schemes”;
  7. Amend its biennial Opinion on ML/TF Risks, by assessing ML/TF risks associated with tax crimes in greater detail than did the previous version of the Opinion;
  8. Continue to allocate, in the EBA’s ongoing multi-annual program of staff-led AML/CFT implementation reviews of AML/CFT competent authorities, “explicit time to authorities’ handling of ML/TF risks associated with tax crimes, where this risk is significant”;
  9. Monitor discussions in AML/CFT supervisory colleges, “and intervene actively as necessary, to ensure that AML/CFT colleges for financial institutions that are exposed to significant ML/TF risks associated with tax crimes, address such risks”; and
  10. Carry out an inquiry, under Article 22 of the EBA Regulation, “into the actions taken by financial institutions and national authorities within their competencies to supervise compliance with requirements applicable to dividend arbitrage trading schemes as amended.”

Note:  These actions by the EBA represent a concerted effort to rationalize and coordinate efforts within the EU to treat Cum-Ex schemes as tax crimes warranting inclusion in AML/CTF regulation.   Financial institutions subject to EBA regulation should closely read the EBA Report and Action Plan, and promptly review their own AML/CTF compliance programs to identify any components that require revision to provide appropriate risk assessment and timely identification of customer participation in Cum-Ex schemes.  As the Action Plan indicates, both the EBA and national AML/CTF supervisors can be expected to devote substantial effort to addressing such schemes in 2020, 2021, and beyond.

GAO Issues Report on Trade-Based Money Laundering

On May 1, the U.S. General Accountability Office (GAO) publicly released a report on trade-based money laundering (TBML).  The report examined three main topics: “(1) what the available evidence indicates about the types and extent of international TBML activities, (2) the practices that international bodies, selected countries, and knowledgeable sources have recommended for detecting and combating TBML, and (3) the extent to which ICE has effectively implemented [the Trade Transparency Unit (TTU) program under the Department of Homeland Security’s (DHS) Immigration and Customs Enforcement (ICE)] and steps the U.S. government has taken to collaborate with international partners to combat TBML.”

The report first stated that different types of criminal organizations use TBML to disguise the origins of illicit proceeds and fund their operations.  These include drug trafficking organizations through Latin America, which “have used TBML schemes for decades to launder the proceeds from illegal drug sales”; other criminal organizations, which “launder proceeds from a range of other crimes, including illegal mining, human trafficking, and the sale of counterfeit goods”; corrupt government officials; and terrorist organizations including Hezbollah and the Revolutionary Armed Forces of Colombia (FARC).

These organizations use a range of TBML schemes involving many different goods and services, such as black market peso exchanges, import-export businesses, purchase and export of gold using drug proceeds, and purchase and export of higher-quality foreign goods.  The most common items in TBML schemes are precious metals, automobiles, clothes and textiles, and electronics.  The United States is not alone in dealing with TBML risks; the U.S. State Department has identified TBML risks in 26 countries or territories in multiple regions of the world, and free trade zones have been identified as particular areas of risk for TBML.

Multiple sources indicate that “the amount of TBML occurring globally is substantial and has increased in recent years,” possibly in the billions of dollars each year.  The report, however, recognized that “specific estimates of the amount of TBML occurring around the world are unavailable” from either academic or government studies.

The report took note of recommendations from official and other sources for governments to strengthen their efforts to detect and combat TBML.  It identified and discussed five categories for these recommendations: “(1) partnerships between governments and the private sector, (2) training in detecting and combatting TBML, (3) sharing information through interagency collaboration, (4) international cooperation through information and knowledge sharing, and (5) further research on challenges, such as potential impediments to combatting TBML.”

According to the report, U.S. officials and knowledgeable sources “noted several challenges to international cooperation related to technology and data uniformity.” These included changes in government administration and technological limitations that “affect the continuity and the commitment to information sharing with foreign partners,” and  a lack of trust among countries, which complicates “arrangements for sharing trade data between multiple countries as a possible means of improving detection of TBML-related activities.”

The report also stated that DHS and the Departments of Justice, State, and the Treasury “provide a variety of support to partner countries to assist in combating TBML, including establishing information-sharing methods, funding training and technical assistance, and providing ongoing law enforcement cooperation.”  In particular, the report observed that the TTU program, which it termed “[t]he U.S. government’s primary partnership effort focused specifically on combating TBML,” “has faced challenges that limited its results in disrupting TBML schemes.”

These challenges included (1) insufficient resources or support for partner TTUs, (2) slow expansion of the TTU program and limited geographic range, (3) delays in launching partner TTUs and lapses in their operation; (4) Differences in objectives between HSI and partner TTUs (i.e., placing higher priority on revenue collection than TBML scheme disruption); (5) limited authorities and lack of interagency coordination in TTU partner countries; and (6) data-sharing and connectivity problems.  The report cited DHS’s Homeland Security Investigations (HSI) for not taking “key management steps to address those challenges and to strengthen the TTU program.”

The report presented two recommendations for the Secretary of DHS: (1) direct the Director of ICE “to develop a strategy for the TTU program to ensure that ICE has a plan to and guide its efforts to effectively partner with existing TTUs, and to expand the program, where appropriate, into additional countries”;  and (2) “direct the Director of ICE to develop a performance monitoring framework for the TTU program that would enable the agency to systematically track program results and how effectively it is achieving the program’s goals.”

Note: This GAO report underscores the importance of TBML as a key, though still inadequately measured, component of money laundering worldwide.  Anti-money laundering (AML) compliance officers should circulate this report within their teams to increase overall awareness about TBML, and to assist in refining their AML risk assessment processes to take greater notice of TBML methods and techniques.

Compliance Week Issues 2020 Anti-Bribery & Corruption Benchmarking Report

On April 30, Compliance Week issued the 2020 Anti-Bribery & Corruption Benchmarking Report.  The risk solutions firm Kroll produced the Report (available via this link) based on survey responses from more than 150 compliance and risk professionals.  Overall, the Report covers four categories of anti-bribery and corruption (ABC) related concerns: third-party risk, enhanced due diligence, third-party training, and emerging technologies.

Key findings of the Report include the following:

  • ABC Program Effectiveness: Only 56 percent of responses rated their companies’ ABC programs as highly effective (22 percent) or effective (34 percent), while 29 percent rated their programs moderately effective, 8 percent minimally effective, and 7 percent non-effective.
  • Adequacy of Resources: A majority of respondents viewed “adequate resources” as a critical factor in ABC program success. 85 percent of those who rated their programs highly effective or effective said they had adequate resources.  In contrast, 67 percent of those who rated their programs moderately effective or lower said that they lacked sufficient resources.
  • Changes in Bribery and Corruption Risks: When asked whether they anticipated that bribery and corruption risks to their companies would increase, decrease, or stay the same over the next two to three years,
    • Increase: 48 percent of those rating their programs moderately effective or lower, and 29 percent of those rating their programs highly effective or effective, said risks would increase.
    • Decrease: 17 percent of those rating their programs highly effective or effective, and only 3 percent of those rating their programs moderately effective or lower, said risks would decrease.
    • Stay the Same: 46 percent of those rating their programs highly effective or effective, and 39 percent of those rating their programs moderately effective or lower, said risks would stay the same.
  • Third Parties in High-Risk Jurisdictions: An equal percentage (33 percent) of those rating their programs highly effective or effective and those rating their programs moderately effective or lower reported that they had third parties operating in high-risk jurisdictions internationally. 50 percent of those rating their programs highly effective or effective, and 40 percent of those rating their programs moderately effective or lower, reported that they did not.
  • C-Suite Awareness of Potential Third-Party Risk: 61 percent of respondents said that their C-Suite was aware of the potential third-party risk that their enterprises faced prior to engaging with them. Another 23 percent said that their C-Suite was sometimes aware of that potential risk, while 13 percent said their C-Suite was not aware.
  • Enhanced Due Diligence of Third Parties: The Report stated that “many companies, according to the survey results, still have mediocre ABC programs is particularly concerning when it comes to enhanced due diligence of third parties.”  More than half (56 percent) of those rating their programs highly effective or effective, and 43 percent of those rating their programs moderately effective or lower, said less than 25 percent of their third parties undergo enhanced due diligence (EDD).  More troubling, 5 percent of those rating their programs highly effective or effective, and 14 percent of those rating their programs moderately effective or lower, said that none of their third parties undergo EDD.
  • EDD Challenges: 38 percent of respondents stated that their biggest challenge regarding EDD was lack of knowledge, while 34 percent rated cost and 15 percent rated delivery time as the biggest challenge.
  • ABC Training for Third Parties: A surprising 46 percent of all respondents, and 37 percent of respondents with third parties in high-risk areas, said that they never train their third parties on ABC.  44 percent of those rating their programs highly effective or effective, and 39 percent of those rating their programs moderately effective or lower, said they trained their third parties annually.  19 percent of those rating their programs highly effective or effective, and 15 percent of those rating their programs moderately effective or lower, said they trained their third parties less frequently (every 2 or 3-5 years).
  • ABC Training Methods for Third Parties: Methods that respondents said their companies were using for such training included “an anti-bribery statement in the Code of Conduct (55 percent), text within the onboarding questionnaire (39 percent), certifications in contract materials (35 percent), and online or Web-based training (25 percent).” As for followup on such trainings, 45 percent of respondents said that they used attestations, 37 percent questionnaires, 32 percent auditing, and 26 percent in-person meetings.  7 percent said that they did not do followup.
  • Emerging Technologies: When asked what emerging technologies their companies currently user or plan to use to enhance their anti-bribery programs, 60 percent said that they did not plan to use artificial intelligence (AI), blockchain, or machine learning.  26 percent said they use or plan to use AI, 8 percent blockchain, and 18 percent machine learning.  In addition, 65 percent of respondents said that their third-party due diligence vendors do not use AI or any other sort of machine learning when conducting their checks.

Note:  ABC compliance officers should use this Report, as it recommended, to benchmark their own ABC programs and identify areas for review and improvement.  The survey results indicate that far too many corporate ABC programs have deficiencies that range from significant to severe, especially with regard to effectively managing third-party risk.  Even if the economic damage that companies are enduring from coronavirus is substantial and likely to last for one or more years, companies must still take stock of their current-state programs and make sure that those programs have a defensible amount of resources devoted to critical ABC compliance needs.

Federal and State Authorities Charge Oncology Group with Market Allocation, Obtain Agreements to Pay More Than $120 Million in Penalties

On April 30, the U.S. Department of Justice announced that it had filed a criminal information against Florida-based oncology group Florida Cancer Specialists & Research Institute LLC (FCS). The information charged FCS with violating section 1 of the Sherman Act by conspiring to allocate medical and radiation oncology treatments for cancer patients in Southwest Florida.  The Department’s release stated that over a 17-year period — beginning as early as 1999 and continuing until at least 2016 — FCS entered into an illegal agreement that allocated chemotherapy treatments to FCS and radiation treatments to a competing oncology group.

The Antitrust Division of the Department also announced that it had entered into a deferred prosecution agreement (DPA), resolving the Sherman Act charge, with FCS.  Under the terms of the DPA, FCS admitted to conspiring to allocate chemotherapy and radiation treatments for cancer patients.  It also agreed to pay a $100 million criminal penalty, to cooperate fully with the Antitrust Division’s ongoing investigation into market allocation in the oncology industry, and to maintain an effective compliance program designed to prevent and detect criminal antitrust violations.

In addition, on April 30 the Florida Office of the Attorney General (OAG) announced that after a parallel civil investigation into oncology market allocation, it filed a civil complaint against FCS, charging it with violating Florida antitrust laws by conspiring in the market-allocation scheme.  The OAG stated that it had reached agreement with FCS on a proposed consent decree “to pay more than $20 million in disgorgement of profits and other relief over four years to resolve the investigation.”

FCS also reportedly agreed to comprehensive injunctive relief, including undertaking a “robust compliance program to ensure conformity with Florida’s antitrust laws,” and to continue to cooperate with the OAG’s ongoing investigation into the alleged market allocation.  The proposed agreement with FCS will still need to be approved by a court.

Note:  Antitrust and health-care compliance officers should take note of these resolutions with FCS, which is reportedly one of the largest independent oncology groups in the United States.  The Justice Department release made a point of stating that the Sherman Act change against FCS was only the first in its ongoing investigation of market allocation in the oncology industry.  As the Florida OAG also noted that its investigation is ongoing, both the Department and the OAG are likely to announce further resolutions with Florida oncology practices.

Antitrust compliance officers should therefore brief their companies’ senior management about the FCS resolutions, making clear that market allocation is a core antitrust violation, and use those resolutions in their in-house antitrust complaint training programs.

Blue Bell Creameries Pleads Guilty to Federal Charges, and Justice Department Charges Former Company President, Over Ice Cream Listeria Contamination

On May 1, the U.S. Department of Justice announced that it had obtained a guilty plea from ice cream manufacturer Blue Bell Creameries L.P. (Blue Bell) to misdemeanor charges under the federal Food, Drug and Cosmetic Act that it had shipped contaminated ice cream products that were linked to a 2015 listeriosis outbreak.  It also stated that Blue Bell’s former president, Paul Kruse, was separately charged in connection with the outbreak, in an information charging seven felony counts of conspiracy and attempted wire fraud relating to Kruse’s alleged efforts to conceal from customers what Blue Bell knew about the listeria contamination.

Under the terms of the plea agreement, Blue Bell agreed to pay a criminal fine and forfeiture totaling $17.25 million.  Under a separate resolution with the Justice Department, it also “agreed to pay an additional $2.1 million to resolve civil False Claims Act allegations regarding ice cream products manufactured under insanitary conditions and sold to federal facilities.”  The $19.35 million total, the Department stated, constitutes “the second largest-ever amount paid in resolution of a food-safety matter.”

The charges against Blue Bell stemmed from a series of actions that Blue Bell took after Texas state officials notified it in February 2015 that two ice cream products from the company’s Texas factory tested positive for Listeria monocytogenes. This bacteria, according to the Mayo Clinic, can causes listeriosis, an illness that “can be fatal to unborn babies, newborns and people with weakened immune systems.”

The plea agreement with Blue Bell stated that Blue Bell “directed its delivery route drivers to remove remaining stock of the two products from store shelves, but . . . did not recall the products or issue any formal communication to inform customers about the potential listeria contamination.”  Two weeks after they were notified of the first positive listeria tests, “Texas state officials informed Blue Bell that additional testing confirmed listeria in a third product.  Blue Bell again chose not to issue any formal notification to customers regarding the positive tests.”

In March 2015, the Food and Drug Administration (FDA) and Centers for Disease Control and Prevention (CDC) conducted tests that “linked the strain of listeria in one of the Blue Bell ice cream products to a strain that sickened five patients at a Kansas hospital with listeriosis.”  On March 13, 2015, the FDA, CDC, and Blue Bell all issued public recall notifications.  On March 23, 2015, a second recall announcement was made after “[s]ubsequent tests confirmed listeria contamination in a product made at another Blue Bell facility in Broken Arrow, Oklahoma.”

FDA inspections in March and April 2015 found sanitation issues at Blue Bell’s Texas and Oklahoma facilities, “including problems with the hot water supply needed to properly clean equipment and deteriorating factory conditions that could lead to insanitary circumstances.”  After temporarily closing all of its plants in April 2015 to clean and update the facilities, Blue Bell reopened its facilities in late 2015.  The Justice Department credited the company with “tak[ing] significant steps to enhance sanitation processes and enact[ing] a program to test products for listeria prior to shipment.”

The Justice Department’s civil False Claims Act settlement with Blue Bell resolves allegations that the company

shipped ice cream products manufactured in insanitary conditions to U.S. facilities, and later failed to abide by contractually required recall procedures when its employees removed products from federal purchasers’ freezers without properly disclosing details about the potentially contaminated ice cream to the appropriate federal officials.

The Justice Department also stated that the information against Kruse alleges that he “orchestrated a scheme to deceive certain Blue Bell customers after he learned that products from the company’s Texas factory tested positive for Listeria monocytogenes.”  In particular, Kruse allegedly “directed other Blue Bell employees to remove potentially contaminated products from store freezers without notifying retailers or consumers about the real reason for the withdrawal,” and “directed employees to tell customers who asked why products were removed that there had been an unspecified issue with a manufacturing machine instead of that samples of the products had tested positive for listeria.”

In a public statement issued on May 1, Blue Bell said that in 2015, it was “heartbroken” about the events that led to its voluntary recall of all of its ice cream from the market, and apologized “to everyone who was impacted.”  It acknowledged that the May 1 agreement with the Justice Department “reflects that we should have handled many things differently and better.”  Since it resumed production in 2015, the company noted, it tests its ice cream “and deliver[s] it to stores only after independent tests confirm it is safe.”

Note:  Coming only ten days after the $25 million fine against Chipotle Mexican Grill for criminal charges stemming from food adulteration that sickened more than 1,100 people, this resolution with Blue Bell provides a strong indication that the Justice Department is treating food safety as a significant consumer-protection and criminal-enforcement issue.  That commitment to food-safety enforcement may become more evident in the coming months, as law enforcement and regulatory agencies monitor food manufacturers’ and chain restaurants’ efforts to reopen in the midst of the coronavirus pandemic.

The Kruse information also provides a strong reminder to all corporate executives that when confronted with potentially damaging information about their companies’ products or services, it is never an acceptable option to limit the damage by concealing that information from, or lying outright to, their customers or the public.  (P.S.: The fact that Kruse was charged by information is noteworthy, as the Justice Department routinely charges by information only when it expects the charged defendant to plead guilty to those charges.)