Royal Bank of Canada is being sued by U.S. regulators over allegations that a small group of executives from the Cayman Islands to Toronto ran an international futures trading operation worth hundreds of millions of dollars in order to reap tax benefits.
The Commodity Futures Trading Commission is suing RBC, Canada’s largest bank, saying that it also concealed the true nature of the trades and made false statements to a futures trading exchange.
RBC vigorously and categorically denied the commission’s allegations Monday.
The documents, filed Monday U.S. district court in New York, paint a picture of a group of executives from RBC’s offices in Toronto, the Bahamas, Cayman Islands, New York, and London, buying and selling futures contracts and the underlying securities among themselves at set times and set prices.
The lawsuit, which an RBC spokesperson called “absurd,” does not name any individuals.
The agency said it is the largest case it has brought against so-called wash trades, a practice in which an investor simultaneously buys and sells shares to create the appearance of a change in ownership.
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.
RBC spokesperson Gillian McArdle said the bank “proactively contacted the exchange to seek its guidance” before making any trades.
“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,” McArdle said in an emailed statement.
“This lawsuit is meritless and we will rigorously defend ourselves against such baseless allegations.”
None of the allegations have been proven in court.
Royal Bank also noted that it did not consider the situation to be material.
Royal Bank traded at $58.50 in U.S. after-markets trading yesterday, down 1.2 per cent from the U.S. market close.
“It sounds very dramatic when the CFTC makes its allegations. But at the end of the day, it doesn’t look quite so clear,” said Andreas Park, a professor at the Department of Economics at the University of Toronto.
“I would like to see how it ends.”
A spokesperson for Finance Canada said that the Office of the Superintendent of Financial Institutions “is aware of the complaint and is in contact with RBC.”
The CFTC alleged that Royal Bank made the trades in stock futures contracts from 2007 to 2010 with two foreign subsidiaries.
The bank co-ordinated the sale and purchase of futures contracts, giving it the right to sell the stock in the future at certain prices, and eliminating the risk of investment losses, the agency said in the filing.
The transactions weren’t at arm’s length, as required by law, and reported by the bank to the exchange, the documents allege.
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 claims that RBC knew the trades didn’t carry any risk, and that it would “reap large tax benefits” through the transactions.
“RBC gave these unlawful trades the appearance of being the result of independent decisions by its branches and subsidiaries to buy and sell futures contracts when, in fact, they were controlled by a small group of senior RBC personnel,” the filing said.
RBC not only designed and executed a wash sale scheme that undermined that purpose, “it went a step further and misled the exchange into believing that its conduct was lawful,” said David Meister, the director of the CFTC’s enforcement division.
The lawsuit comes as the CFTC tries to strike an image as a tougher enforcer, especially after it was criticized for not raising more red flags about collapsed futures brokerage MF Global.
The CFTC and other investigators are searching for an estimated $1.6 billion (U.S.) in missing customer funds that were held in accounts with MF Global.
“The notion of bringing the case and trumpeting it as the largest ‘wash trade’ case they have brought, clearly is designed as an opportunity to send the message that they are on the job,” said Geoffrey Aronow, former enforcement director at the CFTC and a partner at Bingham McCutchen.
Between 2006 and 2010, trades between a Toronto-based RBC account and RBC Europe Ltd. represented all of the narrow-based index volume on OneChicago, an electronic futures exchange in Chicago, Ill, the CFTC said in its complaint.
A narrow-based index contains a small group of industry-specific stocks consisting mostly of future contracts.
Senior members of RBC’s Central Funding Group determined the prices and contracts traded. A co-head of the group, unnamed in the documents, created and coordinated the trading strategy, the CFTC alleged.
The filing also alleges that from 2005 to 2010, RBC concealed material information and made false statements about the trades to CME Group Inc., which had regulatory oversight of the exchange, according to the CFTC.
Banking analyst Brad Smith said legal disputes like this are typical of the banking industry.
“You’re constantly doing things that in hindsight someone can come along and conclude differently,” he said.
“Reputationally, it’s got to be a disappointment for them (Royal Bank) to have that going out from the future commission. The reputation for Royal Bank, as for all financial institutions, is critical.”
CIBC analyst Rob Sedran also highlighted the bank’s reassurance that the allegations were non-material.
“If it’s not financially material, I suspect any lasting valuation impact will be limited,” he said.
With files from Dana Flavelle, Alyshah Hasham and Star wire services