In what could become a test case for defining the limits of personal liability in corporate Germany, a Munich bank, HypoVereinsbank, may move to recover nearly €140 million ($151 million) from three ex-managers for their role in what was later deemed to be an illegal tax-refund investment scheme.
The strategy used at HypoVereinsbank, a unit of Italy's UniCredit bank, was profitable, and not unusual at the time in Germany. Scores of other banks employed similar dividend-stripping investments over a decade to generate tax rebates and high returns for their clients and themselves.
But the investment's underlying structure was later ruled to be illegal by the German government. Since then, the state has been pursuing the banks to recoup billions in lost revenue. HVB has had to return €140 million so far and pay an additional €9.8 million fine.
Now, HVB is taking the next step. It is considering recouping money from its former senior executives who were responsible at the time for the dividend-stripping. The three – a former chief financial officer, a former head of investment banking and head of private banking – could face repayment demands in the triple-digit millions of euros.
There are convincing arguments that the breaches by Friedhofen have led to a loss amounting to approximately €139.4 million. Skadden Arps, Law firm
In dividend stripping, investors buy shares just before a company pays dividends to shareholders, and sell them shortly after. By carrying out these transactions with borrowed money – short-selling – customers can sell shares at a nominal "loss'' without actually losing money.
But the paper “losses” in this case were designed for investors and banks to claim multiple refunds from Germany's capital gains tax.
Late last year, the three managers met with HVB and agreed to pursue a resolution of the situation by the middle of this year.
Dividend-stripping peaked in 2005, when HypoVereinsbank's business was booming and the bank bought and sold shares worth tens of billions of euros.
On May 9 of that year, dealers at the bank snapped up shares in software maker SAP for €483 million ($528 million). A few days later, they resold the shares for about €503 million. But the profits had been eaten up by the costs of option contracts. HypoVereinsbank had a way to get around that problem.
The bank timed its purchase of SAP shares to exploit the company's payment of dividends. SAP shares were bought a few days before the software firm's annual general meeting, when the board approves the annual dividend.
HypoVereinsbank clients involved in the scheme then bought and sold the shares “cum dividend,” whereby the buyer receives the dividend payout, and ex-dividend, where the buyer does not receive the dividend.
Thanks to a loophole at the time in German tax law, many of those involved in the "cum-ex" transactions, known as dividend stripping, had their capital gains tax refunded, including the bank, which traded on its own account.
In the end, the SAP deal earned for HVB a tax credit of about €880,000, an impressive profit for a couple days' work. Within the bank, the cum-ex dealers were celebrated as market wizards.
But times changed. HVB's erstwhile heroes soon attracted official scrutiny. First tax inspectors came knocking, followed by criminal prosecutors.
HVB had to repay around €140 million in taxes, plus a fine of €9.8 million. If that wasn't enough, HVB hired teams of external consultants and lawyers to demonstrate their determination to get to the bottom of the issue.
According to insider sources who declined to be named, seven firms and consultancies charged the bank around €100 million for their services.
The bank wants to recoup its losses from the former board members, which it blames for the illegal dividend stripping.
This is of course big news for those affected.
There is no question bank managers earn well, but damage claims in the range of hundreds of millions of euros are unheard of against corporate managers in Germany.
The situation has evolved into a potential legal test case for making top corporate managers more personally liable in Germany.
The former manager at the center of the controversy is HypoVereinsbank's former chief financial officer, Rolf Friedhofen.
Mr. Friedhofen worked for KPMG and Pricewaterhouse Coopers before joining HVB in 2004. From 2006 to 2010, he served as the Munich bank's finance chief, and the cum-ex transactions happened on his watch.
HVB's supervisory board has sought advice from Skadden Arps, a law firm, to determine how far executives can be held financially responsible.
Mr. Friedhofen, when contacted by Handelsblatt, said he hadn't done anything wrong.
Now, the lawyers hired by the bank have wrapped up their probe. Their conclusion: "Friedhofen failed to inform the board by the October 22, 2008, board meeting about the tax risks of the deals in London" where the bank's trading unit was based at the time.
"There are convincing arguments that the breaches by Friedhofen have led to a loss amounting to approximately €139.4 million," the law firm concluded in the report, a copy of which was seen by Handelsblatt.
Mr. Friedhofen, when contacted by Handelsblatt, said through a representative that he hadn't done anything wrong. Bankers involved in ex-dividend trading have noted that the trades and the tax-rebate mechanism were not explicitly illegal in Germany at the time.
Pushed however to pay back millions to the state, the bank employers are now considering trying to recoup some of their losses from former employees.
The HypoVereinsbank probe also pinpointed alleged errors by two other former directors, saying it appeared “very convincing” that former private-banking chief Andreas Wölfer and his colleague for investment banking, Roland Seilheimer, missed or ignored warnings about the cum-ex deals.
In any case, they “did not adequately supervise” the board about the dubious business, making themselves liable in the process, the law firm concluded.
Mr. Wölfer declined to comment on the case, and Mr. Seilheimer could not be reached for comment by Handelsblatt.
During the probe, the legal experts also noted the millions of euros the departing bankers took with them when they left the firm. The bank declined to comment on whether it will try to recoup part of the compensation.
“That puts me in a difficult position because we on principle do not comment on cases that are still open,” said Theodor Weimer, the head of HVB in Germany and a member of the UniCredit board, after the recent release of bank's recent financial figures.
Asked whether the bank might charge the former executives, Mr. Weimer crossed his arms and said: “I can't comment on that.”
But in the background, conversations and actions are continuing.
Under German law, the bank has to sue the former board members by the end of 2015 or any possible claims will lapse. In the interim, to avoid a nasty public fight, the bank has been pursuing a settlement with its ex-employees.
The theme is an industry phenomenon, and it is still not clear what it is actually tax evasion and what is not. It is a highly complicated matter. Theodor Weimer, CEO, HypoVereinsbank, a unit of Italy's UniCredit bank
The board members at the center of the scandal have agreed to a so-called waiver on the limitations. Now, the parties have until the middle of this year to hammer out an agreement. Failing that, HVB can still sue the ex-bankers.
The boards and supervisory boards of many banks are keeping a close eye on what is happening in Munich. In recent years, more than 100 financial institutions and financial service providers used the controversial cum-ex transactions to generate tax refunds for themselves and their clients.
"The theme is an industry phenomenon, and it is still not clear what it is actually tax evasion and what is not," Mr. Weimer said. "It is a highly complicated matter."
That is true. But it is also true the state is determined not only to recoup money from those concerned, but will use criminal prosecutions to do so.
The state of North Rhine-Westphalia’s finance minister, Norbert Walter-Borjans, has described cum-ex trading as a "criminal fraud." The state paid an informant €5 million for documentation on cum-ex trades performed on behalf of its residents.
Prosecutors in Cologne, Frankfurt and Munich are also busy.
In Berlin, a committee of the Bundestag is focusing on cum-ex transactions.
The German financial regulator BaFin asked nearly all of the 1,800 registered banks in Germany for information on whether they were involved in the controversial stock transactions.
The agency wants to prevent a repeat of Maple Financial Corp., a Canadian bank that Bafin closed on February 7 amid an investigation into illegal ex-dividend trading.
Any success by HypoVereinsbank in retrieving money from its former managers could serve as a blueprint for the financial industry, sparking similar claims against other ex-managers.
In addition to HypoVereinsbank, HSH Nordbank and LBBW, two state-backed regional banks in Hamburg and Stuttgart, respectively, repaid back taxes for ex-dividend dealing. Most recently, Frankfurt-based DZ Bank repaid around €100 million to authorities.
But those repayments may only be the beginning, especially if HypoVereinsbank succeeds in clawing back money from its ex-managers.
“Generally speaking, institutions who have done such transactions cannot avoid checking which executives were to blame," said Franz-Josef Schöne, a corporate law specialist at law firm Hogan Lovells. "If damages to the company can be alleviated, they must be alleviated. That is the duty of the supervisory board.”
Volker Votsmeier is an editor with Handelsblatt's investigative reporting team. Sönke Iwersen leads Handelsblatt’s team of investigative reporters. Kerstin Leitel covers banks and insurance companies. To contact the authors: [email protected], [email protected] and [email protected]