RBC Sued by U.S. Regulators Over Wash Trades

RBC Sued by U.S. Regulators Over Wash Trades for Tax Benefit
Royal Bank enlisted affiliates to help carry out hundreds of futures transactions that were done off-exchange and then reported to OneChicago as block trades between independent affiliates, according to the CFTC. Photographer: Norm Betts/Bloomberg

Royal Bank of Canada was sued by U.S. regulators over claims the Toronto-based lender engaged in illegal futures trades worth hundreds of millions of dollars to garner tax benefits tied to equities.

Canada’s biggest bank made false and misleading statements about “wash trades” from 2007 to 2010 in which affiliates traded among themselves in a way that undermined competition and price discovery on the OneChicago LLC exchange, the Commodity Futures Trading Commission said yesterday in a complaint filed in Manhattan federal court.

“A fundamental purpose of the futures markets is to provide an arm’s-length mechanism for market participants to discover prices and shift risks associated with products traded in those markets,” CFTC enforcement director David Meister said in an e-mailed statement. “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.”

Royal Bank yesterday in a statement called the lawsuit “meritless” and said it intends to defend itself against the allegations.

“We certainly reject the allegations as unwarranted,” Royal Bank Chief Executive Officer Gordon Nixon said today in a conference call. “This is not a financially material event to RBC, but we certainly take the situation seriously and we intend to vigorously defend our reputation.”

Stock Overhang

Royal Bank fell 1.7 percent to C$57.01 at 3:59 p.m. trading in Toronto, the biggest decline since Jan. 24.

“We believe the suit will serve as an overhang on the stock in the near term until investors get more clarity as to the scope of the potential damages,” Morgan Stanley analyst Cheryl Pate said in a note to clients.

The bank intends to defend against the allegations, Kevin Foster, a Royal Bank spokesman, said yesterday in an e-mailed statement.

“Before we made a single trade, we proactively contacted the exchange to seek its guidance,” Foster said. “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.” The trading was permissible under the CFTC’s published guidance, Foster said in the statement.

Hundreds of Transactions

Royal Bank enlisted affiliates to help carry out hundreds of futures transactions that were done off-exchange and then reported to OneChicago as block trades between independent affiliates, according to the CFTC. A single group of RBC employees designed and managed the strategy, the agency said.

The trades, which resulted in Royal Bank not having a financial position in a market, were conducted for Canadian tax benefits tied to holding certain stocks, the CFTC said in its statement. The transactions, involving single-stock futures and narrow-based indexes, were used to hedge the risk of holding the equities, according to the statement.

“We do not believe that the tax benefits were material, say C$20-C$30 million annually (our best guess),” John Reucassel, an analyst with BMO Capital Markets, said today in a note to clients. “While we expect this matter to be settled relatively quickly, this event may highlight why investors remain lukewarm to trading businesses.”

Between 2006 and 2010, the narrow-based index trades between a Toronto-based bank account and RBC Europe Ltd., a London-based bank subsidiary, represented all of the narrow-based index volume on OneChicago, the CFTC said in the complaint. Senior members of the bank’s Central Funding Group determined the prices and contracts traded. A co-head of the group, unnamed in the complaint, created and coordinated the trading strategy, the CFTC said.

Banking Regulator

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. RBC’s responses to CME questions about the trades “concealed information concerning the central role” of the Central Funding Group employee and the bank’s single-stock futures trades, CFTC said.

Canada’s banking regulator, the Office of the Superintendent of Financial Institutions, is “aware of the situation and is monitoring it,” spokesman Rod Giles said in an e-mail. “It would not be appropriate to comment until the court has heard the evidence and the arguments from each party and issues its judgment.”

Chris Grams, a CME spokesman, declined to comment.

The CFTC is seeking monetary penalties and an injunction against further violations, the agency said. Those penalties should be triple the monetary gain for each violation, or $130,000 for each one from October 2004 to October 2008, and $140,000 for each violation since then, said the CFTC, which didn’t disclose the number of incidents.

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