Originally from our sister publication, Advisor.ca.
Royal Bank of Canada is fending off serious allegations from the U.S. Commodity Futures Trading Commission (CFTC), which has accused the bank and its subsidiaries of engaging in “wash trading”.
Read the court filing here.
Wash trading is when an investor simultaneously buys and sells shares in a company through two different brokers to avoid taxes. The practice is illegal in under U.S. futures laws.
In addition, 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, and that the strategy was created and carried out by a group of unnamed executives at the bank.
The CFTC accuses RBC of making several hundred of off-exchange futures transactions through affiliates. These trades were then reported to the OneChicago exchange as block trades between independent affiliates.
At the time in question, OneChicago’s rules permitted parties to enter into prearranged block trade transactions outside the OneChicago System, “at reasonable prices mutually agreed,” subject to certain conditions, the CFTC explains in its complaint.
OneChicago’s block trading rule contained a requirement that parties to such a block trade comply with all applicable rules of the exchange, including compliance to all applicable laws. Therefore, the CFTC charges, the trades were subject to the Commodity Exchange Act’s prohibition against wash sales.
The trading strategy was allegedly constructed to leave RBC with no financial position in the market, while generating tax credits in Canada. The trades in question took place between June 2007 and May 2010.
The CFTC’s primary problem with the trades is that the NBI and SSF trades were not negotiated at arm’s length between the counterparties to the trades, but were designed and controlled by a small group of senior RBC personnel acting on RBC’s behalf.
The CFTC claims the trades, which accounted for the majority of OneChicago’s volume during the relevant period, constituted unlawful non-competitive trades, wash sales and fictitious sales.
“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,” said David Meister, the director of the CFTC’s division of enforcement.
“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. 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.”
For its part, RBC says the accusation is absurd, and that the bank cleared the strategy with regulators before it began.
“Before we made a single trade, we proactively contacted the exchange to seek its guidance,” the bank said in a statement. “These trades were fully documented, transparent, and reviewed by both the CFTC and the exchanges, and were monitored several years.”
The bank maintains that the block trades were made to estaiblish bona fide positions in the market, and were exectured at competitive market pricing, contrary to the CFTC’s allegation. Further, the bank states that no market participants suffered any negative impact, nor has the CFTC alleged any pricing irregularities.
“The CFTC has been aware of these transactions since 2005, and these transactions were done in accordance with market terms, regulations and process,” the statement said. “RBC’s trading was permissible in 2005, was reviewed six months later by the CFTC and encountered no objection, and it is permissible today under the CFTC’s published guidance.
“Given no objection to the trading activity by either the exchange or the CFTC in 2005, it is absurd to now claim these trades were either fictitious or wash sales. This lawsuit is meritless.”
The CFTC, however, is adamant that the bank concealed the true nature of the trades and made false statements to a futures trading exchange.
The CFTC is seeking civil monetary penalties and a permanent injunction against further violations of the Commodity Exchange Act and the CFTC’s Regulations, as charged.