By John O'Donnell and Tom Sims
FRANKFURT (Reuters) - Spain's Santander <SAN.MC> is the latest bank to be caught up in Germany's biggest post-war fraud investigation involving a share-trading scheme that the authorities say cost taxpayers billions of euros.gi
In June, prosecutors in Cologne opened a tax investigation into Santander, confidential documents relating to a state prosecutors' investigation seen by Reuters and other European news organisations reveal for the first time.
Santander's role in the scheme was to carry out trades, the prosecutors say, as one of many parties involved. They are also looking at Australia's Macquarie Bank <MQG.AX> and Germany's Deutsche Bank, <DBKGn.DE> as part of the broader investigation.
A letter from prosecutors to Santander's lawyers sent on June 4 shows that they suspect the bank of having "planned and executed trades" that facilitated "severe tax evasion" from 2007 through 2011.
A Santander spokesman said that the bank was "fully cooperating" with German authorities and conducting its own internal investigation. The bank "doesn't tolerate behaviour" that fails to comply with the rules and laws in the market where it operates, he said, adding "if our investigations do identify misconduct, we will take appropriate action."
Reuters spoke to bankers, officials and people directly involved in the probe and reviewed thousands of pages of internal bank files, correspondence and legal papers obtained as part of a European media investigation called the "cum-ex files" coordinated by non-profit newsroom Correctiv.
The prosecutors say the players in the cum-ex scheme misled the German government into thinking a stock had multiple owners on its dividend payday who were each owed a dividend and a dividend tax credit.
The prosecutors say the scheme was illegal and misled the government into paying tax refunds. A spokesman for Santander declined to comment on whether it had broken the law while a spokesman for Macquarie, which is also under investigation, said it had believed the practice to be legal.
The documents show that the Cologne prosecutors closed in on Santander and other banks this year as the investigation, which began in April 2013, rapidly accelerated.
The models were designed to generate multiple tax rebates, prosecutors say. In essence, here is how it worked, according to the documents viewed by Reuters:
A bank would agree to sell a company stock, for example to a pension fund, before the dividend payout but delivered it after it had been paid. The bank and the fund would both reclaim withholding tax.
Sometimes banks sold shares they did not own and agreed to buy them later in a practice known as short selling. The stock was traded rapidly around a syndicate of banks, investors and hedge funds to create the impression of numerous owners, prosecutors say. The profits from the deals were shared.
To generate bigger profits, the pensions funds could also buy large volumes of stocks, using loans from banks.
The German tax office wrote to the Cologne prosecutors to say there were "concrete indications" that Santander had acted as a short seller. Three pension funds had also used loans from Macquarie, people with direct knowledge of the matter say.
"Macquarie will continue to cooperate fully with the German authorities," a Macquarie spokesman said. "It has already resolved its two other matters involving German dividend trading that took place between 2006 and 2009."
The spokesman declined to say how they were resolved.
Similar investigations have been opened in Frankfurt and Munich, but Cologne, whose prosecutors specialise in international tax crime, made a breakthrough when at least six people involved in the trading gave detailed evidence, according to the documents.
Other banks, including Unicredit's German arm, have acknowledged they were also involved in such trading.
A spokeswoman for UniCredit <CRDI.MI> said its German unit had been involved in cum-ex trading but that all criminal proceedings had since been terminated after, among other things, the payment of fines. She declined to comment further.
A spokesman for Deutsche Bank said it had not participated in an “organised cum-ex market” but that it had been “involved in some of its clients’ cum-ex transactions.” It said it was cooperating with the authorities.
Referring to all the banks involved, Norbert Walter-Borjans, the former finance minister of North Rhine-Westphalia, which includes Cologne, said: "They grabbed the kitty that had been paid for by ordinary tax payers."
"It is clear that it was against the law...How can it be legal to get something back twice or three times that has been paid only once?" he said.
According to the prosecutors, the scheme was promoted by German tax inspector-turned-tax adviser Hanno Berger and others.
He advised Macquarie on cum-ex trading, according to a letter seen by Reuters which was sent by Berger to a Macquarie employee in March 2008.
Berger told Reuters he also provided advice to Macquarie on the scheme in later years but he said he was not paid for it. The Macquarie spokesman declined to comment on Berger or the letter.
Macquarie said last month its incoming and outgoing chief executives are expected to be named as suspects by prosecutors. The pair were aware of the reputational risk to the bank of the trades, the documents show.
Berger, the central suspect in the investigation who is living in exile in the Swiss Alps, said the banks used a legitimate loophole, which was closed in 2012, and did not break the law.
"They (the German state) cannot punish others for their mistakes," he told Reuters.
Some German officials and prosecutors refute this claim, noting that Germany made attempts to stamp out the practice by changing and clarifying the law in 2007, 2009 and 2012. One top German official, who asked not to be named, said those efforts made clear the trading was illegal.
German authorities estimate the scheme cost the state 5.6 billion euros in tax rebates that should never have been paid, while some experts believe the damage could be 10 billion euros.
The state prosecutor in Cologne declined to comment.
The documents show that the prosecutors in Cologne made a major breakthrough last year when a group of bankers, including a former Macquarie employee, offered information that showed Santander, Macquarie and others profited from the scheme.
Macquarie estimates that it may have to pay 100 million euros in total legal settlements from the trades, roughly half of which it has already paid, according to a person with knowledge of the matter.
Internal Macquarie emails show that outgoing CEO Nicholas Moore and his successor in waiting, Shemara Wikramanayake, were aware of the reputational risks of the trades and involved in discussions about the funding. A spokesman for Macquarie said Moore and Wikramanayake would not comment.
In October 2010, Wikramanayake and three other executives sent a memorandum seen by Reuters to Macquarie's board of directors. It outlined a funding opportunity that would earn Macquarie between 15 and 20 million euros on each of three 1.1 billion euro loan facilities.
It earned a fee for these loan facilities.
"There is a risk that German revenue authorities may seek to deny tax reclaims and take some other action against the parties involved," they wrote.
They said the "anticipated returns" should be weighed against the negative "reputational risk".
Wikramanayake and Moore attended part of a meeting of directors on October 28 2010 in Sydney, when the deals and the "reputation risk" were discussed, according to minutes of the meeting seen by Reuters.
The conditional approval for the funding was given at that meeting before the formal signoff in early 2011, according to the documents.
The Macquarie spokesman said the bank lent money to a group of investment funds in 2011 which traded shares that sought to "obtain the benefit of dividend withholding tax credits" but he said the German authorities refused those claims.
The German authorities declined to comment.
"Macquarie received extensive external legal advice in relation to its involvement and believed that it was acting lawfully," he said.
Prosecutors wrote in letters to Santander's lawyers that they believe the Spanish bank, and its UK subsidiary Abbey National Treasury Services, were actively involved in "a large number" of deals involving short sales - a critical part of the cycle that created the impression of multiple share owners.
The Santander spokesman said that to the bank’s understanding, the investigation was focused on three former employees.
“To date we have not identified any evidence that the activities under investigation involved senior management or that any of Santander’s or its subsidiaries' governing bodies were aware of these activities,” said the spokesman.
The bank executed transactions for a number of U.S. pension funds and its customer Macquarie, prosecutors said, which allowed the funds to make what tax investigators say are "illicit" tax reclaims. The prosecutors do not say how many pension funds.
Those services were lucrative for both Santander and Macquarie, the documents show.
For example, on May 13, 2011, the New York-based Sander Gerber pension plan received dividends of almost 162 million euros as a result of the trades supported by the two banks, according to the documents.
Macquarie charged a fee of 4 percent, or 6.5 million euros (£5.7 million), to the pension plan for its services. Santander received an additional 400,000 euros in fees for the 'futures facility' it provided.
A spokesman for Sander Gerber said that its investment decision relied on the "reputation and integrity" of the banks and that Gerber had understood the investment products to be "legitimate".
Germany wants the banks to repay the 5.6 billion euros, the German official told Reuters. Banks have already repaid 2.3 billion euros in settlements, the official said.
Frankfurt prosecutors this year filed the first criminal charges against Berger and five others who are all former employees of the German unit of Unicredit, according to court documents seen by Reuters. Unicredit declined to comment.
Although the investigation has gathered pace and some of the banks have repaid money, pursuing them and other suspects has been difficult, some lawmakers say. This is because, like Berger, several have moved abroad.
One German prosecutor admitted it would take years to bring those involved to justice but that the prosecution sent a clear signal that such wrongdoing would not be tolerated.
(Editing by Anna Willard)