By NEIL HARTNELL
Tribune Business Editor
Royal Bank of Canada (RBC) has agreed to pay a $35 million civil fine to US regulators over a “massive wash trading scheme” that involved its Bahamas branch.
A December 18, 2014, ‘consent order’ filed in the southern New York district court discloses the terms of the settlement reached by the Canadian multinational with the US Commodity Futures Trading Commission (CFTC).
While RBC “neither admits nor denies” the allegations levied against it by the CFTC’s lawsuit, both parties agreed that the bank’s Bahamas branch was one of the counterparties involved in the block trades of derivatives contracts.
The consent order reveals that between June 1, 2007,and May 31, 2010, RBC entities executed 1,026 such transactions, which featured derivative products based on futures contracts involving shares in US and UK companies.
The 1,026 transactions were executed through RBC’s branches in the Bahamas and Cayman Islands, and routed through its internal trading accounts, with the Caribbean entities trading with the bank’s UK and Luxembourg entities.
“The two branches were RBC Bahamas branch and RBC Cayman branch, which were branches of RBC located in the Bahamas and Cayman Islands,” the consent order said.
It added that the trades were designed to offset one another, and involved the same quantity, price and expiration month, thus achieving the “wash result” for RBC as a group.
However, RBC violated the rules of the OneChicago futures exchange, which required all block trades to be reported ‘without delay’. Only the initial trades, not the later, offsetting ones, were reported to the exchange.
The consent order confirmed that RBC broke US law via this strategy, which resulted in “fictitious sales” because the profits and losses from such trading “netted to zero” when consolidated in the Canadian bank’s overall profits and losses.
In a statement e-mailed to the media, RBC said: “We are pleased to put this matter behind us and continue to remain committed to complying with our regulators’ requirements.
“The settlement is in the best interests of our clients and shareholders, recognising that continued litigation is costly and uncertain.”
That, though, is a much-changed position from RBC’s initial reaction, which branded the CFTC’s April 2012 lawsuit as “unwarranted”.
RBC said the CFTC had been made aware of the transactions in question since 2005, and called the lawsuit “meritless”.
The Canadian bank said then: “These transactions were done in accordance with market terms, regulations and process. This is not a financially material event to RBC, but we do take this situation seriously and intend to vigorously defend our reputation.
”Before we made a single trade, we proactively contacted the exchange to seek its guidance. 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, was reviewed six months later by the CFTC and encountered no objection, and it is permissible today under the CFTC’s published guidance.
RBC added: “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 block trades in question were entered into by independent RBC legal entities with the intent to establish genuine, bona fide positions, based on the CFTC’s long-standing regulatory guidance. They were executed at competitive market pricing and no market participants suffered any negative impact, nor has the CFTC alleged any pricing irregularities.”
US regulators had alleged that RBC blamed staff at its Bahamian branch for playing the lead role in devising the scheme, worth hundreds of millions of dollars.
The CFTC lawsuit alleged that when OneChicago’s regulatory overseer began to query the trades, the general counsel for Royal Bank’s capital markets unit replied, on November 17, 2005, that its Bahamian branch staff played the lead role in devising the arrangement.
The general counsel allegedly replied: “The idea of engaging in OneChicago single stock future block transactions originated with the staff in our Bahamas office.
”The decision to engage in the block transactions was then made between the Royal Bank affiliates involved in the transactions (primarily RBC (Bahamas branch) and CMA) after discussions between them.”
The CFTC, though, alleged that the strategy had been developed at Royal Bank’s corporate level, including by the head of global arbitrage and trading for its Caribbean branches.
”The idea of engaging in OneChicago single stock future block transactions did not ‘originate’ with the staff in [RBC’ s] Bahamas office, but was instead conceived by CFG Member 1 and proposed to RBC management when CFG Member 1 was a managing director of RBC Capital Markets working in RBC’s London office,” the CFTC lawsuit alleged.
“The RBC branches and subsidiary that engaged in SSF trading did not ‘independently come up with the idea and strategies to trade’ SSFs. Instead, CFG Member 1 devised the idea to trade SSFs between RBC-affiliated counterparties and created the futures trading strategies for both counterparties to the trades.”
Following the consent order, CFTC director of enforcement, Aitan Goelman, said: “Illegal wash trades may seem innocuous. They are not. They provide misleading signals to the market and are thus prohibited, whether their purpose is to lessen a foreign tax bill or another reason.
“This matter clearly demonstrates that the CFTC will vigorously enforce this prohibition to protect the integrity of our markets.”