Sidebar: Cum-ex, the basics explained

Cum-ex scams only work in countries that impose dividend withholding tax on shareholders
in companies. Germany does and so does South Africa.

A share is “cum” dividend (Latin for “with”) until the dividend gets declared and it becomes
“ex” (without) dividend afterwards.

It’s the same idea as having employers deduct PAYE from employees’ paycheques rather
than wait for them to pay it themselves. The company issuing the dividend pays the tax on
behalf of shareholder and those shareholders who qualify can go claim back this tax at the
end of the tax year.

Cum-ex scams also only work in a few countries that have two loopholes in their stock
exchange and tax systems.

One loophole is that a share sale takes two (or more) days to take effect.

The second is that the tax certificates that allow you to reclaim your tax are not issued by
the company paying the dividend but by your custodian bank.

A custodian bank is one that holds your shares in an account for you, pays out your dividend
and takes care of the mechanics of selling your shares.

Every cum-ex transaction involves the following:

1. A company on a stock exchange declaring dividends..

2. At least three conspirators plotting to score unearned tax “refunds” on those
dividends:
a. A short seller. This means a payment made before dividend is declared, on
shares that will be transferred after the dividend is declared.
b. A buyer of shares from the short seller
c. A supplier of shares to the short seller

Consider three scenarios:

First, if Investor A owns shares in a company which declares dividends, he gets a net
dividend because the company has paid dividend withholding tax on his behalf. If the tax is
25%, then Investor A gets 75% of the dividend plus a tax certificate for the other 25%. He
gets that certificate from his custodian bank.

(INSERT GRAPHIC SCENARIO 1)

Second, consider a case where Investor A carries out a normal (read: legal) cum-ex sale.
Investor A has shares on the day (or the day before) a dividend gets declared but then sells
them to Investor B. The nature of the German market system meant that Investor B was
only going to get those shares two days later – ex-dividend. That’s not fair because when he
bought them they were cum-dividend.
So what kicks in is what the Germans called a “compensation payment”. Investor A’s
custodian account automatically gets debited by the net dividend amount he had received
(75% of the dividend) and this goes to Investor B. Most important, the dividend withholding
tax certificate issued to Investor A gets transferred to Investor B, representing 25% of the
dividend.

(INSERT GRAPHIC SCENARIO 2)

Third, in order to rig the system and carry out a cum-ex fraud you introduce Investor C – the
short seller.

Investor C sells shares to Investor B without actually owning those shares. Instead, the two
agree that Investor A will deliver shares on some day in the future. Investor B pays upfront.

Come delivery day, Investor C will acquire shares from Investor A, the supplier, and deliver
them to Investor B, the buyer, as agreed.

Usually the point of a short sale is to bet on how the share’s value will change because
Investor B paid a pre-arranged price while Investor C is going to pay the market price at
delivery day. Both have taken a risk: Investor C could either be in the money or make a
significant loss.

For a cum-ex scam, short-selling has a completely different function.

(INSERT GRAPHIC SCENARIO 3)

The story still starts with Investor A who owns shares at the time the dividend gets
declared. However, before he sells the shares, his conspirators have to set up a covert short
sale transaction in the background.

Investor C, who doesn’t have any shares before the dividend is declared, short sells shares
to Investor B. These yet-to-be-acquired shares are sold “cum” dividend before the dividend
gets declared. After the dividend gets declared Investor C goes to Investor A to buy the
shares he needs to deliver to Investor B.

Now there is a tricky situation. Investor B had bought “cum” shares upfront from Investor C
but when Investor C goes knocking at Investor A’s door to buy shares to pass on to Investor
B, these are now “ex” shares minus the dividend and tax that got paid.

So who gets the tax certificate?

Investor A has paid the tax and received the tax certificate but is selling to Investor C ex-
dividend. That means that there is no compensation payment and no transfer of the tax
certificate. Investor A rides merrily into the sunset with his certificate in hand.
Investor C had sold the shares upfront to Investor B cum-dividend at the full price. So
Investor B still needs his “compensation”. Crucially (and this is the foundation of the fraud)
that includes a tax certificate that gets issued by Investor B’s custodian bank – a role
Investec sometimes played while allegedly knowing full well Investor B never actually paid
tax.

So now there are two tax certificates even though there had only been one tax payment.
Investor B takes this “extra” certificate to the taxman, gets a refund and divides it between
himself, Investor A and Investor C.

The illicit profit is exactly equal to the tax that was not paid.