Regulators alleged a "wash trading scheme of massive proportion" by Royal Bank of Canada (RY), which was accused in a lawsuit Monday of unlawfully trading hundreds of millions of dollars in stock futures in order to get tax benefits.
The Commodity Futures Trading Commission filed the civil lawsuit against the Canadian bank in the Southern District of New York on Monday.
The scale of the alleged misconduct makes the lawsuit one of the biggest ever brought by the agency. It came as the CFTC is flexing its enforcement muscles in response to being granted much greater oversight powers as part of the Dodd-Frank financial-overhaul law.
RBC denies wrongdoing and intends to fight the allegations, according to a person familiar with the matter. A spokesman for the bank wasn't immediately available for comment.
The CFTC alleged that Royal Bank of Canada broke laws banning "wash trades," or trades a firm does with itself to make it look as if stocks or other securities have been bought and sold.
Wash trades are fictitious trades that carry no market risk.
The trades were orchestrated by a small group of senior bank officials, as part of a strategy to minimize Canadian tax, according to the CFTC's complaint.
A CFTC official declined Monday to say whether the regulator is investigating other financial firms for trading linked to similar tax-avoidance strategies.
The regulator alleged that the Royal Bank of Canada scheme was designed to realize "lucrative" Canadian tax breaks on dividend payments.
The scheme ran from at least June 2007 to May 2010, the CFTC said. It alleged that Royal Bank of Canada made hundreds of trades in U.S. and Canadian stock with the aim of getting tax-free dividends.
The CFTC alleged that the bank eliminated the risk of investment losses on the stock by coordinating with two of its subsidiaries the sale and purchase of futures contracts that gave the right to sell the stock in future at certain prices.
The law requires trades between two different arms of a financial firm to be negotiated at "arms length." But the CFTC alleged that prices paid for these contracts were set by a bank official in the bank's Central Funding Group, which was coordinating the tax strategy, the CFTC said.
The regulator also alleged that the bank tried to cover up the scheme when questions were first asked about it.
From 2006 to 2010, the trades between different RBC subsidiaries were the only transactions of certain products on OneChicago, an electronic futures-trading exchange in Chicago.
CME Group Inc. (CME), a part owner of OneChicago which also runs the exchange's regulatory functions, was asked by the CFTC to investigate.
The CFTC alleged that RBC "willfully concealed" information and made false and misleading statements in response to these inquiries.
Representatives of OneChicago and CME weren't immediately available for comment Monday.
The lawsuit is the largest wash-sale case the CFTC has ever brought, as measured by the notional dollar amount of futures contracts.
David Meister, the CFTC's director of enforcement, said the 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."
The lawsuit comes as the CFTC grapples with pressure to step up oversight of the futures industry after the failure of MF Global Holdings Ltd. (MFGLQ) in October left an estimated $1.6 billion shortfall in customer funds.
CFTC officials still are investigating MF Global's collapse and haven't filed any enforcement actions related to MF Global.
The CFTC is also gearing up to use the new mandate it gained under Dodd-Frank, which became law in 2010.
The law gives the CFTC jurisdiction over a broader swath of derivatives, as well as enhanced powers to pursue fraud and manipulation in those markets.