U.S. regulator accuses RBC of massive trading scheme

A Royal Bank of Canada (RBC) sign is seen in downtown Toronto, March 3, 2011.

WASHINGTON (Reuters) - The U.S. futures regulator accused the Royal Bank of Canada (RY.TO) of running a "trading scheme of massive proportion" to gain lucrative Canadian tax benefits.

The Commodity Futures Trading Commission's civil lawsuit alleges that a small group of senior RBC employees created and managed a "wash trading" strategy in which they improperly coordinated to allow subsidiaries of the bank to buy and sell stock futures without taking a position in the market.

The CFTC said the scheme lasted from at least June 2007 to May 2010 and involved hundreds of millions of dollars in trades.

The lawsuit, filed on Monday in the Southern District of New York, also said RBC concealed and made false statements about its wash trading scheme to the futures exchange CME Group Inc (CME.O).

Wash trades, the simultaneous and offsetting purchase and sale of a contract, are banned under U.S. futures law. The CFTC did not name any RBC employees in its complaint.

RBC called the allegations "absurd" and said the CFTC and the exchanges reviewed and monitored the trades in question.

"RBC's trading was permissible in 2005, and it is permissible today under the CFTC's published guidance," Elisa Barsotti, a spokeswoman for RBC, said in a statement.

"This lawsuit is meritless, and we will rigorously defend ourselves against such baseless allegations."

Barsotti said the bank had taken no action against any RBC employees with regard to the trades, as it disagrees with the charges made against it.

The lawsuit comes as the CFTC tries to strike an image as a tougher enforcer, especially after it was criticized for not raising more red flags about collapsed futures brokerage MF Global.

The CFTC and other investigators are searching for an estimated $1.6 billion in missing customer funds that were held in accounts with MF Global.

"The notion of bringing the case and trumpeting it as the largest 'wash trade' case they have brought, clearly is designed as an opportunity to send the message that they are on the job," said Geoffrey Aronow, former enforcement director at the CFTC and a partner at Bingham McCutchen.

WASH TRADES ON WATCH

The CFTC has filed and settled a handful of complaints against firms for wash sales, levying fines usually in the hundreds of thousands of dollars against gas, electric and other companies engaged in futures trading.

The RBC case is the CFTC's biggest by notional trade value, the agency said.

The CFTC said the trades in narrow-based stock index futures and single stock futures were pre-arranged among RBC and two subsidiaries and then executed as "block" trades on OneChicago.

The lawsuit claims that RBC and its affiliates bought and sold stocks in U.S. and Canadian companies, and took opposing bets on futures written on those same stocks.

The CFTC asserted that the goal of the trades was to earn an undisclosed amount in Canadian tax credits, while limiting market exposure.

Barsotti declined to comment on whether the trades in question were structured to realize Canadian tax credits, as alleged in the lawsuit.

"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," CFTC enforcement director David Meister said in a statement.

"As we allege, 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."

The CFTC proposed guidance in 2004 and 2008 to give market participants a clear understanding of what block trades are appropriate between affiliates, but never finalized the guidance.

The CFTC is seeking civil monetary penalties and a permanent injunction against further violations of the Commodity Exchange Act and the CFTC's regulations.

Spokespersons for the Ontario Securities Commission and the Canadian Revenue Agency were not immediately available to comment on the matter.

(Additional reporting by Euan Rocha in Toronto; editing by David Gregorio and Andre Grenon)