The U.S. regulator that launched a lawsuit against Royal Bank of Canada this week is now coming under scrutiny after facing criticism in recent months over its handling of a high profile case in the United States.
A few months prior to launching a lawsuit against RBC over alleged improper stock trading, the Commodity Futures Trading Commission in Washington faced intense criticism from the U.S. government over the job it did leading up to the collapse of investing firm MF Global.
The Washington-based CFTC is one of the key regulators in charge of overseeing the derivatives market in the U.S., and was the regulator in charge of MF Global, which fell apart in a scandal that saw as much as $1.2-billion worth of money belonging to its clients go missing.
After the CFTC was grilled by U.S. Senators in December over whether it did enough to police the market, and whether it was too cozy with executives at MF Financial. That has prompted observers to question whether the regulator is now looking to send a strong message that it is getting tough on alleged improprieties in the derivatives market, and whether the RBC case is a step in that direction.
“In our view, the CFTC intends its action against [Royal Bank]to be interpreted as a signal of its tougher enforcement policies, particularly in the wake of the MF Global scandal for which the CFTC has come under criticism,” National Bank Financial analyst Peter Routledge said in a research note.
“Tougher enforcement regimes at all U.S. regulators means that regulatory complaints will be swifter and their penalties more severe. As a consequence, banking in the United States will be more risky and more costly for Canada’s banks.”
The Washington-based CFTC has been thrust into the spotlight in Canada over the RBC case, in which Canada’s largest bank is accused of trading large blocks of shares and futures between its various subsidiaries as a way to take advantage of Canadian tax credits on dividend-paying stocks listed in Toronto. RBC wanted to hold the shares for a year to gain a tax credit, but sold derivatives on those shares to mitigate the risk of stock prices fluctuating.
According to the court documents, a separate arm of RBC purchased those derivatives in large block trades that were later reported to the OneChicago exchange in Illinois. The CFTC alleges the deals were executed without respect to market prices and were hidden to the market, and therefore violated U.S. trading rules.
RBC has called the claims “absurd” and said it will vigorously defend its reputation.
A spokesman for the CFTC said the regulator wouldn’t comment beyond the court documents in which the allegations are contained. Canadian authorities were surprised this week when they were given no advance warning that the lawsuit was going to be launched against Canada’s largest bank.
RBC maintains it sought advance permission to execute the block trades in question as far back as 2005, and the CFTC raised no issue.
Arthur Hahn, a partner at Katten Muchin Rosenman LLP in Chicago who is representing RBC in the civil suit, said the bank was never told to stop the trades, but decided on its own to cease after the CFTC began asking more questions about them several years later.
“We concluded they were asking enough questions they were serious about it that we just concluded on our own to cease,” Mr. Hahn said in an interview. “We believe we fully and accurately reported to them at the initial time, and we believe that there is simply no question that the trading fit within that guidance.”
The Globe and Mail learned this week that RBC was offered a settlement but turned it down. The bank would not comment on that issue. However, Mr. Hahn acknowledged the bank would have sought a settlement if it believed its case was weak.
“They specifically allow affiliate trading. So we’re going to have a serious debate with their view of the case. If we thought we did something wrong we would have settled,” he said.
However, Mr. Routledge noted that the door remains open for RBC to quietly settle the dispute outside court.
“We are not surprised that [RBC]evidently asked permission before embarking on this strategy,” Mr. Routledge said. “In our view, [Royal’s]pro-active actions in this regard constitute a reasonably sound foundation for its defence in court, or for beginning a quiet negotiating process with the CFTC.”