The Royal Bank of Canada was accused by the CFTC orchestrating an elaborate trading scheme.  In the lawsuit filed on Monday, the regulators allege that the bank used bogus trades to generate lucrative tax benefits. The Commodity Futures Trading Commission claims that Canada’s biggest and arguably most powerful financial institution concealed from authorities for years violative actions involving hundreds of millions of dollars and trades.  Spanning 3 years, this was the CFTC's largest and most significant enforcement case in recent memory. CFTC Findings and Allegations. In a civil lawsuit filed in federal court in Manhattan, the Commission accused the bank of creating "fictitious trades" between various arms of the firm.  The trades, involving hundreds of unnamed stocks, were "non-competitive" and "unlawful,”" the agency said.  The bank, regulators say, handpicked stocks paying out dividends that came with a generous tax benefit. Wash Trades. By buying and selling the investments internally, the bank was ensured all profits and losses cancelled each other out, the complain said. The alleged violation, known as so-called wash-trades, allowed the bank to reap the tax benefits from the Canadian government while trading in a risk-free environment. Trades with Subsidiaries. While a bank is allowed to trade with its subsidiaries, it must be done so "at arm’s length," meaning that the respective divisions must have independent controllers and other checks on wrongdoing.  But RBC’s scheme was the product of one internal team, according to the complaint. The complaint against RBC stems from mid 2007, when RBC began trading certain stocks of both American and Canadian companies.  Each paid dividends that, under Canadian law, entitled RBC to a robust tax benefit. But to ensure that the trading did not carry costs or risks, RBC allegedly devised a plan to trade the stocks internally.  RBC divisions in the Caribbean teamed up with units in Luxembourg and London to buy and sell these stocks.  The various entities also bought and sold hundreds of millions in futures contracts that allowed the bank to hedge its exposure to the stocks. RBC traded "almost exclusively" with its subsidiaries "at prices that were not determined by competitive market forces," according to the CFTC.  As such, the positions were equal and offsetting in size and price. While RBC portrayed the trades as legitimate to OneChicago, an electronic futures exchange, the trades were designed and controlled by "a small group of senior RBC personnel."  The subsidiaries were not stand-alone entities, as required by law. The bank is also accused of covering up its actions for 5 years. The CME Group, which regulates much of the futures industry, began raising questions about RBC’s trades in 2005 at the behest of the CFTC.  In one letter that year, RBC defended its trades as "arms length transactions." The bank "concealed material information" about its trading strategies.  The deception continued, regulators say, until April 2010. No names of specific executives were disclosed. "Today’s 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." -- David Meister, CFTC Enforcement Chief. RBC's Apparent Response. The CFTC is seeking to levy fines of as much as tens of millions, although RBC has not settled the matter, and the CFTC expects to resolve the case in court.  RBC denied the accusations in a statement on Monday, calling the lawsuit "meritless" and vowing to fight the "baseless allegations."  The bank said it “proactively contacted” regulators to seek guidance on the trades, adding the following statement:

"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.  It is absurd to now claim these trades were either fictitious or wash sales."

Leading the CFTC Enforcement Action. The action on Monday represents a major step for the trading commission’s enforcement effort under Mr. Meister - a former federal prosecutor and partner at Skadden, Arps, Meagher & Flom.  Mr. Meister is credited with revamping the enforcement division.  Enforcement actions last fiscal year jumped 74% from the previous year. The case against RBC is among the more complex cases to come from the trading commission.  The agency routinely files actions against firms for wash trades, but rarely on this size or scale.  RBC also presents a high-profile target for the agency, which often sanctions little-known trading shops and hedge funds. For further details, go to:  [Dealbook, 4/2/12].