U.S. Lets Swiss Banking Giant UBS Off the Hook

Traditions die hard.

Since the founding of the Swiss Confederation in 1291, Switzerland has protected the privacy of its financial accounts. It may be the world's most secretive banking jurisdiction, with a vaunted ability to protect its depositors from unwanted prying.

Switzerland converted this tradition to law in 1934, when it enacted its strict banking secrecy law. Revealing financial information without the client's consent is prohibited.

For more than a year now, this tradition of bank secrecy, or financial privacy as the Swiss call it, has been under attack from one of the most powerful agencies in the world -- the U.S. Internal Revenue Service. In July 2008, the IRS served a "John Doe" summons on UBS, seeking records that would identify U.S. taxpayers with accounts at UBS in Switzerland who have not reported these accounts to the IRS. UBS failed to comply with the summons.

So in February, the U.S. Department of Justice filed a petition to force the Swiss banking giant to turn over some 52,000 names of U.S. account holders the IRS suspects failed to pay taxes on earnings from those accounts, as required under U.S. law. UBS has continued to refuse to disclose the names, arguing that doing so would violate Swiss banking laws. It is a crime in Switzerland for bankers to provide information on client accounts to foreign tax authorities, and bankers who violate this law may be subject to criminal prosecution that includes the possibility of a prison sentence.

Fearing that UBS might, nevertheless, succumb to U.S. pressure, the Swiss government formally joined the fray in early July. The Swiss stated in a friend of the court brief that if a U.S. judge ordered UBS to turn over the account names, the government would seize UBS' bank records, if necessary, to prevent UBS from divulging the information. Switzerland last took this type of action 25 years ago when it seized the accounts of tax fugitive Marc Rich.

The IRS countered, saying that while bank secrecy may be important in Switzerland, protecting that secrecy must be considered in the context of UBS actions. As the bank admitted earlier this year, UBS willfully assisted thousands of U.S. clients to evade hundreds of millions of dollars in taxes.

On the strength of information provided by former UBS private banker Bradley Birkenfeld on the bank's tax practices, U.S. tax authorities were poised to tear down the wall of Swiss banking secrecy.

Yet, such an outcome now appears out of reach.

On July 31, just three days before the parties were to go to trial, the U.S. and Swiss governments reached a tentative agreement in a civil case filed on Feb. 19. This agreement, which has not yet been finalized, means that UBS is not likely to give U.S. tax authorities the names of all 52,000 American clients the IRS suspects are evading taxes on some $15 billion held offshore in secret Swiss bank accounts. Neither the U.S. nor the Swiss government provided details on the number of names that would be provided. On August 7, U.S. District Judge Alan Gold, who is presiding over the civil case, approved a request from both parties for another teleconference Aug. 12. A related but separate criminal case has been settled.

THE UBS STORY

UBS helped its U.S. clients evade U.S. taxes through very creative means. Internal Revenue agent and offshore compliance technical officer Daniel Reeves described many of the bank's practices in his Feb. 19 declaration in the civil case before the federal district court in Miami.

In his declaration, Reeves referred to an investigation by the Permanent Subcommittee on Investigations (PSI) of the Senate Committee on Homeland Security and Governmental Affairs. Its July 2008 report, "Tax Havens and U.S. Tax Compliance," presents evidence that from 2000 to 2007, UBS engaged in practices designed to hide the existence of accounts from U.S. authorities. As the PSI report detailed, UBS opened tens of thousands of accounts in Switzerland for American clients, and these accounts hold billions of dollars in assets that the owners have failed to declare to the U.S. as required under U.S. law. The PSI report also noted that UBS estimated in December 2004 that it had some 52,000 undeclared account relationships with American taxpayers with assets valued at roughly 17 billion francs. UBS further indicated that Swiss bank secrecy laws shielded these accounts from disclosure.

Reeves highlighted evidence from the PSI report showing the extent to which UBS tried to shield its clients:
For example, the bank helped create documents indicating that sham offshore companies, rather than the U.S. taxpayers, were the beneficial owners of the UBS accounts. It told its American clients whom to contact for guidance on setting up offshore structures that would prevent the IRS from learning the true owners, according to the report. Bankers hand-carried client checks when traveling to the U.S. to avoid drawing attention that might have occurred if UBS wired the funds electronically. UBS bankers used encrypted laptops and carried a generic PowerPoint presentation on their computers to show U.S. authorities if needed, the report said. UBS bankers were told to indicate on their customs forms that their trips to the U.S. were for pleasure, not for business, and to avoid staying in the same hotel when they returned to the U.S. They were not to print anything on UBS stationery. The bank advised its American clients to use credit cards issued under UBS' name to avoid detection by U.S. tax authorities.

As the PSI reported, UBS client-advisors came to the U.S. about three times a year, stayed for up to three weeks a time, and met with four customers each day for a total of about 10,000 contacts a year. UBS bankers solicited clients in the U.S. even though they had not been licensed by the Securities and Exchange Commission to do so.

On February 18, UBS entered into a deferred prosecution agreement with the U.S. in the criminal case, and the bank turned over about 250 names and paid a $780 million fine. As part of the agreement, UBS admitted that it helped U.S. taxpayers hide their accounts from the IRS, and it agreed to cooperate fully on any matters related to the criminal investigation of UBS' U.S. cross-border business. Following the agreement, UBS Chairman Peter Kurer said "We accept full responsibility for these improper activities." (Former Swiss Finance Minister Kaspar Villiger replaced Kurer as chairman of the board in March.)

NEXT CHAPTER: THE CIVIL CASE

Although the criminal matter was settled, the civil tax matter brought remains outstanding.

As IRS Deputy Commissioner Barry B. Shott said in his February 19 declaration in the civil case, the Swiss government will provide information on suspected tax cheats only if the person has affirmatively committed fraudulent or deceptive acts, such as falsifying a document. As Shott indicated, the Swiss government will not tell the U.S. government that a taxpayer is simply earning income on an undeclared account (U.S. citizens are liable to tax on all their income wherever earned).

Department of Justice senior litigation counsel Stuart Gibson has little sympathy for UBS. He noted in February that the bank should not be given any credit in the civil case for complying with the terms of the Justice Department's agreement in the criminal case. "Certainly agreeing to cease helping U.S. taxpayers break the law should count for nothing," Gibson remarked. More recently he said, "After all, the fact that UBS finds itself in a difficult position is completely the result of its own conduct."

Depending on the terms of the July 31 agreement, UBS may have won this battle. The U.S. and Swiss governments have tentatively agreed that UBS will turn over significantly fewer than 52,000 names of U.S. clients suspected of dodging taxes.

Although the U.S. has not yet obtained any names through the civil case, many clients with undeclared Swiss accounts are voluntarily coming forward. As part of an IRS program that began in March and ends on September 23, taxpayers who voluntarily disclose their unreported offshore accounts may be eligible for clemency, but not amnesty. The IRS has also made it clear that the taxpayer must disclose the account before the IRS has started an investigation.

Nevertheless, it is unfortunate that the U.S. government appears to be letting UBS off the hook, at least in part, in the civil case. UBS acknowledged in its deferred prosecution agreement that for several years, it participated in schemes designed to defraud the IRS by helping U.S. taxpayers hide their Swiss accounts. Therefore, it would seem that the IRS holds the upper hand in this case. But, there is more at stake than just tax evasion.

TOO BIG TO FAIL

U.S. taxpayers are required to file tax returns every year and to report the existence of, and any income earned from, a foreign bank account that at any time during the year has more than $10,000. But significant tax evasion occurs through offshore accounts. The Permanent Subcommittee on Investigations has looked into tax havens and tax compliance and reported that offshore tax evasion costs the U.S. $100 billion each year.

The Financial Times has expressed a clear opinion on Swiss banking secrecy. Writing on July 9, the paper said in an editorial that "The Swiss, however, do not have a self-evident right to profit from aiding people to evade the laws of other countries. Switzerland's financial secrecy is a vessel for tax evasion, and the U.S. would be justified in taking action against Swiss banks that it suspects of abetting breaches of U.S. law."
As important as collecting unpaid taxes is to the IRS, there are other issues that are more important to the U.S. and Swiss governments.

Preventing the collapse of another major financial institution is one of those issues. The financial services sector accounts for 12.5 percent of Switzerland's gross domestic product. According to the Boston Consulting Group, Switzerland is home to 27 percent of the world's $7.3 trillion of offshore banking deposits. Preserving Switzerland's financial center may, ultimately, explain why the U.S. and Switzerland reached agreement.

Although UBS has a tax problem with its U.S. clients, a bigger problem lies in its own business. And, the Swiss government is well aware of the problem. Last October, the Swiss central bank gave UBS 6 billion francs in cash and entered into an agreement with the bank to transfer up to 73 billion francs of "currently illiquid securities and other assets" (i.e., toxic assets) to a fund owned and controlled by the Swiss government. UBS has written off more than $50 billion of its subprime mortgage portfolio in the United States, yet as reported in its most recent SEC filings, it still remains exposed to billions in potentially toxic credit derivative contracts. UBS reported a 20.9 billion franc loss for 2008, the largest loss in Swiss corporate history, and it has lost an additional 3.4 billion francs so far this year. As of June, UBS had suffered more than 130 billion francs in net redemptions since the start of 2008. Just five years ago, UBS was the sixth largest bank in the world by market capitalization; now it is no longer among the top 20 banks and is not even the largest bank in Switzerland.

Still, as Swiss Economics Minister Doris Leuthard noted in July, allowing UBS to fail might precipitate a new downturn in the global financial markets similar to the financial crisis that was exacerbated when the U.S. government allowed Lehman Brothers to fail. The Lehman bankruptcy is now widely seen as having been a mistake. The U.S. government appears to have decided that UBS, which is the world's second largest global wealth manager after the Bank of America, is yet another bank that is too big to fail.

Perhaps the United States needs to bring in the big guns if it wishes to tear down the wall of Swiss bank secrecy. Fortunately, one of those big guns, Paul Volcker, is already working for the Obama administration. Volcker led a committee established to investigate the Swiss bank accounts of Holocaust victims. In 1999, after a three-year audit, Volcker issued a report that identified some 54,000 accounts held in Swiss banks that were likely linked to Holocaust victims and opened between 1933 and 1945, i.e., largely during the years after Switzerland adopted its strict bank secrecy law. Just three years before Volcker issued the report, the Swiss Bankers Association had said that just 800 such accounts existed.

Volcker now heads the President's Economic Recovery Advisory Board where he is working on identifying ways to reform the U.S. tax code to, among others, reduce tax evasion. Given his success in prying open Swiss banking secrecy a decade ago, Volcker might be just the person the U.S. government could turn to as it seeks to obtain the names of the suspected 52,000 undeclared U.S. taxpayer accounts hiding in UBS' vaults.
In April, the G-20 world leaders declared that "the era of banking secrecy is over."
In July, the G-8 leaders reiterated this view, saying "We cannot continue to tolerate large amounts of capital hidden to evade taxation." Unfortunately, Switzerland did not sign off on these statements.

Furthermore, if you ask the Swiss, they would say that they are providing financial privacy, which they believe is a far cry from banking secrecy. Thus, even though the IRS may be poised to finally break through the wall of Swiss banking secrecy, the apparent conclusion that UBS is too big to fail shows that this wall, although it is now missing a brick or two, is in no danger of collapsing.