By Claudio Guler for ISN Security Watch, 13 Jul 2009

Judge Alan S Gold of the United States Florida Southern District Court was to preside over civil proceedings in the tax dispute between the US and Union Bank of Switzerland (UBS) later today in Miami. US authorities are outraged that UBS client advisors roamed the US from 2002 to 2007 in search of wealthy clients and provided them with unlicensed, tax-free wealth management services.

The US hopes to crack Switzerland’s banking secrecy and obtain the client information of up to 52,000 high-net-worth Americans suspected of withholding an estimated $14.8 billion in taxes from the US Internal Revenue Service (IRS). The Swiss are looking to hammer out a deal that preserves banking secrecy and eschews further disrepute. The US claims that tax havens deprive its treasury of roughly $100 billion a year.

UBS admitted wrongdoing on 18 February 2008, after a former US-based employee, Bradley Birkenfeld, informed on the bank in exchange for a reduced penalty in his own tax fraud investigation. UBS entered into a Deferred Prosecution Agreement and pledged to cooperate with US authorities or again face criminal charges. It also released the names of some 300 alleged US tax cheats, paid a $780 million fine and immediately began exiting the US offshore wealth management business.

The IRS, with the backing of US Senator Carl Levin (D-Michigan) who has since introduced the Stop Tax Haven Abuse Act in the US Congress, felt a civil suit was the best and possibly only means to compel UBS to cooperate and demanded UBS reveal its entire roster of American offshore clients. UBS and the Swiss authorities declined, arguing that the request constituted a “fishing expedition” and would expose UBS employees to criminal proceedings in Switzerland.

The Swiss have largely deemed the IRS’ follow-up civil suit an underhanded blow. They accuse the US – a country with questionable corporate taxation practices of its own, a fresh record of financial calamity, and a thirst for funds to plug fiscal deficits – of targeting asymmetric Switzerland unreasonably.

Yet UBS and Switzerland are on the defensive. UBS’ actions assured that should a climate of fiscal thrift arise, the proverbial sleeping dog would be prime for an awakening. Now, a compromise, one that avoids devastating entirely the integrity of Swiss banking secrecy increasingly looks like the best Switzerland can hope for.

Recent glimmers of hope have proven ephemeral. Switzerland renegotiated a double taxation treaty with the US on 19 June: It is still in ministerial channels. The move is part of Switzerland’s broader initiative to renegotiate 12 double taxation treaties before the end of 2009 to bring itself into line with OECD standards on information exchanges and get off the OECD’s grey list. Some hoped, to no avail, that these negotiations would also resolve the tax dispute.

On 23 June, the New York Times published an article headlined “Settlement Anticipated in UBS Case,” which quoted an American official arguing, “To have a complete meltdown in Swiss-US relations and go to the mat with Switzerland three years from now when money is getting back into the system doesn’t make sense.” The US swiftly denied the official’s conjecture. UBS has three years to appeal any adverse ruling by Judge Gold.

In the interim, frustrations are growing and Swiss-US relations are suffering a setback. The conservative Swiss People’s Party (SVP) is pining to anchor banking secrecy in the national constitution. Other, smaller Swiss banks are avoiding or retreating from the lucrative US market altogether, never mind their legal status.

If releasing names in bulk is not an option for Switzerland (assuming it can mount and maintain a proper defense), the US and Switzerland will likely have to reach a diplomatic compromise – it promises to be expensive. Swiss Finance Minister Hans Rudolf Merz hinted on 7 July that USB might consider paying back lost taxes. Switzerland has also been in talks with the US to receive Guantanamo Bay inmates as President Obama shuts down the base. These overtures, however, may be ineffective in the short run.

In response to the UBS scandal, on 23 March, the IRS initiated a temporary, more lenient voluntary disclosure program to encourage US taxpayers with offshore accounts to come clean.

Considering the unusually aggressive nature of the US’ offensive against UBS, it seems unlikely that the US would settle before the IRS concludes its program has paid adequate dividends. Moreover, for the US, this case is about money, but it is also about names, sovereignty limitations, and just maybe, some showcase criminal proceedings down the road.

If a settlement is in the cards, it may still be some time. But the trial injunction looks auspicious.

Original Print: http://www.isn.ethz.ch/isn/Current-Affairs/Security-Watch/Detail/?ots591=4888CAA0-B3DB-1461-98B9-E20E7B9C13D4&lng=en&id=103183

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By Claudio Guler for ISN Security Watch, 18 Mar 2009

They could have stayed home, waited for the money and profited handsomely. Instead, in the mad dash to make cash, UBS experimented. With its misdeeds now exposed, a Swiss national value stands blighted. And Bern is forced to defend itself in an unpleasant row.

Union Bank of Switzerland (UBS) is the world’s largest wealth management firm. At its apogee in mid-2007, UBS managed assets north of US$2 trillion. The global economic crisis has forced UBS to write down more than any other European bank, US$50 billion plus. The bank has groveled for loans from both the National Bank of Switzerland and the Singapore government. The latest scandal precipitated a massive boardroom reshuffle.

The financial sector is a cornerstone of the Swiss economy. According to the website of the Swiss Federal Department of Foreign Affairs, the financial sector contributes to over 10 percent of Swiss gross domestic product (GDP) and employs roughly 6 percent of the country’s workforce. Estimates suggest Switzerland is the single largest offshore center, caching just under one-third the total offshore assets of the world’s high net-worth individuals (HNWIs). (Typically, any person or family with investable assets in excess of US$1 million constitutes an HNWI.)

The Road to the Courthouse

Instead of operating in the US exclusively by way of its registered wealth management arm, UBS dispatched unlicensed client advisors from Switzerland, possibly on as many as 3800 meetings. They assisted US citizens with funneling money into offshore accounts and hiding incomes from the US Internal Revenue Service (IRS). Internal e-mails leaked to the press confirm UBS understood its behavior to be criminal.

Client advisors employed nefarious tactics. They dubbed clients with code names, made calls using pay phones, traveled with encrypted computers, received training in counter-surveillance techniques, and claimed on US immigration forms that their trips were for personal leisure rather than business. The US Justice Department estimates UBS helped American HNWIs stash in the neighborhood of US$14.8 billion.

The affair first came to light when in June 2008, Bradley Birkenfeld, a US citizen and former UBS employee, himself indicted for tax fraud, cut a deal with US tax authorities. His cooperation alleged that over the period 2002 to 2007 UBS helped American HNWIs commit massive tax fraud.

On 1 July 2008, US authorities initiated a “John Doe summons” against UBS in a Miami criminal court. Their aim: to learn the names of what they suspected to be some 19,000 US citizens banking with UBS. Eight months later, on 18 February 2009, UBS admitted guilt and entered into a deferred prosecution agreement. In exchange, the Swiss Financial Market Supervisory Authority (Finma), with the approval of Swiss Federal Councilor Hans-Rudolf Merz – who oversees the financial dossier – ordered UBS to release the names of some 250 to 300 US clients suspected of meeting the threshold for tax fraud in Switzerland. UBS also paid a US$780 million fine and pledged to exit the US wealth management business.

The deferred prosecution agreement, however, stipulated ancillary conditions. The US would still pursue a civil suit to disclose the names of what is now believed to be some 52,000 US clients. Were UBS to lose the suit or fail to comply, the US reserved the right to reopen criminal proceedings.

The stipulation has grown into a major bone of contention. The Swiss government views it as a fishing expedition, illegal under Swiss law and an existential threat to banking secrecy and has ordered UBS not to comply. The US claims it is simply trying to audit taxpayers, and if necessary, recover back taxes. In the words of Senator Carl Levin (D), who is spearheading the initiative in the US Congress, “This kind of conduct, which actively facilitates tax evasion, amounts to a declaration of war by offshore secrecy jurisdictions against honest hard-working tax payers.

“We’re determined to fight back and end the abuses inflicted on us by those tax havens.”

The Swiss up in Arms

Back in Switzerland, the public chastised Merz for permitting selected information exchanges. He defended himself in front of his party, the FDP/Liberal center-right coalition, arguing that banking secrecy does not shield against blatant cases of tax fraud. Not all were convinced. Many asked themselves, moreover, why diplomats had made no progress during the initial phase of the investigation from July 2008 to February 2009.

On 6 March, Merz convened a group of experts to determine what aspects of banking secrecy could be reformed and enumerated Switzerland’s options: give up banking secrecy altogether, remain steadfast or seek compromise. The Federal Council opted for the latter.

Merz advocated early on the need to make concessions to safeguard banking secrecy. The left-of-center Socialist Democratic Party (SP) welcomed efforts in this direction. The center Christian Democratic People’s Party (CVP) voiced its understanding. The right-wing Swiss People’s Party (SVP), the largest in Parliament, called instead for retaliation.

As Levin put it, the Swiss covet banking secrecy. “The Swiss hold out bank secrecy as a national value. In the way Americans prize freedom and democracy, the Swiss claim that bank secrecy is essential to protecting individual privacy.” Switzerland legally anchored banking secrecy in Article 47 of the Banking Law of 1934. Paradoxically, outside pressure played a role in its codification.

Swiss banking secrecy, which has existed either implicitly or at the cantonal level for roughly 300 years, was written into federal law because of experiences with the economic turmoil of the Great Depression. Suspicions of snooping Nazis and the ‘Paris Affair’ – a scandal in which French authorities tried to recover taxes from their own country’s elite – confirmed the need for federally guaranteed banking secrecy. Most Swiss still deem banking secrecy to be an integral element of an individual’s right to privacy. In a 1984 referendum, 73 percent of Swiss voted to uphold it. An 11 March 2009 opinion poll by the Swiss Bankers Association concluded that 78 percent of Swiss citizens support the preservation of bank-client confidentiality.

In practice, of course, the Swiss financial community profits considerably from banking secrecy. Yet as Vogler argues, it alone cannot explain Switzerland’s financial allure. A high degree of political stability, Switzerland’s sound monetary policy, and the stability and easy convertibility of the Swiss Franc also play their part.

The Swiss argue quietly, moreover, that they are just one among many, competing in an international business worth trillions and governed by tax arbitrage. Numerous other countries also offer incentives to attract HNWIs and other large concentrations of wealth. Morality, the argument goes, is a poor metric.

The trust, a model that emerged from the Anglo-Saxon tradition, offers a similar arrangement to banking secrecy. An irrevocable trust can achieve significant tax breaks, similar if not akin to those afforded by banking secrecy. Moreover, incurious islands, some under the jurisdictions of the US and the UK, provide offshore banking services close to home. Among their ranks are the US Virgin Islands, Anguilla, Bermuda, the Cayman Islands and the Isle of Man.

The US state of Delaware is also a frequent target of criticism, with 63 percent of all Fortune 500 companies and more than 50 percent of all publicly traded companies in the US incorporated there. The US Government Accountability Office estimated in January 2009 that many publicly traded US companies, some even Washington bailout recipients, have offshore holdings. Joseph Stiglitz, the Nobel prize-winning US economist, who heads a UN-sponsored panel charged with making recommendations for reforming the international financial architecture, has expressed his concern over not only offshore banking, but also opaque onshore centers.

Bern Scrambles to React…

Tax treaties exist between the US and Switzerland that set the parameters for information exchanges and double taxation limits. The dilemma with information exchanges, however, is one of the chicken and the egg. Switzerland distinguishes between tax fraud and tax evasion: Tax fraud is a criminal offense, while tax evasion is a civil infraction. The former involves downright lying on tax forms. The latter entails omitting some of the truth.

Under the existing treaty regime, in order to release names and remain in compliance with Swiss law, the authorities at Finma must have convincing evidence of tax fraud. In the case of tax evasion, no information is shared. Any US effort to obtain financial details hinges on providing Finma with a name and evidence of tax fraud, effectively tying the US’ hands but for a few exceptions.

US and EU pressure over the past month, nevertheless, has convinced Switzerland that reforming banking secrecy and embracing diplomatic negotiations are the only viable ways forward.

Switzerland has sought out good company. Officials from Austria and Luxembourg – countries that also have banking secrecy policies – stated on 9 March they backed Switzerland in its row with the US. Czech Foreign Minister Karel Schwarzenberg, a dual Czech and Swiss citizen, argued to the Neue Züricher Zeitung (NZZ) that people should not try to “break” Swiss tradition. His country presently holds the rotating EU presidency.

Switzerland has also started to prime diplomatic channels. Federal Councilor and Justice Minister Eveline Widmer-Schlumpf traveled to Washington DC to meet her US counterpart, Attorney General Eric Holder on 2 March. Upon arrival, a Holder surrogate received her. The attorney general previously represented UBS in legal proceedings, creating a conflict of interest and forcing him to forgo talks. Swiss Foreign Minister Micheline Calmy-Rey met briefly with US Secretary of State Hillary Clinton on 6 March in Geneva.

In addition to making the diplomatic rounds, Switzerland may emphasize its material leverage. The Good Offices of Switzerland protect US interests in Tehran and Havana, as well as of late Russia’s interests in Georgia and vice versa. Switzerland is also considering accepting inmates from the Guantanamo Bay detention center for the US.

UBS’ capital management and investment banking businesses employ roughly 25,000 people in the US. A source, who prefers to remain anonymous, but is intimately familiar with the bank’s US portfolio told the ISN Security Watch, “These businesses are sound, not yet profitable, but solvent. And unlike UBS’ wealth management arm, no noteworthy fraud.”

Holder’s conflict of interest is a harbinger of what probably lies underneath. If Switzerland releases the names of some 47,000 American HNWIs individuals (this was the latest figure hinted at by UBS’ Chief Financial Officer Mark Branson at a 4 March congressional hearing in Washington DC) the names are likely to include prominent personalities in business and government, or in other words, America’s elite.

Bern’s most immediate challenge, however, is to avoid getting blacklisted at the G20 London Summit on 2 April. French President Nicholas Sarkozy and Germany’s Angela Merkel have both expressed their support for stigmatizing Switzerland and adding it to the OECD’s uncooperative tax haven blacklist. Rumors abound that a new draft of the OECD blacklist names Switzerland.

…and Relents

On Friday, 13 March, the Federal Council yielded and adopted a more permissive standard for information exchanges in line with OECD rules. The move came on the heels of Liechtenstein and Andorra announcing that they too would ease banking secrecy laws in response to international pressure.

The Swiss government no longer distinguishes between tax fraud and tax evasion for foreigners. It will have to renegotiate numerous treaties. As before, however, automatic information exchanges are forbidden. A foreign country suspecting its citizen of tax fraud must first furnish Swiss authorities with satisfactory particulars to justify releasing a name, a potentially subjective sticking point. For Swiss citizens, the distinction between tax fraud and tax evasion persists.

The coming weeks will reveal whether the Swiss Federal Council compromised sufficiently to dodge the OECD blacklist. They will also make known whether diplomacy can settle the Miami civil suit. Regardless, UBS’ gall – a patent transgression of US law – has challenged Switzerland’s sovereignty, ignited the debate over offshore tax havens and undermined the reputation of Switzerland’s banking services.

Original Print: http://www.isn.ethz.ch/isn/Current-Affairs/Security-Watch/Detail/?ots591=4888CAA0-B3DB-1461-98B9-E20E7B9C13D4&lng=en&id=97855

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