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The Secret’s Out: Can Swiss Banking Adapt to Scrutiny?

10 minute read
Vivienne Walt / Geneva

In this moneyed, waterfront city, locals sail their yachts in the sunset and fill the parking lots of fine restaurants with luxury cars, while billboards along Lake Geneva advertise $20,000 wristwatches for sale, private islands for lease and private banks for safekeeping your fortune from the prying eyes of tax authorities.

In the Schuylkill Federal Correctional Institution in Minersville, Pa., resides an inmate who, as one of Geneva’s most high-flying former residents, used to live in that universe until his brazenness shook the secretive world of Swiss banking to its core.

Little has been the same for Swiss bankers since Bradley Birkenfeld, a Bostonian working in Geneva for Switzerland’s powerhouse bank UBS, flew to Washington in June 2007 and handed Justice Department officials a pile of confidential UBS documents that revealed that one of the world’s largest financial institutions was helping thousands of American taxpayers illegally hide billions.

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For his role in abetting these tax-evasion schemes, Birkenfeld, 45 — the biggest tax whistle-blower in U.S. history — is serving a 40-month sentence and, to his fury, is the only person jailed so far as a result of the fraud investigation. He’s also filed a suit to claim the millions of dollars in federal reward money he says he’s owed for his pains.

Thanks to the events he set in motion, Switzerland’s banking industry looks set to change forever as the U.S. and European governments expand their hunt for tax cheats. The scrutiny has persuaded thousands of clients to quietly move their money elsewhere. Swiss bankers are scrambling to replace them. To U.S. clients, the Swiss stress that their banks have retained their long tradition of professionalism and discretion despite their legal problems and that they still have value in a more open world. At the same time, the banks are pursuing customers from nations like Russia that aren’t so, shall we say, fussy when it comes to secret accounts. “Until two years ago, Switzerland guaranteed banking secrecy for everybody,” says Hans Geiger, professor emeritus at the University of Zurich’s Swiss Banking Institute, and a former executive at Credit Suisse. “Today there is uncertainty about what is secret and what is not. That is not what Switzerland promised its clients.”

Switzerland has promised its clients total privacy since 1934, when banking secrecy became law partly to protect Europeans who were scrambling to hide their money from the invading Nazis. Forget chocolate and ski resorts. It is banking that powers Switzerland’s prosperity. The tiny country (pop. 7.7 million) handles nearly one-third of the world’s internationally invested private wealth, worth about $2 trillion.

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Switzerland has built that huge stash not by appealing to a mass of regular clients but by servicing some of the world’s richest people. The vast majority of its 330 banks are private ones that manage people’s fortunes, requiring large deposits from each customer and charging relatively high fees to administer the money. The private banks also have institutional clients, like pension funds. “Switzerland specializes in wealth management for wealthy people,” says James Nason, spokesman for the Swiss Bankers Association in Basel. Most banks, he says, require clients to have at least about $250,000 in their accounts.

Other countries, including Singapore and the Bahamas, have copied that model, but none comes close to Switzerland, whose reputation for discretion made it the banking choice of Europe’s aristocracy — as well as some of the world’s less regal characters. Ferdinand Marcos of the Philippines, Jean-Claude Duvalier of Haiti and Nigeria’s Sani Abacha each stashed millions there. Swiss bankers reject the notion that their firms are the repository for dirty money. “That is urban myth,” Nason says. “If you come in with a suitcase of cash, the bank has to establish the origin of the funds.”

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Maybe, but Swiss bankers generally believe it is not their business to know. “Let’s be honest. For the purposes of self-defense, as soon as you know, you would be responsible for that information,” says a private banker in Zurich, who asked not to be named. Birkenfeld says, “Banks argue, ‘We sell the guns, you do the shooting.’ But they are as complicit as the clients themselves.” Still, it is impossible for bankers to monitor their clients’ behavior. “I’m not a policeman, and I’m not a tax adviser,” he says during one of two long phone interviews from prison, where he lectures inmates on real estate investment and helps them write résumés. “I can’t go around to every country to check that they’re signing their tax forms.”

That attitude is fraying fast, however. Swiss banks cannot sidestep the U.S. economy or the Internal Revenue Service, which has ramped up its pursuit of suspected tax cheats. It’s not against U.S. law to have an account in a private Swiss bank, but it is illegal to do so without declaring it on your taxes. U.S. officials threatened to move against UBS’s huge American operation, with its 22,000 employees, unless it cooperated. After months of wrangling, UBS paid a $780 million fine last year in exchange for deferred prosecution. The charge: hiding about $20 billion of American money.

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Much more contentious was a change in Swiss law that permitted UBS to give U.S. officials details of 4,450 American-held accounts. Many Swiss were outraged, and the deal passed a parliamentary vote last June only after intense political battles. Swiss lawmakers claimed the U.S. had bullied their small country into violating its secrecy laws. That was “breathtaking moral duplicity,” wrote Konrad Hummler, chairman of the Swiss Private Banking Association, in a commentary for bankers and investors last year, noting that Florida and Delaware act as tax havens for many Americans. Hummler, who heads the private bank Wegelin & Co., advised his clients to divest from U.S. stocks.

Swiss bankers say they believe the U.S. and the E.U. (of which Switzerland is not a member) are deliberately attacking them in order to boost their own domestic banks. In interviews, two bankers at separate institutions called the tensions “an economic war.”

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It may not amount to war, but there have been some fierce skirmishes. Six months after Birkenfeld exposed UBS’s conspiracy, a computer technician at the LGT Group, a bank in Liechtenstein, a tiny territory with close ties to neighboring Switzerland, stole data showing that hundreds of superrich Germans (including the head of the huge Deutsche Post company) had hidden billions in secret accounts. He sold the information to German intelligence for $6.4 million.

Then in December 2008, Swiss police stormed the Geneva offices of HSBC Private Bank and arrested an employee, Hervé Falciani, for allegedly stealing data on about 24,000 foreign clients’ accounts and hawking the information to governments. Falciani jumped bail, driving a rented car into southern France, then retrieving the data from remote servers. France, Spain and Italy have since used the information to investigate possible tax cheats.

Falciani’s theft was not the final shock. On July 14, German police raided 13 branches of Credit Suisse across Germany, searching for data about secret Swiss bank accounts held by alleged tax-dodging Germans. German officials admitted they paid $3.18 million for a computer disk containing the information from a Credit Suisse employee in Switzerland.

In contrast to those thefts, Birkenfeld blew the whistle in clear daylight. He floored Justice Department officials and the Senate Permanent Subcommittee on Investigations with details of how he and other UBS bankers in Geneva had recruited thousands of wealthy Americans. Birkenfeld and the other bankers breezed in and out of the U.S. carrying bundles of checks, advising clients on art purchases and even once transporting diamonds inside a toothpaste tube. When Birkenfeld wasn’t home in Switzerland, he was wherever affluent people might be found. “Centre Court at Wimbledon every year, regattas at St.-Tropez and St. Barts, the film festivals at Cannes and Bangkok,” Birkenfeld says, listing his old haunts wistfully. It was a sweet life. “I like good cuisine, good beaches, and I traveled in those circles,” he says.

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Once the scandal erupted, UBS folded Birkenfeld’s unit, but the bank is still suffering the aftereffects. Thousands of UBS clients have left “for reputational reasons,” says bank spokesman Serge Steiner. So UBS is out to get new ones. The bank is expanding in Asia, and its new partnership deal with Formula One is seen as an attempt to attract clients outside the U.S. “UBS did wrong things in the past, and that has to be dealt with,” Steiner says. “It hit us hard.”

It has hit Switzerland hard too. The country’s share of global wealth management is still a whopping 27% or so, according to the Boston Consulting Group. But bankers admit that thousands of clients have shifted money elsewhere in search of total secrecy or have brought it home under tax-amnesty programs. Last year, Switzerland began forcing intermediaries, like money-transmitting services, to report all suspicious activity to the Swiss police’s money-laundering office, and a record-high 896 incidents were reported in 2009.

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That leaves the banking industry in a quandary with regard to Americans. The U.S. has large numbers of high-net-worth individuals, but with the IRS on a campaign to roll up foreign tax shelters, “many Swiss banks don’t want to deal with American clients anymore,” says Hans Geiger, the former banking professor in Zurich. “They just throw them out.” Banks are right to feel jittery. Switzerland revised its international-tax-agreement policy and will now provide administrative assistance to foreign governments in cases of suspected tax fraud and tax evasion — its biggest step toward ending 76 years of cherished secrecy.

U.S. officials will be waiting. The IRS announced in August that it had boosted its investigations of foreign bank accounts, focusing on U.S. taxpayers worth more than $10 million. And under a new U.S. law, all foreign banks will need to disclose which U.S. taxpayers have undeclared accounts by 2013. Kevin Downing, a senior U.S. tax attorney for the Justice Department who prosecuted Birkenfeld, said in a speech in Singapore last May that his office would soon net from 4,000 to 7,000 more tax dodgers and that the operation would be easier than its bitter face-off with UBS. “We just took down the largest private wealth-management bank in the world,” Downing was quoted as saying. “Do you really think we’re going to have trouble doing the next one?” If he’s right, Birkenfeld could soon have company.

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