Tax scandal leaves Swiss giant reeling

Banking crisis


UBS could lose its licence in America after an official confessed to illicit tactics that helped clients avoid the Revenue.

Nick Mathiason reports

Nick Mathiason
The Observer, Sunday June 29, 2008
Article history

It was an offer the Californian real-estate billionaire Igor Olenicoff couldn't refuse. For several years, the US Internal Revenue Service had been on his tail. Suspecting serial tax evasion running into tens of millions of dollars, the IRS painstakingly amassed enough information to jail the Russian immigrant for decades.

In 2006, tax investigators offered Olenicoff, a man who has strong connections with Boris Yeltsin, a deal. In return for the identity of those who helped him evade taxes, his sentence would be slashed. It took Olenicoff, who owned 11,000 houses and a large collection of high-grade offices, less than 30 seconds to make up his mind.

After two years of further investigations, Olenicoff's evidence resulted this month in a dramatic development. UBS, the most powerful bank in Switzerland, is now on the edge of a steep cliff. Ten days ago, Bradley Birkenfeld, who between 2001 and 2006 was a senior UBS banker, signed a US court statement detailing how he smuggled diamonds in toothpaste tubes, deliberately destroyed offshore bank records on behalf of clients and helped Olenicoff evade taxes of $200m on offshore assets worth $7.26bn.

In an explosive seven-page deposition, Birkenfeld claims he was encouraged to win clients at UBS-sponsored tennis tournaments and major art events. UBS bankers, he said, assisted wealthy Americans to conceal ownership of their assets by creating 'sham' offshore trusts. Misleading and false documentation was routinely prepared to facilitate this, and the motivation, he concluded, was to ensure that UBS continued to manage a staggering $20bn of assets owned by wealthy US individuals, which generated the bank $200m in fees each year.

'By concealing US clients' ownership and control in the assets held offshore, [UBS] managers and bankers... defrauded the IRS and evaded US income tax,' reads the statement. The US Department of Justice has scented blood and is moving in for the kill. UBS denies authorising or encouraging any breaches of applicable laws and regulations and has put out a statement saying it will fully cooperate with all authorities and address any issues raised by the investigation (see below). It is now faced with having to hand over details of its 20,000 US clients to the authorities.

It is an understatement to say that Birkenfeld's allegations have sent shockwaves through the Swiss financial establishment, which prides itself on selling secrecy to the world's super-rich.

'It does look bad,' says a senior UBS insider in London. 'Everyone is pretty upset. The Swiss government will not allow its wealth management to be badly damaged by this. I think the US government has to be very careful how it deals with foreign companies... The US, of all countries, needs foreign investment. It won't shoot itself in the foot. A lot of shareholders in UBS are US funds.'

Others are not so sure. A Credit Suisse analyst said last week that UBS could lose its banking licence in the US if Birkenfeld's claims are found to be true.

For UBS, the scandal could not come at a worse time. No other European bank has suffered as much from the sub-prime meltdown as the Zurich-based giant. It has been forced to write down a staggering $38bn in assets. Its losses have led to the departure of the chief executive, chairman Marcel Ospel and other managers and have prompted it to seek emergency investment from Singapore and the Middle East. Now predators led by HSBC and Credit Suisse are said to be ready to pounce. Last Wednesday, UBS appointed Lazards to consider its options. 'I envisage it will be broken up,' says the London UBS source. 'But nothing will be done without the Swiss government.'

Indeed, a delegation from the Swiss finance and justice ministries flew to Washington last week. Their mission was somehow to balance the disclosure of UBS's 20,000 clients' details with the need to protect client confidentiality.

To many, the UBS tax evasion allegations present more compelling evidence of the destabilising role that secretive tax havens play in the global financial system. It is a system that connects Wall Street and the City to Liechtenstein, Panama and the British Virgin Islands - all places where Birkenfeld parked the cash of his wealthy clients. This week MPs on the powerful Treasury Select Committee will launch a probe into tax havens.

The allegations of problems at UBS come just five months after details emerged of how tens of thousands of high net worth individuals used a Liechtenstein bank to evade billions of pounds' worth of taxes. The revelations have sparked investigations in the US, UK, Germany and a host of other countries.

Just how US citizens got to park their wealth offshore in ever-increasing numbers dates back to rules framed by former US President Bill Clinton and his Treasury Secretary, Robert Rubin, now chairman at US bank giant Citigroup. Rubin introduced a status known as 'qualified intermediary' for financial institutions to help them assist the wealthy with international income. 'QI' placed the responsibility on banks to declare their clients' tax status. They also had to identify the beneficiaries of overseas bank accounts. But Rubin left a huge loophole: beneficial owners could be corporations. Clever bankers quickly, and legally, created a web of trusts that shielded the identity of the true beneficiary. It was seemingly the very technique deployed by UBS bankers to protect Olenicoff's fortune, according to Birkenfeld's deposition.

Among the Swiss financial community there is shock at what is now the serious prospect of money rushing to leave the Swiss banking system and heading for even more secretive locations like Singapore. But there is also defiance. James Nason of the Swiss Bankers Association says: 'Do a Google search for "Delaware" or "Nevada" plus "offshore" and you'll find more tax avoidance schemes designed for Americans than you can poke a stick at - and they are certainly not made in Switzerland.'

Yet for years Switzerland has faced criticism for being the money launderers' nerve centre. But Nason says: 'Money laundering is a global problem and I think the media unfairly points at Switzerland. Very often large sums of criminal money can be [tracked down] in banks in other countries, where "know-your-customer" rules are less strict than in Switzerland, only because some of the transfers involved a Swiss bank.'

For UBS, and for confidential banking, the future now rests on the outcome of the US election in five months. UBS's links to the US financial establishment centre on its vice-president, Phil Gramm. Gramm, a former Texas senator who is co-chairman of John McCain's campaign, is tipped to be his choice for Treasury Secretary if he is elected. Described by McCain as the most astute political strategist he knows, Gramm was instrumental in pushing through the most fundamental US banking liberalisation since the Thirties. His critics say the Gramm-Leach-Bliley Act broke down walls between commercial banks, investment banks and insurance companies, allowing for the ratcheting up of mortgage offers to the poor. Gramm supporters say he has consistently fought against mis-selling abuses and that, without his legislation, the US mortgage crisis would be even worse.

Democratic candidate Barack Obama, meanwhile, has made no secret of his drive to tax the rich and rein in offshore tax abuses, having signed Senate legislation last year to do just that. Dr Andreas Missbach of the Berne Declaration, a Swiss non-governmental organisation, says: 'Does the future of the Swiss banking system rest on the outcome of the US presidential race? Yes, definitely.'

UBS's statement
'UBS is working diligently with both Swiss and US government authorities, consistent with Swiss law and the legal frameworks for intergovernmental cooperation and assistance, to promptly provide information concerning instances in which the establishment and operation of such offshore entities and their UBS securities accounts appears to have been part of a scheme to defraud US tax authorities. UBS is committed to a fundamental policy of compliance with all applicable laws, rules and regulations, and to our own internal policies, guidelines and procedures.

'Consistent with this fundamental policy, UBS is treating these investigations with the utmost seriousness and will appropriately and responsibly address and correct any issues raise in the investigations, including taking appropriate disciplinary action.'

About this articleClose This article appeared in the Observer on Sunday June 29 2008 on p4 of the Business news & features section. It was last updated at 00:05 on June 29 2008.