A massive tax scandal, an IRS investigation and pursuit by multiple government agencies is creating quite a maelstrom for UBS and tarring its once pristine brand.  Its money-fueled, transnational world, filled with tax-dodging-wealthy-characters gives the entire saga a James Bond air.  At the same time, the episode portends yet another set of banking and possible tax law changes.

UBS, the global bank, stands accused by the IRS and SEC of facilitating tax evasion by U.S. citizens. In its most recent move, thought to be an attempt at trying to regain some semblance of credibility, UBS announced that its Chief Executive, Marcel Rohner, would be leaving the bank. Unfortunately, this move may be a little too late. Prior to that, the SEC filed an enforcement action against UBS for violations of securities law alleging that the bank acted as an unregistered broker dealer and investment adviser and conducted a cross-border business through client advisers located in Switzerland who were not associated with a registered broker-dealer or investment adviser.

In a stunning admission, UBS acknowledged that it had helped taxpayers hide money from the IRS. In an SEC filing, the Swiss bank disclosed that it had entered into a Deferred Prosecution Agreement with the U.S. Department of Justice for violations of tax laws and a Consent Order with the SEC for violations of the Securities Act of 1934.  Under the agreement, it agreed to pay some $780 million in settlement related charges. The Swiss Federal Banking Commission concluded that UBS did not demonstrate proper business conduct and UBS agreed to discontinue its practice of providing banking services to U.S. customers with undeclared accounts. UBS was also ordered by the Swiss Financial Market Supervisory Authority to disclose the names of U.S. account holders.  If UBS had not agreed to disclose the names, then its executives faced being indicted. U.S. authorities are probing even further to get the names of 52,000 additional clients as Swiss-US double taxation treaty will only require UBS to disclose around 300 names.

Tax schemes of the sort now under investigation result in scandal by financial standards, utilizing two areas that are arcane by legal standards.  The first is banking secrecy (made even more arcane by its jurisdiction-shopping to the most favorable island nation or Alpine state).  The second is tax law, always considered opaque other than by a privileged few tax lawyers. 

In an age where banking laws and regulation are being rethought, the probe into UBS raises the issue as to whether financial privacy laws are due for an overhaul as well.  While they’ve been re-thought in recent anti-terrorism and anti-money laundering initiatives, what’s emerging is a need to think through tax (avoidance) laws.  Banking companies are of course aware of this sensitive area and disclose their duty to comply with certain privacy and secrecy laws.  Among the most recent disclosures are those made by the Bank of Hawaii Corp., Canamdaigua National Corp., and TCF Financial Corp. Other financial firms have made disclosures about the importance of customer confidentiality. One such company is Bank Financial Corp., who recognizes its executives’ duty to protect customer information but also notes their duty to provide information if required to do so by an order of a court.

Bank secrecy laws differ between the United States and Switzerland. U.S. authorities are required to protect personal information, but under the Bank Secrecy Act and the Patriot Act, they are given extensive powers to investigate. In Switzerland, banks are prohibited from disclosing client data or names unless the country's authorities believe the client has committed a serious crime such as tax fraud. Imagine the shock to banking-centric Swiss consciousness as the UBS tax probe renders banking confidentiality far from sacred.

Tax strategies take a prominent place in company disclosures relating to both the company’s own strategy and that of its competitors. Companies often make certain disclosures about their own tax havens and shelters. For example, Axis Capital Holdings, Renaissance Holdings and Max Capital Group each disclosed that, due to Bermuda’s commitment to help the Organization for Economic Cooperation and Development eliminate harmful tax practices by counteracting the effects of tax havens, they may be subject to additional taxes. A similar disclosure was made by Greenlight Capital related to the Cayman Islands. Pride International Inc. (a U.S. corporation) seems to take issue with tax evaders stating that some of its competitors, which are incorporated in tax havens, have a leg up due to their “significant tax advantages” Other companies, including Amerigas Partners, Suburban Propane Partners and Enbridge Energy Partners, have disclosed that their status as a registered tax shelter company might increase their risk of audit by the IRS.  Along with UBS, firms have disclosed investigations relating to tax shelters. Examples include Commonwealth Edison and State Street Corp. who both made revelations about sale-in, lease-out (SILO) transactions which the IRS classified as tax shelters. State Street stated that it plans on pursuing its appeal rights with the IRS.

This entire situation has created somewhat of a legal crisis in Switzerland where tax evasion is not considered to be a crime. UBS and their clients are not going down without a fight. UBS has been sued in a Swiss Court by American clients to prohibit the bank from disclosing their names because doing so would violate Swiss secrecy laws. UBS has also stated that it will fight U.S. efforts to have them further disclose client names.  UBS believes doing so would violate Swiss law, exposed it to criminal liability and potentially put it out of business. The investigation goes beyond who the bank may have helped evade taxes and whether the bank properly collected (and remitted) taxes to question the validity of certain jurisdictions’ banking laws.

A crackdown on tax havens may not be a matter of if, but rather when. Leaders in Europe and the U.S. have promised to work together to work on a global regulatory framework to impose sanctions on those countries which allow companies or individuals to avoid their domestic tax laws.  European leaders plan on beginning to tackle this issue at the G-20 Summit, and President Obama has promised to make closing down tax havens an essential component of his budget.  One thing is certain: banking will never be the same.

Published: February 26, 2009