SWITZERLAND: Tax scandal leaves Swiss giant reeling

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.'

• 104 Globalization
• 106 Money & Politics
• 185 Corruption
• 208 Regulation