While world markets are teetering in a global banking meltdown,
another banking drama is playing out in Switzerland that could end the
way private banking has been done there for centuries.
U.S. tax authorities have challenged long-standing Swiss
banking secrecy laws, demanding that UBS AG release the names of 52,000
Americans suspected of opening secret accounts to evade taxes. The bank
agreed to release client information on 250 U.S. citizens and pay a
$780 million fine as part of a settlement, but that decision has put
the entire Swiss banking system in jeopardy, according to Wharton
Swiss banking as we have known it is dead, says Wharton professor of operations and information management Maurice Schweitzer.
Even though UBS has balked at releasing the full 52,000 names,
turning over the 250 client names put a chink in the system that will
destroy the trust of wealthy people around the world in Swiss bank
accounts, he says. Secrecy is at the heart of Swiss banking. This UBS
case shakes that foundation of trust that clients had placed in Swiss
banks regarding the secrecy [of] those accounts.
If the release of individual names triggers a run on UBS, the
already fragile global banking system could be further endangered,
according to Wharton finance professor Franklin Allen.
UBS is one of biggest banks in the world, and it's not clear the Swiss
government could save it. If UBS were to fail, this would be a huge
problem. He says U.S. authorities will have to engage in careful
brinksmanship with UBS to balance their goal of apprehending tax
cheats with the goal of preserving the stability of global finance
Secret banking in Switzerland dates back to 1713 when the
Council of Geneva passed a law preventing banks from sharing client
information. In the 1930s, after France and Germany tried to negate
that ruling in order to prevent capital flight, the Swiss responded by
making the release of banking information a crime. The system was
reaffirmed in 1984 when 73% of Swiss voters agreed to preserve secret
The combination of its secret banking laws and a stable
government gave Switzerland a competitive advantage in private banking,
allowing it to attract capital from overseas. Today, one-third of the
world's total offshore assets of $7 trillion are in Swiss banks,
according to Reuters.
The current dispute pits U.S. tax law against Swiss law which
still makes the release of banking clients' names a crime -- unless
there is a specific client suspected of evasion and the client has the
opportunity to answer to Swiss authorities. The U.S. Internal
Revenue Service (IRS) has filed a civil lawsuit in U.S. District Court
in Miami to force UBS to disclose the identities of U.S. customers who
have secret Swiss bank accounts holding cash and securities valued at
almost $15 billion as of the middle of this decade.
According to Wharton finance professor Richard Marston,
the U.S. takes tax evasion seriously, and the IRS has long been
frustrated by the Swiss private banking system. The current action,
however, comes in response to a concerted effort by UBS to solicit
private banking clients in the United States. As a result, U.S. tax
authorities threatened to indict the firm's U.S. subsidiary, a move
that would have endangered UBS's sizable legitimate financial services
business in the U.S. The bulk of UBS's U.S. business is highly
reputable, Marston adds.
UBS management was really tone-deaf in terms of U.S. tax
policy, says Marston. The one thing that distinguishes investors in
the U.S. from many European countries is the concern that they don't
violate tax laws. It's taken seriously by the IRS, and everyone clearly
UBS has already replaced the management team that agreed to the
settlement. That team, Schweitzer speculates, must have been under
enormous pressure to agree to release the 250 names. The difference
between 250 and 52,000 is small. The levy has been breached. They have
given up names, which to my understanding, no Swiss bank has ever done
before, Schweitzer says. As a result, no Swiss banker can approach [a
potential client] and say with a straight face that his or her banking
will be completely secret.
To much of the world, Swiss bank accounts are viewed as a tool
for certain individuals -- from ultra-rich Americans and Europeans to
African despots and Russian oligarchs -- to hide vast wealth.
Wharton finance professor Marshall Blume
says that, for obvious reasons, it's not exactly clear what kind of
person makes up the bulk of clients at Swiss private banks. Certainly
people who have ill-gotten gains find it attractive to hide them there.
For the U.S., it's tax evasion, but for other countries it's more a
place to hide money.
If the Swiss system were to collapse, Blume suggests, other
havens, such as the Cayman Islands, might see an increase in business.
He adds, however, that other countries willing to shield investors are
not as stable, nor are they immune to the same pressure from U.S. tax
authorities. Confidence in the security of Lichtenstein's bank privacy
laws was shaken last year when a former Lichtenstein bank executive
handed over client names to U.S. authorities and testified before the
Philip M. Nichols,
Wharton professor of legal studies and business ethics acknowledges
that the lack of transparency and accountability invites abuse. When I
talk with people involved in corruption all around the world, the
phrase 'Swiss bank account' almost always comes up.
The importance of Swiss bank accounts varies, Nichols says. For many
individuals in emerging countries, they provide the chance to maintain
safe accounts in a stable currency and shield holdings from currency
controls that limit how much money an individual can take in or out of
the country. There are still plenty of countries in the world that are
somewhat authoritarian, in which the government basically takes money
from the rich and keeps it to themselves. To wealthy persons, [secret
accounts] are an invaluable tool for legitimate purposes. But for
those government or NGO (non-governmental organization) officials who
are trying to aggregate and mobilize capital for development purposes
in emerging economies, they are somewhat frustrating because we wish
the capital would stay in the home country.
Blume and other faculty members say the timing of the case
against UBS has nothing to do with the current global banking meltdown
or the recent election of U.S. President Barack Obama. They note that
U.S. tax authorities have been building this case for some time, and it
has only now come to point where it was ready to go before a judge.
Governments around the world, adds Schweitzer, tolerated the Swiss
private banking system as an historic holdover. UBS is now suffering
because it tried to integrate its private bank services with its
traditional U.S. business. UBS initially hoped they could have it both
ways. When they realized they couldn't, they chose to continue their
ordinary banking services in the U.S.
How will it all turn out?
Blume isn't sure. I don't know why the Swiss gave in [to U.S.
demands] in the first place, unless there is a lot of behind the scenes
pressure that you and I don't know about. Marston predicts that while
the Swiss have the right to establish their own laws, the tax case will
become a serious tug of war between two conflicting philosophies --
one supporting secret accounts and the other opposing tax evasion
regardless of the legal framework. He notes that the issue has not come
to a head until now because more of the cases were isolated incidents
in which an individual taxpayer slipped up and gave the IRS an opening.
It's only when a major bank tries to create a program that builds up
the secret accounts -- that's when you run into trouble, he says.
The U.S. and Switzerland are now on a collision course, according to
Marston, although the U.S. will be reluctant to hurt its relations with
an important European country. It's going to be difficult, and I'm not
sure what will happen, he says, but when push comes to shove, I don't
think the Swiss will allow the general release of names beyond the 250.
Allen, too, notes that UBS is pushing back hard. A U.S.
indictment of the firm would amount to Armageddon. He advises U.S.
tax authorities to continue to apply pressure to force the Swiss banks
and U.S. taxpayers to break away from one another. If U.S. tax
authorities can do this at the right level so that it scares [the
banks] -- without killing them -- they will be successful.
Tax evasion, he adds, is a serious issue, and the entire
global community should be organizing against outlier nations that
provide bank secrecy to put very heavy pressure on all these horrible
dictators who hide money. The world would be a lot better place if bank
secrecy were eliminated.
Schweitzer agrees that the Swiss will fight the IRS case vigorously.
This is not over. It's going to be long and drawn out, but the
precedent has been set. A Swiss bank has agreed that it will disclose
UBS agreed to release names only to avoid criminal indictment, he
says, but I really think the door's been opened here. Even if it is
just UBS, and even though there are just 250 names, that's enough to
set the precedent that secret Swiss banking as it used to happen cannot