This week, a US federal judge ordered the seizure of a bank account at UBS in Stamford, Connecticut. This was a “correspondent account” of Swiss bank Wegelin & Co. A correspondent account is a US account utilized by a foreign bank for banking transactions with a US nexus, when the foreign bank does not otherwise have a US banking presence. Wegelin’s correspondent account at UBS was seized and forfeited to the US Treasury because, as prosecutors alleged, the account had been utilized by Wegelin to facilitate tax fraud and money laundering. Specifically, among other charges, Wegelin (and two other banks) assisted the repatriation of undeclared money at its Swiss bank via checks drawn on the correspondent account, rather than wire transfers or checks from Switzerland, which would have been more conspicuous and suspicious.

This seizure followed the indictment against Wegelin by the US Department of Justice (DOJ), on February 2, 2012, for facilitating tax fraud by US taxpayers with “secret” bank accounts at Wegelin in Switzerland. This was the first time in history that a foreign bank had been criminally charged by the US for tax fraud. DOJ also personally charged three Wegelin bankers in January 2012. The charges included that Wegelin bankers actively sought US clients of UBS who were concerned that DOJ and the IRS would discover their undisclosed UBS accounts, and convinced these US clients to transfer their accounts to Wegelin. Wegelin promised these clients that it was “under the radar” and immune from US prosecution because, unlike UBS, it did not have US branches. Wegelin’s prosecutors stated that Wegelin was “undeterred by the crystal-clear warning they got when they learned that UBS was under investigation for the identical practices”. The charges also included that Wegelin charged higher fees for the former UBS clients, due to their heightened nervousness at getting caught, thus exploiting their vulnerability. The charges also included use of intermediary entities like Liechtenstein and Panama foundations and corporations, designed to obscure the true ownership of the accounts, as well as account code names and instructions not to mail correspondence and statements to the US. Such tactics to avoid detection by the IRS are by now very familiar to prosecutors (and tax and defense attorneys).

Wegelin did not answer these charges, nor appear in court. The bank was labeled a fugitive. When a defendant does not answer the allegations, it is known as a “default”. Because Wegelin defaulted, the account was seized and forfeited. The account was taken because Wegelin was a “no show”, not because it was found guilty of the charges. In practical terms, there is little difference.

The first question is, why did Wegelin default? One possible answer is that the amount at stake in the account, approximately $16.2 million, while a large amount to most people, was not enough of a concern for Wegelin to hire US lawyers and defend itself in a criminal proceeding that could take years to resolve. “Cut bait and fish elsewhere”, as they say.

However, there is little fishing elsewhere for Wegelin. In January, 2012, on the eve of the DOJ indictment, Wegelin split itself up. Wegelin’s US-client accounts, under IRS and DOJ scrutiny, were kept intact, while the non-US accounts were sold off to another Swiss bank (Notenstein Privatbank, an entity set up specifically for this acquisition, which in turn was bought by Swiss bank Raiffeisen). This was an attempt to separate and contain the liability for the US-client accounts, reminiscent of the way other “toxic” assets like subprime mortgages and failed derivatives are packaged, contained and sold off at a discount. The rationale for the Wegelin split was that legal action by the US would be focused on the US-client accounts, while the other accounts would now be owned by a new entity, immune from US legal challenge. It is unlikely that US legal action would follow to the acquiring bank, as there are no allegations the Raiffeisen participated in Wegelin’s tax fraud. Following the split up and US legal challenges, Wegelin is left greatly diminished and weakened, and the lingering question is whether Wegelin, Switzerland’s oldest private bank (since 1741), can survive.

Another open question is whether Wegelin will give up the names of its US account holders? It is likely that the IRS already has those names, following the trail from UBS. Further, it is likely that the IRS has the names, otherwise DOJ would not have had sufficient evidence for criminal prosecution against Wegelin itself, and its bankers. Of the approximately fifty criminal cases for offshore tax fraud brought by DOJ against US taxpayers in recent years, only one has thus far involved accounts at Wegelin (and in that case, the US owner of the Wegelin account was convicted). By comparison, thirty four such cases have involved UBS accounts. It is almost certainly just a matter of time before DOJ files additional criminal cases involving Wegelin accounts. Additional incriminating information against Wegelin was obtained via information provided to the IRS by the thousands of US taxpayer participating in the three offshore voluntary disclosure programs that the IRS has offered since 2009.

There are lessons to be learned from Wegelin’s prosecution and downfall, and the first might be labeled a matter of hubris. In the summer of 2009, following UBS’ settlement with DOJ and agreement to reveal the identities of 4,500 Americans with undeclared UBS accounts, Wegelin managing partner Konrad Hummler published a “commentary” titled “Farewell America” (Wegelin & Co. Investment Commentary No. 265; August 24, 2009), a scathing attack on the United States, its politics, morality, fiscal and tax policy, which ultimately compared the US economic system to Madoff’s Ponzi scheme. Among the accusations, that the US “causes regular crises in the global financial system” and displays “breathtaking moral duplicity in maintaining enormous offshore tax havens in Delaware, Florida and others of its states.” (The full commentary is available here). This was a blatant, angry reaction to DOJ’s success in bringing UBS to its knees, breaking Swiss banking secrecy and extracting the identities of thousands of Americans with UBS accounts.

Beyond that reaction, Wegelin’s hubris was that it actively solicited UBS account holders and offered the very same non-compliant banking services and tax evasion strategies and tactics that brought the IRS and DOJ against UBS in the first place. Moreover, while knowingly offering these services, Wegelin boasted of its non-vulnerability because, unlike UBS, it did not have a US presence. Thus, whereas UBS bankers had been charged with promoting tax non-compliance by visiting the US and courting wealthy Americans at art shows and elsewhere, and then running back to Switzerland and hiding behind Swiss banking confidentiality laws, Wegelin bankers never had to come to the US to promote. The absence of US branches supposedly made Wegelin impervious to US legal action.

Thus, one conclusion is that even if a foreign bank lacks a US presence, it is still vulnerable to US prosecution and seizure of assets. UBS settled with the US (and Credit Suisse appears to be poised to settle) because of its substantial footprint subject to US jurisdiction: branches in the US, assets in the US, employees in the US and a lucrative US banking license. US assets, such as Wegelin’s correspondent account, can be seized by a US court. Wegelin’s boasting of supposed non-vulnerability because of no US presence failed to take into consideration two things: (1) it was offering the very same tax fraud services as UBS, fully aware that UBS was under criminal investigation for those very services, and (2) it had a correspondent account located in the US (at UBS, coincidentally?).

The seizure of $16.2 million from Wegelin’s correspondent account is a small sum by international banking standards, but this could have far-reaching effects. For instance, there are many banks that do not have a US presence, but in order to transact in international banking and finance, need access to correspondent accounts in the US The Wegelin events may cause foreign banks to consider pulling their correspondent accounts out of US banks and utilize correspondent accounts in London, for example. This could have implications for any US counterparties to an international transaction, perhaps causing delays and requiring many steps to transact around the absence of a US correspondent account.

Moreover, the seizure of Wegelin’s correspondent account, in combination with the new requirements applicable to foreign banks under the Foreign Account Tax Compliance Act (FATCA), including 30% withholding on US investment income for non-compliant banks, may cause foreign banks to consider whether they should leave the US entirely. The US has now demonstrated that it has tremendous leverage over the entire world banking system: virtually every bank invests its reserves in US treasuries and other safe US bonds, thereby earning US investment income, and virtually every foreign bank has a correspondent account with one or more US banks.1
The Wegelin matter also demonstrates that the US has more leverage in the four year old offensive against offshore banking secrecy, that unless the Swiss banks deliver what DOJ wants (i.e., the names of Americans with non-compliant accounts), the US can cripple the Swiss banking system and severely affect the Swiss economy. This is exactly why UBS caved to the US in 2009. For UBS to not have revealed the secret accounts would have resulted in US retaliatory action, with significant negative consequences not only to UBS, but to the Swiss nation and economy. Thus, large banks like UBS and Credit Suisse, with assets in the US, are clearly vulnerable to US legal action. Now, after the Wegelin matter, it is clear that small banks, even those without a US presence, are also vulnerable. And US clients with non-compliant accounts at any foreign bank continue to be exposed to discovery and prosecution, and must consider becoming tax compliant.

1 While Wegelin was clearly wrong about its lack of US presence rendering it impervious to US legal enforcement, in an ironic twist, Konrad Hummler, in “Farewell America”, was correct that “the USA is attempting to exploit its almost unlimited position of strength with regard to the international transaction systems (Swift, clearing systems, custodians) and the fundamental attractiveness of its capital market to impose its ideas on the rest of the world.”

Moreover, even prior to FATCA, Hummler concluded that “it will be simply too dangerous to own US securities, to hold them as custodian for third parties, or to trade them as a bank.”