On February 2, 2012, the U.S. Department of Justice (DOJ) indicted Swiss bank Wegelin & Co. for tax fraud. A U.S. court also froze Wegelin’s correspondent account in the US, seizing $16 million, an unprecedented move. In non-legalese, this is a bombshell. It will cause ripple effects in the global banking world. It also shows that the U.S. has the upper hand in the four year old battle with the Swiss over “secret” bank accounts.
As we wrote, six days ago, Wegelin & Co. split itself up. Wegelin’s U.S.-client accounts, under IRS and DOJ scrutiny, were kept intact, while the non-U.S. accounts were sold off to another Swiss bank. This was an attempt to separate and contain the liability for the U.S.-client accounts, similar to the way other “toxic” assets like subprime mortgage and failed derivatives are packaged, contained and sold off at a discount. The rationale for the Wegelin split was that legal action by the U.S. would be focused on the U.S.-client accounts, while the other accounts would now be owned by a new entity, immune from U.S. legal challenge.
The Wegelin split followed the indictments of three Wegelin bankers in early January, 2012. DOJ has been prosecuting individual foreign bankers, lawyers and trustees, as well as the banks themselves, along with U.S. clients who had the Swiss accounts. Following UBS’s 2009 admission of assisting U.S. tax fraud, some fifty separate prosecutions have ensued. DOJ is specifically alleging that after UBS came under IRS and DOJ scrutiny, Wegelin bankers deliberately courted UBS clients, and their non-compliant funds, offering a safe harbor from the IRS. Wegelin bankers assured former UBS clients that because Wegelin has no U.S. branches, it was immune from prosecution.
DOJ’s indictment of Wegelin and seizure of its U.S. correspondent account, and Wegelin’s self-engineered break up, clearly demonstrate that Wegelin bankers were wrong.
Thus, the first conclusion: Even if a foreign bank lacks a U.S. presence, it is still vulnerable to U.S. prosecution and seizure of assets. UBS settled with the U.S. (and Credit Suisse appears to be poised to settle) because of its substantial U.S. assets subject to U.S. jurisdiction: branches in the U.S., assets in the U.S., employees in the U.S. and a lucrative U.S. banking license, any of which could be seized by a U.S. court. Wegelin’s perception of non-vulnerability because of no U.S. assets 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 at a bank in the US, in fact, at a UBS (coincidence?) branch in Connecticut.
The seizure of $16 million is a small sum by international banking standards, but this will have far-reaching effects. Many foreign banks do not have branches in the U.S. but must have access to the U.S. banking system via correspondent accounts in order to transact. The Wegelin events may cause foreign banks to pull their correspondent accounts out of U.S. banks. The seizure of Wegelin’s correspondent accounts, in combination with the new requirements applicable to foreign banks under the Foreign Account Tax Compliance Act (FATCA), including 30% withholding on U.S. investment income for non-compliant banks, may cause foreign banks to consider whether they should leave the U.S. market entirely. The U.S. has now demonstrated that it has tremendous leverage over the entire world banking system: virtually every bank invests its reserves in U.S. treasuries and other safe U.S. bonds, thereby earning U.S. investment income, and virtually every foreign bank has a correspondent account with one or more US banks.
Lately, the IRS and DOJ offensive against the Swiss has been somewhat of a chess match. Following UBS’ settlement with the U.S. in 2009, the US indicted Credit Suisse bankers last July, indicted Julius Baer bankers last October, and Wegelin bankers last month, in addition to investigating other Swiss banks like the Kantonal banks. The Swiss would rather have a global settlement rather than defending bank by bank. Last week, the Swiss responded to a DOJ ultimatum for banking information by surrendering millions of e-mails between bankers and U.S. clients; however, the information was provided in encrypted form, to be un-encrypted when the U.S. side delivered something in return, such as a global settlement.
It’s possible that the Wegelin indictment and asset seizure was a direct response to the cheeky Swiss move of disclosing, but not fully disclosing. However, the indictment required significant time to investigate and prepare. DOJ likely had the Wegelin indictment ready for a while (along with, probably, indictments against Credit Suisse, Julius Baer, the Kontanal banks, etc.) and was waiting for the opportune time to serve it.
The Wegelin indictment and asset seizure can also be viewed as a statement that the U.S. has more leverage in the four year old offensive against banking secrecy, that unless the Swiss deliver what DOJ wants, the U.S. 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 UBS accounts would have resulted in extreme U.S. action, with significant negative consequences to not only UBS, but to Switzerland in its entirety. Thus, large banks like UBS and Credit Suisse, with assets in the U.S., had a clear vulnerability to U.S. legal action. Now, it is clear that small banks, even those without a U.S. presence, are also vulnerable. And U.S. clients with non-compliant accounts at any foreign bank continue to be exposed to discovery and prosecution.
As we wrote last month, the re-opening of the IRS Offshore Voluntary Disclosure Initiative (OVDI) was timed to precede another U.S. step in the offensive against Swiss banking secrecy, so as to incentivize U.S. taxpayers to come forward and make their Swiss accounts compliant. The Wegelin indictment and asset seizure demonstrate that the U.S. is getting closer to checkmate.