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Secret Swiss Bank Accounts are No Longer Secret

Over the past few years, the Tax Division of the United States Department of Justice has been aggressively investigating tax evasion by U.S. taxpayers via offshore bank accounts in countries such as Switzerland, Israel, Luxembourg, and the Caribbean. A Senate report compiled in 2008 revealed that the U.S. Treasury loses approximately $100 billion a year as a result of the use of offshore bank accounts. The problem has been exacerbated by the fact that the internet and growing popularity of complex financial instruments have made it exceedingly easy for U.S. taxpayers to transfer funds abroad. In 2008, the Tax Division, in cooperation with the United States Attorneys’ offices, began the Offshore Compliance Initiative. The goal of the program was to stem the tide of this growing method of tax evasion, which has become one of the Tax Division’s highest litigation priorities.

The Offshore Compliance Initiative began with an investigation of Switzerland’s largest bank, UBS AG. That investigation ended in 2009 when UBS agreed to pay a fine of $780 million, admitted guilt on charges to defraud the U.S. by impeding the IRS, stopped providing banking services to American customers with secret accounts, and signed a deferred prosecution agreement (“DPA”). As part of the DPA, UBS made the unprecedented commitment, by order of the Swiss Financial Markets Supervisory Authority, to provide the U.S. Government with details about undeclared accounts as well as identities of certain American account holders. Furthermore, in June 2008, the IRS received authorization from the U.S. District Court in Miami to serve UBS with a“John Doe” summons, ordering the bank to deliver records that would provide the IRS with the identities of U.S. taxpayers with undeclared Swiss bank accounts at UBS who had hidden their accounts from the IRS. Additionally, as part of the DPA and an agreement between the Swiss and American governments and UBS, the IRS was able to obtain most of the account information it sought when it served the “John Doe” summons upon UBS, revealing details about thousands of U.S. taxpayers who had been evading taxes through undeclared accounts.

Since 2008, the U.S. Government has been conducting similar investigations in various countries. It has charged over 30 bankers and 68 account holders with tax evasion offenses regarding offshore accounts. As a result, it has secured 5 convictions after trial and 54 guilty pleas from taxpayers. For the first four months of 2013 alone, the government secured 2 trial convictions and 16 guilty pleas from taxpayers. Currently, the Tax Division is investigating 14 Swiss financial institutions. Additionally, a federal district court in San Francisco has granted the IRS authorization for another “John Doe” summons, this time in order to gather information about offshore accounts at a Caribbean bank. Recently, federal courts have become increasingly willing to issue subpoenas to people who hold such accounts demanding that they turn over their foreign financial records, despite their Fifth Amendment objections. The Tax Division’s focus on and publicity surrounding new enforcement measures has resulted in more than 38,000 people since 2009 voluntarily coming clean with the IRS and agreeing to pay the U.S. Treasury billions of dollars in penalties and back taxes.

As a result of UBS’ experience, many Swiss banks began coming forward with account information, or have agreed to non-prosecution agreements under which they could give the U.S. Government more information in exchange for guarantees that bank officials would not face criminal charges. It is against this backdrop that on August 29, 2013, the United States and Switzerland issued a joint statement announcing their Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks (“Program”). In the joint statement, the parties note that the Swiss Financial Market Supervisory Authority intends to encourage all Swiss banks to notify U.S. taxpayers or entities of the IRS voluntary disclosure options available to them.

The Program defines four categories of banks and steps they must take in order to participate, as well as the consequences of their participation. Category 1 includes all Swiss Banks that the Tax Division had authorized an investigation into as of the date the Program was announced. Category 1 banks are not allowed to participate in the Program. Category 2 includes banks that the Tax Division had not authorized a formal investigation into as of the date the Program was announced but which have reason to believe they may have committed tax-related offenses. Such banks may request a Non-Prosecution Agreement (“NPA”). Category 3 includes banks that the Tax Division had not authorized a formal investigation into as of the date the Program was announced and which have not committed any tax-related offenses under the applicable statute. Such banks can request a Non-Target Letter (“NTL”). Category 4 are banks that the Tax Division had not authorized a formal investigation into and which are “Deemed Compliant Financial Institutions” as “Financial Institutions with Local Client Base” under the Foreign Account Tax Compliant Act, which was signed into law in March 2010.

Banks requesting an NPA as a Category 2 bank will have to agree to several conditions. Such banks will have to agree to pay large penalties; the penalty scheme has 3 tiers, which vary depending on when the undeclared accounts in question were formed. The scheme is intended to impose greater penalties on banks that allowed the opening of undeclared accounts after the public was made aware that the Tax Division was cracking down on the opening of offshore accounts. Under the Program, penalties are 20% of the maximum aggregate dollar value of all non-disclosed accounts that were held by the bank on August 1, 2008. The penalty increases to 30% for secret accounts that were opened between August 1, 2008 and the end of February 2009. The penalty increases further to 50% for secret accounts opened after the end of February 2009.

In addition to paying a penalty, banks applying for an NPA must make a complete disclosure of their cross-border activities, providing detailed information on how accounts were structured, supervised, and operated. Banks must also provide detailed information for all accounts in which U.S. taxpayers have a direct or indirect interest. This disclosure must include information on how the bank attracted the account holder. Category 2 banks must also cooperate in treaty requests for account information, as well as provide detailed information about other banks that transferred funds into secret accounts or accepted funds when other secret accounts were closed. Such information will allow the authorities to investigate the movement of funds from one account to another once a client was tipped off that the bank was being investigated. Category 2 banks must also provide the number and dollar value of accounts that: existed on August 1, 2008, were opened between August 1, 2008 and February 28, 2009, and were opened after February 28, 2009. The banks must also agree to close accounts belonging to recalcitrant accountholders.

Banks requesting an NTL as Category 3 or Category 4 banks must agree to several conditions. One such condition is that they must retain Independent Examiners to conduct internal investigations of their operations. The banks must maintain all documents and records created or prepared by Independent Examiners for ten years starting on the date of the NTL. Furthermore, banks must close all accounts of uncooperative account holders and prevent employees from helping such account holders to further hide accounts. Category 3 and 4 banks must also agree not to open any U.S.-related accounts unless they provide conditions to potential clients that require them to declare the accounts with the U.S. Government.

The unprecedented agreement between the United States and the Switzerland is the culmination of an immense effort by the Tax Division of the Department of Justice over the past few years to lift the veil of secrecy that has enshrouded Swiss banking and American involvement in it. Although many Swiss bankers maintain that privacy and bank secrecy remain intact, a Swiss newspaper called it “the start of an organized surrender.” Indeed, while the cost of the arrangement to the banks is high, the cost of being vulnerable to litigation and potentially having to pay enormous fines, such as that UBS paid, is even higher. It remains to be seen what the impact of the agreement will be on Switzerland’s reputation as the world’s foremost offshore financial center.