The Secret's Out: Can Swiss Banking Adapt to Scrutiny?

With privacy laws changing, Swiss banks need to find another competitive advantage. Do they have one?

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Bradley C. Bower / Bloomberg / Getty Images

Bradley Birkenfeld is serving 40 months in a U.S. prison after blowing the whistle on UBS

In this moneyed, waterfront city, locals sail their yachts in the sunset and fill the parking lots of fine restaurants with luxury cars, while billboards along Lake Geneva advertise $20,000 wristwatches for sale, private islands for lease and private banks for safekeeping your fortune from the prying eyes of tax authorities.

In the Schuylkill Federal Correctional Institution in Minersville, Pa., resides an inmate who, as one of Geneva's most high-flying former residents, used to live in that universe until his brazenness shook the secretive world of Swiss banking to its core.

Little has been the same for Swiss bankers since Bradley Birkenfeld, a Bostonian working in Geneva for Switzerland's powerhouse bank UBS, flew to Washington in June 2007 and handed Justice Department officials a pile of confidential UBS documents that revealed that one of the world's largest financial institutions was helping thousands of American taxpayers illegally hide billions.

For his role in abetting these tax-evasion schemes, Birkenfeld, 45 — the biggest tax whistle-blower in U.S. history — is serving a 40-month sentence and, to his fury, is the only person jailed so far as a result of the fraud investigation. He's also filed a suit to claim the millions of dollars in federal reward money he says he's owed for his pains.

Thanks to the events he set in motion, Switzerland's banking industry looks set to change forever as the U.S. and European governments expand their hunt for tax cheats. The scrutiny has persuaded thousands of clients to quietly move their money elsewhere. Swiss bankers are scrambling to replace them. To U.S. clients, the Swiss stress that their banks have retained their long tradition of professionalism and discretion despite their legal problems and that they still have value in a more open world. At the same time, the banks are pursuing customers from nations like Russia that aren't so, shall we say, fussy when it comes to secret accounts. "Until two years ago, Switzerland guaranteed banking secrecy for everybody," says Hans Geiger, professor emeritus at the University of Zurich's Swiss Banking Institute, and a former executive at Credit Suisse. "Today there is uncertainty about what is secret and what is not. That is not what Switzerland promised its clients."

Switzerland has promised its clients total privacy since 1934, when banking secrecy became law partly to protect Europeans who were scrambling to hide their money from the invading Nazis. Forget chocolate and ski resorts. It is banking that powers Switzerland's prosperity. The tiny country (pop. 7.7 million) handles nearly one-third of the world's internationally invested private wealth, worth about $2 trillion.

Switzerland has built that huge stash not by appealing to a mass of regular clients but by servicing some of the world's richest people. The vast majority of its 330 banks are private ones that manage people's fortunes, requiring large deposits from each customer and charging relatively high fees to administer the money. The private banks also have institutional clients, like pension funds. "Switzerland specializes in wealth management for wealthy people," says James Nason, spokesman for the Swiss Bankers Association in Basel. Most banks, he says, require clients to have at least about $250,000 in their accounts.

Other countries, including Singapore and the Bahamas, have copied that model, but none comes close to Switzerland, whose reputation for discretion made it the banking choice of Europe's aristocracy — as well as some of the world's less regal characters. Ferdinand Marcos of the Philippines, Jean-Claude Duvalier of Haiti and Nigeria's Sani Abacha each stashed millions there. Swiss bankers reject the notion that their firms are the repository for dirty money. "That is urban myth," Nason says. "If you come in with a suitcase of cash, the bank has to establish the origin of the funds."

Maybe, but Swiss bankers generally believe it is not their business to know. "Let's be honest. For the purposes of self-defense, as soon as you know, you would be responsible for that information," says a private banker in Zurich, who asked not to be named. Birkenfeld says, "Banks argue, 'We sell the guns, you do the shooting.' But they are as complicit as the clients themselves." Still, it is impossible for bankers to monitor their clients' behavior. "I'm not a policeman, and I'm not a tax adviser," he says during one of two long phone interviews from prison, where he lectures inmates on real estate investment and helps them write résumés. "I can't go around to every country to check that they're signing their tax forms."

That attitude is fraying fast, however. Swiss banks cannot sidestep the U.S. economy or the Internal Revenue Service, which has ramped up its pursuit of suspected tax cheats. It's not against U.S. law to have an account in a private Swiss bank, but it is illegal to do so without declaring it on your taxes. U.S. officials threatened to move against UBS's huge American operation, with its 22,000 employees, unless it cooperated. After months of wrangling, UBS paid a $780 million fine last year in exchange for deferred prosecution. The charge: hiding about $20 billion of American money.

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