As Swiss banks wait for the US authorities’ tax evasion spotlight to fall on them, law firms are drafting in extra staff to cope
Since the recession, Swiss banks have come under regular and sustained fire from authorities around the world seeking to challenge banking secrecy. In particular, US authorities have used the global financial crisis and efforts to reduce government debt as a chance to target alleged tax evasion by their citizens – and Switzerland is the starting point of a worldwide campaign.
It is only a marginal exaggeration to suggest that everyone in Swiss business is talking about the four-tier disclosure programme agreed last August between Washington and Bern. And it is certainly not an exaggeration to say that Swiss lawyers are focused on the issue, as they all target varying slices of a pie that is costing the banks a fortune in legal fees.
‘Category 1’ banks are those already under investigation by US authorities. In that bag are about a dozen banks, including Crédit Suisse, Julius Baer Group and the Swiss branch of HSBC Holdings. But, frustratingly for this group, proceedings are effectively on hold while the authorities tackle the much larger ‘category 2’.
C2 banks are participating voluntarily in the disclosure programme on the promise that doing so will reduce potential penalties. There are 106 in this group and, if they wanted to participate, they were required to notify the US Department of Justice by the end of last year. They were then given 120 days to divulge required client data.
That means the deadline looms at the end of this month. However, C2 banks can apply for a 60-day extension and cross their fingers that Justice Department officials are either in good humour or so swamped that they nod through applications to ease their workload.
Category 3 consists of banks maintaining they did not violate US law and have alerted the Justice Department of that position, and category 4 includes banks that had no relationships with US clients. These are predominantly rural institutions providing local mortgages.
All at C2
All eyes are on C1 and C2, but the US authorities are clear that the position regarding the latter has to be resolved before deals with the former can be stuck.
“Not much is happening at the moment with the C1 banks,” says Homburger financial services head Rene Boesch. “The next steps for this category are difficult to envisage because we don’t have a framework. The question will be – what is the basis for a penalty assessment? It’s expected that the banks will have to negotiate deferred prosecution agreements.”
So, it is C2 banks front and centre. Essentially, Washington wants two streams of data from the institutions – details of the conduct of cross-border business involving US clients and information about closed accounts.
“The goal of the US authorities,” explains Swiss firm Pestalozzi chairman Michael Kramer, “is to gather enough information to get the names of US customers.”
That might not sound complicated, but, say local lawyers, it is a minefield, requiring not just Swiss law advice but also ranks of US law firms, plus input from audit practices and forensic accountants.
Leading the US law firm pack are Mayer Brown , Pillsbury Winthrop Shaw Pittman , Shearman & Sterling , Skadden Arps Slate Meagher & Flom , Wachtell Lipton Rosen & Katz , tax specialist Caplin & Drysdale and the DC office of Freshfields Bruckhaus Deringer .
“There’s a massive amount of document review involved,” says Kramer, whose firm is acting for several banks. “All the accounts in the name of a so-called US person must be reviewed, which is time-consuming. Swiss law firms have had to hire temporary staff to deal with this programme, with many lawyers hired on short-term contracts.”
Several banks must have been tempted to tell the Department of Justice to get back in its box. But the disclosure programme was approved by the Swiss government and supported by the Swiss Financial Market Authority.
“If a bank doesn’t comply the Swiss regulator will ask questions about whether it is complaint
with Swiss law – is the bank’s risk management correct?” explains Froriep managing partner Catrina Luchsinger. “Bank boards don’t have much leeway – it isn’t a question of whether or not, but of which documents to deliver.”
It is understood that several large Swiss firms – notably Homburger, Lenz & Staehlin and Bär & Karrer – are acting for the lion’s share of the C1 and C2 banks, although most firms have some of the action. The firms must have expertise in data-mining and email review work, with many bringing in teams of
paralegals and university students to deal with the grunt work.
Getting top-level legal advice is also crucial, as the stakes are high.
“The problem is that if you just look at the numbers the exposure for many banks is significant,” says Philippe Weber, executive committee partner at Niederer Kraft & Frey .
“The only way to cut that exposure is to demonstrate that many of the accounts they had were in fact not US accounts – that they only had a weak link to the US, such as a local phone number. The definition of a US account is broad and unclear, which is a challenge for everyone. So time pressure, unclear parameters and massive exposure all add up to not a very good combination for the banks.”
Understandably, legal advice on the issue is complex. “You have to ensure the banks have been given guidance by the Swiss government on which rules they have to follow,” points out Kramer.
He says Bern heavily emphasises privacy issues, reminding the banks not to divulge information on their employees unless they follow all data protection rules.
“You have to identify all the people in the bank who had something to do with client business, do interviews, collect data and then make a decision as to what data you are required to provide to the US,” he says. “Then you have to notify existing or former employees. If individuals don’t agree they can challenge the decision to give the data to the US in the courts. There are also tricky issues in reporting banks’ financial accounts – looking at what provisions are in accounts and how are they phrased.”
Switzerland is a small jurisdiction so conflict issues are important. The leading law firms have all had to construct Chinese walls so they can deal with multiple banking clients.
“On one hand,” says Kramer, “banks can be happy you’re involved with other banks because they know you have the necessary experience. But on the other, you have to ensure no delicate or confidential information is given to competitors. There’s also an issue for some C2 banks that they don’t share the same interests with C1 banks.”
Issues are further complicated by banks seeking second opinions. Luchsinger says clients are keen to get another view on which documents to deliver and how.
“They have to think about the bargaining process with the US
authorities,” she says. “So if the majority of the banks ask for second opinions, law firms win twice – and I think most will.”
Awash with legal fees
Without doubt, the whole performance is costing Swiss banks a mint in legal fees.
“They’re spending huge amounts to try to reduce their risks,” says Weber, “primarily by demonstrating that as many accounts as possible should not be classified as US accounts. The way the banks are justifying this huge expenditure is that the money they spend on getting the facts together correctly may ultimately save them penalties.”
Under the programme, banks risk fines of up to 20 per cent of management fees of undeclared US assets. So every franc they show was not part of an undeclared account is worth finding. There will be a higher penalty for undeclared funds that came in after August 2008, on the grounds that by then the UBS case had been widely reported.
“Those taking undeclared monies after that knew they were taking a higher risk,” says Weber. “Those penalties will be 30 per cent, or in the worst cases 50 per cent, depending on when the monies arrived.”
The most important element of this Swiss drama is, of course, money, and how much the banking sector will be handing over to the US government. That figure, says Homburger’s Boesch, “is the best kept secret” of the entire saga.
How is all this affecting the normally implacable mood of the Swiss banking sector? According to a lawyer close to many institutions involved, there are two categories of Swiss banker, with an equal number in each – “those who wake up and think the first thing they have to do is see their psychiatrist; and those who say ‘we have to go through this, so let’s get it over with’”.
Another lawyer involved in the cases points out that lingering resentment exists against the US.
“Everyone wonders why it was necessary to give in so quickly,” he says. “But it is difficult to second-guess whether more resistance should have been offered. A general view is that a Lex Americana was imposed on us. But we are where we are and we need to live with it.”
Not all legal life in Switzerland revolves around the banks’ tax tussles with Washington. A year ago the Swiss did what they like to do most – hold a referendum. This one saw the normally pro-business citizenry vote to allow shareholders more say over corporate pay packages.
Dire warnings of a corporate exodus followed, but calmer heads suggested the law’s impact would take at least 12 months to be felt.
“There was a significant amount of legal work generated,’ says Boesch, pointing to advice around executive pay deals and shareholder meetings. “The final rules are not as bad as they could have been. Companies can live with them, they are not overly burdensome, especially when compared with what is going on in the EU.”
However, others suggest the last word has not yet been uttered.
“All the big listed Swiss companies are nervous because we’re approaching the time of year when general assemblies of shareholders take place,” says Kramer. “This is the first time the companies have had to comply with the new law.”
Some lawyers maintain the legislation was poorly drafted.
“There are a lot of elements that are difficult,” says Luchsinger. “For example, what happens if a shareholders’ meeting says no to a pay package but the business has already entered into a working contract? Does that executive suddenly find he has to pay back salary and bonus? We don’t yet know whether it’s more difficult to find new managers as a result of the law. But if the first shareholder meetings say no to some salary packages, that might change.”
On a positive note for Swiss business, lawyers say deals are on the up. But M&A work certainly has a banking element to it.
“We’re expecting consolidation in the banking sector as smaller banks are sold,” explains Kramer. “That’s been caused to a large extent by the costs of regulation.”
Public flotations are also reviving. Lawyers point out that in the past two years there were only three Swiss IPOs, yet there have been three announced this year already.
“And there are others in the pipeline,” says Weber, “so it’s a healthy sign.”
At least some in the Swiss business community are not having to pay daily visits to their psychiatrists.
When will C2 be in the frame?
So how long will the category 2 investigations take – or, in other words, how long before the spotlight is turned on the largest group of banks? Swiss lawyers are not renowned for spontaneous outbursts of uproarious laughter, but that question presses the button.
“That’s the most crucial question,” says Rene Boesch, Homburger ’s financial services head, once he recovers his composure. “The US Department of Justice has expressed the view that it wants to move quickly and complete C2 in the summer. I’m not sure that they have the full capacity, so our projections are that it will slip into the autumn.”
Nadia Tarolli Schmidt, head of Vischer ’s Basel tax team, agrees that timetable crystal ball-gazing is difficult.
“It’s a bit optimistic to think the process will be completed by the end of this year,” she says. “But that could be possible if all the information is filed by the end of June. It depends on the capacity at the justice department.”
And that capacity is by no means assured, claim Swiss lawyers. The US authorities, according to one local lawyer who has been travelling between Zurich and DC on behalf of clients for the past year, “have had to draw on staff from across the department – and not everyone is as up-to-speed with the details of the programme as others”.
Key figures: Switzerland
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Sources: International Monetary Fund, Swiss Federal Statistics Office, Tradingeconomics.com