Financial secrecy is a "product" that has intrinsic value, one that can be bought and sold, consumed and produced. What’s it worth?
Financial secrecy – or more politely “confidentiality” - involves non-disclosure of financial information concerning individuals, firms, financial institutions and governments. It is a key element of banking and financial services, fiduciary relationships, and regulatory structures. It is vital in tax evasion, the drug trade, organized crime, money laundering, terrorism, political and economic corruption, and host of other activities that can cause real damage to civil society. But financial privacy can equally be considered a human right – what regime hasn’t made great efforts to compromise personal privacy in the name of the state?
What financial secrecy is worth depends on where the money came from and the consequences of disclosure, all the way from family tensions to the firing squad. And who’s tasked with safeguarding financial secrets? All the usual suspects ranging from uncle Harry, lawyers, accountants investment advisers, banks, and the ultimate gold standard – highly reputable financial institutions operating abroad in politically and economically stable sovereign countries that maintain tough secrecy laws and blocking statutes.
As long as the bankers can keep it up there’s a treasure trove of fees to be earned and high-paying jobs to be had, much more reliably than grinding away at the mug’s game of trying to outperform the competition on investment returns and risk. As in any good market, financial secrecy is bought and sold and both sides are happy – albeit sometimes at the expense of somebody else.
Here are some FAQs about financial secrecy.[i]
Q. In the last couple of years the US Internal Revenue Service has run an aggressive campaign against US tax evaders and their use of Switzerland as a place to stash their wealth (taxed and untaxed) and evade paying further taxes on interest, dividends and capital gains. This now seems to be unraveling. Why?
A. The US tax code is a bit unusual in that income of American tax residents is universally taxed (not just when remitted back home), tax evasion is a criminal offense, (not just a civil offense), and anyone assisting in the process can be charged with aiding and abetting in the commission of a crime as well as conspiracy and possibly obstruction of justice. These are not good words, especially for Swiss banks heavily exposed to reputational risk. UBS was the first of these banks to face the music as a result of whistleblower testimony and eventually reached an expensive settlement with the US. Its arch-competitor Credit Suisse, engaged in similar practices and is now also in the dock. So are many smaller Swiss banks, some of whom picked-off tax-evading UBS American clients – although it didn’t take long for the spotlight to fall on them. Switzerland’s oldest bank, Bank Wegelin, collapsed after being indicted on criminal charges. Eventually an omnibus Swiss-US agreement was reached covering all Swiss banks, which is currently being implemented.
Q. But UBS apparently had a clearly stated policy for its private bankers not to deal with offshore accounts of clients subject to US tax laws in ways that might constitute “aiding and abetting” actions in criminal violation of the law. For offshore wealth management US clients were potentially toxic. Yet UBS private bankers evidently pursued such clients with enthusiasm. How do you explain that?
A. As in many large organizations, business units dealing with private banking clients are under heavy pressure to “make the numbers.” So despite general policies that play well in public and may be genuinely supported by senior management and boards of directors, line staff looking to make the numbers and generate performance bonuses have the incentive to increase the volume of profitable business. Sometimes these opportunities push very close to the edge of legality. Imperfect markets, after all, is where the money is. So UBS private bankers seem to have overstepped the limits imbedded in the Bank’s own policies. The question is how far up the management hierarchy this went. Testimony in a Florida court ultimately led to indictment of Raoul Weil, global head of the Bank’s private banking business, and an extradition request went to the Swiss government. In October 2013 he was arrested on a visit to Bologna, Italy, extradited to the US, and freed on $9 million bail pending trial. It is an open question whether the Bank’s Global Executive Board or its Supervisory Board was aware of the Bank’s actions or the extreme dangers involved as possible “unindicted co-conspiritors.”
Q. It’s fine to focus on the US, which likes to throw its weight around. But what about other countries?
A. The aggressive US pursuit of its tax evaders perked-up the antennae of tax authorities, all of whom have severe budgetary constraints that need to be addressed, in part through much tougher tax compliance. Embarrassing disclosures include tax evasion charges against former French Budget Minister Jerome Cahuzac and German sports hero and president of the Bayern München soccer club, Uli Hoeness, who was recently sentenced to 3½ years in jail. Of course, enthusiasm for merciless tax enforcement varies between countries and over time, especially when plenty of influential people play the game, so it’s far too early to write an obituary on either financial secrecy or tax evasion. And remember, there are lots of other reasons for needing financial secrecy than stiffing the tax man.
Q. Government victories in recent years in the battle against tax evasion have relied on bank data stolen by former employees and purchased by national tax authorities. Is it ethical for governments to use such data?
A. Governments use all kinds of sources of information to go after criminal activity. This includes undercover police, stool pigeons, eavesdropping and similar ploys. In some cases they are sanctioned by law, in other cases by court order before the fact, and in still other cases by a judge’s determination at trial regarding the admissibility of evidence. Evidence regarding financial secrecy enabling tax evasion would be covered by the same standards anchored in the law and the administration of justice, so there are no ethical questions once the rules of the game are set. This applies to cases where tax evasion is a criminal offense and prosecuted under criminal law. Where tax evasion is a civil offense the ethics issue becomes debatable, since standards of prosecution tend to be much lower – for example, “preponderance of evidence” versus “beyond a reasonable doubt.”
Q. Isn’t poor tax compliance partly a country’s own fault?
A. Sure. Some tax codes are horrible, including the United States – opaque, complex, riddled with exceptions and carve-outs, loopholes and special-interest provisions and viewed by many as not only inefficient but also fundamentally unfair. Couple this with human greed and street smarts - and you have a solid demand for a financial service that extends as far as the eye can see. Switzerland and others have always argued with some justification that it’s not their job to collect other people’s taxes. Too bad. Right now they’re easy targets, a lot easier than sensible tax reform at home.
Q. What impact do anti-terrorist initiatives have on global patterns of tax evasion?
A. The attacks on New York City in 2001 triggered renewed interest in cross-border financial transfers that are necessary to carry out acts of terrorism. The amounts involved are usually very small but nevertheless crucial in enabling terrorism – the classic “needle in a haystack” problem. Terrorist funding must be kept secret, usually disguised as commercial transactions or personal remittances. There have been systematic efforts by the US and other countries to root-out terrorism-related financial flows and promote cooperation among governments. In the process, investigators inevitably come across substantial financial assets that are unrelated to terrorism but are nevertheless the proceeds of criminal activity – such as organized crime, extortion, human trafficking and the drug trade . Surfacing these kinds of financial flows and assets represent a valuable “bycatch” of efforts to cut off the financial air supply to terrorist groups.
Q. The majority of insider trading scandals uncovered by the US Securities and Exchange Commission involved offshore accounts. Why ?
A. Insider trading needs secrecy to work. Financial operations to trade on inside information require significant exposures (and sometimes leverage), which have to remain confidential. The proceeds likewise need the protection of secrecy at the time of the illegal transactions and thereafter. Consequently the use of offshore accounts routed through channels for no commercial purpose other than secrecy is virtually ubiquitous. Suspicious trades are usually flagged by brokers to the authorities (in the United States, the Securities and Exchange Commission) which will decide whether an investigation is warranted. If the insider trading ring is large, prosecution may be facilitated by cutting deals with peripheral members in return for leniency – a tactic that can blow up an insider trading ring remarkably quickly - followed by requests to foreign financial authorities for information relevant to a criminal investigation.
Q. Pretend you are the former Finance Minister of Kleptocia, a small developing country with substantial mineral wealth. Back home you are known as “Mr. 5%” - and you have managed to squirrel-away over $700 million in overseas accounts before your government was ousted and you became an ordinary, law abiding private citizen. You have big plans for homes in Cannes and New York, a flat in Mayfair, and maybe even a personal aircraft. How do you get to keep and use the stash you worked so hard to accumulate?
A. This is not an easy question. Increasingly even the most hard-nosed secrecy havens want to stay well clear of clients who are corrupt politicians. Misdeeds will ultimately come out, often involving heinous acts committed on their watch, and this is very bad for the private banking business. Legitimate wealthy clients, and even otherwise respectable tax evaders, want nothing to do with a bank that has aided and abetted political suppression or crimes against humanity. So finding secrecy havens becomes increasingly tough, involving stacks of intermediaries, shell companies, foundations and the use of financial centers that are not too particular about dealing with crooks.
So your hypothetical ex-government official would do best to leave the country post-haste and establish residence and possibly buy citizenship in a country that will sell it in order to impede later extradition. Meanwhile, employ a “secret agent” who is well plugged-in but has flexible integrity. Have him or her construct a secrecy edifice with as many defenses as possible. It would not be surprising if 20% or so of the investable assets (after adjusting for increased risk) get spent in this project. Even then, you are in no position to take your secret agent to court if you’re shortchanged. Will the sleepless nights ever end? But hey! Better than life in a Kleptocian prison with the rats and cockroaches – or worse.
[i] If you want to know more, take a look at my “The Use and Misuse of Financial Secrecy in Global Banking,” Chapter 15 in John Nofsinger (Ed.), Socially Responsible Financial Investing (New York: Wiley, 2012).