United States: Swiss Bank Settlement Dilemma

Last Updated: November 14 2013
Article by Lawrence M. Hill and Richard A. Nessler

On August 29, 2013, the United States Department of Justice ("DOJ") and the Swiss Federal Department of Finance, following nearly two years of negotiations, jointly announced a settlement program that offers amnesty to Swiss banks and resolution regarding involvement with individuals and entities that used Swiss accounts to evade US taxes and reporting requirements.1 The new program is similar to the IRS Offshore Voluntary Disclosure Program ("OVDP"), which incentivized US taxpayers to report undisclosed foreign accounts to the IRS to reduce substantial civil penalties and eliminate the risk of criminal prosecution. The settlement program provides a unique administrative solution to avoid legal challenge to Swiss bank secrecy law. In addition to the joint announcement, the DOJ issued a document captioned "Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks", which explains the settlement program in greater detail.

The settlement program entails a four-tiered ranking system which is based on respective degrees of culpability and categorizes each Swiss bank's exposure to illegal activity. Any Swiss bank that has reason to believe it may have committed tax-related offenses and is willing to participate in the program must disclose its activity in a letter to the DOJ no later than December 31, 2013. As of January 1, 2014, the DOJ may authorize new criminal investigations of Swiss banks who fail to notify the DOJ of their intent to enter into the settlement program.

Under the ranking system, Category 1 banks consist of the fifteen Swiss banks currently under criminal investigation. Recently, Swiss bank Rahn & Bodmer Co., one of the oldest private banks in Zurich, announced that it was under US criminal investigation. Credit Suisse and Jules Baer Group have also been reported to be under criminal investigation.2 These banks are excluded from the program. Others who are excluded from the program include insurance companies, financial advisors, lawyers, asset managers, and fiduciaries.

Category 2 banks are those that "have a reason to believe" that they have committed tax or related criminal offenses under US tax law in connection with undeclared US taxpayer accounts. Category 2 banks are the only Swiss banks eligible for a non-prosecution agreement ("NPA"). Any Category 2 bank that wishes to obtain an NPA must submit a letter of intent to the DOJ Tax Division containing certain disclosures. The letter must include a plan for complying with the program requirements; provide the identity and qualifications of an independent examiner (a qualified attorney or accountant who will certify the information); represent that the bank will maintain all records required for compliance with the terms of an NPA, including all records that may be sought by treaty; and acknowledge that the bank will waive any potential defense based on the statute of limitations for the period August 29, 2013 to the issuance of the NPA. The bank has 120 days to comply with these requirements from the submission date of the letter of intent. The DOJ will permit a one-time extension of 60 days upon a showing of good cause.

Prior to the execution of an NPA, a Category 2 Swiss bank must disclose to the Tax Division the following evidence and information:

  • How the cross-border business for US-related accounts was structured, operated, and supervised;
  • Provide the name and function of employees who structured, operated, or supervised the cross-border business;
  • Explain how the bank attracted and serviced account holders; and
  • Disclose the total number of US-related accounts and maximum dollar value of accounts greater than $50,000 during three separate periods.

Upon execution of the NPA, the Category 2 bank must provide further details about US-related accounts that were closed after August 1, 2008, including the total number of accounts, and as to each account, the maximum value of each account, whether the account was held in the name of an individual or an entity, the number of US persons or entities affiliated with each account, the name and role of outside advisor, and information regarding transfers of funds into or out of the account. The Swiss bank must also agree to provide an in-person presentation to the DOJ to explain and support the disclosure.

As a condition of the NPA, the Swiss bank must also provide all necessary information for the United States to draft treaty requests to seek account information, and the bank must collect and maintain all records that are potentially responsive to any treaty requests to facilitate prompt responses. The Swiss bank must agree to retain records of all US-related accounts closed after August 1, 2013 for a period of 10 years from the termination date of the NPA. The NPA will further require that the Swiss bank, upon request, will provide testimony of competent witnesses as needed to the United States, and assist to translate significant documents at the bank's expense.

The Category 2 bank must also agree to close any and all accounts of recalcitrant account holders (as defined in I.R.C. Section 1471(d)(6)), agree not to open any US related accounts except on conditions that ensure that the account will be declared to the United States and will be subject to disclosure by the Swiss bank, and implement procedures to prevent its employees from assisting recalcitrant account holders to engage in acts of further concealment.

If the Tax Division concludes that a Swiss bank has met all obligations set forth in the NPA, the DOJ will not prosecute the Swiss bank for any tax-related offenses in connection with undeclared US-related accounts held by the Swiss bank. However, if the Tax Division determines that the Swiss bank's conduct demonstrates extraordinary culpability, the Tax Division may require the Swiss bank to enter a Deferred Prosecution Agreement ("DPA") instead of an NPA. Upon execution of the NPA, a significant civil penalty will be imposed upon the Swiss bank. Penalties will be assessed based on the amount held in the account. The settlement program would require the Swiss banks to pay a 20-percent penalty to the United States of all non-disclosed US- related-accounts that were held by a Swiss bank on August 1, 2008. The penalty would increase to 30 percent if there is evidence that the accounts were opened after that date but before the end of February 2009, when UBS entered into a DPA and agreed to pay a $780 million fine and turn over information on thousands of US accounts. The penalty would increase to 50 percent for accounts opened after February 2009. It is not clear whether the Swiss bank will obtain credit from the Tax Division if an account holder participates in the IRS's voluntary disclosure program. In addition, it is not clear whether Swiss banks will be required to pay a penalty on the same funds, if the US account holder moved the account from one Swiss bank to another.

If a Swiss bank believes that it has not assisted US taxpayers with undisclosed accounts, it may apply to the Tax Division as a Category 3 institution. Category 3 banks are those which are not under criminal investigation and believe to have not assisted US taxpayers with undeclared accounts. A Category 3 bank may request a "Non-Target Letter." A Non-Target Letter refers to a letter from the Tax Division stating that, as of the date of the letter, the Swiss bank is not the target of a criminal investigation by the Tax Division for violation of any tax-related offense in connection with undeclared US-related accounts.

The Category 3 bank must engage an independent examiner to conduct an independent internal investigation. The independent examiner must verify the percent of the Swiss bank's account holdings and assets under management that are US-related accounts; verify that the Swiss bank has an effective compliance program, and provide the Tax Division with a written report that includes (i) the witnesses interviewed, (ii) a summary of the information provided by the witness, (iii) identification of the files reviewed by the examiner, (iv) the factual findings of the examiner, and (v) the conclusions reached by the examiner.

The Tax Division may decline to provide a Non-Target Letter to any Swiss bank if it determines that the bank has failed to meet these requirements, or if the information provided is false, misleading, incomplete, or the DOJ has information that contradicts the examiner's report.

The Category 3 bank must submit a letter to the Tax Division no earlier than July 1, 2014 and no later than October 31, 2014. If a Swiss bank initially believes that it falls under Category 3, but after an internal investigation discovers that it should have instead requested a NPA as a Category 2 bank, the Tax Division may consider whether to grant the bank's request for an NPA so long as the request for such relief is made before October 31, 2014. Relief will be granted at the sole discretion of the Tax Division, but only under "extraordinary circumstances." Moreover, the Tax Division may deny relief if the bank is under criminal investigation, or if the Tax Division has received information concerning wrongful conduct. This may not be known to the bank. Evidence of wrongful conduct may have already been provided to the Tax Division by an account holder who participated in the IRS's OVDP initiative. In addition, the DOJ has declared a moratorium on identifying new banks as criminal targets until January 2014. This means that a bank may miss the deadline to file for relief as a Category 2 bank and be denied Category 3 relief because the bank, unbeknownst to it, was under criminal investigation. Accordingly, both of these factors must be carefully considered before a Swiss bank elects to wait and apply as a Category 3 bank. Because this may leave Swiss banks in a difficult position if they miss the deadline for filing as a Category 2 bank, banks must immediately begin their internal investigation to determine if the bank is culpable under US tax law.

The Tax Division has 270 days from receipt of the independent examiner's report to inform the Swiss Bank whether it is eligible for a Non-Target Letter as a Category 3 bank. The Tax Division may decline to provide a Non-Target Letter to any Swiss bank if it determines that the evidence or information contradicts the report of the independent examiner, or otherwise demonstrates criminal culpability. No penalty is imposed on a Category 3 bank.

The last category, Category 4, covers any Swiss bank that is not under formal criminal investigation and is a "Deemed Compliant Financial Institution" as a "Financial Institution with Local Client Base" under FATCA. A bank requesting a Non-Target Letter as a Category 4 bank must follow the same application time line as a Category 3 bank and include the same information as a Category 3 bank. No penalty is imposed on a Category 4 bank. Also, Category 3 and 4 banks must retain records for 10 years following the signing of a Non-Target Letter.

The decision to participate in the program should not be made lightly. Among the myriad of issues Swiss banks should consider are the following:

  • What are the potential criminal, civil and reputational risks of electing not to participate in the program?
  • What evidence should be compiled to determine whether US-related accounts are noncompliant?
  • What are the potential civil penalties associated with those accounts?
  • How should an acceptable plan be formulated to comply with the program requirements?
  • What is the potential risk of filing as a Category 3 bank when the bank is already under investigation by the DOJ?
  • What criteria should be used to select a qualified independent examiner?
  • How should employees and advisors who structured, operated, or supervised the cross-border business be dealt with?
  • How will disclosure impact customer relationships and how can the bank mitigate reptuational risk associated with such disclosure?

Because of the rapidly approaching deadline and the many uncertainties concerning what the Tax Division's state of knowledge of the Swiss bank's operations, banks must promptly commence an internal review, and complete it expeditiously. The deadline for the submission of the Category 2 application is December 31, 2013. The effort to review accounts and prepare the necessary paperwork will be a costly and time consuming exercise, but failure to act quickly and correctly may lead to more severe treatment if no application or the wrong application is filed with the Tax Division. Although far from optimal, the settlement program provides a unique remedial opportunity for Swiss banks to obtain closure of US criminal tax exposure. A Swiss bank that ignores the settlement program may face years of litigation and uncertain reputational, financial and criminal risks.

Foontote

1 The press release can be found at http://www.justice.gov/iso/opa/resources/7532013829164644664074.pdf.

2 Bank Frey & Co. AG was also the subject of a DOJ criminal investigation. On October 17, 2013, Bank Frey announced that it would cease operations as a bank, citing "unsustainable requirements" that resulted from Switzerland's tax dispute with the United States.

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