04/12/2011 08:13 pm ET Updated Jun 12, 2011

Your Broker Can Eliminate Your Tax Liability

It's tax time, so I thought I would blog about a little known benefit of using major brokerage firms.

A huge profit center for the brokerage industry is its willingness to assist clients who wish to engage in tax evasion. It's a very lucrative business.

You may remember the conduct of UBS, which agreed to pay $780 million and hand over customer details to settle charges of tax fraud in the U.S. UBS allegedly set up shell accounts to assist U.S. based customers in hiding assets from the IRS. Its scheme involved 250-300 U.S. citizens.

This conduct is not limited to UBS or to U.S. citizens. I recently experienced it firsthand. A foreign citizen asked me to review his portfolio which was held in the Cayman Islands, in a trust set up by a foreign subsidiary of a major U.S. brokerage firm. The account was managed by another affiliate of the U.S. broker, based in the Caymans.

The portfolio was the typical broker fare: high expense ratio proprietary mutual funds, and a mish mash of individual stocks and bonds. I advised the client to extricate himself from the clutches of the broker and to set up another trust in the Caymans, so that he could invest in a globally diversified portfolio of low cost index funds. I referred him to a prominent law firm in the Caymans. Nice plan, but it didn't work.

The law firm, in compliance with local law, insisted on proof that taxes had been paid on these funds. The client could not produce this proof. The firm refused to set up the trust. When I asked how the U.S. brokerage firm was able to create a trust without complying with local law, he told me "everyone knew" how the big brokerage firms use their resources to avoid tax liability for their clients and skirt local laws.

It would have been a lot cheaper for this client to pay his taxes and implement a portfolio based on sound principles of finance. Instead, he is essentially held hostage by a brokerage firm that can do whatever it wants with his portfolio, without fear of redress.

The experience of this foreign citizen is repeated countless times in the many tax havens in the world. U.S. based brokerage firms, and their foreign counterparts, stand ready to help anyone with sufficient assets avoid their tax obligations, in exchange for taking over "investment management" of their money.

For their clients, it's a Faustian bargain. For the brokerage firms, it's another day at the office.

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