09/17/2009 05:12 am ET Updated May 25, 2011

Tax Fraud, Tax Havens, UBS and Bears ... Oh My!

The U.S. government has come to an agreement with UBS regarding a long-running tax fraud investigation. This has been a fascinating case to watch for several reasons that I will explain.

First, in the interest of full disclosure, I am a tax attorney and I deal with international transactions. As such, I am familiar with many of the jurisdictions involved.

Here is the settlement announcement:

The days of secret bank accounts are numbered for Americans after UBS and the U.S. and Swiss governments agreed to settle a dispute over whether the Swiss bank should be forced to disclose the names of 52,000 rich U.S. clients suspected of tax evasion.

Lawyers involved in the case said Wednesday's settlement could involve the disclosure to U.S. authorities of 3,000 to perhaps more than 10,000 names of American clients suspected of using offshore accounts to evade taxes.

While details weren't disclosed, the parties have initialed agreements that will "take a little time to be signed in final form," Department of Justice lawyer Stuart Gibson told U.S. District Court Judge Alan Gold during a brief conference call.

The case is expected to be dismissed once a final agreement is in place. UBS and the government had reached a settlement in principle on July 31.

The deal is also expected to put European tax dodgers on notice as other governments are encouraged to seek out hidden accounts.

Let's back up in history to explain what's going on from a macro-perspective. Starting in the late 1990s, the OECD (Organisation for Economic Co-operation and Development) engaged in a very serious campaign to limit the impact and availability of offshore jurisdictions. The OECD reframed the debate claiming these jurisdictions engaged in "unfair tax competition." The reason is large industrialized countries were seeing their tax base move offshore and they needed to do something to stop it.

After 9/11 the U.S. and other industrialized countries started attacking off shore secrecy, arguing that it promoted terrorism and organized crime. This argument had traction. As a result, many jurisdictions have signed (and will continue to sign) "mutual assistance treaties." These treaties allow one country to access the financial records of an individual in another jurisdiction if the first jurisdiction meets certain standards. While the standards vary depending on the treaty, the end result has been a continued erosion in offshore secrecy. This trend will continue for the rest of our lives.

Let's come back to the present to explain what is going on. The U.S. -- like most industrialized countries -- has a world wide tax system. That means the U.S. will tax a U.S. resident's/citizen's income regardless of the income's location. In addition, we have a self-reporting system, meaning we tell the government where our money goes. When a U.S. citizen moves money offshore he has to file certain documents with the IRS to be in compliance with the law.

Secrecy helps to shield transfers from this system of self-reporting. Once money moves into a foreign bank account that is numbered, and it's located in a country that has strict secrecy laws, the probability is high that the money will fall into a tacking black hole. There will be some kind of record of the money leaving the country (via a wire transfer or a large withdrawal), but then it disappears. Once the money is in one secret bank account, the account holder will probably move the money to another country with strict bank secrecy laws:

On Friday, John McCarthy, a UBS client in California, agreed to plead guilty to one count of failing to file an annual report to the Treasury Department. A document filed with the plea shows the tax scheme relied in part on channeling funds to a Swiss UBS account held in the name of a Hong Kong entity, the second time accounts in the Asian financial hub have figured in these cases.


Between 2003 and 2008, Mr. McCarthy talked with UBS representatives and the Swiss lawyer in Beverly Hills and Switzerland to hash out details of his business, according to the statement. UBS representatives told Mr. McCarthy that "a lot of United States clients don't report their income and just take it off the top."

At one point, the Swiss lawyer recommended to Mr. McCarthy that he set up a Liechtenstein foundation that would serve as an umbrella over a Panamanian or Hong Kong corporation. That "would allow for an extra layer of privacy and help to conceal" Mr. McCarthy's identity, said the statement of facts.

Mr. McCarthy also transferred funds into other UBS accounts from a bank in the Cayman Islands, the statement says. He is due to appear in federal court on Sept. 14. He faces a maximum penalty of five years in prison and fines totaling $250,000.

"Mr. McCarthy has accepted responsibility for his conduct," said his lawyer, Steven Toscher. "He, like many other U.S. taxpayers, has made serious mistakes regarding the use of foreign bank accounts. Mr. McCarthy has decided to get right with his tax obligations and his case should serve as a strong signal to other taxpayers."

Jeffrey Chernick of New York, who pleaded guilty in July to filing a false tax return, also used a Hong Kong corporation and offshore bank accounts to conceal from the IRS commissions paid for sales, according to a statement of facts agreed to by the Justice Department and Mr. Chernick. A lawyer for Mr. Chernick declined to comment.

The UBS case has been fascinating from a legal perspective for two reasons.

1.) UBS settled the case. In doing so, they are possibly exposing themselves to Swiss lawsuits regarding a violation of Swiss banking secrecy laws. That tells us a very important fact: the U.S. government had UBS dead to rights.

2.) This is a major crack in the bank secrecy issue. Switzerland is the gold standard of secrecy. If they crack, expect the bank secrecy issue to fall faster than anticipated.