08 Jan 2020
Diligent KYC360 readers should take note of the recent action by the US Department of Justice (DOJ) against HSBC Private Bank (Suisse) SA (HSBC) following the bank’s admission that it conspired with American customers to facilitate tax evasion. The bank entered into a Deferred Prosecution Agreement (DPA) with the Justice Department and paid a penalty of $192 million.
As part of the DPA, the private bank admitted to coordinating with its employees, third-party and wholly owned fiduciaries and US clients in a scheme that defrauded the US of tax revenue between 2000 and 2010. At one point in 2002, the bank had 720 undeclared US client relationships with a total value exceeding $800 million. By 2007, the bank’s asset management arm controlled $1.26 billion in undeclared assets on behalf of US clients.
“HSBC Switzerland conspired with US account holders to conceal assets abroad and evade taxes that every American must pay. Banks, asset managers and other financial firms enable such crimes – and we will hold these institutions to account, right along with the taxpayers that use them to facilitate and disguise illegal activities,” a Justice Department official said in a statement.
HSBC Switzerland was incorporated in 2001 with its headquarters in Geneva. It is a product of mergers and takeovers, principally Republic National Bank of New York, Safra Republic Holdings SA and HSBC Guyerzeller. The bank offered private banking and asset management services to customers both inside and outside Switzerland. Each customer had a relationship manager while the bank acted as a custodian of assets overseen by third-party investment managers and trustees.
Code words and nominees
Between 2000 and 2010, HSBC assisted US taxpayers in filing false returns and concealing offshore assets and income from the IRS. HSBC did this by knowingly opening and maintaining concealed accounts for US taxpayers, allowing third-party investment managers to oversee concealed assets on behalf of the clients and assisting them in concealing their assets and income in other ways.
Accounts controlled by US persons often had a number or code word in the account title rather than the name of the individual taxpayer, as did bank correspondence with customers. Nominees were regularly used for accounts controlled by US persons by means of specially established trusts, foundations or shell companies established in offshore tax havens with strict secrecy rules.
HSBC conducted business with its clients via its bankers and client advisors. At least twenty bankers travelled to the US to meet with wealthy clients. At other times, American account holders who had concealed assets and income travelled to Switzerland to meet their bankers and client advisors.
HSBC helped their US clients conceal assets and income from the IRS in a variety of ways. Bankers advised clients not to return to the US with more than $10,000 in cash in order to avoid having to make a currency declaration at the border. Clients were also told to make international fund transfers of less than $10,000 to conceal their activities from US authorities.
The bank provided clients with debit, credit and prepaid cards linked to their undeclared accounts. Debts incurred on the cards were settled from the undeclared accounts, which also funded the bank’s prepaid cards. Some clients were advised not to use their cards in the United States, while the cards themselves often omitted the account holder’s name.
HSBC also provided American customers with nameless cheques that could be drawn on accounts held at its correspondent banks. These cheques, which were essentially cashiers cheques, obscured the link to the clients’ concealed accounts. The bank encouraged its US clients not to receive correspondence, including account statements, from Switzerland. During their visits to the United States, bankers would request clients to sign “hold mail” agreements to assist in the concealment of the accounts from the IRS.
Additionally, the bank often advised its US clients to establish trusts, foundations or shell companies to conceal the link between a US taxpayer and an account. Sometimes the bank used fellow companies in the HSBC Group to facilitate the creation of these vehicles, which were frequently domiciled in the British Virgin Islands, Liechtenstein or Panama, all of which maintain strict secrecy laws.
Staff employed by HSBC Group entities or third-party firms acted as trustees or directors in these structures. However, rather than acting independently, they acted at the direction of customers who beneficially controlled the accounts. Furthermore, the bank knowingly accepted an IRS tax declaration W-8BEN that falsely stated that directors of shell corporates or trustees of trusts were the beneficial owners of the vehicles for US tax reporting purposes.
Historically, the IRS established the Qualified Intermediary Agreement (QIA) programme so that foreign institutions could report holdings in US securities by their own clients. The objective of the programme was to ensure foreign holders of US securities were subject to the correct withholding tax rate, while American citizens properly paid their taxes.
To overcome local secrecy laws, the QIA required the Swiss banks to obtain its client’s consent to disclose their name to the IRS. The programme also required the banks to report to the IRS all holdings in US securities by all existing and new US clients.
To avoid these reporting obligations, HSBC recommended that its US clients establish offshore trusts, foundations and shell companies. The bank accepted declarations that trustees and nominee directors were the beneficial owners of the entities despite knowing that the declarations were false and misleading. Even in those cases when a US client gave permission for full disclosure of the account details, the bank failed to report the correct information to the IRS.
The edifice crumbles
The Swiss private banking sector was aghast to learn in early 2008 that the Justice Department had launched a criminal investigation of UBS, the largest bank in Switzerland, for tax evasion regarding undeclared assets and income of its American clients. HSBC responded by managing a series of policy changes that eventually led to its withdrawal from this market.
The first step was an instruction to the bankers not to accept any new US clients who wanted to transfer from UBS—a mandate ultimately ignored by some HSBC bankers. The second step was to implement a policy whereby accounts would only be opened for US clients in “exceptional circumstances” when evidence was provided that the “account is not for tax avoidance”.
In early 2009, HSBC decided to close accounts of US clients who held less than $1 million of assets under management. Those US clients who met this test were required to make a US tax declaration confirming they were the beneficial owner of the account and provide a waiver from Swiss banking secrecy. Faced with this new policy, some HSBC bankers helped their US clients to move their undeclared assets and accounts to other Swiss private banks that were still accepting American customers. In other cases, bankers allowed US clients to withdraw their funds in cash, thus contravening bank policy. After one client was found guilty of trying to import cash from his HSBC account into the United States, the bank set monetary limits on cash withdrawals.
Eventually, in late 2010, HSBC decided that it would only accept fully documented US clients with at least $5 million in assets. The bank also prohibited a number of specific types of transactions that clients had use to conceal undeclared assets.
Case studies in tax evasion
As part of the settlement, DOJ provided some case studies to demonstrate how HSBC acted illegally. In the first example, Client A and her siblings inherited the funds in an HSBC account in 1996. Her banker advised her to establish a shell company in an offshore tax haven, which in turn would be owned by a trust. The bank arranged for corporate directors and trustees to represent the entities. The HSBC banker informed Client A that this structure would make it difficult for the IRS to detect her account ownership. Under this arrangement, Client A still had direct access, via her banker, to the corporate account and could bypass the directors who legally managed the company. Her banker also provided credit cards to Client A’s children and had any debts incurred on the cards settled with the corporate account. Under Client A’s instruction, her banker purchased work of arts outside the United States, again funding the purchases from the undeclared account. Finally, when in 2007, the HSBC Group decided not to provide trusts, foundations and shell companies for US clients, the bank transferred management of the company to a third-party fiduciary, who was a former employee of HSBC.
In the second case study, an HSBC banker persuaded Client B to transfer some of his undeclared assets from three other Swiss banks to HSBC Switzerland. To obscure funds transfers, the customer should establish a shell company in Panama, the banker suggested. But Client B should be careful not to call the banker from the United States or to transport any account statements back across the US border, he was told. Client B closed his account in 2009, around the time when the institution began imposing new restrictions on its American clients.
In the third case study, Client C had a HSBC account from 1990 to 2009 that was funded by his non-US family. In 2000, his banker advised Client C that if he wished to continue to hold US securities in the account, a shell company based in an offshore tax haven, such as the British Virgin Islands, should hold the assets. However, this advice was not acted on. The HSBC banker provided the client with a travel card, used in both Europe and the US, that was frequently replenished from the undeclared account. Client C closed his account in 2009 around the time HSBC began closing US accounts.
HSBC comes clean
In December 2008, HSBC self-reported its activities to the DOJ prior to the conclusion of the UBS investigation that eventually led to a $780 million settlement with US authorities. The bank provided extensive cooperation to the DOJ, including reporting the results of an internal investigation, which assisted in the prosecution of several US taxpayers.
HSBC also encouraged its US clients to self-report their undeclared assets and income to the IRS, while in Switzerland it lobbied the federal government to change Swiss law to provide for greater tax transparency. The bank implemented new procedures to mitigate tax evasion, including limiting cash withdrawals and discouraging the use of the “hold mail” facility. Accounts are now monitored for potential tax evasion “red flags” and, whenever matters cannot be resolved, accounts are closed. HSBC has effectively withdrawn from the US client market. The bank now participates in mandatory schemes for automatic exchange of tax information between Switzerland and other countries.
Lessons to be learned
There are a number of lessons that Compliance staff may learn from this saga.
Firstly, the Statement of Facts agreed to by the DOJ and HSBC deserves close inspection. It demonstrates, once again, that when the first line of defence—the client-facing staff—decides to ignore or disregard any form of regulatory risk, there may be serious consequences. The document also provides Compliance staff with various typologies and a wealth of training material that may be used as a part of their procedures to prevent tax evasion.
Secondly, one lesson that Compliance staff should learn is that, whenever they discover a significant issue in one part of their corporate group, they should consider whether similar issues exist elsewhere in the group. Although the bank self-reported its illegal acts to US authorities, the wider HSBC failed to consider whether its Swiss operation was helping clients based in other jurisdictions to evade tax. Following a leak by a whistleblower in 2014, HSBC paid a fine of €353 million to the French authorities to settle charges that its French unit, again with the help of HSBC Switzerland, assisted local clients evade tax on $1.6 billion of assets. Similarly, in August 2019, HSBC paid a fine of €294 million to the Belgian authorities for tax offences, whilst currently the HSBC Group is resisting legal attempts by the Argentinian government to recover $3.5 billion following a claim of tax evasion by local clients.
Thirdly, with the introduction of the automatic exchange of tax information as a matter of routine between jurisdictions brought about by the US Foreign Account Tax Compliance Act and the Organisation for Economic Cooperation and Development’s Common Reporting Standard, Compliance staff should not become complacent about the potential for their firms to be used for tax evasion. Similarly, they would not disregard the possibility of clients trading in the securities whilst in the possession of inside information simply because all securities transactions are routinely reported by firms to regulators. Like HSBC, some 82 Swiss banks have similarly settled with US authorities. Invariably, this means that US taxpayers have transferred funds to Switzerland in order to evade US tax obligations. A reasonable person may ponder whether banks in Switzerland or other secrecy jurisdictions only assisted US taxpayers to evade their taxes or whether their services were available to taxpayers of other nations.
Fourthly, Compliance staff should remember that Article 3 of the EU Fourth Money Laundering Directive explicitly includes “tax crimes” as an underlying predicate offence. Accordingly, EU-based firms and groups should be considering, as part of their business and client-risk assessments, the potential for their services to be used for tax evasion. Appropriate staff training and transaction monitoring may be required as well.
Fifthly, Compliance staff in firms or groups with a UK nexus should consider whether they have adequate procedures to prevent the corporate criminal offence of facilitating tax evasion. Unlimited fines are a possibility for firms that are found to have assisted tax evaders. Official UK government guidance on the “adequate procedures” defence to the corporate offence should be reviewed.
Finally, the ongoing CumEx scandal in Europe involving a reported €63 billion in fraudulent repayment claims of withholding tax on corporate stock dividends demonstrates that Compliance staff should remain alert to the possibility that both their firms and their clients may be involved in tax evasion.
The DOJ action against HSBC is just the latest in a long line of sanctions against Swiss banks for helping US clients evade their taxes. There must be doubts as to whether the Swiss banking industry only assisted US persons in evading their taxes rather offering their facilities to nationals of other jurisdictions for a similar purpose. Legislators around the world have now implemented measures to significantly reduce tax evasion by requiring financial firms to be more transparent about their customers’ tax affairs.
Firms that have not realised the “new normal” regarding tax evasion may be in for a big shock!
Denis O’Connor is both a Fellow of the Institute of Chartered Accountants in England & Wales and the Chartered Institute of Securities and Investment. He was a member of the British Bankers’ Association Money Laundering Committee from 2003 -10; and a member of the JMLSG’s Board and Editorial Panel between 2010 and 2016.
He has been a frequent speaker at industry conferences on financial crime issues, both in the UK and abroad.
This article is expressing personal opinions and is meant for information purposes only. The article does not intend to replace professional or legal advice. It is recommended that readers seek independent professional or legal advice, or speak to authorised persons/organisations.
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