UBS and the Diamond Smuggler

The private-banking scandal that is rocking Swiss finance began with illegal diamonds, a tube of toothpaste, and a rogue American banker. An exclusive look inside the low end of high finance.

Condé Nast Portfolio
Portfolio.com
By Paul Sullivan
October, 2008

Brad Birkenfeld was a frequent trans-Atlantic flier. He lived and worked in Switzerland, dividing his time between an apartment in Geneva and a house in Zermatt, an Alpine village at the base of the Matterhorn. But his biggest client was in California, and however grueling the trip through nine time zones was, it was worth it. Without that client’s $200 million to manage, Birkenfeld’s position in the private-banking division of UBS would have been far less secure.

Although Birkenfeld’s job title was innocuous enough—director at the Swiss bank—his job since October 2001 was not. He helped the very rich hide tens, if not hundreds, of millions of dollars from U.S. tax authorities. He was willing to go the extra mile for his clients, so he didn’t blink when one of them asked him to do something that was blatantly illegal by any country’s standard: Buy diamonds with secret Swiss funds and bring them into the U.S. undeclared and undetected.

This would have been a challenge at any time, but in the aftermath of the September 11 terrorist attacks, getting the diamonds into the U.S. seemed nearly impossible. If Birkenfeld put the diamonds in his carry-on bag and a screener found them, he would have to exhaust his powers of persuasion concocting a story about how he had forgotten to declare hundreds of thousands of dollars in precious stones.

Yet declaring them wasn’t an option. That would have created a paper trail. Since the money that purchased the jewels was unknown to U.S. tax authorities, the diamonds had to be as well. To get them into the country, Birkenfeld had only one option. He had to smuggle them in.

So Brad Birkenfeld, a banker at one of the most prestigious institutions in global finance, began jamming his clients’ loose diamonds into a tube of toothpaste. Believing he had successfully masked the stones from security screeners, he boarded his flight. He was wrong about the disguise, though. Unlike cocaine, diamonds look exactly the same in an X-ray as they do in plain sight, and toothpaste certainly doesn’t mask that. Either the security screener wasn’t paying attention or he thought the shiny bits were very large whitening crystals.

As Birkenfeld strolled out of the airport onto U.S. soil, he had no idea how lucky he had been. Like a high-end mule, he delivered the tube of toothpaste to his client without incident. His audacious scheme had worked—until it didn’t.

It took seven years, but on a humid South Florida morning in June, Birkenfeld was finally called to account. Bulked up, with a goatee on his tan face, he was sandwiched between his two attorneys as they entered federal court in Fort Lauderdale. He looked nothing like a smuggler or, for that matter, a jet-setting private banker. He most closely resembled a once-great high-school athlete whose best days were behind him. He had, however, packed the courtroom to capacity. He was a star criminal.

A U.S. citizen, Birkenfeld had become a regular feature on Swiss news programs, because the information he promised to provide could well unwind 300 years of bank secrecy and dismantle the largest Swiss bank operating in the U.S.

When the judge, William Zloch, appeared, Birkenfeld popped to his feet. He had been cooperating with U.S. investigators for over a year from Geneva, hoping to avoid arrest by helping them build a case against UBS. But he had been charged anyway, for conspiracy to defraud the U.S. government by helping his biggest client, Igor Olenicoff, a Russian-born property developer in California, evade $7.2 million in taxes on $200 million in assets he had hidden in Switzerland and Liechtenstein. Birkenfeld was looking at a jail sentence of five years and a $250,000 fine, but had pledged in a plea agreement to cooperate formally with the U.S. government, promising to tell everything he knew about UBS’s offshore private-banking business in exchange for leniency.

Judge Zloch, a former Notre Dame quarterback, was all that stood between Birkenfeld and a lighter sentence. But before accepting Birkenfeld’s guilty plea, the judge ran him through a preliminary set of questions—name, age, education, drug use (Lipitor, 10 milligrams that morning)—until he arrived at the meat of the case against him.

“You committed these acts willfully. No one forced you to do this?” the judge asked.

“No, Your Honor.”

“Is that correct?”

“That’s correct.”

“Why did you engage in this conduct?”

“I was employed by UBS, and I was paid a large salary and incentivized to do this business,” Birkenfeld answered.

“Even though it was fraudulent.”

“Yes, Your Honor.”

Since Birkenfeld waived the reading of the indictment and the statement of facts, the most shocking details about his deeds came out later in a series of court filings that make him sound more like a spy than a banker. He put cash and valuables, the documents stated, in Swiss safe-deposit boxes. He purchased jewels and artwork with funds from secret Swiss accounts. He misrepresented funds from clients’ bank accounts as loans. He destroyed all records of clients’ offshore banking.

After a pause, Zloch asked Birkenfeld if he was concerned about what he did.

 “It did concern me,” he said.

“But not enough to stop you?”

“I did have doubts about that and then resigned from my bank several years ago.”

“But that was after the fact.”

“Yes, Your Honor.”

Zloch noted that the defendant agreed to “render…substantial assistance to the government” in exchange for punishment that is less than what is stipulated in the sentencing guidelines. But he made sure that Birkenfeld understood that this was no free pass and that any reduction in sentencing would be decided by the U.S. Attorney’s office based on the degree of Birkenfeld’s cooperation.

Birkenfeld was hurried out of the courtroom, looking like a bloated, tan version of Jim Cramer, if the Mad Money host had lost his manic energy. His deep-blue eyes were fixed on the rain outside. If there was one look on his otherwise blank face, it was bafflement: How did Brad Birkenfeld, international banker, end up here? And how could one man inside a huge bank come to threaten a way of doing private-banking business that dates back to Louis XIV?

The last thing UBS needed this summer was Brad Birkenfeld. The public disclosure of his actions, which were later luridly described to federal investigators, was one of several crises to hit UBS this year. It had already written down $38 billion from subprime-mortgage-related losses, and in the summer it became the target of lawsuits brought by a host of state attorneys general over its role in the auction-rate securities market, which involved investments that were supposed to be safe and liquid for mainstream investors but turned out to be neither. (Those suits have since been settled, with UBS admitting no wrongdoing.)

Yet none of that was as hurtful to UBS and its reputation as the mess uncorked by Birkenfeld. For three centuries, Swiss banking has meant private banking—secretive, exclusive, rich. It has helped make tiny Switzerland a giant in global banking and UBS the largest private banker on the planet, with nearly $3 trillion invested on behalf of its clients.

The damage Birkenfeld caused stems from his lifting the veil of that James Bond-like business to show it for what it is: an often seedy exercise in helping very rich Americans hide their money from the Internal Revenue Service. It now seems more Sopranos than Casino Royale.

Birkenfeld used his deposition to lay the blame on UBS and paint himself as a largely unwitting participant in its schemes. He provided investigators with information about prospecting trips by UBS bankers to events like a yacht race in Newport, Rhode Island, and meetings and cocktail parties at Art Basel Miami, an annual art fair that is a magnet for the globally rich. He said the purpose of these visits was to persuade U.S. citizens to move their millions to undeclared accounts offshore and that UBS not only paid for the trips but also helped people establish sham foreign entities everywhere from Liechtenstein to Panama that existed solely to hide assets from U.S. tax authorities. A UBS spokeswoman declined to comment on any of Birkenfeld’s allegations.

The Securities and Exchange Commission and the Department of Justice seized on Birkenfeld’s deposition and launched separate investigations into UBS in May. The S.E.C. is looking at the bankers who went to Newport, Miami, and elsewhere in the U.S. to solicit business without proper broker-dealer licenses. The Justice Department is focused on whether UBS actively and knowingly helped U.S. citizens evade taxes by creating shell companies that disguised the true beneficiaries.

Neither case is good for the embattled Swiss bank, but the Justice Department investigation is far more serious. Criminal tax fraud carries prison sentences and huge fines and could severely damage the bank’s reputation. But even the loss of billions is not the worst-case scenario. If the government could prove that the creation of sham foreign companies was done knowingly, with institutional backing, in violation of the law, UBS’s banking license in the U.S. could be revoked.

The fallout for UBS has already been steep. In the second quarter, the company’s wealth-management division reported huge outflows of money, leaking $15.8 billion. (In 2007, during the same period, the bank had inflows of about $34.6 billion.) Pretax profit at the unit was down 11 percent. In a number of statements in recent months, UBS has said it is cooperating fully with both government investigations.

This April, Martin Liechti, a UBS board member who heads the company’s international wealth-management operations, was detained based on Birkenfeld’s information and held as a material witness. Facing the prospect of being formally charged, Liechti was called before the Senate Permanent Subcommittee on Investigations this summer to explain UBS’s actions. He took the Fifth Amendment and refused to testify.

In the beginning, it was Igor Olenicoff, not Brad Birkenfeld, whom U.S. investigators were after.

Born in 1942 into a well-connected Russian family that fled to Iran during World War II, Olenicoff moved to the U.S. at 15. He earned a business degree at the University of Southern California and in 1973 founded Olen Properties in tony Newport Beach. Over the next three decades, Olenicoff built Olen into a multibillion-dollar real estate development company with operations in five states.

Olenicoff maintained tight control over Olen, shunning the equity markets to raise capital and, in the process, keeping the company’s financial details as private as possible. The firm’s ownership was parceled out among an increasingly complicated web of offshore entities. Olenicoff ultimately controlled all these shell companies, though it took the I.R.S. a good deal of sleuthing to piece everything together and force him to plead guilty to tax fraud in 2007.

As the I.R.S. was untangling Olenicoff’s case, Birkenfeld’s name came up. Until that moment, Birkenfeld had led a charmed life. He grew up outside Boston, one of three sons in a comfortable, upper-middle-class home. His older brother David described their upbringing simply: “We were all South Shore boys.”

The South Shore refers to a string of affluent seaside towns between Boston and Cape Cod, but the term has a more luxurious connotation, evoking crisp white shirts and pressed khaki shorts, gin and tonics on the porch, summer days spent on the links or under sail.

As the son of a brain surgeon—no one from South Boston would have said “neurosurgeon”—Birkenfeld was part of the South Shore establishment. He learned that his father’s standing could protect him. When Birkenfeld was arrested on drug charges at the end of high school, nothing came of it. “It was dismissed, Your Honor, I believe,” he told Judge Zloch. “I don’t recall.”

In 1984, Birkenfeld arrived at Norwich University, a military school in Vermont. He’d had a false start at another college and been shipped off to a place known as much for its corps of cadets as for its discipline-driven approach to making men of boys. “Brad slipped through the cracks,” says a Norwich classmate, who admitted that he himself had been a class-skipping jock at a state college before starting over. He says that “Birkenfeld was a fun-loving guy. He came from a life of privilege, and he always referred back to his dad’s money and how it would get him out of things.”

Birkenfeld had bigger plans than to live a rulebound life. While he had to endure the military rigor to graduate, he wasn’t required to join the military after graduation. In 1988, with an economics degree, he returned to Boston and got a job at State Street Bank. For the next six years, he worked in low-level positions in the asset-management division, which would eventually become State Street Global Advisors.

In 1994, he left. A State Street spokeswoman would not comment on his departure, but a colleague says it was a less than amicable split. Birkenfeld, the colleague said, had been asked to leave when his supervisors found that he had tried to cover up a series of account errors he’d made. Birkenfeld, through his lawyer, declined to comment about this or anything else.

Out of a job, Birkenfeld enrolled in the M.B.A. program at the American Graduate School of Business, near Vevey, Switzerland. Nestled on the shore of Lake Geneva, the school was founded just three years before Birkenfeld arrived.

It was a far cry from the martial austerity of Norwich, offering such extracurricular activities as “tasting fine wines,” “enjoying exquisite cuisine,” and “pasturing in the Alps,” according to the Student Life section of the school’s website.

After graduation, Birkenfeld landed a job at the Geneva office of Credit Suisse and then later moved to Barclays, where he worked his way up the wealth-management ladder. Then in the fall of 2001, he moved to UBS.

For the next four years, life was good. Working out of UBS’s office in Geneva, he kept an apartment on Cours de Rive, a street off the eastern end of the city’s main shopping area. He cruised around in a new BMW and spent weekends at his house in Zermatt.

Though it was an enviable existence, dealings with his new bosses soon became strained. Although Birkenfeld initially impressed UBS by bringing in a $200 million client—Olenicoff followed him over from Barclays, where Birkenfeld had grabbed him from another banker after Barclays exited the offshore business for U.S. clients—Birkenfeld peaked early. After four years, he still had only a handful of clients, and none was anywhere close to Olenicoff in terms of asset size.

When asked to sign his 2004 annual review, which detailed his poor performance, Birkenfeld balked. In the ensuing negotiations over his departure, the two sides couldn’t come to terms on a package, and Birkenfeld left in October 2005 feeling that he had been denied bonus money he had earned.

Before leaving, Birkenfeld helped Olenicoff—who, unknown to Birkenfeld, was now under federal investigation—move the money he had at UBS to New Haven Trust, a small private bank in Liechtenstein. His sales pitch was straightforward: Liechtenstein had better bank secrecy laws than Switzerland.

In May 2008, Birkenfeld flew home to Boston from Switzerland to attend his 25-year high-school reunion. As he stepped off the plane at Logan Airport, federal agents grabbed him.

Soon he found himself scrambling to make bail, an embarrassment for a 43-year-old who had been living the life of a flush American expat. His father and brother pledged their homes to secure the $2 million bond. His brother also agreed to let Birkenfeld live with him in a waterfront condominium, where Birkenfeld’s movements would be monitored by an electronic device.

This would seem to be an ignominious end for a private banker who had jetted around the world. But his life got worse. Instead of quickly resolving what he’d hoped would remain an essentially private matter—something that could be addressed with fines or maybe a short jail sentence—he became the poster boy for the U.S. government’s case against international tax cheats, the banks that enable them to move money offshore, and the Swiss government itself.

Behind the scenes, the U.S. government was already hard at work on a UBS case. On July 1, the government persuaded a federal judge in Miami to approve an I.R.S. summons that would force UBS to turn over records on 19,000 U.S. citizens thought to have undisclosed offshore accounts. The summons read, “Based on a statement submitted to the court by former UBS banker Bradley Birkenfeld, UBS employees assisted wealthy U.S. clients in concealing their ownership of assets held offshore by creating sham entities and then filing I.R.S. forms falsely claiming that the entities were the owners of the accounts. According to Birkenfeld’s court statement, UBS had approximately $20 billion of assets under management in ‘undeclared’ accounts for U.S. taxpayers.”

The summons was unprecedented. With the backing of a federal judge, the D.O.J. was essentially asking the bank to name names, whether or not there was any proof of criminal wrongdoing. For UBS, this was the nuclear scenario. The bank had already enlisted the help of the Swiss government to negotiate with the Justice Department. A week earlier, a team of Swiss negotiators had gone to Washington to hash out a compromise, and some felt that progress was being made until the I.R.S. summons shattered the talks.

UBS answered the summons with an exasperated statement. “As we have noted, UBS takes this matter very seriously and is working diligently with both Swiss and U.S. government authorities, consistent with Swiss law and the legal frameworks for intergovernmental cooperation and assistance.”

The word of one midlevel private banker, ousted for poor performance, had put UBS in the crosshairs of two countries’ legal systems. If UBS failed to comply with the U.S. summons, it could be held in contempt and, at the very least, fined. But even worse, the idea of revoking UBS’s license to run a banking business in the U.S. was gaining traction.

The bank was equally squeezed in Switzerland. If it complied with the blanket summons and turned over the names, UBS would be prosecuted in its home country. “Switzerland does not permit fishing expeditions in its banks,” says James Nason, head of international communications for the Swiss Bankers Association. “A blanket release of client names outside a criminal investigation would be unprecedented and in any case precluded by Swiss law.”

A spokesman for the Swiss justice ministry said that there would have to be “the indication of further circumstances” for the request to be honored, and that if UBS complied with such a blanket request, it would be in violation of the Swiss Banking Act.

Even Justice Department spokesman Charles Miller admitted the request was “unprecedented, particularly for a foreign bank.”

UBS was left scrambling to make sense of its options. “We should have exited this business for Americans two years ago,” a UBS official says. “It was tiny compared with the rest—$20 billion versus $2.7 trillion in assets worldwide.”

But it was too late. The case was about to come to a head.

Michigan senator Carl Levin was in a feisty mood when he convened the Senate Permanent Subcommittee on Investigations for a July 17 hearing on global tax havens. The senator made that clear in an interview with ABC News on the eve of the hearing. “I don’t think that any bank that goes to the extent that UBS has gone through to avoid doing what their agreements with the United States require them to do should be allowed to continue to do business unless they clean up their act,” he said.

With this, he made the whispers explicit. UBS had better make amends because its U.S. banking license was on the line. This was no idle threat: 28,000 of the firm’s 81,000 employees worldwide are in the U.S.

Looking out on the vast hearing room, which was standing-room-only before he started, Levin maintained his seriousness. “Today, we will look at two banks that relied on secrecy and deception to hide not just the tax-avoidance schemes of their clients but the actions they themselves took to facilitate U.S. tax evasion,” he said.

Much to UBS’s chagrin, they had been painted with the same brush as LGT Group, a private bank owned and operated by the royal family of Liechtenstein. In February, one of LGT’s back-office workers stole a list of 1,400 account names and sold it to the German government for a reported $6.2 million. Seven U.S. citizens were named in the report, and three were subpoenaed to appear before the committee.

UBS’s case was similar to LGT’s only in that it involved U.S. citizens who had evaded taxes. Heinrich Kieber, the LGT whistleblower, had the goods on almost all the bank’s clients and had not been involved in any of the wrongdoing. Per I.R.S. policy, he stood to receive up to 30 percent of whatever the agency recouped from the tax cheats he named. On the other hand, Birkenfeld had been complicit in tax fraud committed through one of the world’s largest banks and was cooperating with the government to save his skin and reduce his jail sentence.

The Senate had much more evidence on the LGT clients, but because LGT has no meaningful U.S. presence, it chose not to appear before the committee. This put UBS front and center. With a parade of witnesses invoking their right against self-incrimination all morning, the first nongovernment witness to say anything was Mark Branson, UBS’s chief financial officer of global wealth management and business banking.

Levin had been building a case against UBS throughout the hearing. At one point, he announced that the investigation had “managed to pierce some of the layers of Swiss secrecy that for too long have made Switzerland the place to bank for people with something to hide.”

At other times, he quoted Birkenfeld to paint the picture of a well-oiled tax-evading operation. The bank gave clients secret foreign credit cards, encrypted client information on laptops, and trained bankers on how to evade F.B.I. and customs inquiries. “UBS efforts targeting U.S. clients to open Swiss accounts were, in the words of Mr. Birkenfeld, a ‘massive machine,’ ” Levin thundered.

In a strong turn, Branson apologized for “any compliance failures that may have occurred.” UBS would no longer provide offshore banking services to U.S. citizens, he said, and he revealed that the bank was working with the U.S. and Swiss governments to identify clients who had committed tax fraud. “We will fully support and assist that process,” he said. In the minutes it took Branson to read his opening statement, he had knocked the wind out of Senator Levin.

As much of a headache as Birkenfeld had been for UBS, whatever he had told or was promising to tell the U.S. government was a much bigger problem for Liechti, the company’s private-banking czar. Liechti had been detained on April 23 when he tried to change planes in Miami for a business trip to Latin America. At the time of the Levin hearing, the father of five had already been held as a material witness for nearly three months without being charged with anything.

Brought in front of Levin’s committee, Liechti was nervous, but tan—he was reputedly holed up at the Four Seasons in Miami because the U.S. had confiscated his passport—and he invoked his right against self-incrimination in halting English that seemed to belie his reputation as one of the world’s top private bankers.

After the hearing, a UBS spokesperson said, “Martin Liechti’s decision to take the Fifth Amendment follows legal advice from his counsel. The decision to take the Fifth is his own entirely. Pleading the Fifth while there is an ongoing federal investigation whose outcome is undecided is certainly not unprecedented.”

Glowing support, this was not. It could be read as an indication of the precarious nature of Liechti’s situation. While detained, he remained fully employed by UBS, but his future was very uncertain.

Birkenfeld clearly blamed Liechti for his own failures during his career at UBS. He had given up Liechti’s name to U.S. authorities, information that led to Liechti’s detainment. In an email forwarded to me by his college roommate, his anger was palpable. “This guy called me too and left a message,” Birkenfeld wrote of my attempts to reach him. “I will not call him back. If you speak to him, why don’t you tell him to research Martin Liechti, the senior executive for UBS in charge of North & South America who is in custody and who pled the Fifth Amendment (nothing to hide—right). He is a Swiss citizen.”

The truth is, Birkenfeld had been a midlevel relationship manager who by age 40 had not distinguished himself. His knowledge of the broader goings-on at UBS was limited to his own clients and whatever he overheard from other client advisers. But Liechti was the mother lode for U.S. prosecutors. Since he was the person running the group that the offshore business fell under, he theoretically knew everything that was going on. He was the one person who could shed light on the 19,000 accounts that supposedly hold $20 billion in undeclared assets. Even if he provided information on only 1 percent of those account holders, were they to owe anything in the neighborhood of the $52 million Olenicoff paid to settle his case, the government’s investigation would be a runaway success.

The speculation through the summer was that Liechti would have to disclose a lot of information or face formal charges. But then, surprisingly, he boarded a plane and returned to Zurich on August 12. Neither his attorney nor the U.S. government would say what Liechti had said or done to secure his release. A UBS spokeswoman says he is still employed by the bank.

Birkenfeld, on the other hand, will probably never return to Switzerland. He would be taken into custody at the Geneva airport, just as he was in Boston, and be charged with violating bank secrecy laws. Despite his cooperation with the U.S. government, he still faces jail time in America. And, in a twist of fate, his future could well be tied to whatever Liechti may have divulged to win his own release.

Birkenfeld is not going quietly. From his brother’s condo on the bay, he sent an email on August 16 to his college roommate and asked that it be forwarded to their classmates. In it, he cites a newspaper article about a whistleblowing letter he had sent to UBS’s group general counsel that pointed out inconsistencies between bank rules and actual bank practices. “What client would ever trust this bank again??? What person would ever want to work for this bank???”

His email concluded, “Happy day! The truth is clear, thanks to ME! Pass this on to all those know-it-alls that think I don’t know how to defend myself!”

What Birkenfeld’s email leaves out is that he did not write his letter until after he was forced out of UBS and only when he became concerned about money he felt UBS owed him.

Between leaving UBS and getting arrested in Boston, Birkenfeld was a partner at Union Charter, a boutique bank owned by David Schwedel, a wealthy Miami entrepreneur. Schwedel has spoken to Birkenfeld and says he sounds fine. “He understands what this is all about,” Schwedel says. “The way they painted it was Brad came up with these structures and that he would fly around the U.S. and prey on unsuspecting billionaires.” He added, “Bankers such as Brad don’t come up with them on their own. The banks come up with them.”

His belief in Birkenfeld has not wavered. “We were not the ones who asked him to resign. We fought him on this,” Schwedel says. “It takes a number of years to get to the level Brad has on a global basis. You can’t find people like that.”

That may well be true. But it’s also true that these investigations are probably not going to stop wealthy U.S. citizens from seeking ways to hide assets from the I.R.S., nor will they persuade all Swiss banks to turn these citizens away. Already, other private banks around the world are stepping up to woo UBS’s clients. “Money is like water,” Nason says. “If you put obstacles in its way, it will always find its way around.”

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