Anti-money laundering compliance experts say that within the financial institution’s universe of business segments, the private banking unit is arguably the one that deserves the highest level of scrutiny.
Chris Focacci, an AML expert, former private banker and founder of AML Source says the private banking unit requires a higher level of due diligence and know-your-customer (KYC) protocols at onboarding and a robust ongoing monitoring program, especially because of the nature of the clients.
“At a private bank you have high net worth individuals, companies, trusts, entities, and corporate structures that could obscure ownership,” Focacci said.
High net worth clients come with a unique structure of ownership that also comes with a higher risk profile than traditional retail banking clients.
Compliance professionals working with private bank accounts walk a thin line between crafting tailored wealth management services that offer discreetness and convenience to the elite, and keeping the bank secure from money launders, tax evaders and other financial criminals.
HSBC, one of the largest financial institutions in the world with a 150-year old private banking unit sought by the rich in nations all over the globe, chose to take the risk and the client’s business, in spite of the compliance, regulatory and legal missteps along the way.
According to “Swiss leaks,” a deluge of information disclosed for the first time this week, HSBC had been sheltering unreported and sometimes illicit money for years up to2007, when it held $100 billion in assets.
The HSBC case is part of a much more complex and entrenched issue. Despite global efforts to boost financial account information exchange and corporate transparency, there are still bastions of secrecy the world over, proffered by financial institutions, nations and jurisdictions, and wealthy clientele willing to seek them out.
Experts estimate that $7.6 trillion is held in overseas tax havens, costing government treasuries at least $200 billion a year.
The good, the bad, and the rich
In 2008, a one-time employee of HSBC left the company with the largest stolen treasure in the bank’s history – five disks of confidential information.
Herve Falciani is the whistleblower/heister who leaked the bank’s data to governments and journalists all over the world, inciting a barrage of questions about the bank’s activities.
“Banks such as HSBC have created a system for making themselves rich at the expense of society, by assisting in tax evasion and money laundering,” Falciani said in a July 2013 interview with Der Spiegel.
According to the information, published in an analysis by the International Consortium of International Journalists last Sunday, the private banking unit of HSBC Holdings PLC handled accounts, many of them secret and unreported to tax authorities, for years for over 100,000 clients from 200 countries.
The account holders included royal families, foreign ambassadors, celebrities, elected officials, corporate executives and athletes, who relied on the bank to keep their assets private. See the Interactive Map of HSBC clients with accounts associated with drug traffickers, corrupt politicians, and more:
The documents laid out by the ICIJ suggest HSBC Private Banking was facilitating tax evasion and avoidance, going against the institution’s own policy of regulatory and legal compliance. HSBC at first insisted that ICIJ destroy the data.
The disclosure also reveals some even more malevolent details – some of those accounts that were granted secrecy under the guise of a compliant operation were held by terror suspects, drug traffickers, blood diamond traders, and other illicit actors.
Dirty money deposited into the pristine vaults of the Swiss-based bank went undiscovered for years, until now.
According to the leaks, bank employees allowed clients to keep their accounts despite evidence suggesting that accounts were unreported to tax authorities in the client’s home country.
Communication with clients even discussed how they might avoid taxes through creating offshore corporations that would not be subject to the European Savings Directive.
A February 2005 letter to clients from the former chief operating officer of HSBC Swiss Private Bank, Colin Wyss, and the bank’s head of tax, Denis Soussi, illustrated that mantra, telling customers “You should be aware of different options that exist to attenuate the economic effect of this tax.”
‘Standards were significantly lower than today,’ HSBC says
HSBC has admitted to the past lapses in compliance standards, stating that both the global standards for reporting and internal controls around these business units have risen.
Frank Morra, the chief executive officer (CEO) of HSBC’s Swiss subsidiary, said in a statement that new management had shut down accounts from clients who “did not meet our high standards.” According to the bank’s written statement to media outlets:
“HSBC Global Private Banking and in particular its Swiss private bank have undergone a radical transformation in recent years…In the past, the Swiss private banking industry operated very differently to the way it does today. Private banks, including HSBC’s Swiss private bank, assumed that responsibility for payment of taxes rested with individual clients, rather than the institutions that banked them.”
The statement lauds the regulatory changes around the world to improve information exchange, citing the US Foreign Account Tax Compliance Act enacted in 2010, the Organisation for Economic Co-operation and Development’s (OECD’s) Common Reporting Standard, and other bilateral tax treaties that prevent assets from being shrouded from authorities.
According to the bank, there was a deep-seated change in the structure of HSBC’s four business lines, including Global Private Banking.
Part of this change was developing a tax transparency policy in 2012 and vowing to close accounts and refuse new business when the unit has reason to believe the client or potential client is not in full compliance with relevant tax obligations.
Focacci from AML Source said that while private banking units have an extensive audit trail, they still operate in “incredibly siloed and segmented” ways.
While banks strive to have “enterprise-wide” compliance strategies, in large institutions, each unit technically operates as a stand-alone operation. In a private banking business unit, Focacci said, there is a separation between the business-to-client front end and the compliance function.
“The bankers are basically salesmen and then you have a back office function that does the KYC and the customer-due-diligence that determines the customer’s risk level,” Focacci explained.
“They have some separation in the group between the banker and the compliance [functions]. The separation is good because [of] its checks and balances, but If you’re in the compliance group, there’s still pressure on you from the business part.”
Focacci says that there are many levels of auditing once a client is on-boarded, but still says it is difficult to know whether HSBC did not catch the irregularities or helped their clients evade taxes.
However, the opportunity for new high-net worth clients weighs heavy on the latter alternative.
“Is the risk worth dealing with these clients? For the bank it probably is,” Focacci said.
Since the activity disclosed from the information stops at 2007, it is unknown whether the bank’s claims of their own “complete overhaul of the entire private banking business” is a reality. The statistics show that HSBC has at least decreased the private bank’s business by two thirds, closing accounts with clients linked with 100 countries.
In 2007, the Swiss Private bank was handling $118.4 billion. At the end of 2014, the total assets handled were down to $68 billion. London-based HSBC operates in more than 70 countries and has private banking units located in Geneva and Zurich.
Reactions from the government
As political pressure mounts, national governments have both swiftly responded to the allegations, and defended their own faults in regards to the data.
The bank is facing threats of criminal prosecutions and government probes, and it’s not the first time that HSBC has faced the wrath of government prosecution for financial crime-related wrongdoing.
In 2012, HSBC avoided criminal prosecution by agreeing to pay more than $1.9 billion to settle US criminal and civil investigations and entered in to a five-year prosecution agreement over alleged money laundering with Mexican drug cartels and breaches of US sanctions.
The bank has been under monitoring to ensure improvement to its AML controls. If HSBC is found to have breached the terms of the agreement, which would likely include committing further crimes willfully or due to weak protocols, it could face another round of penalties or an extended remediation period. The appointed future Attorney General Loretta Lynch said the new evidence of tax evasion could spur a new investigation and further criminal prosecutions, in a statement.
Switzerland on the other hand, is seeking to prosecute Falciani, but not the bank. The effect of the leaks is far-reaching, as governments in Spain, Ireland, India, Denmark and other nations seek to expand their own tax investigations in light of the allegations raised by the Swiss Leaks project, according to public statements and published reports.
The US Justice Department and the Internal Revenue Service have used financial sanctions and the threat of criminal prosecution before to pressure other Swiss banks, such as UBS and Credit Suisse, to disclose the names of thousands of clients who avoided or evaded taxes with the help of the banks’ services.
EU seeks tougher measures against tax evasion
In Europe, the concept of beneficial ownership transparency and sanctions laws have been championed for decades. However, tax secrecy is still a problem that policy-makers in the European Union are wrestling with, as they balance increased transparency against the laws and traditions of bank secrecy in many countries in the region.
The European Union (EU) Commission’s spokeswoman Vanessa Mock said the revelations confirm that banking secrecy continues to be a choice avenue to avoid taxation.
In a statement, Mock said the EU has initiated an action plan in 2012 involving more than two dozen measures to more effectively combat tax fraud and tax evasion, a central aim would be eradicating the scourge of secret bank accounts, with implementation expected to occur by 2018 at the latest.
“Many of the measures announced at that time, and now approved, aim to improve transparency and increase the exchange of information between tax administrations, so that tax authorities can collect the tax due by their own taxpayers,” Mock said in the statement.
Watchdog groups believe bank secrecy aids in draining of public funds
To independent watchdogs leading the fight on tax evasion and corruption, the disclosures are not shocking, though they confirm that opacity in the global financial system continues to allow tax haven secrecy, corporate anonymity, trade-based money laundering, and other crimes which drain approximately $1 trillion per year out of developing and emerging economies.
The figure, estimated by Global Financial Integrity (GFI), an advocacy group promoting transparency, is more than developing nations receive in foreign direct investment or foreign aid.
“While the leaks do really expose a culture of corruption at HSBC, it seems almost unfair at this point to single them out,” said GFI Policy Counsel Joshua Simmons. “From Credit Suisse to UBS and BNP Paribas to Standard Chartered, it feels like nearly every major bank is either under investigation or subject to settlements for engaging in serious financial crimes.”
Simmons cited that HSBC acknowledged in 2012 that it let $200 trillion—roughly three times the gross domestic product of the US – flow through its New York office over a three-year period without applying the legally required AML controls.
“Nevertheless, not a single bank employee or executive has been prosecuted in any of these cases. Until the U.S. Department of Justice—and financial regulators worldwide—begin holding individuals accountable for their actions, we’re going to continue living in a financial Wild West.”
Switzerland has negotiated with the European Union on the taxation of savings, known as the European Savings Directive, implemented in 2005, along with the OECD and G20 Global Standard of the Automatic Exchange of Financial Account Information.
However, the reporting agreements aren’t bulletproof, says Financial Transparency Coalition Director Porter McConnell.
“There are going to be major loopholes in the common reporting standard, especially in areas like real estate, jewelry and art since the standard does not include hard assets,” she said.
The Financial Transparency Coalition works with more than 150 non-governmental organizations, including the Tax Justice Network, on five continents, to crimp illicit financial flows.
In light of the HSBC leaks, McConnell said is clear evidence that more needs to be done at the national and international levels to obliterate opacity and allow such information to move more freely across borders.
“Whenever we see a new trove of private bank accounts, we see that as further fodder for the argument that we need countries to exchange this information freely,” she said.
“Corporations have a public charter and are granted the authority to operate by governments; they have a responsibility to citizens of those governments to file the appropriate information,” McConnell added.
“Everybody has a role, there are good and bad actors – financial transparency can help everyone know the rules of the road.”