To the average citizen unskilled in the ways of banking, it might seem unusual that The Citizens and Southern National Bank, The First Tennessee Bank, The Hartford (Conn.) National Bank and Trust, The Indiana National Bank, The New England Merchants National Bank, The Omaha National Bank, The Pittsburgh National Bank, The Riggs National Bank, The Society National Bank of Cleveland and hundreds of other U.S. banks have branches in the same city, in fact on the same block of that city and in some cases even in the same office.
But to those familiar with the world of internationl finance, that one block-Bay Street in Nassau, the Bahamas-is known to be a perfectly legal tax haven used to help facilitate the flow of the world's money and to provide tidy tax breaks for the banks involved.
And for the first time since offshore tax havens began to be used on a large scale in recent years, the general public is getting a glimpse of how this mysterious world of high finance operates.
The lesson in international finance is coming at the expense of Citibank, the second largest bank in the world, and the most aggressive U.S. bank in the field of world money trading.
A former officer who worked as a money trader for the bank in Europe has filed a $14 million wrongful dismissal suit against Citibank charging that he was branded a troublemaker and fired after he persisted in bringing allegations of corporate misconduct in Europe to the attention of bank officials. David Edwards charged, among other things, that the bank was violating tax and currency control laws in several European countries by "parking" large sums of money in its Nassau branch.
Edwards contended that by setting up a series of paper transactions, the bank would shift currency trading profits from [TEXT OMITTED FROM SOURCE]
European branches to Nassau, thus lowering the paper profits of the European branches, which are taxed by those countries, to Nassau, where there is virtually no tax on profits.
He said such transactions appeared to violate laws in several countries against creating transactions solely to evade payment of taxes.
In response to Edwards' suit, the bank's board of directors ordered a study by its lawyers, Shearman & Sterling, and its accountants, Peat, Marwick, Mitchell & co., to determine whether any laws were indeed being violated in Europe.
Local attorneys in seven European countries were asked to help out in the investigation, which lasted eight months. When the report finally was issued last month, it was a bombshell, noting that laws in five of the seven countries may have been violated.
Sources at the bank recently disclosed that the bank is negotiating with Swiss authorities in an attempt to settle on an amount that the bank owes in back taxes due to improper shifting of profits to Nassau. While it confirmed that talks had begun, the bank would not say how much money was in question.
Swiss authorities confirmed that they were investigating Citibank for both the tax violations and the possibility of other "more serious" banking and currency violations.
The events surrounding the Edwards case have raised new questions about offshore banking, questions that previously were raised only within the banking community itself. Now the Justice Department, Securities and Exchange Commission and three congressional committees are looking into the growing ability of the banks to move money and profits around the world with little or no outside scrutiny.
The Citibank self-investigatory report offered interesting descriptions and explanations for many of the transactions that Edward had alleged were illegal. Although the final report did not deal with the specific examples in print, it was clear that the situations it described were based on Edwards' examples. After all, he had supplied the court with dozens of telexes, order forms and other papers documenting the various transcations.
What follows is a close look at two of Edwards' allegations and how the bank report explained them.
On Oct. 6, 1976, at 3:44 a.m., the Frankfurt office of Citibank informed the Nassau branch through the New York headquarters that Nassau should sell 6 million pounds sterling to Frankfurt at the rate of $1.666 per pound.
At 8:43 a.m., Frankfurt sold 6 million pounds sterling back to Nassau at the rate of $1.6525. At the end of the cable confirming the second transaction, the Frankfurt office pronounced the "position squared."
The net effect of the transactions was to give Frankfurt a paper loss of about 200,000 West German marks because it had sold the British pounds at a lower price than it had paid for them at an earlier time.
Although the transactions involved pounds and dollars, the profits were declared in marks for bookkepping purposes in Frankfurt. And although the profits were shifted to Nassau and declared there for tax purposes, the Frankfurt branch telexed instructions to the New York headquarterss to allocate the profit to Frankfurt for internal purposes, to give a true picture of the business done by the Frankfurt branch.
The Citibank report pointed out that transactions like the preceding "may be inconsistent with (German law)." The report also said that, in order to be legal, such transactions " must be accompanied by an actual transfer of risk to the transferee (Nassau) which would require that rates within the prevailing market range be used. If all risk of loss or gain remained with Frankfurt, the purpose of the transaction would be found to be solely to escape the (German) regulatory restritions." It pointed out that there is "a severe risk that income realized in Nassau might be found (by German authorities) attributable to Frankfurt."
"When a position is transferred and reaquired within the same day, there is a greater likelihood that revenue officials will suspect a tax motivation," the Citibank report noted.
Another critical factor that could lead to problems for Citibank is the West German "arm's length dealing rule." That rule says that transactions made at rates outside the prevailing market range for the currency on the day of the transaction likely were not made at "arm's length"-meaning that the transaction was set up with a specific goal in mind and was managed to accomplish that goal.
Because the Frankfurt branch dictated the sale price of both transactions in the same cable, it is likely that German authorities would consider the transaction not to be at "arm's length."
As part of a series of transactions, Citibank's Zurich branch bought $35 million from the Nassau branch on Dec. 8, 1976, at the rate of 2.4543 Swiss francs per dollar, squaring a situation in which Nassau was holding $35 million from Zurich. The transaction left Nassau with a profit of 563,500 Swiss francs.
On the same day, Zurich bought the 563,500 francs from Nassau at the rate of 2.45 francs per dollar, leaving Nassau with $230,000.
Still on the same day, Zurich sold $35 million to Nassau for German marks at an exchange rate of 2.399 marks per dollar, squaring off another earlier transaction that had left Nassau with that number of marks. Again, Naussau was left with a profit on the sale, this time amounting to 647,000 German marks. And again, Zurich bought those marks from Nassau for dollars at the pre-set rate of 2.398148148-converting Nassau's profit to $270,000.
Those two transactions caused $500,000 in profits from entirely paper transactions to be "parked" in Bassau.
Citibank's Frankfurt office, still on the same day, then sold $70 million to Nassau for German marks at a predetermined rate of 2.3903 marks per dollar. The Zurich bought $70 million from Nassau for marks - this time setting the exchange rate at 2.4080.
According to a telex from Zurich to Nassau, "This will leave you with a profit of 1,204,000 (marks)-which we will buy from you at the rate of 2.4080 . . . and sell you $500,000." This brought the total profits due to these transactions to $1 million.
In the same telex, Zurich reminded New York that it must credit Zurich with a profit of $1 million of the company's internal bookkepping system, although for tax purposes the profit would be shown in Nassau.
The next line of the telex indicated that the situation was about to happen again. "And here," it said, "the new positions to be parked with you . . . "
The Citibank report reflects the problems that those transactions may face. "Zurich has entered into transactions . . . sometimes at rates which have not been within the prevailing market range," the report stated.
Such transactions would violate the Swiss version of the "arm's length rule" and would result in profits "improperly diverted from the Swiss establishment," the report pointed out.Consequently, income earned by Nassau in those transactions should be considered as Zurich income and so be taxed by the Swiss government.
Finally, under the explanation given by the Citibank report, the type of transaction described above would "be a violation of the laws of the Condederation and of the Canton of Zurich," the report said.
It is unclear just what kind of legal problems the bank could face in the U.S. beacuse of its foreign problems. But a report by the Congressional Research Service for a congressional subcommittee that has begun to look into Edwards' allegations raises, for the first time, the possibility that Citibank could face criminal sanctions here.
While the report cites several possible federal statutes that could cover the kinds of activites described, the key law cited was under Title 12, U.S. Code, Section 630, which "prohibits any false entry in any book, report, or statement of a corporation organized to do foreign banking with intent to injure or defraud any other company, body politic or corporate, and sets criminal penalties for making such entries or aiding or abetting the making of such entries."
Assuming that a foreign country is a "body politic," that statute would make any bank official-no matter how high or low in the bank hierarchy-liable to prosecution and, upon conviction, a sentence of "not less than two years nor more than ten years," and a fine of not more than $5,000."
Another crucial law-Section 618 of the same title-prohibits any corporation organized to do foreign banking from either directly or indirectly controlling or fixing, or attempting to control or fix, the price of any commodities.Although Edwards has charged, independently of his court case, that the major New York banks conspired through their money traders to manipulate the price of the dollar for profit through series of transactions, the Congressional Research Service said "it is doubtful that currency would be encompassed within the term 'commodity'."
Other laws cited by the congressional study also provide criminal penalties for a bank's failure to keep or file certain reports of foreign currency transactions.
At least some of the information that will come out of Edward's suit still may never reach the public because a court-imposed gag order prevents the release of many internal Citibank documents said by Edwards to show that the practices described above are more of the rule than the exception.