Less Go-Go in Switzerland

God, after all, created Switzerland for one purpose--to be the clearinghouse of the world.

--Paul Rossy, former vice chairman, Swiss Banking Commission

By all appearances, divine purpose is still faithfully served along Zurich's elegant Bahnhofstrasse, where the great names of Swiss banking conduct their worldwide affairs behind stately fagades of Alpine granite. Yet the air of heavenly serenity on the stylish street provides a curtain for mundane turmoil. After the worst scandal in Swiss banking history, that sedate and secretive industry has moved--or rather been pushed--to tighten up some practices that have proved shockingly loose. The changes may turn out to be far-reaching.

First Step. Swiss officials are considering a variety of measures aimed at toughening the regulation of the country's 553 banks, which currently have assets totaling $139 billion. Until now, these banks had operated virtually by their own rules. Many of the possible reforms affect the way the banks handle funds from abroad--including stolen funds, flight capital, tax-dodge money and other unsavory negotiables that have found their way into the Swiss system, no questions asked.

The first step in Switzerland's bank reform program took effect this month: a new code of conduct, drawn up by the Swiss National Bank, the country's central financial institution, and the Swiss Bankers' Association. No longer are clients allowed to open a Swiss account without revealing their true identity. Anonymous banking, when it was allowed, was a powerful attraction for corrupt dictators and Mafiosi, among others, seeking to hide their funds. Under the new rules, Swiss bankers are barred from providing active assistance to customers who evade taxes or export capital illegally from foreign countries. The code also forbids bankers to accept funds that they have reason to believe were acquired by acts punishable under Swiss law, such as fraud and trafficking in narcotics. However, the code does not require the banks to investigate the background of every customer to ascertain the origin of his money.

No one expects the new code, which carries penalties ranging up to $4 million for infractions, to halt completely the flow of tainted funds into Switzerland. But Swiss National Bank President Fritz Leutwiler, who has long crusaded for such reforms, hopes that the code will deter banks from actively assisting their customers in breaking national laws. Says he: "We are no longer assuming that every banker is a gentleman and that he observes the rules." Leutwiler speculates that the new code may even force the eventual closing of a "small minority" of lesser banks that have operated on the fringes of the vaunted Swiss system.

The scandal that prompted these reforms bloomed at 121-year-old Credit Suisse, whose assets of $18 billion make it one of the storied Big Three of Swiss banking (the other two: Swiss Bank Corp. and Union Bank of Switzerland). Together they account for nearly half of all the banking assets in the country. A Credit Suisse branch manager. Ernst Kuhrmeier, 57, has been accused of "disloyal management"--the Swiss equivalent of business fraud. He allegedly manipulated more than $800 million in a series of questionable and outright illegal dealings (TIME, May 23). Kuhrmeier is now in jail awaiting trial on charges that could put him behind bars for up to 7 1/2 years.

Last month the officers of Credit Suisse convened an extraordinary meeting to explain to 3,000 stunned stockholders how the debacle could have occurred. Newly elected Board Chairman Oswald Aeppli was unable to put a specific figure on the bank's losses. So tangled was the trail of the fraudulent investments, he said, that a 100-man Credit Suisse investigating team has still not sorted out the mess. The investigation could take months longer.

Same Dividend. Other bankers have estimated that the Chiasso affair --named for the town in the Italian-speaking Swiss canton of Ticino where the scandal centered--could cost the firm some $400 million. Nonetheless. Aeppli assured stockholders that the rest of Credit Suisse's affairs were in good order and indicated that this year's dividend would most likely be the same as that paid in 1976: $32 per bearer share.

The disaster was a clear consequence of go-go banking in Switzerland. Between 1965 and 1976, Swiss bank assets ballooned by about 480%, from $24 billion to $139 billion. Equally remarkable has been the expansion of the banks' foreign clientele. Today, better than a quarter of the Swiss banks' deposits are held by foreigners, v. only 7% at the end of World War II.

One reason for the influx of foreign cash has been Switzerland's enviable history of territorial neutrality. But in the postwar decades an equally big attraction has been the hermetic seal imposed by Swiss officials on banking activity--reinforced with maximum fines of $20,000 or jail sentences for revealing details of a customer's account. Tax-shy foreigners also know that under Swiss law, tax evasion is considered a civil rather than a criminal offense, which means that Swiss bankers are expressly forbidden to cooperate with investigators from abroad. (A new bilateral treaty with the U.S. on cooperation in tracking down criminals has not altered this aspect of Swiss law.)

Nowhere has the boom been more thoroughly exploited than in Ticino (pop.: 265,000), which lies along the country's border with Italy. The banking industry there, centered largely in the towns of Lugano and Chiasso, is built on Italian flight capital. Billions of lire are smuggled out of Italy each year by depositors worried variously about high taxes, inflation (current annual rate: 21%), and the political gains of the Communist Party. As many as 254 Swiss banks or branches located in Ticino compete fiercely for these loose lire. Some of the banks are suspected of collaborating in the smuggling, either by providing transport or by bribing low-level diplomatic officials to make currency runs in their cars, which are exempt from border inspections.

In 1975, when an influx of foreign currency sharply forced up the value of the Swiss franc, the Swiss National Bank tried to slow down the flow by imposing a 10% quarterly negative interest rate on large nonresident accounts in Swiss banks. But most institutions got around the rule by accepting this nervous money in "fiduciary" (trust) accounts to be invested in Eurodollar deposits--a safe investment yielding modest returns. The safety of the investments was crucial, since by Swiss law the banks could not issue guarantees on the accounts without incurring a 35% withholding tax.

Too Tempting. The traffic in "hot" Italian funds was all too tempting to Credit Suisse's Kuhrmeier, manager of the bank's Chiasso branch. He brought huge volumes of business to his bank. Swiss investigators eventually discovered, Kuhrmeier did this by offering depositors 1) interest rates higher than those paid for Eurodollar accounts and 2) written assurances that Credit Suisse guaranteed depositors' funds. In short, he exploited the advantages of the fiduciary account ploy without obeying its restrictions.

To get depositors the higher interest rates, Kuhrmeier had to find riskier investments than the Eurodollar market. He chose a Liechtenstein-based holding company called Texon Finanzanstalt, which he had founded in 1961. Over the years Kuhrmeier funneled $868 million of Credit Suisse's Chiasso deposits to Texon. The company then bought stakes in more than 150 Italian companies dealing in, among other things, wine, plastics and vacation resorts.

Kuhrmeier concealed this operation from his superiors in Zurich. Whenever bank auditors visited the Chiasso branch, the books that recorded Kuhrmeier's Texon dealings and other incriminating papers were spirited through a private doorway into a collaborating law firm next door. Credit Suisse's Chiasso branch, says Bernhard Miiller, director of the Swiss Banking Commission, "was a bank within a bank."

Top management at Credit Suisse chose to overlook some astonishingly clear signals that all was not well at their Chiasso branch. In January 1976, for example, Philippe de Weck, chairman of the Union Bank of Switzerland, showed Credit Suisse a copy of a bank guarantee, improperly issued on fiduciary deposits, that had been channeled to Texon. Questioned about the violation, Kuhrmeier explained it away by saying, "It was a special favor that had to be done for a friend."

Last March, Credit Suisse belatedly decided to dispatch a special team, of investigators to Chiasso. What they found, as Chairman Aeppli delicately described it later, was that "contacts between the Chiasso branch and Texon ... were of a completely different nature than we had thought." Kuhrmeier and two assistants were arrested, along with three lawyers from next door. Credit Suisse's then president Heinz Wuffli resigned, along with two other top company officials.

What moved Kuhrmeier to set up his bank within a bank remains a psychological mystery. So far, investigators appear to be convinced that he gained no personal profit from the alleged fraud. But as a top London banker points out, the scandal "could have happened in any other country. Slack management is not just a Swiss problem." What makes the case special is that no other country seeks to maintain such a mystique about its "inviolable" banking system. The scandal spotlighted the extent to which Swiss banks are trusted to police themselves. The chief external watchdog, the Bern-based Federal Banking Commission, has only twelve employees assigned to keep tabs on the industry.

Warning signals about the Swiss system have been flashing on and off for several years. In 1970 the Basel branch of the United California Bank went broke after losing $50 million in cocoa futures trading. Around the same time came the collapse of Bernard Cornfeld's Geneva-based Investors Overseas Services empire, built with the assistance of Switzerland's loose banking laws --and in part with that of the banks themselves. In 1974 the Union Bank of Switzerland lost $56 million in foreign-exchange speculations, and the Lugano branch of Britain's Lloyd's Bank dropped $89 million in similar dealings.

Export Disadvantage. Increasingly, there are indications that among the Swiss public banking is no longer quite the hallowed institution it once was. Manufacturers feel that the flow of funds into Switzerland has overvalued the Swiss franc and thus put Swiss textiles, watches and machinery at a disadvantage in export markets. Says Swiss Accountant Max Fluri: "Our banking sector has grown taller than the Swiss Confederation. For some time, it has been bringing the country more harm than good."

The country's largest party, the Social Democrats, has promised to draft an "initiative" on banking control to be placed before Swiss voters within three years. Among the possible proposals: putting government representatives on bank boards of directors and making tax evasion a criminal offense, which would remove a big attraction for tax cheaters. There is no guarantee that the Social Democrats' ideas will become law, but the debate means that the bankers --and their customers around the world --will be able to take far less for granted in Switzerland than ever before.

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