UBS tax probe seen bruising U.S. broker unit

By Joseph A. Giannone - Analysis

NEW YORK (Reuters) - A federal probe into alleged tax evasion schemes at UBS AG (UBSN.VX) could do lasting damage to its U.S. wealth management unit, just as the hard-hit Swiss bank faces speculation it might sell this lucrative business.

UBS has been accused by U.S. authorities of helping rich Americans hide assets and evade taxes. Last month, UBS banker Bradley Birkenfeld pleaded guilty in federal court to helping UBS clients avoid U.S. reporting requirements. He also told investigators the bank holds $20 billion in undeclared accounts for U.S. taxpayers.

Allegations of widespread wrongdoing could dent the reputation of UBS, which has already emerged as the hardest hit global bank of the credit crunch, with more than $37 billion of mortgage and other losses. Clients may now think twice before handing over their money, analysts and bankers say.

"When an organization has these kinds of situations, it can't help but have an impact on the business and the way clients perceive the firm," said Aaron Dorr, Jefferies Putnam Lovell's head of asset management M&A. "The investors and consultants who drive asset flows will see this as a big challenge."

Eight years ago, UBS acquired PaineWebber Group for $12 billion at the peak of the tech stock bubble as part of a plan to use its dominance in Europe to take on Wall Street and capture some of the world's wealthiest market. UBS for years did just that and the brokerage arm expanded through takeovers.

Yet over the past year, UBS has mostly acquired a reputation for generating bad news -- from the failure of its Dillon Read Capital Management hedge fund venture and massive subprime mortgage losses to a long list of regulatory probes.

SHRINKING BALANCES

Credit setbacks have already hurt wealth management, UBS said. U.S. brokerage client assets declined to 773 billion Swiss francs ($756 billion) in the first quarter from 917 billion francs and from 944 billion francs in the year earlier period.

Meanwhile, net new money flowing into accounts slowed to 3.1 billion francs in the first quarter from 8.1 billion in the previous quarter and 11 billion francs a year earlier.

Clients were "diversifying assets away from UBS due to the effects of the credit market turbulence on the firm's operating performance and reputation," UBS reported in May.

The shrinking numbers also reflect a weak U.S. dollar.

Now UBS must contend with expanding investigations by the Justice Department and Internal Revenue Service. On Wednesday, a judge authorized the IRS to serve a summons on UBS to get information about possible fraud by people whose identities are unknown.

UBS says it is cooperating with U.S. authorities and has contended the fraudulent acts were those of a rogue employee.

On June 26, Massachusetts authorities sued UBS for fraud, saying it misled investors about the safety of auction-rate securities. The bank sold these investments to customers even as a top bank executive was dumping them from personal holdings and money managers were losing faith in them, the state said.

"We will defend the specific allegations of the complaint" a spokeswoman said at the time. "Contrary to the allegations, UBS is committed to serving the best interests of our clients."

But Gerard Cassidy, a banking analyst at RBC Capital Markets said the wealth management business is sensitive to headlines about the parent company.

"This is a very lucrative business, but customers want to be with a firm on solid footing," he added.

The tax probe follows investigations into a number of other areas, including the marketing of fee-based advisory accounts, the sale of auction rate securities and its actions as an underwriter of mortgage securities.

Meanwhile, UBS is scrambling to replace capital lost to its trading mistakes, selling stakes to sovereign wealth funds and issuing rights offerings. More recently, UBS hired Lazard to help determine which businesses to keep or sell.

Everything, even U.S. wealth management, is under consideration, Reuters reported last week, citing sources. UBS later said, "no major business is for sale."

A UBS spokesman declined further comment on the speculation.

SALE NOT LIKELY

UBS has long been under pressure from some shareholders to split the company and focus on private banking and money management. The U.S. brokerage, critics argue, has been a laggard weighing down the global private wealth business.

But UBS still aspires to be a global bank and the United States is too big a market to abandon. UBS would also be hard pressed to accept a steep discount for the business when it can still raise capital through other offerings.

If UBS did sell, possible suitors include Royal Bank of Canada (RY.TO), which has acquired a number of small U.S. brokers; European banks such as HSBC Holdings Plc (HSBA.L) or BNP Paribas SA (BNPP.PA); and JPMorgan Chase & CO (JPM.N), which does not have a major brokerage business.

UBS might also sell a stake or merge the unit into another organization in exchange for cash or stock. Given the problems surrounding UBS, and the state of the markets, some analysts estimate the unit could fetch as little as $8 billion.

For now, a straight sale remains unlikely, bankers said.

"We are in one of the toughest equity markets any of us have seen in their adult lives. They'd really be bucking the tide by selling in these times," said John Siciliano, a managing partner at Grail Partners, an M&A boutique focused on asset management.

"It would be a sign of intense desperation."

(Editing by Andre Grenon)