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."