The tiny principality of Liechtenstein, tucked into an Alpine valley studded with medieval castles, looks like the picture-postcard setting for a fairy tale.
But the spell has just been rudely broken. In a string of recent reports, international investigators have fingered Liechtenstein as a hotbed of a very real and modern crime: money laundering. A criminal investigation at home, meanwhile, has seen a police raid on the royal family's private bank, and put the brothers of the chief justice and the deputy prime minister under arrest.
Liechtenstein is among several tiny nations - including Malta, Cyprus, and the Cayman Islands - now buckling to US and European pressure as authorities put the squeeze on places that have profited handsomely by helping tax evaders and by cleansing "dirty" money.
Here, these authorities smell victory: The principality is in danger of losing its raison d'tre as a quiet offshore financial center where nobody asks too many questions, and bank secrecy is sacrosanct.
"Just the fact that we are in the news does damage to our reputation" says Siegbert Lampert, a prominent lawyer here. "What our clients liked about Liechtenstein was that no one knew anything about the place."
That changed last November, when somebody leaked allegations from a report by the German intelligence agency that Liechtenstein banks, and some of the 80,000 "letter box companies" incorporated in the low-tax principality, have laundered money from Colombian drug barons and Russian mafia dons.
The report outraged bankers and officials in this close-knit community - there are only 32,000 inhabitants of Liechtenstein - but the Austrian prosecutor brought in to investigate the charges has shown that all is not well here. Five prominent citizens are in preventive detention, and the investigation is reaching ever deeper into the secretive corners of the principality's lucrative asset-management business.
At the same time, international organizations accuse Liechtenstein of obstruction in the fight against money laundering.
"The system for reporting suspicious transactions is still inadequate, there are not proper laws in place for exchanging information about money- laundering investigations and cooperating with foreign authorities in prosecuting cases, and the resources devoted to tackling money laundering are inadequate," said a report issued two weeks ago by the Financial Action Task Force on Money Laundering (FATF) - a group linked to the Paris-based Organization for Economic Cooperation and Development (OECD).
Even Liechtenstein's reigning prince, Hans-Adam II, admits that "the fight against white-collar crime has not been very efficient in the past, and that is perhaps putting it politely."
All this, insists Prime Minister Mario Frick, will be put right within six months, when a batch of reforms have gone through Parliament. New laws will make it easier for foreign investigators to get information from the Liechtenstein authorities about suspects, and require more bank reporting of suspicious transactions.
Three new foreign prosecutors are being hired- along with foreign financial detectives - to bolster the police force. The country's financial supervision agency, where just six people regulate a market with $120 billion of assets under management, is being doubled.
"It is very important to us to be off the FATF blacklist as soon as possible," says Mr. Frick, not least because of legislation currently before the US Congress that would authorize the Treasury secretary to ban US financial institutions from dealing with banks in countries on the list. "I am sure we will be off it" by the end of the year, the prime minister says.
The reforms, say officials here and at the FATF, are evidence that international pressure works in the growing worldwide bid to shut down dirty-money havens. "Everyone knew we had problems, but nobody wanted to do anything about it," says Roland Muller, head of Liechtenstein's Financial Supervision Agency. "Obviously there was a need for strong pressure from abroad in order to change something."
Indeed, another piece of US legislation may well oblige Liechtenstein banks to fill a gap in local law that will remain despite the reforms. One of Liechtenstein's attractions, both to money launderers and to foreign tax evaders, is that banks do not insist on knowing whose money they are looking after. As long as the trustee or lawyer who introduces the client - and opens an account on the client's behalf - knows who he is, that has always been enough.
But in the new international climate, it will not be enough. As investment funds and other foreign financial institutions ask more questions about the source of money they handle, "trustees will have to reveal their clients to the banks, because the banks will not be able to place their money anywhere" if they don't, argues Prince Hans-Adam, whose family bank, the LGT Bank, is the principality's largest.
More specifically, he says, US tax law coming into force in January means banks will have to know who their clients are if they want to win the status of "qualified intermediary" with the Internal Revenue Service - a status essential if they want to handle transactions on the US stock market. "There is no getting around the IRS regulations," says Mr. Lampert, who is secretary general of the Association of Trustees, the 130 or so powerful men who act as lynchpins of Liechtenstein's financial system. They are the only people allowed to incorporate and administer companies or trusts, give financial advice, or offer accounting services.
The IRS law will effectively oblige the banks to identify their customers who are US taxpayers - a first chink in Liechtenstein's bank secrecy that could signal the beginning of the end for the principality's role as a tax haven.
Nobody in Liechtenstein has any qualms about offering a refuge to foreigners seeking to hide their money from their own tax-inspectors at home. "So long as you have tax pirates (charging high rates of income tax) I don't feel any moral guilt about being a tax haven, just as people once took up slaves to help them escape their poor fate," says Prince Hans-Adam.
That is not how Washington, London, Paris or Berlin see things, as they step up efforts to track down their tax dodgers. The OECD last week threatened economic sanctions against Liechtenstein if it did not cooperate with the tax crackdown. This pressure, officials predict, is likely to intensify, and will be hard to resist. "I fear that bank secrecy will fall away, and the idea of privacy will fall too," says Mr. Frick. "That makes people here anxious."
(c) Copyright 2000. The Christian Science Publishing Society