Katharina Pistor | Pandora’s Account | Business
T he Pandora Papers, a new investigation by the International Consortium of Investigative Journalists, has sparked outrage around the world. Politicians, businessmen, sports stars and cultural icons have been caught hiding their wealth and lying about it. But what is the likelihood of a calculation for the lawyers and accountants who have helped them?
There is nothing new in the practices uncovered by the ICIJ survey. Certainly the scale, sophistication, and forensic firepower deployed to enable today’s ultra-rich and powerful to play with the law may be of note.
But the only truly shocking revelation is that it took more than 600 journalists from around the world to speak out against these practices, often risking their own safety and professional future. The difficulty of this task attests to the extent to which lawyers, legislatures and courts have tilted the law in favor of the elites.
To hide their wealth, the rich and powerful of today have resorted to centuries-old legal coding strategies. In 1535, King Henry VIII of England suppressed a legal device called “use” because it threatened to undermine existing (feudal) property relations and served as a vehicle for tax evasion. But thanks to a clever legal arbitration, it was quickly replaced by an even more powerful device: “confidence”.
Legally coded by notaries and recognized by the courts of equity, the trust remains one of the most ingenious legal tools ever invented for the creation and preservation of private wealth. In the past, it allowed the rich to bypass the rules of inheritance. Today, it is the vehicle of choice for tax evasion and for structuring financial assets, including asset-backed securities and their derivatives.
Functionally, a trust modifies the rights and obligations of an asset without respecting the formal rules of property law; it thus creates a phantom property right. Establishing a trust requires an asset – such as land, stocks, or bonds – and three people: an owner (settler), a manager (administrator), and a beneficiary. The owner transfers legal title (but not necessarily actual possession) to the asset to the trustee, who promises to manage it on behalf of the beneficiary in accordance with the owner’s instructions.
No one else needs to know about this arrangement, as there is no obligation to register title or disclose the identity of the parties. This lack of transparency makes the trust the ideal vehicle for playing hide and seek with creditors and tax authorities. And because legal title and economic benefits are shared among the three personas, no one voluntarily assumes the obligations that come with ownership.
The trust has become a privileged legal instrument for global elites not by an invisible hand of the market, but rather by a deliberate legal conception. Lawyers pushed existing legal boundaries, courts recognized and applied their innovations, and then lawmakers – many of whom are likely beholden to wealthy donors – codified these practices into statutory law. As the previous restrictions have been removed, the Trust Act has broadened its remit.
These legal changes ensured that an ever wider range of assets could be held in trust and that the role of the trustee could be delegated to legal persons rather than to reputable persons such as judges. In addition, fiduciary obligations have been reduced, the liability of trustees has been limited, and the life of the trust has become increasingly elastic. Together, these legal adaptations made trust suitable for global finance.
Countries that did not have this device were encouraged to emulate it. An international treaty, the 1985 Hague Trust Convention, was adopted for this purpose. In countries where lawmakers have resisted pressure to sanction trusts, lawyers have devised equivalent arrangements based on laws governing foundations, associations or corporations – betting (often rightly) that the courts would justify their innovations. .
While some jurisdictions have done their utmost to be legally hospitable to private wealth creation, others have attempted to crack down on tax and legal arbitration. But legal restrictions only work if the legislature controls which law is practiced in its jurisdiction.
In the age of globalization, most legislatures have effectively been stripped of such control, because the law has become portable. If one country does not have the “right” law, another might. As long as the institution recognizes and applies foreign law, legal and accounting documents can be routed to the most user-friendly foreign jurisdiction, and the deed is done.
National legal systems have thus become part of an international menu of options from which asset owners choose the laws by which they wish to be governed. They don’t need a passport or visa; all they need is a legal shell.
By assuming a new legal identity in this way, the privileged few can decide how much tax to pay and what regulations to follow. And if legal hurdles can’t be overcome so easily, lawyers from the world’s leading law firms will draft legislation to bring a country into line with “best practices” in global finance. Here, tax and trust havens such as South Dakota and the British Virgin Islands offer the gold standard.
The costs of these practices are borne by the less mobile and the insufficiently wealthy. But turning the law into a gold mine for the rich and powerful does damage far beyond the immediate inequalities it generates. By potentially undermining the legitimacy of the law, it threatens the very foundation of democratic governance.
The more wealthy elites and their lawyers insist that everything they do is legal, the less the public will trust the law. Today’s global elites could continue to ward off private wealth from the law. But no resource can be exploited forever.
Once lost, confidence in the law will be difficult to regain. The rich would have lost their most precious possession.
Katharina Pistor, professor of comparative law at Columbia Law School, is the author of The capital code: how the law creates wealth and inequality.
© Project union, 2021