new investigation spearheaded by the International Consortium of Investigative Journalists, the “Pandora Papers,” has sparked worldwide concern.
Politicians, executives, athletes, and cultural celebrities have all been discovered lying and concealing their money. But, how likely is it that the lawyers and accountants who assisted them would be held accountable?
The practices exposed by the International Consortium of Investigative Journalists’ (ICIJ) investigation are nothing new. True, the sheer magnitude, intelligence, and legal firepower used by today’s ultra-rich and powerful to game the system may be noteworthy.
The only genuinely astonishing finding is that it took more than 600 journalists from all around the world to uncover these activities, often at great personal risk and harm to their careers. The difficulty of completing that task demonstrates how effectively lawyers, politicians, and judges have skewed the law in favour of the wealthy.
Today’s wealthy have used centuries-old legal coding tactics to conceal their wealth. In 1535, King Henry the eighth of England put a stop to a legal device known as “the use,” which he saw as a danger to existing (feudal) property relations and a way to evade paying taxes. It was quickly supplanted by an even more effective device: “the trust,” thanks to sophisticated legal arbitrage.
The trust is one of the most creative legal vehicles ever developed for the establishment and preservation of private wealth, having been legally encoded by lawyers and acknowledged by courts of equity. It used to be that the wealthy could get around inheritance laws this way. It is now the go-to instrument for tax evasion and financial asset structuring, including asset-backed securities and related derivatives.
A trust, in effect, modifies the rights and obligations attached to an object without according to the formal requirements of property law, resulting in the creation of a shadow property right. To create a trust, you will need an asset – such as property, stocks, or bonds – as well as three people: a settlor, a trustee, and a beneficiary. The settlor, who happens to be the owner, transfers legal ownership to the asset (though not necessarily physical possession) to the trustee, that is, a manager, who undertakes to administer it on behalf of the beneficiary according to the settlor’s (owner’s) instructions.
Since there is no necessity to register the title or reveal the parties’ identity, no one else needs to know about this arrangement. Because of the trust’s lack of transparency, it is the ideal vehicle for playing hide-and-seek with creditors and tax officials. And, because the legal title and financial rewards are shared among the three personalities, no one wants to take on the responsibilities that come with ownership.
Due to deliberate legal design rather than some unseen hand of the market forces, the trust became a popular legal tool for global elites. Attorneys stretched the edges of the law, courts recognized and upheld their innovations, and lawmakers (many of whom were presumably indebted to affluent contributors) enshrined such practices into statute. Trust law grew in scope as prior prohibitions were lifted.
These legal innovations made it possible to hold a wider range of assets in trust and to assign the job of trustee to legal entities rather than honorable individuals like judges. Furthermore, fiduciary responsibilities were reduced, trustee liability was minimized, and the trust’s lifespan became more flexible. These legislative changes combined to make the trust suitable for international financial transactions.
Those countries who did not have this mechanism were encouraged to copy it. The Hague Convention on Trusts, which was enacted in 1985, was designed with this purpose in mind. Attorneys have fashioned analogous mechanisms from the rules governing foundations, associations, or companies in nations where politicians have resisted the temptation to penalize trusts, calculating (usually right) that courts would uphold their innovations.
While some governments (countries) have gone to great lengths to make private wealth creation legally permissible, others have attempted to curtail tax and legal arbitrage. However, legal constraints only operate if the legislature has authority over which laws are applied inside its borders. Because legislation has become portable in the age of globalization, most governments have lost control. If one country lacks the “appropriate” legislation, another may. The legal and accounting paperwork can be routed to the friendliest foreign jurisdiction, and the deed is complete, as long as the place of business recognizes and enforces foreign law.
As a result, national legal systems have become alternatives on an international menu from which asset owners can select the rules under which they want to be governed. They do not require a passport/visa to enter the country; all they need is a legal shell. The wealthy few can pick how much to pay in taxes and which rules to bear by assuming a new legal identity in this way. If legal impediments cannot be overcome as readily, top global law firms will design legislation to bring a country into compliance with global finance’s “best practices.” South Dakota and the British Virgin Islands, for example, are tax and trust havens that set the gold standard.
The poorest and least well-off bear the brunt of these practices’ expenses. However, turning the law into a gold mine for the wealthy and powerful has long-term consequences that go beyond the immediate disparities it creates. It jeopardizes democratic government by posing a challenge to the law’s credibility.
The public will lose faith in the law the more wealthy elites and their lawyers argue that whatever they do is legal. In the future, today’s global elites may still be able to wrest private riches from the law. No resource, however, can be mined indefinitely. It will be difficult to recover trust in the legal system once it has been lost. By then, the wealthiest individuals will have lost their most precious asset of all.