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Texas A&M University School of Texas A&M Law Scholarship

Faculty Scholarship

1-2009

Changing the Rules of the Game: Offshore Financial Centers, Regulatory & Financial Crises

Andrew P. Morriss Texas A&M University School of Law, [email protected]

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Recommended Citation Andrew P. Morriss, Changing the Rules of the Game: Offshore Financial Centers, & Financial Crises, 15 NEXUS 15 (2009). Available at: https://scholarship.law.tamu.edu/facscholar/186

This Article is brought to you for free and open access by Texas A&M Law Scholarship. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of Texas A&M Law Scholarship. For more information, please contact [email protected]. Changing the Rules of the Game: Offshore Financial Centers, Regulatory Competition & Financial Crises Andrew P. Morriss*

Even ardent proponents of free mar- Serfdom" 2 by arguing they merely seek to kets often concede a significant role for "level the playing field" by adding suffi- the state in providing the "rules of the cient safeguards to prevent fraud and fi- game" for market competition by creating nancial crises, preserving market contract and property law, providing dis- competition while taming what they view pute resolution services, and enforcing as its excesses.8 However, because goods, court judgments.' At the same time, services, capital, and people can move those favoring a more substantial role for across borders, states must compete for the state resist politically inconvenient these resources. That competition limits charges that interventionist policies can the ability of states to move toward the lead down Friedrich Hayek's "Road to interventionist end of the spectrum and

* H. Ross & Helen Workman Professor of Law and Business and Professor, Institute for Government and Public Affairs, University of Illinois. 1. See Richard A. Epstein & Michael S. Greve, Introduction: The IntractableProblem of Antitrust, COM- PETITION IN CONFLICT: ANTITRUST JURISDICTION IN THE GLOBAL ECONOMY, May 2004, at 3. ("Make govern- ment prevent force and fraud; otherwise, let people do what they will. That position leads quite naturally to the development of ordinary markets . . ..") 2. See FRIEDRICH A. HAYEK, THE ROAD TO SERFDOM (University of Chicago Press) (1944). 3. See, e.g., Justice Nework, Our Core Themes available at http://www.taxjustice.net/cms/ front-content.php?idcatart=2 ("We support simplicity and a level playing field on tax."); See also Rebecca Christie & Robert Schmid, Geithner Calls for New 'Rules of the Game' in Finance, REUTERS (March 26, 2009) ("'To address this will require comprehensive reform,' Geithner said at a House Financial Services Committee hearing. 'Not modest repairs at the margin, but new rules of the game."'); For criticism of the concept of a "level playing field" see William Vicek, "A Level Playing Field and the Space for Small States," Paper presented at the annual meeting of the International Studies Association 48th Annual Convention, Feb 28, 2007.

15 NEXUS so frustrates proponents of greater regu- interests, I will discuss three of the lation of financial markets. claims made in support of such regula- Part of the competition for economic tions: (1) that OFCs provide lax regula- activity involves provision of law and tory regimes that undercut onshore competition among states, which helps efforts to provide stability; (2) that confi- shape the law they provide.4 This compe- dentiality laws undercut onshore efforts tition takes place within a framework of at financial regulation; and (3) that tax including treaties, cus- competition inhibits onshore regulatory tomary public and private law, and con- efforts. I conclude that these are an in- flict of law rules. Like any competitor sufficient basis for limiting regulatory with power to affect the rules of the competition. game, however, states seek to alter this Changing the Rules framework to provide themselves with advantages against their competitors. Soon after the current financial crisis The global financial crisis provided a began, public officials of onshore econo- powerful group of states, including the mies began to blame offshore financial United States, the United Kingdom, centers ("OFCs") for contributing to the France, and Germany, with an opportu- crisis and to call for regulatory measures nity to change the rules of international to limit OFCs' abilities to compete in the regulatory competition to disadvantage global financial market: New York City offshore financial centers (OFCs) in their District Attorney Robert Morgenthau competition with these onshore govern- complained that "vast sums of money ... ments over financial services. Putting lie outside the jurisdiction of U.S. regula- White House Chief of Staff Rahm Eman- tors and other supervisory authorities."6 uel's dictum of "never let a serious crisis UK Prime Minister Gordon Brown called go to waste"5 into practice, interest on "the whole of the world to take action. groups favoring additional regulation in That will mean action against regulatory these onshore jurisdictions have sought and tax havens in parts of the world to use the financial crisis to seek changes which have escaped the regulatory atten- in the rules of the game for international tion they need."7 French President Nico- financial competition that reduce OFCs' las Sarkozy denounced "the excesses of comparative advantages. financial capitalism which has exper- After briefly describing some of the ienced serious abuses: concealment of changes sought by pro-regulation onshore risks, uncontrolled sophistication of fi-

4. ERIN O'HARA & LARRY E. RIBSTEIN, THE LAW MARKET _ (Oxford University Press) (2008). 5. A 40-Year Wish List, WALL ST.J., January 28, 2009, at A14. 6. Robert M. Morgenthau, Too Much Money is Beyond Legal Reach, WALL ST.J., September 30, 2008 at A19 available at http://online.wsj.com/article/SB122273062657688131.html. 7. Nigel Morris, Brown leads global drive to close down tax havens," THE SUNDAY INDEPENDENT, February 19, 2009, available at http://www.independent.co.uk/news/uk/politics/brown-leads-global-drive-to- close-down-tax-havens-1625959.html.

16 Andrew P. Morriss nancial instruments, gaps in regulation identity for the informant through a wit- and persistence of tax havens capturing a ness protection program-despite Liech- part of global savings that would be more tenstein's attempt to arrest the justly employed financing investment informant for violation of its banking and growth."" laws," a dramatic unwillingness to abide At the same time, several large coun- by the usual norms of comity toward a tries are acting inconsistently with well- fellow member of the European single established international legal principles market. In a third major departure from as part of efforts to restrict competition established international legal principles, by OFCs. In the United States, the Britain invoked anti-terrorism laws Obama Administration endorsed the Stop against a bank in NATO ally Iceland to Abuse Act, legislation pro- seize assets after the bank's internet sub- posed by Sen. Carl Levin aimed squarely sidiary collapsed, putting the bank on the 2 at OFCs that did not cooperate with the same terrorism list as al-Qaeda.1 All U.S. Treasury in enforcing American tax these measures are expressions of inter- laws. The Levin proposal requires that est groups within large, developed econo- OFCs assist in stopping not only criminal mies' desire to rewrite the rules to limit but also legal ,9 regulatory and by small ignoring well-established international jurisdictions. law principles that jurisdictions are not If successful, these efforts will dam- required to assist each other in collection age the world economy by removing an of .'0 In a second departure important set of competitors from the from normal state-to-state conduct, Ger- scene. The losers will include not just the many and other European governments residents of OFCs but the residents of the have paid millions of Euros to the thief developed economies, since OFCs play an for account data stolen from a Liechten- important role in encouraging transac- stein bank and Germany created a new tion cost minimizing regulatory and fi-

8. Quoted in Sarkozy on Tax Havens, and more, , August 28, 2008 available at http:/ /taxjustice.blogspot.com/2008/08/sarkozy-on-tax-havens.html, original speech, XVIeme Conference Des Ambas- sadeurs Discours Du President De La Republique, M. Nicolas Sarkozy available at http://www.ambafrance- uk.org/XVIeme-conference-des-Ambassadeurs.html. 9. Kevin Drawbaugh & Corbett Daly, Obama admin. backs tax haven bill, Reuters Mar. 3, 2009 available 2 2 7 2 0 09 3 at http://www.reuters.com/article/politicsNews/idUSTRE5 lL 030 (endorsement). S. 506, Stop Tax Ha- ven Abuse Act, §101 (requiring jurisdictions to assist in ending tax avoidance). 10. See Rose-Marie Antoine, The Legitimacy of the Offshore Financial Sector - A Legal Perspective, in REGULATORY COMPETITION & OFFSHORE FINANcIAL CENTERS (forthcoming). 11. See, e.g., Informant in German Investigation 'Fears'for his Life, Der Spiegel, March 8, 2008 available 8 5 4 0 28 3 at http://www.spiegel.de/international/business/0,151 , ,00.html; Mark Landler, Liechtenstein Issues Warrant for Tax Informant, N.Y. TIMES, March 13, 2008 available at http://www.nytimes.com/2008/03/13/ business/worldbusiness/13tax.html. 12. Id.

17 NEXUS nancial innovations.1 3 Moreover, OFCs of more than simple enforcement of con- play a critical role in pressuring auto- tracts and protection of property rights as cratic governments into ceding power part of their provision of the rule of law. over their economies to market forces, re- To encourage economic activity, govern- ducing the scope of autocracies' ability to ments can provide efficiency-enhancing interfere with the rule of law.14 rules. For example, providing standard Governments compete to attract eco- corporate, partnership, and other entities nomic activity to their jurisdiction for reduces transactions costs and encour- three reasons. All governments require ages economic activity within a jurisdic- economic activity within their jurisdic- tion. tion to generate the tax revenues neces- When one jurisdiction discovers a sary to fund their operation.15 To draw new efficiency-enhancing innovation, it economic activity to their jurisdictions, can lure economic activities to it. Other governments can offer direct incentives jurisdictions then must adopt similar in- (e.g. tax exemptions, direct subsidies), ef- novations if they are to compete effec- fectively discounting the price of operat- tively. The spread of the LLC in the ing within their boundaries. Such United States following its initial adop- discounts are costly, however, as they re- tion by Wyoming is an example of such duce the net revenue to the government competition. 6 The development of segre- from the economic activity. Moreover, di- gated portfolio companies (also known as rect subsidies can lead to "price wars" segregated cell companies) by offshore ju- among jurisdictions competing for the ec- risdictions is another, with several do- onomic activity and investments lured by mestic U.S. jurisdictions soon following discounts are vulnerable to better offers the OFCs' lead and adopting their own from competing jurisdictions. laws allowing versions of these entities . Governments also compete for eco- Competition can also produce bad nomic activity by providing subsidized outcomes. For example, actors interested services that lower transactions costs, in- in committing fraud may offer benefits to cluding the rule of law. Moreover, gov- governments to turn a blind eye to the ernments can offer packages that consist fraud. Antigua's relationship to Sir Allen

13. See Andrew P. Morriss, The Role of Offshore FinancialCenters in Regulatory Competition, REGULA- TORY COMPETITION & OFFSHORE FINANCIAL CENTERS, U Illinois Law & Research Paper No. LEO7- 032. available at SSRN: http://ssrn.com/abstract=1275390; See also Jonathan R. Macey & Anna Manasco Dionne, Offshore Finance & Onshore Markets: Racing to the Bottom or Moving Toward Efficient? 14. Id. 15. Benevolent governments also seek to encourage economic activity because such activity directly in- creases the wealth of their citizens. Malevolent governments will seek economic activity because it generates wealth they can confiscate. 16. See, e.g., Larry E. Ribstein, The Evolving Partnership,26 J. CORP. L. 819 (2001); O'HARA & RIBSTEIN, supra note 4, at 29, 114; Susan Pace Hamill, The Origins Behind the Limited Liability Company, 59 OHIO ST. L. J. 1459 (1998). 17. Morriss, supra note 13.

18 Andrew P. Morriss

2 Stanford and Stanford International as the state of incorporation). 1 Jonathan Bank, which appears to have been little Macey and Anna Dionne have recently more than a sizeable Ponzi scheme,' 8 is a argued that competition between offshore recent example.'" The legal literature and onshore jurisdictions produces effi- contains many claims of such competition ciency-increasing competition to offer producing a "," includ- regulatory measures and innovations in ing with respect to 's role in cor- both onshore and offshore jurisdictions as porate governance, although these claims a result of competition to offer "optimal are often contested.20 The challenge is to laxity."22 Rose-Marie Antoine has shown distinguish legitimate efforts to prevent that offshore jurisdictions are more inno- fraud, money laundering, and other crim- vative than onshore jurisdictions in de- inal activity from efforts to weaken com- veloping governance mechanisms for petitors under the guise of tackling such trusts as a result of their competition for problems. Thus evaluating regulatory trust business.23 I have argued elsewhere competition requires that we attempt to that OFCs have produced beneficial inno- determine whether it will lead to good vations in hedge fund and captive insur- outcomes (promoting efficiency enhanc- ance law.24 ing, wealth maximizing innovations) or However, as noted earlier the finan- bad outcomes (races to the bottom that cial crisis has prompted a wide range of reduce welfare). policy proposals from onshore govern- There are a number of reasons to ments aimed at restricting the ability of think regulatory competition is likely to OFCs to compete with the onshore gov- be beneficial. Erin O'Hara and Larry Rib- ernments. Implicit in these proposals is stein have offered a theory of regulatory the argument that competition between competition based on domestic interest OFCs and onshore governments reduces groups lobbying for laws that will attract onshore jurisdictions' ability to regulate outsiders to do business in a jurisdiction, in beneficial ways. Other critics of OFCs with the additional business benefiting have argued that offshore jurisdictions the domestic interest groups (e.g. the Del- promote fraud and theft, particularly in aware corporate bar benefits from the use countries with poor governance and pro- of Delaware by out-of-state corporations posed regulatory measures limiting com-

18. S.E.C., SEC Charges Two Accountants And Antiguan Regulator For Roles In Stanford Ponzi Scheme, Litigation Release No. 21092, June 19, 2009 available at http://www.sec.gov/litigation/litreleases/2009/ Ir21092.htm. 19. Stacey-Marie Ishmael, Sir Allen's Antigua, or the curious case of Stanford InternationalBank, FT Alphaville, Feb. 17, 2009 available at http://ftalphaville.ft.com/blog/2009/02/17/52560/sir-allens-antigua-or-the- curious-case-of-stanford-international-bank/. 20. See O'ILAA & RIBSTEIN, supra note 4, at - (summarizing debate). 21. Id. 22. Macey & Dionne, supra note 13. 23. Antoine, supra note 10. 24. Morriss, supra note 13.

19 NEXUS petition from OFCs. 25 These proposals tions reduce onshore governments' abili- rest on two propositions: ties to tax their citizens by enabling Onshore government regulatory ef- onshore taxpayers to structure transac- forts in financial services are undercut by tions to reduce their . 2 9 competition from OFCs. Restricting competition from OFCs Regulatory Laxity will therefore enhance onshore regula- tory efforts in financial services. Are offshore financial centers too lax Both of these statements are contro- in regulating financial services provid- versial, although the policymakers mak- ers? There are three reasons to believe ing these arguments have generally they are not. First, there is no agreed ob- treated them as self-evident and not re- jective measure of regulatory stringency quiring an effort to provide proof. 26 Both by which we can compare regulators in are related to important questions about different jurisdictions. While onshore the role of the state in regulating finan- politicians sometimes suggest that OFCs cial markets. are unregulated, regulators in major Do OFCs Undercut Onshore Regula- OFCs often have broader powers than on- tion of Financial Services? shore regulators. For example, one of the The claim that onshore regulatory ef- Cayman Islands' chief financial regula- forts are undercut by the regulatory com- tors, the Financial Secretary, described petition provided by OFCs can be divided an interview he conducted with a banker into three parts. First, onshore regulators he suspected of problematic behavior as claim that offshore jurisdictions regulate follows: "I called [the banker] to my office, too little.27 Second, onshore regulators locked the door behind him, and seriously argue that offshore confidentiality laws questioned his involvement [in the activi- allow onshore taxpayers to illegally evade ties], while reminding him of his moral taxes they owe onshore governments. 28 and official obligations in the community Third, onshore governments argue that as a Class A banker." Ultimately, the the lower tax rates in offshore jurisdic- regulator concluded that the banker's

25. See, e.g., RAYMOND BAKER, CAPITALISM'S ACHILLES HEEL: DIRTY MONEY AND How To RENEW THE FREE-MARKET SYSTEM (2005). 26. A third, unstated premise underlying these proposals is the claim that increasing the effectiveness of onshore regulatory efforts in financial services will lead to improved financial stability and prevent events like those that produced the current financial crisis from recurring. Addressing this question is beyond the scope of this Article. 27. See note 7 supra. 28. See EU proposes tougher rules to tackle tax evasion, AFP, Nov. 13, 2008 available at http:// afp.google.com/article/ALeqM5iX8cL3opKyKcyNXGXCkgScluQnw. 29. See, United States Department of the Treasury, Leveling the Playing Field: Curbing Tax Havens and Removing Tax Incentives for Shifting Jobs Overseas, May 4, 2009 available at http://www.treas.gov/press/re- leases/tg119.htm (United States government "seek[s] to reduce the amount of taxes lost to tax havens - either through unintended loopholes that allow companies to legally avoid paying billions in taxes, or through the illegal use of hidden accounts by well-off individuals.").

20 Andrew P. Morriss

"side of the story had merits and I ac- behavior would quickly lose its ability to cepted it. However, before unlocking my attract business and so deprive its popu- door for his exit, I impressed on him the lation of the benefit of the offshore finan- fact that if at any time he should slip out cial sector.38 These revenues are of his bounds as a banker and hurt people significant: the Cayman Islands derive or the local banking community, I would approximately half their government rev- see him behind bars."3o It is impossible to enues from offshore-financial industry imagine such an interview between, for fees and a significant portion of tourism example, the U.S. Secretary of the Trea- there is finance-industry-related as sury and the head of an American bank well.34 As a result, the major OFCs have without the presence of a herd of lawyers invested heavily in their regulatory infra- on both sides, an absence of similarly structure. For example, the Cayman Is- frank discussion, and a press conference lands' major regulator is the Cayman on the Treasury steps at which the ag- Islands Monetary Authority, whose board grieved banker and his lawyers de- consists of financial professionals drawn nounced the heavy-handed efforts of the from both the islands and internationally Treasury. Comparing regulatory and whose credentials compare favorably frameworks thus requires both evaluat- to those of regulators in the United 3 ing formal rules and powers and the ac- States. 5 The Cayman Islands Stock Ex- tual practice of regulation across change is an affiliate member of the In- jurisdictions.3 ' Leading OFCs like Ber- ternational Organization of Securities muda, the Cayman Islands, the Channel Commissions, a member of the In- Islands, Dubai, and Singapore offer a termarket Surveillance Group and recog- combination of laws, regulations, regula- nized by the U.K. Revenue and tors, and regulatory culture that makes Board, signals that it meets international the effective degree of regulation at least standards and allowing listed securities equal to that in onshore jurisdictions, al- to be sold in major markets.36 Major though sometimes with different goals. 3 2 OFCs are regularly reviewed by the In- Second, offshore jurisdictions have ternational Monetary Fund, an organiza- large investments in their reputations, tion controlled by onshore governments, since any offshore jurisdiction that al- and generally received favorable reviews lowed significant fraudulent or criminal when compared against best practices

30. VASSEL JOHNSON, As I SEE IT: How CAYMAN BECAME A LEADING FINANCIAL SECTOR 159-160 (2001). Note that the banker, Jean Doucet, eventually did end up behind bars on an unrelated matter; id. at 163-164. 31. See Andrew P. Morriss, Regulatory Intensity & Offshore FinancialCenters, Working Paper (2009). 32. Id. 33. A similar argument is made concerning Delaware's role as a provider of within the United States. See Macey & Dionne, supra note 13. 34. Andrew P. Morriss & Craig M. Boise, Creating Cayman, (Working Paper, 2009). 35. Morriss, supra note 31. 36. See Cayman Islands Stock Exchange, Recognitions, Affiliations, and Memberships, (2008) available at http://www.csx.com.ky/.

21 NEXUS standards that onshore governments vices business is at least as intense as the sometimes do not themselves meet.3 7 competition between those financial cen- British OFCs are also reviewed by the ters and OFCs.40 Thus aside from juris- British Treasury, and also have received dictions without any serious regulatory favorable reviews.3 Thus by most objec- oversight (e.g. Antigua) or corruption tive measures, the major OFCs (if not the problems (e.g. the Turks & Caicos Is- less developed ones like Antigua) have lands),'41 the largest OFCs provide what is been successful at providing adequate best described as a different form of regu- regulation, at times even exceeding the lation rather than an absence of regula- regulatory stringency of onshore govern- tion. This is not surprising; as Macey ments. There is some indirect evidence to and Dionne note, jurisdictions compete in support this contention: the most dra- many regulatory dimensions and zero is matic frauds in recent years have oc- not always the desired level of regulation curred not in OFCs but in onshore by financial services firms.42 Since OFCs jurisdictions: Enron, Parmalat, and specialize in products for sophisticated Madoff are all financial scandals with on- investors, it is not surprising that OFCs shore roots. regulate differently from onshore juris- Third, even among regulators in ma- dictions where regulatory concern is fo- jor onshore financial centers there are cused on retail products .4 Thus the dramatic differences in how regulatory differences between OFCs and onshore agencies are structured, the regulatory regulators are differences in focus, philos- philosophy, and the regulations imposed ophy, and approach similar to the differ- on financial services firms. For example, ences among onshore jurisdictions rather the United States and the United King- than differences in regulatory laxity. The dom take dramatically different ap- differences between onshore and offshore proaches to financial services regulation regulators are thus not adequately de- in both the structure of their respective scribed as two ends of a uni-dimensional regulators and the type of regulation.3 9 spectrum. The regulatory competition is The competition between the New York thus better described as a competition for City and London over the financial ser- the optimal level of regulation.

37. Richard K. Gordon, The InternationalMonetary Fund & the Regulation of Offshore Centers, REGULA- TORY COMPETITION & OFFSHORE FINANCIAL CENTERS (forthcoming). 38. Morriss, supra note 31. 39. See James D. Cox & Edward F. Greene, FinancialRegulation in a Global Market Place: Report of the Duke Global Capital Markets Roundtable, 18 DUKE J. COMP. & INT'L L. 239, 243-244 (2007). 40. See Edward F. Greene, Modernizing U.S. Regulation of Capital Markets, in SEVENTH ANNUAL INSTI- TUTE ON SECURITIES REGULATION IN EUROPE: A CONTRAST IN EU AND US PRovISIoNS, 379-390 (Practicing Law Institute 2008). 41. Alex Barker, "Turks and Caicos premier hits out at UK moves," Financial Times, March 18, 2009 at al; M Rensselaer W. Lee III, THE WHITE LABYRINTH: COCAINE AND POLITICAL POWER 183 (Transaction Publish- ers)(1991). 42. Macey & Dionne, supra note 13. 43. Morriss, supra note 31.

22 Andrew P. Morriss

Confidentiality and common law. For example, most com- mon law OFCs trace their confidentiality Onshore governments regularly at- laws to the landmark 1924 U.K. decision, 46 tack offshore governments for providing Tournier v. National Provincial Bank strong financial privacy laws. An attack and confidentiality in commercial mat- on confidentiality is central to the pro- ters is the basis for the protection of posed Stop Tax Haven Abuse Act in the secrets, a position that the United States United States, with the draft legislation (among others) has vigorously asserted.47 including a series of presumptions to dis- Civil law jurisdictions have their own advantage those jurisdictions that fail to long history of respecting financial pri- assist the United States in stopping tax vacy.4 8 Differences over confidentiality avoidance as well as tax evasion .44 between onshore jurisdictions and OFCs Does confidentiality undermine on- thus reflect differences in emphasis, not shore efforts at regulation? Certainly the differences in kind. inability of onshore law enforcement or Further, financial confidentiality also tax authorities to obtain comprehensive protects opposition politicians from coun- information on offshore financial activity tries like Venezuela, Russia, and means that money laundering and tax Zimbabwe, where governments have at- evasion are more likely to succeed than if tempted to undercut domestic opponents onshore authorities had complete infor- by attacking their financial resources. 4 9 mation. But success in law enforcement A significant problem with the attacks on and tax collection are not the sole metrics confidentiality by the by which policies must be evaluated. As and United States is that those attacks Rose-Marie Antoine argues, "[that confi- make it harder for jurisdictions to refuse dentiality can sometimes be abused does requests for information from unsavory not make confidentiality itself an abusive regimes. or illegitimate concept. Rather, we have Confidentiality is thus not an issue accepted that in every financial endeavor on which onshore governments can legiti- and structure there will be weaknesses mately claim that other interests must and what we need to do is to have checks yield to their interests in enforcing their and balances and avenues for redress."45 tax laws. Rather it requires that jurisdic- Financial privacy is not something of tions negotiate accommodations to each interest only to OFCs or money launders. others' interests, with both OFCs and on- Confidentiality in financial matters is a well-established principle in both civil

44. See note 9 supra. 45. Antoine, supra note 10. 46. Tournier v. Nat'l ProvincialBank, [19241 1 K.B. 461. 47. Antoine, supra note 10. 48. Antoine, supra note 10. 49. Morriss, supra note 13.

23 NEXUS shore jurisdictions treating each others' and tax cheats seeking to launder or con- interests as deserving of respect.50 ceal assets will need only to further de- At the moment, the onshore assault velop their existing financial networks on offshore jurisdictions' confidentiality outside the formal financial system (e.g. laws is yielding some results, with Swit- the Peso Exchange) or pay zerland tentatively agreeing to breaches the additional transactions costs of more of bank secrecy that would have been pre- complex financial structures to avoid viously unthinkable as a result of the triggering onshore regulatory attention.4 UBS scandal.61 And if the Stop Tax Ha- In sum, even if onshore pressure on ven Abuse Act becomes law in the United OFCs over confidentiality laws is success- States in anything approximating its ful, it is not likely to yield significant dif- summer 2009 form, it will be virtually ferences in financial services activities impossible for any jurisdiction to avoid a because confidentiality is not an integral high degree of cooperation with the part of modern OFCs' business models. United States tax authorities to avoid the draconian presumptions the act will ap- Tax Competition ply to non-cooperative jurisdictions.52 These changes are unlikely to have Tax competition is often misleadingly the effects their sponsors anticipate, how- described as a simple competition be- ever. Confidentiality was vital to the tween high and low tax jurisdictions over 1960s and 1970s business models of rates applied to a single form of taxation. OFCs seeking individual wealth manage- Rather, as Craig Boise has noted, differ- ment business but is irrelevant to the ent jurisdictions have different tax struc- 1990s and later business models built on tures and those differences create aircraft financing, captive insurance, as- opportunities for business structuring to set securitization, and hedge fund domi- reduce overall tax bills.66 For example, cile.63 Moreover, criminal enterprises the "zero tax" Cayman Islands indeed

50. Antoine, supra note 10; Craig M. Boise, Regulating Competition in Offshore Financial Centers (Case Research Papers Series in Legal Studies, Paper No. 08-26, 2008), available at http://ssrn.com/ab- stract=1266329. 51. See Carrick Mollenkamp, et al., UBS to Give 4,450 Names to U.S.: Tax-Evasion Pact May Disclose 10,000 Clients: Swiss Government, WALL ST.J., Aug. 20, 2009, available at http://online.wsj.com/article/ SB125068571743342973.html. Swiss law allows the major changes the United States is seeking be subject to referenda in the cantons and so any tentative agreement with the Swiss federal government may not survive that process. See COUNCIL OF EUROPE, TREATY MAKING - EXPRESSION OF CONSENT BY STATES TO BE BOUND BY A TREATY 268-269 (2001). It is not clear, however, that reducing the scope of confidentiality provisions will actu- ally produce a major increase in enforcement of onshore tax and regulatory laws. 52. See supra note 9. 53. Indeed, even by 1976 when the Cayman Islands created the Confidential Relationships (Protection) Act, making it a criminal offense to reveal confidential information, the Act's main purpose was to build confi- dence in the jurisdiction's reliability rather than to shelter dodgy money. See Morriss & Boise, supra note 34. 54. See James Sloan, Black Market Peso Exchange Update, 12 UNITED STATES DEPT. OF THE TREASURY, FinCEN Advisory, June 1999, available at http://www.fincen.gov/news room/rp/advisory/pdfladvisl2.pdf. 55. Boise, supra note 50.

24 Andrew P. Morriss have no but they have what is tion typically portray this as a loss of tax effectively a hefty (with rates revenue to the high tax domestic jurisdic- approaching 50% on some goods).56 Cay- tion.61 It is equally possible, however, to man also has significant property trans- consider it as enabling the high tax juris- 5 fer taxes. 1 Cayman's tax structure is diction to price discriminate in its taxa- similar to that used by Texas, which also tion between international and domestic has no income tax and a predominately activity, applying a higher rate to domes- sales and regime.58 Not sur- tic income than would be possible other- prisingly, given onshore jurisdictions' hy- wise. For example, Canadian natural pocrisy on tax practices,"9 Cayman, but resource companies, among the world's not Texas, is considered to be engaged in leaders in their field, would find it diffi- "unfair tax competition" and is the sub- cult to compete internationally if they ject of pressure from onshore govern- had to pay domestic Canadian tax rates ments over its tax structure. on their non-Canadian operations. Differences in tax systems are inevi- Moreover, there are a number of ar- table because the purpose of tax rules dif- eas where taxation is irrelevant to OFCs' fers among societies and because of path- business models. For example, the Cay- dependent choices about definitions and man Islands are the domicile of the cap- concepts. As a result, businesses have an tive insurance companies of many U.S. incentive to minimize their costs by non-profit health care providers, a group structuring themselves to minimize the unconcerned with taxation of earnings. total cost of doing business (legal and ac- And many offshore captives opt to pay counting fees plus tax payments). On- U.S. income taxes as if they were U.S. en- shore governments can restrict such tities, again making tax issues irrelevant competition by erecting barriers that to the decision to locate offshore. Simi- raise the cost of using OFC structures, larly, many investors in offshore hedge but they do so at a cost to themselves. funds are nonprofit organizations, such For example, Barbados has an extensive as university endowments. For these in- network of tax treaties that allow compa- vestors, the of an OFC- nies from high tax jurisdictions (e.g. Ca- based hedge fund is not a means of avoid- nada) to reduce their tax burden on ing U.S. income taxes. Finally, tax-re- international operations below the do- lated OFC structures often offer onshore mestic level.6 o Opponents of tax competi- jurisdictions considerable benefits. For

56. The tax is collected as an import . Because the Islands import virtually everything and because virtually all imports come through a relatively easy to monitor port, the tax can be collected most efficiently as a duty rather than at the point of sale. 57. See Rates, available at http://www.tamarasiemens.com/stampduty.html. 58. See , Texas, available at http://www.taxfoundation.org/research/topic/60.html 59. Boise, supra note 50. 60. See, e.g., Jamal Hejazi & Matthew Zadro, Canada: Barbados InternationalBusiness Corporations, GOWLINGS, July 3, 2008, available at http://www.mondaq.com/article.asp?articleid=62580. 61. See, e.g., OXFAm, TAx HAVENS: RELEASING THE HIDDEN BILLIONS FOR POVERTY ERADICATION (2000).

25 NEXUS example, the use of finance subsidiaries Will Limiting Competition by in the Netherlands Antilles in the 1970s OFCs Enhance Onshore Regulation? and early 1980s saved U.S. corporate bor- rowers an estimated 2-3% interest be- The short answer is "'no." The signifi- cause such subsidiaries allowed the U.S. cant OFCs like Bermuda, the Cayman Is- parents to obtain financing in the lands, the Channel Islands, Kong cheaper Eurodollar market.62 and Singapore provide important compe- Tax structuring undoubtedly plays a tition for onshore jurisdictions. Rather role in some aspects of modern OFC busi- than undermining onshore regulation, ness models but it is less important than OFCs can play a constructive role in in- onshore governments appear to believe. ternational finance for three reasons. As a result, onshore governments efforts First, OFCs offer onshore jurisdictions to limit tax competition are likely to be at important advantages. OFCs provide a least partially counterproductive, since means of price-discrimination. Some eco- obstructing use of OFCs will deny the nomic activities sensitive to transactions benefits of OFC structures to onshore ju- costs, including tax rates, relocate to risdictions' economies. To the extent that OFCs. But the profits from the OFC-lo- tax competition from OFCs does limit the cated segment ultimately will be rein- upper level of tax rates an onshore juris- vested or spent in onshore jurisdictions, diction can charge, an onshore jurisdic- creating more economic activity onshore, tion wishing to charge more must simply because investment opportunities within find other margins on which to compete. OFCs are too small to absorb the capital New York and France are able to levy created by the offshore sector. As the ex- high taxes on entities operating within ample of Canadian natural resource com- their boundaries despite tax competition panies shows, allowing businesses to opt from Texas and Ireland because the for- out of domestic tax regimes for their in- mer two jurisdictions offer amenities and ternational businesses can have impor- advantages not available in the latter tant benefits for both shareholders and two.62 New York and France may not be businesses. As the nonprofit health care able to accomplish all of their captive example shows, OFCs offer more objectives, but their tax policies can ways to cut transactions costs than low hardly be said to have been completely taxes. frustrated by tax competition from lower Second, the constraints imposed on tax jurisdictions within or without the well-run onshore economies by OFCs are United States and European Union. relatively small and likely affect large economies like the United States and Eu-

62. CraigM. Boise & Andrew P. Morriss, Change, Dependency, and Regime Plasticity in Offshore Finan- cial Intermediation: The Saga of the Netherlands Antilles, _ TEX. INT'L L. J. (forthcoming). 63. The mix of taxes charged by New York and France may be different than it would be in the absence of tax competition.

26 Andrew P. Morriss ropean Union only on the margin. For ex- by new international financial regula- ample, even assuming the worst case tions. Where OFCs likely have a larger scenario, nominal U.S. impact is on smaller economies, where rates remain among the world's highest.6 4 the ability to opt out of a corrupt or ineffi- At most, OFCs offer some American busi- cient legal system is important to creat- nesses a chance to lower their tax rates in ing viable non-state sectors. 6 6 the same fashion as the complexities of Third, setting the "rules of the game" the Internal Revenue Code do for for international finance is properly the others.65 Confidentiality provisions are subject of multilateral negotiations largely irrelevant to most business struc- among all affected jurisdictions. The do- tures and virtually all OFCs already have mestic interests of any one sector, tax information exchange agreements whether concerned with tax collections or that permit transfer of information where securities regulation, cannot be the only there is specific evidence of criminal ac- concern. In their efforts to resist compe- tivity. Even the impact of legal innova- tition from OFCs, the United States and tions offshore is attenuated by the European Union risk damaging an inter- additional transactions costs of operating national financial system that has served in multiple jurisdictions. It seems hard the world economy well since World War to credit onshore politicians' claims that II. Rather than changing the rules, on- there is a significant pool of unregulated shore jurisdictions should strive to com- and under-taxed funds to be recaptured pete more effectively on the merits.

64. See Scott A. Hodge & Andre Dammert, U.S. Lags While Competitors Accelerate CorporateIncome 184 TAx FOUND. (Aug. 2009), available at http://www.taxfoundation.org/files/ffl84.pdf. 65. See Chye-Ching Huang, Putting U.S. Corporate Taxes in Perspective, CENTER ON BUDGET AND POLICY PRIORITIES, Oct. 27, 2008, available at http://www.cbpp.org/cms/?fa=view&id=784. 66. Morriss, supra note 13.

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