The Pandora Papers

The Wharton business ethics expert talks surprise tax havens, international tax evasion, and when secrecy makes sense.

While offshore accounts conjure up images of Lichtenstein or the Caribbean, these financial dealings are legal in several U.S. states.

The Pandora Papers, a trove of 12 million leaked documents filled with financial information, was released by the International Consortium of Investigative Journalists (ICIJ) last month. The ICIJI collaborated with over 140 international media organizations to process the documents, which noted both legal and illegal dealings in offshore accounts, shell companies, and real estate investments. Among the individuals named in the Papers were Tony Blair, former Prime Minister of the United Kingdom, King Abdullah II of Jordan, the Prime Minister of the Czech Republic Andrej Babiš, along with Colombian singer Shakira, martial arts star Jackie Chan, and German supermodel Claudia Schiffer.

Many of these interactions are legitimate, says David Zaring, Elizabeth F. Putzel Professor and professor of legal studies and business ethics at the Wharton School. “This is a fascinating project, but most of these shell companies were set up for legitimate reasons; they’re not all a bunch of criminal masterminds,” he says.

Penn Today spoke with Zaring about surprise tax havens in the United States, the difficulty involved in getting multiple countries to agree on shared rules, and why he has sympathy for Tony Blair.

The Pandora Papers shed light on secret trusts inside the United States, namely in South Dakota, Delaware, and Florida. What are the implications of that kind of activity being legal within the U.S.?

I was surprised at how much action there was from these things that were created in the United States. I sometimes understand why people want to act in secrecy and I can see why there might be a market for the kind of secret trusts that South Dakota created. If you’re a business and you’re trying to assemble a bunch of property, like you want to develop a city block and you want to acquire all the houses on the block, you don’t want to let everyone on that block know that you’re going to be buying all the houses, because they might hold out on you. So it’s that kind of thing, or if you’re a celebrity and you don’t want everyone to know where you live. Or potential kidnapper types to know where you live, if you’re a high net-worth individual. Here’s where I might have some sympathy, like Tony Blair, he might have not wanted people to know where his office was.

The question is always whether these guys are using these secret trusts to take ill-gotten money out of their country and then hide it, and it looks to me like in many cases the answer that question is yes, but maybe not in [every] case. Maybe it’s a weird way of hiding taxes. But sometimes this stuff looks bad, but is motivated by an understandable desire to not let everyone know where you live. That’s the kind of thing where, I sort of get the point of secrecy. Delaware and South Dakota came up with these tools that can be used for those reasons.

What does surprise me, though is that there’s a sense that United States doesn’t get the tax revenue it’s entitled to get, and there’s been an effort to fund the Internal Revenue Service to do the kinds of investigations which could help them uncover wealthy people who are under-paying their taxes. It looks like that effort’s been stymied.

It’s kind of interesting to see that sensible requirement—that people pay the full amount of taxes they’re supposed to pay—be stymied and then at the same time this comes out, which identifies just how many people are taking advantage of these vehicles to hide their money and doing so not by going out offshore but by staying onshore and going into South Dakota.

The other thing that I’ll say is that Delaware has the addition of being a business-friendly state that will let you do things the way you want to do them. And it’s prospered that way. Delaware’s the home of corporations. It’s got a thriving financial services and legal services practice that caters to those institutions, a corporate-friendly legislature, limited liability companies that are pretty sophisticated, and so to layer on top of that the ability to create these sorts of trusts adds to the one-stop shopping they can provide you with. It also has a track record of being the kind of state that’s willing to adapt its laws so that it’s business- and wealthy-person friendly, and I’m not sure South Dakota has that kind of reputation. It has tried to do something similar, but it’s obviously a lot further away from New York and maybe that’s a reason why it hasn’t been able to do quite so much. For South Dakota, is the squeeze worth the juice?

Internationally, does the U.S. have a role to play in ending tax havens?

Internationally, the United States is going to have to work with foreign countries. The G20 has often railed against tax havens. They’ve done so since they were reinvigorated in response to the financial crisis, where they agreed to take a bunch of steps to reform the global financial system. One of the steps has always been to address the problem of tax havens being used to deprive wealthy countries of the sort of tax income they were expecting. And that international effort has not been too successful, but you’ll note that one thing that happened in the wake of the financial crisis is that Switzerland sort of deemphasized secrecy and cooperated with the United States to help bring prosecution against a bunch of banks that enabled Americans to hide money in Switzerland and evade taxes that way. And so you can maybe see this international effort persuading at least one of these traditional tax havens from being less willing to do that kind of thing. But, persuading countries like the Cayman Islands, Bahamas, The Isle of Man, and Lichtenstein, not to take advantage of the big countries around them by offering this tax haven stuff has been super hard to do.

That is definitely not the case with South Dakota, Florida, and Delaware; the United States could pass a law, and I saw that Tom Malinowski introduced the Enablers Act, which would require, not just banks but lawyers, investment advisors, and accountants—they would all be subject to some of the reporting required under the Bank Secrecy Act, and that would make it harder for law firms to avoid this kind of thing. And it would also mean that you could create these sort of secret trusts in Delaware in South Dakota but it wouldn’t be that secret because you’d have to report this information to the IRS and the Department of the Treasury, as well as to the state of South Dakota. I don’t know if that’s going to happen, but [the law] was introduced on a bipartisan basis, and that kind of legislation could affect the availability of these sort of secret trusts in the United States.

How would it be possible to regulate this massive and deeply secretive industry on an international scale?

It’s been a persistent problem, because a lot of times the tax havens just don’t see their interests as aligned with the countries that lose out on tax and other kinds of revenue from these processes, and so getting the tax havens to agree has been this big problem. And it’s a problem that could be solved with a sort of international convention that had really broad buy-in, or that maybe could be solved with reference to the sorts of organizations that don’t usually like to get involved in this kind of thing, like the World Trade Organization (WTO).

If the WTO’s convention can be amended to deal with buying financial services and offshore stuff, I don’t think the tax havens would exit the WTO, there’s just too much at stake for them. So it’s that kind of global compact which would be required to really solve this problem, and the fact that that global compact hasn’t happened, an international multilateral treaty, it’s almost impossible to imagine that kind of thing coming together these days. It's going to be really hard to solve it on a global level.

So then, what you’re left with is this sort of bilateral effort by the United States to sanction countries that it thinks are taking advantage of their offshore location, and that becomes harder, because we can’t control how these other countries do business and often the annoyance that the Treasury Department feels about this stuff isn’t necessarily shared by American citizens who want to take advantage of what’s going on in the Cayman Islands.

What do you think is still out there that the Pandora papers didn’t turn up?

I always assume there’s lots of tax evasion going on. One of the things that these [journalists] focused on was politicians and I wonder if there might be other interesting developments. I expect that a lot of the people who take advantage of these sorts of shell corporations are high net-worth individuals, like athletes and entertainers and CEOs, who are interested in making purchases or maybe hiding assets in a tax-friendly way, shall we say, without making those kinds of disclosures. I can imagine that that kind of thing is stuff that we haven’t seen.

The other question that I think takes a lot more digging, would be the way that criminals are taking advantage of these opportunities to either move or hide wealth, and I would expect that one of the things that law enforcement would be very interested in would be getting ahold of the papers to see if they could link criminal assets with particular companies that they could then enforce against. As far as I can see, that sort of process hasn’t really happened yet.

I will also say that after the Panama Papers, there was some follow-up sort of enforcement and definitely there were plenty of scandals, but that set of papers didn’t appear to be so fruitful as far as uncovering criminality. These are obviously a lot larger set of documents from a bunch of different firms as opposed to one firm, and so maybe that’s something that we’ll see going forward.

How far should trust companies go to ensure that their services aren’t being used essentially for money laundering?

I think the question here is whether these institutions and lawyers and the people who create [these trusts] ought to be subject to the same rules that banks are subject to. Banks have to know their customer (KYC), and they have to check to see whether their customer is on a blacklist, like narco-traffickers and terrorist-financing organizations, so that the bank doesn’t end up financing these people’s bad deeds. And that makes sense to me. I don’t see why trust companies shouldn’t have to report that information, that seems reasonable and it doesn't seem like something that’s [currently] required.

I will say that banks complain a lot about how burdensome this reporting is, the KYC, anti-money laundering, counterterrorism stuff, they say they spent a lot of money on it, it’s pretty expensive. That’s the big argument against it. This is a fascinating project, but most of these shell companies were set up for legitimate reasons, they’re not all a bunch of criminal masterminds, and reporting on who exactly owns what and who’s then checking that against the list of people who we’re worried about, the argument is that it’s pretty burdensome.

The International Consortium of Investigative Journalists is planning to publish a searchable public database with a list of the account holders’ names. What would that accomplish?

I think that gets a real degree of transparency into the process, so everybody who wanted to sort of hide a transaction or the acquisition of some real estate will no longer be able to do so. That kind of radical transparency is not going to be what these people expected, but maybe they shouldn’t be entitled to this sort of secrecy that they’ve been taking advantage of. That also is a good way of leveraging the resources to investigate what’s been going on. The ICIJ has put together a worldwide team of journalists who have been going through these documents, and doing so carefully and comprehensively, but a crowdsourced investigation can afford even more insights and eventually, if these documents did get publicized, that sort of crowdsourced investigation becomes more possible.