Russian Strategic Thought: Prisoner of the Past

Recently, U.S. President Obama showed a high degree of candor when he quipped that Russian Prime Minister Vladimir Putin still had one foot in the Cold War.

At this week’s Moscow Summit, he was more diplomatic (i.e. restrained).  He focused his attention on areas where the U.S. and Russia seem to have  common interests:  achieving greater strategic arms reductions, counter-acting Islamic militants in South Asia, and most probably slowing down nuclear proliferation (although possibly not including Iran).

It seems only those subjects upon which there was agreement in advance among the two sides’ staff can be considered resulting from the meeting.  Still deadlines produce results.  Achieving results on complex issues is far more difficult.

Unfortunately, the U.S. may have seemingly forgot about the Russian invasion of Georgia when it agreed to resume limited military cooperation that were suspended in the aftermath of last August’s events.  Perhaps it would have been wiser for President Obama to make a commitment to seek to end trade restrictions that are in place as a result of outdated Jackson-Vanik Amendment.

No agreement was achieved on contentious topics.  This demonstrates that Russia wishes that the U.S. would acknowledge its sphere of influence in the “near abroad” (i.e. the Soviet Union’s successor states (minus the Baltic States) — most significantly Georgia and Ukraine).  This will not come to pass.  It also seems that a large share of the Russian national security community have yet to accept that the Czech Republic and Poland are sovereign countries.

No doubt, upon his return to the U.S., the Obama administration will point to the President’s meeting with opposition figures as evidence that he had not abandoned the promotion of human rights and the rule of lawin Russia since he met with Russian opposition figures.

Still there does not appear to be any major concrete consequences for Russia to penalize it for its domestic policy — but the possible loosening up of  requirements for non-governmental organizations to register seems to be a positive development — now to see how it is implemented.

Just as the Soviets were fearful of the implications of Reagan’s Strategic Defense Initiative (“Star Wars”), the Russians’ anxiety over missile defense in Europe is unjustified.  The deployment of any defensive system would be limited in scope.  The Russian military has far greater confidence in the U.S.’s ability to develop and operate an effective missile defense system, thus Moscow’s concern appears exaggerated.

Apparently, the Russian leadership is no longer threatening to deploy offensive missiles in Kaliningrad.  This is inherently logical as ever military threat creates the necessity of countermeasures.  Events in both Georgia and Estonia suggest that the Russian military establishment is examining the potential of cyber-attacks, after all anti-missile systems rely on computers.

Now in a war-time environment, how much confidence should we have that our weapons systems will be able to operate as planned? Just think how many times that U.S. launches of rockets have to be postponed due to bad whether or the malfunctioning of some part or system that had already been checked by NASA engineers many times over.

Russian strategic planners may not fully  appreciate that nuclear power plants are very attractive targets for cruise missiles and conventional aircraft. Russia (and other countries dependent on nuclear energy such as France), face the very real danger of having their population irradiated; such a calamity would result in an untold number of deaths due to cancer and other disease as well as give rise to a food crisis the world has never seen.

At this stage, no news in U.S.-Russian relations is probably good news.  President Obama can show the Russians the respect they crave without making any concessions.  If both Zbigniew Brzezinski and Michael McFaul seem pleased with the results, who am I to disagree?

The Russian Judiciary

For more than 15 years, many specialists on the Russian “legal system” have been writing about widespread political abuse of the courts by the ruling Russian political elite in order to increase their own power and for financial gain. Unfortunately, this problem extends to the Russian Procuracy and other state bodies charged with enforcing the “law” in the country.

Yet most Russian officials and business persons, foreign judges, and other promoters of increased trade and investment in Russia have largely downplayed this. The Kremlin prefers to spend large sums of money on public diplomacy rather than addressing the problem.

Now that former German Minister of Justice Sabine Leuthheusser-Schnarrenberger has issued a Report on this phenomenon and IKEA announced that it is ending any further investment (at least in the near-term) due to corruption in the country, the situation is being widely covered by the mass media.

Why is it that many foreign government officials (including judges) and others only now are acting upon what has been common knowledge for quite some time?

Did it take the world economic crisis to bring candor to the forefront? Could concerns about legal or political survival play a role? Bravo to the NGO and the many brave individuals in the press who have been willing to speak the truth.

Will there ever be any accountability for the officials in international organizations governmental “aid” bodies who funded judicial “reform” in Russia with minimal positive results? Should the numerous consultants and lawyers who profited but not fully informing their clients of the genuine risks of doing business in Russia think of making restitution?

Why have so few paid attention to Dmitrii Kozak’s inability in introduce political reform in Russia, much less the comments of its President Dmitrii Medvedev? The number of questions is indeed quite large.

Ultimately, the bulk of the Russian people are the ultimate victims of the situation. Apart from the denial of their constitutional rights, their government is not providing most of them with decent public schools, environmental protection, housing and quality health care due to a lack of funds (and will to do so).

I doubt that hosting the Winter Olympics in Sochi will provide much solace to them.

Iran and Belarus: Each Voting Situation is Sui Generis

Persons interested in gaining greater insight into whether there was election fraud in the recent Iranian voting process should read a recent Chatham House (Royal Institute for International Affairs) Report available at

http://www.chathamhouse.org.uk/files/14234_iranelection0609.pdf

Iranians appearing on television saying they were acting due the encouragement of Voice of America and BBC is a good illustration, assuming that they are not supporters of the existing system, of what people might do if they feel that their families will be harmed if they do not cooperate.

The West has learned a lot about the consequences of giving people hoping for political reform false hopes since Hungary 1956.

One might wonder what Iranian President Mahmoud Ahmadi-Nejad and Belarusian President Aleksandr Lukashenka might have discussed during their reciprocal visits in recent years.  Conceivably, Mr. Ahmadi-Nejad might have solicited advice about how best to achieve “electoral” victory, for example how to tally millions of votes in a matter of hours.

In comparison to his counterpart, Mr. Lukashenka enjoys two key advantages: (i) his principal political opponents seem to lack deep roots in Belarusian society, and hence behave more akin to dissidents, and (ii) Belarus ranks low on most countries’ foreign policy agenda.  For Mr. Ahmadi-Nejad this is not the case.

Former Iran Premier Mir-Hossein Moussavi is an experienced, credible national leader with considerable support among the frustrated Iranian mass, which have been experiencing a decline in its living standards; and while sharing Belarus’ status as a pariah state, Iran’s nuclear program is of great concern to world leaders.

Elections do not a democracy make — often they are merely mechanisms for creating the illusion of legitimacy when none exists.  As it has been said, what is important about elections is not how people vote, but how the ballots are counted.

Iranian students have a tradition in toppling regimes that are not responsive to the people’s needs.  It should come as no surprise that both the Chinese and Russian leadership believe the election outcome is already a settled matter.

Domestic Changes in Israel and the Arab States May be The Key to A Solution to the Mid-East Conflict

President Obama’s speech in Cairo struck the right tone.  Of course, words are one thing, actions on the Arab states, Israel and the U.S. are another.  Unfortunately, he stayed clear of how Israel was being unfairly scapegoated by certain Arab states for their domestic problems.  While many Israelis did not like Mr. Obama’s words of tough love, Israel has many friends in the Obama administration, Rahm Emanuel being the first to come to mind and he is not a naive optimistic.

Throughout history 2-5% of a given population has made life worse for the remainder.  Sometimes, these groups have extremist views when compared with that of the population at large.  Often their leaders have had troubled childhoods and a level of grandiosity that might lead psychiatrists to designate them as “psychopaths” (e.g. Genghis Khan, Adolph Hitler, Saddam Hussein, Joseph Stalin, etc.).

The influence of many of these small, extremist, non-representative groups has had (and will continue to have) immense economic and political ramifications.  Just think of the long-term consequences of the terrorist attack on the World Trade Center and the Pentagon on 9/11 and the U.S.-led invasion of Iraq.

The overwhelming majority of people want fairly modest things for themselves and their families: food, clothing, housing, access to medical care, education for their children, steady work, the ability to save for the purchase of certain material possessions, physical security and a sense of dignity in their lives.

Unfortunately, the aforementioned extremists often makes this impossible by exploiting economic, ethnic, national and religious tensions.  As a result, an intractable cycle of violence can result that in many cases can only be solved in the short-term by violence, although on occasion peaceful dispute resolution can be successful.

Ironically, it is often the cases that people, who share the greatest in common – after all, Bosniaks, Croats and Serbs were for many years engaged in a bloody war following the break-up of former Yugoslavia.  This may be because of historical events — a people may lack a sense of identity and thus make the “other” their scapegoat/enemy.

U.S. President Barak Obama has called on Israeli Prime Minister Netanyahu to halt the building of new settlements on the West Bank in the hope of creating an environment that might facilitate settlement negotiations.  In the absence of tangible progress towards peace (or more realistically a permanent absence of conflict), the most extremist and confrontational elements of Israeli and Palestinian society, the more moderate political figures appear impotent.

While truth is not arrived at by a majority vote, perhaps Prime Minister Netanyahu should call for an Israeli national referendum on the building of new settlements on the West Bank for a limited period (say 3 years – to overlap with Mr. Obama’s first term of office).

In addition, the referendum should raise two other issues: requiring political parties to receive at least 10% of the parliamentary vote to obtain seats in the Knesset or alternatively, the establishment of election districts for each Knesset member.  The effect of either alternative will reduce the influence of extremists in Israel that can hold parliamentary coalitions hostage to positions not held by the overwhelming share of the country’s population.

This minimum threshold concept is not without precedent.  Some countries use such systems to keep fringe parties out of parliament – Germany immediately comes to mind.  The result can be a ruling government capable of addressing the challenging the country.

Many Israelis view Iran’s development of nuclear weapons to represent an “existential threat.”  Within the Middle East, fear of Iran is not a characteristic solely of Israel.  Iran has the largest population in the region, is increasingly playing a role in the Shiite-dominated portion of Iraq, and is the first oil producing country likely to exhaust its oil reserves.  The Emirates, Iraq, Kuwait, Saudi Arabia and others are well aware of this situation.

Prime Minister Netanyahu need not dismantle existing settlements.  Nor should be be required to make tangible concessions that might threaten Israeli security for mere words.  Nonetheless, he can help create an environment where negotiations could have a chance.  The Palestinian Authority (but not) Hamas should be accepted as negotiation partners by his Government.  The Arab States should declare their willingness to recognize Israel’s right to exist within secure borders, full-diplomatic relations and the development of trade relations.  If any real progress is made in the near-term, Arab extremists will be undermined.

Former Prime Minister Ariel Sharon recognized that the present situation could not continue indefinitely.  Israel faces a demographic nightmare.  Its incursions into Gaza and Lebanon illustrated the limits of the use of force for achieving Israel’s objectives.  The late Yitzhak Rabin understood that one has to accept risks in the hope to obtain peace.  He, like the late Jordanian King Abdullah I, both paid with their lives for recognizing the need to reach some form of accommodation.

For Prime Minister Netanyahu freezing new settlements on the West Bank would not endanger Israel’s security.  Failing to do will damage Israeli national security and the world economy.  Only a psychopath would choose to do so — a diagnosis that does not fit him.

*  *  *  *

Waiting for the Other Shoe To Fall?

According to its website, the Carlyle Group has approximately $100 billion dollars under its management (see http://www.carlyle.com/Company/item1677.html). It proclaims that it has “480 investment professionals working in offices in 20 countries. These individuals collaborate across geography, sharing industry knowledge and insight to source, research and consummate investments in Carlyle’s focus industries” (see http://www.carlyle.com/Team/Alphabetically/item7697.html).

It is hard enough for parents to remember their children’s weekend schedules (acting class, fencing, religious school) — if you also have to recall the names of their teachers, friends, etc., one faces a very challenging task.  Today, when children are home, they can usually be found stationed at their PCs.  In addition to completing their homework, they are instant messaging their friends and sending out e-mails.

I presume that it is considerably harder managing the activities of nearly 500 individuals located in 20 countries managing $100 billion dollars.  Each employee will at a minimum have to comply with the laws and ethical rules of the countries in which they work.  To complicate matters. not all these professionals have the same native language and many work in different time zones.  Given all these complexities, why should anyone be held responsible?

So how should one process that that at the conclusion of alleged corruption at one of the biggest public pension funds in N.Y., the Carlyle Group “agreed” to pay $20 million dollars as a penalty and adopt a Code of Conduct that would, inter alia, ban outside agents from soliciting public pension funds and prohibit asset managers from doing business with pension funds for two years after contributing to the campaigns of officials who can influence such funds.  This Code of Conduct is apparently the first for private equity firms that cover political donations.  It is not clear if this is the final chapter of a 2-year investigation of alleged kickbacks to secure over $120 billion from New York State’s Common Retirement Fund.

To most people $20 million is a large sum of money.  To the Carlyle Group, it probably represents a fraction of the cost of the lawyers and other professionals it hired to conduct an internal investigation of its apparent wrongful conduct.  I imagine that the Carlyle Group probably spends at least this amount on travel in a given month.  What explains what seems to be either a mere cost of doing business or a slap on the wrist?

I would think that most investment professionals in today’s environment would be scrupulous in complying with their employer’s code of conduct.  The failure to do so could not merely result in civil or criminal liability, it could cost the individual or the Carlyle Group many times the cost of the $20 paid to the State of New York.  What explains this outcome?  There can be many explanations.

1) The Carlyle Group has joined the category of entities that are too big to fail.

2) The Carlyle Group has cultivated numerous prominent individuals and government officials who have no real desire to punish it.

3) More bad news about a major economic actor and another story of large-scale greed could have a harmful effect on the economy.

4) Various governmental entities don’t want to admit how badly regulated the economy has become.

According to the Center for Media and Democracy, “[t]he collection of influential characters who now work, have worked, or have invested in the group . . . include John Major, former British Prime Minister; Fidel Ramos, former Philippines President; Park Tae Joon, former South Korean Prime Minister; Saudi Prince Al-Walid; Colin Powell, former Secretary of State; James Baker III, former Secretary of State; Caspar Weinberger, former Defense Secretary; Richard Darman, former White House Budget Director; the billionaire George Soros, and even some bin Laden family members. You can add Alice Albright, daughter of Madeleine Albright, former Secretary of State; Arthur Lewitt, former SEC head; William Kennard, former head of the FCC, to this list. Finally, add in the Europeans: Karl Otto Poehl, former Bundesbank president; the now-deceased Henri Martre, who was president of Aerospatiale; and Etienne Davignon, former president of the Belgian Generale Holding Company” (see http://www.sourcewatch.org/index.php?title=Carlyle_Group)

Why do most states have investment boards managing pension funds, while in New York all responsibility in this area belonged to the State’s Comptroller?  New York’s Comptroller from 2003-6 was Alan Hevesi who has not be charged with any wrongdoing in this case (though he entered a plea bargain in an unrelated matter).  Do we have the legislators and journalists who know what questions should be asked?  Are they capable of determining whether the answers they receive are truthful?

A Question of Identity

http://www.rgemonitor.com/globalmacro-monitor/256718/a_question_of_identity

Ethan S. Burger | May 11, 2009

Nobel Laureate Amartya Sen, in his insightful book “Identity and Violence: The Illusion of Destiny,” grapples with the complexity of how individuals define themselves (although Professor Sen seems overly eager at undercutting the generalizations used by the late Samuel Huntington in his “Clash of Civilizations,” which as a conceptual framework can be helpful).  Indeed, Prag Khanna in “The Second World: How Emerging Powers Are Redefining Global Competition in the Twenty-First Century” may offer a more useful model for policymakers.  Nonetheless, the issue of identity is complex with respect to humans as we have multiple identities and even within one category (e.g. ethnicity, religion, profession) are seldom “pure.”

Many people have difficulty understanding that with respect to individuals “citizenship” and “nationality” are seldom identical.  The former is a legal concept and the latter a sociological subject.  Many countries permit their citizens to have more than one citizenship.  This is often allowed since it is often the case that one of the countries that has granted citizenship to an individual ignores the fact that s/he has another/other citizenship as well.  Not so long ago, the U.S. took the position that if one of its citizens actively acquired a second citizenship, the individual lost her/his U.S. citizenship. In recent years, this situation has changed.  Unless one renounces U.S. citizenship or commits treason, the U.S. government does not care about any other citizenship a person may hold.  The U.S. government is unusual in that it taxes its citizens on their worldwide income (though this situation may be made less severe through bilateral treaties), as opposed to merely income earned within the country.

In Canada, many of its citizens live abroad.  Indeed, a debate was triggered among Canadian citizens when its government spent nearly $100 million dollars (Canadian) to rescue Canadian citizens from Lebanon at the time of the Israeli conflict with Hizbollah.  Some of the grateful individuals who were rescued had lived in Canada for a small percentage of their lives.  Many Canadians grumbled as they regarded many of those saved as merely holders of a Canadian passport.  What did it mean to be Canadian?  In reality today, there are few true nation-states — borders are largely historical accidents.

Granted, there are countries like Poland where due to the movements of its borders and the Holocaust, “national minorities” within its territory “disappeared” (the lucky ones largely emigrated to France, Germany or the Soviet Union), while the remaining Polish population in the area of religion are nominally Catholic.  Yet if one considers mixed marriages and conversions, the country is not entirely homogeneous (it is not worth considering generational or educational differences).  While there is no doubt as to the faith of the late Pope John Paul II (the first Polish Pope), there is debate about his lineage on his mother’s side.

Recently, Ingrid Betancourt, a French-Colombian national, was rescued from the FARC guerillas after being held hostage for many years.  Some have suggested that she has political futures in both France and Colombia.  Ironically, France was the first country that sought to rally its citizenry around the concept of the French nation.  Today, the French government is prohibited from keeping data on the religious or ethnic origins of its population.  The country operates under the idea that it is enough that a person is a citizen to be French.  Not all Corsicans would agree.

Across the Channel, Britain has a different problem.  Many people in the country have national identities that are territorially-based (e.g. English, Northern Irish, Scotts, and Welsh).  While others prefer to think of themselves as British (e.g. many people from the Commonwealth countries and Jews). Of course, there are mixed marriages and internal migration that has a major impact on the country.  At the same time, many British citizens have an affinity to the country from which they or their parents came — made possible by advances in technology.  This is a problem that the British government grapples with on a daily basis.

There are many reasons to have multiple citizenships.  One can be the product of a mixed marriage where one parent is Dutch and the other German.  Some counties will grant citizenship to individuals who had one grandparent who held (or would have held if it were possible) the citizenship of a particular country (e.g. Hungary Ireland, Israel, and Lithuania).  Having multiple citizenships is generally a good thing — particularly with regard to the right to live and work in a particular country (or any country in the EU).  It can also present certain problems, such as a risk of conscription into the armed forces.  It can also be a “bad” thing for the world as criminals acquire multiple citizenships to facilitate their illegal activities.  In some instances, citizenship can be purchased (just read the advertisements at the rear of The Economist).

The point of the above discussion is to highlight the difficulty of determining the “nationality” and sometimes citizenships of human beings.  Now let’s turn to legal entities, many forms of which are treated by law as a “legal persons,” even though they are artificial.  In fact, they can be established in a matter of minutes after the payment of certain fees and complying with a variety of local requirements.  Nonetheless, legal persons frequently enjoy the same rights as if they were made up of flesh and blood (such as freedom of speech in the U.S.).  Personally, this idea has always troubled me.

Last year, then-presidential candidate Barak Obama spoke of the desirability of “buying American.”  He was really addressing the U.S. unemployment problem, not the falling value of some U.S. securities.  It probably never entered his (or others’) head that some might misconstrue his comments as an effort to encourage persons to buy Argentine, Bolivian, Canadian, Colombian or Mexican goods.  The States has expropriated the term “American” and “America” and does not pay royalties to anyone for having done so.

This year, U.S. President Obama indicated that it was time to crack down on U.S. corporations “that ship jobs overseas” and avoid U.S. taxes with off-shore havens.  The U.S. has to deal with a huge budgetary deficit and his plan would in theory generate $21 billion a year in taxes for the U.S. government (few will discuss the option of inflating the deficit away).  Many lobbyists for U.S. multinational corporations no longer will have to fear for their jobs since they will have a lot of work to do for the foreseeable future — meeting government officials, trying to influence opinion makers, placing OP-ED pieces, producing advertisements, etc.  These are “good jobs” being preserved or created in America no doubt but probably not the type that politicians have in mind when they speak to their constituents.

This presents an existential question: “what is a “U.S. corporation” in today’s world?”  Is the “citizenship” of a corporation “U.S.” merely because it is registered in the country.  To my knowledge, more corporations are registered in the tiny state of Delaware than any other, but few major corporations have their corporate headquarters or principal operations there — with perhaps the Dupont Corporation being an exception.  The Dupont family was originally of French origin, but its founder was probably a U.S. citizen.  Do we care that Henry Ford or Bill Gates are U.S. citizens?  Is this important when considering the nationality of these car and software manufacturers?

Public companies can be owned by foreign citizens and foreign legal entities.  The identities of the beneficial owner may be known, or hidden through shills, shell companies and trusts.  I suspect that at some time it might be discovered that British Petroleum will have been purchased by the Russian government, its citizens and legal entities.  This will be difficult or at least expensive to ascertain.  How else can one explain that whereas other major Western energy corporations have been driven out of Russia, BP remains a partner in the BP-TNK joint venture?  While some Russians are Anglophiles and apparently enjoy living in London (and who can blame them), there has to be a better explanation.

When determining the citizenship of a corporation, do we care about its employees’s citizenship?  On a day-to-day basis, the citizenship of one’s employees can have practical impact such as the legal right to work and determining the amount of withholdings for taxes.  Many U.S. corporations are learning the hard way that EU directives on data protection relate not merely to intellectual property but also personal information on individuals that are typically readily available within U.S. corporations — concepts of privacy vary.  Similarly, U.S. export laws in some cases would require an export license if a foreign national is given access to certain technical information.  Indeed, today’s transnational business world is complex. Should the nationality of a corporation’s management matter?  Where its operations or personnel are located?  Should we even care about a corporation’s stakeholders?

Today, there is much talk about “saving” the U.S. auto industry (and other employers dependent on it).  In most contexts, this refers to the so-called “Big Three”. Chrysler, Ford and General Motors (i.e. those automobile manufacturers typically associated with Detroit).  Why is it understood that we are not talking about Honda, Subaru, Toyota, and Volkswagon which assemble cars either within the U.S. or our NAFTA neighbors Canada and Mexico?  Apparently, they make many types of cars appealing to the American consumer.  Abroad, one can find a small minivan.  Why did GM not think to make a larger version of the PT Cruiser — it would dominate the taxi industry.  To make our analysis even more complicated, the Big 3 manufacture and sell their products abroad — so are Ford and GM REALLY U.S. companies if they are not creating a large number of U.S. jobs — whatever happened to exporting?  Furthermore, many of the parts that go into U.S. products are manufactured abroad and merely assembled in the U.S. to reduce customs cost or political reasons.  When determining the content of a product, how much has to be made in the U.S. to qualify under U.S. foreign trade regulations?  Each industrial sector deals with these types of issues in different ways — such selling to and buying from wholly-owned subsidiaries.

Let’s look again at the human aspect of this subject.  It is not entirely an accident that companies that have significant trade relations with the U.S. tend to be less criticized for human rights violations than those who do not.  This is not merely a result of governmental decision-making; it is also because U.S. companies do not want to risk their bottom line if bilateral political relations become tense.  In conclusion, there are no simple solutions to the current global economic crisis.  In seeking to craft policies that might accomplish this, the relationships between private entities cannot be ignored.  Governments and international organizations cannot ignore the private sector nor the human component.  The needs of the world’s population can only be ignored at great peril to particular groups of people (typically minorities within larger countries — think Darfur) as well as regional/global stability.  While the world’s wealthiest individuals may be concerned about exchange rates and the implications of changing rules with respect to bank secrecy, one cannot overlook the economic components of the situations in countries such as Pakistan.

Tax Evasion vs. Tax Avoidance

Anyone who has been involved in transnational commerce should appreciate the difficulty in determining where tax avoidance strategies ends and tax evasion begins.  In crafting new, clear and effective rules in this area, many things must be taken into account — including the need to coordinate with other countries (and not just OECD members).

1)  The level of infrastructure and public education vary widely throughout the world.  They arguably can be viewed as having the effect of being subsidies for business.

2)  Countries that are members of members customs unions (e.g. the EU or NAFTA) and parties to networks of tax treaties to avoid double taxation may present special complexities that must be addressed.

3)  The denial of internationally-recognized worker rights and reasonable environmental regulations do not provide legitimate “competitive advantages.”   At the same time, it is understandable that companies explore moving production to countries have low-labor costs.  If this is not permitted, people who have the misfortune to be born in poor countries have little opportunity to increase the quality of their lives other than by moving (which unleashes a whole set of issues).

4) It is difficult to assess the true tax rates for corporations as they differ by sector, taking advantage of certain tax holidays, the existence of export production zones and the existence of  companies that conduct business outside the company in which they are registered pay a lower tax rate than those active (or sell) within the country’s territory.

That being said, countries that permit their banks and other institutions to engage in activities to facilitate tax evasion must be addressed.

Off-shore tax and banking havens are indeed a problem.  They facilitate money laundering.  Unfortunately, the U.S. does not regard tax evasion when committed abroad to be a predicate offence, instead following the so-called “revenue rule.”  While there are legitimate reasons for this policy, I think they have the impact of making the U.S. seem hypocritical when it complains about problem of money laundering.

Finally, professionals (accountants, lawyers, etc.) should risk losing their licenses should they violate the rules that are ultimately adopted.

Today’s Financial Crisis, Corporate Governance, and the Issue of Third-Party Liability

<This piece appeared on RGE Monitor’s Finance and Market Monitor, available at http://www.rgemonitor.com/financemarkets-monitor/256477/todays_financial_crisis_corporate_governance_and_the_issue_of_third-party_liability.>

According to the U.S. Securities and Exchange Commission, the principal laws that protect investors and preserve business integrity are (i) the Securities Act of 1933, (ii) the Securities Act of 1934, (iii) the Trust Indenture Act of 1939, (iv) the Investment Company Act of 1940, (v) the Investment Advisers Act of 1940, and (vi) the Sarbanes-Oxley Act of 2002.  With the exception of the Sarbanes-Oxley Act (SOX), the above statutes are products of the New Deal. Congress enacted them in response to the country’s greatest financial crisis to date.

The factors that produced the Great Depression and the present economic situation are too numerous to list and complex to adequately analyze. It must not be overlooked, however, that the causes were global in nature and undermined confidence in all economic sectors and among the population as a whole.

Unlike in the 1920s, large numbers of Americans today are “investors” – as purchasers (i.e. shareholders) of individual stocks, mutual funds, etc. In recent months, both individual and institutional investors have witnessed the decline in the value of their portfolio. This situation has made many people ponder: what is the appropriate role of governmental bodies and international institutions when regulating the private sector.

For more than fifty years, most western governments generally evinced considerable faith in the market system, albeit subject to varying degrees of government regulation and social welfare benefits. In addition, policy makers are questioning the roles of private self-regulating organizations in our financial system since many perform quasi-governmental functions.

Central to U.S. thinking about our economic model of organization is the belief that private corporations should have a central role in the economy. Unfortunately, our corporate model is based on the myth of shareholder control. In reality, most shareholders do not monitor the corporations they own part of (much less vote their shares). More annual reports and proxy statements are tossed into the garbage than are analyzed. In lieu of shareholder control a cozy relationship between management and boards of directors has developed that effectively controls the way corporations operate.

Unfortunately, many Chief Executive Officers are also Chairmen of the Boards that employ them – an obvious conflict of interest as is recognized by many countries, including England. The U.S. and its political subdivisions do not limit an individual from serving on numerous boards of directors (though some countries do, such as Colombia – not a country well-known for having a well-developed system of corporate governance).

The procedures and other requirements governing the number and substance of corporate board meetings are seldom set out in great detail. Furthermore, there is no education or training requirements for persons to serve as board members. Board members typically are nominated by senior management or existing board members; it is rare that shareholders are successful in choosing a majority of the board – the costs and dedication needed to organize are significant impediments.[1] Recent events have demonstrated that corporate oversight can be lax. Furthermore, federal and state government regulators frequently lack the resources and political support to perform effective oversight functions or bring enforcement actions.

Finally, there seems to be recognition within Washington that existing laws and regulations have not kept pace with business practices – the need to regulate derivatives and hedge funds is no longer a matter of whether, but how.

After the passages of SOX, many people were lulled into complacency that the factors contributing to corporate governance scandals had been addressed by assigning greater responsibilities to corporate board of directors. In fact, this is only partially the case as recent events have shown.

It is not possible to regulate morality and frequently companies have incentives not to rigorously carry out internal compliance systems as they do not generate a profit. A good share of the blame for corporate governance failures (and poorly performing corporations in general belong to passive boards of directors (the members of which are often handsomely remunerated).[2]   These individuals frequently serve on numerous boards while spending very little time examining the activities of the corporation – the details of which are frequently supplied by management.

Even the so-called independent directors are often only independent in the sense of not being employees of the company. Of course, investors should have understood that it is not logical for the increasing value of stock portfolios to greatly outpace the GNP growth or gains in worker productivity.

Now is the time for people to remember to live within their means. According to New York University Professor Nouriel Roubini, the Anglo-Saxon model of supervision and regulation of the financial system has failed – the same may be true for numerous corporations.[3]  Professor Roubini remarks, “Indeed, it seems that for approximately nine years, the U.S. Securities Commission’s Enforcement Division chose to ignore “red flags” that Bernard Madoff was orchestrating a large scale financial fraud”.[4]

Congress’ seeming inability to pass laws and for the executive branch to issue effective regulations in large part can be attributed to effective lobbying by corporations. For corporate governance to be effective, steps must be taken to ensure that directors, managers, and professionals working for companies are made more accountable.

At times it seems that the higher one rises in a corporation (or the public sector as well), the less accountable they become. Another problem is that corporation managers and board members are sometimes reluctant to file law suits on behalf of the corporation when it has been injured by third parties. This can be explained by numerous factors, including not wanting to damage personal relationships, fearing shareholder law suits or reducing the value of the corporation’s stock (which depending on the manner in which individuals are compensated, creates a divergence between their interests and those of the shareholders).

At present, it is cumbersome for shareholders to obtain the right to file derivative lawsuits. Perhaps, individual or groups of shareholders should be permitted to file claims in court when management and board members fail to investigate thoroughly potentially meritorious claims against third parties who cause through their negligence or wrongdoing harm to the corporation. Professionals working on behalf of corporate clients may be influenced by what could be characterized as conflicts of interest.

Similarly, certified public accountants continue to be hired by the corporations they are supposed to scrutinize. Lawyers are expected to exercise independent professional judgment, particularly. In reality, both accountants and lawyers are frequently asked to bless questionable corporate actions and in fact even devise them. Imagine if the SEC or federal Public Company Accounting Oversight Board (PCAOB) assigned accounting firms to companies.

Do you think that the auditors might have shown some skepticism when individuals were being approved for mortgages for amounts greatly exceeding three times their income?‌ Would questions have been raised about “no doc” loans?‌ Since many shareholders vote with their feet rather than attempt to assert their rights through the procedures set out in the corporate documents, senior management and board members can often act with impunity (and in any event, corporations typically pay for their errors and omissions insurance).

One way corporate governance could possibly be strengthened would be if Congress were to legislatively overturn the U.S. Supreme Court’s unfortunate decision in Stoneridge Investment Partners vs. Scientific-Atlanta, Inc., issued in January 2008.[5] Recent events illustrate that the existing laws relating to corporate governance as well as regulatory scheme cannot achieve the goals for which they were created. Resources in this area are almost always inadequate to investigate, identify and when appropriate ensure the prosecution of financial crimes.

Stoneridge concerned whether plaintiffs had the right to bring private causes of action based on the theory of “scheme liability,” where the actions of third parties allowed the corporation “to mislead its auditor and issue a misleading financial statement affecting the stock price” (i.e. commit a fraud on the market).[6] Justice Kennedy, writing for the Court’s five judge majority, ruled that the plaintiffs had no right to bring such a lawsuit since federal securities law did not create any implied right of action – and in any case the plaintiffs were precluded from bringing their case since they did not rely upon the statements of the third-parties.

This meant that shareholders are not permitted to file lawsuits against third-parties that allegedly aided and abetted a fraud such as assisting in the preparation of a deceptive financial statements in the absence of “reliance” on the third parties’ deceptive actions. Furthermore, Justice Kennedy asserted that only the SEC and not private parties were authorized under US. securities law to bring claims for aiding and abetting liability, that is, not by private parties. Of course private parties may have a greater incentive to bring such a claim than a federal regulator.[7]

In his dissenting opinion, Judge Stevens (joined by three other justices, Judge Breyer did not participate) rejected the majority’s opinion. Not only did Judge Stevens believe that Justice Kennedy misconstrued existing precedent he ignored “the history of court-created remedies and specifically the history of implied causes of action under § 10(b) . . . .”[8]

Judge Stevens was very direct when he wrote that “the Court is simply wrong when it states that Congress did not impliedly authorize this private cause of action “when it first enacted the statute” and that when “Congress enacted § 10(b)” it did so “with the understanding that federal courts respected the principle that every wrong would have a remedy.”[9]

As a practical matter, to restore investors’ faith in the market, Congress must amend existing laws that permit regulators or plaintiffs’ attorneys to aggressively take action against those who facilitate corporate wrongdoing to prevent future financial meltdowns.[10]

* * * * *

[1] See Robert A.G. Monks and Nell Minnow, Corporate Governance, Chapter 2 – Shareholder Ownership, at 94-222. (4th Ed. 2008).

[2] See William S. Laufer, Corporate Bodies and Guilty Minds: The Failure of Corporate Criminal Liability, at 108-129, (2008).

[3] Ask the Expert, The Anglo-Saxon model has failed,” The Financial Times, at 10,February 10, 2009.

[4] See Testimony of Harry Markapolos, available on the Wall Street Journal’s website, available at http://online.wsj.com/public/resources/documents/MarkopolosTestimony20090203.pdf (Last Accessed February 12, 2009). Shortly after Mr. Markopolos testimony U.S. House of Representatives Committee on Financial Services on February 4, 20089, the SEC’s Senior Enforcement Official Linda Thomsen, who had been in her post for approximately five years, resigned her position “to pursue opportunities in the private sector, but did not provide further details.” Marcy Gordon, SEC Enforcement Chief Linda Thomsen Resigns,” The Washington Post’s website, available at http://www.washingtonpost.com/wp-dyn/content/article/2009/02/09/AR2009020901409.html‌nav=rss_business/industries (Last Accessed February 12, 2009).

[5] Stoneridge Investment Partners LLC v. Scientific Atlantic, Inc., 128 S. Ct. 761; 169 L. Ed. 2d 627 (Sup. Ct. 2008). [6] Id.,169 L. Ed. 2d at 634.

[7] See Ethan S. Burger and Mary S. Holland, Why the Private Sector is Likely to Lead the Next Stage in the Global Fight Against Corruption, 30 FORDHAM INT’L L. J. 45 (2006).

[8] Stoneridge Investment Partners LLC v. Scientific Atlantic, Inc., 128 S. Ct. at 781. [9] Id. [10] For some critiques of the Supreme Court’s decision in Stoneridge and its impact on the protection of shareholders and the SEC’s enforcement record, see Robert Prentice, Stoneridge, Securities Fraud Litigation, and the Supreme Court,45 Am. Bus. L.J. 611(2008); Faith Stevelman, Corporate Governance Five Years After Sarbanes-Oxley: Is there Real change‌: 52 N.Y.L. Sch. L. Rev. 475 (2007 / 2008) (noting that Sarbanes-Oxley’s emphasis on the role of corporate and governmental bodies to achieve improved oversight and accountability for public companies has contributed to anti-litigation attitude the consequence of which has been to reduce SOX’s ability to achieve its goals); and Rodney D. Chrisman, Stoneridge v. Scientific-Atlanta: Do Section 10(b) and Rule 10b-5 Require a Misstatement or Omission, 26 Quinnipiac L. Rev. 839 (2008) (viewing the Supreme Court’s decision in Stonebridge as not being based on principle and precedent, but a ruling based largely on policy grounds).

Challenging Fundamental Assumptions

<A version of this piece was published in the newsletter of the Academy for Legal Studies in Business>

Let’s get rid of the corporation as a legal entity:

Here’s a plan for how to do it.

By

Ethan S. Burger

Adjunct Professor

Georgetown University Law Center

Washington, D.C.

The causes of today’s financial crisis are many and complex. It will take time to examine them systematically and understand their impact. Nonetheless, two explanations suggest themselves as ripe for a closer look: corporate governance failures and ineffective regulatory oversight.

The belief in the unregulated pursuit of profit had come to acquire the power of religious conviction, the tenets of which only the most intrepid—or foolhardy—dared challenge. It was an article of faith that government was a prosperity inhibitor to be kept arms-length and permitted to intervene only as a last resort. Doubters were deemed heretics or, at best, seen as naïve and uninformed.

With critics no longer under threat of banishment and the window of self-reflection still open, this is the moment to challenge the conventional wisdom.

(1) Do corporations, artificial legal persons with overweening economic and political influence but limited liability, distort market principles? Former Federal Reserve Chairman Alan Greenspan’s recent testimony before Congress suggests that the answer is yes. He admitted that his assumption about the behavior of banks and other financial institutions had been flawed. Their zeal for maximizing profits was to have maximized long-term economic growth, provided that governmental regulation was kept to a minimum. Recent events have dispatched that notion.

(2) The rules for corporations and their behavior are governed by the states, not the federal government. Is not this balkanized legal universe an anachronism at a time when many U.S. companies operate not only across fifty states but across the globe?

(3) Gramm-Leach-Bliley and Sarbanes-Oxley aside, the legal infrastructure has not kept pace with advances in sophistication of the financial markets. Technology permits us to move millions of dollars or purchase thousands of shares of stock in seconds. Does it make sense, then, to have this market continue to be governed by two New Deal-era laws regulating the buying and selling of securities?

(4) Businesses organized in corporate forms limit shareholder risk to the value of shares held, yet are capable of causing harm far beyond the aggregate value of those shares. When the financial system is at risk, what is a legitimate rationale for shifting to the public the downside consequences of that risk while leaving the upside in private hands? Given the intricacies of today’s financial markets and, as we have seen recently, the viral-like transmissibility of shattered faith in those markets, is it acceptable not to require corporations to insure themselves against such risks?

(5) Corporations are legal fictions, originally created to encourage risk-taking. Over time, it became gospel that, without insulation against liability, there would be less innovation, lower productivity, and a lower standard of living. But if sole proprietorships and partnerships in fact employ a majority of the world’s workforce, how essential to a thriving economy are limited liability companies and limited liability partnerships?

These questions suggest that it is time to consider eliminating limited liability entities and to apply true market principles as they relate to risk. Proprietorships and partnerships would be required to insure themselves against a variety of risks and in amounts consistent with the nature and scope of their activities. They would be liable for all losses in excess of the coverage amounts.

Doing away with the corporate form would have other salutary consequences. If only individuals had liability, the whole world of corporate taxation, and with it the issue of double taxation, would disappear. The same holds true for criminal liability and the conceit that a fictional entity, rather than the people running it, could form the requisite intent to violate the law. Lastly, rendered moot would be the eternal wrangling over the issue as to whom the attorney-client privilege belong, the corporate entity or its officers, directors, or employees.

Tradition and faith are inadequate justifications to continue a way of doing business that has shown glaring limitations. The current financial crisis, and the solutions proposed to date are signals that the prevailing ethos in economics, law, and politics requires rethinking the fundamentals.

* * * *

Public Choice Theory & the Current Economic Crisis

The late Professor Mancur Olsen (University of Maryland and George Mason University) was well-known for applying economic concepts to explain legislative outcomes (Yale Professor William Eskridge and Berkeley Professor Phillip Frickey have also done work on this topic.

In a nutshell, Olsen believed that if one used basic supply and demand curves — it was possible to gain insight into the political process.  If the benefits of a particular proposal (embodied in a draft law or bill) were concentrated and lucrative while the costs were diffuse — thus discouraging the expenditure of resources to organize in opposition to the proposal, those who favored the concept (i.e. interest groups”) would obtain that which they sought.

In contrast, if the benefits were diffuse and the costs concentrated, those who would have to bear the costs would have an incentive to organize to kill the measure.

The hybrid cases were where BOTH:

(i) the benefits and costs were diffuse, there would be no legislative action or “feel good” laws such as an appropriation for building a statute to a well-known poet or to have a particular month declared national “exercise” month; and

(ii) the benefits and costs were concentrated, then the legislature would adopt “framework legislation” in which some ideas acceptable to both sides might be adopted, but in general the legislature would delegate to an administrative agency the task of resolving the conflict.  With respect to a particular matter, those who would receive greater benefits or have to bear higher costs would prevail, provided the cost of organizing a coalition were not prohibitively expensive.

There are a multitude of explanations for the present economic situation.  That being said, there is general agreement that a large part of the problem was the absence of an appropriate system for regulating particular activities (e.g. the buying and selling of derivatives or securitization of mortgages) or that there were an insufficient number of trained and motivated regulators with sufficient resources and political support to fulfill the purposes for which they were hired.

How else can one explain that AIG (an insurance company) essentially had a division that operated as a hedge fund?  How is it possible that whistleblowers suspicious of Messrs. Madoff’s or Stanford’s activities were ignored?  Perhaps the whistleblowers were not sufficiently persistent, but it may have been a shortage or resources or a “dissent channel” if ones’ hire-ups are ignoring red flags.

Essentially, the political system is broken and there is little consensus or desire to fix it.  Ever wonder why if increasing the number of IRS auditors results in larger amounts for the treasury than the cost of hiring such individuals, there are not more IRS auditors hired?  Why do Congresspersons represent districts the population of which may vary significantly?

If politicians actually wanted a large share of the population to vote, why not spread voting over the course of a week, make it easier to obtain absentee ballots or make election day a federal holiday?

The absence of rules in many areas is not accidental.  The reason that a small portion of the population benefit from particular laws is not mere happenstance.  Those taxpayers who did not undertake to become informed and active have only themselves to blame.  In many cases, people get the governments they deserve and those who see loopholes in regulatory schemes to make money generally will do so.