Feb 23 2012

Nevada wins race to the bottom on U.S. corporate governance. Yuk

Posted by: Nick Shaxson in: Thoughts

John Gapper has an article in the Financial Times looking at a fight between two hardened Las Vegas gambling moguls, Steve Wynn and Kazuo Okada, over their stakes in a big casino enterprise. The story involves one of the two, Steve Wynn, unceremoniously grabbing the stake of the other, Kazuo Okada, at a knock-down price. From Okada’s perspective, it probably looks and feels like outright theft – though Okada seems to have plenty of mud on him too.

The bigger point that Gapper notes, however, could have been lifted straight out of the Delaware chapter of Treasure Islands. The struggle, he summarises, is

a sad reflection of the lack of investors’ rights in Nevada, which takes to deliberate extremes the US tendency to place the interests of corporate directors above those of their shareholders.

This is a kind of offshore business, in my sense of the term, a model copied by numerous jurisdictions such as New Zealand or the British Virgin Islands (see here, for example.)

At its simplest, offshore business involves luring hot money from elsewhere by cutting taxes or relaxing standards: whether standards of disclosure, of financial regulation, of criminal laws, or (in this case) of the governance of corporations.

As a result of this kind of business model, unscrupulous managers who want to trample over shareholders or business partners will be attracted to lax states like Nevada, which essentially lets the bosses write the rules by which their corporations – and their minions and rivals in those corporations – can be treated. This is an example of what economists call unproductive and harmful ‘rent-seeking behaviour,” as Robin Hardin of the FT recently explained:

“In the jargon, this behaviour is called “rent-seeking” . . . some analysts say that part of the reason for high executive pay is because managers can extract rents from shareholders.”

On the articles of incorporation of the company (which dictate how a corporation is supposed to be managed,) Gapper continues:

“Mr Wynn devised them, as well as insisting on Mr Okada signing over his voting rights and barring him from selling his stake without Mr Wynn’s approval.
. . .
In most places, it would rightly be illegal for a board to confiscate the property of a shareholder of whom it doesn’t approve, in such a manner. But this is Nevada and these are the deeds of Wynn Resorts, drafted and signed by Mr Wynn in 2002.
. . .
As well as arrogating voting rights, he specified that its directors’ liability “shall be eliminated or limited to the fullest extent permitted” by Nevada law.
That is very full indeed, since Nevada has one of the laxest corporate statutes in the US”

Looking into Nevada in more depth, Michal Barzuza of the University of Virginia Law school said in an important August 2011 paper:

“This paper exposes and analyzes the rise of Nevada as an almost liability-free jurisdiction. During the last decade Nevada has embarked on a lucrative strategy of market segmentation with a differentiated product – a shockingly lax corporate law.
. . .
Without much public attention, Nevada has reformed its laws over the past decade to free officers and directors from virtually any liability arising from the operation and supervision of their companies. This strategy has allowed Nevada – against all predictions – to attract a substantial segment of the interstate market for incorporations and to make real money.”

Barzuza is quoted in an earlier, also excellent Reuters investigation of Nevada shenanigans, as saying:

“Nevada has all but hung up a ‘no law’ for-sale sign”.

She also notes two particular areas of concern. The first is that exactly those firms that are most in need of good and strong regulation are the ones that will choose places with the most lax regulations, in order to allow their bosses’ abuses to run wildest. (This is one of the great problems with the offshore system, worldwide.) And she goes on:

another reason for concern is that Nevada, by creating a competitive pressure towards the bottom, may be dragging Delaware down.

Indeed. And that matters, since Delaware is the undisputed incorporation capital of the United States. Barzuza is making exactly, precisely, the kind of argument I make in Treasure Islands.

What she is talking about, in her second point, is a race to the bottom between jurisdictions. Inside the United States, the race is between individual states, and it has been going on for a very long time. Treasure Islands notes, for example:

“In 1974 William Cary, a former chairman of the US Securities and Exchange Commission, wrote in a landmark article in the Yale Law Journal that Delaware law had ‘watered down the rights of shareholders vis-à-vis management to a thin gruel. They have a direct interest in permitting suits to be brought in Delaware. Necessary high standards of conduct cannot be maintained by courts shackled to public policy based upon the production of revenue, pride in being “number one,” and the creation of a “favorable climate” for new incorporations.’ “

There has been some academic dispute over whether Delaware is engaging in a race to the bottom on corporate governance, or not. Some argue that Delaware’s removal of pesky things like taxes and regulations is ‘efficient’ and therefore a race to the top, while other, more sensible ones, argue that such things as strong regulation are, for all their warts and imperfections, generally put in place for good reasons – and the willy-nilly removal of them, in the simple pursuit of more state revenue, is bad for society.

In this particular respect of mucky corporate governance Delaware is far superior to Nevada, though still far from being clean. (A learned but wonkish and rather legalistic blog called racetothebottom.org, provides updates in this little-noticed field – see, for example this and this just in the last few days, looking at just a couple Delaware’s more subtle offerings.)

Nevada has other corporate nasties up its sleeve, potentially even worse. A case in point is permission for (and the consequent provision of) cheap and very dirty corporate secrecy structures, which provide anonymity potentially as strong as anything you will find in a Swiss bank.  Take a look at this recent CNBC report:

“Drive down Wedge Lane, the winding road that gets its name because of the golf community it runs through (near the corner of Dog Leg Court and Divot Drive), and you will find the unassuming home of businessman Robert Harris, 65, who describes himself as a former bartender with an eighth grade education.

The house is also home to some 2,400 Nevada corporations, all registered to Harris’ address. For as little as $174, Harris will set you up with your own Nevada corporation. And he promises he won’t ask too many questions.

“I don’t do any investigative work on the people,” he told CNBC Investigations Inc. in an interview in his small home office. “If they want to spend money, I take their business.”

For a little extra money, Harris offers what he calls “Ultimate Asset Protection,” which includes a “virtual office with phone message and fax forwarding,” according to his web site. More important, Harris’ name and address appears on the official corporate documents instead of the owner’s.

“(T)here is no better way to cloak your assets from public view,” the web site says. “Moreover, it is far better than taking your assets out of the country.”

All of this is legal in Nevada, and, like the corporate governance problem, profoundly harmful and corrosive of democracy and the rule of law, around the world. (If you want to dig into this secrecy business more deeply, see Senator Carl Levin’s fine work with the Senate Permanent Subcommittee on Investigations, or the Reuters Shell Games series.)

Any time you hear someone talking about a jurisdiction (as opposed to a company) being ‘competitive’ on tax loopholes, on corporate governance, on secrecy and disclosure or whatever, remember that this is the kind of thing they are talking about: racing to the bottom faster than others.

There is nothing remotely productive or efficient about this kind of ‘competition.’ It is unremittingly poisonous. Unfortunately, it shares the same word ‘competition’ as the generally healthy kind that occurs between firms in fair markets, and busy (or lazy) people too often let themselves be gulled into thinking that this race-to-the-bottom kind of ‘competition’ must be a good thing too.

What is more, jurisdictions like Nevada or the BVI, which can both be considered to be ‘offshore’ in their own way, deliberately set out to do undermine and undercut the laws of other jurisdictions. One might call this kind of thing economic warfare. Gapper notes:

“Nevada’s regime is no accident, since it set out to compete with Delaware, where most US companies incorporate, by being more laissez faire.”

And Barzuza provides more specifics:

“In legislative debates over the bill broadening directors’ and officers’ liability protections, some lawmakers voiced their concern that the bill would cause “scoundrels” and “sleaze balls” to incorporate in Nevada.”

But they went ahead anyway.

I can summarise the Nevada approach to local corporations — and indeed the whole process of ‘competition’ between jurisdictions on these kinds of factors — in just three letters.


Finally, there is one possibly hopeful note in this whole ugly story. As Barzuza notes:

“If Delaware were to follow Nevada by degrading its corporate law, Congress might intervene. Since federal intervention could take many forms, even, in the most extreme scenario, the sweeping federalization of corporate law, Delaware could not afford to degrade its law as much as Nevada does.”

Things have got so far out of hand, in so many different areas, that the sweeping federalisation of corporate law – killing the pernicious process of tax and regulatory competition between states stone dead – is long overdue.

It is time for the adults to step in.

one comment

eddie torres 2th February, 2012 8.07 am

Nevada’s Race To The Bottom (the ‘Rattys’) award acceptance speech:

“I’d like to thank the IRS for its relentless pursuit of computerized efficiency, going on 25 years now, without which this opacity would not be possible. I’d also like to thank Macau and Las Vegas, which represent limitless gateways for laundered tycoon cash from constituent Corporate elites. Who would have suspected a global gambling empire might emerge from two tiny city states surrounded by legal wasteland? And finally, I’d like to thank Mom and Dad. Love you guys!”

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