Nick Shaxson ■ TJN response: the UK Law Commission and investment intermediaries
The UK Law Commission consultation on the fiduciary duties of investment intermediaries:
Response from the Tax Justice Network
March 24, 2014
Prepared by David Quentin
Full TJN response here.
- Tax avoidance in companies is like refined sugar in the human body – empty financial calories with adverse long-term health effects
- Tax avoidance is a “litmus test” issue as regards stewardship by investment intermediaries: a warning that the investment chain is not encouraging sensible long-term corporate behaviour.
- Investment intermediaries are generally not mandated to pursue specific values. So they pursue purely financial performance by default, often at the expense of other values. But the pursuit of financial performance at any cost is itself a “value” – which is often not shared by the investors or beneficiaries.
- New systems of investment intermediation are required to transmit specific values from investors to company directors, but a change in the law is not necessary to achieve this.
A large proportion of listed shares are owned, not by individual shareholders, but by “institutional investors” – in other words pension funds and other collective investment vehicles. In these instances, decisions about what to invest in are made by professional “investment intermediaries”, who compete with each other for business by reference to measurable past performance. For a variety of reasons – including in particular misaligned incentives identified in Professor John Kay’s high-profile review of the sector – their behaviour is often blamed for short-termism in the companies they invest in.
Prompted by the Kay Review, the Law Commission is holding a consultation on “fiduciary duties” – a term used loosely to refer to a category of duties which the law imposes both on company directors and on investment intermediaries. “Fiduciary duties” are controversial because they are sometimes said to prevent, and sometimes said to promote, ethical behaviour through the investment chain.
This briefing document summarises our contribution to the consultation – see here. The Law Commission’s final report is due to be published in June 2014.
Corporate tax avoidance
Companies avoid tax to boost their financial performance but tax avoidance activity is unrelated to underlying value creation and (like any highly anti-social behaviour) is generally harmful to a company’s business in the long term. Tax avoidance in companies is like refined sugar in the human body – empty financial calories with adverse long-term health effects.
It is sometimes said that companies avoid tax because of fiduciary duties that require them to do so – but this is not true: see the legal opinion we commissioned here.
In reality, companies avoid tax to impress investors with the apparent boost in short-term financial performance which tax avoidance provides. Tax avoidance is therefore a “litmus test” issue as regards whether the system of investment intermediaries is working or not. While companies are still avoiding tax, the investment chain is not encouraging sensible long-term corporate behaviour.
In addition, since tax is (in the short term at least) a zero-sum game as between taxpayer and the public exchequer, tax avoidance brings into the sharpest possible focus the discrepancy between purported “ethical” or “responsible” behaviour by companies, and their actual attitude to the societies in which they operate. Many so-called “ethical” investment products involve investing in companies which avoid tax. For example, the largest single holding in one “ethical” fund we have seen is currently in Apple, a notorious tax avoider.
Fiduciary duties of investment intermediaries: the problem
The fiduciary duties of investment intermediaries are determined by reference to the terms on which the investment is held – in other words by reference to the purpose embodied in the wording of the legal documents constituting their role.
If investment intermediaries are mandated in those documents to pursue specific values (for example treating tax not as a cost to be eliminated, but as a necessary distribution of profits to society), they will be empowered, and indeed required, to pursue those values. This would mean preferring investments which realise those values, provided that the investment is prudent on other grounds.
Generally speaking, however, investment intermediaries are not mandated to pursue specific values, and a default purpose for investment, once all other values are stripped away, is financial performance.
The difficulty with this is that the pursuit of financial performance at any cost is itself a “value” in this sense, and it is not one shared by many collective investment scheme participants or pension fund beneficiaries. Many people recognise that the pursuit of financial performance at any cost can lead to a huge range of adverse social and environmental consequences that should not be subordinated to the accumulation of private wealth. These consequences include gross human rights violations, corruption, circumvention of the rule of law, armed civil conflict, catastrophic pollution, runaway exhaustion of the Earth’s resources, severe labour abuses of various kinds which pervade the supply chain, and tax dodging.
Fiduciary duties of investment intermediaries: an objective for a better future
New systems of investment intermediation are required which transmit specific values, standing in opposition to these adverse social and environmental outcomes, from the investors at one end of the equity capital supply chain to company directors at the other. The existing mechanism of so-called “ethical” fund offerings is inadequate: pension fund contributors and participants in collective investment schemes should, as a matter of course, be asked about the values that are important to them. This could be done by means of (for example) a standard questionnaire about values and preferences regarding corporate behaviour developed by the investment management industry in consultation with civil society and professional and business bodies.
Importantly, no change in the law of fiduciary duties is necessary in order to achieve this. Fiduciary duties can attach as easily to the pursuit of a range of other values as they can to the pursuit of financial performance at any cost. What is necessary is creative thinking by investment intermediaries, civil society, and industry experts, to work out how fiduciary roles can be reconstituted throughout the system of intermediated investment.
The objective should be that investment intermediaries are positively mandated to pursue whatever specific shareholder values are held by the ultimate beneficiary of the investment capital they are handling, right down to granular details like not not being a tax avoider.
David Quentin is a barrister specialising in UK and international tax law and a Senior Adviser to the Tax Justice Network. Read the full Tax Justice Network response to the Law Commission consultation here.