Luxembourg is a country half the size of the U.S. state of Delaware. The comparison is significant because, like Delaware, Luxembourg is the nominal seat of countless corporations that do not necessarily do business there. Many of these Luxembourg-based corporations are household names. Many are shadowy operations where it is impossible to tell what exactly the corporations do or even who their owners and officers are. Many are both.
Luxembourg fell reluctantly into the spotlight this year with the spectacular collapse of the Espírito Santo commercial empire in Portugal, which had owned one of Portugal’s largest banks, Banco Espírito Santo. The dominoes started to fall when one of the bank’s parent companies filed for bankruptcy in Luxembourg. There were assurances that the bank was not affected by the bankruptcy, but those proved false, and within weeks, the bank too had failed. The blanket of secrecy that Luxembourg allows corporations to operate under had made it possible for both the Luxembourg-based holding company and its Portuguese banking subsidiary to obscure their true financial condition for years — perhaps as long as 12 years, investigators in Portugal think. The same blanket of secrecy is complicating the bankruptcy proceedings, so that it could take courts a year or longer just to determine which company properly owns which assets.
More recently it is the tax avoidance strategies of international corporations that have kept people talking about Luxembourg. A major parliamentary investigation into tax avoidance by U.K. businesses points to secret deals between U.K.-based businesses and the government in Luxembourg. A smaller U.S. investigation on the same theme has pointed to Luxembourg more than once. European Union investigators are convinced that Luxembourg is breaking EU rules with its secret tax deals with companies like Pepsi, FedEx, and AIG, along with a list of banks including JPMorgan Chase and Deutsche Bank. However, formal action is still pending because Luxembourg authorities, citing secrecy laws, are still stonewalling investigators. Some investigative journalists point to the role of major accounting firms in setting up these secret Luxembourg money funnels. They believe even the government in Luxembourg is being duped by the accountants.
The theme in all this is secrecy, or the lack of transparency. The Luxembourg tax arrangements wouldn’t be possible if the whole world knew about them. Just the way publicly held and even government-owned corporations have kept these tax avoidance schemes under wraps raises questions. The most pointed question: is it even legal for a public company to depend on billions of euros in tax avoidance without ever mentioning this or the associated risks to its owners?
One of the corporate mechanisms for secrecy is the subsidiary, an arrangement in which a corporation that everyone knows about can own another corporation whose existence is almost a secret. Every secret Luxembourg tax deal seems to involve a Luxembourg-based subsidiary, which in many cases does nothing more than own other subsidiaries. Gaps in corporate governance laws allow corporations in many cases to treat subsidiaries as trivial entities — to get all the benefit of the subsidiary while at the same time pretending that it does not exist. Subsidiaries are gaps in corporate transparency. A corporation that is laudably transparent in its own headquarters can still hide a multitude of sins in a foreign subsidiary that no one talks about.
In my opinion, the fuzzy status of subsidiaries, sometimes treated as entities and sometimes not, is the weak point or loophole in corporate law that is being exploited. The tax avoidance schemes and other financial smoke screens would be much harder to arrange if subsidiaries were required to keep records, report results, pay taxes, and face audits like the corporations that they are. This would be an easy legislative change to make, requiring only a few paragraphs of legislation. But the corporate world would lose more than a trillion dollars annually from the loss of their tax shelters, so they will never let it happen.
Exiting bankruptcy: Detroit had its bankruptcy plan approved today. The plan mostly protects creditors, reducing the city’s debts by $7 billion and cutting pensions by 4.5 percent. The court spent two months going over objections one by one, but found little legal basis for them. The court’s main concern was that the plan would still leave the city strapped for cash, but this worry was not enough to persuade the court to reject the plan, which would have directed lawyers to start all over again. In total, Detroit’s bankruptcy case ran for 16 months, a surprisingly short time. While on the subject of municipal bankruptcies, it is worth mentioning that the flood of bankruptcy filings that many analysts expected to see this year did not materialize — although that may simply be because the high-profile bankruptcies that did occur made creditors more hesitant to launch litigation against municipalities in arrears.
Struggling: Executives said it could take 10 years to fix the problems at Standard Chartered Bank, which has struggled with overconfidence, operational difficulties, and repeated penalties for money laundering (and is, the bank confirmed, now facing a third U.S. investigation).
Under investigation: Banking giants’ currency exchange practices are being investigated by authorities on at least three continents, and banks have set aside at least $2 billion to settle those cases. Some reports have suggested that banks manipulated currency exchange rates for short periods of a few minutes in order to pollute the statistics used in other traders’ analyses. A fresh U.K. competition investigation aims to find out whether the big four banks in that country really compete with each other.
Insecure: A criminal group that broke in to Home Depot’s network to steal transaction data didn’t need any advanced techniques, according to new details released by the retailer. The intruders exploited stolen credentials and a well-known Microsoft operating system flaw. Once opened, the network intrusion went undetected for seven months. With retailer networks so wide open, making credit cards themselves more secure won’t make an immediate difference. POS terminals and the associated network software will have to be overhauled before there can be a reasonable level of confidence in the security of retail networks.
Failed: El Paseo Bank, with two locations in Palm Desert, California; $82 million in deposits. Successor is Bank of Southern California.