Trusts: The hidden legal form driving financialization
by Brooke Harrington
The story of financialization, as told by sociologists, has been the story of firms. Corporate structures and wealth have put investors at the forefront of the global political economy since the 1970s. The rise of the investor has radically transformed our world, increasing inequality and shifting the balance of power in ways that benefit rentier finance over nearly everyone and everything else.
This account, I argue, is persuasive but incomplete. Among other things, it leaves out another key player in the story of financialization: the trust. Trusts are asset-holding structures that are widely used to preserve private wealth and make complex commercial arrangements—like mutual funds, bond issues, and asset securitization—possible. In a recent article in Socio-Economic Review, I make the case that trusts have to be considered as co-stars in the financialization story—and sometimes as competitors for the leading role.
In several key domains of finance, trusts dominate, yet they are little known outside the practice of corporate finance or the circles of the ultra-rich (the main creators and beneficiaries of private trusts). Trusts have played a key role in significant political and economic events of recent years, from the Panama Papers to the subprime mortgage crisis, but they have received virtually no interest from researchers in sociology.
Trusts contribute to financialization in three main ways: by consolidating the power of the investor as the central figure in the global economy; by facilitating the dominance of Anglo-American finance; and by increasing the autonomy of finance from the nation-state system. My article details the evidence for each of these assertions, and extends understanding of financialization in two ways: by showing how trusts operate in concert and competition with the better-known corporate form, and by showing how private capital is implicated in the world financial system alongside corporate wealth.
A rough idea of the scope of the phenomenon suggests trusts’ significance: secondary data suggest that the private capital held in trusts by Americans amounts to at least $16 trillion, and that American corporate trusts hold significantly more than that. While the secrecy surrounding trusts means that these estimates are necessarily provisional, they indicate the need for further inquiry.
What are trusts?
Like corporations, trusts are structures for holding and managing assets. But unlike firms, trusts are not legal entities in their own right: thus, they cannot be sued, they cannot go bankrupt, and they are often lightly regulated, if at all. In most places, they are not registered, are not taxed, and are not subject to any public accounting or reporting requirements. In sum, trusts don’t do any of the things that make corporate data accessible to scholars and others.
No one knows how many trusts exist in the world, or what kinds of assets they contain. This presents a huge problem for research because trusts are essentially invisible: what little we know about them comes from data leaks like the Panama Papers, or lawsuits that put trust documents into the public record. However, the advantages of these features in a global market economy can hardly be overstated. In essence, trusts allow assets to be moved around the world, accumulating wealth or being parceled out to different recipients, with a minimum of restrictions and legal friction. By creating strategic obscurity around assets and their ownership, it becomes virtually impossible to impose limitations or accountability—and easy to do all manner of things that are not permitted to corporations.
Trusts are private agreements which depend on a strange treatment of property, based on the concept of bifurcated ownership. A trust arises when one person (known as the trustee) accepts assets from another person (the settlor), to hold and manage for the benefit of a third party (known as the beneficiary). In this arrangement, legal ownership and responsibility for the assets pass from the settlor to the trustee, but the use and enjoyment of the assets go the beneficiaries. Thus, ownership is split into two components: legal and beneficial.
How are trusts used?
While trusts originated in the Middle Ages as a tool for private individuals to avoid taxes and concentrate wealth within families, there are now two primary types of trust in use. One is the original, known as the “private express trust,” which has survived basically intact since its creation in 14th century England. The other is the “purpose trust,” a variation on the classic form which can be used by both individuals and firms, to achieve objectives ranging from asset protection to the creation of complex collective investment vehicles.
In the past few years, both types of trusts have appeared in the news. During the US presidential candidacy of Mitt Romney, it was discovered that his $250 million personal fortune was held in an international network of private express trusts, allowing him to pay just 13.9% in taxes—about one-third of the top marginal rate on income. Purpose trusts were at the center of the 2008 global financial crisis, as the vehicle through which mortgage obligations were “securitized,” turning them into investment vehicles. Similarly, purpose trusts were used by Enron to hide the firm’s ballooning debts, allowing the firm to attract investment capital and new loans even when it was factually insolvent.
The simplicity and flexibility of trusts have been essential to their survival over the centuries. For example, trusts have been the organizational basis for mutual funds since they were first developed in the 1700s, and they are now the preferred structure through which firms issue bonds to the financial markets. The idea of split ownership, distinctive to the Common Law tradition of England and its former colonies, has now been recognized—if not adopted wholesale—by many countries whose legal systems have an entirely different basis, such as China and Japan.
Trusts have also flourished offshore, where jurisdictions compete to expand the powers of the trust and lower constraints on it. For both firms and private individuals, offshore trusts are attractive because legal ownership can be attributed to trustees based in states where tax and regulatory compliance costs are low to non-existent. This gives trusts an immense competitive advantage in terms of transaction costs over firms, which are subject to much more tax and regulatory scrutiny.
The future of trusts
Trusts have provided vital legal scaffolding for the spread of financialization, foregrounding the role of the investor in the global political economy, propagating the Anglo-American model, and detaching wealth from the control of the nation-state. All of this has been done in coordination and sometimes competition with the firm, although the corporate form has received the lion’s share of attention from scholars and policy-makers alike. In a way, this has only served to enhance the power of trusts.
With every corporate scandal and financial crisis, regulatory scrutiny of firms has increased, raising the stakes of organizing activities through firms—both in terms of transaction costs and privacy concerns. In the meantime, trusts have continued to operate and develop in conditions of near-invisibility to policy-makers. While the world’s attention has been on firms, legal innovations have taken place allowing trusts to adopt many of the most attractive features of the corporate form—such as the ability to exist in perpetuity—without losing any of their distinctive advantages. As trusts to grow in importance in the international political economy, sociological research needs to catch up.
Brooke Harrington is Professor mso in the Department of Business and Politics at the Copenhagen Business School in Denmark. She is the author of Capital without Borders: Wealth Management and the One Percent (Harvard University Press, 2016). This article is adapted from “Trusts and Financialization” in Socio-Economic Review.
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