Reconceptualising Corporate Compliance: Responsibility, Freedom and the Law 9781509918744, 9781509918775, 9781509918751

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RECONCEPTUALISING CORPORATE COMPLIANCE This book offers a comprehensive examination of the issues surrounding corporate compliance. Why is it that technical compliance is so widely rejected by society yet so widely adopted and defended by corporate actors? Why is it that otherwise lawabiding citizens act contrary to their personal values when making compliance decisions within a corporation? In this book, Dr Donovan answers these questions and provides a persuasive argument for the legitimate role of spirited compliance within a market economy. In doing so, she employs the lens of classical liberal ideology, challenging the widespread view that technical compliance is simply ‘capitalism’. In an examination that has relevance beyond the compliance arena, the author also explores why and how corporate architecture contributes to the often atypical decisions that individuals make when acting within a corporate environment. The book draws upon behavioural psychology and offers insights into how the often-elusive goal of corporate behavioural change can be achieved.

CONTEMPORARY STUDIES IN CORPORATE LAW Corporate law scholarship has a relatively recent history despite the fact that corporations have existed and been subject to legal regulation for three c­ enturies. The modern flourishing of corporate law scholarship has been matched by some broadening of the field of study to embrace insolvency, corporate finance, corporate governance and regulation of the financial markets. At the same time the intersection between other branches of law such as, for example, labour, contract, criminal law, competition, and intellectual property law and the introduction of new inter-disciplinary methodologies affords new possibilities for studying the corporation. This series seeks to foster intellectually diverse approaches to thinking about the law and its role, scope and effectiveness in the context of corporate activity. In so doing the series aims to publish works of high intellectual content and theoretical rigour. Titles in this series Working Within Two Kinds of Capitalism: Corporate Governance and Employee Stakeholding: US and EC Perspectives Irene Lynch Fannon Contracting with Companies Andrew Griffiths The Jurisprudence of the Takeover Panel Tunde Ogowewo The Law and Economics of Takeovers: An Acquirer’s Perspective Athanasios Kouloridas The Foundations and Anatomy of Shareholder Activism Iris H-Y Chiu Corporate Governance in the Shadow of the State Marc T Moore

Reconceptualising Corporate Compliance Responsibility, Freedom and the Law

Anna Donovan

HART PUBLISHING Bloomsbury Publishing Plc Kemp House, Chawley Park, Cumnor Hill, Oxford, OX2 9PH, UK 1385 Broadway, New York, NY 10018, USA 29 Earlsfort Terrace, Dublin 2, Ireland HART PUBLISHING, the Hart/Stag logo, BLOOMSBURY and the Diana logo are trademarks of Bloomsbury Publishing Plc First published in Great Britain 2021 Copyright © Anna Donovan, 2021 Anna Donovan has asserted her right under the Copyright, Designs and Patents Act 1988 to be identified as Author of this work. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage or retrieval system, without prior permission in writing from the publishers. While every care has been taken to ensure the accuracy of this work, no responsibility for loss or damage occasioned to any person acting or refraining from action as a result of any statement in it can be accepted by the authors, editors or publishers. All UK Government legislation and other public sector information used in the work is Crown Copyright ©. All House of Lords and House of Commons information used in the work is Parliamentary Copyright ©. This information is reused under the terms of the Open Government Licence v3.0 (http://www.nationalarchives.gov.uk/doc/ open-government-licence/version/3) except where otherwise stated. All Eur-lex material used in the work is © European Union, http://eur-lex.europa.eu/, 1998–2021. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication data Names: Donovan, Anna H. L. P., author. Title: Reconceptualising corporate compliance : responsibility, freedom and the law / Anna Donovan. Description: Oxford, UK ; New York, NY : Hart Publishing, an imprint of Bloomsbury Publishing, 2021.  |  Series: Contemporary studies in corporate law  |  Includes bibliographical references and index. Identifiers: LCCN 2020051774 (print)  |  LCCN 2020051775 (ebook)  |  ISBN 9781509918744 (hardback)  |  ISBN 9781509946662 (paperback)  |  ISBN 9781509918751 (pdf)  |  ISBN 9781509918768 (Epub) Subjects: LCSH: Corporate governance—Law and legislation.  |  Social responsibility of business—Law and legislation.  |  Corporations—Corrupt practices.  |  Ethics and compliance officers.  |  Business ethics. Classification: LCC K1318 .D66 2021 (print)  |  LCC K1318 (ebook)  |  DDC 346/.0664—dc23 LC record available at https://lccn.loc.gov/2020051774 LC ebook record available at https://lccn.loc.gov/2020051775 ISBN: HB: 978-1-50991-874-4 ePDF: 978-1-50991-875-1 ePub: 978-1-50991-876-8 Typeset by Compuscript Ltd, Shannon To find out more about our authors and books visit www.hartpublishing.co.uk. Here you will find extracts, author information, details of forthcoming events and the option to sign up for our newsletters.

For Jonathan, In memory of Elsie Pope

vi

Acknowledgements

I

n writing this book I have been incredibly grateful for the generosity of kindness, wisdom and time that many people having given to me, and whose acknowledgement here fails to do justice to the debt of gratitude that I owe to them. However, to the extent it might go some way to expressing my most sincere thanks and appreciation there are several people to whom acknowledgement is very much due. This book is the product of research undertaken with sponsorship from the UCL Centre for Ethics and Law and the UCL Impact Fund, whose support was invaluable and very much appreciated. I would also like to thank the UCL Faculty of Laws for the grant of a Research Impact and Innovation Fund award to enable my archival research at the Hoover Institution at Stanford University, a trip that was instrumental to the production of several chapters of the book. Also, no small amount of thanks must be extended to Rosie Mearns and Roberta Bassi for their help and patience in bringing this work to print. Throughout this research, I have been truly touched by the support of my colleagues both at UCL and further afield, who are too numerous to mention individually. However, the encouragement and counsel of Professor Dame Hazel Genn and Professor Cheryl Thomas has been particularly invaluable. My thanks also to Dr Prince Saprai for his consideration of earlier drafts. I am especially indebted to Professor Charlotte Villiers and Chris Riley for their encouragement and insightful feedback, which has improved this work immeasurably (although all errors do of course remain my own). It is without exaggeration to say that this work simply would not have been possible without the support of Professor Marc Moore. I owe Marc an absolutely incalculable debt of thanks, not simply for his guidance and expertise but for being an incredible mentor and showing me the type of academic that I would one day aspire to be. Marc has been a wonderful friend and colleague throughout my move to academia and I remain forever grateful. It is perhaps also at this juncture that I should make clear that any such acknowledgements do not suggest political endorsement of some of the chapters that follow. I have been fortunate throughout my career to meet several people who have shown me support that is above and beyond that expected. In this regard, Professor John Lowry has been someone who has provided not only mentorship but shown me incredible amounts of kindness. John has been a true inspiration and I am not only sincerely thankful for his guidance but consider it a privilege to call him a colleague.

viii  Acknowledgements It is becoming increasingly apparent that, far from being a solitary affair, writing a book is anything but. The support of my friends and family has been unwavering. Sadie, I feel so blessed that you were behind the door. I simply don’t have the words for how important our friendship is and how excited I am to see Bert grow up. Mayyah, thank you for keeping me strong (and sane), for being a constant source of encouragement and such a wonderful friend. To the strong team, too many to mention individually, thank you for being an amazing family that I feel blessed to be a part of. Candice, I feel so lucky we met and truly­ treasure our friendship. Erika and Jerry, what can I say? You are a constant source of inspiration and I am so happy that our (international) paths crossed. Finally, Steve, thank you for helping me find my words. As with all my endeavours to date, I want to thank my parents for their support (in more ways than one!) in my pursuit of this book. I also wanted to thank my brother, Edward, whose commitment to the truth is more of an inspiration to me than I suspect he knows. To Freya, my sidekick for life, I cannot wait for the adventures we have yet to share. It is with great sadness that in endeavours as long as these, not everyone is able to share in their completion. As such, I write this in the memory of Elsie Pope whose resolute belief in education and to doing the right thing will forever remain guiding principles in my life. Finally, but by no means least, this work simply would not have happened without the love of my husband Jonathan, who has shown nothing but unwavering support in all that I do. For your patience, understanding and belief in me, I thank you and dedicate this work to you.

Table of Contents Acknowledgements��������������������������������������������������������������������������������������vii Table of Cases������������������������������������������������������������������������������������������� xiii PART I CONTEXT 1. Capitalism’s Compliance Crisis����������������������������������������������������������������3 I. Why Narrative Matters�������������������������������������������������������������������5 II. The Consequences of Creativity: What Harm is it Really?����������������8 III. Recontextualising Compliance: From Subject to System�����������������10 IV. Scope of the Book�������������������������������������������������������������������������11 V. Structure of the Book��������������������������������������������������������������������13 VI. Conclusion������������������������������������������������������������������������������������17 2. Creative Compliance in Practice�������������������������������������������������������������19 I. The Rise and Rise of Creative Compliance�������������������������������������20 II. Loopholes in the Law: A Focus on Tax Avoidance��������������������������25 A. Towards a Judicial Anti-Avoidance Doctrine?�������������������������25 B. The 2012 Tax Scandals�����������������������������������������������������������30 III. The (Current) Limitations of Legislation���������������������������������������33 IV. Conclusion������������������������������������������������������������������������������������39 3. Constructing Compliance: Freedom to Choose?�������������������������������������41 I. The Social Construction of (Creative) Compliance�������������������������43 A. Social Constructionism: Driving Divergent Definitions�����������43 B. Intra-Group Convergence: Habitualisation and Isomorphism�������������������������������������������������������������������46 C. The Implications of Compliance as a Social Construct�����������48 II. The Meaning and Influence of Norms�������������������������������������������49 A. Defining ‘Norms’�������������������������������������������������������������������50 B. The Behavioural Impact of Norms�����������������������������������������51 C. The Interaction between Descriptive and Injunctive Norms�����54 III. The Homogeneity of Corporate Norms�����������������������������������������57 A. The Expressive Function of Law���������������������������������������������57 B. The Dominance of the Shareholder Wealth Maximisation Norm������������������������������������������������������������������������������������59

x  Table of Contents IV. The Function of Norms: Free to Choose?���������������������������������������62 A. Norms and Freedom of Choice: Taxes and Subsidies��������������62 B. Influencing Norms to Influence Behaviour������������������������������63 V. Conclusion������������������������������������������������������������������������������������64 4. Motivating Compliance: Freedom to Act?����������������������������������������������65 I. Deterrence-Based Compliance: Motivating ‘Amoral Calculators’��������67 A. It’s Called Capitalism … Again����������������������������������������������68 B. Explanatory Limitations of a Deterrence-Based Approach������69 C. Regulatory Relationships and Practical Challenges�����������������71 D. Retaining a Role for Deterrence?���������������������������������������������73 II. Legitimacy-Based Compliance�������������������������������������������������������74 A. Legitimacy-Based Compliance�����������������������������������������������74 B. Procedural Justice: The Legitimacy of the Originating Authority�������������������������������������������������������������������������������76 C. Procedural Justice: The Legitimate Exercise of Authority��������78 D. The Duality of Authority�������������������������������������������������������82 III. Legitimising Creative Compliance: Dissonance Reduction and Over-Rationalisation��������������������������������������������������������������83 A. The Duality of Norms�����������������������������������������������������������84 B. The Salience of Corporate Norms������������������������������������������85 C. Cognitive Dissonance and Over-Rationalisation���������������������89 IV. The Compliance Degeneration Cycle���������������������������������������������92 A. Stage One: Initial Drivers of Creative Compliance������������������92 B. Stage Two: Undermining Legitimacy��������������������������������������93 C. Stage Three: Illegitimacy and Creative Compliance�����������������94 V. Conclusion������������������������������������������������������������������������������������95 PART II THE CASE FOR REFORM 5. Compliance, Predictability and the Market Order����������������������������������99 I. (Mis)Conceptions of the ‘Liberty Tradition’��������������������������������� 102 A. Perceptions of Self-Interest and Illegitimate Government Interference�������������������������������������������������������������������������� 103 B. The Emergence of ‘Everyday’ Liberalism������������������������������ 105 II. Defining (and Constraining) Freedom within the Classical Tradition������������������������������������������������������������������������������������� 106 A. Freedom of the Individual���������������������������������������������������� 107 B. Limited State Interference���������������������������������������������������� 109 C. Dispelling the Paradox: Individualism and Cooperation�������� 111

Table of Contents  xi III. In Defence of the Market Order��������������������������������������������������� 113 A. The Market as a Conduit of Knowledge������������������������������� 113 B. Conveying Knowledge Through the Price Mechanism����������� 115 C. Polycentric Systems and Market Order��������������������������������� 116 IV. Complex Systems and Spontaneous Order����������������������������������� 118 A. The Architecture of Order���������������������������������������������������� 119 B. Predictability, Order and the Rule of Law����������������������������� 121 V. Conclusion���������������������������������������������������������������������������������� 122 6. The (Ostensible) Equality Paradox: Privilege and Obligation���������������� 124 I. Defining ‘Equality’ before the Law����������������������������������������������� 126 A. The Rule of Law: Precepts and Conceptions������������������������� 126 B. Equality of Law, not Outcome���������������������������������������������� 129 C. The Rule of Law: Between Thick and Thin Conceptions?������ 132 II. Constraining ‘Lawful’ Conduct���������������������������������������������������� 134 A. Equality as a Meta-Legal Principle��������������������������������������� 135 B. A Positive Obligation to Maintain Equality before the Law?������������������������������������������������������������������������������ 137 III. Inequality and Legal Privilege������������������������������������������������������ 139 IV. Conclusion���������������������������������������������������������������������������������� 142 PART III BARRIERS TO REFORM 7. A Person without Personality: The Fiduciary Ladder of Corporate ‘Personhood’��������������������������������������������������������������������������������������� 147 I. Separate Personality, Limited Liability and the Reification of the Corporation���������������������������������������������������������������������� 149 II. Redefining the Beneficiary: From ‘Company’ to ‘Market’�������������� 152 A. Shareholder Wealth Maximisation as a Proxy for Rentier Shareholders������������������������������������������������������������������������ 153 B. Distorting Fiduciary Duties; the Changing Status of the ‘Company’ Beneficiary��������������������������������������������������������� 156 III. The Corporate Fiduciary Ladder������������������������������������������������� 158 A. The Structure of the Fiduciary Ladder���������������������������������� 158 B. The Psychological Consequences of the Fiduciary Ladder����� 162 C. Responding to the Fiduciary Ladder������������������������������������� 166 IV. Contrasting Other Actors������������������������������������������������������������ 167 V. Conclusion���������������������������������������������������������������������������������� 169

xii  Table of Contents PART IV REFORM 8. It is Called Capitalism: Towards a New Market Integrity��������������������� 173 I. Responsibility, Freedom and the Law�������������������������������������������� 175 A. Market Order, Integrity and Freedom����������������������������������� 175 B. Freedom, Choice and Responsibility������������������������������������� 177 II. Radical Integrity������������������������������������������������������������������������� 178 A. Towards a More Radical Integrity���������������������������������������� 179 B. A Roadmap for Reform�������������������������������������������������������� 180 III. Conclusion���������������������������������������������������������������������������������� 182 Bibliography���������������������������������������������������������������������������������������������� 184 Index��������������������������������������������������������������������������������������������������������� 195

Table of Cases Aberdeen Railway Co v Blaikie Bros (1954) 1 Macq 461������������������������������ 160 Adams v Cape Industries Plc [1990] Ch 433������������������������������������������������ 149 Bligh v Brent (1837) 2 Y. & C. Ex 268��������������������������������������������������������� 152 Barclays Mercantile Business Finance Ltd v Mawson [2005] 1 AC 684�����������29 Borland’s Trustee v Steel Brothers & Co Limited [1901] 1 Ch 279���������������� 152 Broderip v Salomon [1895] 2 Ch 323�������������������������������������������������������������21 Buckeridge v Ingram (1795) 2 Ves. Jun 652�������������������������������������������������� 152 Canadian Eagle Oil Co. Ltd v R. [1946] AC 119��������������������������������������������25 Cape Brandy Syndicate v I. R. C. [1921] 1 KB 64�������������������������������������������25 Carlen v Drury (1812) 1 Ves & B 154���������������������������������������������������������� 157 Dodge v Ford Motor Co 170 NW 668��������������������������������������������������������� 147 Dovey and the Metropolitan Bank (of England and Wales) v John Cory [1901] AC 477������������������������������������������������������������������� 161 Ex parte Belchier (1754) 27 ER 144������������������������������������������������������������� 161 Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598�����������������60 F. G. (Films) Ltd, Re [1952] 1 WLR 483������������������������������������������������������� 151 Furniss (Inspector of Taxes) v Dawson [1984] AC 474����������������������������� 26, 28 Gaiman v National Association for Mental Health [1971] Ch 317��������148, 157 Geys v Société Générale, London Branch [2012] UKSC 63��������������������������� 159 Gilford Motor Co Ltd v Horne [1933] Ch 935��������������������������������������������� 151 Greenhalgh v Arderne Cinemas Ltd and Others [1951] Ch 286�������������148, 157 Helvering v Gregory 293 U.S. 465 (1935)���������������������������������������������������������7 Inland Revenue Commissioners v Barclays Bank [1951] AC 421���������������������25 Inland Revenue Commissioners v Burmah Oil Co. Ltd (1982) SC (HL) 114����������������������������������������������������������������������������� 7, 26 Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991������������ 26, 28 Inland Revenue Commissioners v Willoughby [1997] 1 WLR 1071�����������������18 Jones v Lipman [1962] 1 WLR 832�������������������������������������������������������������� 151 Latilla v Inland Revenue Commissioners [1943] AC 377��������������������������������26 Levene v Inland Revenue Commissioners [1928] AC 217��������������������������������26 Lord Howard de Walden v Inland Revenue Commissioners [1942] 1 KB 389��������������������������������������������������������������������������������������26 MacNiven v Westmoreland Investments Ltd [2003] 1 AC 311������������������������28 Owners of Cargo Laden on Board the Albacruz v Owners of the Albazero (The Albazero) [1977] AC 744�������������������������������������� 149 Partington v Attorney General (1869) LR 4 HL 100���������������������������������������25 People’s Department Stores v Wise [2004] SCC 68��������������������������������������� 157 Percival v Wright [1902] 2 Ch 421 �������������������������������������������������������������� 157

xiv  Table of Cases R (on the application of Cart) v The Upper Tribunal [2011] UKSC 28, [2011] 3 WLR 107��������������������������������������������������������������������������������� 124 Railway Express Agency Inc v New York 336 US 106, 112–113 (1949)������������������������������������������������������������������������������122, 140 Regentcrest plc v Cohen [2001] BCC 494���������������������������������������������������� 157 RFC 2012 Plc (in liquidation) v Advocate General for Scotland [2017] UKSC 45��������������������������������������������������������������������������������������29 Salomon v A. Salomon & Co Ltd [1897] AC 22���������������������� 21, 149–150, 152 Smith & Fawcett, Re [1942] Ch 304������������������������������������������������������������ 157 Smith, Stone & Knight Ltd v Birmingham Corporation [1939] 4 All ER 116������������������������������������������������������������������������������� 151 The Commissioners of Inland Revenue v His Grace the Duke of Westminster [1936] AC 1������������������������������������������������������� 21–22, 123 Trustor AB v Smallbone & Others (No 2) [2001] 2 BCLC 436��������������������� 151 W. T. Ramsay Ltd v Inland Revenue Commissioners, Eilbeck (Inspector of Taxes) v Rawling [1982] AC 300��������������������������������7, 26–27 Weeks v Sibley (1920) 269 Fed. 155������������������������������������������������������������� 100 Woolfson v Strathclyde DC (1978) 38 P & CR 521�������������������������������������� 151

Part I

Context

2

1 Capitalism’s Compliance Crisis The diagnosis of some asserted social ill and the prescription of the remedy are undertaken offhand by the first comer, and without reflecting that the diagnosis of a social disease is many times harder than that of a disease in an individual, and that to prescribe for a society is to prescribe for an organism which is immortal. To err in prescribing for a man is at worst to kill him; to err in prescribing for a society is to set in operation injurious forces which extend, ramify, and multiply their effects in ever new combinations throughout an indefinite future.1 William Graham Sumner

‘I

t’s called capitalism.’2 This is how Eric Schmidt, the then Chairman of Google defended his company’s decision to redirect nearly $9.8 billon of revenue from overseas subsidiaries to Bermuda, effectively halving its overall tax rate.3 His comments were made in response to the UK public accounts committee (‘PAC’) inquiry, which had been convened to investigate the pervasive practice of corporate ‘creative compliance,’4 that is, compliance with the letter of the law in defeat of its spirit. As the sheer scale of these practices emerged, there were widespread calls for reform and global condemnation of the fact that corporations could undermine the intention of regulation in this way. Reflecting public sentiment, Margaret Hodge (chair of the PAC inquiry) told Matt Brittin5 that Google’s approach to tax compliance was ‘devious, calculating and unethical’.6 1 WG Sumner, ‘Sociology’ in RC Bannister (ed) On Liberty, Society and Politics The Essential Essays of William Graham Sumner, (Liberty Fund Inc, 1992), 186. 2 ‘Google’s Tax Avoidance is Called “Capitalism,” Says Chairman Eric Schmidt,’ The Telegraph (12 December 2012). 3 Jesse Drucker, ‘Google Revenues Sheltered in No-Tax Bermuda Soar to $10 Billion,’ Bloomberg (10 December 2012) https://www.bloomberg.com/news/articles/2012-12-10/google-revenues-shelteredin-no-tax-bermuda-soar-to-10-billion (accessed 30 January 2021). 4 For a broader discussion of creative compliance see D McBarnet’s work in this area, including: D McBarnet, ‘After Enron Will “Whiter Than White Collar Crime” Still Wash?’ (2006) 46(6) British Journal of Criminology 1091; D McBarnet, ‘After Enron: Corporate Governance, Creative Compliance and the Uses of Corporate Social Responsibility,’ in J O’Brien (ed) Governing the Corporation: Regulation and Corporate Governance in an Age of Scandal and Global Markets (John Wiley & Sons, 2005) 205–222; D McBarnet and C Whelan, ‘The Elusive Spirit of the Law: Formalism and the Struggle for Legal Control’ (1991) 54 Modern Law Review 849. 5 Google’s then Vice President for Sales and Operations in Northern and Central Europe. 6 O Wright, ‘Google: MPs confront search giant over “devious” attempt to avoid paying UK tax,’ Independent (17 May 2013) www.independent.co.uk/news/uk/politics/hmrc-are-beingbamboozled-by-google-mps-confront-search-giant-over-devious-attempt-to-avoid-paying-8618695. html (accessed 8 August 2020).

4  Capitalism’s Compliance Crisis She went on to say, referring to Google’s unofficial motto, that ‘you are a ­company that says you “do no evil.” Well I think that you do do evil in that you use smoke and mirrors to avoid paying tax.’7 In the face of such widespread criticism, the company was unyielding. Both Brittin and Schmidt were unequivocal in their positions that the structures in question were implemented entirely in accordance with the strict letter of the law and therefore beyond censure. Put another way, if the law allowed for the use of ‘smoke and mirrors’ then the company was entitled to use them. Indeed, not only were these structures legally permissible, Schmidt suggested (alluding to the shareholder wealth maximising paradigm that underpins much of company law) that ‘there is probably some law against’8 the company failing to adopt a strategy that reduced their tax liability as much as possible. Whilst Schmidt’s defence of creative compliance might be intuitively challenging, particularly when Google’s own code of conduct encouraged its employees to comply with the code in ‘both its spirit and letter’,9 it does help to explain why the question of creative compliance has proven to be so difficult to resolve. Google was not the first company to adopt these compliance strategies and nor will it be the last. Indeed, Google’s tax structures came to light alongside those of Amazon and Starbucks and, as we will see in Chapter 2, the creative compliance crisis was foreshadowed in 1998 (somewhat prophetically three years before Enron’s collapse). Rather, what the exchanges between Google and the PAC demonstrate is how deeply held the beliefs that define and legitimise our compliance behaviour are. To the PAC, these structures were met with clear disdain. However, for Schmidt (and others before him) aggressive tax structures were conceived and rationalised as something to be proud of. These structures did not reflect a breach of a corporation’s civic duty and nor were they actions that undermined trust in the corporate community. Rather, they were indicators of capitalistic ingenuity that furthered the corporate objective. But was Schmidt right? To many, his view that aggressive tax structures are archetypal capitalistic behaviour was astute. The free market economy is often characterised as mandating profit maximising behaviour to the exclusion of broader notions of equity and fairness. As Milton Friedman’s often cited New York Times article claimed, the ‘social responsibility of business is to increase its profits’.10 But does capitalism really mandate compliance decisions 7 ibid – note that the motto of ‘don’t be evil’ enshrined in the company’s code of conduct was amended in or about early 2018 as part of the Alphabet reorganisation to ‘do the right thing.’ Of note is that Google’s own code of conduct asks that employees comply with the code ‘both its spirit and letter’. The ‘don’t be evil’ version of the code of conduct is available at https://web.archive. org/web/20180421105327/https://abc.xyz/investor/other/google-code-of-conduct.html (accessed 26 February 2020). 8 N Kumar and O Wright, ‘Google boss: I’m very proud of our tax avoidance scheme,’ Independent (13 December 2012) www.independent.co.uk/news/uk/home-news/google-boss-im-very-proud-ofour-tax-avoidance-scheme-8411974.html (accessed 8 August 2020). 9 Google code of conduct (n 7). 10 M Friedman, ‘The Social Responsibility of Business is to Increase its Profits,’ New York Times Magazine (13 September 1970), 1.

Why Narrative Matters  5 that are so egregious to so many? If, for all its flaws, a free market economy ‘faces no serious contender as an approach to organizing large-scale economies’11 does it advocate behaviour that is truly as terrible as popular opinion would have us believe? Alternatively, as this book suggests, does the commonly held understanding of ‘capitalism’ espoused by Eric Schmidt (and shared by many) reflect a fundamental misconception of the principles of our market economy? A misconception that helps to explain the frequent conscription of Friedman’s claim which, if read in full, actually makes clear that the pursuit of profits must be done ‘while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom’.12 Is there in fact not only a place, but a need, for responsible compliance within a capitalist market economy? I.  WHY NARRATIVE MATTERS

An immediate, and entirely valid, question is whether posturing as to the norms of the market and wider corporate framework really matters. Does it make a difference that Eric Schmidt believed Google’s tax strategy aligned with his perception of market ideology? Moreover, no one is suggesting that Google executives undertook a Hayekian analysis of classical liberal principles before deciding to implement a structure that allegedly manufactured losses across the group. So why is this understanding of market norms (broadly defined) important and, if creative compliance is so offensive to public policy, why can’t we simply mandate that corporations comply with parliamentary intent? Narrative matters as compliance is not a term of art but a complex and oftentimes multifaceted social construct.13 That is, whilst the obligation to comply with the law is a personal one, our interpretation of the scope of that obligation is nonetheless shaped by the political, social and economic environments that we operate within.14 Over time, a set of common beliefs as to what is right or wrong, legitimate or otherwise, are shared and reinforced across those environments in such a way that what started as a subjective interpretation becomes embedded and perceived, within those groups, as an objective truth.15 11 EA Posner and RG Weyl, Radical Markets, Uprooting Capitalism and Democracy for a Just Society (Princeton University Press, 2018), 19. 12 Friedman ‘The Social Responsibility’ (n 10). 13 On which see: C Parker and VL Nielsen, ‘Introduction’ in C Parker and VL Nielsen (eds) Explaining Compliance Business Responses to Regulation (Edward Elgar, 2011), 6–7. 14 Edelman et al describe compliance as a ‘social and political process that evolves over time’ influenced by the political climate that a subject operates within and their interpretation of the law. In this regard, a corporation’s interpretation of compliance is subject to both ‘internal and environmental normative pressures’. See L Edelman, S Petterson, E Chambliss and H Erlanger, ‘Legal Ambiguity and the Politics of Compliance: Affirmative Action Officers’ Dilemma,’ (1991) 13(1) Law and Policy 73, 74. As to the relevance of the socio-political environment, see BM Hutter, ‘Negotiating Social, Economic and Political Environments: Compliance with Regulation within and beyond the State,’ in Parker and Nielsen Explaining Compliance (n 13) 305. 15 On this social constructionism more generally, see PL Berger and T Luckmann, The Social Construction of Reality, A Treatise in the Sociology of Knowledge, (Anchor Books, 1966).

6  Capitalism’s Compliance Crisis Truths that influence our behaviour in often subtle and subconscious ways. Of course, different communities share different histories and the path dependency of ‘compliance’ in one environment can be very different to that of another, rendering the definition of ‘compliance’ a highly contextual one. As a consequence, we can arrive at a situation where two people, sitting in a room together, can conclude with an equal and absolute conviction that a given legal structure is either evil or ingenious. For civil society, this means that we do not necessarily have a commonly agreed upon definition of the compliance standards that we expect from our corporate citizens. In general terms there is broad, albeit not absolute, consensus that corporations should at least comply with the strict letter of the law.16 In contrast, where a difference of opinion (or, as a minimum, greater uncertainty) arises is when we look to constrain creative compliance. This divergence is not surprising. By its very nature, creative compliance is technically lawful behaviour that raises the seemingly paradoxical problem of seeking to prohibit ‘legal’ compliance.17 Nevertheless, the response to the 2012 scandals demonstrated that, for large parts of the global community, creative compliance was intuitively an illegitimate course of action to pursue (Chapters 5 and 6 offer an explanation for this perspective and, in so doing, a normative justification for reform). However, without changing the norms of the corporate environment, creative compliance risks continuing to be, in the minds of corporates at least, a legitimate (and for reasons discussed in Chapters 3 and 4, legitimised) course of conduct. One that remains resolutely resistant to reform. Against this, we start to see that the power of environmental norms is that they have three important implications for our understanding of, and response to, creative compliance (each of which are considered in more detail throughout the book). First, norms derived from the dominant political philosophy of a group directly inform the perceived legitimacy of the authority of the state (or others) to constrain individual (including corporate) action. As we have already seen, for the corporate community this is a belief that tends to be heavily influenced by a liberal market ideology, which is commonly interpreted to promote a deregulatory approach to market order. The significance of this, as Chapter 4 explores, is that it is the perceived legitimacy (or otherwise) of regulatory intervention (and the corresponding right of enforcement authorities to exercise coercive control) that is a fundamental determinant of compliance behaviour.

16 This book accepts the proposition that there is an obligation to obey the law (itself a significant normative enquiry that is outside of the scope of this work) and is instead concerned with the question as to the extent of that obligation. The literature concerning legal obedience more generally is vast. For arguments against a general obligation see J Raz, The Authority of Law 2nd edn (Oxford University Press, 2009), 233; and MBE Smith, ‘Is There a Prima Facie Obligation to Obey the Law?’ (1972–3) 82 Yale Law Journal 950. For literature in support see J Rawls, ‘Legal Obligation and the Duty of Fair Play,’ in S Hook (ed), Law and Philosophy (New York University Press, 1968), 3. 17 See ch 6 for an argument as to why spirited compliance is in fact a meta-legal principle of society.

Why Narrative Matters  7 Second, by recognising compliance as a social construct that is shaped by environmental norms (rather than an absolute standard), we can start to understand the limitations of reform efforts to date. Traditionally, compliance scandals are met with a targeted regulatory response. Following Enron and the related accounting scandals in 2001, the US introduced the Sarbanes-Oxley Act 2002, whilst the UK responded to the PAC tax inquiry with the General Anti-Abuse Rule (‘GAAR’). However, as history has demonstrated, the problem of creative compliance persists and it has become increasingly clear that the ongoing challenge is not the lack of regulation, but rather its effectiveness.18 The reasons for this emerge when we explore the causes of creative compliance, which are not the absence of regulation but how corporations interpret their obligation towards that regulation.19 Understood in this way, the intractability of the issue becomes apparent as it is almost a contradiction in terms to discuss regulating what is, in effect, meta-regulatory behaviour. Rather, what we need to be addressing is how corporations define their legal obligations, including when faced with the discretion and gaps that will inevitably be left by any form of regulatory design. That is, how they define what ‘compliance’ means both in the presence and absence of bright line rules. This brings us to the final reason why understanding the interplay between narrative (including the norms that it embodies) and compliance is so important. It provides the foundation that allows us to appreciate the extra-legal ­mechanisms that constrain human behaviour and help us to understand (in part) why these do

18 Chapter 2 considers the limited success (and unintended consequences) of earlier regulatory intervention, including the Sarbanes-Oxley Act 2002. UK tax legislation is a pertinent example of the development of highly complex, piecemeal and substantial tax codes developed in response to each new avoidance scheme, from manufactured dividends to transfer pricing. This limited success in controlling such behaviour extends to common law decisions such as W. T. Ramsay Ltd v Inland Revenue Commissioners, Eilbeck (Inspector of Taxes) v Rawling [1982] AC 300 and Inland Revenue Commissioners v Burmah Oil Co. Ltd (1982) SC (HL) 114 (together known as the ‘Ramsay principle’). The scope of the Ramsay principle is considered in ch 2. However, at this juncture it is pertinent to note that even after this judicial attempt to curtail abusive tax structures, aggressive (and, arguably, artificial) tax planning continued. The rejection of tax avoidance as an end to a transaction in itself is also reflected in American jurisprudence (see Helvering v Gregory 293 U.S. 465 (1935), concerning the dividend in specie of corporate assets being redefined as a ‘reorganisation’). As with the Ramsay principle, this decision did not nevertheless stop aggressive tax structuring in the US. 19 This is particularly the case with the use of new governance techniques, which necessarily impose ambiguous obligations. For example, an obligation to avoid ‘abusive’ structures (s 206(1), Finance Act 2013). Whilst unavoidable (as by its very nature creative compliance ‘thrives’ on bright line, command and control style, rules) this ambiguity can lead to organisations i­mplementing ‘symbolic structures’ that do not meaningfully address the regulation’s mischief. As such, broader cultural change is needed to redefine compliance rather than seeking to introduce specific ­regulation to address individual transgressions. As to the relationship between creative compliance and command and control style legislation see D McBarnet, ‘Financial Engineering or Legal ­Engineering? Legal Work, Legal Integrity and the Banking Crisis,’ in I MacNeil and J O’Brien (eds) The Future of Financial Regulation (Hart Publishing, 2010), 79; as to the relationship between ambiguity, compliance and symbolic structures see L Edelman, ‘Legal Ambiguity and Symbolic Structures: Organizational Mediation of Civil Rights Law,’ (1992) 97(6) American Journal of Sociology 1531.

8  Capitalism’s Compliance Crisis not always apply in the same way in a corporate setting. Personal ethics, together with feelings of judgment and shame often coalesce to constrain individual decision making. For example, as a general rule individuals refrain from violent acts not because it is illegal but because we consider it wrong to do so. We maintain the appearance of our properties (at personal expense) in part because of the judgment of others. In contrast, corporations engage in aggressive tax structuring because they can do so not just with legal, but also, social ‘impunity’.20 Yet, this cannot be explained simply by reference to the fact that the corporation has ‘no soul to damn’21 and is therefore immune to the pressure of social sanctions. As artificial legal entities, corporations are necessarily governed by human actors raising the question (explored in Chapters 4 and 7) as to why the personal ethics of the individuals acting on a corporation’s behalf do not operate to supersede those attributed to the corporation? This reflects a final, but critical, theme of this book. Namely, how artificial rules and structures (such as the corporation) can have a surprisingly powerful impact on the seemingly autonomous actions of individuals. Our reflections on this final point have fundamental and far reaching consequences for our current understanding of corporate law and, indeed, our expectations of it. If figuratively stepping into the corporate environment has the potential to reshape our decision-making framework as individuals, to risk engendering a way of thinking (or, at least, acting) that does not align with our own moral compass, then what consequences should flow from this? To what extent should corporations (and corporate law) be responsible for the impact that the architecture of the firm can have on individual choice? II.  THE CONSEQUENCES OF CREATIVITY: WHAT HARM IS IT REALLY?

A second, and equally valid, question is whether and to what extent (if at all), we should be concerned with constraining technically legal behaviour. Returning to our earlier example, if the law permits the use of complex tax structures why are they the subject of such consternation (it being quite a separate question, considered in Chapter 6, as to whether it is legitimate or even possible to restrain technically legal behaviour). From a financial perspective, creative compliance clearly has significant economic ramifications. It reduces the availability of public funds, either shifting the burden onto third parties or simply restricting a jurisdiction’s ability to provide public services (including, somewhat ironically, the enforcement of tax transgressions). In the year that the PAC investigated the tax scandals of Google, Starbucks and Amazon, the UK tax gap, that is the difference between the tax 20 McBarnet, ‘After Enron’ (n 4), 1091. 21 J Coffee, ‘“No Soul to Damn: no Body to Kick”: An Unscandalized Inquiry into the Problem of Corporate Punishment,” (1980) 79 Michigan Law Review 386.

The Consequences of Creativity: What Harm is it Really?  9 due and the tax collected, was estimated at £34 billion.22 Within that sum, £7.6 billion was attributable to creative compliance.23 To put that figure into context, UCLH (a 72,500 square metre state of the art hospital in the centre of London) cost £422 million to construct, placing the fiscal impact of creative compliance at (albeit somewhat crudely) the equivalent to building 15 hospitals a year.24 However, the impact of creative compliance extends beyond the purely economic, undermining public trust in important social institutions, including corporations themselves. As we see throughout this book, corporate compliance is often undertaken by large, economically significant, organisations. It is these entities (in contrast to natural or smaller corporate citizens) that have the requisite resources and legal architecture to obtain and implement the highly technical structures that characterise creative compliance, increasing the economic divide between corporate and individual citizens. In doing so it furthers the already significant public scepticism towards not only the corporate community and market economy (the latter commonly depicted by caricatures of ‘fat cats’ and allegations of ‘crony capitalism’) but also in a legal system that is seen to allow this practice to proceed without sanction.25 That is, a practice that allows corporations to implement technically legal structures that, in some cases, ‘accomplish the same ends as criminal action’.26 Aligned with this deepening mistrust is a more fundamental concern about the behaviour that should be reasonably expected from corporate citizens. In particular, the extent to which spirited compliance is a legitimate component of the social contract between citizen and state. Whilst Chapter 6 explores the question as to whether there is a meta-legal principle that supports calls for corporate spirited compliance, the point here is a more fundamental one. Namely, the expectations we have of citizens who avail themselves of the benefits of society and the harm that it causes when they fail to adhere to their side of the bargain. Claims that human citizens consent to obey the law as part of a social contract are subject to persuasive criticism. Can it truly be said that a human citizen ‘consents’ to the rules of a jurisdiction? However, this critique loses force when looking at corporate actors, for whom incorporation is very clearly a conscious and ongoing decision. Not only that, but the jurisdiction of incorporation is similarly quite deliberate, as we see from the use of inversions in Chapter 2 or the ‘race to the bottom’ debate characterising the development

22 HM Revenue & Customs, ‘Measuring Tax Gaps 2014 Edition: Tax Gap Estimates for 2012–13,’ 16 October 2014. 23 This figure is comprised of the tax gap attributed to ‘tax avoidance,’ which stood at £3.1 billion; and ‘legal interpretation,’ which stood at £4.5 billion. See HM Revenue & Customs (n 22), 4. 24 Figures taken from: Hospital Management, University College Hospital London (undated) www.hospitalmanagement.net/projects/uclh/ (accessed 8 August 2020). 25 M Wenzel, ‘Misperceptions of social norms about tax compliance: From theory to ­intervention,’ (2005) 26 Journal of Economic Psychology 862, 863. 26 McBarnet, ‘After Enron’ (n 4), 1092.

10  Capitalism’s Compliance Crisis of corporate law more generally. Understood in this way, it is much harder to argue that corporations do not, on incorporation, agree to be bound by the laws, including the rule of law, that apply in their jurisdiction of choice. III.  RECONTEXTUALISING COMPLIANCE: FROM SUBJECT TO SYSTEM

Traditionally, creative compliance is tackled as a ‘corporate’ problem or, as a sub-set of that generalisation, as a ‘tax’ or ‘accounting’ problem. The difficulty with this subject-centred approach is that it gives rise to both polarised and largely unassailable perspectives. Arguments for spirited compliance based, broadly speaking, on the position of corporations as significant economic actors (with responsibilities to wider stakeholders) are readily met with the rebuttal that corporations are private actors that, like their non-corporate counterparts, do not have a responsibility to act beyond the strict requirements of the law. Similarly, if we view the challenge as simply a ‘tax’ or ‘accounting’ problem, the response, as we have seen, has been to introduce more tax or accounting regulation. Whilst it is, ostensibly, entirely logical that we rely on regulation to close legislative loopholes, this strategy has limited scope for success. The problem, as repeated corporate scandals demonstrate, is that we will never be able to close all the regulatory gaps or to remove all legislative uncertainty. Nevertheless, repeated efforts to do so have left us with an ever-growing statute book of piecemeal and complex regulation, which can actually serve to facilitate further creative compliance providing (as we see in Chapter 2) a roadmap of bright line rules that can facilitate, rather than frustrate, technical compliance. To address these inevitable challenges, this book reframes the issue by approaching the underlying question of creative compliance not from the starting point of the corporation as a powerful economic actor with attendant obligations, but by considering the functional role of compliance itself.27 Compliance, like many legal concepts, is not a word in search of a dictionary definition but one that requires meaning derived from the context in which it is used.28 To define ‘compliance’ in a literal sense is easy, to understand a corporation’s obligations in respect thereof is a more complicated enquiry. Therefore, to answer this substantive question of definition, the book moves away from the starting point of the corporation as a legal subject, towards the functional role of compliance within the broader legal and market system. In doing so, it

27 The way a question is asked/interpreted is critical. For example, ‘can I smoke whilst I pray / can I pray whilst I smoke’, L Katz, Ill-Gotten Gains Evasion, Blackmail, Fraud and Kindred Puzzles of the Law, (University of Chicago Press, 1987), 106. Indeed, characterisation and categorisation are critical to properly understanding an issue, its moral standing and the consequences thereof. 28 On which see HLA Hart, Essays in Jurisprudence and Philosophy (Clarendon Paperbacks, 1983), 21.

Scope of the Book  11 focuses on the role that spirited compliance (and the trust that it generates) plays in the operation of the social orders that are essential to civil society, examining the market order as a paradigm case. By understanding the role of compliance in this way, namely by looking at the instrumental role of compliance and its interplay with existing social systems, the book is able to offer a conceptual framework in which to examine some of the more challenging questions that the creative compliance debate gives rise to. In particular, it enables us to answer concerns as to equality (between corporate and natural citizens), whilst establishing the ex ante legitimacy of demands that corporations adopt spirited compliance strategies, even if this does not maximise short-term profit. One oblique consequence of this systems-based analysis is that it reduces the reversion to, and reliance on, traditional assumptions and potentially false dichotomies that can divide more general corporate responsibility debates (for example between contractarian and pluralist theories of the firm). Instead, by looking first to the function of compliance, rather than the economic influence of the corporation, we can identify an analytical architecture that helps us to navigate (rather than simply reject) these oftentimes intractable positions. This reframing of the question of compliance enables us to not only identify the causes of creative compliance but, as a consequence, structure alternative avenues to reform. By recognising compliance as one component of a broader social system, we are able to explore the issue beyond the point at which the decision to creatively comply was made. Rather, we can ask what came before? What caused a director or manager to agree to the structure in question? Why were they willing to make that decision, particularly if it does not align with the norms that govern their personal frame of reference? What is it about the corporate environment, including the corporate architecture itself, that might segregate corporate actions from a person’s individual values? Does this corporate decision-making cause an escalation in personal and organisational risk profiles? Is it desirable or possible to hold some citizens to a different standard of account than others? It is these questions, and more, that are considered throughout the book and that make the question of corporate compliance such a rich and interesting one to explore. IV.  SCOPE OF THE BOOK

In broad terms, this book is concerned with understanding whether there is a normative case for spirited (or responsible) compliance and, if so, what barriers exist (legal, normative, cognitive and political) that are preventing corporations from adopting that standard. It is once we establish this understanding that we can fully identify how to implement reform and how to ensure that corporations see regulation not as a tool to exploit but as the requisite ‘rules of the game’ to adhere to, both in letter and in spirit.

12  Capitalism’s Compliance Crisis To consider these questions, the book looks primarily at the paradigm case of creative compliance with tax regulation and the regulatory response thereto. However, it should be made clear from the outset that the findings of this work are not limited to this field. A corporation’s compliance strategy has a significant impact on both its culture and the individuals that act on its behalf (discussed in Chapter 7), providing insights into broader questions of behavioural change within organisations. It is an issue that goes to the essence of a corporation’s relationship with, and obligations to, civil society (as examined in Chapter 6), whilst the normative basis for reform put forward by this book is predicated on the broad concepts of integrity, trust, equality and social order, values that are, of course, relevant to all areas of practice. Rather, the focus (where necessary) on tax arises, as it is a useful case study for several reasons. First, this is a recent area of regulatory reform that demonstrates how governments are attempting to address the problem of creative compliance. This facilitates an analysis of how, whilst welcome, even these sophisticated regulatory responses are still subject to important limitations unless accompanied by wider normative change. Second, it is an area that engages with the oftencited claim that the financial gains derived from aggressive tax structures align with a director’s duty to their shareholders (the suggestion being that spirited compliance does not). Therefore, it enables an analysis of the interplay between compliance and our understanding of the perennial question of the scope of a director’s duty under section 172 of the Companies Act 2006. Finally, the use of tax as a case study helps to distil the functional role of compliance (and the normative value of spirited compliance) with a subject matter that is not viewed, ethically, in universally accepted terms (allowing, to a degree, greater clarity of analysis). This is in contrast to, for example, bribery where most people intuitively feel that to ‘bribe,’ even when technically permissible,29 is a moral wrong that can legitimately be constrained, potentially obscuring an objective analysis of corporate compliance standards more generally. Two final points on scope are necessary at this juncture. First, the research is concerned with the compliance practices of public limited companies. As Chapters 2 and 7 explain in more detail, corporations (both public and private) are uniquely positioned to be able to adopt the tax structures that are the focus of this book. However, unlike (most) private and closely held organisations, the public company is more likely to be characterised by the economic (as well as legal) separation of ownership and control. As Chapter 7 explores, it is this separation that helps to support a decision to creatively comply due to, inter alia, the lack of personal responsibility within an organisation for the consequences of creative compliance. It is this complete emancipation that also serves to minimise the normative sanctions (introduced in Chapter 3) that may 29 For example, certain facilitation payments where the conduct is governed by the Foreign Corrupt Practices Act 1977 (note that such a payment would be unlawful under the more stringent Bribery Act 2010).

Structure of the Book  13 ­ therwise apply in response to the implementation of abusive tax structures.30 o In light of this focus, references to the ‘corporation’ throughout this book are references to public companies. Second, it should be made clear from the outset that the problem of creative compliance is not an exclusively corporate concern (notionally individuals can and arguably do creatively comply). However, it is a manifestly more complicated enquiry within the corporate arena and there are a number of factors inherent within the corporate form that exacerbate (and facilitate) both the practice of creative compliance and the ability to rationalise it as a legitimate course of conduct. For the corporate citizen, compliance strategies and standards sit at the apex of a number of conflicting theoretical positions and ideologies, including political philosophy, corporate theory and social psychology. Navigating these conceptual concerns is made more challenging as compliance strategies engage multiple actors, operating within multiple systems or environments. For example, the question of whether to implement a tax avoidance scheme concerns the norms (and, where applicable, moral values) of each of the market, the corporation, the applicable legal framework and the individual acting on behalf of the corporation. At any given time, these norms may conflict, reinforce or, as a minimum, influence each other, mandating an understanding of each of these spheres of operation to effectively understand and address the challenges that arise when seeking to reform corporate compliance practices. V.  STRUCTURE OF THE BOOK

In making the claim that corporations should adopt a responsible (or spirited) standard of compliance, the book has three aims. First, to establish the normative basis for spirited compliance and thereby provide the ex ante legitimacy that is crucial to a sustainable change in corporate behaviour. Second, to understand the impact that the existing corporate law framework has on compliance decision-making within the company and the barriers that this might present to reform. Finally, to offer effective solutions to the problems that the book identifies. To achieve these objectives, the book is structured as follows.

30 There are, of course, some exceptions to this claim. For example, some listed corporations retain an entrepreneurial, rather than managerial, model. In these organisations the company is (or was) clearly identified with an individual. For example, Apple and Steve Jobs. However, even in these corporations the threat of personal reputational damage only arises once a breach has occurred and, as discussed in ch 6, one problem with creative compliance is the difficulty with detection. Moreover, even after an allegation has been made, such individuals can still rely on the corporate norms that are discussed in this book to seek to justify (to themselves if not others) their behaviour. For example, Sports Direct International plc’s major shareholder Mike Ashley’s claim that he is ‘not Father Christmas’. See: Editorial, ‘The Guardian view on Mike Ashley: the unacceptable face of modern capitalism,’ The Guardian (7 June 2006) available at www.theguardian.com/commentisfree/2016/jun/07/the-guardianview-on-mike-ashley-unacceptable-face-of-modern-capitalism (accessed 8 August 2020).

14  Capitalism’s Compliance Crisis To help provide context to and a practical grounding for the rest of the book, Chapter 2 examines how creative compliance manifests in practice with a focus on the proliferation of aggressive tax planning. It explores the development of the relevant common law, which shows the early emergence of a corporate norm of technical compliance. The chapter returns to the 2012 tax scandals to understand the specific structures in more detail, providing the foundation to later parts of the book that consider the unique ability of corporations to comply with the law in this way. In concluding, the chapter examines the structure of the GAAR and suggests that, in line with historic attempts to change corporate compliance behaviour, it is subject to both structural and situational difficulties that are highly likely to impede meaningful behavioural change in accordance with its objectives. Having explored the practice of creative compliance in Chapter 2, Chapter 3 considers the process by which corporations define compliance and examines compliance as a social construct. That is, in contrast to objectively observable and verifiable facts, compliance as a concept derives its meaning from society and those who engage with it. It is by understanding this process of construction that we can start to see the pivotal role of social (or environmental) norms in developing and ascribing meaning to a concept. Chapter 3 explores both the function of norms in shaping social meaning and how, once developed, a norm can rapidly be accepted and institutionalised within a group. As this chapter explains, the homogeneity of the profit-maximising norm that traditionally pervades all aspects of corporate regulation, governance and theory adopts a position of authority and legitimacy (premised on, inter alia, the expressive function of law). As a consequence, it is not only the norm per se that is legitimised but those acts, omissions and regulatory provisions that support it. Conversely, this wealth maximising norm operates to undermine the legitimacy of reform proposals, such as the GAAR, that adopt a contrary view. In looking at this instrumental impact of norms, a fundamental and highly challenging question necessarily ensues. If social norms (which are outside of our control) are so impactful on our behaviour, what does this mean about our genuine freedom to act in a particular way? Moreover, what does this mean for personal responsibility? Whilst critical, how corporations define compliance (and the factors that influence this) is only the first step in understanding the current compliance crisis. It is also necessary to consider what motivates a person to comply with the law (or otherwise) in accordance with a corporation’s potentially narrow construction of compliance, even when this conflicts with their personal norms. This interplay between definition and action does, of course, have profound consequences. Whilst we can all define ‘theft’ one hopes this does not result in positive action towards it raising the question as to why corporate definitions of compliance have proven to be so influential on individual action. In exploring the question of motivation, Chapter 4 introduces an important theme of the book, namely the relationship between legitimacy and compliance. In doing so, it introduces what I term the ‘compliance degeneration cycle’. This cycle draws

Structure of the Book  15 on Tom Tyler’s work to demonstrate how a manifest belief in the legitimacy of creative compliance (and, conversely, the illegitimacy of calls for spirited compliance) justifies the initial decision to adopt a narrow interpretation of compliance. Once a corporation has adopted this creative approach to compliance, this means that the regulation in question no longer applies equally to all legal subjects (as the ability to creatively comply is dependent upon a number of factors ranging from a subject’s risk profile, financial and legal resources). This inequality of application further reduces the legitimacy of regulation, conversely increasing the likelihood of creative compliance (due to the nexus between legitimacy and compliance). Thus, for reasons explored in more detail in the chapter, the act of creative compliance itself contributes to a self-perpetuating cycle of degenerative compliance behaviour, which permeates and perpetuates across the corporate sector. Chapters 1 to 4 analyse how creative compliance manifests in practice (and some of the consequences of this). Chapter 5 is the first of two chapters that provide the normative justification for spirited compliance. It explores the classical liberal ideology that the market economy is premised on and challenges the misconception that classical liberal thinking tacitly, if not expressly, supports creative compliance. Drawing on the work of Friedrich Hayek, the chapter examines the argument that society depends upon the development of ‘spontaneous’ (in contrast to planned) orders as the only mechanisms that are capable of ordering complex social systems. In particular, it looks at the market as a paradigm case of a spontaneous order and demonstrates the symbiotic relationship between market order and spirited compliance. By analysing the function of social systems in this way, the chapter introduces the critical importance of the maintenance of the rule of law and, most crucially, equality before the law if such order is to be achieved (and how this order is fundamentally undermined by creative compliance). The principle of the rule of law and, in particular, equality before the law is critical to the book. However, it also reflects two of its biggest challenges. First, how can we legitimately sanction behaviour that whilst undesirable is nevertheless legal? Second, if we reject the legitimacy of creative compliance on the basis that, inter alia, it undermines the principle of equality before the law, how can we then argue that corporations should be held to a higher (unequal) standard of compliance? Chapter 6 responds to this issue by first exploring what we mean by ‘equality before the law’ and demonstrating how creative compliance undermines this principle. It explores the Hayekian notion of the rule of law as a meta-legal principle and explains (by reference to modern thinking on ‘cheating’) why it is the breach of this meta-legal principle that provides justification for controlling apparently lawful behaviour. The chapter then examines arguments that support a claim that corporations, as a legal subject, have an obligation to maintain the rule of law. It concludes by examining the role of legal privilege as the only justification for derogating from the strict application of equality before the law (by holding corporations to a different compliance standard than non-corporate citizens).

16  Capitalism’s Compliance Crisis One challenge to the claim that corporations are driven by a regulatory imbued and homogenous norm of profit maximisation, which leads to ‘unethical’ compliance decisions, is the fact that corporations necessarily act through individuals who are constrained by notions of right and wrong. Chapter 7 responds to this charge by exploring how the structural characteristics of the firm create a powerful psychological impact on the decision making of those within it (in doing so it provides important insight into the challenges of instrumentalising behavioural change in corporations). Within the corporation, decision-making is distributed across a hierarchy of employees resting ultimately with the board of directors. In this regard, the corporation is premised on an edifice of fiduciary obligations towards others. Internally, these obligations are built on a command structure: junior employees look to senior management, senior management to directors and directors to shareholders. Thus, an internal ‘fiduciary ladder’ exists which enables each stratum of employees to justify outsourcing responsibility for the ethics of their actions (legally and, as we shall see, psychologically) to the rung above it. However, the reality of the modern corporation is that shareholders are now supplanted by a faceless ‘market’, leading to a system of ownerless capitalism and, as we shall see, ownerless responsibility. The fiduciary ladder helps to demonstrate both the relative lack of an identifiable human presence within a firm to attribute moral responsibility to and how the homogenised norm of shareholder wealth maximisation (considered in Chapter 3) is accepted as a proxy for shareholder interests. By recognising the impact of the corporate structure in this way, we can better understand how corporate compliance decisions are seemingly immune to non-legal behavioural constraints (such as personal ethics, religious views or a fear of personal reputational damage) that would otherwise operate to restrict individual behaviour. We can also start to see how the operation of the fiduciary ladder insulates corporate decision makers from public (and private) ethical scrutiny. It is this reputational impunity that helps to support a director’s decision to pursue pure profit maximising objectives even where these transcend what is typically regarded as ethical or responsible conduct. In conclusion, Chapter 8 draws together the earlier discussions of the book to reflect on how, if we return to first principles, we can see the instrumental importance that adopting a more responsible approach to compliance has for society. How, far from undermining the market order, it is fundamental to its integrity (used in this context to mean completeness) and sustainability. In doing so, the chapter also takes the opportunity to return to the question of freedom and responsibility, drawing on some of the more potentially sobering aspects of the previous chapters. Namely, our understanding of how the rules of society (both those enshrined in law and in the norms of a citizen’s social environment) are powerful drivers of behaviour. In this way, it considers to what extent freedom, and how we define the choices that underpin it, shape our expectations of responsibility. That is, both an individual’s responsibility for their own conduct but also that of the state to manage (or mitigate) the unforeseen circumstances

Conclusion  17 arising from the laws (broadly defined) that govern society. Put another way, to what extent does (or should) responsibility vest in the player or the rules of the game? VI. CONCLUSION

The problem of corporate compliance is profound and pressing. Its complexity necessitates a return to first principles to understand the multi-faceted reasons why some corporations act in this way and why it is a problem that has pervaded company law for so long. Whilst the focus of this work is on tax, it is important to recognise that creative compliance is not simply a fiscal concern but goes to the core of what it means to be a corporate citizen and the expectations that this carries with it. As we enter into the fourth industrial revolution, and a new age of corporate power, this is a question that is becoming ever critical. The social, economic and political power of corporations (and collective organisations more generally) is expanding to a scale that was unimaginable at the time that the theories that inform the current compliance debate were developed. Indeed, the importance of reconceptualising our understanding of corporate compliance has never been so acute. We should be abundantly clear; this concern is not hypothetical. Six years after Eric Schmidt declared that he was ‘perplexed’ by the UK tax debate and that the solution was simply for the UK to ‘change the laws’,31 Mark Zuckerberg testified before the US Senate in respect of the Cambridge Analytica scandal, which saw the data of over 87 million Facebook users being mined. ­Zuckerberg denied that Facebook sold user data, explaining that advertisers would ‘tell us who they want to reach, and then we do the placement … [this shows] the ads to the right people without data ever changing hands’.32 In adopting what was to became a repeatedly relied upon distinction,33 Facebook he argued was not selling data but merely targeted advertising. Put another way, Facebook was complying with the letter of the law, albeit in circumstances that many would consider to undermine its spirit. As Michal Kosinksi observed in the New York Times, Facebook’s technical assertion ‘that it is not selling user data is like a bar[’s] giving away a free martini with every $12 bag of peanuts and then claiming that it’s not selling drinks’.34

31 G Topham, ‘Google’s Eric Schmidt: change British law and we’d pay more tax’ The Guardian (27 May 2013) www.theguardian.com/technology/2013/may/27/google-eric-schmidt-change-law-tax (accessed 8 August 2020). 32 ‘Transcript of Mark Zuckerberg’s Senate Hearing,’ The Washington Post (11 April 2018) www. washingtonpost.com/news/the-switch/wp/2018/04/10/transcript-of-mark-zuckerbergs-senatehearing/ (accessed 8 August 2020). 33 See M Kosinski, ‘Congress May Have Fallen for Facebook’s Trap, but You Don’t Have To’ The New York Times (12 December 2018) www.nytimes.com/2018/12/12/opinion/facebook-dataprivacy-advertising.html (accessed 8 August 2020). 34 ibid.

18  Capitalism’s Compliance Crisis Corporate creative compliance is not simply a problem of regulation, or of bad people making bad decisions. It is, as this book seeks to show, a systems failure. Of course, at its most fundamental level an individual makes the ­ ­decision to implement a tax structure. However, that individual works in a team, which answers to a board of directors, who set the strategy for the corporation, which has shareholders and operates within a market economy all of which exist within a framework of legal rules and principles. Over time, somewhere in that system (or, more accurately, multiple overlapping systems) the norm has been established, accepted, endorsed and internalised that it is legitimate for corporations to undermine the ‘evident intention of Parliament’35 regardless of the impact. At a most basic and intuitive level this cannot be right. However, there is hope. As this book suggests, these norms are not necessarily accurate and proposals for reform do not need to be seen in direct conflict with market objectives. Whilst there are few who would argue that current market sentiment is perfect, this work seeks to demonstrate how market institutions can in fact support a more responsible approach to compliance. What is needed is not a new political philosophy or legal ideology. Rather, a return to, and understanding of, the original principles and values that not only underpin our current market order but are critical to its success. In rediscovering those tenets, what emerges is an appreciation for the central role that rules and compliance play within the system. A recognition that compliance is not an afterthought but a central cog in the success of the market economy and what is needed is not more laws, but a reconceptualisation of corporate compliance obligations towards them.



35 Inland

Revenue Commissioners v Willoughby [1997] 1 WLR 1071, 1079.

2 Creative Compliance in Practice [Rules] can be seized on as an easier option than the diligent pursuit of corporate governance objectives. It would then not be difficult for lazy or unscrupulous d ­ irectors – or shareholders – to arrange matters so that the letter of every governance rule was complied with but not the substance. It might even be possible for the next disaster to emerge in a company with, on paper, a 100% record of compliance.1 Hampel Committee on Corporate Governance

C

reative compliance is not a new phenomenon. In January 1998, in what transpired to be a striking prophecy of the impending Enron ­collapse,2 the Hampel Committee on Corporate Governance anticipated that the next corporate scandal could involve a corporation with a technically impeccable compliance record.3 As such, it is perhaps surprising that notwithstanding the devastating impact of Enron’s collapse, and widespread public consternation, creative compliance has not merely continued as a corporate practice but, as we saw in Chapter 1, escalated to become (for some at least) a seemingly accepted component of corporate strategy.4 To understand why there is such a discrepancy between public opinion and corporate conduct, and to ground the theoretical discussions in this book, it is helpful to first look to the path dependency of corporate creative compliance. As noted above, whilst Enron was not the last compliance scandal it was also not the first, raising the question as to why such a damaging practice continues to persist. In part, this question can be answered when we see that modern company law is replete not only with examples of where creative compliance has been adopted but also where it has been expressly endorsed by the courts, creating a powerful culture of legitimacy. As we see in Chapter 4, this legitimacy plays an important and highly influential role in shaping a corporation’s compliance decisions. 1 Committee on Corporate Governance, Final Report (January 1998), para 1.14 (the ‘Hampel Report’). The Hampel Committee was established in November 1995 to review the implementation of the Cadbury and Greenbury committees (see: Hampel Report, para 1). 2 Enron filed for Chapter 11 bankruptcy on 2 December 2001. 3 Hampel Report (n 1), para 1.14. 4 On this see the respondents to Doreen McBarnet’s empirical work in this field, who saw the law as a ‘hurdle’ to overcome, or as something that ‘inconveniently’ got in the way and was to be ‘creatively dealt with’. See D McBarnet, ‘Financial Engineering or Legal Engineering? Legal Work, Legal Integrity and the Banking Crisis,’ in I MacNeil and J O’Brien (eds), The Future of Financial Regulation (Hart Publishing, 2010), 69.

20  Creative Compliance in Practice This chapter begins by exploring the increasingly endemic practice of corporate compliance and its interpretation by the courts. Thereafter, Section II looks at the paradigm case of creative tax compliance, as it is here that we can see in stark terms how corporations utilise their legal status (in particular their ability to incorporate multiple legal personalities within a single group) to implement artificial intra-group structures that, inter alia, both reduce a corporation’s tax base and relocate it to a low tax jurisdiction.5 In doing so, this section also considers the development of judicial thinking as it moved towards a purposive approach to interpreting tax statutes. Or, more accurately, as the courts acknowledged that the interpretation of tax statutes had, traditionally, been something of a historical anomaly in not fully recognising the applicability of purposive interpretation. The focus on tax structuring acts as a particularly useful case study as it highlights the often-complex relationship between regulation and compliance. Section III examines the UK’s traditional approach to tax statutes, which has resulted in a proliferation of complex and prescriptive rules. Ironically, it is this network of rules that can be utilised in tax structures, providing a roadmap of provisions that avoidance schemes can be structured around.6 However, as the final substantive part of the chapter explains, whilst the UK adopted a different approach to regulatory design when implementing the General Anti-Abuse Rule (‘GAAR’)7 as a response to the 2012 tax scandals, this has yet to achieve the impact that many would hope for. We continue to see therefore that whilst regulation may certainly be one important component of a holistic response to creative compliance (in part due to the expressive function of law discussed in Chapter 3), in isolation it is unlikely to have the behavioural impact that is needed. I.  THE RISE AND RISE OF CREATIVE COMPLIANCE

Whilst creative compliance is now synonymous with the highly complex legal structures considered in Section II, it is in fact a practice that has permeated the development of modern company law. As is well-known to corporate lawyers, 5 Discussed further in Section II.B. 6 Organisation for Economic Co-operation and Development, ‘Reducing the Risk of Policy Failure: Challenges for Regulatory Compliance,’ (2000), 17. 7 The GAAR was introduced pursuant to Pt 5, Finance Act 2013, whilst its procedural requirements are set out in Sch 43, Finance Act 2013. The Aaronson Report, which sets out the findings of the study group set up to consider the introduction of a GAAR in the UK, is instructive as to the benefits and potential concerns of implementing a GAAR. See G Aaronson QC, ‘GAAR Study, A Study to Consider Whether a General Anti-Avoidance Rule Should be Introduced into the UK Tax System,’ 11 November 2011 (the ‘Aaronson Report’). Of note is that prior to the recent tax scandals referred to in Section II, the UK had previously resisted GAAR. On this see J Freedman, ‘General Anti-Avoidance Rules (GAARs) – a Key Element of Tax Systems in the Post-BEPS Tax World?’ (2016) University of Oxford Legal Research Paper Series 1, 7.

The Rise and Rise of Creative Compliance   21 UK company law is itself characterised by a decision that legitimised a literal approach to compliance, providing an instructive foundation from which corporate compliance norms could develop.8 The seminal decision of Salomon v Salomon & Co Ltd,9 concerned the use of six nominee shareholders (in addition to the founder) to satisfy the requirement of the Companies Act 1862 that a company needed to have seven shareholders to incorporate.10 The question before the court was whether these shareholders needed to have a real or substantial interest in the company or whether the use of nominees (as was the case here) would comply with the Act’s requirements. Although the Act was silent on the need for materiality, it was widely considered that the Act envisaged the presence of shareholders of substance, reflecting both the development of the corporation from economically significant partnerships11 and also broader concerns as to the abuse of the corporate form.12 Nevertheless, overruling the decisions of the lower courts, the House of Lords accepted that strict compliance with the Act was sufficient and that the court could not (and should not) read a materiality requirement into its terms. In doing so, the court approved a formalistic and, for many, reductive approach to compliance that would align with economic theories of the firm to be promulgated over 50 years later. This early endorsement of technical compliance by the House of Lords was followed in 1936 by the decision of The Commissioners of Inland Revenue v His Grace the Duke of Westminster.13 Whilst not a company law case, as will be seen in Section II below, the Duke of Westminster decision was highly influential in establishing the normative environment in which corporate compliance standards were, and continue to be, determined. Here, the House of Lords had to consider whether to uphold the Duke of Westminster’s claim that he had paid his gardener a tax-deductible annuity, rather than a salary. In sustaining this classification, Lord Tomlin observed that ‘every man is entitled if he can

8 As Edelman recognises, compliance is defined by industry norms that become institutionalised and reflect a citizen’s understanding of ‘legality, morality and rationality’. Judicial decision-making plays an important role in that construction, both endorsing industry norms and shaping our understanding of legality. See LB Edelman and SA Talesh, ‘To Comply or Not to Comply – That isn’t the Question: How Organizations Construct the Meaning of Compliance,’ in C Parker and VL Nielsen (eds), Explaining Compliance Business Responses to Regulation (Edward Elgar, 2011), 103. 9 [1897] AC 22. 10 Companies Act 1862, s 6. 11 Outlined in more detail in ch 7. 12 Broderip v Salomon [1895] 2 Ch 323, per Lindley LJ [337] ‘There can be no doubt that in this case an attempt has been made to use the machinery of the Companies Act, 1862, for a purpose for which it was never intended … Although in the present case there were, and are, seven members, yet it is manifest that six of them are members simply in order to enable the seventh himself to carry on business with limited liability. The object of the whole arrangement is to do the very thing which the legislature intended not to be done.’ For a more detailed discussion as to the mischief and intentions of the 1862 Act, see P Ireland, ‘The Rise of the Limited Liability Company,’ (1984) 12 International Journal of the Sociology of Law 15–17. 13 [1936] AC 1.

22  Creative Compliance in Practice [emphasis added] to order his affairs so as the tax attaching under the appropriate Acts is less than it otherwise would be’14 regardless of how ‘unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity’.15 Indeed Lord Russell, in concurring with Lord Tomlin, explained that ‘if the Crown … cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be’.16 The Duke of Westminster decision is instructive not simply because the court rejected attempts to constrain creative compliance, a principle that was not disrupted (and even then only notionally) until the Ramsay decision some 50 years later.17 Rather, it also highlights three critical aspects of the corporate compliance debate that remain relevant today. First, is the tacit acknowledgment that not every citizen is able to order his or her affairs to avoid tax (regardless of the morality or legality of the decision to do so). This inequality of opportunity is particularly acute when comparing corporate and human citizens, but (as discussed in Chapter 6) also applies when comparing the corporate community inter se. As shall be seen, such inequality has multiple consequences, not simply offending the rule of law (on which see Chapter 6) but, as Chapter 4 explores, it also perpetuates the practice of creative compliance contributing to a cycle of creative compliance decisions. Second, Lord Tomlin’s reference to the ‘ingenuity’ of the structure reflects the view that, on one level at least, creative compliance is something that is to be revered. To the extent that this observation was not entirely earnest on Lord Tomlin’s part, it is nevertheless indicative of industry’s current view that creative compliance is ‘proudly capitalistic’,18 a sentiment that was apparent from McBarnet’s empirical work in this field. In a testament to the cultural environment that corporations operate within, creative compliance was not a practice that McBarnet’s interviewees felt needed to be hidden; rather it was seen as something ‘clever’19 that should be admired. Finally, and given this perspective, it is perhaps not surprising that McBarnet’s interviewees, much like Lord Russell (and indeed more recently Eric Schmidt and Mark Zuckerberg), placed responsibility for controlling technical compliance practices firmly on the regulators: ‘if they can’t make regulations legal-engineering proof … it is fair game to exploit that situation. Ideas such as responsibility, the public good, morality, ethics or

14 The Commissioners of Inland Revenue v His Grace the Duke of Westminster [1936] AC 1, 19. 15 ibid. 16 ibid, 25. 17 Discussed in Section II. 18 N Kumar and O Wright, ‘Google boss: I’m very proud of our tax avoidance scheme’ The Independent (13 December 2012) www.independent.co.uk/news/uk/home-news/google-boss-imvery-proud-of-our-tax-avoidance-scheme-8411974.html (accessed 8 August 2020). 19 D McBarnet, ‘Compliance, Ethics and Responsibility: Emergent Governance Strategies in the US and UK,’ in J O’Brien (ed), Private Equity, Corporate Governance and the Dynamics of Capital Market Regulation (Imperial College Press, 2007), 214.

The Rise and Rise of Creative Compliance   23 integrity do not enter into the equation.’20 It is a trite observation to note that this level of ‘legal-engineering proof’ regulation is neither possible nor desirable. Indeed, as we discuss later, it is the very essence of the compliance debate that there will be inevitable gap-filling left by even the most innovative regulatory approaches, it is how corporations interpret their obligations within these regulatory gaps that is important. These early decisions encapsulate the attitudes that legitimise more recent compliance scandals, which use legal devices to enable the form of a transaction to fall ‘on the right side of the boundary between lawfulness and illegality’.21 However, this technical approach to compliance is not simply a concern of semantics or theoretical debate. Rather, as modern examples are demonstrating, corporate creative compliance can have a globally catastrophic impact. Most notably, it was the accounting scandals of 2001, which resulted in the spectacular failures of Enron, WorldCom and Parmalat that brought the practice of creative compliance to public attention (a practice that in many of these cases was a precursor to, or implemented in parallel with, unlawful activities). In brief, Enron incorporated a substantial number of special purpose vehicles (‘SPVs’),22 typically limited partnerships, designed to protect Enron’s credit rating by keeping substantial debts off the Enron group’s balance sheet.23 As newly incorporated entities, these partnerships had the appearance of being reliable borrowers. They would acquire debt to finance new business ventures and utilise Enron stock as collateral for the relevant loan (Enron being rated as ‘investment grade’24 stock at the time). Importantly for Enron, these SPVs also, ostensibly, satisfied accounting regulations which stipulated that provided three per cent of the issued equity in the SPV was owned by a non-Enron entity then Enron did not need to include the SPV debts on its consolidated financial reports. By availing itself of these regulations Enron was able to conceal considerable liabilities from the market. However, as we now know, whilst Enron had, technically, complied with these accounting requirements, the general partners of the SPVs were largely controlled by Enron officers, primarily its Chief Financial Officer, Andy Fastow, or members of his family.25

20 McBarnet, ‘Financial Engineering’ (n 4), 80. 21 ibid. 22 As to the scale of Enron’s creative accounting, of note is that for the year ending 31 December 2000 (that immediately proceeding the year in which Enron filed for chapter 11 bankruptcy protection) its annual 10-k filing listed over 2,000 subsidiaries: www.secinfo.com/dv8Cu.4f895.a.htm#1stPage (accessed 9 August 2020). 23 SL Schwarz, ‘Enron and the Use and Abuse of Special Purpose Entities in Corporate Structures,’ (2002) 70 University of Cincinnati Law Review 1309, 1310. 24 CA Hill, ‘Why did Rating Agencies do Such a Bad Job Rating Subprime Securities?’ (2010) 71 University of Pittsburgh Law Review 1, 14. 25 For a summary of these partnerships see WC Powers, RS Troubh and HS Winokur Jr., Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp (1 February 2002), 2–5 http://picker.uchicago.edu/Enron/PowersReport(2-2-02).pdf (accessed 9 August 2020).

24  Creative Compliance in Practice The repercussions of Enron’s failure (and the associated scandals of that time) were global and acute. In addition to the collapse of Enron and WorldCom’s auditor, Arthur Andersen, there was widespread consternation that corporations could mislead the market in this way. Of particular concern was the fact that a large part of the deception was ‘perfectly legal’26 and it was against this wave of corporate failures that we started to see a significant regulatory reaction. In particular, it was in response to the 2001 accounting scandals that the US introduced the Sarbanes-Oxley Act 2002 (‘SOX’) requiring, inter alia, stringent internal control disclosures and written confirmation by management as to its responsibility for such controls.27 The consequences of SOX, both intended and otherwise, are familiar. The Act attracted considerable industry criticism and resulted in a number of firms delisting from the New York Stock Exchange.28 Critics of SOX cite, amongst other matters, the substantial compliance costs that it imposes on firms that are subject to its remit,29 together with the indirect costs of ‘managing in the shadow of SOX’.30 In contrast, its advocates point to a reduced cost of capital,31 improved auditing32 and the (perhaps surprising) appreciation of some management teams at the mandatory strengthening of their corporation’s internal control environment.33 Notwithstanding the differing views as to the merits of SOX, what is striking for our purposes, is that following its introduction (even though it was supported by global condemnation of the behaviour of Enron and its counterparts) the practice of creative compliance was not materially reduced.34 Rather, despite these highly publicised failures (and, as shall be seen in the next section, judicial

26 Hearing Before the Committee on Governmental Affairs United States Senate, One Hundred Seventh Congress Second Sitting, ‘The Fall of Enron: How Could it Have Happened?’ Hearing 107–376 (24 January 2002) per Senator Thomson, 17 www.gpo.gov/fdsys/pkg/CHRG107shrg78614/pdf/CHRG-107shrg78614.pdf (accessed 9 August 2020). 27 Sarbanes-Oxley Act 2002, ss 302, 404 and 906. 28 In particular, as a result of the impact of the cost of complying with its onerous internal control requirements. For commentary as to the relationship between Sarbanes-Oxley 2002 and the decision to de-list see B Norris and M Fox, ‘Reducing Sarbanes-Oxley Compliance Costs for Smaller Companies,’ (2008) Journal of International Banking Law and Regulation 28, 32. 29 Outlined in S Bainbridge, The Complete Guide to Sarbanes-Oxley, (Adams Media, 2007), 4–5. 30 These include, managerial distraction, risk-aversion and potential internal inefficiencies in decision making. On this see H Butler and L Ribstein, The Sarbanes-Oxley Debacle, What We’ve Learned and How to Fix It (AEI Press, 2006), 43–50. 31 S-AK Stephen and PJ de Jong, ‘The Impact of the Sarbanes-Oxley Act (SOX) on the Cost of Equity Capital of S&P Firms’ (2012) 13(2) Journal of Business and Economics 102. 32 JC Coates IV, ‘The Goals and Promise of the Sarbanes-Oxley Act,’ (2007) 21(1) Journal of Economic Perspectives 91, 92. 33 S Wagner and L Dittmar, ‘The Unexpected Benefits of Sarbanes-Oxley,’ (April 2006) Harvard Business Review 1, 2. 34 For a discussion as to why this rule-based approach might not have been successful see ML Michael, ‘Business Ethics: The Law of Rules,’ (2006) Corporate Social Responsibility ­Initiative Working Paper No 19. Michael’s reasoning includes not only creative compliance but also the potentially negative impact of ‘external’ motivations such as rules on individual ‘ethical’ behaviour. Section III considers more broadly, in the context of the UK GAAR, why regulatory responses alone (regardless of design) are insufficient without wider normative change.

Loopholes in the Law: A Focus on Tax Avoidance  25 attempts to introduce broader compliance standards), we saw an escalation in creative compliance, particularly with regard to tax avoidance. II.  LOOPHOLES IN THE LAW: A FOCUS ON TAX AVOIDANCE

The paradigm case of creative compliance, particularly in recent times, is tax avoidance. It is a practice that involves exploiting ‘loopholes in the law’35 to facilitate the implementation of technically legal transactions that are designed primarily, if not exclusively, to reduce tax liabilities, oftentimes contrary to the intention of the relevant legislation.36 Commonly, these structures involve multiple, pre-determined, steps to manufacture (or create) losses and gains (sometimes referred to as a ‘composite’ structure). As a result, courts had to grapple with how to interpret these schemes as, when taken at face value and looked at in isolation, each step could appear legitimate (whereas if the scheme was looked at as a whole its intent to undermine the purpose of the legislation became a lot clearer). In facing this challenge, the role of the courts has been instrumental in shaping the contours of legitimate tax compliance. Whilst early decisions expressly endorsed creative compliance, more recent decisions started to recognise that tax statutes are not, and should not be, immune from purposive interpretation. A.  Towards a Judicial Anti-Avoidance Doctrine?37 As we saw in Section I, notwithstanding the recognition that many tax avoidance structures undermine regulatory intent, the orthodoxy of the courts when interpreting tax statutes (as enshrined in the Duke of Westminster doctrine) has been to base their decision on looking solely at ‘what is clearly said. There is no room for any intendment.’38 These decisions are premised on, and endorse, the principle that technical compliance with tax regulation is a legitimate standard to apply ‘however apparently within the spirit of the law the case might otherwise appear to be’39 and that citizens ‘incur no legal penalties and, strictly speaking

35 A Seely, Tax Avoidance: a General Anti-Avoidance Rule – Background History (1997–2010) Commons Briefing Paper Number 2956 (16 January 2020), 3. 36 G Wheatcroft, ‘The Attitude of the Legislature and the Courts to Tax Avoidance,’ (1955) 18(3) Modern Law Review 209, 209. 37 Tax Law Review Committee, ‘Tax Avoidance,’ November 1997, citing Lord Oliver of Aylmerton ‘Judicial Approaches to Revenue Law,’ in Gammie and Shipwrights (Eds) Striking the Balance: Tax Administration, Enforcement and Compliance in the 1990s IFS 1996. 38 Cape Brandy Syndicate v I.R.C. [1921] 1 KB 64, at 71 and approved in Canadian Eagle Oil Co. Ltd v R. [1946] AC 119, per Lord Simon at 140. 39 Partington v Attorney General (1869) LR 4 HL 100, per Lord Cairns at 122. This approach was subsequently endorsed in I.R.C. v Barclays Bank [1951] AC 421, 439.

26  Creative Compliance in Practice no moral censure’40 if they adopt a technical, rather than spirited standard of compliance. The influence of these decisions was such that the Tax Law Review Committee observed that it could be claimed that ‘the traditional attitude of the UK Courts to the interpretation of tax law has in the past created the conditions that promote tax avoidance arrangements’.41 Following this seeming endorsement of technical compliance, a line of decisions started to develop in the mid-twentieth century that expressed an increasing uneasiness with creative compliance. In particular, judicial doctrine emerged that suggested strict compliance with the letter of tax law (in defeat of its spirit) should not be regarded as the ‘discharge of the duties of good citizenship’.42 This criticism of creative compliance was commonly grounded in notions of manifest unfairness, namely that those who could creatively comply were conferring a disproportionate burden on their fellow citizens.43 In drawing upon notions of citizenship in this way, we started to see a judicial recognition of the relationship between civic responsibility (if not absolute duty) and compliance. Nevertheless, for some the shadows of the Duke of Westminster decision remained and the courts felt effectively bound by a formalistic interpretation of express statutory wording, in respect of which there was limited discretion.44 So constrained were the courts at this time that Lord Steyn later reflected that ‘the court appeared to be relegated to the role of a spectator concentrating on the individual moves in a highly skilled game: the courts were mesmerised by the moves in the game and paid no regard to the strategy of the participants or the end result’.45 In practice, this meant that provided the technical steps in any given structure complied with the strict letter of the law the scheme would be upheld as the courts had become ‘habituated to this narrow view of their role’.46 An important move away from this literalist approach to interpretation (and therefore a departure from a strict application of the Duke of Westminster decision) came with the development of the ‘Ramsay principle’ (so-called as it was derived from, amongst others,47 the House of Lords’ decision in W. T. Ramsay Ltd v Inland Revenue Commissioners).48 Ramsay represented a move towards 40 Levene v I.R.C. [1928] AC 217, per Lord Sumner at 227. 41 Tax Law Review Committee, Tax Avoidance, November 1997, 2. 42 Latilla v I.R.C. [1943] AC 377, per Lord Simon at 381. 43 See, eg, Lord Howard de Walden v I.R.C. [1942] 1 KB 389, per Lord Greene MR at 397. 44 Wheatcroft ‘The Attitude of the Legislature’ (n 36), 218. 45 Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991, 999. 46 ibid. 47 The principle also reflects the House of Lords decision of the same year in I.R.C. v Burmah Oil Co Ltd. [1982] SC (HL) 114. It was subsequently extended a few years later by the House of Lords in Furniss (Inspector of Taxes) v Dawson [1984] AC 474, which held that the Ramsay principle applied to all transactions with pre-ordained steps that serve no commercial purpose, not simply those involving self-cancelling steps (which had been one interpretation of Ramsay). Where a series of transactions fall within this definition then tax should be calculated on the effect of the structure as a whole. 48 [1982] AC 300.

Loopholes in the Law: A Focus on Tax Avoidance  27 what Lord Oliver described as the ‘new realism’.49 That is, the willingness of the court to look at the economic reality (or substance) of a particular transaction (or, as is often the case, series of transactions) and thereafter to adopt a more purposive rather than literal approach to the interpretation of the relevant statute. Ramsay concerned the manufacture by Ramsay of a deductible loss so as to counteract a genuine chargeable gain that it had realised through the sale of its freehold farmland. The House of Lords held that the creation of the loss arose simply as a consequence of a complex ‘capital loss scheme’ that had no commercial justification and the sole purpose of which was to offset the chargeable gain that had been made following the sale of the farm. Crucially, the House of Lords accepted that, taken in isolation, each stage of the scheme was genuine and would have to be accepted under the Duke of Westminster doctrine.50 However, when considering the scheme as a whole, a deductible loss did not arise. Looked at in this way (that is, in aggregate) the scheme was, in fact, a financial nullity with neither a gain nor a loss arising. In effect, the Lords held that when considering an otherwise lawful transaction, with individual pre-determined steps that were intended to be carried out as a whole, they were not obliged to consider each step individually but could look at the transaction in its consolidated form. In moving away from a purely literal interpretation, Lord Wilberforce noted that when applying the relevant Act its purpose ‘may, indeed should, be regarded’.51 The Ramsay decision was, undoubtedly, an important step towards constraining creative compliance. However, when we look at the detail of the judgment its impact is not quite as substantial as it could have been. Critically, in giving their judgment the Lords affirmed the principle that a taxpayer is entitled to ‘arrange his affairs so as to reduce his liability to tax … that [the mere fact that] the motive for a transaction may be to avoid tax does not invalidate it unless a particular enactment so provides’.52 Moreover, the Lords did not overrule the Duke of Westminster decision, rather they held that it did not need to be applied ‘in blinkers, isolated from any context to which it properly belongs’.53 In fact, the Lords expressly stated that Ramsay was not preferring substance to form, rather that it was acknowledging that if a transaction is part of a series of transactions then it is that series in aggregate, not any one of its individual steps, that should be considered. In doing so, the Lords did not dispute the legitimacy of creative compliance per se (the importance of which is considered in Chapter 4).

49 Lord Oliver of Aylmerton, ‘Judicial Approaches to Revenue Law,’ in Gammie and Shipwrights (eds) Striking the Balance: Tax Administration, Enforcement and Compliance in the 1990s IFS (1996) 173, 179. 50 [1982] AC 300, at 325, 337–340. 51 ibid, 323C-D. 52 ibid, 323. 53 ibid. In this way, the ‘Ramsay principle subsisted alongside, and did not overrule, the Duke of Westminster principle,’ see J Freedman, ‘Defining Taxpayer Responsibility: in Support of a General Anti Avoidance Principle,’ (2004) 4 British Tax Review 332, 350.

28  Creative Compliance in Practice Instead, Ramsay made clear that earlier decisions such as the Duke of Westminster should be applied having regard to the reality of the transaction (or series of transactions) before the court.54 In doing so, Ramsay was nonetheless the first in an influential line of cases to acknowledge and reflect a move towards a purposive approach to interpreting tax statutes, ‘giving effect to the intention of Parliament’.55 Nevertheless, Ramsay was not without its limitations and, as a judicial antiavoidance rule, remained subject to crucial challenges. In particular, following the extension of the principle by the court in Furniss v Dawson56 (from, inter alia, purely circular schemes to linear ones) there was a concern that the courts had conferred upon the Revenue a ‘discretionary power to determine, without any Parliamentary sanction, what transactions should be taxed and what should be permitted to take place without the imposition of fiscal burden’.57 It was argued that this approach risked ‘creating, almost arbitrarily, two categories of tax avoidance; permissible tax avoidance and impermissible tax avoidance’,58 without sufficient clarity as to when a transaction would fall into one category or the other. The perceived arbitrariness of the approach risked undermining (in the mind of the taxpayer at least) its legitimacy, which as the following chapter discusses, is crucial to engendering broad and voluntary compliance behaviour. In light of these challenges, efforts followed to better define the application or boundaries of Ramsay. In MacNiven v Westmoreland Investments Ltd59 Lord Hoffmann explained that the Ramsay construction would apply where the statute in question refers to a ‘commercial’ concept and here the courts would disregard steps in a composite transaction that had no commercial purpose (for example, if the step in question was inserted purely for tax purposes).60 However, in providing clarity to the ambiguity of Ramsay, Lord Hoffmann arguably limited its application when noting that to apply Ramsay the court must first: construe the statutory language and decide that it refers to a concept which Parliament intended to be given a commercial meaning capable of transcending the juristic

54 There have, of course, been a number of tax cases following Ramsay. However, scope does not permit a detailed analysis of these decisions within this book. Rather, it focuses on Ramsay as the seminal decision that both sought to reduce the type of structures that the GAAR is now targeting, whilst nevertheless failing to make a meaningful incursion into either the normative standing of tax avoidance or corporations’ implementation of abusive structures. 55 IRC v McGuckian [1997] 1 WLR 991, 1001. 56 [1984] AC 474. Here, the court went beyond looking at the economic reality of a series of connected transactions predicated on the intention of the taxpayer, but ultimately imposed a tax analysis based on a transaction that was very different to that which the taxpayer had intended to enter into (based on the taxpayer’s motive). 57 Lord Oliver ‘Judicial Approaches to Revenue Law’ (n 49), 185. For a detailed discussion of the constitutionality of Ramsay see RT Bartlett, ‘The Constitutionality of the Ramsay Principle,’ [1985] British Tax Review 338. 58 ibid, 186. 59 [2003] 1 AC 311, 48–49. 60 ibid, 48.

Loopholes in the Law: A Focus on Tax Avoidance  29 individuality of its component parts. But there are many terms in tax legislation which cannot be construed in this way. They refer to purely legal concepts which have no broader commercial meaning. In such cases, the Ramsay principle can have no application.61

In so doing, Lord Hoffmann made clear the limitations of Ramsay and the ‘new realism’ approach. In particular, that there was not a ‘general’ judicial anti-abuse rule that applied to all structures. The observation, Lord Hoffmann noted, was necessary ‘because, in the first flush of victory after … Ramsay … there was a tendency on the part of the Inland Revenue to treat Lord Brightman’s words as if they were a broad spectrum antibiotic which killed off all tax avoidance schemes’.62 In the same year that MacNiven was decided, further clarity (and, for some, conscription) was provided by the Lords in Barclays Mercantile Business Finance Ltd v Mawson.63 Whilst the Lords confirmed that in the majority of tax cases a purposive Ramsay construction would apply, it was noted that Ramsay did not introduce a new doctrine for tax cases, rather it ‘rescued tax law from being “some island of literal” interpretation and brought it within generally applicable principles’.64 Rather, and reflecting the artificiality of many structures, the tendency up until that point to view Ramsay as developing a new jurisprudence was the product of two features of tax law. That is, the interaction between economic activities and the ‘real world’ and the ‘good deal of intellectual effort [that] is devoted to structuring transactions in a form which will have the same or nearly the same economic effect as a taxable transaction but which it is hoped will fall outside the terms of the taxing statute’.65 In Barclays Mercantile the Lords felt that, following Ramsay, cases had gone ‘too far’ in giving ‘rise to a view that, in the application of any taxing statute, transactions or elements of transactions which had no commercial purpose were to be disregarded’.66 The impact of Barclays Mercantile was significant, with one commentator maligning that since the ‘fateful’ decision ‘a much wider range of entirely artificial tax planning “solutions” has been pushed aggressively to taxpayers’.67 The confirmation that a purposive approach to construction applies to the tax sector is to be welcomed.68 However, it is instructive as to the culture of the sector, and the construction of compliance, that Ramsay was seen for so long to be the advent of a new and special jurisprudence. It is not therefore surprising that, despite clarification (and for many circumscription) of Ramsay 61 ibid, 49. 62 ibid. 63 [2005] 1 AC 684. 64 ibid, 33. 65 ibid, 34. 66 ibid, 36 67 M Truman, ‘How Far Would You Go?’ Taxation 3 July 2012. 68 The Barclays Mercantile approach was affirmed in RFC 2012 Plc (in liquidation) v Advocate General for Scotland [2017] UKSC 45.

30  Creative Compliance in Practice by the Lords, challenges with this purely judicial approach remained. This was recognised by Graham Aaronson QC (who was commissioned to consider the adoption of a GAAR in the UK) when he shared his concern at ‘the lengths to which judges will go to stretch the purposive interpretation of tax statutes in order to defeat what they see as tax avoidance schemes … this is leading to a distortion of true purposive interpretation’.69 In practice, and in addition to these legitimacy concerns, even a move towards a more purposive approach was unable to stop the implementation of highly technical creative tax structures that ‘focus on prescriptive tax rules which are not susceptible to contextual interpretation’.70 The challenge that persisted is that without a greater, intrinsic (or normative), motivation for responsible compliance the ‘substantial demand from clients for tax avoidance schemes’71 remained. B.  The 2012 Tax Scandals Against this backdrop it is perhaps not surprising that we return to the 2012 tax scandals, which were the subject of the PAC inquiry discussed in Chapter 1 and that were the catalyst for regulatory reform.72 It is instructive to look at some of the detail of these structures, which highlight not only the artificiality of the arrangements (helping to explain the public outcry towards them) but also how corporate groups utilise the privilege of incorporation to reduce their tax liability in this way. Indeed, these structures go a significant way to demonstrating the ongoing practice of what Lord Hodge described as the ‘immense intellectual firepower, which has been expended by tax advisers on the development and marketing of sophisticated avoidance schemes comprising a contrived series of transactions which have no purpose other than to save tax’.73 At the time of the 2012 scandals, public attention focussed on the use of two structures. First, the use of ‘inversions’ and, secondly, the colloquially entitled ‘Double Irish,’ which often also incorporated a ‘Dutch Sandwich.’ An inversion typically involves the acquisition of a new parent company by an existing

69 P Stainforth ‘Interview: Aaronson on the progress of the GAAR study,’ Tax Journal 15 July 2011. 70 Graham Aaronson QC, ‘GAAR Study, A Study to Consider Whether a General Anti-Avoidance Rule Should be Introduced into the UK Tax System,’ 11 November 2011, para 3.20. 71 M Truman, ‘So long,’ Taxation 3 March 2015, 3. 72 Including the General Anti-Abuse Rule discussed in Section III of this chapter. The Google, Amazon and Starbucks structures were the subject of media attention although it should be made clear that these structures have been utilised for many years. For a summary of such activity see J Voget, ‘Relocation of Headquarters and International Taxation,’ (2011) 95 Journal of Public Economics 1067. The reform activities included the General Anti-Abuse Rule discussed in Section III of this chapter. 73 Lord Hodge, ‘The RFC case, tax avoidance schemes and statutory interpretation: offside goals, yellow cards and own goals,’ Edinburgh Tax Network Annual Lecture Parliament House, 14 December 2017, 2.

Loopholes in the Law: A Focus on Tax Avoidance  31 c­ orporate group. Crucially, this new entity is situated in a tax haven74 or other such lower tax jurisdiction, whilst the former parent company (now a subsidiary of the new parent) remains in its original jurisdiction of operation, for example the US. Following the inversion, the group seeks to ‘shift’ as much of its profits to the lower tax territory, regardless of where the activity giving rise to the profit actually occurred. The consequence of the inversion is that the group’s operations continue largely as before (often with the management team remaining in situ) but the taxable gains (if any) are relocated to a low-tax jurisdiction, effectively reducing the tax base in the jurisdiction in which the gain was arguably made. The so-called Double Irish scheme involved the implementation of a complex and artificial75 corporate structure that utilised both the low tax rate in Ireland together with the fact that (at the time) Irish tax law stipulated that a corporation is resident for tax purposes in the jurisdiction that it is ‘managed and controlled’, not where it is incorporated.76 In brief,77 the scheme operated as follows. Two companies were incorporated in Ireland, although one was managed and controlled (and therefore taxed, if at all) in a tax haven. This offshore entity held the legal title to the groups’ intellectual property rights that it then licensed (for meaningful consideration) to the second company, which was tax resident in Ireland. The taxable income that the Irish resident entity generated from the use of the intellectual property was reduced by the tax-deductible consideration that it paid to the offshore entity, with any remaining profit being taxed at the lower rate of Irish corporation tax (lower in comparison to that levied in its ‘true’ jurisdiction of operation). The fiscal impact of the Double Irish scheme could then be further increased (namely, tax further reduced) by the insertion of a ‘Dutch Sandwich.’ That is, the group could incorporate a Dutch entity that was used to take advantage of Ireland’s Double Taxation Treaty with the Netherlands, meaning that the Irish company did not pay tax on payments made to its Dutch counterpart.78 As such, when the tax resident Irish company generated a profit, it paid this by way of a royalty, supported by the requisite 74 The OECD sets out four characteristics of a tax haven: (i) low or nominal taxes; (ii) a lack of transparency; (iii) the existence of laws or practices that hinder the exchange of information with other jurisdictions for tax purposes; and (iv) the absence of a requirement for activity to be substantial in that jurisdiction. See OECD, ‘Tax Haven Criteria’ https://web.archive.org/web/20120512074208/ http://www.oecd.org/document/63/0,3343,en_2649_37427_30575447_1_1_1_37427,00.html (accessed 9 August 2020). 75 Artificial in the sense that the primary objective of the structure was arguably tax avoidance, rather than a genuine commercial purpose. 76 In response to international pressure, and with effect from 1 January 2015 (subject to a transition period for existing corporations until 2020), Ireland’s Finance Act 2014 has now introduced reform that requires all Irish incorporated companies to be tax resident in Ireland. 77 For a more detailed analysis of the mechanics of the ‘Double Irish Dutch Sandwich’ structure, see A Quiquerez, ‘Intellectual Property Holding Companies: an International Perspective,’ (2013) 4 Intellectual Property Quarterly 303, 331–337. 78 Double tax treaties are designed to avoid an international transaction being taxed in every jurisdiction that it engages with.

32  Creative Compliance in Practice legal and ownership structure, to a Dutch company within the organisation. This Dutch shell company then relied upon favourable Dutch tax laws to pass on the royalty to the ‘offshore’ Irish company, where it paid little or no tax on the funds transferred.79 Both the use of inversions and the Double Irish Dutch Sandwich involved technically compliant, and legally effective, transactions. Nevertheless, the perceived manifest unfairness of large corporations being able to so clearly undermine the intention (or spirit) of the legislation in this way resulted in widespread public and parliamentary censure. By implementing these artificial structures, large corporate groups were able to gain the benefit of the resources, know-how and institutions of a particular jurisdiction whilst avoiding the concomitant ‘moral’ obligation to pay taxes to that jurisdiction. The tax avoidance structures that were the subject of the PAC inquiry do, of course, have a considerable fiscal impact. In the year of the PAC investigation the UK tax-gap, that is the difference between the tax ‘due’ and that collected, was estimated at £3.1 billion for tax ‘avoidance’ structures and £4.5 billion attributable to ‘legal interpretation’.80 However, the indirect and non-fiscal consequences of creative compliance are also critical. The scandals were another reason (if any were needed) to increase public distrust in large corporates. They fuelled the sense that a capitalist market economy was inherently unfair, serving only to increase financial and regulatory inequality whilst undermining the integrity of the system as a whole.81 Moreover, the scandals demonstrated in stark and uncompromising terms that the modern corporation understood its compliance obligations to be ones of mere legality, nothing more, regardless of the broader consequences. Indeed, as we saw in Chapter 1, Eric Schmidt was clear that ‘what we are doing is legal’,82 and that he was ‘very proud’83 of the company’s approach, whilst claiming a likely fiduciary responsibility to shareholders to act in this way.84

79 An analysis of the financial and policy repercussions of these structures, drawing specifically on those adopted by Google, Amazon and Starbucks, is set out in Part 1 of the Public Accounts Committee – Nineteenth Report, ‘HM Revenue and Customs: Annual Report and Accounts,’ 3 December 2012 www.publications.parliament.uk/pa/cm201213/cmselect/cmpubacc/716/71602.htm (accessed 9 August 2020). Note in para 10 of Pt 1 that Google maintained that ‘it minimised tax within the letter of the law’. 80 See HM Revenue & Customs, ‘Measuring Tax Gaps 2014 Edition: Tax Gap Estimates for 2012–13,’ 16 October 2014. 81 KA Clausing, The Effect of Profit Shifting on the Corporate Tax Base in the United States and Beyond (June 17, 2016). Available at SSRN: https://ssrn.com/abstract=2685442. 82 G Topham, ‘Google’s Eric Schmidt: change British Law and we’d pay more tax,’ The Guardian (27 May 2013) www.theguardian.com/technology/2013/may/27/google-eric-schmidt-change-law-tax (accessed 9 August 2020). 83 ‘Google’s Tax Avoidance is Called Capitalism, Says Chairman Eric Schmidt,’ The Telegraph (12 December 2012) www.telegraph.co.uk/technology/google/9739039/Googles-tax-avoidance-iscalled-capitalism-says-chairman-Eric-Schmidt.html (accessed 9 August 2020). 84 A perspective that is disputed in ch 7.

The (Current) Limitations of Legislation  33 III.  THE (CURRENT) LIMITATIONS OF LEGISLATION

In response to the widespread condemnation of the 2012 tax avoidance structures, and in an effort to bolster the legislative gaps that remained despite judicial moves towards an anti-avoidance doctrine, the UK introduced the GAAR. A GAAR had long been discussed in the UK but it was the 2012 scandals that proved to be the catalyst for adoption, with the rule coming into force on 17 July 2013.85 Perhaps explaining part of the reason for the delay, the GAAR was a significant move away from the UK’s traditional policy towards tax avoidance, which historically introduced targeted legislation to close down specific, undesirable, structures. The rationale for this approach is understandable. Tax avoidance is a highly contentious area and, as we have seen, is typically considered in a literal and formalistic way. Against this context it is not surprising that the government prioritised legal certainty over broader concerns of equity. However, the shortcomings of this legislative approach are similarly clear. Given that creative compliance is a practice that ‘thrives [upon] bright line rules’86 the consequence of this regulatory strategy become immediately apparent. What emerged was a cycle of behaviour whereby creative tax structures would be closed down by a detailed regulatory response, only for a new scheme to be adopted once specialists had designed a structure to circumvent the latest set of reforms. These new schemes would then be met with further regulation, which would again be responded to with the development of new structures, and so the cycle ­continued. In an effort to avoid this, by now familiar, regulatory cycle, the GAAR was designed to have a general and preventative effect, namely to discourage the adoption of ‘abusive tax arrangements’ by counteracting (effectively nullifying) the tax benefit that they would otherwise confer.87 That is, the repercussion of breaching the GAAR as originally implemented was simply to remove the artificial tax gain that the structure sought to achieve; it did not include a punitive element. More recently, in recognition of the limitation of this approach (discussed further below), a punitive element has now been introduced.88 However, for the reasons discussed in Chapter 4, without broader change the GAAR penalty is, on its own, unlikely to motivate a more responsible conception of compliance. The GAAR defines a ‘tax arrangement’ as an arrangement in respect of which it would be ‘reasonable to conclude that the obtaining of a tax advantage was the main purpose, or one of the main purposes’ of the structure concerned.89 85 The Inland Revenue published a GAAR consultation in 1998. See Inland Revenue Press Notice 127/98, 5 October 1998. 86 McBarnet ‘Financial Engineering or Legal Engineering?’ (n 4), 79. 87 Finance Act 2013, s 206. 88 Equal to 60% of the tax due. Finance Act 2016, s 158. 89 Finance Act 2013, s 207(1).

34  Creative Compliance in Practice Such an arrangement is ‘abusive’ if it ‘cannot reasonably be regarded as a reasonable course of action’90 (the so-called ‘double reasonableness’ test) having regard to, inter alia, the underlying policy objectives of the relevant regulatory provision.91 Thus, the GAAR seeks to change traditional standards of compliance, as enshrined in the Duke of Westminster decision, by replacing them with a broader, more spirited construction that prohibits both illegal and abusive structures. Given that the usual time period for understanding the impact of tax legislation can be as long as ten years,92 the GAAR is still in its relative infancy (the first ruling of the GAAR Panel was given in 2017 with its second in 2019).93 As such, we are not fully able to assess how it will fare in reaching its objectives. However, several indicators suggest an element of scepticism. Historically, single-issue regulation (such as SOX), passed without substantial change to the wider context that corporations operate within have had a limited impact on changing corporate behaviour regarding the complex issue of corporate compliance.94 As Chapter 1 explained (and Chapter 3 explores in more detail), compliance is a social construct, informed by a range of environmental factors (industry, market and cultural norms for example), and is rarely motivated by a targeted legislative requirement.95 The consequence of this is that if we do not address the norms that define ‘compliance’, a discrete regulatory intervention such as the GAAR is unlikely to achieve meaningful change. Indeed, the somewhat paradoxical implications of failing to amend a corporation’s intrinsic definition of ‘compliance’ is clear. Without wider conceptual reform, the GAAR is itself susceptible to the technical compliance practices it is trying to prevent. The relatively small number of Panel rulings (to date only 15 opinions have been published)96 and the perceived need to introduce the GAAR penalty suggest that this scepticism of the GAAR’s impact is well-founded. However, whilst this scepticism is borne, in part, from previous experience this is not the only basis for cynicism. Rather, when looking at the structure of the GAAR itself we see three potential, although arguably unavoidable, limitations to its success.97 First, notwithstanding the apparent breadth of the GAAR’s application to ‘abusive tax arrangements’, on closer analysis it does not necessarily apply to 90 ibid, s 207(2). 91 ibid, s 207(2)(a). 92 See H Self, ‘Do we Still need a GAAR?’ Tax Journal 2 September 2016. 93 A Seely, Tax Avoidance: A General Anti-Abuse Rule, Commons Briefing Paper (Number 6265) 4 February 2020, 48. 94 Notwithstanding the significant provisions introduced by SOX, subsequent corporate scandals (such as those outlined in this chapter) indicate that it failed to achieve the wholesale behavioural change that was necessary to curtail such corporate practices moving forward. 95 L Edelman, S Petterson, E Chambliss and H Erlanger, ‘Legal Ambiguity and the Politics of Compliance: Affirmative Action Officers’ Dilemma,’ (1991) 13(1) Law and Policy 73, 74. 96 GAAR Panel opinions are published online: www.gov.uk/government/collections/tax-avoidancegeneral-anti-abuse-rule-gaar#gaar-advisory-panel-opinions. 97 For a wider discussion as to the challenges of anti-abuse rules see D Weisbach, ‘Ten Truths About Tax Shelters,’ (2002) 55(2) Tax Law Review 215, 247–251.

The (Current) Limitations of Legislation  35 the intra-group, international schemes that gave rise to its introduction. In its original guidance on the GAAR, HMRC acknowledged that the mere fact that a transaction benefits from a double tax treaty does not mean it constitutes ‘abusive’ conduct. To fall within the remit of the GAAR, the transaction would need to exploit particular provisions of the tax treaty, or its interaction with UK tax law, in a way that ‘could not have been intended’98 by the UK and its counterparty. This is a seemingly reasonable approach to adopt on the face of the regulation. However, it will be recalled that this is the very type of activity that the Double Irish Dutch Sandwich structure engaged, such that the HMRC’s own guidance on the GAAR acknowledged, perhaps surprisingly, that ‘many cases of the sort which generated a great deal of media and Parliamentary debate in the months leading up to the enactment of the GAAR cannot be dealt with by the GAAR’.99 This, combined with the double-reasonableness test, which is expressly stated to act as a taxpayer safeguard, is likely to operate to reduce the number of large corporate structures that are caught by the GAAR. The limited scope of the rule therefore goes some way to explaining the lack of enforcement action to date,100 reflected in the description by the then Shadow Exchequer Secretary that the GAAR was ‘disappointingly narrow’.101 This limitation, arguably the product of trying to balance (and some have suggested favour)102 taxpayer certainty with broader efforts to mitigate abuse, gives rise to the second difficulty inherent within the text of the rule. That is, the GAAR fails to make a sufficiently unequivocal admonishment of creative tax structures. As shall be seen in Chapter 3, attempts to reconceptualise corporate compliance standards are operating against powerful norms that support (and legitimise) narrow compliance definitions. One important element in changing this perception (although by no means the only one) is harnessing the expressive (or symbolic) function of law to make a clear statement as to the normative wrong of creative compliance.103 The introduction of a punitive element will go some way to strengthen the expressive function of the GAAR. However, the penalty of 60 per cent was less than the 100 per cent argued for by the opposition

98 HM Revenue & Customs, General Anti Abuse Rule (GAAR) Guidance – Part D (30 January 2015), para D12: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_ data/file/602421/HMRC_GAAR_Guidance_Part_D_-_with_effect_from_30_January_2015.pdf (accessed 9 August 2020). 99 HM Revenue & Customs, General Anti Abuse Rule (GAAR) Guidance (30 January 2015), (‘GAAR Guidance’) para B5.2: https://assets.publishing.service.gov.uk/government/uploads/system/ uploads/attachment_data/file/602420/HMRC_GAAR_Guidance_Parts_A_B_and_C_-_with_ effect_from_30_January_2015.pdf (accessed 9 August 2020). 100 As to the intentions of the double reasonableness test, see GAAR Guidance (n 99), paras B12 and C5.10.3. 101 Catherine McKinnell, HC Deb 13 September 2012, c 525. 102 Jolyon Maugham QC, ‘Tax Avoidance – Game Over?’ ICAEW Hardman Lecture, ICAEW Tac Faculty 12 November 2014. 103 On the expressive function of law more generally see C Sunstein, ‘On the Expressive Function of Law,’ (1996) 144 University of Pennsylvania Law Review 2021.

36  Creative Compliance in Practice party, and will need to be balanced against the perceived risk of prosecution.104 At this stage, even with the additional penalty, there is little to suggest that the GAAR will change the current perception of tax compliance as a mere costbenefit analysis. If the GAAR had adopted a more robust prohibition on corporate structures this would have gone further in changing the social meaning of acceptable compliance and therefore the standing against which abusive structures would be judged.105 One relatively recent example of the success of such an approach is the UK Bribery Act 2010. The Bribery Act 2010 received significant (and global) early success in changing corporate attitudes to anti-corruption initiatives by adopting a zero tolerance approach to bribery (combined with significant penalties for breach).106 It is clear that bribery is, normatively, viewed as a different category of behaviour to tax avoidance, which it could be argued explains the widespread engagement with the Bribery Act 2010. However, it must be noted that bribery has always been illegal in the UK and thankfully never considered to be ‘ethical’ conduct (even before the 2010 Act).107 Nevertheless, the Bribery Act 2010 had a significant impact on corporate practice and, in particular, supply chain management (thereby extending its reach considerably). In this way, it appears that the unequivocal stance of the Bribery Act, its breadth of application and consequences for breach (all of which are lacking from or, at best, not as significant within, the GAAR) generated a swift and significant behavioural response.108 In contrast to the Bribery Act, the GAAR has failed to instil, in the

104 In August 2016 the government released a consultation seeking to impose a significant punitive sanction on professionals that advise upon such abusive tax structures, see HM Revenue & Customs, Strengthening Tax Avoidance Sanctions and Deterrents: A Discussion Document, Consultation Document (17 August 2016), paras 2.15 and 2.16. This is a welcome development that should limit certain incidents of aggressive tax planning. 105 Sunstein, ‘Expressive Function’ (n 103), 2022. Note that in this context, the existence of a punitive sanction is valuable in harnessing the expressive function of the regulation. As discussed in ch 4, the mere existence of a severe punishment is not in itself sufficient to engender material changes to compliance behaviour. 106 Bribery Act 2010, ss 7 and 11. When considering the Bribery Act 2010 it is prudent to note the importance of enforcement decisions when examining the expressive function of law. The early success of the Bribery Act 2010 is starting to be potentially undermined by the relative lack of enforcement decisions taken to date and the introduction of Deferred Prosecution Agreements (pursuant to Sch 17, Crime and Courts Act 2013). For a more detailed discussion of the Bribery Act 2010 see A Donovan, ‘Systems and Controls in Anti-Bribery and Corruption’ in HY Chiu and M McKee (eds), The Legal Framework for Corporate Governance in Banks and Financial Institutions in the UK (Edward Elgar Publishing Limited, 2014). 107 Anti-corruption legislation included: the Sale of Offices Act 1551; the Sale of Offices Act 1809; the Public Bodies Corrupt Practices Act 1889; the Prevention of Corruption Act 1906; the Prevention of Corruption Act 1916; Honours (Prevention of Abuses) Act 1925; Licensing Act 1964, s 178; Criminal Law Act 1967, s 5; Local Government Act 1972, s 117(2); Customs and Excise Management Act 1979, s 15; Representation of the People Act 1983, ss 107, 109 and 111–115; and, more recently, the Anti-Terrorism, Crime and Security Act 2001 (ss 108–110). 108 The importance of a significant sanction to this book is its impact on the normative perception of breach. However, the GAAR’s initial lack of punitive sanction (and then relatively low penalty) means that it is also unlikely to be effective in the current normative environment, which views

The (Current) Limitations of Legislation  37 mind of corporations at least, the view that tax avoidance is a normative wrong that should be prevented. The final structural challenge with meeting the GAAR’s objective is the perennial problem of regulatory design. In this regard, the GAAR eschews ‘command and control’109 style regulation and instead adopts a ‘New ­Governance’110 technique of principles-based regulation. That is, it prohibits ‘abusive arrangements’ rather than engaging in a prescriptive rules-based approach.111 The use of this regulatory technique is not surprising. Principles-based regulation aligns with the rhetoric of the current compliance debate and, in particular, the need for more responsible corporate behaviour.112 More than this, it is the optimum regulatory design to ‘minimize the scope for creative compliance’,113 which as we saw in Chapter 1 is a practice that manipulates bright line rules to undermine the spirit of regulation (Enron’s use of the 3 per cent rule being a case in point).114 However, whilst principles-based regulation may be the correct regulatory design to adopt,115 there nevertheless remains a significant and, perhaps ­unavoidable, challenge to the efficacy of this design strategy in the long term. compliance as a mere pricing exercise. On which see C Williams, ‘Corporate Compliance with the Law in the Era of Efficiency,’ (1997) 76 North Carolina Law Review 1265, 1286–1287. 109 Command and control style regulation being the use of ‘detailed rules backed by criminal sanctions overseen by a government agency’. See J Black, ‘Paradoxes and Failures: “New Governance” Techniques and the Financial Crisis’ (2012) 75 Modern Law Review 1037, 1041. 110 There is no single agreed definition of ‘new-governance’. However, it is generally accepted that it embraces regulatory design that has moved away from traditional command and control style regulation to a more nuanced approach that often engages both private and public actors to achieve regulatory objectives, see R Weber, ‘New Governance, Financial Regulation, and Challenges to Legitimacy: The Example of the Internal Models Approach to Capital Adequacy Regulation’ (2010) 62 Administrative Law Review 783, 836. In this way it seeks to ‘offer a third way vision between unregulated markets and top-down government controls’, see O Lobel, ‘New Governance as Regulatory Governance,’ (2012) San Diego Legal Studies Paper No 12-101, 3. Examples of new governance techniques include principles-based regulation and meta-regulation (where regulators require corporations to develop their own systems for compliance). On this see Black, ‘Paradoxes and Failures’ (n 109). 111 Kaplow explains the distinction between a rule and a principle (or standard) as follows: ‘a rule may entail an advance determination of what is permissible, leaving only factual issues for the adjudicator … A standard may entail leaving both specification of what conduct is permissible and factual issues for the adjudicator.’ See L Kaplow, ‘Rules Versus Standards: an Economic Analysis’ (1992) 42(3) Duke Law Journal 557, 560. In offering this definition, Kaplow provides the example of the difference between a rule that requires a driver to keep within a speed limit of 55 miles per hour and a principle that prohibits ‘excessive’ speed. 112 For a broader discussion of the rhetoric of principles-based regulation see J Black, ‘Forms and Paradoxes of Principles Based Regulation,’ (2008) 3(4) Capital Markets Law Journal 425, 430–432. 113 ibid, 438. 114 Lord Justice Diplock observed that not only are tax transactions that come before the courts not envisaged by the relevant regulation but that they were indeed ‘devised as a result of it’, see Lord Justice Diplock, ‘The Courts as Legislators,’ Presidential Address to the Holdsworth Club, University of Birmingham 1965, 6 www.kessler.co.uk/wp-content/uploads/2012/05/CourtsAsLegistlators. pdf (accessed 9 August 2020). 115 Although note that it is unlikely that a regulatory system will rely upon a single approach to design. See CL Ford, ‘New Governance, Compliance and Principles-Based Securities Regulation,’ (2008) 45(1) American Business Law Journal 1, 8.

38  Creative Compliance in Practice Pending judicial or other relevant determination, principles-based regulation can be seen (by those subject to it) to lack legitimacy on the basis of its uncertainty.116 In due course, this certainty is achieved as the broad principles are interpreted either by the courts, advising counsel or enforcement agencies and it is here that we see the long-term difficulty with this type of regulatory design. That is, over time the principle eventually becomes narrowed to ‘congeal around a particular meaning’.117 This gives rise to the paradox of interpretation recognised by Julia Black, namely that broad principles, designed to give flexibility, are nevertheless capable of detailed interpretation.118 In effect, this congruence of rules and principles, means that after a while the principle exists only ‘at the formal level’119 whilst in practice the regulation is effectively comprised of clear rules that remain susceptible to the creative compliance processes that they were designed to avoid.120 Against these inevitable regulatory challenges, even when adopting a more principles-based approach, the importance of trust in the regulatory system, and the approach to regulatory gap-filling adopted by legal subjects, starts to emerge. Julia Black observes that a successful principles-based regime is dependent on a ‘high level of trust between all the participants in the regulatory regime’.121 Specifically, for principles-based regulation to work ‘firms need to be concerned to go beyond minimal compliance’122 and that without this trust, the regulation ‘will never be operationalised’.123 The difficulty facing the GAAR is that one of the significant consequences of creative compliance (discussed in Chapter 4) is that it undermines not only the trust between the regulator and regulatee, but also as between regulatees inter se. Despite these difficulties, it is important to appreciate that principles-based regulation has one significant benefit. That is, it facilitates the continued revaluation by a corporation of their ‘understanding of compliance’124 making it susceptible to changing social norms. Harnessed in the right way, this gives the GAAR the capability to reduce creative compliance practices, provided such social norms are supportive of spirited compliance. However, to utilise this potential what is crucial, and reflecting the central claim of this book, is that we

116 Black, ‘Forms and Paradoxes’ (n 112), 426. 117 Ford, ‘New Governance’ (n 115), 9. As to this convergence of rules and principles more generally, see F Schauer, ‘The Convergence of Rules and Standards,’ (2003) New Zealand Law Review 303. 118 Black ‘Forms and Paradoxes’ (n 112), 446. 119 ibid, 447. 120 Indeed, this could be seen in practice with the response to the Ramsay decision. Initially feared to prohibit any transaction without a genuine commercial purpose, the ‘big four’ accounting firms quickly established structures that circumvented and survived the decision’s seemingly broad application. 121 Black, ‘Forms and Paradoxes’ (n 112), 456. 122 ibid, 427. 123 ibid, 456. 124 Ford, ‘New Governance’ (n 115), 28.

Conclusion  39 establish the requisite norms and supporting framework to encourage a broad definition of compliance and legitimise efforts to constrain creative compliance. Thus, whilst Hector Sants (acting in his former capacity as the Chief Executive Office of the then Financial Services Authority) was arguably being somewhat facetious when he said that a ‘principles-based approach does not work with people who have no principles’,125 there is some merit to this observation. We need to change the frame of reference that corporations both operate, and define compliance, within for the GAAR to be a success.126 That is, to move ethical compliance from being rule (or principle) governed to norm governed.127 IV. CONCLUSION

Tax avoidance has proven to be a seemingly intractable problem to resolve. Even against the backdrop of increasingly purposive approaches to legislative interpretation and the introduction of a general anti-abuse rule, corporations persist with artificial, yet lucrative, creative compliance practices. The continued focus on the symptoms of creative compliance, rather than its cause, has meant that we have yet to meaningfully curtail the fundamental challenge of how compliance is defined and understood by legal subjects. The problem of creative compliance is, in part, one of legislative gap-filling. These gaps will always remain, whether regulations are complex and targeted (like the UK’s early responses to tax avoidance) or adopt a broader approach like the GAAR. As we continue to see, corporations are proving resistant to even the most sophisticated of regulatory designs, meaning that these gaps (and indeed express statutory language) are defined in reductive and profit maximising terms. The challenge we face is not necessarily more regulation, but a better understanding of the root cause of why, and therefore how best to address, the reductive approach to compliance that seemingly pervades the corporate community. As has been noted elsewhere, ‘the existence of widespread tax avoidance is evidence that the system, not the taxpayer, stands in need of reform’.128 To undertake this holistic review, we need to return to the root cause of the problem. That is, why do corporations have such latitude to interpret compliance in the way that they do and what does that process of construction tell us about the current crisis? The next chapter answers these questions by exploring

125 A Townshend, ‘Hector Sants says bankers should be “very frightened” of the FSA’ The Telegraph 12 March 2009 www.telegraph.co.uk/finance/newsbysector/banksandfinance/4978496/ Hector-Sants-says-bankers-should-be-very-frightened-of-the-FSA.html (accessed 9 August 2020). 126 Edelman, ‘To Comply or Not to Comply’ (n 8), 105. 127 Michael, ‘Business Ethics’ (n 34), 8. 128 Malcolm Gammie QC, The Draft Finance Bill 2013: Oral and Written Evidence, 13 March 2013, 114 citing the Royal Commission on the Taxation of Profits and Income Final Report, Cmd 9474 June 1955.

40  Creative Compliance in Practice compliance as a social construct, how this has enabled such a reductive definition to emerge and the process by which this definition can rapidly become institutionalised across the corporate community. In doing so, this enquiry provides a foundation for the rest of the book, distilling those elements of the corporate environment that require further analysis if we are to fully understand the reasons for the compliance crisis and why it has proven to be such an intractable problem to resolve.

3 Constructing Compliance: Freedom to Choose? There can be a serious obstacle to freedom in the fact that individual choices are a function of social norms, social meanings and social roles, which individual agents may deplore, and over which individual agents have little or no control.1 Cass Sunstein

T

he 2012 tax scandals (and associated efforts at reform) revealed a pressing need to return to first principles, none more so than to the very definition of compliance itself. The debates surrounding the PAC investigation, as well as the PAC exchanges themselves, exposed a striking discrepancy between expectations of what ‘compliance with the law’ actually meant (or should mean), with opinions divided as to whether the tax structures in question were ‘evil’ or ‘ingenious’. Yet, how has such a seemingly straightforward concept as legal compliance proven not only to be this illusory but capable of such widely different, yet equally entrenched, points of view? Moreover, what does the process of defining compliance tell us about the current crisis and possible avenues for reform? Ostensibly, we can attribute this discrepancy in definition to the apparent freedom that individuals have to interpret what compliance might mean in any given situation. The concept of compliance is, after all, an ambiguous one. There is no general rule to refer to that specifies whether to ‘comply’ with the law requires compliance with its letter or its spirit.2 However, whilst there is indeed a relative latitude for interpretation, if we explore the process of construction in more detail, we see that a number of important (and challenging) questions emerge as to the extent to which an individual can truly be described as free to choose the definition (and standard) of compliance that they adopt in a corporate environment. In particular, and as this chapter explores, we see the powerful and pervasive impact that social (including corporate) norms play in shaping a person’s definition of compliance, raising complex questions as to individual freedom and accountability. The answers to these questions then raise similarly challenging questions as to the regulatory responsibility, if any, for mitigating these norm-driven behaviours and concerns.3

1 CR

Sunstein, ‘Social Norms and Social Roles’ (1996) 96(4) Columbia Law Review 903, 910. 6 suggests that the rule of law provides a framework for answering this question. 3 See Sunstein, ‘Social norms,’ (n 1) 907 and discussion at footnote 11. 2 Chapter

42  Constructing Compliance: Freedom to Choose? This chapter begins by exploring the nature of compliance as a social construct. Whilst there are many facets to social constructionism, Section I focuses on the process by which a person defines and gives meaning to a concept such as compliance.4 In doing so, it shows how a particular construction of a term can rapidly become legitimised (the importance of which is considered further in Chapter 4), habitualised and ultimately institutionalised within a particular community. Whilst understanding the impact of norms in this way highlights the scale of the challenge in reforming deeply held, and often entrenched, views it is nonetheless reassuring. It shows how the current construction of compliance, which is undertaken through a profit maximising and reductive lens, is not an inevitable state of affairs but is, if given due reflection, capable of reconstruction. Against this overview, Section II then explores the nature of norms and the depth of their influence in more detail. The word ‘norm’ is an often used, but not always defined, term and there is a risk that its increasingly colloquial usage belies the critical and instrumental role that norms play in society. As such, Section II considers the definition of social norms (both descriptive and injunctive) and their function in shaping not only a citizen’s definition of compliance but, crucially, how they also ascribe meaning to it. Building on this general discussion, Section III examines the nature of corporate norms more specifically. It explores how shareholder wealth maximisation has emerged as a dominant norm within the corporate environment, the legitimacy of which is perceived to be reinforced by the legal system itself, imbuing it with a particularly symbolic (or expressive) force.5 The salience of this norm has an acute behavioural impact (considered in this chapter and the next), operating as both a descriptive and injunctive norm making it exceptionally difficult to challenge. It is for this reason that, as we have seen with reform efforts such as the GAAR, norm divergence (and therefore normative and social change) has, to date, proven to be extremely difficult and rare. Concluding the substantive parts of the chapter, Section IV draws the discussion of the function of norms together and returns to the question of freedom, itself a central theme of this book. It explores the powerful impact of norms on individual choice and behaviour, raising the question as to what extent can an individual be said to truly ‘choose’ a particular construction of compliance? Drawing on Cass Sunstein’s work, this section introduces the conceptual foundations for the empirical studies considered in the next chapter, explaining how norms underpin individuals’ seemingly economically irrational decisions. In closing, Section IV considers how we might seek to change social norms as a mechanism for reforming how constructs such as compliance are defined.6 4 I Hacking, The Social Construction of What? (Cambridge University Press, 1999).1–3. On social constructionism more generally, see PL Berger and T Luckmann, The Social Construction of Reality, A Treatise in the Sociology of Knowledge (Anchor Books, 1966). 5 As to the expressive function of law, see Sunstein’s seminal work: CR Sunstein, ‘On the ­Expressive Function of Law,’ (1996) 144 University of Pennsylvania Law Review 2021. 6 Sunstein, ‘Social norms’ (n 1), 930.

The Social Construction of (Creative) Compliance  43 I.  THE SOCIAL CONSTRUCTION OF (CREATIVE) COMPLIANCE

How we interpret a concept such as compliance can have profound consequences. It influences how we behave, how we judge the actions of others and how we define our responsibilities to society and its institutions. Understanding this process of construction is not therefore an exercise in mere semantics but a critical step in reflecting upon the causes of the compliance crisis and informing our views as to the relative responsibilities for it. In particular, if (as this chapter suggests) our construction of compliance is, at least in part, the product of influences that are beyond our control, what are the implications of this for personal liability and regulatory policy? To build the foundations for this analysis, the following sections explore the process of ‘social constructionism’.7 That is, the way in which society ascribes meaning to concepts such as money, law and, as a corollary, compliance with those laws. In doing so, we start to see the instrumental role that social norms play in shaping our definition of compliance and, as a consequence, why creative compliance has proven to be such a seeminlgy intractable problem to resolve. Nonetheless, and somewhat reassuringly, it is this understanding that also provides important insights into how we can approach structuring potential avenues for effective reform. A.  Social Constructionism: Driving Divergent Definitions Unlike a building or physical object that can be observed, described and objectively verified, ‘compliance’ is an abstract concept. It does not have an incontrovertible meaning that simply needs to be discovered, rather it requires legal subjects to navigate its ambiguity, defining what the legitimate boundaries of compliance might be in any given situation.8 In this way, compliance is a social construct, a concept that acquires its meaning from (or, as we shall see, is given its meaning by) those engaging with it. On the face of it, this exercise in interpretation seems to afford a legal subject significant freedom to ‘influence the meaning of compliance to suit [their] own priorities’,9 and, to a degree, this is true. However, if we explore this process of social construction in more detail, 7 This chapter cannot do justice to the many contours of the social constructionism debate and the literature on social constructionism is vast. However, for a useful and engaging introduction see Hacking, The Social Construction (n 4). 8 This interpretive exercise is particularly acute when looking at principles-based regulation such as the GAAR. Here, regulation is necessary (and rightly) open-textured to encourage reflexive engagement with regulatory objectives in an effort to encourage broader behavioural change and avoid the pitfalls and relative ineffectiveness of a more command and control style approach (see ch 2 for a more detailed discussion of the GAAR and the regulatory principles underpinning it). 9 C Parker and VL Nielsen, ‘Introduction’ in C Parker and VL Nielsen (eds) Explaining ­Compliance Business Responses to Regulation (Edward Elgar 2011), 15. As we have already seen, this interpretation does not always align with regulatory intent.

44  Constructing Compliance: Freedom to Choose? we can start to see that far from being the product of unbridled free choice, a person’s determination of compliance is both informed, and constrained, by the normative environment that they operate within. One point of clarity should be made from the outset, namely that saying creative compliance is a social construct is something of a slight misnomer.10 Rather, a legal subject ‘socially constructs’ compliance, a distinction that might be subtle, but it is important. By separating the legal subject (in our case the corporation) from the object of construction (compliance), we are better placed to visualise the process of interpretation and its implications. In particular, this separation is helpful in emphasising the role and, more specifically, the perspective of the individual in ascribing meaning to a particular concept. Understood in this way, we can start to see how a single object, concept or idea (such as compliance) can be construed differently by different people and, importantly when looking to structure reform, the reasons for this. Namely, that each person undertakes this exercise in construction informed by their own sphere of influence, which is composed of multiple social norms that are themselves contingent on a range of variables (including the relevant social context and any applicable social roles). Against this, we can immediately appreciate that the process of social construction is not an atomised or siloed exercise. In fact, far from it (indeed this is the crux of the issue). Whilst understanding the centrality of the person is critical to anchor the perspective from which a definition is produced, individuals are subject to a wide and diverse range of influences and it follows that concepts such as compliance ‘do not exist in a vacuum’.11 Rather, they are viewed (and therefore defined) through the lens, and subject to the influence, of an individual’s wider normative environment.12 As a consequence, to understand how (and why) a legal subject has defined compliance in a particular way, we need to understand the norms inherent within their environment, or what DiMaggio and Powell describe as their ‘organizational field’.13 These social (or environmental) norms inform our interpretation of concepts such as compliance in a very particular way. They do not simply provide a dictionary definition of a term;14 they attach meaning to it. In doing so they not only act as a guide to our behaviour, but also imbue our actions with an ‘expressive dimension’.15 That is, our actions in and of themselves convey meaning as to our ‘attitudes and commitments’.16 For example, when we think about 10 R Mallon, ‘Naturalistic Approaches to Social Construction’, in EN Zalta (ed) The Stanford Encyclopedia of Philosophy (Spring 2019 Edition), https://plato.stanford.edu/archives/spr2019/ entries/social-construction-naturalistic/ (accessed 9 August 2020). 11 Hacking, The Social Construction (n 4), 10. 12 L Edelman, ‘Legal Environments and Organizational Governance: The Expansion of Due Process in the American Workplace,’ (1990) 95(6) American Journal of Sociology 1401, 1403. 13 PJ DiMaggio and WW Powell, ‘The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields’ (1983) 48 American Sociological Review 147, 148. 14 On which see HLA Hart, Essays in Jurisprudence and Philosophy (Clarendon Paperbacks, 1983), 21. 15 Sunstein, ‘Social norms’ (n 1) 925. 16 ibid.

The Social Construction of (Creative) Compliance  45 paying a ‘tip’ or gratuity to a service provider this is not simply understood as the giving of money to a person performing their job. Rather, our construction of the term delineates when, to whom and how much we tip, attaching meanings to each of these things.17 For example, when we tip our hairdresser this is a positive act that conveys appreciation for their work. In contrast, an attempt to ‘tip’ a police officer leads to entirely different consequences. We can see, therefore, that the meaning that a norm applies to any given concept can rarely be understood in isolation but is often highly context contingent. As well as being context specific, social meaning can change depending on the social role that someone occupies. A person having a glass of wine on a Saturday night with friends will not be met with social disapproval. However, that same person having a glass of wine in their capacity as a primary school teacher whilst on a school field trip will.18 Similarly, we may find that corporate officers described as ‘fat cats’, acting within a perceived ideology of ‘crony capitalism’, working for organisations described as ‘evil’ will ascribe a similar meaning as to the expectations of their conduct. Importantly, and this is explored in more detail in Chapter 4, so too can the regulators that they engage with. By understanding how a person defines a particular concept, we can start to build a better picture of the wider factors that need to be addressed (their social environment, comprising their social norms, context and role), if we want to develop effective policies to encourage a redefinition of that term. As later parts of the chapter discuss, it is this social meaning that also provides the basis for social sanctions, which act as powerful constraints on behaviour that would otherwise deviate from the accepted norm. In some respects, different normative communities (or organisational fields) can share a number of similar norms. For example, there may be widely and commonly held norms concerning the presupposition that a legal system exists, that its framework of rules legitimately demands at least some level of adherence and that the corporation is a recognisable legal actor in its own right.19 However, in other respects, these communities can differ significantly (even within the same jurisdiction). For example, when looking at expectations of corporate purpose, the normative ordering between profit maximisation and ‘ethical’ decision making and the perceived legitimacy of the state to control private decision making. From a compliance perspective, and returning to the question posed at the start of the chapter, we can therefore start to see how different definitions of the same term emerge between social groups. As compliance is the product of social norms, where those norms differ then so too does the corresponding definition. As Berger and Luckmann observed, the reality of a Tibetan monk may differ to that of an American businessperson, whilst similarly (and as we saw in 17 The example is drawn from L Lessig, ‘The Regulation of Social meaning’ (1995) 62 University of Chicago Law Review 943, 952. 18 Sunstein, ‘Social norms’ (n 1) 934. 19 Hart, Essays in Jurisprudence (n 14).

46  Constructing Compliance: Freedom to Choose? Chapter 1), the expectations of compliance by members of the PAC can differ to those held by the executives of a large multinational.20 In contrast to the divergent definitions that can emerge between different communities, when we look within a social group (which embodies a common set of social norms) it is not surprising that we see a singular definition or construction emerge. However, what is interesting about this commonality of meaning, which is considered in more detail in the next section, is how that meaning becomes entrenched and proliferates across group, rendering it exceedingly resilient to reform.21 B.  Intra-Group Convergence: Habitualisation and Isomorphism One consequence of the social construction of compliance is that once a meaning attaches to a concept it is often readily accepted and adopted by the rest of the relevant community. By their very nature, social constructs are ambiguous meaning that when a person (corporate or individual) seeks to understand and define a term they look to their normative environment for guidance (particularly when liability can attach to the wrong conclusion).22 These environments embody a sense of not only what, in the case of compliance, the law means or what ‘best practice’ might look like, but (as we shall in the next section) they convey the expectations, and therefore potential social sanctions, of the relevant community. Returning to our tax examples, legislation might provide a tax deduction for investment in research and development that was intended for arm’s length transactions, but in respect of which some communities develop a norm that accommodates utilising these provisions as part of a manufactured intra-group arrangement. After a corporation has adopted a particular interpretation of compliance, this standard can then become ‘habitualised’.23 That is, having made the decision to adopt a certain construction (and behaviour) this is simply repeated when the corporation is faced with a similar set of circumstances in the future. This replication of behaviour intuitively makes sense. Once a decision to act in a certain way has been made, there is no longer a need to engage in the cognitive tension of deciding how to proceed every time the same set of facts is presented as the normative analysis has already been undertaken. On the contrary, it would actually increase stress to come to a different decision on similar facts in the 20 Berger and Luckmann, The Social Construction (n 4), 2. 21 As Luckmann later observed, social concepts once defined through ‘social interaction … they are again transmitted in interaction’. See T Luckmann, ‘The Communicative Construction of Reality and Sequential Analysis, A Personal Reminiscence’ (2013) 9(2) Qualitative Sociology Review 40, 43. 22 LB Edelman and SA Talesh, ‘To Comply or Not to Comply – That isn’t the Question: How Organizations Construct the Meaning of Compliance,’ in C Parker and VL Nielsen (eds) Explaining Compliance Business Responses to Regulation (Edward Elgar, 2011), 107. 23 Berger and Luckmann, The Social Construction (n 4), 51.

The Social Construction of (Creative) Compliance  47 future due to the cognitive dissonance that this would create. The benefit of this habitualisation, and what makes it so attractive to the individual entity, is clear. It effectively removes the ‘burden’24 of choice and reduces friction by allowing a corporation to default to an agreed construction with minimum effort.25 Once habitualised, a particular construction can, remarkably quickly, become institutionalised across the rest of the organisational field, becoming a norm in and of itself.26 As a practice becomes sufficiently widespread within a given community (or deployed by particularly influential participants within it) its adoption becomes a matter of ‘legitimacy rather than improv[ing] performance’.27 In effect, the construct (such as creative compliance) becomes ‘sanctioned’28 by the group, graduating from an indication of, or guide to, permissible behaviour to becoming an accepted baseline or, in some cases, even an expectation. This replication leads to what Meyer and Rowan described as ‘institutional isomorphism’.29 That is, entities within the same organisational field start to model the successful behaviours of others within the group,30 particularly when faced with uncertainties.31 The systemic consequences of this convergence and institutionalisation of behaviours is both clear and profound. Determinations of social constructs, once ambiguous (potentially even questionable), become normatively permissible, and ‘take on a rulelike [sic] status’.32 Once this institutionalisation has occurred, these norms are ‘in some measure beyond the discretion of any individual participant or organization … [and are] … taken for granted as legitimate’.33 In sum, members of a given community are able to define their own social constructs with the consequence, in the case of

24 ibid, 53. 25 ibid, 52. As we shall see in ch 4, this contributes to a self-perpetuating cycle of behaviour, which has been a powerful contributor to the current compliance crisis. 26 ibid, 54. 27 DiMaggio and Powell, ‘The Iron Cage Revisited’ (n 13), 148. 28 ibid. 29 JW Meyer and B Rowan, ‘Institutionalized Organizations: Formal Structure as Myth and ­Ceremony’ (1977) 83(2) American Journal of Sociology 340, 349. See also DiMaggio and Powell, ‘The Iron Cage Revisited’ (n 13), 149, drawing on Hawley’s definition of isomorphism as a ‘constraining process that forces on unit in a population to resemble other units that face the same set of environmental conditions’. A Hawley, ‘Human Ecology’ in DL Sills (ed) International Encyclopedia of the Social Sciences (New York, Macmillan, 1968), 328–7. 30 In this way, other market participants are subject to ‘mimetic’ isomorphism, that is they seek to emulate the successful behaviour of others to address ambiguity. This is in contrast to, although not entirely mutually exclusive from, coercive isomorphism where dominant market actors exert pressure on other organisations to adopt certain behaviours and normative isomorphism used here in a very specific sense to refer to the professionalisation of members of a specific occupation). For a discussion of coercive, mimetic and normative isomorphism see DiMaggio and Powell, ‘The Iron Cage Revisited’ (n 13), 150–4. 31 Note that institutional isomorphism arises for multiple reasons, not merely uncertainty, see: DiMaggio and Powell, ‘The Iron Cage Revisited’ (n 13), note also their discussion on goal uncertainty (at 155). However, uncertainty as a driver of isomorphism is particularly relevant when looking at compliance behaviours. 32 Meyer and Rowan, ‘Institutionalized Organizations’ (n 29), 341. 33 ibid, 344.

48  Constructing Compliance: Freedom to Choose? creative ­compliance, that they can ‘adapt the law to their own interests’,34 effectively creating their own legal standard.35 C.  The Implications of Compliance as a Social Construct Understanding compliance as a social construct (and how it is so constituted) provides two crucial insights into the necessary pathways to change. First, and perhaps reassuringly for advocates of reform, if the current practice of creative compliance is, in part,36 the product of social construction then it follows that this construction is not inevitable or, perhaps more accurately, completely intractable.37 That is, if we change the relevant ‘social practices … social change will automatically follow’.38 Indeed, we have seen how deeply held social views, such as those relating to the risks (or otherwise) of passive smoking, have been subject to rapid and significant change, giving rise to what Sunstein describes as ‘norm cascades’.39 This ability to trigger effective change brings us onto the second insight that social constructionism offers. Namely, that by understanding how a person construes a social concept (so-called idea-constructionism)40 we are better able to identify the levers that need to be engaged to effect reform (including those that can be used as a catalyst for a norm cascade). For example, in the case of compliance, those parts of the normative environment that not only drive a reductive and profit focussed definition of compliance, but do so despite, and oftentimes to the exclusion of, an individual officer’s personal (and potentially conflicting) views.41 In doing so, this analysis starts to illuminate one of the key reasons why compliance reform has, to date, been so challenging. By relying on single issue regulatory reform, the policy response has not yet sufficiently engaged with the multiple factors that converge to shape the root cause of the problem.

34 L Edelman ‘Legal Ambiguity and Symbolic Structures: Organizational Mediation of Civil Rights Law,’ (1992) 97(6) Law and Policy 1531, 1534–1535. 35 Edelman and Talish, ‘To Comply or Not to Comply’ (n 22), 103. 36 The process of definition is only one part of the creative compliance process. Having defined a term, the ‘what’ of compliance, this does not guarantee that a citizen’s actions will follow (the ‘why’ of compliance). The issue of compliance motivation is considered in the next chapter. 37 For a discussion of the relationship between social constructionism and inevitability see E Diaz-Leon, ‘What is Social Construction?’ (2015) 23(4) European Journal of Philosophy 1137. 38 ibid, 1145. 39 Sunstein, ‘Social norms’ (n 1), 909. 40 Diaz-Leon, ‘What is Social Construction?’ (n 37) 1139. 41 This is particularly the case for constitutive social construction, such as ‘compliance’. That is, where the metaphysical possibility of the object in question is not dependent on the construction in question, rather (and in exceptionally high-level terms) where it is only the meaning of the matter at hand that is informed by our social construction of it. See Diaz-Leon, ‘What is Social Construction?’ (n 37), 1145.

The Meaning and Influence of Norms   49 That is, how citizens construe the meaning of compliance and the psychological and behavioural consequences that this gives rise to. One final note of caution should be raised before the following section explores the meaning and function of norms in more detail. There is an understandable risk that discussions of ‘social constructionism’ can give the impression that a socially constructed term is ephemeral, somehow lacking weight or authority. That, either way, it is certainly known by those interpreting it that it is a transient and subjective determination. However, as this section has discussed, the power of norms is such that the truth is, in fact, quite the opposite. Once defined, a social construct and its corresponding meaning, underpinned by the relevant community’s norms, becomes authority for that community,42 embodying a collective reality.43 Indeed, it is this reality that means we accept currency not as pieces of paper but something representing value, why writing is not simply ink marks on a page but something that conveys an agreed upon message and why the very existence of laws that require a discussion of what compliance means are recognised as claims having authority over our behaviour. Thus, once conceived, a social construct although not an objective or verifiable fact, adopts an equivalent status.44 It becomes natural and taken for granted, conveying meaning and becoming an often-automatic driver of, or constraint on, our behaviour. II.  THE MEANING AND INFLUENCE OF NORMS

It is beyond dispute that norms impact our behaviour in powerful and instinctive ways. Indeed, we see it in our everyday lives when we automatically give up our seat on a train if a pregnant passenger boards and raise our hand to cover our mouths when we sneeze. As the previous section explained, it is also how a creative standard of compliance becomes an automatic and default rule, no longer requiring detailed analysis or debate. Norms are, in effect, the rules that we actually live by rather than those that we are asked to live by.45 This section considers how norms function in such a commanding and pervasive way. In doing so, it helps to show not only how norms can shape the initial construction of compliance in narrow and reductive terms but also how they coalesce to act as formidable barriers to reform.

42 Lessig, ‘The Regulation of Social meaning’ (n 17), 947. 43 Luckmann, ‘The Communicative Construction’ (n 21), 44. 44 Berger and Luckmann, The Social Construction (n 4), 19. That ‘traditions and institutions may appear less tangible than buildings and artifacts, but they are equally real,’ see Luckmann, ‘The Communicative Construction’ (n 21), 43. 45 C Bicchieri, The Grammar of Society, The Nature and Dynamics of Social Norms (Cambridge University Press, 2006), ix.

50  Constructing Compliance: Freedom to Choose? A.  Defining ‘Norms’ A ‘norm’ operates in one of two key ways, although both serve to express ‘social attitudes of approval or disapproval’.46 That is, norms both describe a citizen’s conduct (namely, how does behaviour appear to a third person), whilst also answering the question, posed from a first person perspective, why is it that I ought to act in the way in which you are asking?47 In this way norms can be both descriptive (what is) and injunctive (what ought to be).48 The difference between these two definitions is instructive when seeking to understand behavioural choices. The descriptive norm ‘describes what is normal’49 and reflects what ‘most people do’.50 In short, a descriptive norm explains (or indicates) what conduct has occurred and, therefore, by extension, what conduct is considered permissible within that particular environment or organisational field.51 As a consequence, descriptive norms motivate the behaviours of others by communicating the norms and attitudes of the environment in question. In sum, when we observe the conduct of a community, we make judgments as to what is acceptable within that community. As we saw in Section I, for an individual, relying on a descriptive norm as a driver of behaviour is highly attractive (and efficient) as it reduces the cognitive stress that is otherwise involved in deciding what course of conduct to pursue.52 Rather than undertake their own normative analysis, and the attendant risk of coming to the wrong conclusion, an individual can instead effectively outsource this decision by simply replicating the conduct of others within the same social group or environment. In contrast, although often closely related,53 an injunctive norm describes what ought to be done (as opposed to what is done). It is this aspect of the normative environment that we tend to discuss in more everyday conversation. That is, within the relevant community, what is considered the right course of conduct to adopt? What attitude do we want to convey or do we think should be expressed? Put simply, what behaviour do we think we should adopt, notwithstanding the behaviour that is being adopted. It is commonly the injunctive norm that attracts social sanctions when breached,54 most notably the potential judgment of the relevant community (and, as we have seen with recent corporate scandals, those outside of the community when the conduct in question complies with the actor’s group norms but not that of other stakeholders). 46 Sunstein, ‘Social norms’ (n 1), 914. 47 CM Korsgaard, The Sources of Normativity (Cambridge University Press, 1996), 16. 48 RB Cialdini, RR Reno and KA Kallgren, ‘A Focus Theory of Normative Conduct: Recycling the Concept of Norms to Reduce Littering in Public Places,’ (1990) 58(6) Journal of Personality and Social Psychology 1015–1026, 1015. 49 ibid, 1015. 50 ibid. 51 Sunstein, ‘Social norms’ (n 1), 917. 52 Cialdini et al, ‘A Focus Theory’ (n 48), 1015. Although see ch 4 for the consequences that emerge if the norms of our immediate environment when acting in one capacity (eg on behalf of the corporation) do not align with our personal norms. 53 As behaviour that we consider we ought to adopt is often behaviour that we do adopt (ibid.) 54 ibid.

The Meaning and Influence of Norms   51 Importantly, norms are not always as entrenched as we might think and, as we have seen, are capable of surprisingly rapid change. As a consequence, and given that our behaviours are commonly norm driven (both descriptive and injunctive), it stands that by changing social norms we can change the attitudes and behaviours of the citizens subject to those norms. It is for this reason that we have witnessed significant (and often quite quick) attitude changes towards, for example, smoking in public places, equal suffrage and the protection of marriage rights for all.55 In short, if we successfully alter social norms, then we can see a corresponding and significant change in behaviour.56 When looking at how to stimulate this norm change, regulation is certainly one tool that is available to policy makers. However, this is where the importance of understanding the behavioural impact of norms comes to the fore. As we have witnessed with the GAAR, regulatory success (or otherwise) can be heavily influenced by the extent to which the desired change aligns with the wider normative environment (particularly when those norms constrain the standards of compliance that are deemed acceptable). For the reasons that the next sections explain, if the proposed policy change conflicts with the existing community norms (including those enshrined, or perceived to be enshrined, within existing regulation) then the likelihood of achieving the intended behavioural change is significantly reduced. B.  The Behavioural Impact of Norms The importance of norms, particularly injunctive norms, is that they operate as more than mere ethical ideals. Rather, they make a claim on our behaviour, suggesting that we ought to act in a certain manner,57 and are enforced through powerful ‘social sanctions that are, to say the least, pervasive’.58 Indeed, the influence of norms (and the corresponding social sanctions) is such that we respond to them in both ‘practical and psychological ways’.59 That is, the fear of sanction for breaching a norm is so great that it drives (oftentimes automatic) norm-compliant behaviours. In this way, most people refrain from acts of violence, not because it is unlawful, but because they inherently consider it morally wrong. In less extreme examples, we might maintain our property in good condition (notwithstanding that there is no legal mandate to do so) or turn up to the office in a suit and smart shoes (notwithstanding our preference for a tracksuit and trainers), not out of personal preference but because we think it is legitimately expected of us by others. Put starkly, we are willing to expend money on our property, wear more expensive clothes (and certainly less

55 The speed of this change is attributable to what Sunstein describes as a ‘norm cascade,’ see: Sunstein, ‘On the Expressive Function’ (n 5), 2033. 56 Sunstein, ‘Social norms’ (n 1), 910. 57 Korsgaard, The Sources of Normativity (n 47), 8. 58 Sunstein, ‘Social norms’ (n 1), 915. 59 Korsgaard, The Sources of Normativity (n 47), 11.

52  Constructing Compliance: Freedom to Choose? comfortable shoes) not because we intrinsically want to but because we fear (or at least anticipate) the judgment of others if we do not. We can therefore start to see just how powerful the impact of norm-based social sanctions can be, often exceeding that of more formal instruments (where the likelihood of breach, and as a consequence, sanction can be perceived as presenting a far more remote risk). Psychologically, these sanctions operate to constrain our behaviour as norms serve to facilitate judgment (both of others and ourselves) and engender corresponding feelings of shame or embarrassment when behaviours fall outside of the normative framework.60 In doing so, they set the boundaries of what is deemed to be ‘acceptable’ conduct. If an individual transgresses a norm, rightly or wrongly it shapes our interaction with them. Depending on the conduct in question, we may judge them silently (feeling frustrated at those speaking in a library for example), express our dissatisfaction (passively, by staring at those still speaking in the library, or more directly by raising it with them) or, ultimately, even shun them from our social community (ending a friendship, not inviting people to social functions, albeit hopefully for a better reason than talking in a library).61 It is this fear of social sanction that arises when a norm is violated (often manifesting as shame),62 that operates as a powerful ex ante constraint on (or driver of) individual conduct.63 The impact of these feelings should not be underestimated, we have all felt the emotional response of breaking an established group norm and even the anticipation of breach can give rise to surprising behavioural responses. Norms do of course also work in the opposite direction, providing comfort (or encouragement) for behaviour that in a different context (or normative community) might attract social admonishment. For example, corporations can ‘proudly’ adopt aggressive tax structures, confident that they align with the norms of their immediate (if not wider) community, behaviour which clearly attracts criticism in a different social group. Indeed, Chapter 4 returns to the power of group norms when it examines how individuals were willing to provide clearly wrong answers to a very simple test (ostensibly diverging from widely held norms that endorse intelligence and success) simply to align themselves with the observable group norm.64 The fear of social judgment is therefore a powerful tool in the regulator’s toolkit, acting as a powerful motivator to engender change in human behaviour.65 However, the difficulty in utilising this approach to control corporate behaviour is clear. 60 Sunstein, ‘On the Expressive Function’ (n 5), 2032. 61 Korsgaard, The Sources of Normativity (n 47), 11. 62 Sunstein, ‘Social norms’ (n 1), 909. 63 Sunstein, ‘On the Expressive Function’ (n 5), 2030. 64 See the discussion of the Asch perception experiment in ch 4. 65 Sunstein, ‘Social norms’ (n 1), 8. Although shaming is not without its critics, for example the risk of shaming being ‘too’ effective, creating a ‘sub-culture’ of those who have been shamed who are then unable to reintegrate into society. See J Braithwaite, Crime, Shame and ­Reintegration (Cambridge University Press, 1989), 54–68. Also, the risk that shaming does not operate equally across all offenders, see TM Massaro, ‘Shame, Culture and American Criminal Law,’ (1991) 89 Michigan Law Review 1880, 1896. For a summary of common criticisms of shaming, see DA Skeel Jr., ‘Shaming in Corporate Law,’ (2001) 149(6) University of Pennsylvania Law Review 1811, 1817–1819.

The Meaning and Influence of Norms   53 First, the apprehension of social judgment as a sanction is most effective in ‘closeknit communities’66 as this is where any reputational impact will be felt most acutely. However, this is not an environment that large public corporations traditionally inhabit. Second, corporations, as juridical persons, clearly do not feel social sanction (or shame) in the same way that natural citizens do. Whilst there will be an inflection point at which reputational damage might act as a proxy for shame, this is a different psychological trigger. Concerns of corporate reputation align more closely with considerations of sales and investor relations than intrinsic behavioural drivers. Indeed, from human rights abuses to bribery,67 numerous examples exist that demonstrate whilst reputational risk is, of course, a corporate concern it seems insufficient to operate as a meaningful control on everyday corporate behaviour, certainly not in the same way that corresponding feelings of judgment curtail individual conduct.68 Thus, whilst authors such as Skeel outline the ‘tangible ways’69 in which a corporate norm violation can be punished, for example by ‘investors refusing to buy their stock … and consumers may avoid their product’,70 we have seen, all too frequently that in practice that this is not often the case.71 One way in which social sanctions may apply to influence corporate behaviour is for the transgression to be felt so acutely so as to confer individual shame on those natural citizens implementing corporate actions.72 However, for the reasons discussed in Chapter 7, this is a very high threshold to meet. Moreover, shame, and shaming sanctions, only work if they are enforced. The convergence of corporate norms means that, particularly in the case of creative compliance when the impact of the conduct in question is seen to be ‘merely’ financial, the corporate community will often not consider the conduct to be a norm transgression. When looking to shareholders the problem is twofold. If creative compliance furthers a shareholder’s interests, they are unlikely to want to unwind that conduct. Even if they were so motivated, then we run into the usual collective action problems with any type of shareholder activity.73 Thus, we are left with an accountability gap that currently can often only be filled through public enforcement (either by the state or, as with the start of the 2012 66 Skeel, ‘Shaming in Corporate Law’ (n 65), 1811. 67 For example, the alleged human rights violations of retailers such as Gap: G Chamberlain, ‘Gap, M&S and Next in New Sweatshop Scandal,’ The Guardian (8 August 2010) www.theguardian.com/ world/2010/aug/08/gap-next-marks-spencer-sweatshops (accessed 9 August 2020). 68 That is not to say that market pressures are irrelevant when considering corporate normative transgressions. Rather, that the operation of the fiduciary ladder (explained in ch 7) is such that the norm violations do not register in a way so as to act as a behavioural constraint. 69 Skeel, ‘Shaming in Corporate Law’ (n 65), 1823. 70 ibid, 1823. 71 For example, the continued success of Nike, notwithstanding initial consumer outrage at their production practices. See B Wazir, ‘Nike Accused of Tolerating Sweatshops,’ The Guardian 20 May 2001 www.theguardian.com/world/2001/may/20/burhanwazir.theobserver (accessed 9 August 2020). 72 Arguably, it was this individual shame that operated as an effective sanction when (as cited by David Skeel as an example of corporate shame) Robert Monks and Nell Minow took out a full-page advert in the Wall Street Journal ‘shaming the directors of Sears by name’. See Skeel, ‘Shaming in Corporate Law’ (n 65), 1814. 73 Collective action problems are discussed further in ch 7.

54  Constructing Compliance: Freedom to Choose? tax scandals, media attention). Leaving the question of legitimacy to one side, the problem with media scrutiny brings us full circle. Of what effect is a headline for an entity that does not fear (in real terms) social sanctions? This resilience to ‘shame’ does not mean that corporations are immune to the impact of norms. Rather, and as we have seen throughout this book already, it means that the sheer dominance of the wealth maximising norm (discussed in Section III) means that, as a general rule, corporations are extremely resilient to social sanctions derived from a breach of norms other than shareholder wealth maximisation (such as public criticism surrounding the 2012 tax scandals). This resilience (such as that towards the GAAR) can be understood when we consider the factors that dictate the extent of influence that a norm is likely to exert. Sunstein argues that the scope of a norm’s influence depends on five factors: (i) the intensity of the norm; (ii) the nature of the norm, namely what attitude does compliance with or divergence from the norm convey; (iii) the actor’s attitude towards the norm and any censure that its breach/convergence will trigger; (iv) the likelihood of forgiveness amongst the actor’s normative group; and (v) the existence, nature and influence of other factors relevant to the decision (such as conflicting norms).74 Applying these factors to corporate creative compliance, a corporation’s robustness in the face of even global condemnation is perhaps not surprising. Adopting Sunstein’s framework we see that: (i) creative compliance is driven by a highly salient wealth maximising norm; (ii) compliance with that norm suggests a (favourable) marketoriented approach to compliance; (iii) the corporation is, as we have seen, robust against social sanction; (iv) the corporation’s normative group commonly shares a profit maximising norm and are likely to forgive the transgression of spirited compliance in favour of profit; and (v) the dominance of shareholder wealth maximisation is such that there are few conflicting norms of sufficient weight. However, whilst social sanctions do not operate in the same way to influence corporate, in contrast to individual, behaviour they remain vitally important if we are to fully understand how corporations define their compliance obligations. In particular, whilst corporate norms might be less easily triggered to constrain behaviour, they perform a clear permissive function, validating behaviour such as creative compliance that aligns with their demonstrable descriptive norm. Moreover, and as discussed in the next section, when looking at the architecture of reform, these descriptive norms operate as significant barriers to change, necessitating a holistic approach to intervention. One that addresses both existing normative obstacles as well as seeking to introduce new norms and behaviours. C.  The Interaction between Descriptive and Injunctive Norms Whilst it might be a ‘truism’75 that norms influence our behaviour, it is important to understand the different role that different types of norms play in the

74 Sunstein, 75 SE

‘Social norms’ (n 1), 939. Asch, ‘Opinions and Social Pressure,’ (1955) 193(5) Scientific American 31, 31.

The Meaning and Influence of Norms   55 construction process. Doing so allows us to structure more tailored ­policies for reform, either by changing existing norms (and therefore different definitions of compliance) or by supporting new norms through external (­regulatory) means, and the challenge that these efforts at reform face. Of particular importance is the interplay between descriptive and injunctive norms (each as defined in Section I). More specifically, how descriptive norms can impede attempts to ­instrumentalise new or conflicting injunctive norms. In looking to unpack these questions the answer can be found in a somewhat surprising place: litter. To identify how norms influence behaviour Robert Cialdini conducted empirical research into littering (an injunctive norm that does not necessarily correlate to the descriptive one).76 Cialdini and his team wanted to determine the extent to which the salience of a norm, namely how observable it was in practice, influenced an individual’s behaviour. To do this, they monitored individuals as they left a hospital to return to their vehicles parked in an adjacent car park.77 The project was structured so that one half of the research subjects walked past members of the research team who were reading leaflets, which they then discarded (littered) onto the car park floor. The other half of the research subjects were not exposed to any littering. When the research subject reached their own vehicle, it had the same leaflet that the researchers had discarded placed under their windscreen wiper. To test the impact that the descriptive norm (littering) had on an individual’s behaviour, variables to the research exercise included changing the physical condition of the car park so that in some cases the car park was heavily littered and at other times it had been cleaned.78 A further variable included the extent to which the subject’s attention was drawn to the norm in question, for example by including a highly noticeable piece of litter near to the litter pile, or having a member of the research team visibly tidy up litter in front of the research subject. The research identified that in cases where the car park had been littered, 41 per cent of subjects also littered by discarding their own leaflets on the floor. Littering was also more likely when the subject had witnessed littering by others, namely where there was ‘high norm salience’.79 Moreover, when drawing the subject’s attention to the relevant norm (be it the presence or absence of litter, namely either the desirable or undesirable norm), they were more likely to act in accordance with that norm. Cialdini’s findings provide two important insights when thinking about how to influence norm-based behaviour. First, we see that the descriptive (or observable) norms within an environment serve to inform an actor as to the norms of that particular environment and encourage them or, as a minimum grant permission, to act in conformity. Therefore, to change the conduct of someone within a community, it is not enough to simply encourage



76 ibid,

1015–1026. of the experiment are explained in: ibid, 1016–1017. 78 ibid, 1016. 79 ibid, 1017. 77 Details

56  Constructing Compliance: Freedom to Choose? the introduction of new injunctive norms. Rather, we must also address existing and conflicting descriptive (or observable) norms as well. Second, that a norm is more likely to be acted upon when a subject engages with it, namely when their attention is specifically drawn to it.80 However, there is an obvious word of caution that arises when looking at the descriptive, rather than the injunctive norm. Focussing a citizen’s attention on the descriptive norm (here the existing state of the physical environment) is only of social benefit if that norm aligns with desirable behaviour.81 That is, if the car park is not littered or, in the case of tax, if the observable norm is spirited, rather than creative compliance. If we are seeking to change the descriptive norm, then Cialdini’s findings suggest that we need to find ways to make the new norm highly visible.82 Cialdini’s findings provide helpful insights into why creative compliance has seemed so resistant to reform and the techniques that we may adopt to improve compliance standards moving forward. First, we see that the current descriptive normative environment (of shareholder wealth maximisation, which is discussed in Section III) may be impeding the implementation of a new injunctive norm. As shall be seen (and indeed has been clear throughout the previous chapters of this book) shareholder wealth maximisation is a highly salient norm that permeates all aspects of corporate activity, from the corporate objective, to financial incentives and shareholder motivation. The dominance of this norm provides an incredibly robust and resistant environment in which to introduce new and conflicting injunctive norms, necessitating a holistic plan for reform. Second, and as a corollary to the first point, to effectively introduce a new injunctive norm (for example, moving from creative to spirited compliance), we need to increase the salience and visibility of the new norm. We cannot rely on passing regulation and trusting that it will have an impact (particularly if there is a perception of a relatively low level of enforcement risk). Of note is that the influence of this norm salience can be further increased when accompanied by a clear, rather than tacit, expression of approval of the norm (or disapproval of breach). This was tested by Cialdini and his team by adding a variant to their littering experiment. Here they replicated their littering study but this time introduced a variable that, for half of the research subjects, the litter had been swept into piles, indicating disapproval of littering (effectively enhancing the descriptive norm). In this instance, littering fell even further (to 18 per cent in conditions of high norm salience).83 Therefore we start to see that whilst norms clearly do have an impact on individual behaviour, there are ways in which this influence can be increased (without relying directly on social embarrassment or shame, the challenges of

80 Cialdini et al, ‘A Focus Theory’ (n 48), 1015. 81 ibid, 1020. 82 This also challenges the commonly held assumption (and often times over-assumption) as to the extent to which other people within the organisational field are acting in accordance with the descriptive norm. 83 Cialdini et al, ‘A Focus Theory’ (n 48), 1022.

The Homogeneity of Corporate Norms  57 which were discussed above).84 Moreover, for corporate compliance, this a­ nalysis shows that the descriptive (or observable) norms of the environment, namely the prevalence of creative compliance, serve to undermine the influence of any injunctive norms to the contrary (or, more accurately, the attempt to introduce any such contrary norms through instruments such as the GAAR). As a consequence, it is imperative that reform proposals address both the injunctive and descriptive norms if they are to increase their chances of success. III.  THE HOMOGENEITY OF CORPORATE NORMS

Having understood the general function of norms in the process of construction, two immediate questions arise. That is, what specific norms exist in the corporate community (which shape their interpretation of compliance) and how do these emerge? Distilling the norms inherent within a corporation’s immediate environment is arguably a far simpler task than were we to undertake the same exercise for natural citizens. The latter are subject to a range of complex and multifaceted norms, reflecting diverse influences such as religion, education, age and family. In contrast, a corporation’s norms are generally perceived (rightly or wrongly) to coalesce around a dominant norm of shareholder wealth maximisation.85 As this section explores, the influential weight of this norm is not simply the product of its homogeneity but from its perceived endorsement by the company law framework itself. A.  The Expressive Function of Law The law, much like social actions, can be ‘expressive’.86 That is, it carries a meaning so as to postulate a norm and not simply operate as a control on behaviour.87 By mandating that citizens act in a certain way (or indeed refrain from so acting) the law is making a normative statement, expressing a view as to the rights or wrongs of the conduct concerned.88 When the GAAR demands that 84 ibid, 1024. 85 Of course, corporations act by individuals who bring their own norms to the corporate environment. However, as shall be seen in this section and chs 4 and 7, when acting in a corporate context, it is the corporate norms that tend to dominate those of the individual. Indeed, it is quite possible for a group to ‘express attitudes that none of its members have individually’, see ES Anderson and RH Pildes, ‘Expressive Theories of Law: a General Restatement,’ (2000) 148 University of Pennsylvania Law Review 1503, 1518, citing the example of a building association that chooses not to discriminate against a disliked neighbour notwithstanding how all the other residents feel. Here we see a further importance of ascribing norms to a particular role. That is, when acting in their capacity as a board member (for example) a director adopts the norms of that position rather than those that apply in their private domain. 86 Sunstein, ‘On the Expressive Function’ (n 5), 2022. 87 ibid, 2024. 88 Effectively it ‘manifests a state of mind’. See Anderson and Pildes, ‘Expressive Theories of Law’ (n 85), 1506.

58  Constructing Compliance: Freedom to Choose? corporations refrain from implementing ‘abusive’ structures, it is not merely demanding certain behaviour without moral censure. It is also expressing a belief that such structures are unacceptable or, put another way, morally impermissible. Indeed, even the language adopted by the GAAR of ‘abusive’ (rather than, for example, ‘technical’) has expressive import.89 By performing this expressive function, the law makes a public statement of expected standards for all citizens to recognise and interpret.90 As a consequence, social norms can be ‘fortified by … [or] even owe their existence to law’.91 Crucially, when a norm is enshrined in regulation it adopts a particular status of authority, namely that it is the product of a democratic institution that speaks for society and has coercive force.92 In this way, the law expresses the view that the relevant norm is to be regarded as particularly important increasing the likelihood that it will be institutionalised by the relevant community. Moreover, the law serves to provide a hallmark of legitimacy to a particular point of view, especially when that point of view (or norm) is consistently repeated throughout the legislative framework. In this way, the law is able to make a particular norm ‘focal’93 enhancing its symbolic or expressive status and, as we saw with Cialdini’s research, increasing the salience of the norm within a community. Needless to say, the law is also capable of expressing undesirable norms. That is, norms that unintentionally signal roles or functions that lead to damaging behaviour. For example, and considered further in the following section, the law can express that the ‘sole’ objective of the corporation is profit maximisation, justifying the creative compliance standards that are the subject of this research. Importantly, such legal provisions not only express social norms but can cause ‘expressive harm’. That is, the law can convey a message (albeit unintentionally) that a citizen can be, or is, ‘treated according to principles that express negative or inappropriate attitudes’.94 Thus, when the law seemingly enshrines a singular profit maximising norm that applies to corporate conduct it expresses (again, potentially unintentionally) more than simply the state’s view as to the legitimate objective of the firm. Namely, it risks conveying the view that corporations are entitled to pursue profit over broader welfare concerns and that it is legitimate for non-corporate citizens to be subject to that conduct. 89 The same, but opposing, claim can be made of ‘creative compliance’. The moniker itself suggests a view that such practices are clever and normatively acceptable. 90 Anderson and Pildes, Expressive Theories of Law’ (n 85), 1507. 91 Sunstein, ‘Social norms’ (n 1), 920. 92 Further, that ‘legal standards of conduct … influence the social norms of directors, officers, and lawyers’. See EB Rock, ‘Saints and Sinners: How Does Delaware Corporate Law Work?’ (1997) 44 UCLA Lew Review 1009, 1016. Rock goes on to argue that company law provides a set of parables that ‘fill out the normative job description of’ directors and officers (ibid, 1018). This latter observation endorses Sunstein’s view that in addition to social norms, we also have role norms. That is, that we identify certain norms with certain roles, such as lawyers, doctors or teachers. See Sunstein, ‘Social norms’ (n 1), 921. 93 EA Posner, ‘Symbols, Signals, and Social Norms in Politics and the Law,’ (1998) 27(S2) The Journal of Legal Studies 765, 772–3. 94 Anderson and Pildes, ‘Expressive Theories of Law’ (n 85), 1527.

The Homogeneity of Corporate Norms  59 The following section considers this shareholder wealth maximisation norm with a particular focus on section 172 of the Companies Act 2006. It is this expressive function of law that applies not simply to entrench this norm but also to powerfully identify it with the function and the role of the corporation in society.95 B.  The Dominance of the Shareholder Wealth Maximisation Norm The dominant norm enshrined within company law and practice is the paradigm of shareholder wealth maximisation. That is, the perspective that the legitimate (and sole) objective of the corporation should be to promote the success of the company (broadly defined as the ‘long-term increase in value’96 of the company) for the benefit of its members as a whole.97 Were this perspective in doubt, the Company Law Review Steering Group made it clear that, notwithstanding the introduction of the concept of ‘enlightened’ shareholder value, the Companies Act 2006 was nonetheless predicated on (and therefore endorsed), a model of shareholder exclusivity. Namely that the corporation was ‘managed for the benefit of shareholders’98 and simply ‘subject to safeguards’99 for creditors, whilst being bound by disclosure obligations for the benefit of the wider community. As a consequence, the significant reforms introduced by the Companies Act 2006 did little to disrupt the view that the ultimate objective of the corporation was to ‘generate maximum value for shareholders’.100 Rather, when section 172 of the Act (which codified a director’s duty to promote the success of the company) introduced the concept of enlightened shareholder value, it simply provided that in discharging this duty directors should ‘have regard’ to, amongst others, the list of statutory factors (namely, wider interests) set out in section 172. That is, directors should have regard to interests more commonly associated with a stakeholder view of the firm, including those of the community, employees and the environment. The list of statutory factors is not exhaustive and could, quite feasibly, include an obligation to consider the impact of compliance practices on, for example, the local community (by reducing the public purse) and the legitimacy and stability of the legal and market order (by undermining the principle of equality before the law).101 Indeed, this view is strengthened if we recall the j­udicial 95 For a discussion of the identification of certain norms with certain social roles see Sunstein, ‘Social norms’ (n 1), 918. 96 Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 255, cited in Ministerial Statements, Companies Act 2006, Duties of Company Directors, June 2007, 7. https://webarchive. nationalarchives.gov.uk/20090609024504/http://www.berr.gov.uk/files/file40139.pdf (accessed 9 August 2020). 97 Companies Act 2006, s 172. 98 Company Law Review Steering Group, Modern Company Law For a Competitive Economy: The Strategic Framework, (February 1999) para 5.1.4. 99 ibid. 100 ibid, para 5.1.9. 101 See ch 6.

60  Constructing Compliance: Freedom to Choose? observations noted in Chapter 2, namely that a purposive interpretation of tax statutes was not only permissible, but it was surprising that tax law had operated as such a purposive island for so long.102 Nonetheless, for reasons that this chapter explores, section 172 has yet to be fully interpreted by boards in this way. In response to the inevitable criticism as to the uncertainty of how section 172 should be applied (and, in particular, the relative standing of the statutory factors against the primary duty to promote the success of the company), the government released a collection of non-binding ministerial statements that sought to expand upon what was meant by section 172. These statements suggested that ‘have regard to’ should be construed to mean ‘give proper consideration to’103 the statutory factors set out in section 172.104 Returning to the expressive function of law, it is trite to say that a requirement to have ‘proper consideration’ of the statutory factors when discharging the duty to increase shareholder wealth has little, although granted, some, symbolic force. The challenge that exists is the manner in which this duty is interpreted by the board (namely that it remains one of pure, rather than enlightened, shareholder value), which is exacerbated by the lack of obligation to act on any concerns that may be identified once ‘regard’ has been given to the statutory factors. As a result, despite the effort of section 172 to introduce wider considerations into the corporate decision-making process, the Act continues to be seen as one which promotes an uncompromising shareholder wealth maximising norm. This in itself has several important consequences. First, it justifies and legitimises a suite of potentially powerful shareholder rights set out in the Companies Act 2006.105 In particular, it validates the claim that directors owe their fiduciary duties to the company (which, in effect is taken to mean the shareholder body),106 and that shareholders possess the right to remove directors by a simple majority.107 Crucially, this legislative endorsement of shareholder primacy is then reflected in internal incentive structures. As discussed in more detail in Chapter 7, remuneration and rewards packages are linked to firm ‘performance’, which is itself equated with earnings per share. Further, it is shareholders who have the right to enforce a breach of section 172 by way of derivative claim.108 102 See ch 2 Section II A. 103 Lord Goldsmith, Ministerial Statements (n 96), 9. 104 Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598. 105 Companies Act 2006: s 168 (right to remove directors); s 172 (duty to promote the success of the company for the benefit of its members); s 239 (ability to ratify acts of directors); s 260 (derivative claims); ss 302–305 and 338 (convening general meetings); s 314 (power to circulate statements); s 510 (power to remove auditors); s 551 (authorisation of share allotment); s 561 (rights of preemption); and rule 21, The City Code on Takeovers and Mergers (restrictions on frustrating action). The literature on shareholder exclusivity is vast. Key works include: S Bainbridge, ‘In Defense of the Shareholder Wealth Maximization Norm: A Reply to Professor Green,’ (1993) 50 Washington and Lee Law Review 1423; DG Smith, ‘The Shareholder Primacy Norm,’ (1997) 23 Journal of Corporation Law, 277; L Stout, ‘Bad and Not-So-Bad arguments for Shareholder Primacy,’ (2009) 75 Southern Californian Law Review 1189. 106 On this see ch 7. 107 Companies Act 2006, s 168. 108 Companies Act 2006, 260(1).

The Homogeneity of Corporate Norms  61 These practical factors coalesce to mean that when considering how to discharge their obligation to have ‘proper consideration to’ the statutory factors, it is perhaps not surprising that many directors will do so in a manner that is going to satisfy the cohort to whom they are accountable. Thus, when looked at in the round, section 172 did little to intrude upon the widely held view that the polar star of corporate management is the unwavering profit maximisation. From a compliance perspective, this manifestation of shareholder wealth maximisation across the corporate law and governance framework creates a homogenised norm within the corporate community, effectively creating a self-reinforcing normative system (encouraging, and then rewarding, behaviour that furthers the wealth maximising norm).109 This self-perpetuating norm therefore adopts a position of authority, legitimising not only the norm per se but those acts, omissions and regulatory provisions that support it, whilst undermining the legitimacy of those adopting a contrary view.110 One consequence of this is that it starts to embody and legitimise a view that the only role of the corporation is as a pure profit maximising entity, devoid of broader responsibilities and considerations (also contributing to the views of the market that are considered in Chapter 5). We thus start to appreciate why within this environment it becomes increasingly unrealistic to expect corporations to pursue anything other than a ‘pricing’ approach to compliance, notwithstanding the actual breadth of discretion that the Companies Act 2006 grants to directors (which is considered further in Chapter 7). Indeed, it starts to explain the view put forward by Easterbrook and Fischel that ‘managers not only may but also should violate the rules when it is profitable to do so’.111 To be clear, this section is not suggesting that shareholder wealth maximisation (and the consequential provisions in the Act that derive from it) is an objectionable corporate objective per se. As Carroll identified, the corporation has many faces, an important one of which is profit maximisation. Indeed, Chapter 5 explores the benefit that the pursuit of self-interest has for both the individual corporation and for wider society.112 From a functional perspective, this singular objective serves to facilitate the efficiency of corporate decision-making as well as enhance (albeit relatively) corporate accountability.113 Rather, the claim that the book makes is that over the years corporate norms have been interpreted and applied to create

109 For a broader discussion of law as an autopoietic system see G Teubner, Law as an Autopoietic System (Blackwell, Oxford 1993). For a critical discussion of Teubner’s theory, see A Beck, ‘Is Law an Autopoietic System?’ (1994) 14 Oxford Journal of Legal Studies 401. 110 Recall Eric Schmidt’s justification of creative compliance, namely that there was ‘probably some law’ against spirited tax compliance, see ‘Google’s Tax Avoidance is Called “Capitalism,” Says Chairman Eric Schmidt,’ The Telegraph (12 December 2012) www.telegraph.co.uk/technology/google/9739039/Googles-tax-avoidance-is-called-capitalism-says-chairman-Eric-Schmidt.html (accessed 9 August 2020). 111 FH Easterbrook and DR Fischel, ‘Antitrust Suits by Targets of Tender Offers,’ (1982) 80 ­Michigan Law Review 1155, 1177. 112 For a complementary argument see A Carroll, ‘The Four Faces of Corporate Citizenship,’ (1998)100(1) Business and Society Review, 1. 113 S Bainbridge, ‘Director Primacy: The Means and Ends of Corporate Governance,’ (2002) 97 Northwestern University Law Review 547, 557–558.

62  Constructing Compliance: Freedom to Choose? an erroneous ‘focal point’,114 endorsing an unyielding commitment to this norm. Instead, this work suggests there is a legitimate basis within the current legal framework to constrain the harmful expressive and normative effects of how this norm is currently (and narrowly) being construed. IV.  THE FUNCTION OF NORMS: FREE TO CHOOSE?

The preceding parts of the chapter explored the process of construction that legal subjects adopt to determine their compliance obligations. In doing so, it becomes clear that a critical determinant of this social construction, and the behaviours that ensue, are the norms inherent within a subject’s environment. Indeed, these norms are so powerful that not only do they ascribe meaning to our actions but can automate them, legitimising behaviours that are normcompliant and sanctioning those that are not social sanctions. This part draws those discussions together to consider a question of fundamental importance in the legal arena. Namely to what extent can a person be said to have freedom of choice over their behaviour if it is dictated in this way? Is there, as Sunstein observed, a ‘serious obstacle to freedom in the fact that individual choices are a function of social norms, social meanings and social roles, which individual agents may deplore, and over which individual agents have little or no control’?115 A.  Norms and Freedom of Choice: Taxes and Subsidies We have seen how norms operate to apply a social meaning to a person’s acts or omissions. Our conduct is not simply a neutral act, normatively speaking, but conveys a message about who we are. It is from this social meaning that social sanctions can be applied, giving rise to either opprobrium or acceptance. Put another way, and to use Sunstein’s taxonomy, norms operate so as to impose ‘taxes or subsidies’.116 Thus, when deciding to act, one important factor (conscious or otherwise) is the normative tax or subsidy that is likely to arise as a result. As we start to understand the function of norms in society, and the extent to which they operate as a driver of, or constraint on, individual behaviour, this necessarily raises questions about the reality and extent of freedom that an individual truly has to define a term such as compliance. As Sunstein notes, the freedom that we consider an individual has in this context depends on whether we are concerned with the technical ability to choose (notionally we could diverge from the norm) or the reasons underpinning any such choice.117 Technically, we can choose not to work for a corporation if we disagree with its 114 RH McAdams, The Expressive Powers of Law, Theories and Limits (Harvard University Press, 2015), 7. 115 Sunstein, ‘Social norms’ (n 1), 910. 116 ibid. 117 ibid, 932.

The Function of Norms: Free to Choose?  63 ‘corporate ideology’ but, in reality, for most of us that is not a feasible option. Technically, as an individual we can refuse to implement the strictly lawful instructions of our employer if we don’t agree with them but, for reasons explored in more detail in Chapter 4, for most of us that is not a ­feasible option. Technically, corporations can choose to adopt spirited c­ ompliance standards but, as we are witnessing, for most of them that is not proving to be a feasible option. It is here that we start to see complex and challenging questions emerge. If we consider an individual’s freedom to be curtailed by the powerful influence of social norms, some of which are derived from the legal system itself, to what extent can (or should) we hold that person responsible for their decisions? Alternatively, and perhaps more legitimately, to what extent is (or should) the state be responsible for mitigate those harmful norms? B.  Influencing Norms to Influence Behaviour Changing a dominant norm is not an easy task. As we saw, efforts to introduce a new injunctive norm are likely to be of limited effect without a change in the descriptive norm or some other trigger event. An associated challenge is that norms are ‘commonly based on beliefs about relevant facts’.118 Whilst smoking is seen as ‘cool’ teenagers will still do it, if littering is not seen as a ‘big deal’ then people continue to drop their rubbish. In contrast, once passive smoking was understood to cause serious medical harm, smokers respected the ban on smoking in public places and significant social censure arises in the event of breach.119 The speed and breadth of normative (and therefore behavioural) change regarding smoking was significant, demonstrating a highly efficient method of ‘norm management’.120 That is, one effective way to change a norm is to change the beliefs that are attached to the facts surrounding, or associated with, the norm. Returning to smoking is a useful example. It was not that long ago that people could smoke in hospitals, airplanes and offices. Today, such behaviour is unheard of and unimaginable to those who were not born at that time, primarily because of the change in our understanding of the harm caused by the activity in question. Thus, to change a social construction, we need to change the underlying norm (at scale to address the collective action issues that would otherwise arise) and the beliefs associated with it. As the smoking example shows, one valuable technique for doing this is to change a person’s understanding of the harm (or lack thereof) associated with the norm in question. This is particularly important in cases such as creative compliance where the dominant descriptive norm is not only incredibly salient but runs counter to the objective of reform (namely less profitable spirited compliance). Disrupting such a long-held, and singular, belief is not an easy or straightforward task. However, Chapters 5 and 6 offer

118 ibid,

930. 911. 120 ibid, 907. 119 ibid,

64  Constructing Compliance: Freedom to Choose? a basis for doing so by demonstrating the damage that creative compliance can cause to both the market order (Chapter 5) and the rule of law (Chapter 6). Not only does this help to show the systemic harm caused by creative compliance but it should act as a salient warning of both the risk and consequences of further reactionary regulation if creative compliance is not meaningfully curtailed. There is one other way of expediting change, which is to appeal to people’s natural tendency towards conformity (as seen when looking at the institutionalisation of norms earlier in the chapter). Research has shown that people ‘are willing to cooperate, and hence to solve collective action problems without coercion, if most people are seen as co-operators’.121 Indeed this was replicated in the Cialdini experiments were the observation of other people clearing the litter prompted non-littering behaviour in the research subjects. Appealing to this sense of collegiality and cooperation (whilst challenging the view that ‘everyone’ is creatively complying) is a useful component of what will need to be a holistic and varied toolkit of reform if we are to effectively challenge creative compliance behaviours that align with the current, highly salient, and dominant descriptive norm. V. CONCLUSION

This chapter has examined the influences that shape how corporations define compliance, in particular how the impact of pervasive corporate norms support a reductive and profit-maximising construction. Recognising the power and influence of norms provides important, instrumental, insights into the path forward and those aspects of the corporate community that we need to understand if we are to structure an effective toolkit for reform. In this way, this chapter helps to highlight the roadmap for the rest of the book, demonstrating the critical need to take a holistic view of the organisational field that corporations operate within, from market ideology to the very architecture of the firm itself, if we are to truly understand the barriers to reform. However, before we turn to that exercise there is one final aspect of the current landscape that we need to consider. That is, having explored how corporations define compliance we also need to understand what motivates them to comply (or otherwise) with the law. The definition of a term does not necessarily guarantee that we act accordingly. Moreover, whilst corporate norms might drive a profit-driven definition, the corporation does necessarily act through human officers. This raises the question of how their, arguably more complex norms, factor into the corporate decision making framework and the implications that this has on the motivation to implement corporate compliance strategies. As such, in concluding the book’s analysis of the current context to the compliance crisis, the following chapter explores what it is that motivates people to comply with the law, including the added layers of complexity that need to be considered when considering this question in a corporate setting.

121 Sunstein,

‘Social norms’ (n 1), 945.

4 Motivating Compliance: Freedom to Act? a theory of legal behaviour must be multiple; legal acts work on the minds of subjects in various ways … First there are sanctions – threats and promises. Second, there is the influence, positive or negative, of the social world: the peer group. Third there are internal values: conscience and related attitudes, the sense of what is and is not legitimate and what is or is not worthy to be obeyed. Each of these factors is itself complex1 Lawrence Friedman All other things equal, most [business people] would unhesitatingly choose the high road. But, except in hypothetical situations, all other things are never equal. And we often see that factors with more motivational punch – sales quotas, corporate financial health and survival, competitive concerns, career advancement – outweigh ethical choices in business decisions.2 Robert B Cialdini

O

ne aspect of Google’s response to the PAC investigation that was particularly striking was just how zealous it was.3 Rather than simply defend their use of the tax structures (discussed in Chapter 2) on the basis of their legality, the company’s officers were emphatic in their justification of the decisions that had been made. The schemes were not simply lawful, but executives were ‘very proud’4 of the arrangements in question. Indeed, despite the increasing, and intense, global controversy surrounding the practice, it was argued that not only had the company done nothing wrong but, on the contrary, implementing the schemes was ‘absolutely’5 the right thing to do. There was, it 1 L Friedman, The Legal System: A Social Sciences Perspective (Russell Sage Foundation, 1975), 69. 2 RB Cialdini, ‘Social Influence and the Triple Tumor Structure of Organizational Dishonesty’ in DM Messick and AE Tenbrunsel (eds) Codes of Conduct: Behavioral Research into Business Ethics (Russell Sage Foundation, 1996), 51. 3 See ch 1. 4 N Kumar and O Wright, ‘Google boss: I’m very proud of our tax avoidance scheme’ The Independent (13 December 2012) www.independent.co.uk/news/uk/home-news/google-bossim-very-proud-of-our-tax-avoidance-scheme-8411974.html (accessed 8 August 2020). 5 S Cao, ‘Ex-Google CEO Eric Schmidt Defends Tax Dodging, Monopoly in New Hardball Interview’ Observer (15 May 2019) https://observer.com/2019/05/ex-google-ceo-eric-schmidt-defendstax-dodging-monopoly-bbc-interview/ (accessed 9 August 2020).

66  Motivating Compliance: Freedom to Act? would appear, an eagerness not merely to defend, but to rationalise and justify, the compliance strategy that had been adopted. On the one hand, this approach is not surprising. The company was facing international condemnation and no one would expect it to equivocate in its response to an investigation such as this. Yet, on the other, when in the same year, individual taxpayers were found to have engaged in similarly creative schemes their responses were entirely different, with the comedian Jimmy Carr acknowledging a ‘terrible error of judgment’.6 But why such a difference in response and what does this tell us about taxpayer motivation? The answer is more instructive about corporate compliance practices, and their resistance to reform, than may at first seem. In particular, it sheds light on the surprisingly powerful psychological drivers and compensatory responses that shape, legitimise and ultimately entrench a corporate culture of creative compliance. As shall be seen, it is this legitimation (and ultimate habitualisation) of creative compliance that acts as a significant barrier to reform and it is here that we need to focus our efforts if we are to achieve meaningful progress towards a more spirited interpretation of corporate compliance responsibility. To fully understand this interaction between compliance decisions and the psychological processes that underpin them, it is first necessary to reflect on the factors that motivate people to comply (or otherwise) with the law. As such, this chapter begins by considering traditional, but somewhat limited, deterrencebased explanations of compliance, which suggest that it is simply a fear of sanction the promotes legal obedience. In looking at this orthodox approach, Section I recognises that whilst an ongoing role for deterrence-based sanctions does remain (and that exploring our historic experience with this model provides valuable lessons to help improve the modern regulatory relationship), taken in isolation it is unable to engender the transition towards spirited compliance that is being called for. Rather, and as Section II explores, a more accurate explanation of people’s compliance behaviours is grounded in notions of legitimacy (specifically, perceptions concerning the existence and exercise of power by enforcement authorities). By moving beyond a purely instrumental approach, to incorporate sociological and psychological considerations (amongst others), legitimacy theory helps to provide a more accurate framework in which to recognise the complexities of what motivates compliance and understand why people behave in the way that they do. As a consequence, whilst economic theories (such as the deterrence model) suggest that legal subjects are entirely rational actors, a legitimacy-based approach recognises that, in reality, citizens (both corporate and human) can make decidedly irrational compliance decisions. The theories considered in Sections I and II are helpful in highlighting the factors that shape an individual’s compliance behaviour, but they can stop short in offering a complete explanation of corporate compliance. To fully 6 ‘Comedian Jimmy Carr, I’ve Made a Terrible Error of Judgment’ BBC News www.bbc.co.uk/ news/uk-politics-18531008 (21 June 2012) (accessed 9 August 2020).

Deterrence-Based Compliance: Motivating ‘Amoral Calculators’  67 understand corporate compliance behaviours, we need to take into account the consequences that arise from the fact that, in contrast to individuals, corporate decision-making involves multiple parties. In particular, that a decision is made by one party (often the board or senior management, who are themselves subject to dominant corporate norms) but implemented by another (management or mid- and junior-level employees). This separation of decision and execution can, as Section III explains, result in the psychological triggers and compensatory responses referred to earlier that operate to entrench a culture of reductive decision making. This understanding is critical if we are to rethink our approach to a hitherto intransigent compliance problem. Without it, we risk continuing to explain (and respond to) corporate behaviour simply as the product of a singular profit maximising norm, whilst failing to address how this norm gets embedded to such a degree that is supersedes individual preferences. This not only belies the complexities that often underpin corporate conduct but also potential avenues for more sustainable and effective reform. In contrast, by examining the interplay between legitimacy, the mechanics of corporate decision-making and the behavioural consequences of this, we are then better placed to model the corporate compliance process and understand the challenges of reform to date. With this in mind, Section IV introduces what I call the ‘compliance degeneration cycle’. The compliance degeneration cycle draws on the analyses in Chapters 3 and 4 to provide insights into why creative compliance has become an almost self-perpetuating practice, whilst showing where in the decisionmaking cycle reform needs to be targeted for maximum effect. Subsequent chapters then use this model as a foundation to explore these issues in more detail. I.  DETERRENCE-BASED COMPLIANCE: MOTIVATING ‘AMORAL CALCULATORS’

Traditionally, the dominant explanation for why corporations obey the law (or not, as the case may be), has been a purely economic one. At its most ­fundamental,7 this instrumental, deterrence-based, approach views all legal subjects as homo economicus, or rational actors, who will comply with regulation only when it is profitable (or utility) maximising for them to do so.8 Returning to the ­question of tax compliance, this model suggests that a rational taxpayer will comply with tax regulation only if the probability of conviction is low, or the penalty for breach 7 The early development of the deterrence model was based on four key assumptions. First, that corporations are fully informed utility maximisers, second that legislation is clear and unambiguous, third that legal punishment is the primary incentive for compliance and finally that enforcement agencies adequately prosecute breaches. For a more detailed discussion of these see JT Sholz, ‘Enforcement Policy and Corporate Misconduct: The Changing Perspective of Deterrence Theory,’ (1997) 60(3) Law and Contemporary Problems 253, 254. 8 MG Allingham and A Sandmo, ‘Income Tax Evasion: A Theoretical Analysis,’ (1972) 1 Journal of Public Economics 323.

68  Motivating Compliance: Freedom to Act? does not sufficiently outweigh the possible gain.9 Seen in this way, motivation is simply, and consistently, the product of a binary cost-benefit analysis. This section explores this orthodox approach to compliance and its relationship with the dominant, and by now familiar, construction of corporate and capitalist market ideology. In doing so, it suggests that a deterrence-based model does not fully account for taxpayer behaviour and that it is necessary to look to a more holistic theory to better understand taxpayer motivation. Nonetheless, that does not mean that this approach is entirely without value. On the contrary, it provides helpful insights into the matters that we should be cognisant of when looking to structure an effective approach to reform, including the nature of the regulatory relationship itself. A.  It’s Called Capitalism … Again The claim that corporate compliance decisions are motivated solely by unbiased, economic, factors is undeniably compelling. Corporations are artificial legal constructs and it could be argued that they are the epitome of a rational actor. Freed from concerns of shame and solidarity, corporations famously have ‘no soul to damn’10 and are ‘rationalistic, amoral and unsentimental’11 entities. They are, quite simply, unconstrained in their pursuit of self-interest, with considerations of the common good and free riding12 being ignored in favour of entirely individualistic decision making. This image of the self-interested decision-maker is reinforced by a return to the stereotypes and rhetoric of market ideology. When discussing regulatory strategy, we see the characterisation of corporations ‘in a liberal capitalist society [as] nothing but vehicles for profit-maximisation’.13 Moreover, even if corporations wanted to pursue a primary commitment to social responsibility then this, it has been suggested, ignores the very ‘nature of the existing economic system’.14 Very few would deny that corporations are imbued with a 9 This approach applies Becker’s ‘economics of crime’ model that offered ‘economic analysis to develop optimal public and private policies to combat illegal behavior’, see G Becker, ‘Crime and Punishment an Economic Approach,’ in G Becker and W Landes (eds) Essays in the Economics of Crime and Punishment (National Bureau of Economic Research, 1974), 43. Becker’s model incor­ porates, inter alia, the view that ‘an increase in a person’s probability of conviction or punishment … would generally decrease … the number of offenses he commits’ and that a ‘person commits an offense if the expected utility to him exceeds the utility he could get by using his time and other resources at other activities’ 9. 10 J Coffee, ‘“No Soul to Damn: no Body to Kick”: An Unscandalized Inquiry into the Problem of Corporate Punishment,’ (1980) 79 Michigan Law Review 386. 11 E Sutherland, White-Collar Crime: The Uncut Version (Yale University Press, 1983), 237. 12 M Olson, The Logic of Collective Action (Harvard University Press, 1965). 13 HJ Glasbeek, ‘The Corporate Social Responsibility Movement – The Latest in Maginot Lines to Save Capitalism,’ (1988) 11(2) Dalhousie Law Journal 363, 367 (at fn 17). 14 F Pearce and S Tombs, ‘Ideology, Hegemony, and Empiricism’ (1990) 30(4) British Journal of Criminology 423, 424.

Deterrence-Based Compliance: Motivating ‘Amoral Calculators’  69 profit-maximising norm, one that is further endorsed by the legal, commercial and market environments that they operate within. Indeed, Chapter 3 explored the strength of this norm more fully.15 However, the challenge raised by this book is whether this narrow interpretation of a corporation’s objective, and its perceived alignment with fundamental market principles, is correct. If not, the implications of obscuring the arguably more complex and nuanced motivations underpinning compliance practices are significant. From a behavioural perspective, a critical problem with this somewhat myopic understanding of the corporation is that it has a considerable impact on regulatory policy and design, risking several unintended consequences. If corporate decisions are perceived to be the product of an entirely rational, economic analysis, driven by a singular and unwavering profit maximising norm then it follows that regulation should be structured accordingly. That is, traditional deterrence models are correct and all that is needed to increase compliance with a given requirement is to increase the visibility, likelihood and cost of breach.16 Applying this reasoning, provided it is rigorously enforced (and that enforcement actions are sufficiently publicised to the market), the introduction of the GAAR penalty should yield results.17 However, whilst this deterrence-based approach to legal obedience (or otherwise) is attractive for its conceptual clarity, it faces two key problems, both of which are explored further below. First, the fact that it does not fully explain the compliance decisions that corporations actually make, which for reasons that we shall come on to are far more nuanced than this traditional model suggests. Second, to the extent that the model is theoretically effective, it suffers from several, significant, practical limitations. In particular, it can drive behaviours that risk damaging the quality of the regulatory relationship, which in turn can undermine the quality of compliance practices. This is quite aside from the perennial funding challenge that deterrence models face. Namely, that, most governments lack the resources necessary to implement an effective deterrence strategy, which is dependent on robust (and resource heavy) oversight and enforcement for success. B.  Explanatory Limitations of a Deterrence-Based Approach A deterrence-based model of compliance faces one, fairly fundamental (some might say fatal), challenge. That is, it does not fully explain taxpayer behaviour. On the 15 A view that is supported, in part, by the size of the global tax advisory services market, which has an estimated value of $34.4 billion. See Source Global Research, The Global Tax Advisory Market 2019, (December 2019). This figure does not of course relate solely to ‘abusive’ or aggressive tax advice. However, it does indicate the rise of specialist advice in navigating the increasingly complex regulatory environment. 16 B Torgler, ‘Tax Morale and Compliance, Review of Evidence and Case Studies for Europe’ (2011) The World Bank Policy Research Working Paper 5922, 3. 17 What is needed to enhance compliance is simply to adopt ‘a more punitive regulatory approach’. See Pearce and Tombs, ‘Ideology’ (n 14), 436. See ch 2 for a more detail discussion of the GAAR reforms.

70  Motivating Compliance: Freedom to Act? contrary, if it was an accurate explanation as to why people obey the law, then there should in fact be more instances of tax avoidance.18 Research demonstrates that, on the whole, the likelihood of detection and the severity of sanction for tax evasion and avoidance has, traditionally, been quite low.19 In which case, when applying a deterrence-based (or instrumental) model of compliance ‘the puzzle of tax compliance is that most people continue to pay’20 taxes, not that they evade them. This anomaly between economic explanations of compliance and actual taxpayer behaviour was recognised by Dwenger et al in their empirical study looking at the legal obligation to pay Church taxes in Germany.21 Their research found that a significant proportion of individuals complied with the obligation to pay, despite the fact that that it was widely known that the Church would not enforce its claim in the event of avoidance or evasion.22 The deterrence baseline was, in effect, zero. In this environment, if the decision to comply was premised solely on an economic calculation a decision to avoid (or even evade) tax would be entirely rational and we would expect to see a significant amount of non-payment. However, the high levels of compliance suggested the existence of other factors that were operating to constrain purely opportunistic (or, in the language of an economic model, rational) behaviour. One immediate response to Dwenger’s study is that it focuses on individual compliance behaviour within a closely held community (although it is noteworthy that many of the taxpayers did not actively attend Church services).23 However, we also see examples where, similarly, corporations do not creatively comply even though it would be economically beneficial to do so (and in circumstances when the likelihood of sanction was low).24 In their review of empirical studies examining corporate compliance practices across a range of sectors Kagan and Sholz found little structural correlation (for example in firm profitability) to explain why some firms would violate regulations, whilst others would comply.25 Rather, and in a reflection of Dwenger’s findings, their work revealed that it was ‘managerial attitudes toward the particular regulation or agency in question’26 that was determinative, ‘rather than (or in addition to) purely economic calculations’.27 18 See J Alm, I Sanchez, and A de Juan, ‘Economic and Non-economic Factors in Tax ­Compliance,’ (1995) 48(1) KYKLOS 1, 2; Torgler, ‘Tax Morale’ (n 16). 19 Alm et al, ‘Economic and Non-economic’ (n 18), 1. 20 J Alm, G McClelland and W Shulze, ‘Why do People Pay Taxes?’ (1992) 48 Journal of Public Economics 21. 21 N Dwenger, H Kleven, I Rasul, and J Rincke, ‘Extrinsic and Intrinsic Motivations for Tax Compliance: Evidence from a Field Experiment in Germany,’ (2016) 8(3) American Economic Journal: Economic Policy 203. 22 ibid, 3. Thereby mitigating a sense of religious obligation to pay. 23 For more on this discussion, see Pearce and Tombs, ‘Ideology’ (n 14). 24 R Kagan, Regulatory Justice: Implementing a Wage-Price Freeze (New York Russell Sage ­Foundation, 1978). 25 R Kagan and J Scholz, ‘The “Criminology of the Corporation” and Regulatory Enforcement Strategies’ in Blankenburg and Lenk (eds) Organisation und Recht. Jahrbuch für Rechtssoziologie und Rechtstheorie vol 7 (VE Verlag für Sozialwissenschaften, 1980) 357. 26 ibid, 358. 27 ibid.

Deterrence-Based Compliance: Motivating ‘Amoral Calculators’  71 We therefore start to see two important, but related, themes emerge. First, that the perception of individual managers as to what constitutes a legitimate compliance standard is critical. Second, that it is not only a manager’s perception of the regulation in question that is relevant but also their view of, and relationship with, the applicable enforcement authority. As will be seen in Section II, both factors are significant when considering legitimacy-based models of compliance. C.  Regulatory Relationships and Practical Challenges Relying on a purely deterrence-based approach to compliance can also give rise to several unintended consequences, not least the impact it has on the regulatory relationship. How we characterise any regulated entity can, consciously or otherwise, influence the tenor of the relationship between a regulator and regulatee. Perhaps unsurprisingly, when corporations are viewed simply as ­ ‘amoral calculators’, or indeed as ‘evil’, this creates the risk that regulators will treat them as such, resulting in a rigid enforcement culture.28 However, as shall be seen, the behavioural impact of this framing of the regulatory relationship is not limited to the regulator. Rather, it operates to narrow attitudes on both sides of the regulatory divide, with the risk that this can trigger the very behaviours that the authorities are seeking to discourage. In contrast, as Murphy’s empirical work on tax compliance showed, the more a regulator demonstrated trustworthy behaviours towards investors, in this case the Australian Taxation Office, the greater the trust that investors had in the regulator.29 Indeed, it is becoming increasingly clear that the nature of the relationship between corporations and the relevant enforcement authorities is not merely a ‘nice to have’ but it has an instrumental impact on compliance behaviours. Research demonstrates that where the regulatory relationship is adversarial in nature, it can result in a formalistic approach to enforcement, reduce the opportunity for collaborative or cooperative compliance and, ironically, risks ‘legalistic counter measures’30 by regulated entities. These counter measures can manifest in socially and institutionally damaging behaviours, such as an unwillingness to provide voluntary disclosures31 and the replacement of a trained safety engineer as the lead of an accident prevention programme with a lawyer.32 In these cases, far from supporting the achievement of regulatory objectives, the adoption of a deterrence model (without wider contextual considerations) was a catalyst for moving corporate actions away from them. This emergence of regulatory

28 ibid, 359, with the discussion of ‘amoral calculators’ at 357. 29 K Murphy, ‘The Role of Trust in Nurturing Compliance: A Study of Accused Tax Avoiders,’ (2004) 28(2) Law and Human Behaviour 187, 203. 30 Kagan and Scholz, ‘Criminology of the Corporation’ (n 25), 359. 31 ibid. 32 ibid, 360.

72  Motivating Compliance: Freedom to Act? trust is a particularly valuable policy tool for one fundamentally practical reason (beyond its instrumental benefit). That is, and as Murphy recognised, it is a variable that is within the regulator’s sphere of influence and control meaning that it can be readily (and efficiently) explored as a basis for effective reform.33 Beyond this relational concern, deterrence-based models face a very stark and very real practical problem. Namely, a lack of resources. To be effective, economic models rely on the assumption that penalties will be sufficiently severe and that ‘enforcement agents optimally detect and punish misbehaviour’.34 Indeed, it is the monitoring aspect of sanctions-based approaches that have proven to be the most salient in achieving behavioural change. Research analysing the effectiveness of Occupational Safety and Health Administration regulation in the US found that regular and thorough inspections can have a greater impact than penalties.35 However, very few (if any) enforcement authorities have adequate funding to monitor and enforce all compliance breaches. If proof beyond the well-publicised pressures on public resources were needed, one commentator observed that ASIC’s36 estimate of the resources needed to effectively monitor all regulated entities revealed ‘in very brutal terms … there is at present no realistic prospect of developing anything approaching a regular surveillance or inspection programme’.37 This does, of course, leave to one side the secondary question of whether, even if the requisite resources were available, we would want them to be deployed in this way. This issue of enforcement serves to highlight one final limitation of relying on deterrence as the sole motivation for compliance. To the extent that a deterrence-based model is effective in securing compliance it tends to motivate the temporary, strict and formalistic approaches to compliance that characterised the 2012 scandals and that reform is now seeking to change. Indeed, this is the very crux of the issue. Absent intrinsic motivation, compliance standards ‘are not maintained when the risk of punishment diminishes or disappears’.38

33 Muprhy, ‘The Role of Trust’ (n 29), 8. As an aside, it is at this juncture that we can start to see the oblique, but powerful, consequences that seemingly discrete compliance decisions can have on wider corporate culture. It sends a very robust message to the workforce about cultural norms and priorities, regardless of what any formal policy might say, when the lead safety engineer is replaced with a lawyer. When decisions such as these are made, it also becomes easier to understand why reductive compliance practices are not simply a ‘tax’ problem but go to the wider question of corporate responsibility, helping to explain why a corporation that implores compliance with both the ‘spirit and letter’ of its own corporate code of conduct can nevertheless implement creative compliance strategies with ‘pride’. 34 JT Sholz, ‘Enforcement Policy and Corporate Misconduct the Changing Perspective of ­Deterrence Theory,’ (1997) 60(3) Law & Contemporary Problems 253, 253. 35 W Gray and J Scholz, ‘Analyzing the Equity and Efficiency of OSHA Regulation’ (1991) 13(3) Law and Policy 185. 36 The Australian Securities and Investment Committee. 37 D Kingsford-Smith, ‘A Harder Nut to Crack? Responsive Regulation in the Financial Services Sector’ (2011) 44(2) University of British Columbia Law Review 695, 724. 38 T Tyler, Why People Obey the Law (Princeton University Press, 2006), 275.

Deterrence-Based Compliance: Motivating ‘Amoral Calculators’  73 This leaves societies vulnerable to the ‘collapse of social order’39 if, or when, enforcement activity is reduced or is otherwise insufficient (whether due to resource scarcity, a change in political focus or any other such disruptions). We thus start to see that not only does a deterrence model fail to fully explain corporate behaviour but that it is simply not structured to meet the challenge of creative compliance. In short, it is not well-placed to engender the extra-legal, voluntary, behaviours needed to fill the legislative gaps and loopholes that will inevitably, and unavoidably, always remain. D.  Retaining a Role for Deterrence? The misalignment between a purely economic model of compliance and actual tax paying behaviour required a new understanding of why people (both corporate and natural) make the compliance decisions that they do. In a move away from defining taxpayers as wholly rational economic actors, an increased focus on the influence of social (collective) and personal (individual) norms emerged. Recognising the potential impact that a more normative approach to compliance could have in explaining compliance behaviours, attention turned to understanding the influence of intrinsic motivations and, in particular, the impact that the perceived legitimacy of legal instruments (and their enforcement authorities) had on compliance decisions. Importantly, this work revealed that legitimacy was not only a driver of compliance in absolute terms but was a key motivation for voluntary and spirited compliance, in contrast to the temporary and strict standards that were often the product of extrinsic motivation borne from a risk of sanction.40 Nevertheless, before we turn to an alternative, legitimacy-based, theory of motivation one final comment on the value of deterrence is needed. For all its limitations, an ongoing role for deterrence-based sanctions does nonetheless remain. As much as we would want to be able to envisage a society where everyone is intrinsically motivated to voluntarily adopt a spirited compliance standard the fact remains that we need to provide some form of sanction for the most incalcitrant of actors. However, the claim that this section makes is that we need to be very deliberate about how sanctions are engaged to avoid the risks that an inflexible and rigid enforcement regime can cause (including, albeit inadvertently, undermining regulatory effectiveness).41 When built on the right foundations (namely a complete understanding of the root cause of corporate

39 T Tyler, ‘Psychological Perspectives on Legitimacy and Legitimation’ (2006) 57 Annual Review of Psychology 375, 377. 40 Alm et al, ‘Economic and Non-economic’ (n 18), 1; Torgler, ‘Tax Morale’ (n 16), 6. 41 J Braithwaite and V Braithwaite, ‘The politics of legalism: Rules versus Standards in ­Nursing-Home Regulation,’ (1995) Social and Legal Studies 307.

74  Motivating Compliance: Freedom to Act? compliance behaviours) sanctions retain value as a final, rather than central, pillar of regulatory strategy and design. In particular, when utilised in the right way (and as discussed in Chapter 3), penalties can serve not only an instrumental role but also an expressive one,42 making a clear normative statement as to the expected conduct of corporate citizens. In this way, and the importance of this becomes clear in the following section, sanctions can be engaged to help increase the salience of regulatory norms over others that may otherwise assert dominance within the wider corporate environment. II.  LEGITIMACY-BASED COMPLIANCE

In his seminal work exploring the question of legal obedience,43 Tom Tyler sought to address the shortcomings of a deterrence model by showing that it was a citizen’s perception of the legitimacy of the law, rather than the threat of sanction, that was a critical determinant of their ‘law-related behaviour’.44 Specifically, Tyler found that it was a normative commitment to the law, based on either personal morality (a view that the law is just) or legitimacy (that an authority has the right to control their behaviour),45 rather than the risk of detection, that was a key driver of voluntary compliance. Put simply, people were motivated to comply with the law because they felt it ‘appropriate, proper and just’46 to do so, not (as conventional wisdom at the time suggested) because they feared a penalty for breach. A.  Legitimacy-Based Compliance The impact of Tyler’s work was profound. It challenged the then ‘ubiquitous’47 view discussed in Section I that, as rational actors, citizens are most likely to respond to a deterrence-based approach to regulation. Rather, Tyler’s findings suggested that to achieve greater compliance (and, in his subsequent work, legal deference)48 it was necessary to enhance trust in, and the legitimacy of, the law rather than simply increase sanctions.49 His research showed that c­ ompliance 42 CR Sunstein, ‘On the Expressive Function of Law,’ (1996) 144 University of Pennsylvania Law Review 2021. 43 ibid. 44 T Tyler and J Jackson, ‘Future Challenges in the Study of Legitimacy and Criminal Justice,’ in S Simpson and D Weisburd (eds) The Criminology of White-Collar Crime (Springer, 2009), 83. 45 Tyler, Why People Obey the Law (n 38), 4. 46 Tyler, ‘Psychological Perspectives’ (n 39), 376. 47 Tyler, Why People Obey the Law (n 38), 269. 48 ibid, 273. 49 This discussion of penalties is different to that considering the expressive function of the law discussed in Section I. Here, Tyler is looking at sanctions simply as a driver of compliance based on a fear of punishment, not their capacity as a normative statement of moral wrong.

Legitimacy-Based Compliance  75 decisions were not simply the product of a rational, cost-benefit, analysis. Instead, it was a person’s attitudes and beliefs about the exercise of power and control,50 as well as how they felt they should behave, that were much bigger drivers of their compliance behaviours (irrespective of the risk of punishment).51 Beyond its explanatory value, legitimacy-based compliance is important because of the type of compliance that it gives rise to. Whereas deterrence-based compliance tends to be technical and transient (fluctuating according to the likely risk of enforcement), decisions driven by legitimacy are more likely to be voluntary, constant and spirited. This remains true even when the regulatory demand conflicts with a person’s immediate material self-interest, as is often the case with taxation. Provided an authority’s right to control our behaviour is deemed to be legitimate, or we consider the request itself to be reasonable (namely aligned with our sense of personal morality), we are generally willing to comply with the demands being made. As a consequence, we see that most people will buy a train ticket on a route where they know there is no conductor, adhere to speed limits in busy residential areas regardless of whether or not there are traffic cameras or stop at a red light even though no one else is around. It is not due to the fear of prosecution that we act in this way but because we recognise that this is conduct that is reasonably and legitimately expected of us. Moreover, if we consider a demand to be legitimate, then we generally also extend our expectation of compliance to others (in addition to ourselves).52 The instrumental importance and value of this voluntary, legitimacy-based, compliance should not be underestimated as it acts as a powerful instrument of change when properly engaged (and, as multiple corporate scandals have shown, the reverse is also true). If our compliance decisions are driven by intrinsic motivation, namely because we think spirited compliance is the right thing to do, they become automatic and self-regulating.53 Using the examples above, without incentive or threat we purchase a ticket, stop at a red light or stick to the speed limit. Similarly, as the participants in Dwenger’s study demonstrated, if we are motivated by legitimacy, we pay our taxes on demand even if the risk of sanction is remote (or non-existent). Thus, in contrast to deterrence-based motivation, legitimacy-based compliance reduces the need for external surveillance (although of course some exists as a necessary insurance policy where the consequences of breach are serious), alleviating the resource burdens and barriers that arise with sanctions-based models.54 Aligned with this is the fact 50 Tyler and Jackson, ‘Future Challenges’ (n 44), 87. See ch 5 for a detailed analysis of the factors that influence our perception of the legitimacy of the state’s right to regulate. 51 Tyler, Why People Obey the Law (n 38), 3. 52 J French and B Raven, ‘The Bases of Social Power’ in D Cartwright (ed) Studies in Social Power (Ann Arbor: Research Center for Group Dynamics, Institute for Social Research, University of Michigan, 1959), 150, 156. 53 Tyler, ‘Psychological Perspectives’ (n 39), 378. See also M Weber, Economy and Society ­(University of California Press, 1968). 54 For a more detailed discussion between legitimacy-based power and surveillance see French and Raven, ‘The Bases of Social Power’ (n 52).

76  Motivating Compliance: Freedom to Act? that intrinsically motivated compliance offers a more stable and sustainable compliance model, as compliance behaviours are less susceptible to fluctuating enforcement risks. It is this sustainability, and the predictability of behaviours that it supports, which helps to maintain the social orders (considered further in Chapter 5) that civil society depends upon.55 Recognising that compliance is motivated by legitimacy, not simply the fear of sanction, provides important insights into where to focus reform efforts and the nature of the tools that should be engaged (and avoided) to achieve regulatory objectives. If we consider this approach alongside our understanding of norm-driven behaviours (and perceptions of legitimacy derived therefrom) that were considered in Chapter 3, we can start to develop a holistic understanding of the landscape in which compliance decisions are made (and where reform might be needed). However, before we do so, several preliminary questions remain. Not least, what we mean by ‘legitimacy’ in this context and the implications of how this manifests in a corporate setting.56 B.  Procedural Justice: The Legitimacy of the Originating Authority Legitimacy-based compliance is, fundamentally, a psychological model of understanding compliance decisions.57 One that seeks to explain why a person responds to legal demands in the way that they do. In particular, it explores how a person’s perception of both the existence and exercise of coercive power (be it by the police, courts or other regulatory body) influences their compliance behaviours.58 Adopting this approach, psychologists have shown that it is a person’s subjective interpretation of whether a system satisfies notions of ‘procedural justice’, that are determinative of their law-abiding behaviour.59 A legitimacy-based theory of compliance is comprised of two stages. The first is concerned with whether or not a citizen considers the relevant authority to be legitimate, with the second being focussed on the fair exercise of power.60 Commonly, discussions exploring the definition of ‘legitimacy’ centre

55 Tyer, Why People Obey the Law (n 38), 269; T Tyler and Y Huo, Trust in the Law, ­Encouraging Public Cooperation with the Police and Courts (Russell Sage Foundation, 2002), xiii. See also, D Beetham, The Legitimation of Power 2nd edn (Palgrave Macmillan, 2013). 56 Whilst ch 5 explores the broader question of the legitimacy of a state’s originating authority. 57 TR Tyler, ‘Procedural Justice, Legitimacy, and the Effective Rule of Law,’ (2003) 30 Crime and Justice 283, 285. 58 ibid. 59 Chapter 5 looks at the origins of political power, specifically how a citizen’s interpretation of the state’s right to intervene in their freedom of activity influences perceptions of legitimacy. Historically, the perceived ‘unfairness’ or ‘illegitimacy’ of legislation was cited as a justification for tax avoidance, which could ‘make fair what legislators have made unfair’. This, Sears argued, justified taking advantage of regulatory loopholes. See JH Sears, ‘Effective and Lawful Avoidance of Taxes,’ (1921) 8(2) Virginia Law Review 77, 79. See also, Tyler and Huo, Trust in the Law (n 55), 104. 60 Tyler, ‘Procedural Justice’ (n 57), 306.

Legitimacy-Based Compliance  77 on the second phase, considered in the next section, namely the process-based determinants (or antecedents) of legitimacy. Whilst this focus on process is understandable (as discussed previously authorities have greater ability to influence the exercise of power rather than individual and subjective views as to its originating legitimacy), there are two key reasons why it is important that the influence of the first stage (a person’s perception of an authority’s coercive power) is nonetheless borne in mind. First, it demonstrates the instrumental importance of the market norms and narratives that have emerged in our modern economy and that shape our view of the legitimacy of coercive power (these narratives are discussed throughout this book but in particular in Chapter 5). Second, it also helps to frame and explain the particular challenge that individuals face when making (or implementing) compliance decisions within a corporate setting (a challenge that is considered further in Section III). That is, the significant psychological consquences of being subjected to two legitimate forces of authority, namely the state through regulation and the corporation through the employment relationship.61 Our perception of the legitimacy of the state to exercise authority, or dominance, over our behaviour is anchored in our own personal political philosophy, which can itself be heavily influenced by social norms (the power of which we discussed in Chapter 3).62 In particular, it reflects an internalised view of the state’s legitimate right (or otherwise) to intervene in our individual lives, constrain our freedom of choice and curtail or direct our decision making.63 It is therefore at this juncture that we can start to see the instrumental importance of the fact that corporate compliance decisions (and the corresponding social judgment of them) are closely entwined with everyday notions of capitalist market ideology, often characterised in libertarian terms. Put simply, if a corporation’s primary strategic framework is shaped by commonly accepted notions of market libertarianism, which reject the right of state interference, this operates to fundamentally undermine the legitimacy of that authority and, as a consequence, our intrinsic motivation to comply with their directions. Including, for example, regulatory demands to adopt a more spirited, or ‘non-abusive’, compliance strategy. Whilst Chapter 5 challenges the accuracy of this interpretation of market ideology, it is nonetheless important to acknowledge. When exploring why a person adopts certain compliance behaviours, it is their subjective perception of legitimacy, regardless of its factual accuracy, that we are concerned with. Thus, a legal subject’s theoretical framing of their relationship with the state can have a powerful impact on their everyday decision making. In particular, although by

61 H Kelman and L Hamilton, Crimes of Obedience (Yale University Press, 1989), 16. 62 See ch 3. 63 As to the internalised values of legitimate power and authority see French and Raven, ‘The Bases of Social Power’ (n 52), 156.

78  Motivating Compliance: Freedom to Act? no means exclusively, when looking at matters of taxation, a libertarian view of both the power of the state to intervene and the objectives of the substantive rule in question, can serve to dismiss taxation statutes as an illegitimate intrusion on individual freedom and private property, driving a technical approach (if any) to compliance. Put simply, if people do not consider an authority to have the legitimate right to demand deference, then this has a significant influence on the scope of their compliance behaviour. Moreover, this impact is not limited to the first phase of the procedural justice model. Our view of the legitimacy of an authority’s originating power has the potential to shape our interactions with them, thereby also influencing our perception of the manner in which that power is then exercised. C.  Procedural Justice: The Legitimate Exercise of Authority Much like assessing the legitimacy of the state’s originating power to exercise authority, identifying the procedural elements of what constitutes a ‘procedurally just’ system is not a clear or binary process either. Procedural justice is a ‘psychological construct’64 that is shaped by an individual’s perception of an authority’s conduct, rather than by an objective or universal standard.65 As a result, the term ‘procedural justice’ is not only a subjective concept but a multidimensional and contextual one.66 There are a broad range of factors that influence an individual’s experience with an enforcement authority (and that can vary from person to person), from personal and social norms to actual interactions with the legal system and its institutions. Despite this subjectivity, there are common elements that usually inform a person’s perception of procedural justice and an understanding of these is useful in identifying the mechanisms that authorities can, to a large degree, influence (or engage) in an effort to improve the regulatory relationship. As has been noted elsewhere, regulators might not be able to ‘change unpopular laws but they are able to change the way they treat those they are charged with regulating’.67 There is a vast body of literature that looks to define the exact contours of what could be seen as the otherwise amorphous concept of ‘procedural justice’ in any given context. However, these generally coalesce around four key pillars,68 which are both relational and instrumental in nature. That is, they concern both 64 R Hollander-Blumoff and TR Tyler, ‘Procedural Justice and the Rule of Law: Fostering ­Legitimacy in Alternative Dispute Resolution,’ 2011(1) Journal of Dispute Resolution 1, 3. 65 EA Lind and TR Tyler, The Social Psychology of Procedural Justice, (Springer, 1988) 63–65. Tyler, Why People Obey the Law (n 38), 164. 66 Tyler, Why People Obey the Law (n 38). 67 K Murphy, ‘Procedural Justice and its Role in Promoting Voluntary Compliance,’ in P Drahos (ed) Regulatory Theory: Foundations and Applications (ANU Press, 2017) 43, 46. 68 T Tyler and SL Blader, ‘Justice and Negotiation,’ in MJ Gelfand and JM Brett (eds) The ­Handbook of Negotiation and Culture (Stanford Business Books, 2004) 295, 300. See also, Murphy, ‘Procedural Justice’ (n 67), 46.

Legitimacy-Based Compliance  79 the interpersonal contact between a regulator and the regulated entity as well as the outcome that is ultimately reached and the processes that are followed to get there.69 In fact, repeated studies have demonstrated that not only are relational factors important, but these can often be more influential than the favourability of the result in shaping a person’s perceived legitimacy of, and therefore deference to, legal institutions and their decisions.70 The first pillar concerns a person’s right to exercise their voice, namely the opportunity and ability to be heard. Specifically, people that are engaged in a legal process (of whatever nature) need to feel that they have been able to participate in that process.71 This goes beyond a notional right for someone to state their point of view, but necessitates a process in which an individual feels that not only were they able to put their case but this was genuinely listened to and, where relevant, reflected on and responded to. A hearing (or other such equivalent), which is seen as nothing but a ‘show trial’, or foregone conclusion, will do little to enhance the legitimacy of the adjudication process in the eyes of the regulated. It is of note that this need to be heard can also extend to the ability to influence, or at least be represented in, broader policy decisions.72 We thus start to see how the disproportionate ability of corporations, particularly economically significant ones, to lobby or otherwise engage with the policy process (including the eventual application of, or compliance with, any legal instruments) can undermine the legitimacy of (and therefore compliance with) the system in the eyes of those who are not so positioned. Beyond its impact on the personal experience of the respondent and their perception of the legitimacy of proceedings, protecting the right to participate in this way also facilitates one oblique, but potentially very powerful, benefit. Namely, that the parties get to engage and interact with each other.73 If structured correctly and conducted with respect (see pillar three), this interaction can serve to enhance the regulatory relationship, humanising both parties whilst allowing some appreciation of the other side’s point of view. This then serves to strengthen the underpinning of trust that Murphy recognised, and discussed above, as being so important to engendering voluntary compliance practices. Returning to the core elements of procedural justice, the second pillar explains that the neutrality of the decision maker is, unsurprisingly, critical. However, this plays a particularly important and specific role when looking at the relationship between legitimacy and creative compliance. Here we are not solely concerned with the lack of perceived bias, but the ‘consistency in the application 69 TR Tyler, ‘The Psychology of Legitimacy: A relational Perspective on Voluntary Deference to Authorities,’ (1997) 1(4) Personality and Psychology Review 323, 323. 70 Tyler and Huo, Trust in the Law (n 55). Hollander-Blumoff and Tyler, ‘Procedural Justice’ (n 64), 7. Tyler, Why People Obey the Law (n 38), 115–124. 71 Tyler, Why People Obey the Law (n 38), 163. 72 M Levi, A Sacks and T Tyler, ‘Conceptualizing Legitimacy, Measuring Legitimating Beliefs,’ (2009) 53(3) American Behavioral Scientists 354, 360. 73 Tyler, Why People Obey the Law (n 38), 163.

80  Motivating Compliance: Freedom to Act? of rules over time’.74 People want to be reassured that enforcement bodies are treating them in ‘the same way as any other individual in society’.75 However, as we saw in Chapter 2, one of the more systemic consequences of creative compliance is that it undermines the equal application of rules. In particular, it is large multinational corporations that are both technically and financially much more able to creatively comply in comparison to smaller organisations or individuals. Quite simply, ‘[a]voidance opportunities, however, are likely to be disproportionally available to the better off and to the better advised’.76 The implications of this asymmetry are discussed further in Section IV but, put simply, when laws are unequally applied ‘disobedience is likely to increase’.77 This inequality aligns with concerns raised by the third pillar of procedural justice, namely whether or not an authority treats people with respect. As one would expect, this includes everyday concepts of politeness and professional courtesy, such as whether the authority treats a regulated entity with due regard. However, it also extends beyond the interpersonal and includes whether or not an authority has ‘respect for people’s rights’.78 Again we see the inherent tension between these critical determinants of legitimacy and the inequality that creative compliance gives rise to. The principle of equality before the law, including the equal application of laws, is a basic right of citizenship in a society governed by the rule of law (and discussed further in Chapter 6). However, this is fundamentally compromised when a specific cohort (namely corporations) can, effectively, ‘manipulate’79 the application of the law. Whilst undermining the rule of law in this way has clear consequences for the integrity of the legal framework, it also operates to undermine a widespread view of the legitimacy (defined in procedural justice terms) of the legal system as citizens are influenced by ‘the degree to which … the authorities did or did not act in terms of the ideas underlying the rule of law’.80 Thus, we see a common theme emerge across all pillars, namely how the act of creative compliance can in and of itself undermine the legitimacy of the legal framework and, as a consequence, the ‘everyday rule-following behaviour’81 of other regulated entities. Put another way, if it is manifest fairness that ‘enhances voluntary compliance’,82 then it is manifest unfairness that risks enhancing creative compliance. 74 Hollander-Blumoff and Tyler, ‘Procedural Justice’ (n 64), 5. 75 Murphy, ‘Procedural Justice’ (n 67), 46. 76 Malcolm Gammie QC, The Draft Finance Bill 2013: Oral and Written Evidence, 13 March 2013, 114 citing the Royal Commission on the Taxation of Profits and Income Final Report, Cmd 9474 June 1955. 77 M Levi, A Sacks and T Tyler, ‘Conceptualizing Legitimacy, Measuring Legitimating Beliefs,’ (2009) 53(3) American Behavioral Scientists 354, 360. 78 Hollander-Blumoff and Tyler, ‘Procedural Justice’ (n 64), 6. 79 D McBarnet and C Whelan, ‘The Elusive Spirit of the Law: Formalism and the Struggle for Legal Control,’ (1991) 54 Modern Law Review 849. 80 T Tyler, ‘Does the American Public Accept the Rule of Law? The Findings of Psychological Research on Deference to authority,’ (2007) 56 DePaul Law Review 661, 669. 81 Tyler, Why People Obey the Law (n 38) 274. 82 L Martinez, ‘Taxes, Morals, and Legitimacy,’ (1994) Brigham Young University Law Review 521, 548, 550.

Legitimacy-Based Compliance  81 The fourth and final pillar returns to the role of trust in the compliance process and, in particular, the trustworthiness of the decision maker. We will see throughout the book (and specifically in Chapter 5) the instrumental role that trust, and the predictability of behaviours that it supports, plays in protecting social order. However, it also performs an equally impactful role in enhancing legitimacy-based compliance. Research has repeatedly shown that trust in an enforcement authority (social trust based on relationships),83 and the decisions that it makes (instrumental trust borne from outcomes),84 ‘nurtures compliance’.85 Whilst both social and instrumental trust are important, recent studies have found that it is social-based trust, established through relationships and fair treatment that can be paramount.86 In short, ‘trust in government’87 has more of an impact on compliance than outcome and the fear of being caught. Developing this type of trust is not necessarily easy. It is an ‘inference on the part of the subject that the authority was sincerely trying to do what was right … shaped by how the authorities act’.88 It is here that we can start to see the interaction between the four pillars of procedural justice and a return to the reciprocal nature of trust in the regulatory relationship.89 If an authority is deemed to treat a subject with courtesy, respect and a genuine openness to listening to their position this will enhance that subject’s trust (both social and instrumental) in the authority in question. Conversely, we can better understand the damaging effect that the use of, often widely publicised, rhetoric in the enforcement and investigatory process can have on compliance practices. Cases involving tax avoidance can become both inflammatory and politicised. However, even if this rhetoric speaks to commonly shared public sentiment, by understanding the relational pillars that comprise procedural justice we can start to recognise how this language can risk undermining the perception (if not the actuality) of trust in the decision-making process. In doing so, the narrative that often characterises capitalism and corporations as ‘amoral calculators’ (and worse) risks driving further rigid, legalistic and entrenched responses, moving us away from the behavioural change that is often being sought. Understanding these pillars of procedural justice, and the impact that a citizen’s perception of the legitimacy of authority has on their deference to that authority, enables a more nuanced (and effective) examination of how to enhance compliance behaviours. In practical terms, it endorses the need (discussed in Chapter 3) to adopt a pluralistic regulatory toolkit, one that engages techniques beyond sanctions and incorporates this understanding of the normative underpinnings of creative compliance. Specifically, it helps to distil the fact that when 83 Murphy, ‘The Role of Trust’ (n 29). 84 J Sholz and M Lubell, ‘Trust and Taxpaying: Testing the Heuristic Approach to Collective Action’ (1998) 42(2) American Journal of Political Science 398. 85 J Braithwaite and T Makkai, ‘Trust and Compliance’ (1994) 4(1) Policing and Society 1. 86 Murphy, ‘The Role of Trust’ (n 29). 87 Sholz and Lubell, ‘Trust and Taxpaying’ (n 84). 88 Hollander-Blumoff and Tyler, ‘Procedural Justice’ (n 64). 89 Murphy, ‘The Role of Trust’ (n 29).

82  Motivating Compliance: Freedom to Act? seeking to change behaviour in one domain (such as tax) we cannot adopt a myopic view of the issue. Rather, we need to appreciate a subject’s broader relationship with authority and, specifically, their perception of its legitimacy. It is this insight that starts to build a framework in which to address the seeming paradox that emerges when looking at corporate compliance. That is, if so many individuals found the 2012 tax structures to be illegitimate (and, as Kagan and Sholz’s meta-study discussed in Section I demonstrated, it is the attitudes of individual managers that is a significant factor in shaping corporate compliance strategies), why did so many individual managers (as many before them) implement the structures in question? Thereafter, why were they so robust in their defence of it? D.  The Duality of Authority The answer can be found if we start to look at the reality of corporate decision making and how this influences the lens through which corporate determinations of legitimacy are made. Indeed, one of the oblique benefits of understanding legitimacy-based compliance is that it helps us to reflect upon, and identify, the fact that an individual corporate officer or employee has two sources of authority, and therefore two points of legitimacy, to navigate. That is, the state (through regulation) and the corporation itself (through the employment relationship). As employees, we accept and acknowledge (both positively and normatively) the right of our employer to determine the scope of our employment obligations, how we occupy our time at work and the strategic direction of the company. If we are asked to achieve a certain corporate objective, focus on a particular sector or meet specific sales targets then that is what we do (the psychological impacts of which are explained in detail in Chapter 7). This duality gives rise to several persistent and powerful challenges, the most immediate being which line of authority an individual should (or will) comply with if the two are in conflict. On the face of it, and in the abstract, this decision might seem both binary and also fairly straightforward to resolve. The corporation is itself a subject of the state and an individual should simply adhere to the directions of the state as the highest order in the hierarchy. However, the luxury of this conceptual clarity very rarely exists in practice. As shall be seen, we are, as a general rule, willing not only to acquiesce to the demands of non-state authority but take positive steps to implement them.90 Establishing which source of authority will prevail (that is, which one an individual will comply with), is not the only problem that emerges from this duality. There is an important third party to consider, namely the individual themselves. As individual citizens we do, of course, hold personal views as



90 See

Section 3 and ch 7.

Legitimising Creative Compliance  83 to our expected rights and obligations towards the state, civil society and its citizens. Thus, a further conflict arises from this duality if the demands of the corporate authority on our behaviour do not align with our own views as to our legal or moral obligations to the state and society. Again, the answer might appear simple, individuals should ‘do the right thing’, in situations of legal or moral conflict. Regrettably, if there is any doubt as to the influence of authority on our behaviour, countless examples exist where, even in the most extreme of situations, ‘individuals characteristically feel obligated to obey the orders of authorities, whether or not these correspond with their personal preferences’.91 From a compliance perspective, this duality means that a situation can arise where an individual acts in a manner that does not fully align with their own personal attitudes and beliefs. That is, they may implement an aggressive tax structure to minimise the amount of tax that a corporation pays, thereby reducing public funds and undermining social cohesion even when they hold personal views that do not support this reductive approach to compliance. This conduct may well trigger immediate and apparent tensions for the individual concerned. However, it also gives rise to a more systemic issue, which is explained in the next section, namely that this conflict between a person’s beliefs and their actions triggers a powerful (and oftentimes subconscious) psychological response. It is this response that can, ironically, act as a catalyst to further embed and legitimise the conflicting behaviour within the normative environment. III.  LEGITIMISING CREATIVE COMPLIANCE: DISSONANCE REDUCTION AND OVER-RATIONALISATION

Recognising this duality of authority, and its relationship with legitimacy, is a critical first step in understanding the persistent challenge that we have faced when trying to reform corporate compliance practices. Specifically, it helps us to appreciate that corporate behaviour is not simply the product of the abstract motivations of an artificial legal entity nor, separately, those of the individual officers that it necessarily acts by. Rather, it is the outcome of decisions made by those individual officers whilst acting on behalf of the corporation.92 Unpacking this subtle distinction can seem like an idiosyncratic exercise but it is absolutely crucial that we do so. It is the nuance of this interaction that precipitates a powerful psychological tension (and reaction) that arises when an individual acts in conflict with their own beliefs. A tension that is more instrumental in creating a culture of reductive decision making than may at first seem. In particular, understanding this conflict helps to explain both the lens through 91 Kelman and Hamilton, Crimes of Obedience (n 61), 16. See also ch 7. 92 As shall be seen, and as we explore throughout the book, the decisions individuals make when acting within a corporate setting can, oftentimes, be quite different to those that they would make outside of it.

84  Motivating Compliance: Freedom to Act? which corporate determinations of legitimacy (and therefore compliance) are made and why that (reductive) perspective has become so entrenched in corporate culture. A.  The Duality of Norms The duality of authority that corporate officers operate within gives rise to a related issue, namely a corresponding duality (or potential triality) of norms. As discussed in more detail in Chapter 3, norms operate to shape a person’s perception of right and wrong in any given situation, acting as a powerful determinant of legitimacy. They are, as Bicchieri described, the ‘grammar of society’,93 embodying the values of a community and functioning as the baseline from which social sanctions are applied. Personal norms have a wide sphere of influence, informing our judgments about the ethics of tax evasion, the legitimacy of government regulation,94 the desire to be part of a group or the guilt of not paying our fair share. In short, they are fundamental to our determinations of the compliance standards that we should legitimately adopt and the tax strategies we should apply. Indeed, they are such a powerful driver of behaviour that, when harnessed correctly, some commentators have suggested that they could render deterrence-based and sanction-oriented compliance models ‘superfluous’.95 The problem for individuals discharging corporate responsibilities is that they are operating within a normative environment that embodies a potentially different set of norms from their own, with little practical opportunity to move to a different normative environment.96 That is, as Chapter 3 discussed, a corporation’s normative environment generally embodies a dominant shareholder wealth maximising norm, endorsing a purely creative approach to compliance, whereas individuals may take a broader, more holistic view, towards the value and legitimacy of spirited compliance. Nonetheless, when acting on behalf of the corporation an individual is, of course, discharging their corporate responsibilities in respect of corporate assets. They are conducting themselves on behalf of a third party (albeit an artificial legal one) and in respect of assets that are ‘endowed [not] earned’.97 Understood through this lens, the normative framework for corporate decision making could be said to actually be quite clear. 93 C Bicchieri, The Grammar of Society, The Nature and Dynamics of Social Norms (Cambridge University Press, 2006), ix. 94 See ch 5. 95 M Wenzel, ‘The Social Side of Sanctions: Personal and Social Norms as Moderators of Deterrence,’ (2004) 28(5) Law and Human Behaviour 547, 549. 96 For a discussion of exiting normative communities see CR Sunstein, ‘Social Norms and Social Roles,’ (1996) 96(4) Columbia Law Review 903, 920. 97 A Downs and B Stetson, ‘Economic versus Non-Economic Factors: An Anlaysis of Corporate Tax Compliance,’ (5 August 2011) 2011 American Accounting Association Annual Meeting – Tax Concurrent Sessions. Available at SSRN: https://ssrn.com/abstract=1905075.

Legitimising Creative Compliance  85 Namely, that individuals will simply act in accordance with the profit maximising norm of the corporation and do so with impunity. Indeed, as we shall see, it is commonly the case that individuals will favour corporate norms to their own. In which case, can it be said that a normative conflict arises at all.? Moreover, if so, why? The answer lies in the fact that this analysis views the corporate decisionmaking process in an artificially clinical and abstract way. The reality is that individuals acting in a corporate capacity unavoidably remain exposed to the norms that exist in, and govern, their everyday life. Far from enjoying the clarity of a singular profit-maximising norm (even if this ultimately dictates their behaviour) they are instead navigating, even if subconsciously, a more complex normative framework. That is, one where corporate and personal norms intersect. In a corporate environment, personal norms are not simply overridden and left at the proverbial corporate door but have to co-exist with potentially conflicting, but oftentimes more salient, corporate norms. As humans, we are not able to simply segregate or ‘box’ our values, nor are we the wholly rational decision makers that economic theory would have us believe (although note the discussion in Chapter 3 of the hidden ‘taxes’ of norm divergence, which goes some way to helping explain seemingly irrational decisions). We are, as Thaler and Sunstein observe, homo sapiens, not homo economicus.98 It is this complex normative environment that presents a particular challenge for explanatory models of corporate compliance. Nonetheless, it is crucial that we fully understand this interaction (or collision) of personal and corporate norms and the consequences that it gives rise to. This is not simply an interesting theoretical or academic debate. Without it, when considering the architecture of reform, we are left with an unreliable focus on profit maximisation as the singular driver of ostensibly self-interested behaviour, ignoring (at worst) or over-simplifying (at best) the complex cognitive processes that underpin corporate compliance decisions and create hostile environments for change. B.  The Salience of Corporate Norms The following sections explore the consequences that arise from this normative tension. However, first we need to address the basic assumption that this analysis is based upon, namely that individuals will indeed favour corporate norms and objectives over their own when the two are in conflict. In particular, we need to reflect upon whether this a fair assumption to make. Do we all step into our places of work and immediately avail ourselves of corporate values at the expense of our own? Perhaps not entirely. There are undoubtedly personal norms that we either consider to be shared by the relevant group



98 R

Thaler and C Sunstein Nudge (first published 2008, Penguin Books, 2009), 7.

86  Motivating Compliance: Freedom to Act? (and therefore feel comfortable upholding in the face of conflict) or that we hold so strongly that we are willing to risk ‘­rejection’ by the group to act in alignment with them. For example, we would very comfortably refuse an instruction to act in a violent way against a colleague (confident that it is a shared norm) or decline to eat meat at a corporate function if we are vegan (a strongly held personal norm). However, outside of these extremes, the extent to which we are willing to ignore our personal beliefs, in some cases even disregard facts that are self-evidently true, in an effort to adhere to group norms (subconscious or otherwise) is striking.99 This willingness to conform is often exacerbated by the norms that are internalised with respect to certain roles, such as the subservience of an employee or the expectations we have of a Finance Director.100 Psychologists, keen to understand the extent to which people will alter their personal behaviour to conform to group norms, have long studied the impact of group behaviour on individual decision-making. One of the most remarkable of these was the Asch conformity experiments.101 Asch convened a group of eight participants in the same room all of whom, bar one (the ‘research participant’), were actors. The research participant was not aware that the other participants were actors and had been informed that the experiment was designed to test perception. Once introductions had been made (to maintain the pretence that all participants were unknown to each other) the group was asked to look at two cards. The first card had a single line on it and the second had three lines on it (labelled individually A, B and C), each of which was clearly a different length to the other. The participants were then asked in turn to state which of the three lines was the same length as the single line on the original card. Each participant would answer in front of the whole group, with the research participant answering last (research participants had been deliberately seated at the end of the line of participants to ensure that this would be the case). The simplicity of the line perception task was such that the correct answer was, deliberately, beyond all reasonable doubt.102 Indeed, the ease of the exercise was borne out by the fact that in a control group where all participants were genuine research participants the error rate in identifying the corresponding line was less than 1 per cent.103 Nevertheless, when the real experiment was 99 This goes some way to answering the question of why is that individuals who wouldn’t act unethically outside of the firm can nevertheless perpetrate a fraud, or implement an abusive tax structure when acting within the corporation. As Anand, Ashforth and Joshi observe, most of the acts were ‘committed by individuals who were upstanding members of the community’. See V Anand, BE Ashforth and M Joshi, ‘Business as Usual: The Acceptance and Perpetuation of Corruption in Organizations,’ (2004) 18(2) Academy of Management Executive 39, 39. Chapter 7 considers how the architecture of the firm contributes to this seeming paradox between individual values and actions within the corporation. 100 Sunstein, ‘Social Norms’ (n 96), 922. 101 SE Asch ‘Opinions and Social Pressure,’ (1955) 193(5) Scientific American 31. 102 Asch had been concerned that similar, earlier experiments, had used questions that did not have a definitive answer and that this risked obscuring the clarity of their findings, eg Sherif, ‘A study of some social factors in perception,’ Archives of Psychology, 27(187). 103 Asch, ‘Opinions and Social Pressure’ (n 101), 3.

Legitimising Creative Compliance  87 conducted, the results were astounding.104 Asch ran the perception test 18 times. However, for 12 of the 18 tests the actors in the room gave a pre-agreed incorrect answer when asked to identify the matching line. Notwithstanding an error rate of less than 1 per cent in the control experiment, in the 12 test experiments the error rate by the research participant (by providing the same incorrect answer as the actors in the group) was 36.8 per cent.105 That is, a third of people were willing to state that two lines, which were clearly of different length, were identical simply because the remainder of the group had expressed that opinion. As Asch observed, and in something of an understatement, the fact that intelligent people (the participants were all college students) ‘are willing to call white black is a matter of concern’.106 If Asch’s findings are troubling in a research setting, their application to a corporate environment can be even more profound. Not only are the stakes considerably higher, but the psychological pressure of group conformity is much greater, increasing the likelihood that individuals will act against their own opinion in favour of the group. In Asch’s experiment, the only pressure to conform came from the mere existence of group members who were to all extents and purposes strangers (although there was homogeneity of age and gender as all group members were male college students). Furthermore, there were no financial or professional incentives (or tangible negative consequences) that would arise from acting in accordance with, or contrary to, the group norm. In contrast, for individuals in a corporate setting, the group is comprised of individuals with whom there is either a social, cultural or hierarchical relationship, which serves to increase the pressure to conform. Moreover, this relational influence is then exacerbated by the significant material incentives that exist within a corporation to encourage compliance with the relevant group norms (or culture). Not least through direct financial benefit (salary or bonus) and the real risk of negative repercussions (again both social and financial), including reputational impact and being shunned for ‘not being a team player’. Faced with the decision of having to challenge group norms, or comply with a lawful, even if challenging, direction to implement creative compliance structures, it is not surprising that acquiescing (and as we shall see rationalising) the decision to act in conformity is often considerably more palatable.107 As Thaler and Sunstein observed, there is ‘no question that social pressures nudge people to accept some pretty odd conclusions and those conclusions might well affect their behaviour’.108 104 As with many experiments of this nature, the Asch conformity tests have been subject to criticism. These generally centre on the homogeneity of male-college student participants. Nevertheless, subsequent experiments have found similar responses in respect of the pressure of group conformity. For criticisms, see F Gibbons, ‘Self-Attention and Behavior: A Review and Theoretical Update,’ (1990) 23 Advances in Experimental Social Psychology 249. 105 Asch, ‘Opinions and Social Pressure’ (n 101), 4. 106 ibid, 5. 107 ibid, 8. Downs and Stetson, ‘Economic versus Non-Economic’ (n 97). 108 Thaler and Sunstein, Nudge (n 98), 64.

88  Motivating Compliance: Freedom to Act? The sheer impact of a tendency towards group conformity can be appreciated if we consider it alongside two other important, and common, phenomena in a corporate setting. First, that the voice of a dominant individual can have a disproportionate impact on group decisions. Sherif109 found that an opinion expressed assertively by a dominant individual would be disproportionately persuasive in leading the rest of the group to a particular decision. That is, whilst Asch’s experiment showed the power of the group in effectively imposing a conflicting opinion on an individual, Sherif found that a similar outcome could also be achieved by a single person acting with confidence. For example, the well-known case of the dominant CEO.110 Once the view of a group has been swayed, this is then compounded by the second phenomenon, namely a propensity towards ‘collective conservatism’,111 which embeds the initial decision within the organisation. That is, and reflecting the habitualisation of norms introduced in Chapter 3, once a decision has been made by an organisation there is a strong (individual and group) tendency to act in accordance with the status quo when making future decisions of a similar nature.112 Not only is this the easiest path to choose, removing the friction of undertaking further normative analysis, but adopting the default option diffuses a sense of personal responsibility (an outcome that can, as Chapter 7 explains, have fatal consequences), as a person is simply following a path that has already been decided by others. This susceptibility towards inertia thus serves to entrench a decision (and the culture it promotes) for years beyond its immediate adoption. Moreover, it is a decision that could have been driven entirely by the, potentially erroneous, views of a group dominated by a single individual. Thus, we start to see the importance of the salience and impact of corporate norms in corporate decision making. Individuals are subject to a myriad of norms and influences. However, in a corporate setting profit maximisation, and the rejection of the legitimacy of efforts to constrain it, is, currently, dominant. It is the status quo, shared across the market and has become the default frame of reference. When faced with a compliance decision, it is cognitively easier to comply with the relevant corporate norm (reinforced by personal incentives) than risk the economic, social and cultural consequences of an alternative approach. This is particularly the case when the corporate environment means that individuals are often distanced from the ultimate or long-term consequences of their decision making and when concerns of creative compliance can be moderated by the ‘perceived legality’113 of the transaction. However, whilst there are clear explanations for why an individual may favour (and implement) creative compliance strategies in line with corporate norms, this does not mean it is without



109 Sherif,

‘A study of some social factors’ (n 102). impact of authority is discussed further in ch 7. 111 Thaler and Sunstein, Nudge (n 98), 62. 112 ibid, 8 and 64. 113 ibid, 8. 110 The

Legitimising Creative Compliance  89 personal consequences. Even when an individual consciously chooses (for potentially understandable reasons) to act in accordance with corporate rather than personal norms, these personal norms still exist, giving rise to potentially significant psychological tension. It is the consequences of this tension that the following section explores, namely the cognitive responses that are triggered when a person acts in accordance with a set of norms that are in conflict with their own. C.  Cognitive Dissonance and Over-Rationalisation Returning to the question of corporate compliance, why does the salience of corporate norms, and an individual’s willingness to comply with them notwithstanding conflicting personal norms, really matter? Is it not a person’s prerogative to choose to prioritise compliance with the arguably self-serving (in the short-term) corporate norm over their personal attitudes and beliefs? Whilst an ostensibly persuasive point of view, one problem this gives rise to is that the psychological consequences that this seemingly free choice triggers have significant, and potentially systemic, consequences. When a person acts in a manner that is contrary to their intrinsic values or beliefs, be it consciously or otherwise, this generates a cognitive tension, or dissonance, that triggers an attempt to reduce that discomfort.114 In particular, and as shall be seen, people engage in (surprisingly predictable) compensatory efforts designed to legitimise the conduct in question and thereby minimise or remove the conflict. It is these compensatory efforts that serve to legitimise (and ultimately entrench and habitualise) the behaviours that would otherwise cause conflict, in this case, the adoption of creative compliance practices. Recognising this phenomenon, Leon Festinger explained that once a decision to act has been made, individuals seek ‘internal … consistency’115 for the conduct in question. That is, we have an innate need for our actions to be aligned with our personal (and sometimes) social norms, for us to be able to view them as legitimate. In contrast, if there is a contradiction between either two beliefs that we hold or, as can be the case with compliance, between our beliefs and our actions then this gives rise to psychological stress or, as Festinger termed it, cognitive dissonance. Indeed, this is an experience that we can all recognise in our personal lives. When we act in a manner that does not align with our personal norms (even if we believed we had a justification for doing so) this triggers negative feelings that we want to rid ourselves of. It is this last point that is critical. Cognitive dissonance is not simply a passive feeling or occurrence. Despite being a term that has taken on an increasingly 114 That is, to maintain ‘cognitive consistency’. On this, see M Wenzel, ‘Motivation or ­Rationalisation? Causal Relations between Ethics, Norms and Tax Compliance,’ (2005) 26 Journal of Economic Psychology 491, 494. 115 L Festinger, A Theory of Cognitive Dissonance (Stanford University Press, 1957), 1 and 260.

90  Motivating Compliance: Freedom to Act? colloquial use, cognitive dissonance is in fact a highly influential driver of individual (and therefore, ultimately, collective) behaviours. It is, as Festinger described, a ‘motivating state’.116 In particular, the presence of cognitive dissonance triggers steps to reduce the psychological tension that emerges as a result.117 We try to reduce the feelings of discomfort by rationalising and, for reasons that shall be seen, over-rationalising our behaviour. Whilst Festinger identified several ways in which cognitive dissonance is reduced (and that are deployed with surprisingly predictable accuracy), two are particularly pertinent to the compliance debate.118 First, individuals may seek to justify or rationalise the behaviour in question.119 If we are rude to someone then we note how they were being unreasonable in the first instance, if we eat unhealthy food we justify it on the basis that we have had a bad day or ‘one bite won’t hurt’. We arguably saw examples of this in Chapter 1, where corporations sought to justify creative compliance by claiming that it aligns with market ideology, that there is an obligation to shareholders to act in this way or simply that it is something that all corporations engage in. Put simply, we try to legitimise the conduct in question, to align it with our perceived norms (of being kind or healthy), in an effort to reduce our cognitive discomfort. Alternatively, people (such as taxpayers or corporate officers) seek to consciously reframe their personal ethics and beliefs ‘so as to justify their behaviour as right and ethical’.120 Second, people seek to avoid cognitive dissonance by ignoring conflicting information or values that could otherwise suggest that their behaviour is either harmful or morally objectionable. Again, we see these strategies engaged in response to the scandals that gave rise to the GAAR. By either justifying creative compliance, or ignoring arguments against it (suggesting there may even be ‘some law against’ not creatively complying), corporations not only disregard the damage it causes but they force themselves to positively deny there is anything wrong with it. Far from it, they are proud of their conduct. That is, to consciously affirm creative

116 L Festinger, Cognitive Dissonance, (1962) 207(4) Scientific American 93, 94. 117 ibid, 3. 118 ibid, 19–24. 119 LB Edelman and SA Talesh, ‘To Comply or Not to Comply – That isn’t the Question: How Organizations Construct the Meaning of Compliance,’ in C Parker and VL Nielsen (eds) Explaining Compliance Business Responses to Regulation (Edward Elgar, 2011), 103. In the case of creative compliance, this rationalisation is further helped by the use of ‘euphemistic language’, that helps to reduce stigma, see Ashforth et al, ‘Business as Usual’ (n 99), 47. When adopted, such language helps to reduce any stigma associated with the conduct concerned. For example, conduct is not discussed or labelled as being contrary to the spirit of the law, removing funds from the public purse or transferring an undue burden onto fellow citizens. Rather it is deemed to be ‘creative’ compliance, whilst tax structuring products are given abstract names, such as the Double Irish (ch 2). It is perhaps not surprising that Doreen McBarnet referred to this type of conduct as ‘whiter than white collar crime’, see D McBarnet, ‘After Enron Will “Whiter Than White Collar Crime” Still Wash?’ (2006) 46(6) ­British Journal of Criminology 1091. These factors coalesce to tacitly support the legitimacy of creative compliance as a market and industry norm, something that is the acceptable within a capitalist economy. 120 Wenzel, ‘Motivation or Rationalisation?’ (n 114), 19–20.

Legitimising Creative Compliance  91 compliance as a legitimate strategy to pursue. This has two profound consequences. First, it shapes a corporation’s culture, which now inculcates a view that technical compliance (even beyond tax regulation) is legitimate. Second, this then influences the behaviours of other corporations that look to their competitor’s decisions to creatively comply to further reinforce and justify their own similar conduct (furthering the mimetic isomorphism discussed in Chapter 3). Whatever approach taken, these compensatory responses serve to legitimise (and ultimately habitualise) behaviours that otherwise contravene a person’s sense of right and wrong. However, whilst arguably problematic for individuals on a diet looking to justify a second slice of cake, such habitualisation can be catastrophic for corporate compliance as our baseline sense of ‘legitimacy’ is moved further and further away from our starting point of view. One particularly concerning aspect of this process of justification (or rationalisation) is that it is not a perfect science. It is simply not possible to determine with specificity the extent of rationalisation required in any given situation. As such, when individuals seek to reduce any anxiety they may feel, they often need to over-rationalise their conduct, to ensure that it is adequately justified (thereby alleviating in full any cognitive discomfort).121 The consequence of this over-rationalisation is that, in effect, a greater misdeed is ultimately justified than the one in question.122 As a result, the boundary of what is considered ‘ethical’ (or justifiable) expands with each iteration of over-rationalisation. In this way, the corporate ethical parameters (or culture) that individuals operate within become more and more permissive, changing the frame of reference in which decisions are made and compliance is defined.123 It is perhaps not surprising therefore, that when considering the accounting scandals of 2001, we saw that creative compliance escalated into a culture of systemic and eventually even illegal behaviour.124 When looking at those cases it also appeared that the individuals involved often saw nothing wrong with their early behaviour, a perspective that is seemingly reflected in corporate responses to the 2012 tax scandal.125 Recognising the willingness of individuals to conform to group norms is not to criticise any given individual, indeed far from it. One fundamental theme of this book is to emphasise the pressing need to understand the oftentimes unavoidable influence of institutional rules and architecture on individual behaviour, raising the question as to the impact that this influence has on ­individual, 121 SC Zyglidopoulos, PJ Fleming and S Rothenberg, ‘Rationalization, Overcompensation and the Escalation of Corruption in Organizations,’ (2009) 84 Journal of Business Ethics 65, 66. 122 ibid, 66. 123 ibid, 70. 124 ibid, 69. 125 The extent to which an actor will engage in these dissonance reduction processes is influenced, in part, by the extent to which they are committed to (or invested in) a particular position. Not only does the individual need to feel justified by their decision to act in that way but they are then subject to confirmation bias in which they have regard to (or actively seek) only those opinions or positions that support their own. See P Jenoff, ‘Going Native: Incentive, Identity and the Inherent Ethical Problem of In-house Counsel,’ (2011) 114 West Virginia Law Review 725, 743.

92  Motivating Compliance: Freedom to Act? c­orporate and institutional responsibility and reform. To help answer this question, the final section of this chapter uses these insights to model the corporate compliance decision-making process, providing guidance as to where within that process we should focus efforts at reform. IV.  THE COMPLIANCE DEGENERATION CYCLE

Drawing together the earlier parts of this chapter and the discussions in Chapter 3, we are able to better model corporate creative compliance to understand how it has become an almost self-perpetuating cycle of behaviour. This section sets out the three stages of what I term the ‘compliance degeneration cycle’,126 which shows how once the decision to creatively comply has been made (predicated on current perceptions of dominant market norms) a cycle of behaviour is triggered that serves to both legitimise creative compliance and create powerful barriers to reform. A.  Stage One: Initial Drivers of Creative Compliance The first stage of the cycle encapsulates the initial decision to creatively comply and the factors that motivate this. As we saw in Chapter 3, compliance decisions (accepting that most legal subjects accept technical obedience as a baseline level of compliance) are driven by a citizen’s construction of that term and, as discussed in this chapter, what they consider to be a legitimate course of conduct to pursue. For individuals, this construction can be informed by a wide range of influences, including education, religion and shame,127 which often contribute to broad (and diverse) notions of what compliance should mean. In contrast, for corporate actors, compliance is a term that is more singularly defined by industry and market norms, which eventually become institutionalised and, ultimately, legitimised. For corporations, these norms (rightly or wrongly) are perceived to coalesce to legitimise unwavering wealth maximising behaviour.128 Within this framework, profitable, yet creative, interpretations of compliance become acceptable, legitimised and habitualised. Thus, the first stage of the compliance degeneration cycle is the perceived legitimacy and implementation of creative compliance strategies, predicated on 126 Degeneration is used in this context to denote both the state of something getting worse, but also to encapsulate the notion of a low standard of behaviour. 127 The role of shame, and its lack of application to corporations, is discussed further in ch 3. 128 Bankman discusses the factors that corporations take into account when undertaking a cost-benefit analysis of engaging aggressive, creative, tax structures. These include the expenses of implementing the structure, the likelihood of sanction and the cost of sanction (if at all). See J ­Bankman, ‘The New Market in Corporate Tax Shelters,’ (1999) 83 Tax Notes 1775, 1778.

The Compliance Degeneration Cycle  93 corporate norms that legitimise a narrow construction of compliance obligations. As outlined earlier in this chapter, this legitimacy is then entrenched by the engagement of behavioural mechanisms that operate to mitigate any dissonance felt as a result of such conduct, whilst excluding any suggestions that creative compliance is, itself, an illegitimate practice to pursue. B.  Stage Two: Undermining Legitimacy In direct contrast to the increasing legitimisation of creative compliance, the legitimacy of regulation itself is undermined as creative compliance becomes more widespread. One critical reason for this is that not all citizens are equally positioned to creatively comply. Rather, as discussed further in this chapter (and Chapter 2), it is a practice that is predominantly available to large corporate groups that have the legal and economic capacity to operate in this way.129 Therefore, this difference in capability applies not only between corporations and individuals but also between larger corporate groups and smaller private entities. As a result, a limited number of corporations can effectively elect how certain regulatory provisions apply to them, giving rise to a system where the regulated, rather than the regulator, determine the application of rules. As a consequence, regulation no longer applies (and is perceived to no longer apply) equally to all legal subjects. This unequal application of law has two, related, effects. First, other corporations feel justified in adopting a similarly creative approach to compliance.130 Put another way, ‘if it is not necessary that everybody should play fair, why should I?’131 Therefore, we see that unfairness encourages avoidance,132 leading to what Wheatcroft described as the practice of a neighbour seeing you ‘get away with it’133 and seeking to replicate the benefit by whatever means possible.134 This reflects the fact that (as discussed in Chapter 3) our behaviour, much like the law, also has an expressive function. By implementing creative compliance strategies, corporations are expressing, through action, their perspective that such conduct is normatively permissible.135 In this way, our conduct is a function 129 In brief, the reason being that multinational groups can utilise the multiple ‘personalities’ within the group to manufacture legal relationships, economic positions (such as dividends or tax deductible losses) and ring-fence liability. Further, these groups commonly have the economic resources to pay for the requisite professional advice to implement such structures. 130 K Arrow, The Limits of Organization, (W. W. Norton & Company, 1974), 72. 131 J Murray, ‘The problem of Mr Rawls’s Problem’ in S Hook (ed) Law and Philosophy a ­Symposium (New York University Press, 1964), 33. 132 J Freedman, ‘Defining Taxpayer Responsibility: In Support of a General Anti-Avoidance ­Principle,’ [2004] 4 British Tax Review 332, 343. 133 G Wheatcroft ‘The Attitude of the Legislature and the Courts to Tax Avoidance,’ (1955) 18(3) Modern Law Review 209, 212–213. 134 ibid. 135 ES Anderson and RH Pildes, ‘Expressive Theories of Law: A General Restatement,’ (2000) 148 University of Pennsylvania Law Review 1503, 1508.

94  Motivating Compliance: Freedom to Act? of both the existence of social norms and also the observation of the conduct of others (as a reflection, and reinforcement, of those norms).136 Second, this manipulation, and unequal application, of regulation erodes the legitimacy of both the regulation in question and also of the wider legal system as a whole.137 As Tyler recognised, our perception of legislative legitimacy is shaped not simply by the content of any given rule but (as we saw in Section II) also its implementation. Creative compliance is a striking demonstration of the inequality of regulatory application as only those corporations with the requisite legal and financial resources (and risk profiles) to implement such technical structures can do so. This observable inequality before the law serves to significantly undermine legal legitimacy and, indeed, trust in the wider legal and corporate systems. A consequence that was, anecdotally, apparent from the public response to the corporate scandals that gave rise to the GAAR. C.  Stage Three: Illegitimacy and Creative Compliance It is this loss of legitimacy that brings the cycle full circle. The practice of creative compliance (stage one) undermines the legitimacy of regulation (stage two), which, as outlined in Section II of this chapter, undermines an actor’s motivation for compliance. Thus, the act of creative compliance itself gives rise to a wider, systemic, compliance problem (stage three). The ‘perception of unfairness … overshadow[s] any moral obligations’138 to comply with the law. Moreover, legitimate authority (and as a consequence compliance with its demands) is the subject of ‘convergent expectations. An individual obeys authority because he expects that others will obey it.’139 When a citizen sees that others are not complying with the spirit of the law (and doing so with impunity) then they will not feel bound to do so, by replicating this approach they are simply ‘joining in’.140 We thus have a cycle of behaviour, where corporate norms are seen to support creative compliance, these initial acts of creative compliance result in a loss of legitimacy, which then contributes to further creative compliance.141 Understood 136 Sunstein, ‘Social Norms’ (n 96), 905. 137 As to illegitimacy as an output of inequality, see M Levi, ‘Legitimacy, Crimes and Compliance in ‘the City’: De Maximis Non Curat Lex?’ in J Tankebe and A Liebling (eds) Legitimacy and Criminal Justice, an International Exploration (Oxford University Press, 2013), 157. 138 Leo Martinez, ‘Taxes, Morals, and Legitimacy’ (n 82), 548. 139 Arrow, The Limits of Organization (n 130), 72. 140 M Truman, ‘How Far Would You Go?’ Taxation 3 July 2012. 141 Chapter 5 explains the importance of predictability to market order, and argues that creative compliance undermines that predictability. One challenge to this claim, premised on the compliance degeneration cycle, could be that the cycle itself is sufficiently certain to create a new predictability (albeit of undesirable behaviour). However, the inequality in corporations’ abilities to creative comply means that the cycle is not sufficient to create a new pattern of predictability and does not therefore provide an adequate basis to contest the arguments set out in ch 5. See also, ch 2, Section IV.B for a more detailed explanation as to why creative compliance does not itself create sufficient predictability for the market order to operate efficiently.

Conclusion  95 in this way, we can start to see how creative compliance forms part of a selfperpetuating cycle of behaviour that also serves to reinforce the early norms that defined compliance in such narrow terms. To interrupt this cycle requires a change in the perceived legitimacy of creative compliance (and corresponding illegitimacy of calls for spirited compliance). That is, we must first address the perceived norms of corporate conduct that contribute to a corporation’s narrow definition of what constitutes legitimate compliance obligations. As Chapter 3 showed, one way to do this is to challenge the perceived lack of harm (in the eyes of the corporate community) that creative compliance causes. Without this normative change, ad hoc regulation such as the GAAR is likely to have only limited success as it fails to interrupt this cycle of behaviour. Rather, it serves to apply only after the damage has occurred, that is, after the initial stages of the ­legitimisation of creative compliance and the perceived illegitimacy of regulation has occurred. V. CONCLUSION

Chapter 2 demonstrated how repeated attempts to constrain reductive corporate compliance practices have, to date, failed to achieve a change in how corporations interpret their compliance responsibilities. This chapter, together with Chapter 3, has started to shine a light on why that is and why, without more fundamental change, it will continue to be, the case. Compliance decisions are predicated not simply on a binary economic calculation but are the product of a multiplicity of influences that comprise a person’s view of the legitimacy of their law-related behaviour. These influences are complicated enough in our everyday lives but are compounded in a corporate environment where both corporate and social norms have a role to play. By modelling the, ultimately self-perpetuating, cycle of creative compliance the compliance degeneration cycle helps to explain why the solution to the compliance crisis does not lie in single-issue tax regulation. Rather, it demands that we interrupt commonly held conceptions of the legitimacy of creative compliance, predicated to a large part on the view that creative compliance is a legitimate course of conduct to pursue in a capitalist market economy. One that does not cause harm to society and is not a normative wrong or transgression. As the next chapter demonstrates, common conceptions of classical liberal market ideology are in fact subject to challenge. Moreover, that far from furthering market ideology, creative compliance (and rejecting regulatory intervention) can in fact undermine the fundamental principles that classical liberalism and market ideology are predicated upon.

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Part II

The Case for Reform

98

5 Compliance, Predictability and the Market Order If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that, in this, as in all other fields where essential complexity of an organised kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, as the gardener does for his plants.1 FA Hayek

W

hat if it is not called capitalism? We have seen in the earlier chapters of this book that the perceived norms of a capitalist market economy, premised on a classical liberal ideology, have frequently and consistently been offered in support of reductive compliance practices.2 Put simply, that a technical approach to compliance is nothing more than the permissible (some may say inevitable) product of market philosophy. However, for the reasons that this chapter explores, not only is this view based on a misconception of the core tenets of classical liberalism but, ironically, it actually risks damaging the proper functioning of the very market order that it relies on in support. Recognising this risk is, of course, intrinsically important. However, it also plays a critical role in challenging prevailing views about the relative lack of harm caused by, and fundamental legitimacy of, creative compliance. A challenge that must, as Chapter 3 explored, be addressed if we are to achieve effective and sustainable reform. This narrow interpretation of market ideology is, undeniably, persuasive. ‘Liberalism’ is generally perceived to enshrine uncompromising principles of individualism, private property and limited state interference,3 messages that align with widely held views of capitalist thinking. In contrast, when seen 1 FA Hayek, ‘The Pretence of Knowledge,’ Nobel Memorial Lecture (11 December 1974), 7. 2 Encapsulated in the view that managers do not have an ‘ethical duty to comply with r­ egulatory laws … that managers not only may but also should violate the rules when it is profitable to do so,’ see FH Easterbrook and DR Fischel, ‘Antitrust Suits by Targets of Tender Offers,’ (1982) 80 ­Michigan Law Review 1155, 1177 (fn 57). 3 These principles are discussed further in Sections I and II (from a libertarian and classical liberal perspective respectively).

100  Compliance, Predictability and the Market Order through this lens, efforts to constrain creative compliance are viewed as nothing more than an illegitimate interference with a citizen’s freedom to act within their private domain.4 However, if we examine the roots of classical liberalism we see that it is in fact predicated on wider notions of social cooperation, trust and the maintenance of the rule of law.5 These principles are not offered by classical liberals simply as ethical ideals but as characteristics that are functionally integral to the proper order of society. In particular, they are necessary to facilitate the ‘spontaneous orders’6 (of which the market is a paradigm case) that are essential for the coordination of complex social systems.7 It is these principles, and the order that is dependent upon them, that are at risk from creative compliance. Indeed, when understood in this way, spirited compliance is not only accommodated within the classical liberal tradition but strengthens one of its core objectives, namely the facilitation of the unique coordination that is crucial for the development of society.8

4 This question of legitimacy, as discussed in ch 4, has a number of profound consequences concerning behavioural change and the scope of legitimate government. The primacy of individual property rights, an ostensibly liberal ideal, has been argued in support of the moral (and legal) legitimacy of tax avoidance. See Weeks v Sibley (1920) 269 Fed. 155, where the court held that the right to structure a corporation’s affairs to avoid tax: ‘is an incidental right, inseparably connected with an individual’s right to own and control his property’. As to the potential tension between tax and the protection of private property more generally (whilst acknowledging that both are fundamental to civil society) see E Troup, ‘Unacceptable Discretion: Countering Tax Avoidance and Preserving the Rights of the Individual,’ (1992) 13(4) Fiscal Studies 128. 5 These themes at first sight seem antithetical to market ideologies. However, they are commonly accepted as integral to the proper function of the market. For example, Mark Carney was clear that the ‘real economy relies on the financial system. And the financial system depends on trust’, see M Carney, ‘Rebuilding Trust in Global Banking’ (Remarks to the 7th Annual Thomas d’Aquino Lecture on Leadership, Lawrence National Centre for Policy and Management, Richard Ivey School of Business, Western University, London, Ontario,’ (25 February 2013) www.bis.org/review/ r130226c.pdf (accessed 9 August 2020). Further, John Kay explained that ‘financial intermediation depends on trust confidence’, see Department for Business Innovation and Skills, The Kay Review of UK Equity Markets and Long-Term Decision Making: Final Report, July 2012, 5. 6 M Polanyi, The Logic of Liberty, (first published 1951, Liberty Fund Inc., 1998), 195. Hayek wrote extensively on the spontaneous order. However, for an instructive introduction to his work on the market as a spontaneous order, see F Hayek, Law, Legislation and Liberty (first published as one volume 1982, Routledge, 2013), 34–52 (spontaneous orders generally) and 267–290 (markets as spontaneous orders). 7 See, eg, J Gray, Liberalism 2nd edn (Oxford University Press, 1995), 61: ‘free markets r­ epresent the only noncoercive means of coordinating economic activity in a complex industrial society’. As we shall see in Sections III and IV Hayek, in contrast, would take this statement one step further and argue that the market, properly supported, is the only way (coercive or otherwise) to effectively coordinate economic activity in a complex society. 8 As discussed in ch 3, repositioning the normative value of compliance is much more likely to result in behavioural change. See also T Tyler, ‘The Psychology of Self-Regulation: Normative Motivations for Compliance,’ in C Parker and VL Nielsen (eds) Explaining Compliance Business Responses to Regulation (Edward Elgar, 2011), 78. As ch 3 explains, it is a corporation’s n ­ ormative environment that can both seemingly endorse creative compliance, whilst rejecting claims for spirited compliance. As a consequence, it is the normative framing that is of crucial importance and one powerful influence on this framework is the norms of the political philosophy that dominates the market.

Compliance, Predictability and the Market Order  101 This chapter begins by examining the perceived legitimacy of creative compliance within the market economy and, in particular, the influence of current misconceptions of the ‘liberty tradition’9 on corporate compliance practices. In doing so, it suggests that the erroneous conflation of disparate political philosophies under the broad rubric of ‘liberalism’ has resulted in a mischaracterisation of classical liberalism. It is this mischaracterised notion of ‘liberalism’ that is then relied upon to legitimise creative compliance practices as aligning with market ideology.10 Dispelling this misconception, Section II explores the foundations of individualism and limited state interference within the classical liberal tradition. It explains why a classical construction of individual freedom does not endorse an unfettered right to pursue self-interest and introduces the perhaps surprising relationship between individualism and the realisation of broader social benefits. Section II also starts to introduce the important role that classical liberals ascribe to government in protecting this freedom and the legitimate role (and function) of law in society. Thus, it is here that we start to see the value that classical liberalism places on social cooperation and order, a benefit that is explained (not precluded) by the methodological individualism engaged by classical liberal thinkers. Having established the importance of social cooperation and order, Section III explores the market as a paradigm case of social order,11 distilling the specific way in which complex social systems operate and the unique value that they contribute to society. In particular, it shows how the complexity of social systems (complexity in this context meaning that the system is comprised of multiple variables) necessitates their operation as a polycentric system, with each constituent part reacting to the actions of the other. It is this fluidity of operation that enables us to better understand the importance of the relationships between system participants inter se, the regulatory architecture that is required to support them and the damage that is caused when participants undermine that regulatory framework. Developing this analysis, Section IV sets out the contours of what this regulatory framework should look like. Specifically, it examines how complex systems (unlike those with limited variables) operate as spontaneous, rather

9 This term is offered by Mack and Gaus to capture the wide spectrum of views within the broad spectrum of ‘liberalism’ that whilst different ideologies nevertheless share sufficient ‘fundamental agreements’ to fall within MacIntyre’s characterisation of a ‘tradition’. See E Mack and GF Gaus, ‘Classical Liberalism and Libertarianism: The Liberty Tradition,’ in GF Gaus and C Kukathas (eds) Handbook of Political Theory (Sage Publications, 2004), 11 citing A MacIntyre, Whose Justice? Which Rationality? (University of Notre Dame Press, 1988), 12. 10 For a discussion of the principles of classical liberalism and their relationship with a c­ apitalist market, see S Freeman, ‘Capitalism in the Classic and High Traditions,’ (2011) 28(2) Social ­Philosophy and Policy 19. 11 Other examples include language, money and queuing, see E van de Haar, Classical ­Liberalism and International Relations Theory: Hume, Smith, Mises, and Hayek’ (Palgrave Macmillan, 2009), 28.

102  Compliance, Predictability and the Market Order than planned, orders.12 Drawing primarily on the work of Friedrich Hayek, it explores how spontaneous orders can be achieved by adopting a framework of general rules of behaviour that are applied equally to all. It is this principle of equality, and the predictability of behaviour that it engenders, that is critical to the success of a spontaneous order. Without it, the system lacks integrity as it is missing a vital component, risking inefficiency or even failure.13 More immediately, and as we have seen in previous chapters, this inequality can act as the catalyst for the introduction of targeted reactionary regulation, which itself undermines the optimum architecture needed for the system to survive. By looking at the operation of society in this way, this chapter seeks to reframe how we address the question of compliance by recognising the intrinsic and instrumental value of compliance itself.14 In doing so, it builds upon the architecture for reform outlined in Chapter 3, by providing the foundation for challenging and changing the normative environment that corporate compliance is commonly analysed, defined and legitimised within. Importantly, this systems-based approach (namely starting from a position of understanding the value of compliance and only then analysing corporate responsibility to maintain it), provides a framework in which to consider the additional and often challenging questions that calls for corporate spirited compliance necessarily raise (and that are explored in the next chapter). Namely, whether within a paradigm based on the values of equality and the rule of law there are justifications for a departure from this principle of equality? That is, whether we are legitimately able to hold corporations to a higher standard of compliance than their natural counterparts?15 I.  (MIS)CONCEPTIONS OF THE ‘LIBERTY TRADITION’

Chapter 3 explained how wider environmental norms shape a citizen’s definition of compliance. For corporations, the dominant norm of wealth maximisation supports the belief that creative compliance is not only unobjectionable but, to the contrary, positively endorsed by a capitalist economy. Underpinned by perceptions of individualistic ideology and a belief that the sole responsibility of the corporation is ‘to increase its profits’,16 not only is creative compliance 12 The term ‘spontaneous order’ was originally used by Polanyi (see n 6) and later developed in a market context by Hayek, see Hayek, Law, Legislation and Liberty (n 6), 37–52. 13 Adopting Erhard, Jensen and Zaffron’s definition of ‘integrity’, namely the need for both ‘completeness’ and ‘trust,’ (discussed further in ch 8). See W Erhard, MC Jensen and S Zaffron, ‘Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics and Legality,’ (March 23, 2009). Harvard Business School NOM Working Paper No 06-11; Barbados Group Working Paper No 06-03; Simon School Working Paper No FR 08-05. 14 That is, spirited compliance is intrinsically valuable as it maintains the rule of law (discussed further in ch 6) and instrumentally valuable as, which is explored further in Sections II and III, it facilitates the market order that society depends on. 15 These questions are considered in ch 6. 16 M Friedman, ‘The Social Responsibility of Business is to Increase its Profits,’ New York Times Magazine (13 September 1970), 1.

(Mis)Conceptions of the ‘Liberty Tradition’  103 seen as a legitimate standard to pursue within a corporation’s normative environment but calls for spirited compliance are rejected as illegitimate intrusions on corporate purpose. However, if ‘all told, the market faces no serious contender as an approach to organising large scale economies’17 are we really left with an economy where we have little choice but to accept such a reductive approach to compliance? One where the most influential economic actors in civil society can legitimately ‘manipulate’18 their relationship with our legal framework? In challenging this view, this section explores the core tenets of classical liberalism and suggests that by returning to the roots of this ideology we can see how it has been misconceived. In doing so, it starts to lay the foundations (developed throughout the chapter) for understanding how spirited compliance is not only justified within this political philosophy but positively supports its fundamental objectives. A.  Perceptions of Self-Interest and Illegitimate Government Interference At its core, creative compliance reflects a view that the pursuit of self-interest, through the adoption of profitable compliance strategies, is entirely legitimate, notwithstanding the harm that this can cause (to the extent that any such harm is even acknowledged by those adopting this approach). In essence, this encapsulates the fundamental belief that an individual citizen is, and should be, free to pursue whatever ends they please with minimal state interference. This primacy of the individual, to the exclusion of wider considerations, reflects the (libertarian) ideal that individuals are full ‘self-owners’,19 much like one can own property. The consequence of this, and its analogy with property ownership, is significant. To the libertarian, property ownership confers on an owner the right to exercise complete control over the underlying asset including, given the definition of self-ownership, oneself.20 Understood in this way, not only is an individual free to control what they do (without a duty to help others) but this perspective embodies an enforceable claim that third parties cannot interfere with such personal sovereignty.21 Indeed, to advocates of this libertarian way

17 EA Posner and EG Weyl, Radical Markets, Uprooting Capitalism and Democracy for a Just Society (Princeton University Press, 2018), 19. 18 D McBarnet and C Whelan, ‘The Elusive Spirit of the Law: Formalism and the Struggle for Legal Control,‘ (1991) 54 Modern Law Review 849, 849. 19 For a discussion of self-ownership, see W Block, ‘Toward a Libertarian Theory of Inalienability: A Critique of Rothbard, Barnett, Smith, Kinsella, Gordon, and Epstein,’ (2003) 17(2) Journal of Libertarian Studies 39. 20 Thus, for a libertarian, citizens have the right to freely contract themselves into servitude, see Block, ‘Toward a Libertarian Theory’ (n 19). A view that is not shared by classical liberals (see, Freeman, ‘Capitalism’ (n 10), 20). 21 Aligned with this robust notion of self-ownership is the libertarian conception of the ­absolute nature of economic rights, such as the right to freedom of contract and property ownership. On which, see Freeman, ‘Capitalism’ (n 10), 20.

104  Compliance, Predictability and the Market Order of thinking, it is entirely legitimate to pursue a strategy of creative compliance as a means of furthering a corporation’s self-interest (to increase its profits), notwithstanding the externalities that it may cause. It is perhaps also the reason that libertarianism is seen to advocate an ‘unbridled selfish materialism’,22 whilst the market economy it endorses has been characterised as an ‘impersonal monster’.23 Given this ‘extreme individualism’,24 it follows that libertarians reject most forms of government intervention,25 which is considered to be a violation of an individual’s freedom.26 Taxation is a clear case in point which, if applying this philosophical lens, can be construed as an illegitimate demand for the transfer of individual assets.27 In contrast, creative compliance is simply the permissible pursuit of self-interest and the legitimate exercise of control over one’s own property. That said, libertarian arguments against central control are not only grounded in autonomy and self-sovereignty. Rather, if we adopt a libertarian perspective, regulatory intervention is also considered to be inefficient, as it undermines individual utility. When individuals are free to act as they wish, they will, it is argued, naturally choose to do so in a utility maximising way.28 Thus, to a libertarian, regulatory demands are by their very nature asking for conduct that would not have been entered into voluntarily and that is not therefore utility maximising.29 It is these libertarian principles of self-ownership and minimal government intervention that support the view that a liberal market economy rejects the coercive constraint of creative compliance. In particular, the market is perceived to promote the unfettered pursuit of self-interest, which ‘repudiates sacrifice’30 and

22 MN Rothbard, Man, Economy, and State with Power and Market 2nd edn (Mises Institute, 2009), 1321. 23 ibid, 1324. 24 S Razeen, Classical Liberalism and International Economic Order (Routledge, 1998), 16. 25 Rothbard outlines three forms of intervention: (i) autistic intervention (the unilateral coercion by the state over a citizen without receiving anything in return, eg the prohibition on murder); (ii) binary intervention (coerced exchange where the state received something in return, such as taxation); and (iii) triangular intervention (where the state compels or prohibits exchanges between two subjects, such as price control and licensing). See Rothbard, Man, Economy, and State (n 22), 877–878. 26 To the extent that individual coercion is required (and few admissions are made in this regard), libertarians argue that it can (and should) be left to the freely competitive market to identify a private agency that would perform such services, see Rothbard, Man, Economy, and State (n 22), 1030. This broad commitment to the primacy of the market extends to the provision of ‘public’ goods such as police or judicial protection, see Rothbard, Man, Economy, and State (n 22), 1048. It is not surprising that libertarian approaches to compliance adopt a highly formalist practice, on this see WH Simon, ‘After Confidentiality: Rethinking the Professional Responsibilities of the Business Lawyer,’ (2006) 75(3) Fordham Law Review 1453, 1459. 27 L Murphy and T Nagel, The Myth of Ownership (Oxford University Press, 2002), 9. 28 Rothbard, Man, Economy, and State (n 22), 879. 29 ibid. 30 E Mack, ‘Individualism, Rights and the Open Society,’ in T Machan (ed) The Libertarian Reader (Rowman and Littlefield, 1982), 4.

(Mis)Conceptions of the ‘Liberty Tradition’  105 where individuals are concerned with ‘nothing but [their] own enrichment’.31 Yet is it really the case that our modern economy is founded on principles that endorse such myopic behaviours? Fortunately, as Section II explains, this libertarian analysis does not reflect the classical liberalism that the market is premised upon, giving rise to the question as to how this misconception has occurred. B.  The Emergence of ‘Everyday’ Liberalism The difficulty in distilling the true principles of the market economy is that ‘liberalism’ or the ‘liberty tradition’ enshrines a number of diverse philosophies, including libertarianism and classical liberalism.32 It is indeed the case that, at their core, all ‘liberals’ share a commitment to the ‘polar star’33 of freedom.34 That is, freedom of the person is seen as a fundamental (or basic) liberty that, whilst not wholly absolute,35 is to be protected from coercion, be it by the government or fellow citizens.36 As a consequence, most liberals also agree that the role of government should be limited, often to the protection of the individual rights that are necessary to maintain this freedom.37 However, notwithstanding these broad similarities, significant differences exist across the liberal spectrum as to the appropriate scope of individual freedom and the corresponding sphere of legitimate government intervention (and, as a corollary, compliance with such intervention).38 In particular, and as outlined further in Section II, there are important distinctions between libertarian thinkers and their classical liberal counterparts. 31 L von Mises, Liberalism, the Classical Tradition (first published 1927, Liberty Fund, 2005), xxvi. 32 In general terms, a helpful taxonomy (understanding that the extent of variations are such that a precise definition, and one without criticism, is a difficult task) is that offered by Edwin van de Haar: social liberalism (a modern variant that calls for the greatest government i­ntervention); ­libertarianism (which advocates individualism in the strictest sense and favours minimal state ­intervention); and classical liberalism that occupies the middle ground. See Evan de Haar, Classical Liberalism (n 11), 19. The distinctions between these schools of thought, which are premised on different p ­ hilosophical foundations, result in important policy consequences (for example, as to the legitimacy of state interference and the provision of public goods, on this, see NP Barry, On ­Classical Liberalism and Libertarianism (Palgrave Macmillan, 1986), 3. 33 A liberal is a person whose ‘polar star is liberty’, Lord Acton, cited in GH Smith, The System of Liberty, Themes in this History of Classical Liberalism (Cambridge University Press, 2013), 2. 34 Hence the name liberal from liber ‘to be free’. 35 Important exceptions do exist for the classical liberal, which are discussed in Section II. These basic liberties, whilst not ‘absolute’ can only be infringed to ‘protect other basic liberties and maintain essential background conditions for their effective exercise, see Freeman, ‘Capitalism’ (n 10), 19. 36 For a discussion of basic liberties (including the qualification that basic liberties should be capable of equal coterminous enjoyment by all citizens, which is discussed in Section II) see P Pettit, ‘The Basic Liberties,’ in MH Kramer (ed) The Legacy of H.L.A. Hart: Legal, Political and Moral Philosophy (Oxford University Press, 2008), 201–224. 37 van de Haar, Classical Liberalism (n 11), 19–20; and Gray, Liberalism (n 7), 70–77. These rights include the basic liberty of freedom of the person, together with economic rights such as the freedom of contract and property, on which see Freeman, ‘Capitalism’ (n 10), 31–35; S Freeman, ‘Illiberal Libertarians: Why Libertarianism is Not a Liberal View,’ (2001) 30(2) ­Philosophy and Public Affairs 105, 108–111. 38 Freeman, ‘Illiberal Libertarians’ (n 37); van der Haar, Classical Liberalism (n 11), 19.

106  Compliance, Predictability and the Market Order Regardless of these differences, the perceived similarities between ‘liberal’ ideologies have caused an ‘everyday’39 liberalism to emerge, which conflates multiple liberal philosophies into a single school of thought. In doing so, the important diversity across the liberal spectrum is lost40 as elements of a particular liberal ideology are ‘taken to be the whole liberal story’41 giving rise to ‘much misunderstanding’.42 Most notably, it is the more extreme libertarian ideologies discussed in this section that are adopted as key tenets of this ‘everyday’ liberalism. Notwithstanding its lack of conceptual coherence, this conflated, hybrid philosophy gains legitimacy as a school of thought as its libertarianesque principles align, as we saw in Chapter 1, with common perceptions of the shortcomings of a capitalist market economy. As a consequence, the nuances of various liberal ideologies become lost, resulting in a somewhat binary interpretation of the needs and values of classical liberal thinking. This convergence of broad ideals is unlikely to survive more than a cursory analysis. However, as we have seen,43 it is the perception of these norms, rather than their reality, that shape a corporation’s understanding of the legitimacy of regulation and their corresponding compliance obligations. Therefore, it is perhaps not surprising that if we return to Friedman’s oft-cited quote, we see that it is circumscribed to simply refer to a corporation’s singular responsibility to increase profits, presenting a view that aligns with a decidedly libertarian ideology. However, in doing so, this obscures the fact that Friedman proceeded to expressly restrict this duty in a manner that demonstrates the stark contrast between libertarian and classical liberal principles (particularly from a compliance perspective). That is, Friedman was clear that the obligation to increase profits was subject to a duty to conform ‘to the basic rules of the society, both those embodied in law and those embodied in ethical custom’.44 II.  DEFINING (AND CONSTRAINING) FREEDOM WITHIN THE CLASSICAL TRADITION

In contrast to this highly libertarian approach, classical liberalism acknowledges an important, but not absolute, role for the state within society. Specifically, 39 This ‘everyday liberalism’ reflects the ‘extension of more restricted concepts beyond the boundaries within which they actually apply … a muted or confused version of the real thing’. See Murphy and Nagel, The Myth of Ownership (n 27) 34–35. See also Razeen, Classical Liberalism (n 24), 16. 40 The ‘idea that there is one doctrine of liberalism is illusory’, see Barry, On Classical ­Liberalism (n 32), 17. Indeed, the search for unity across this ideology ‘disintegrate[s] even under the most superficial of analyses,’ Barry, On Classical Liberalism (n 32), 11. Ludwig von Mises lamented that the ‘term “liberalism” today … stands in direct opposition to what the history of ideas must designate as liberalism’. See von Mises, Liberalism, the Classical Tradition (n 31), 157. 41 van de Haar, Classical Liberalism (n 11), 1. 42 Barry, On Classical Liberalism (n 32), 17. 43 See ch 4. 44 Friedman, ‘The Social Responsibility’ (n 16), 1.

Defining (and Constraining) Freedom within the Classical Tradition  107 whilst classical liberalism clearly endorses personal freedom as a basic liberty it nevertheless recognises vital constraints that preclude an unfettered right for a citizen to do as they please (including the adoption of creative compliance strategies). By understanding these foundations of individualism within the classical tradition, we are able to appreciate both how this informs the boundaries of ‘legitimate’ regulatory intervention and its, perhaps surprising, interaction with the importance that classical liberals place on cooperation. As shall be seen, it is this cooperation that depends upon a respect for, and meaningful compliance with, the necessary rules of civil society including the fundamental (and instrumental) importance of the maintenance of equality before the law. A.  Freedom of the Individual In common with other liberal traditions, and by its very definition, classical liberalism is normatively individualistic,45 recognising individual freedom as a basic liberty.46 Its central claim is that citizens should be free to pursue their own self-interest across all aspects of life: social, political and economic, subject only to the corresponding right of others to do the same (an important qualification that this section will return to).47 Thus, the primary objective of classical liberalism (and the government that it endorses) is to maintain the equal freedom of citizens as a bulwark against illegitimate encroachment, be it from the monarchy, the state or other citizens.48 It follows from this characterisation that any restriction (or coercion) of that freedom, whilst not prohibited, must nevertheless be justified, regardless of the source of such interference.49 For the classical liberal, this focus on the individual encompasses both a positive and normative analysis.50 Positively, it adopts a methodological individualism that, far from disregarding social cooperation (or responsibility), acknowledges the role and importance of collectives within society.51 Rather, 45 That is, it endorses both the freedom of the individual and a methodological individualism (Razeen, Classical Liberalism (n 24), 16. On the latter see FA Hayek, Individualism and Economic Order, (first published 1948, University of Chicago Press, 1980). 46 Gaus and Mack, ‘Classical Liberalism’ (n 9), 116. 47 See Section II.B. For classical liberals, the individualism that characterises their philosophy was that introduced by Locke, Mandeville and Hume and developed by the Scottish Enlightenment, in particular Ferguson and Smith, see Hayek, Individualism and Economic Order (n 45), 4. 48 It is important to note that the right to freedom extends to protection from encroachment by both the state and fellow citizens. Chapter 6 considers this right further to consider whether it extends a corresponding duty to citizens as well as the state. 49 FA Hayek, The Constitution of Liberty (first published 1960, Routledge Classics, 2006), 19. 50 D Boaz, The Libertarian Reader (Free Press, 1997), 117. 51 Hayek described individualism as ‘a theory of society, an attempt to understand the forces which determines the social life of man, and only in the second instance a set of political maxims derived from this view of society. This fact should by itself be sufficient to refute the silliest of the common misunderstandings: the belief that individualism postulates … the existence of isolated or self-contained individuals instead of starting from men whose whole nature and character is determined by their existence in society.’ See Hayek, Individualism and Economic Order (n 45), 6.

108  Compliance, Predictability and the Market Order what it suggests is that as society (or any other collective group) is comprised of, and acts by, individuals then the individual should be the first unit of analysis.52 Thus, whilst the actions of a collective or institution are important,53 to understand them we must first discern what motivates the individuals that they are comprised of (hence the importance of the analyses in Chapters 3 and 4). This is a conceptually significant contrast to libertarian notions of individualism. That is, classical liberals do not reject the value of society, cooperation or the need to protect the frameworks that support them. Instead, they simply acknowledge that to understand society we must first understand its individual citizens. Normatively, this respect for self-interest enables the diversity of a society to develop, as citizens are free to pursue a wide range of personal preferences.54 In doing so, individuals are able to contribute their own perspective, abilities and knowledge to society and Section III examines the integral role that these contributions make to the proper order (and development) of the market as a vital social system. However, at this juncture it is important to note that there is a significant public utility in facilitating the freedom to pursue self-interest. It is by striving to meet our own needs (for example, wealth maximisation) that we identify and serve the needs of others.55 As Adam Smith famously observed, ‘it is not from the benevolence of the butcher, the brewer or the baker that we get our dinner, but from their regard to their own self-interest’.56 Somewhat ironically, it is these benefits (amongst others) that are at risk if we damage, through narrow compliance practices, the institutional architecture that supports them. The fallacy of the claim that a market economy, premised on classical liberal ideals, promotes (or should promote) an unbridled self-interest is immediately clear when we consider the implausibility of such a proposition. Whilst the broad classical liberal commitment to individual freedom is not in dispute, it is equally apparent that such a right cannot be absolute.57 If each individual were free to pursue their own self-interest this would involve granting citizens an unhindered right over the otherwise private and protected domain of others. By way of example, my right to reside in my own property to the exclusion of others cannot coexist with an unfettered right in others to occupy it (should they 52 ibid. 53 The impact of corporate actions, norms and architecture are considered in chs 3, 4 and 7. 54 FA Hayek, ‘The Use of Knowledge in Society,’ (1945) 35(4) The American Economic Review 519. 55 When the rights of this autonomous individual are protected, they will ‘exchange with … fellow men so as to advance the values of each’, see Barry, On Classical Liberalism (n 32), 4. However, as made clear in this section and ch 6, this pursuit of self-interest ought to be constrained when it intrudes on the equal rights of others and damages the legal and market orders. 56 A Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, (first published 1776, Oxford University Press, 2008) book 1, ch II, para 2. See also ‘The advantages derived from peaceful cooperation and division of labor are universal. They immediately benefit every generation … When social cooperation is intensified by enlarging the field in which there is division of labor or when legal protection and the safeguarding of peace are strengthened, the incentive is the desire of all those concerned to improve their own conditions. In striving after his own – rightly understood – interests the individual works toward an intensification of social cooperation and peaceful intercourse.’ von Mises, Liberalism, the Classical Tradition (n 31), xxii. 57 P Manent, An Intellectual History of Liberalism, (Princeton University Press, 1995), xvi.

Defining (and Constraining) Freedom within the Classical Tradition  109 so wish). Thus, the question arises as to how, within an ideology of freedom and individualism, are citizens’ respective rights to freedom compatible with each other?58 The classical liberal response to this challenge is that the freedom of the individual is, broadly, constrained in one important way. An individual’s freedom is limited to the extent that it would otherwise encroach upon another citizen’s equal right, such that ‘every man may claim the fullest liberty to exercise his faculties compatible with the possession of like liberty by every other man’.59 This negative conception of freedom60 means that I can act as I wish so long as I do not interfere with your equal right to do so.61 Therefore, to live (and prosper) in society, without fear of encroachment, requires mutual agreement between citizens to curtail the absolute freedoms they may otherwise enjoy. As Pettit acknowledges, as a right of citizenship, it is critical that the basic liberties coexist, that is, that they are capable of co-enjoyment.62 We thus start to see the integral importance of mutual agreement and trust (namely that one’s co-citizens will adhere to this agreement) to the order of society and the protection of individual freedom within it. This right to freedom, subject only to a duty to respect the corresponding right of others, enshrines the classical liberal commitment to equal treatment.63 It is this commitment that delineates the ‘classical liberal view, [that] liberty and the protection of the individual domain partly depend on protection through law secured by the state’.64 As a consequence, we start to understand the two principles that inform a classical liberal interpretation of what individual compliance obligations should be. First, that the state does have some form of legitimate right of intervention (or coercion) over individual freedom. Second, that the proper order of society is premised on a strong principle of equality, and, in particular, equality before the law (a principle considered further in Chapter 6). B.  Limited State Interference Pursuant to this negative conception of freedom, it follows that it is legitimate (indeed, necessary) for the state to create a protected sphere of individual action.65 58 On ‘compossible’ rights see H Steiner, ‘The Structure of a Set of Compossible Rights,’ (1997) 74(12) The Journal of Philosophy 767. 59 H Spencer, Social Statistics; or, the Conditions Essential to Human Happiness Specified, and the First of them Developed, (first published 1851, Palala Press, 2016), part two, ch four, § 3. 60 Namely, that ‘liberty in this sense is simply the area within which a man can act unobstructed by others’, see I Berlin, Four Essays on Liberty (first published 1969, Oxford University Press, 2013), 122. 61 Rights ‘always have obligations as their correlative’, see Mack, ‘Individualism’ (n 30), 5. 62 Pettit, ‘The Basic Liberties’ (n 36), 207. 63 Barry, On Classical Liberalism (n 32), 4. This commitment reflects a particular understanding of equal rights and, as a corollary, equal liberties. This concept of equality is examined further in ch 6. 64 van de Haar, Classical Liberalism (n 11), 30. 65 Hayek, The Constitution of Liberty (n 49), 130.

110  Compliance, Predictability and the Market Order That is, the legal space within which an individual is able to act, free from ­illegitimate coercion, but subject to (namely, delineated by) the equal right of other citizens. Seen in this way, the ‘common misconception’66 that classical liberals advocate an absolute laissez-faire state becomes clear.67 That far from endorsing a lack of regulation, it would be ‘disastrous’68 to suggest that it is not possible to limit personal freedom. Rather, classical liberals seek to understand the appropriate scope of legitimate government action,69 premised on this negative construction of freedom and the belief that the onus of proof on justifying regulatory intrusion rests on those seeking to introduce it.70 It follows from this analysis that one role of government is to establish and enforce the rights necessary to facilitate personal freedom whilst protecting ‘every member of society from the injustice or oppression of every other member’.71 In broad terms, these rights include the performance of promises (including the freedom of contract), the protection of property rights and the maintenance of the rule of law.72 Protecting the performance of promises not only facilitates the freedom to engage with (and control) individual property but it reflects a deeper need to be able to rely on the voluntary agreements that we enter into with others. Namely, to trust that others will act in the way that they have agreed to, that they will honour their word. It is by protecting the performance of promises that we help to support the certainty and predictability of behaviour that is vital to maintain the very particular order that complex social systems depend upon. It will be of no surprise that property rights are fundamental to a classical liberal society. However, their role is not to delineate the relationship between a citizen and an asset per se, but ‘between a person and a person’.73 That is, they identify what other citizens cannot do, including the right of an owner to largely exclude both citizens and the state from interfering with their property. It is by safeguarding a person’s title to their property that we grant them the freedom to exchange it, to create and extract value from it. Thus, the protection

66 BZ Tamanaha, On the Rule of Law: History, Politics, Theory (Cambridge University Press, 2004), 45. 67 Indeed, ‘probably nothing has done so much harm to the liberal cause as the wooden insistence of some liberals on certain rough rules of thumb, above all the principle of laissez faire’, see F Hayek, The Road to Serfdom, (first published 1944, Routledge Classics, 2001), 21. 68 C King, ‘Moral Theory and the Foundations of Social Order’ in T Machan (ed) The Libertarian Reader (Rowman and Littlefield, 1982), 31. 69 Hayek, The Constitution of Liberty (n 49), part two of the Constitution of Liberty discusses this issue, specifically ch 10. 70 The onus of proof ‘of making out a case always lies on the defenders of legal prohibitions’, see JS Mill in J Riley (ed) Principles of Political Economy and Chapters on Socialism (first published 1899, Oxford University Press, 1998), 327. 71 Smith, An Inquiry (n 56) book 4, ch 9, 51. 72 For a more detailed discussion of these rights see Boaz, The Libertarian Reader (n 50), 64–70. 73 I Shivji, ‘Lawyers in Neoliberalism: Authority’s Professional Supplicants or Society’s ­Amateurish Conscience?’ Valedictory Lecture (15 July 2006) 6 http://mokoro.co.uk/wp-content/uploads/shivji_ lawyers_in_neoliberalism.pdf (accessed 9 August 2020).

Defining (and Constraining) Freedom within the Classical Tradition  111 of promises and property rights are, largely, permissive. They enable a citizen to act freely, entering into voluntary relationships to pursue their own interests (the importance of which is, as we shall see, fundamental not only to intrinsic human enjoyment but also to the proper function of the market order). In contrast, it is the rule of law and, in particular the principle of equality before the law, which operates to constrain the otherwise broad freedom of the individual. It is this principle that provides the necessary protection to ensure that ‘individualism’ is not construed to mean an ‘unfettered right to do as one pleases’ with the attendant difficulties and chaos that would ensue. Moreover, and as Sections III and IV explore, it is this principle that is under threat by creative compliance, risking damage to the order that society is dependent upon. Against this overview, we start to see that, for the classical liberal, the state is justified in intervening to establish the regulatory and institutional frameworks that are necessary to protect individual freedom and the coordination (or order) of the complex social systems that such freedom operates within.74 In contrast to common perceptions of the everyday liberalism outlined above, these frameworks are premised, and depend, upon broader notions of trust and equality, the functional impact of which is considered later in the chapter. Indeed, the institutional importance of maintaining this architecture of rules is such that when these frameworks break down ‘it is government’s role to intervene’.75 Thus, when understood in this way, it is not surprising that Ludwig von Mises described the suggestion that classical liberalism rejected government intervention as a strategy adopted by critics to misrepresent and impose a completely ‘pejorative connotation’76 on classical liberal philosophy. To the contrary, a great deal of attention was paid by classical liberals to the appropriate ‘rules of the game’ and the remaining parts of this chapter consider what these rules, and their relationship with compliance, are. C.  Dispelling the Paradox: Individualism and Cooperation Creative compliance is, inherently, an act of self-interest. It prioritises the pursuit of individual profit over broader social interests including fundamental principles of civil society such as equality before the law. We have seen that to constrain individual freedom within a classical liberal ideology requires justification, but that there is, nonetheless, legitimate scope to do so. Nevertheless, there is a seeming paradox between a philosophy premised on individualism (­including 74 Oakeshott observed that civil society had identified a set of ‘arrangements in which we are associated with each other … agreed-upon procedures that secure opportunities for self-regulating individuals to pursue their self-chosen, widely varying forms of flourishing in voluntary associations, supported especially by the rule of law’, see M Oakeshott, On History and Other Essays (Liberty Fund, 1999), xii. 75 Freeman, ‘Capitalism’ (n 10), 23. 76 von Mises, Liberalism (n 31), xxvi.

112  Compliance, Predictability and the Market Order the pursuit of self-interest) and calls for spirited compliance that are based (as shall be seen in the following section) on broader notions of social order. Notwithstanding this ostensible tension, classical liberalism does not exclude considerations of social interest and coordination.77 On the contrary, the need to protect the order of society is a ‘central element’78 of classical liberal thinking. It is this order that helps facilitate the benefits outlined in Section A, including the diversity of society and the attainment of social needs. For individuals to prosper and live peacefully together within society, they necessarily need to (and do) engage with each other. Classical liberal ideology is therefore clear that ‘individualism and community are coextensive, not in conflict’.79 In fact, achieving voluntary (and, as shall be seen in Section IV, spontaneous) social order is not simply coexistent with individual freedom but rather a mechanism for protecting it. Early classical liberals, including Adam Smith, accepted that the Great Society was a ‘complex and productive society made possible by social interaction’.80 Rather, the challenge that arises is how to achieve such coordination, namely how the apparent chaos of a complex social system can find order.81 The problem identified by classical liberals is that if order is not secured voluntarily then citizens are exposed to the risk of compulsion.82 Therefore, what is important to the classical liberal (and the subject of the remainder of this chapter) is establishing the necessary regulatory and institutional architecture that facilitates voluntary cooperation, rather than facing a centrally planned (or dictated) order that restricts individual freedom. To the classical liberal, individualism serves both as a protection against illegitimate coercion and as a means of contributing to the interests of society as a whole.83 It is the foundation for understanding the unique framework that is needed to support the maintenance of order in a diverse and fragmented society, the paradigm case of which is the market. The capitalist market economy is, as we have seen, also the justification offered by corporations in defence of creative compliance. The following sections explore the function and architecture of the market order in more detail, demonstrating both the value of this very particular order to society and why, far from maintaining it, creative compliance fundamentally undermines the principles of trust and equality that it is premised on.

77 Hayek, Individualism and Economic Order (n 45), 6. 78 Described as a ‘central element’ of classical liberalism. See van de Haar, Classical Liberalism (n 11), 17. 79 Boaz, The Libertarian Reader (n 50), 51. 80 D Boaz, The Libertarian Mind (Simon & Schuster, 1997), 120. In this way, society is a produce of human action in which individuals cooperate to best meet their needs, see L von Mises, Human Action, a Treatise on Economics Volume I (first published 1949, Liberty Fund, 2007), 146–147. 81 Hayek, Individualism and Economic Order (n 45), 77. 82 H Spencer, ‘The New Toryism’ in AJ Nock (ed) The Man Versus the State (first published 1892, Liberty Classics, 1981), 10. 83 van de Haar, Classical Liberalism (n 11), 27; L von Mises, Human Action: A Treatise on Economics (first published 1949, Liberty Fund, 2007), 731.

In Defence of the Market Order   113 III.  IN DEFENCE OF THE MARKET ORDER

As Section II explained, for the classical liberal, social cooperation is a fundamental element of civil society.84 Whilst this has been true throughout the ages, in a modern, global, society we find ourselves almost wholly dependent on others to meet even our most basic of individual needs such as the provision of work, food, infrastructure and support. Yet, as with many things that have become both commonplace and essential for day-to-day living, we risk a complacency as to the function and value of this cooperation to society. None more so than in the case of the market order. This section reflects upon the unique benefit that the market provides to society. In doing so, it not only acts as a salient reminder of, for all its challenges, the benefits that the market provides but it also distils the relationship between individual freedom and cooperation (thus helping to explain the methodological individualism explored in Section II). It is by exploring the function of the market that we can start to identify the relationships that it depends upon and, in so doing, better understand the interactions that the market’s regulatory architecture needs to support. Section IV then examines this infrastructure, and its relationship with creative compliance, in more detail. A.  The Market as a Conduit of Knowledge Notwithstanding its importance, the primary purpose of the market is often misunderstood. It is commonly presumed that the central function of the market is to help market participants logically allocate their resources, premised on complete knowledge.85 However, there is a deeper and infinitely more difficult problem that a modern, global economy faces and which the market manages to resolve. That is, those who possess resources need to know where to invest (or deploy) them. To do that, it is necessary to know the needs of others to understand how those needs might be met.86 Without this information, it is simply not possible to ‘allocate resources according to consumer preferences’.87 As such, the critical challenge we face in society (particularly a dispersed one such as ours) is how to allocate resources when no single individual possesses the entire knowledge necessary to make such a decision.88 Thus, the fundamental role that the market performs is not resource a­ llocation but the necessary precursor to that (secondary) function, namely the collation and communication of knowledge. The ability of the market to convey such



84 Hayek,

Individualism and Economic Order (n 45), 16. 77. 86 ibid, 78. 87 Boaz, The Libertarian Reader (n 50), 12. 88 Hayek, Individualism and Economic Order (n 45), 78. 85 ibid,

114  Compliance, Predictability and the Market Order knowledge is critical to the proper functioning of society, f­acilitating research and development, the growth of business, the creation of jobs and the protection of competition (in favour of the consumer). However, this function of the market as a conduit of knowledge is commonly forgotten or, at best, taken for granted. This risks a dangerous complacency (particularly when public sentiment tends to concentrate on the negatives of a market economy), both as to the important role of the market in society and the unique framework required to support it. The complexity of this communication task becomes clear when we examine (in broad terms) the nature of the information that the market conveys. The knowledge that the market communicates is highly fragmented, dispersed and, importantly, context specific.89 That is, this information is held on a piecemeal and global basis, distributed across a wide array of unconnected individuals. Nevertheless, the market is able to collate this information from multiple actors and communicate it to otherwise unconnected market participants.90 The consequences of this should not be, but often are, underestimated. Specifically, that those operating within (or even simply observing) the market are able to employ information that neither they, nor any one individual, possesses in totality.91 The outcome is that market participants are able to utilise knowledge that they do not, and cannot, possess,92 to satisfy the demands of people whom they have never met and whose needs they do not, personally, know. Thus, it is the utilisation, not simply possession, of knowledge that is made possible by the market.93 The scale of this coordination and communication exercise can be understood by considering, briefly, a simple yet common transaction. Each morning busy commuters buy cups of coffee at train stations across the country, drinks that are purchased with little thought and are a fleeting part of a person’s day. However, this seemingly simple purchase is part of a transaction that brings together coffee farmers and owners from around the world, local landlords, franchisors from North America, cargo and transportation companies, airlines, utility companies, branding executives and a supporting plethora of professional advisors including lawyers and accountants, all to produce a hot drink for a busy traveller that is forgotten within half an hour. Yet how does the coffee franchisee know where to locate their shop, the landlord know how much to charge for the lease, the professional advisors know what to charge for their services and where to advertise them, the farmer know which type of bean to

89 ibid, 80. 90 ibid. 91 This is the fundamental value of the market, namely that partial knowledge can be acted on and contribute to the whole, see Razeen, Classical Liberalism (n 24) 19. 92 Hayek, Law, Legislation and Liberty (n 6), 16. 93 The function of the market as an aggregator of dispersed knowledge was something that ­Friedrich Hayek wrote on extensively (particularly in response to what he saw as the threat of central planning in a socialist’s political environment). His work in this regard is extensive but a useful ­introduction is Hayek, Individualism and Economic Order (n 45).

In Defence of the Market Order   115 grow, in what q ­ uantities and for how much (and that’s before we even start to consider the array of milks, syrups and blends that are now on offer)?94 The magnitude of this task and its ramifications are, put simply, remarkable. The market enables individuals to act upon an ever-changing cycle of information, which they do not personally possess. In this way, business has developed on a global scale with concomitant increases in, amongst other things, k ­ nowledge and financial prosperity. However, this information cannot be realistically gained from a costly and time-consuming process of due diligence. The question considered in the following section is how this knowledge is conveyed in a quick, efficient and meaningful way allowing market participants to act in a timely and relatively frictionless manner. B.  Conveying Knowledge Through the Price Mechanism To share such dispersed and fragmented knowledge effectively, the market requires a communication method that satisfies two conditions. First, whilst the information to be conveyed is highly fragmented and complex, the method of communication must be simple and accessible. Each market participant must be able to access the same information at the same time to enable them to respond quickly to changes in market knowledge. Second, the knowledge that market participants require (and therefore that needs to be communicated) is not absolute knowledge but the relative value of particular goods or services. That is, the market needs to know about their scarcity or demand, not the reason why they are so coveted (or not as the case may be).95 For example, the coffee vendor simply needs to know that they should invest resources into a particular location because there is sufficient demand (not that this demand exists because of a lack of competition or popularity of route).96 The way that the market meets these two challenges is through the price mechanism.97 The price mechanism is, ostensibly, a deceptively simple process 94 This example is drawn from T Harford, The Undercover Economist, (Abacus, 2011), 2. 95 Hayek, Individualism and Economic Order (n 45), 84. 96 This decision as to resource allocation is made possible because of the economic calculation facilitated by the simplicity of the price system: ‘Capitalist economic calculation, which alone makes rational production possible, is based on monetary calculation. Only because the prices of all goods and services in the market can be expressed in terms of money is it possible for them, in spite of their heterogeneity to enter into a calculation involving homogeneous units of measurement.’ See von Mises, Liberalism (n 31), 47. 97 The price mechanism is ‘the sum of information reflected or precipitated in the prices is wholly the product of competition, or at least of the openness of the market to anyone who has relevant information about some source of demand or supply for the good in question … Competition operates as a discovery procedure not only by giving anyone who has the opportunity to exploit special circumstances the possibility to do so profitably but also by conveying to the other parties the information that there is some such opportunity. It is by this conveying of information in coded form that the competitive efforts of the market game secure the utilisation of widely dispersed knowledge.’ See Hayek, Law, Legislation and Liberty (n 6), 276–277.

116  Compliance, Predictability and the Market Order that aggregates information concerning the scarcity of a particular commodity and communicates it, via a single number, to the market as a whole.98 In doing so, it takes the local knowledge of all market participants and enables the rest of the market to utilise it; knowledge that they do not possess themselves. Crucially, this system is automatic, communicating local information to the market without the need for intermediaries. Effectively, the system ‘works itself’.99 In response, market participants are able to adjust their own behaviour to facts that they simply do not know and, in doing so, further contribute to the aggregate knowledge of the market.100 Returning to our coffee shop owner, they are able to increase prices to reflect the scarcity of coffee beans (premised on the increase of the cost of the raw materials) as a consequence of a drought that they were completely unaware of. Thus, the price mechanism facilitates ‘the marvel’101 that information which only a handful of people are aware of can be utilised by the whole market, simply by watching price fluctuations in the market and acting accordingly. C.  Polycentric Systems and Market Order The market facilitates the utilisation of dispersed knowledge in a very specific way. Once the price mechanism has communicated information to the market, participants are free to respond in any manner that they choose. It is through that response that each participant contributes information to the market about their local environment, potentially triggering further price adjustments. As prices change, market participants continue to respond, with these responses themselves further impacting market prices, which adjust accordingly and so on and so forth. Thus, otherwise unconnected market actors effectively interact freely with each other, through market pricing, quickly adjusting their own conduct in response to the decisions of others.102 In this way, the market operates as a polycentric order that facilitates a fluidity of perpetual adjustment around decentralised loci of decision-making.103 This process of adjustment is continuous and self-generating; by pursuing individual self-interest in response to the price system each participant automatically contributes to the collective knowledge of the market. The order does not arise from ‘a single centre,

98 Hayek, Individualism and Economic Order (n 45), 86. 99 RH Coase, ‘The Nature of the Firm,’ (1937) 16(4) Economica 386, 387. 100 Hayek, Individualism and Economic Order (n 45), 86. 101 ibid, 87. 102 This adjustment is, generally, premised on the notion of exchange, namely of buying and selling goods and services. These exchange transactions are dependent on the rules of contract and property ownership that were discussed in Section II and it is here that we see their importance. It is only by having security of title, and the ability to exchange that title with confidence, that these exchange relationships can occur. 103 Polanyi, The Logic of Liberty (n 6), 174–5 and 195–6.

In Defence of the Market Order   117 but … is produced by the responses of the individual elements to their respective surroundings’.104 Moreover, this process allows an order to be achieved without dictating an ultimate outcome, or evaluating and prioritising the interests of one group over another.105 It allows all participants the equal right or, put another way, freedom to pursue their own desires and for this to be perpetually aggregated and reflected in the overall knowledge of the market.106 It is this polycentricism that renders the market incapable of central design and, as a consequence, dependent upon a particular regulatory structure. The market is comprised of a vast number of constituents (who could never be fully identified at any given moment in time), each of whom are responding to multiple influences and motivations. As market information changes, so too can their actions, which can have a corresponding impact on the decisions of others (and the market as a whole).107 The reality is that more knowledge enters into the market, which is then reflected in market prices, than can ever be known to a single authority.108 Ideologically, central market control is undesirable to many. However, such control raises concerns beyond the purely ideological. Rather, one of the risks that arises from centralised control is that the constraint of individual freedom undermines the core function of the market as a conduit of knowledge (as participants are unable to respond freely to the price mechanism). It is here that we see why it is so critical to remind ourselves both of the function of the market in society and the magnitude of the task that it (and other social systems) achieve. To create a system that can, through a single price mechanism, reflect the knowledge of a global market, aggregate dispersed events of which we are completely unaware, facilitate entrepreneurial growth and support personal freedom is something that we should be very careful not, through familiarity, to take for granted. Indeed, the complexity of the task is such that had the market been specifically designed it would be considered one of the greatest achievements of mankind.109 It is at this juncture that the relationship between freedom and cooperation starts to emerge. Specifically, it is the freedom that individuals have to pursue their self-interest in response to market movements that enables them to contribute local knowledge to the market.110 If participants were directed to act in a certain way, or to achieve a certain objective, then this contrived behaviour would not inform the market of local conditions (other than the existence of a central diktat). Not only would this distort the accuracy of the information in 104 F Hayek, in B Caldwell (ed) The Collected Works of F. A. Hayek, The Market and Other Orders (Routledge, 2014), 161. 105 The difficulty of which is discussed in ch 6. 106 This ‘strict’ definition of equality is considered further in ch 6. 107 Hayek, Individualism and Economic Order (n 45), 87. 108 ibid, 80. 109 Hayek, Individualism and Economic Order (n 45), 87. 110 ibid, 84.

118  Compliance, Predictability and the Market Order the market, but it would also undermine trust in the price mechanism. Once this trust is lost, and participants are no longer able to rely on the price mechanism with certainty, the coordination that it facilitates can similarly start to dissipate. Thus, for market participants to operate within this polycentric process of adjustment and readjustment, it is essential that ‘market order’ be maintained. That is, for those operating within the market to have a reasonable certainty and expectation of the behaviours of their co-participants.111 It is only through this relative predictability that individuals can rely, and act, on market information and pursue their own interests (thereby contributing to the overall knowledge in the system). Without this reasonable reliance, participants would be engaged in an ongoing and complex operation akin to the prisoners’ dilemma That is, constantly trying to guess (and second-guess) the accuracy of information that market prices are predicated upon and the local variables that will influence how their co-participants will similarly respond (and the factors that might influence this). It is this functional requirement of predictability that distils the, perhaps surprising, yet integral role of trust in the proper operation of the market. That ‘trust is, and always has been, at the heart of financial markets’.112 Without trust, the market is incomplete, as the system has lost an essential element and, as a consequence, its integrity.113 Indeed, it is this element of trust, achieved in a large part through the performance of promises and the corresponding meeting of market participants’ expectations, that helps to delineate the particular regulatory framework that is needed to support market order. The reality is that this behavioural predictability is only possible if individuals ‘obey such rules as will produce an order’114 and creative compliance fundamentally undermines this requirement of legal obedience. Whilst creative compliance does, of course, involve technical compliance, this is not sufficient to meet the needs of the market. As Section IV explains, market order requires a level of compliance that ensures the equal application of law in practice, a standard that is lost through creative compliance. IV.  COMPLEX SYSTEMS AND SPONTANEOUS ORDER

The significant success of the market should not belie its complexity. Unlike their physical counterparts, social systems are incredibly complex, and it is a ‘fatal conceit’115 to think that social order is capable of central (or synthetic) design. Rather, order emerges spontaneously, derived from compliance with a particular regulatory architecture that supports the environment necessary for order to, perhaps counterintuitively, emerge from the pursuit of personal freedom. As 111 Hayek, Law Legislation and Liberty (n 6), 35. 112 Carney, ‘Rebuilding Trust in Global Banking’ (n 5). 113 As defined by Erhard at al, ‘Integrity: A Positive Model’ (n 13). 114 Hayek, Law, Legislation and Liberty (n 6), 43. 115 FA Hayek, in WW Bartley (ed) The Fatal Conceit, the Errors of Socialism (first published 1988, Routledge, 1998), 21.

Complex Systems and Spontaneous Order  119 shall be seen, for this otherwise (and said without hyperbole) impossible task of social ordering to be successful, it is crucial for such rules to apply equally to, and be equally observed by, all participants. Thus, it is here that the instrumental (as well as normative) importance of the principle of equality before the law to the market order emerges.116 A.  The Architecture of Order In broad terms, order within a system can be achieved deliberately by design (the corporation being an example of a planned order) or arise spontaneously, which, as shall be seen, is the case with the market and other social systems. Whilst effective, there are two critical features of a planned (or synthetic) order that distinguish it from a spontaneous one and that render it unsuitable for complex organisms. First, planned orders often serve a clear purpose of the ‘designer’. For example, in the case of the corporation, the reduction of transaction costs.117 Second, by their nature, as they are capable of design, planned orders generally relate to relatively simple systems (as all variables need to be known to the designer).118 A planned order is not therefore readily transposable onto a complex system with multiple, unknown variables and an undefined outcome (characteristics that are typical of social systems such as the market). In contrast to planned orders, spontaneous orders ‘consist of a system of abstract relations’.119 Within social systems, decisions are made by individual actors whose strategies may be influenced by an innumerable number of factors, influences that neither their co-participants nor a central regulator can possibly ever know.120 As a result, it is impossible for a central authority to regulate social systems fully to achieve an intended output, as they are simply not able to anticipate all of the decisions that the market participants will make. Returning to the market order as an example, within a polycentric system, once one participant acts, others will respond creating a continuous relationship of decision-making and adjustment. Thus, to legislate for every eventuality, a regulator would need to know not only all of the variables that contribute to one participant’s decisionmaking process but also those that influence how the rest of the market will respond to that decision and so on and so forth. Whilst this is clearly impossible, even if we were able to initially ‘design’ a social order, supporting its ongoing operation would be beyond the capability of regulatory infrastructure and oversight (as this would need to be able to perpetually respond to new information entering the system). In contrast, the fundamental benefit of a spontaneous order is that



116 Chapter

6 considers in more detail what is meant by equality in this context. The Nature of the Firm’ (n 99), 19. 118 Hayek, Law, Legislation and Liberty (n 6), 37. 119 ibid. 120 Hayek, Individualism and Economic Order (n 45), 54. 117 Coase,

120  Compliance, Predictability and the Market Order it is self-sustaining, neither limited by human knowledge, vision nor decree.121 It is this unique ability to support ever-increasing complex systems that renders the protection of the spontaneous order so important. To support the emergence of social order what is needed is the implementation of general rules of conduct, the so-called ‘rules of the game’,122 which facilitate a certain predictability of behaviour amongst system constituents. It is from this framework of rules that spontaneous orders arise as the product of ‘human action, not design’.123 In sum, these are the rules of general behaviour, explored in Section II, that establish ‘stability of possession, of transference by consent, and of the performance of promises’.124 If followed, these rules leave individuals free and able to act with ‘the maximum degree of certainty according to their individual plans’125 and are integral to economic security and prosperity.126 Indeed, Scully’s empirical work on the institutional frameworks that are necessary to support economic growth found that societies that ‘subscribe to the rule of law to private property, and to the market allocation of resources’,127 grew at three times the rate of those without,128 whilst markets in particular depend on ‘the establishment of an environment in which legal rights, especially property and contractual rights, are enforced and protected’.129 Whilst rules of property and contract are fundamental to the market order, it is crucial that these rules are bound by the rule of law and, in particular, the principle of equality before the law. Historically, exchange relationships (and, in particular, the expectation that others would perform their promises) were premised on interpersonal relationships.130 That is, the parties to a transaction knew each other and held expectations as to the behaviour of their counterparty from previous dealings. This is what North described as the first historical type of exchange, which did not rely upon robust legal institutions to create the conditions necessary for trade.131 However, in modern society, 121 Hayek, Law, Legislation and Liberty (n 6), 37. 122 That is, ‘within the known rules of the game the individual is free to pursue his personal ends and desires’, see FA Hayek, Road to Serfdom (first published 1944, Routledge Classics, 2001), 73. 123 A Ferguson, An Essay on the History of Civil Society 5th edn (first published 1782 T. Cadell, Cambridge University Press, 2011) http://lf-oll.s3.amazonaws.com/titles/1428/1229_Bk.pdf (accessed 10 September 2016). Hayek, drawing on Whately’s earlier work, described this order that arises from the ‘mutual adjustment of many individual economies in a market’ as a catallaxy from the Greek ‘kattalattein’ meaning ‘to exchange [and] … admit into the community’. See Hayek, Law, Legislation and Liberty (n 6), 268–9. 124 Hayek, The Constitution of Liberty (n 49), 138. 125 Hayek, The Collected Works of F. A. Hayek Volume 15, (n 104), 162. 126 S Pejovich, Law, Informal Rules and Economic Performance: the Case for Common Law (Edward Elgar, 2008), 41–43. 127 G Scully, ‘The Institutional Framework and Economic Development,’ (1988) 96(3) Journal of Political Economy 652, 652. 128 ibid, 658. 129 R Posner, ‘Creating a Legal Framework for Economic Development, (1998) 13(1) World Bank Research Observer 1, 1. 130 Hayek, The Constitution of Liberty (n 49), 193–5. 131 D North, Institutions, Institutional Change and economic Performance (Cambridge University Press, 1990), 34–5.

Complex Systems and Spontaneous Order  121 exchange now takes place on an impersonal and global stage. In this environment, legal institutions are required to ensure that the requisite trust and predictability of behaviour (considered in the following section) that are integral to exchange relationships exists.132 One critical way that we achieve this trust (as well as being fundamental to the legitimacy and integrity of our wider legal system) is through the maintenance of the rule of law and, specifically, of the principle of equality before the law. Thus, for the classical liberal we see the important, and legitimate, role that regulation plays in achieving economic and social order. Law is seen as the ‘glue that holds a complex society together’133 whilst the government is required to ‘enforce the rules of the game as an “umpire”’.134 Within this regulatory framework, individuals are free ‘to interact with each other on their own initiate – subject only to laws which uniformly apply to all of them’.135 B.  Predictability, Order and the Rule of Law The question that remains is to understand how this market analysis contributes to our analysis of corporate compliance? The answer is this. The challenge with creative compliance is that it undermines the predictability of behaviour that a spontaneous order requires. The previous sections explained that for order to arise in a social system, citizens need the freedom to act whilst knowing that (within reason) their fellow citizens will act, and react, in a certain way, namely in response to their local conditions and in accordance with the promises that they have made. This is achieved by protecting a citizen’s freedom to pursue their self-interest whilst requiring that they nevertheless adhere to certain general rules of behaviour. More specifically, that each constituent within the system ‘obey[s] the same rules’.136 When these rules are not followed, the order is threatened as behaviour becomes unpredictable, participants no longer share an expectation of conduct and the natural equilibrium of the polycentric system is lost. Moreover, and as explained in Chapter 2, when these rules are not followed, eventually reactionary regulation can be introduced which itself risks disrupting the particular regulatory framework that otherwise supports order. In contrast, when rules are applied and followed equally, market order (that is, behavioural predictability) is supported. Within a market governed by a regulatory framework, a critical component of achieving market order (or behavioural predictability) is ensuring the equal application of rules to all market participants. This equality, which also



132 ibid,

35.

133 Razeen, 134 ibid.

135 Polanyi, 136 Hayek,

Classical Liberalism (n 24), 184–5.

The Logic of Liberty (n 6), 195. Law, Legislation and Liberty (n 6), 39.

122  Compliance, Predictability and the Market Order serves to enhance the legitimacy of the market system, is achieved by the maintenance of the rule of law and, in particular, the principle of equality before the law.137 Once the exclusive purview of law and politics, the rule of law is increasingly recognised as central to the development of economic growth.138 Indeed, it is ‘necessary as a precondition of capitalist society’,139 which requires a dependability and generality of law. It is this broad requirement of equality that serves to create a predictable framework of behaviours within the market, whilst maintaining each citizen’s freedom to act. Needless to say, it does give rise to the perennial questions (both of which are considered in the next chapter) of what we mean by ‘equality’ in this context and, moreover, whether a c­ itizen (in addition to the state) is under an obligation to maintain it. However, at this juncture, it is imperative to note that for the proper function of complex social systems what is required is equality in the actual operation of the law, not simply its theoretical application.140 Thus, arguments that an entity has technically complied with the letter of the law (albeit in defeat of its spirit) do little to satisfy this standard. One potential challenge to the claim that creative compliance undermines that trust that the market relies upon is that if all multinationals, subject to largely similar norms, were motivated to creatively comply then this would, on one level, create its own sense of order. However, this claim meets two difficulties. First, the practice of creative compliance (no matter how regular) is one that creates disorder. As the extent of creative compliance adopted by each corporation is not known (and the ability of each corporation to creatively comply differs),141 it continues to lead to a level of uncertainty and the prisoners’ dilemma outlined in Section III. Second, creative compliance is a practice that fundamentally and manifestly undermines trust in the corporate, market and regulatory systems. Once this trust is lost, corporations risk ‘compulsion’142 as direct regulatory intervention is introduced. V. CONCLUSION

Those that dispute the legitimacy of calls to constrain creative compliance claim, in part, that creative compliance is lawful behaviour that aligns with the norms

137 It also provides a standard by which to determine legitimate government interference, whilst the potentially ‘predatory extremes’ of self-interest are kept in check by procedural justice that proscribes harm to others’ protected sphere of interest, see Razeen, Classical Liberalism (n 24), 26. 138 See, eg, ‘Economics and the Rule of Law, Order in the Jungle,’ The Economist (13 March 2008) www.economist.com/node/10849115 (accessed 9 August 2020); C May, The Rule of Law, The Common Sense of Global Politics (Edward Elgar, 2014), xxiv and 108–133. 139 F Neumann, ‘The Change in the Function of Law in a Modern Society,’ in F Neumann and H Marcuse (eds), The Democratic and Authoritarian State (The Free Press, 1957), 40. 140 Railway Express Agency Inc. v New York, 336 U.S. 106 (1949), 112–3. 141 For example, depending on their resources, geographical presence and risk profile. 142 Hayek, Individualism and Economic Order (n 45), 18.

Conclusion  123 of the market economy. On this basis, such constraints are seen as nothing more than the illegitimate coercion of individual freedom contrary to the norms of market ideology.143 However, this chapter has examined how creative compliance in fact erodes the predictability of behaviour that is essential for the proper order of society, including the market itself. This erosion of market order risks, inter alia, reactionary regulatory responses and, ultimately, jeopardises both the market order and its primary function as a conduit of knowledge. Examined in this way, we see both the interdependence and ‘mutual reinforcement of the economic, political and legal orders of society’.144 By understanding the role of compliance in this way, we see it as a functional means to achieve social cooperation, whilst protecting the individualism that classical liberalism promotes. In doing so, we can start to change corporate perceptions of the harm caused by creative compliance by demonstrating that, notwithstanding the potential short-term financial gain, in the long term, it risks significant systemic harm. In turn, this can lead to the imposition of further ad hoc reactionary regulation that can undermine the architecture of rules needed to support the market order. By changing the conception of harm in this way, we therefore start to engage with the principles explained in Chapter 3, namely that to effect meaningful behavioural change we need to challenge a person’s perception of the harm caused by (and social meaning attached to) a particular action. However, having established the normative basis for change, predicated in part on the need to protect equality within such a system, this nevertheless raises a number of difficult questions itself, not least what do we mean by ‘equality’ in this context? Chapter 6 explores this question and, in doing so, provides a framework in which to examine one further outstanding, but crucial, question. That is, whether corporations (in addition to the state) are under an obligation to uphold the principle of equality before the law. Conversely, were McBarnet’s interviewees145 (much like Lord Russell)146 correct in their view that it is for the legislature to achieve the requisite behavioural standard in its citizens? Furthermore, if we conclude that corporations should uphold the principle of equality before the law, on what basis is it legitimate for corporations to be held to a different standard of compliance from their natural counterparts?

143 This chapter is concerned with the primary question of the normative justification of corporate spirited compliance. However, the question necessarily raises a company law question, namely the legitimacy of pursuing potentially less profitable strategies (in the direct, short-term understanding of the word ‘profitable’) to do so. This enquiry requires a consideration of inter alia the proper application of the Companies Act 2006, s 172 (duty to promote the success of the company), which is an enquiry undertaken in ch 7. 144 Razeen, Classical Liberalism (n 24), 18. 145 See D McBarnet, ‘Financial Engineering or Legal Engineering? Legal Work, Legal Integrity and the Banking Crisis,’ in I MacNeil and J O’Brien (eds) The Future of Financial Regulation (Hart Publishing, 2010), 69. 146 See the discussion of The Commissioners of Inland Revenue v His Grace the Duke of ­Westminster [1936] AC 1 in ch 2.

6 The (Ostensible) Equality Paradox: Privilege and Obligation Authority is not needed (although much exists) to show that there is no principle more basic to our system of law than the maintenance of rule of law itself.1 Lord Dyson While the idea of the rule of law continues to mean the safety of the individual from big government, it also has come to imply the need for a government that is strong enough to protect individuals from illegal attacks by their fellow men.2 Gottfried Dietze

C

alls for spirited compliance face one fundamental, some may say fatal, challenge. On what legitimate basis can we constrain what is, ostensibly, lawful behaviour? We have seen throughout this book that there is a commonality of view that creative compliance is an undesirable practice, giving rise to a wide range of negative externalities. For example, Chapter 1 outlined the substantial fiscal impact that it has, whilst Chapter 5 demonstrated that, far from advancing the liberal ideology of the market (as many proponents of the practice would claim), creative compliance in fact runs counter to it. Nonetheless, without a legal foundation for reform, calls for spirited compliance risk remaining unanswered. It is perhaps surprising that the answer to the current compliance crisis can be found in a decidedly traditional place. One that, as the previous chapter explained, is not only fundamental to the proper functioning of the market order, but the very fabric of our society. That is, the rule of law and, specifically, the principle of equality before the law. Whilst increasingly used simply as a proxy for good governance or an abstract doctrine to determine the legality of government behaviour,3 this chapter shows that the rule of law in fact provides a critical framework in which to determine a corporation’s obligations 1 R (on the application of Cart) v The Upper Tribunal [2011] UKSC 28, [2011] 3 WLR 107. 2 G Dietze, ‘Hayek on the Rule of Law,’ in Machlup (ed) Essays on Hayek (New York University Press, 1976), 107. 3 This use of the ‘rule of law’ as a proxy for good governance or mere legality has meant that it has lost its meaning. See FA Hayek, The Constitution of Liberty (first published 1960, Routledge Classics, 2006), 180.

The (Ostensible) Equality Paradox: Privilege and Obligation  125 towards the legal system itself. Examined in this way, the rule of law not only provides a justification for restricting behaviour such as creative compliance but it also serves as a guide to delineate the boundaries of those restraints.4 Importantly, it is through this lens of equality that we can also consider some of the more challenging questions that calls for spirited compliance face. For example, what do we mean by equality in this context? To what extent, if any, should citizens (rather than states) be under a positive obligation to uphold the rule of law? Moreover, if a key criticism of creative compliance is that it undermines the principle of equality before the law, then is it not paradoxical to argue that corporations should be held to a different standard of account than their natural counterparts? In exploring the relationship between the rule of law and corporate compliance obligations, this chapter begins by offering a definition of ‘equality’ before the law. Beyond providing useful contextual information, an examination of such an often-used term may seem otiose. However, as this first section explains, the common acceptance of the rhetoric of equality reflects a critical challenge in modern debate. Whilst the rule of law, and the principles that it enshrines, is the product of many hard-fought battles, modern society risks becoming complacent as to both its existence and meaning. As a consequence, the rule of law has increasingly been engaged simply as shorthand to denote that a ‘legal system is legally in good shape’.5 Moreover, within that discussion the term ‘equality’ is itself a challenging concept, with opinion divided as to whether it is, or should be, defined in strict or material terms. In accepting a strict definition of equality, this section explains why this does not, as has sometimes been suggested, preclude concerns of distributive equality being met through other means (even within a classical liberal framework). Having defined equality, Section II then examines the role of the rule of law and, specifically, the principle of equality before the law as a meta-legal principle of society. That is, an overarching rule that should itself be complied with and that governs the application of, and compliance with, regulation and other legal instruments. Seen in this way, equality is both a rule to be complied with and, as a consequence, a basis on which to constrain behaviour (including that which technically complies with the underlying substantive legislation in question but is in breach of the meta-principle of equality). By understanding this function of the principle of equality, and its positioning within the broader legal framework, we are also able to identify why there was such widespread consternation in respect of lawful, albeit creative, tax practices. That is, this condemnation was not directed towards technical compliance with the underlying regulation per se, but rather an intuitive response to the breach of this overarching principle of equality.



4 ibid. 5 J

Finnis, Natural Law and Natural Rights 2nd edn (Oxford University Press 2011), 270.

126  The (Ostensible) Equality Paradox: Privilege and Obligation Building on this examination of the interplay between equality and substantive regulation, Section III then considers whether corporations have a positive obligation to maintain these principles, which are commonly seen as constraints on government, not individual, power. Traditionally, a citizen’s legal obligation is premised on the notion of consent. Namely, that a legal subject has, tacitly at least, consented to be bound by the provisions of the law. This argument is not without its difficulties, particularly for human citizens. However, whilst it is challenging to meaningfully maintain that individuals have ‘chosen’ to be bound by the laws of their jurisdiction (either that of their birth or ongoing domicile) this section explains why the same cannot be said of corporations. Looking at factors such as the choice of incorporation and ongoing operation in a particular jurisdiction this section argues that a corporate citizen can in fact be said to have chosen to be bound by a particular regulatory framework (including the rule of law), strengthening claims that there is therefore a corresponding obligation to maintain the integrity of that system. Section IV concludes the chapter by addressing the apparent paradox between a claim to formal equality and the argument that corporations should adopt a higher compliance standard than non-corporate (and indeed private, closely held, corporate) citizens. It does so by exploring the concept of legal privilege as the only legitimate derogation from the principle that all citizens are subject to the equal application of law. That is, it is only where the law creates a p ­ rivilege (facilitating a transgression of the rule of law itself) that a departure from the principle of equality can be permitted (namely, as a mechanism to mitigate the impact of the privilege in question). I.  DEFINING ‘EQUALITY’ BEFORE THE LAW

A detailed enquiry into the origins, meaning and implications of the rule of law and, more specifically, the principle of equality before the law would be a significant exercise to say the least. Therefore, the more modest intentions of this section should be made clear from the outset. Chapter 5 outlined the importance that classical liberals placed on the rule of law and the instrumental role that trust, predicated on the equal application of law, plays in the maintenance of market order. As such, this section provides some context to these principles and, in doing so, starts to establish a framework in which we can explore the more challenging questions (posed in the introduction to this chapter) that calls for spirited compliance give rise to. A.  The Rule of Law: Precepts and Conceptions The rule of law is inherently entwined with the development of liberal thinking. As the previous chapter intimated, it is perhaps surprising that a philosophy

Defining ‘Equality’ before the Law  127 predicated on the protection of individual freedom recognises an important role for a coercive instrument such as the law (broadly defined).6 However, drawing on its foundations in social contract ideology,7 classical liberalism accepts the existence of law as the consideration that an individual pays for the broader benefits of social cooperation. Understood in this way, citizens are deemed to have consented to the operation of the law (although Section II explains some of the challenges of this view) and thus are ‘at once ruler and ruled’.8 Nevertheless, we must be clear that this agreement to the imposition of law is neither unilateral nor absolute. Rather, as the product of a bargain in exchange for certain received benefits, it is predicated (and arguably conditional) on the protection offered by the rule of law as a bulwark against undue government coercion, operating to constrain the exercise of arbitrary government power. An early formulation of the rule of law can be found in Locke’s Second ­Treatise of Government.9 In his seminal work, Locke recognised that in a state of nature, whilst freedom and equality may be protected, a difficulty arose when an individual sought to enforce their rights against a fellow citizen.10 Without an independent arbiter, the parties to a dispute would favour their own interests and therefore resolution would be impossible. As such, Locke concluded that a governing body was required to make and enforce laws for the benefit of the members of society. However, Locke’s primary concern was that in conceding authority, citizens should not be subject to an ‘arbitrary power … which men would not quit the freedom of the state of nature for’. It was against these concerns that Locke offered his concept of the rule of law, which would act to both facilitate the need for a governing body whilst protecting against the fear of arbitrary control. That is, individual freedom would be protected, notwithstanding the grant of power to a central authority, by having ‘a standing rule to live by, common to every one of that society, and made by the legislative power erected in it … and not to be subject to the inconstant, uncertain, unknown, arbitrary will of another man’.11 Missing from Locke’s formulation of the rule of law was the existence of a separate judiciary. This omission was later recognised by Montesquieu who prescribed a separation of powers, and in particular an independent judiciary, without which he argued ‘there can be no liberty’12 as a citizen would be

6 See ch 5 for the framework of general rules of behaviour that is endorsed. 7 BZ Tamanaha, On the Rule of Law: History, Politics, Theory (Cambridge University Press, 2004), 48. 8 Tamanaha, On the Rule of Law (n 7), 34. This notion of consent is not unproblematic and is considered further in Section III. 9 J Locke, The Second Treatise of Government and a Letter Concerning Toleration (first published 1690, Dover Publications, 2002). 10 Tamanaha, On the Rule of Law (n 7), 49. 11 Locke, The Second Treatise of Government (n 9), section 23. 12 CL de Secondat Montesquieu, in AM Cohler, BC Miller and HS Stone (eds) The Spirit of the Laws (first published 1777, Cambridge University Press, 1989), book XI, section 4.

128  The (Ostensible) Equality Paradox: Privilege and Obligation ‘subject to arbitrary control’.13 Of note, is that Montesquieu recognised that a legitimate function of government, as discussed in Chapter 5, was creating a protected sphere of conduct in which an individual is free to act. Seen in this way, ­Montesquieu also observed that liberty is not a freedom to ‘do whatever one pleases’14 but a requirement to act within the boundaries of the law, provided citizens are free from tyranny. Thus, we see that even in these early conceptions of the rule of law an obligation of legal obedience exists, one that, as Section II will argue, includes observing the rule of law itself. It was these early formulations that provided the foundation for Dicey’s classic exposition of the three pillars of the rule of law.15 First, the supremacy of the law rather than of the arbitrary authority of man. Second, the principle of equality before the law,16 and finally that the law is ‘defined and enforced by the Courts’.17 Inherent within Dicey’s definition was the view that discretion, in the form of discretionary powers of constraint, was the antithesis to the rule of law. In this context, Dicey was of course concerned with the discretion of government. However, in modern society, where large corporations can (and do) exercise state-like power,18 the question arises as to whether it is necessary (and, separately, legitimate) to similarly restrain the discretion that now vests in the corporation? In particular, the discretion that creative compliance vests in the large corporation to effectively achieve the ‘manipulation of law – no matter what the intention of legislators or enforcers’.19 More modern formulations of the rule of law have sought to develop Dicey’s conception (see, for example, Lord Bingham’s eight sub-rules of the rule of law).20 However, as with Dicey’s predecessors, all share a commitment to the equal application of law. Indeed, it is of no surprise that in Hayek’s own exposition of the rule of law he claimed that laws themselves must be ‘general, equal and certain’.21 By this he meant general, in the sense that laws should be written in the abstract and not aimed at any particular individual. Of note, is that this construction of generality is also aligned with the notion of impartiality, namely that such general rules must refer to ‘unknown cases and containing no references to particular persons, places or objects’.22 Equal, in that the law applies to all, without arbitrary distinction and certain, such that subjects are aware of

13 ibid. 14 Tamanaha, On the Rule of Law (n 7), 52. 15 AV Dicey, in RE Michener (ed) Introduction to the Study of the Law of the Constitution (first published 1902, Elibron Classics, 2005), 8. 16 ibid, 114. 17 ibid, 115. 18 See, eg, A Berle and G Means, The Modern Corporation and Private Property (first published 1932, Transaction Publishers, 2010). 19 D McBarnet and C Whelan, ‘The Elusive Spirit of the Law: Formalism and the Struggle for Legal Control’ (1991) 54 Modern Law Review 849, 849. 20 Lord Bingham, ‘The Rule of Law,’ (2007) 66(1) Cambridge Law Journal 67. 21 FA Hayek, The Road to Serfdom (first published 1944, Routledge Classics, 2001), 80. 22 Hayek, The Constitution of Liberty (n 3), 182.

Defining ‘Equality’ before the Law  129 the content of the rules (thereby facilitating predictability, which itself is fundamental to individual freedom). Constructed in this way, Hayek argued that the law acted as a signpost on a road, allowing citizens the requisite certainty to plan their own conduct but without telling them which direction to travel in.23 This enables the law to perform the ordering function considered in Chapter 5, affording individuals the freedom to act whilst providing sufficient constraint on the conduct of others to protect individual liberty and maintain order.24 To achieve this order, our legal framework needs to comprise of general rules of behaviour that are equally applied to all (a requirement that is, as we have seen, at risk from creative compliance).25 However, the difficulty that remains in considering the true implications of this for corporate compliance (indeed for legal subjects more generally) is that equality in any context is a subjective and somewhat nebulous term. In the context of the rule of law, our clarity of what equality means (or requires) is further undermined as it is a principle that is often taken for granted, with most people simply accepting the rule of law as ‘unobjectionable common sense’.26 Whilst this is a view that is indeed hopefully shared by many, this nonetheless risks undermining the practical utility (and protection) of its core principles.27 As a minimum, this complacency renders the rule of law itself, much less its precepts, an ‘exceedingly elusive notion’.28 To help address this, the following section offers a definition of equality to frame our understanding of its functional role in modern society and anchor the claim made later in the chapter that corporations are, and should be, subject to an obligation to maintain its principles. B.  Equality of Law, not Outcome As we have seen, from its inception the rule of law has enshrined notions of equality. Derived from the Greek ‘isonomia’, meaning ‘equality of laws to all manner of persons’29 even the earliest iterations of the rule of law contained a commitment to equality in some form. In particular, the doctrine has embodied the principle that it should not be lawful to propose a law unless it applies equally to all, as ‘every citizen has an equal share in civil rights, so everybody should have an equal share in the laws’.30 23 Hayek, The Road to Serfdom (n 21), 78. 24 Adopting the negative conception of liberty discussed and defined in ch 5. 25 See, eg, Hayek, The Road to Serfdom (n 21), 197. 26 C May, The Rule of Law, The Common Sense of Global Politics (Edward Elgar, 2014), 9. 27 A Bedner, ‘An Elementary Approach to the Rule of Law’ (2010) 2(1) Hague Journal on the Rule of Law 48, 50. 28 Tamanaha, On the Rule of Law (n 7), 3. 29 FA Hayek, ‘The Political Ideal of the Rule of Law,’ in B Caldwell (ed), The Collected Works of F. A. Hayek Volume 15, The Market and Other Orders (Routledge, 2014), 130. 30 Here, Hayek cites an account given by Demosthenes of an Athenian law, see Hayek, ‘The ­Political Ideal’ (n 29), 132.

130  The (Ostensible) Equality Paradox: Privilege and Obligation Nevertheless, and perhaps not surprisingly, the concept of equality is both normatively challenging and difficult to define. In the context of the rule of law, ‘equality’ suffers both as an expression, the meaning of which ‘users … assume to be clear’,31 but also as a prescriptive term that is highly value laden and susceptible to subjective interpretation. In particular, tension arises when considering the distinction between, and adoption of, strict and substantive concepts of equality (both of which are defined below). How we define equality has significant consequences and, depending on the approach adopted, there is a risk of externalities arising that therefore rightly demand justification (it is for this reason that this section addresses some of those challenges even though they extend beyond the strict confines of the compliance debate). From a compliance perspective, our construction of equality provides the framework in which standards are defined and, as Section III explains, deviations potentially required or permitted. It is essential therefore that we are clear on the definition we adopt, in particular whether it is a strict or substantive standard of equality that is endorsed, and the reasons for this. A strict (or formal) definition of equality before the law requires the equal application of laws, without the grant of any privileges designed to achieve ‘material’ (that is, distributive or substantive) equality.32 This approach flows from the premise that the law must be general and achieve equality of objective opportunity, not of subjective result.33 Applied in this way, the law protects the equal freedom of citizens to act in the manner that they deem fit, subject only to pre-determined rules that are known by, and applied to, all. Notwithstanding the logical elegance of this approach, it raises one immediate and clear difficulty. Applying a strict definition of equality might provide everybody with the same right to, for example, purchase a Rolls Royce or to enter the Olympics, but the reality is that only those with significant wealth or sporting excellence can do so. In these somewhat extreme examples, the adoption of a principle of strict equality may not be so unpalatable. However, it can become more difficult when looking at the ability to purchase a home, provide food for one’s family or satisfy basic sustenance needs. In short, the challenge with strict legal equality is that it can lead to material (or substantive) inequality,34 with the law forbidding ‘the rich as well as the poor to sleep under bridges’.35 To mitigate this problem, an alternative interpretation of equality could be adopted. Namely, that equality should be defined so as to achieve ‘substantive’ or distributive equality. Applying this approach, equality should, in effect, mean distributive sameness (or a position as near to sameness as possible). Intuitively, this substantive definition of equality is attractive and suggests a welcome view 31 U Mattei and L Nader, Plunder: When the Rule of Law is Illegal, (Blackwell Publishing, 2008), 10. 32 Hayek, Road to Serfdom (n 21), 82. 33 ibid. 34 ibid. 35 A France, The Red Lily (first published 1894, Yurica Press, 2015), ch 7.

Defining ‘Equality’ before the Law  131 of society, particularly when looking at wealth distribution. However, it raises a number of challenges that, as difficult as they may be, cannot and should not be ignored. Conceptually, requiring a specific allocation of rights (and resources) to effectively level the social playing field, undermines another tenet of the rule of law, which mandates that rules should be abstract, agreed in advance and then applied equally to all.36 We therefore face the problem that allocating rights and opportunities according to individual need, risks undermining other fundamental principles of the rule of law, themselves designed to protect, amongst others, individual freedom from encroachment. Adopting a substantive standard of equality does of course also raise both practical and definitional challenges, including what a fair or equal distribution would entail in any given case. This would be a significant (arguably, impossible) exercise, namely to evaluate each individual’s entitlement, respective needs and thereafter agree the values to apply to any such distribution. However, the greater challenge (and the one that Hayek argued forcibly)37 is that as desirable as they may be, substantive standards of equality cannot be sustained through market regulation or by the adoption of a substantive (or distributive) approach to equality. Aside from the difficulties of determination, once an initial allocation has been made it would need to be continuously remade as an individual’s position changes, necessitating constant surveillance, analysis and redistribution. As we saw in the previous chapter, this level of polycentricism is simply not possible when looking at the exercise of centralised decision making and control. In this way, as intuitively attractive as it might seem ‘the use of regulation to re-distribute income [is seen] as a blunt and inefficient instrument. It distorts prices and incentives, and hence leads to … unintended effects which often harm those whom it is designed to benefit.’38 Against this, it is a strict (or formal) definition of equality that this book suggests needs to be maintained. Whilst the focus of this work is on the relationship between compliance and equality, given its importance a comment on the relationship between a strict definition of equality and the potential for distributive inequality should be made. In particular, it is important to be clear that adopting a strict approach to the principle of equality before the law does not mandate that we ignore social inequality. Rather, and again in contrast to common misconceptions as to classical liberal policy,39 this should simply be addressed 36 As Hayek, citing Rousseau, observed: ‘the object of laws is always general, I mean that the law always considers the subject in the round and actions in the abstract and never any individual man or one particular action’, see Hayek, ‘The Political Ideal’ (n 29), 144. This reflects the genesis of the doctrine, designed to constrain the arbitrary authority of the party in power or of other elites. See D Acemoglu and JA Robinson, Why Nations Fail (Profile Books, 2013), 308. Indeed, ch 5 explored the critical relationship between this principle and the proper function of spontaneous orders. 37 See, eg, Hayek, The Constitution of Liberty (n 3), ch six. 38 C Veljanovski, ‘Economic Approaches to Regulation,’ in R Baldwin, M Cave and M Lodge (eds) The Oxford Handbook of Regulation (Oxford University Press, 2010), 24. 39 As explained in ch 5, classical liberalism does not eschew the imposition of law or any state intervention but sets clear boundaries for its legitimate use.

132  The (Ostensible) Equality Paradox: Privilege and Obligation by other means. For example, Hayek, unlike his libertarian ­counterparts,40 was cognisant of the need to provide social welfare, noting that ‘there can be no doubt’41 that a level of support should be assured to all. It cannot be, and it is not, suggested that such welfare will fully address the inevitable unfairness that arises from the lottery of opportunity at birth. Whilst no system will ever perfectly address material inequality (although it should certainly strive to try), the protection of the rule of law in this way seeks to support the integrity and function of the institutions that are necessary to maximise (and protect) welfare and freedom to the fullest extent possible.42 C.  The Rule of Law: Between Thick and Thin Conceptions? There is one final question to consider regarding the general construction of the rule of law, namely the broad evaluative role or function that the rule of law should perform in society. Specifically, should the rule of law be conceived in what has been described as formal (thin) or substantive (thick) terms?43 Put another way, does the rule of law comprise merely a set of procedural requirements to be satisfied (a thin conception of the rule of law), or does it demand something more (a thick conception)? In brief, formal (or thin) conceptions of the rule of law concern the ‘manner in which the law was promulgated’.44 That is, was the law properly authorised? Is it capable of guiding individual conduct? Is the legislation prospective (rather than retrospective) and is there an independent judiciary? A formal construction of the rule of law is not therefore concerned with the substance of the law, namely whether it is a good or a just law, merely that the law was passed and is to be applied in the proper manner. Advocates of a thin construction defend their claim on the basis that to shroud the rule of law in concerns of ‘justice’ or ‘fairness’ is to ‘propound a complete social philosophy’45 and that this would obfuscate any independent function that the rule of law has. That is, independent from the political philosophies that would necessarily be engaged to argue

40 For example, R Nozick, Anarchy State and Utopia, (first published 1974, Blackwell Publishing, 2003), 149. 41 Hayek, The Road to Serfdom (n 21), 124–125. 42 Hayek, The Constitution of Liberty (n 3), 203. 43 Different taxonomy concerning these conceptions of the rule are engaged. Craig utilises the terms ‘formal’ and ‘substantive,’ Pech expounds the differences between ‘thin’ and ‘thick’, whilst Fuller suggests ‘procedural’ and ‘substantive’. See P Craig, Select Committee on the Constitution, Relations Between the Executive, the Judiciary and Parliament: Report With Evidence, 6th Report of Session 2006-07 (HL 2006, 151-I) 97, 101; L Pech, ‘A Union Founded on the Rule of Law: Meaning and Reality of the Rule of Law as a Constitutional Principle of EU Law’ (2010) 6 European Constitutional Law Review 359, 369; L Fuller, The Morality of Law, (Yale University Press, 1969), 96. 44 Craig, Relations Between the Executive (n 43), 467. 45 ibid, 468.

Defining ‘Equality’ before the Law  133 for a particular conception of a just or fair law.46 Against this view is the classic criticism that manifestly unjust or undesirable laws, no matter how offensive, are capable of technically satisfying a thin construction of the rule of law whilst those enacted by a democracy could fail to meet the requisite standard.47 In contrast, advocates of a substantive (or thick) conception of the rule of law suggest that the doctrine should aspire to be more than a set of procedural requirements. That is, the rule of law should be the foundation to help distinguish between ‘good’ and ‘bad’ laws (through the recognition of certain individual rights).48 Seen in this way, an individual’s moral rights should be recognised in law so that they may then be enforced.49 Thus, in contrast to a purely procedural or formal perspective, a ‘state which savagely represses or persecutes sections of its people cannot … be regarded as observing the rule of law’.50 On this view, proponents of a substantive view do not suggest that the rule of law comprises the ‘full range of [individual] freedoms’51 but that it should nevertheless protect certain fundamental rights. Much like the definition itself, debate abounds not only as to which classification should be adopted but as to the approach that any given scholar endorses (arguably due in part to the challenges of adopting such a binary classification to a broad continuum of views). This uncertainty is particularly prevalent when considering a classical liberal view of the rule of law and its role in maintaining the spontaneous orders examined in Chapter 5. For example, Hayek endorses the maintenance of the rule of law to both constrain illegitimate government intrusion but also to protect the stability of behaviours necessary for the spontaneous order to emerge. In this regard, it is the equal application of laws that is important. This definition has caused scholars such as Tamanaha52 to argue that Hayek endorses a thin conception of the rule of law, using the label in a pejorative sense to claim that Hayek’s approach had no regard to the substantive aims of the law. Indeed, the critique reflects the commonly held view that a liberal interpretation of the rule of law is ‘substantially procedural in bent’.53 However, this claim does not fully represent the classical liberal view of the rule of law, whilst illustrating the difficulty of trying to characterise such a complex principle into broad, thick or thin, definitions. Indeed, moving from this stark classification, May acknowledges that Hayek adopts an ‘essentially’ thin conception, whilst nevertheless accepting that he advocated a rule of law with certain substantive content, including the importance of equality as an

46 On which, see J Raz, ‘The Rule of Law and its Virtue,’ (1977) 93 Law Quarterly Review 195. 47 J Rose, ‘The Rule of Law in the Western World: an Overview,’ (2004) 35(4) Journal of Social Philosophy 457, 460. 48 Craig, Relations Between the Executive (n 43), 467. 49 R Dworkin, A Matter of Principle, (Harvard University Press, 1985), 12. 50 Bingham, ‘The Rule of Law’ (n 20), 76. 51 ibid. 52 Tamanaha, On the Rule of Law (n 7), 94. 53 ibid, 41.

134  The (Ostensible) Equality Paradox: Privilege and Obligation essential characteristic.54 Indeed, if we look at what Hayek actually claimed, he argued that the law should be indifferent to ends, that it operated to guide behaviour rather than to dictate it.55 This is in stark contrast to commands or orders, which constrain people’s freedom and tell them how to act. A Hayekian approach does not therefore endorse a view that the law can impose whatever it pleases, provided it complies with certain procedural demands. Rather, it suggests that whilst the rule of law acts as a constraint on government power it also exists ‘as the governing opinion about the attributes good laws should possess’.56 Thus, May’s observation was an astute one. The classical liberal conception of the rule of law belies the traditional binary distinction between thick and thin conceptions. It goes beyond orthodox interpretations of a ‘thin’ view of the rule of law, demanding as the next section explains, that it performs a more substantive role in society. II.  CONSTRAINING ‘LAWFUL’ CONDUCT

If calls to constrain creative compliance are to be successful, they need to overcome one particularly powerful and somewhat fundamental challenge. Put simply, that creative compliance, whilst undesirable to many, is nonetheless technically lawful conduct. This necessarily raises the fundamental question asked at the start of the chapter, namely on what legitimate basis can the practice be constrained? Chapter 1 outlined the fiscal harm that creative compliance causes. However, whilst significant, this loss to the public purse has proven to be an insufficient basis from which to engender meaningful change.57 In contrast, the earlier chapters of this book (and, in particular, Chapters 4 and 5) offer an insight into the institutional harm that creative compliance causes, providing a more robust foundation for reform. Rather helpfully, it is by recognising how creative compliance erodes the requirement of equality before the law that we can identify a framework that provides both normative justification for reform and a lens through which some of the more challenging questions raised by calls for reform can be considered. For example, by applying this framework, and as the next section explores, we can understand how the rule of law operates as a ‘meta-legal principle’ and the implications of this for the ostensible challenge of constraining creative, yet seemingly lawful, compliance.

54 May, The Rule of Law (n 26), 41. 55 Hayek, The Constitution of Liberty (n 3), 203. 56 Hayek, ‘The Political Ideal’ (n 29), 155, rejecting the argument that the rule of law meant mere legality. 57 This section is focussed on the framework for legitimate reform. However, to effect behavioural change, and as ch 3 explained, we need to change a person’s perception of the harm caused by (and social meaning attached to) a particular action. Thus, the normative analysis in the previous chapter is an important corollary to this analysis as a mechanism for implementing the behavioural change needed for reform.

Constraining ‘Lawful’ Conduct  135 A.  Equality as a Meta-Legal Principle As Section I explained, the rule of law protects the principle that it is only as a servant of the law, not of people, that a citizen can be free.58 However, to ensure our ongoing freedom in this way it is crucial that the law (not those in power from time to time) reigns supreme, not only at the point of royal assent but also in the manner in which laws are interpreted and applied. That is, we need to protect against and uphold equality throughout the regulatory life cycle, from content and adoption (namely protection against lobbying and regulatory capture) through to enforcement, ensuring that laws are applied equally to all citizens without discrimination or discretion.59 Thus, the principle of equality is best understood as an overarching standard that other rules are required to meet. It is, in effect, a rule about what the law, and the exercise of power, ought to be,60 that is, it is what Hayek described as a ‘meta-legal principle’61 that binds other, discrete, legal rules. Understanding equality in this way is crucial to fully appreciating both its function and practical application in modern society (whilst helping to mitigate some of the complacency concerns discussed earlier in the chapter). If, as citizens, we see the equal application of laws as an overarching standard to be achieved, we can start to move away from viewing ‘equality before the law’ as an abstract legal principle that is the sole remit of legal scholars, towards recognising it as an important social objective that acts as a guide to our own behaviour. Specifically, this conception of equality as a meta-legal principle (or meta-norm) informs how we should comply with society’s primary legal principles (or primary norms), namely with express regulatory demands (such as the requirement to pay tax).62 Put a different way, equality is a general rule that tells us how to comply with specific rules, setting the standard to be applied when making compliance decisions. Thus, it is here that we can start to see how the classic exposition of the rule of law, which underpins our liberal democracy, provides the framework from which we can start to address the modern compliance crisis. This relationship between primary legal principles and the meta-legal principle of equality can be better understood by looking at an example. When considering tax statutes, the primary principle (a statutory provision) 58 Marcus Tullius Cicero, Pro Cluentio 53.146 ‘The Magistrates who administer the law, the jurors who interpret it – all of us in short – obey the law to the end that we may be free,’ cited in Hayek, The Constitution of Liberty (n 3), 146. 59 iIbid, 180–181. 60 ibid, 181. 61 Hayek, ‘The Political Ideal’ (n 29), 163. 62 This idea (or a form of it) was introduced by Mitchell Berman in a lecture at University College London, although any errors or misrepresentations do of course remain my own (and no ­endorsement of the ideas set out in this chapter or their expression should be implied). M ­ itchell Berman, ‘Cheating, Loopholing and Metanorms’ Social and Legal Philosophy Colloquium ­University College London (11 March 2015) (unpublished).

136  The (Ostensible) Equality Paradox: Privilege and Obligation might stipulate that a corporation should pay tax on any capital gain. The ­meta-principle (equality) stipulates that the subject must comply with the statute in a way that ensures the equal application of law without discretion or discrimination (put another way, applying a compliance standard that ensures all legal subjects are on an equal footing). On the face of it, the meta-principle seems unnecessary; it is not adding anything to the underlying rule.63 However, this is not strictly the case. The underlying rule does not prohibit its own violation; it simply sets out a sanction for so doing (the so-called ‘law-as-price’ theory of law).64 It is the meta-principle of equality that provides normative force for complying with the spirit of the primary principle. For example, by precluding corporate groups from incorporating multiple entities in multiple jurisdictions to reduce their tax burden (as described more fully in Chapter 2) in a way that was not intended by the statute and that is not available to other citizens, including smaller corporate entities. Recognised in this way, the rule of law also helps us to understand why we find lawful, yet creative, compliance to be so egregious. That is, whilst creative compliance might comply with the strict letter of the law (the primary legislative requirement to pay tax), it clearly contravenes the requirement of the meta-legal principle that laws be applied equally to all. It is this latter breach that triggered the widespread public outcry. This analysis also helps to identify a particular challenge with enforcing the principle of equality. That is, unlike a breach of the primary statute, a breach of the equality principle is not always easily identifiable.65 Subject to the perennial challenge of resource constraints, we are able to identify, and pursue, the breach of the primary principle (the failure to pay taxes). In contrast, a breach of the meta-principle (creative compliance) might intuitively feel wrong but can evade discovery, leading to an actual and perceived enforcement deficit. Beyond the immediate problem this raises it also serves to exacerbate the prisoners’ dilemma discussed in respect of the compliance degeneration cycle in Chapter 4. That is, as other actors anticipate this breach of the meta-principle, they do not know the extent to which it has been breached. Therefore, in an attempt to put themselves on an equal footing with other market participants they must estimate what others have done, leading to a cycle of approximation and overestimation as to the normative breach and, as a consequence, the normative wrong.66 This functional role of equality as a meta-legal principle also serves to meet one ongoing need that single-issue regulatory responses to the compliance crisis

63 ibid. 64 On which, see C Williams, ‘Corporate Compliance with the Law in the Era of Efficiency,’ (1997) 76 North Carolina Law Review 1265. 65 This is also a point that Akerloff and Shiller recognise, that in complex societies ‘sharp’ practice is not always immediately identified and communicated, see G Akerlof and R Shiller, Animal Spirits: How Human Psychology Drives the Economy and Why it Matters for Global Capitalism, (Princeton University Press, 2009), 27–39. 66 In this way, we see similar behaviour to that of the rationalisation, and over-rationalisation of general ethical breaches discussed in ch 4.

Constraining ‘Lawful’ Conduct  137 are not able to address. That is, it is able to ‘fill the gaps’ that are (as discussed in Chapter 2) inevitably left by regulation and that therefore fall to legal subjects and, in the event of dispute, the judiciary to interpret and define. If we are able to reinforce equality as a meta-norm, to embed it as part of wider corporate culture, this serves as an overarching reference point, performing a normative ordering function67 for legal subjects deciding how such gaps should be filled. For individual corporate officers, it also provides legal justification (and therefore comfort) for prioritising long-term gains (by supporting the regulatory and market systems that corporations depend on) over short-term profit maximisation. We have seen how the rule of law, and its core tenet of equality before the law, developed as a constraint on ‘the uninhibited exercise of government power’,68 a device to mitigate against the risk of arbitrary authority. As such, it is commonly viewed as ‘expressive of how the state ought to behave towards individuals’.69 However, this section looked more closely at its implications for individual citizens, derived from its function as a meta-legal principle of society. Having done so, the immediate question that arises is that whilst there are clear consequences if state actors act contrary to the rule of law,70 can the same be said of non-state actors? In particular, does the principle of equality create a political obligation,71 namely a moral duty, for corporations to comply with (or maintain) its principles? Put another way, does this meta-principle carry with it a right of obedience? B.  A Positive Obligation to Maintain Equality before the Law? Within liberal ideology, legal obedience is commonly legitimised by reference to consent-based arguments founded in social contract theory.72 That is, an individual citizen is deemed to have agreed to be bound by the law (and coercive power of the state) as consideration (or in exchange) for their participation in civil society. Whilst this legal obedience requires the abrogation of certain individual freedoms, this is simply the rational bargain that has been struck for broader legal and political protection, together with the maintenance of social order. Thus, an obligation to obey the law is derived from consent, predicated on the benefit of (amongst other things) the maintenance of civil society and social order. Notwithstanding its conceptual clarity, consent-based justifications are,

67 On which, see C O’Reilly, ‘Corporations, Culture, and Commitment: Motivation and Social Control in Organizations,‘ (1989) California Management review 31(4), 12. 68 Craig, Relations Between the Executive (n 43), 101. 69 ibid. 70 For example, judicial review. 71 Note that political obligation is utilised to reflect the broader, moral obligation, to that of a legal obligation. One has a legal obligation, that is, an obligation to obey the law only if they consider themselves under a moral, namely political, obligation to do so. 72 As discussed in Section I.

138  The (Ostensible) Equality Paradox: Privilege and Obligation clearly, not without their difficulties. When can consent be revoked? Are there limits to what an individual can consent to? What about those deemed unfit or unable to consent? In particular, and aside from each of these questions, absent express consent, on what basis can we legitimately assert that an individual has agreed to be so bound? Advocates of a consent-based model answer this last question by arguing that individual consent (or, perhaps more accurately, acquiescence) to this bargain is evidenced through participation in civil society. For example, by voting73 or, recognising that many individuals do not exercise this right, through tacit consent either by ongoing residence in a jurisdiction or notions of fair play (by availing themselves of the benefits of civil society).74 Yet the limitations of these arguments are similarly clear, most notably the reality that most individuals do not have the financial means to, realistically, have a choice about their participation in (and therefore, on this reasoning, consent to), civil society.75 Indeed, it was this issue that prompted David Hume to observe that claiming a person’s ongoing residence in their country of birth constituted consent to its system of laws was akin to saying that a person who had been carried unawares onto a ship whilst they were sleeping consented to being there if they remained on the vessel rather than jumping overboard to escape.76 However, when we turn to corporate citizens and, in particular, large public corporations, this consent-based argument in support of legal obedience becomes much easier to sustain. In contrast to their natural counterparts (who have no say over their birth), the decision to incorporate is a conscious one. Moreover, this choice is not simply limited to the initial decision to bring a company into existence but, importantly, extends to the jurisdiction of incorporation. Indeed, the choice of a company’s seat of incorporation is often a very deliberate one, as can be seen by arguments concerning regulatory arbitrage and a ‘race to the bottom’ in an effort to attract corporate residents (be it in a specific sector77 or more generally).78 In making the decision as to where to incorporate, a company’s original promoters elect (in full knowledge) the legal system that will apply to both the creation of the corporation and its ongoing operations. The ability to establish a consent-based argument to corporate legal obligation extends beyond the initial decision to incorporate the company. Whilst it is arguably naïve to suggest that individuals are able to move to jurisdictions 73 P Steinberger, The Idea of the State, (Cambridge University Press, 2014), 218–220. 74 HLA Hart, ‘Are There Any Natural Rights?’ (1955) 64(2) Philosophy Review 175, 185. 75 See R Dworkin, Justice for Hedgehogs, (Harvard University Press, 2011) ch 14; J Simmons, Moral Principles and Political Obligations (Princeton University Press, 1979) chs 3 and 4. 76 D Hume, ‘Of the Original Contract,’ in K Haakonssen (ed) Hume Political Essays (Cambridge University Press, 2006), 193. 77 Note the recent interest in becoming the Blockchain state: J Brett, ‘“States” Rights to B ­ lockchain: the “Liberty Cowboy” that Drove Wyoming to Crypto Paradise,’ Forbes (12 May 2020) www. forbes.com/sites/jasonbrett/2020/05/12/states-rights-to-blockchain-the-liberty-cowboy-that-drovewyoming-to-crypto-paradise/#6efe063e225f (accessed 9 August 2002). 78 Such as Delaware’s well-known position as the incorporation state in the US.

Inequality and Legal Privilege  139 where they feel greater alignment with the domestic legal system (and therefore choose to be bound by it), corporations have much greater geographical flexibility. This applies both in the ability to effectively move an entity to a new jurisdiction (through re-registration, an inversion79 or other acquisition) or by simply incorporating new group subsidiaries in the desired territory (and, should they so wish, effectively or actually winding down operations in the old one). In contrast to technical arguments as to the ability of individual citizens to relocate, these are choices that corporations can and often regularly do avail themselves of. Moreover, once incorporated (or registered) in a jurisdiction (decisions that require existing shareholder approval), new shareholders invest in the organisation knowing the rules that will apply (enabling express consent to be identified at both a corporate and shareholder level). Thus, when incorporation, reincorporation and registration decisions are looked at in the round, it becomes clear that many of the challenges that a consent-based argument for individual legal obedience faces can be persuasively addressed when looking at corporate citizens. For the latter, incorporation and domicile are clear and express decisions, which are often made in whole or in part on the desirability of the legal framework of the jurisdiction in question. The rule of law provides a powerful framework of expectations that underpin civil society, protecting her fundamental values and the freedoms of her citizens (corporate and individual). Yet, as this chapter has shown, these are not simply abstract ideals. The requirement of equality before the law is a fundamental meta-legal principle that guides and governs how a citizen should comply with underlying regulatory requirements. When understood in this way, and complied with accordingly, this meta-principle provides all citizens with the ‘confidence that the law will underpin both sides’ actions equally’.80 As a core part of our legal framework, it is this rule, this compliance standard, that corporations elect to be bound by when choosing to incorporate (and remain) within the jurisdiction. It is this standard that underpins the political obligation to comply with its terms. Against this justification, one question remains to be answered. That is, how do we align this obligation with the earlier, formal, definition of equality? How can we address the seeming paradox of relying on arguments of equality to call for a fundamentally unequal (when looking to hold corporations to a higher compliance account than natural citizens) standard of compliance? III.  INEQUALITY AND LEGAL PRIVILEGE

The first section of this chapter argued that ‘equality’ in the context of the rule of law should mean formal equality, that the requirement of the rule of law was

79 See

ch 2 for a discussion of inversions. The Rule of Law (n 26), 130.

80 May,

140  The (Ostensible) Equality Paradox: Privilege and Obligation that laws should apply equally, regardless of the material outcome. However, against this, Section II suggested that corporations should be under an obligation to maintain the rule of law by refraining from the creative compliance practices that undermine it. These two assertions seem to be paradoxical, with the claim in Section II seemingly endorsing a material or substantive definition of equality. This section addresses this apparent conflict, by exploring legal privilege (defined below) as the basis on which an exception to formal equality can be made. Throughout its development, advocates of the rule of law have been clear that one of its objectives is to protect against privilege. In this context, privilege adopts a very specific definition, meaning a derogation or exception from the principle of equality such that the law does not apply equally (either in theory or in effect).81 Indeed, the very genesis of the principle of equality is that all citizens, regardless of rank or status, are equal before the law, such that the rule of law and special privilege are irreconcilable.82 It is of little surprise therefore that not only is legal privilege heavily criticised,83 but that it provides the one foundation from which we can legitimately justify a deviation from a formal standard of equality. That is, whilst it is contrary to the rule of law to use arbitrary distinctions to deviate from the principle of equality,84 where the law itself creates a privilege (that enables a citizen to undermine the rule of law) then it is legitimate to depart from a formal construction of equality to restore equilibrium. Put another way, the law can treat citizens in a prima facie unequal manner to ensure ‘that laws [are] equal in operation’.85 Notionally, all legal subjects can creatively comply, suggesting that it does not constitute a legal privilege as defined. However, as Chapter 2 explained, it is a practice that is predominantly adopted by large multinationals due to legally imbued characteristics that are unique to the corporation and that can encourage (for reasons discussed in the next chapter) and certainly facilitate such compliance standards.86 To consider the relationship between legal privilege and corporate compliance standards it is instructive to recall the so-called ‘Double Irish Dutch Sandwich’ structure that was outlined in Chapter 2 (and which is typical of many aggressive tax structures). The structure is dependent on the existence of multiple subsidiaries in different jurisdictions (three as a minimum: Ireland, the Netherlands and a ‘tax haven’ such as Bermuda). Therefore, from a basic structural perspective the scheme necessitates the existence of multiple entities (each constituting a separate legal personality), which can oper 81 Hayek, The Road to Serfdom (n 21), 82. 82 ibid. 83 Bingham, ‘The Rule of Law’ (n 20), 73–75. 84 ibid, 73. 85 Railway Express Agency Inc v New York 336 US 106, 112–113 (1949). 86 Gammie similarly recognises the inequality of ability to creatively comply within society. See M Gammie, ‘Moral Taxation, Immoral Avoidance – What Role for the Law,’ (2013) British Tax Review 577, 581.

Inequality and Legal Privilege  141 ate and exist at the same time in multiple jurisdictions (yet still be controlled, and the benefits accrue, to the same parent entity). This ability for a single group to simultaneously comprise of multiple personalities in multiple territories is, of course, not available to an individual in their individual capacity. It is a uniquely corporate ability, facilitated by our company law framework, and one that is not available to natural citizens qua natural citizen.87 Beyond this structural ability to creatively comply, the corporation also facilitates, in two important ways, the necessary risk profile to implement such aggressive structures. First, the combination of separate legal personality and limited liability88 operate to isolate and restrict the level of risk associated with a particular tax structure, should it subsequently be disallowed. In doing so, these principles enable a group to limit their exposure in the event a structure fails (that is, the tax benefit is denied), reducing the risk (and therefore increasing the likelihood) of implementing an ‘abusive’ transaction in the first instance. In contrast, an individual implementing a high-risk strategy risks their entire asset base in the event of failure. Second, for reasons explored in more detail in Chapter 7 the corporate form enables individuals within the corporation to implement riskier strategies than they may otherwise do if acting in their own capacity. In essence, an individual is able to distance themselves from the potential ‘ethical’ questions of their conduct, outsourcing that moral responsibility to the fact that the conduct in question is in fact that of the corporation (or undertaken on the direction of their superiors in the corporation) and not of them personally. Once the decision to implement the structure has been made, and as Chapter 4 outlined, individuals within the corporation are then likely to engage in a process of rationalisation to reduce any cognitive dissonance that they may otherwise feel as a result of the decision to creatively comply in this way. The importance of this personal disassociation is evident from the responses of highprofile individuals who were identified as having adopted creative tax strategies at and around the same time of the 2012 corporate tax scandals. As explained at the start of Chapter 4, these individuals (in contrast to their corporate counterparts) quickly expressed remorse for the structures in question and, in several cases, sought to unwind them. One final, but not insignificant, point is that it is commonly (although not exclusively) corporate groups that have the requisite resources to obtain the professional advice need to implement such structures. Tax structuring requires the implementation of highly complex structures that in turn require the execution of, often, many hundreds of documents across multiple jurisdictions. This necessitates the advice of tax specialists (to design the structure), solicitors in each jurisdiction to prepare the necessary documentation and, with 87 Clearly individuals can, and do, incorporate entities to achieve such benefits (see, eg, Philip Green and the Arcadia group or Richard Branson and Virgin). However, in so doing it is the ­corporate form that enables them to do this for the reasons outlined in this section. 88 Discussed in more detail in ch 5.

142  The (Ostensible) Equality Paradox: Privilege and Obligation regard to particularly high-risk transactions, the opinion of counsel. Depending on the value of the structure to the corporation, these professional fees will be significant. The ability to pay for these fees is made possible by the corporate characteristics that are specifically intended to facilitate commerce and economic prosperity. That is, the principles of separate personality and limited liability (together with the associated benefits of dispersed ownership, transferable equity and board management that have enabled the corporation to become such a significant economic actor).89 In contrast, most individuals, even those with a relatively high net worth, would not have the resources necessary (even if it were structurally possible) to implement such complex tax arrangements (beyond, for example, fairly standard family trusts). We thus see that there are a number of statutory provisions that coalesce to have the effect of imparting a legal privilege on the corporation, namely the extraordinary capacity to creatively comply. It is this ability to creatively comply that undermines the principle of equality and that is unique to the multinational corporation, facilitating creative compliance in a way that their natural counterparts, and even smaller private corporations, simply cannot do. It is this legal privilege that brings with it not only the responsibility to uphold the rule of law, but the corresponding right to demand it of them. As a consequence, this privilege provides the justification to depart from a formal definition of equality (set out in Section I) to the extent necessary to mitigate its impact, namely to uphold the meta-legal principle of equality. That is, to maintain the equal application of law in operation, not just in theory, by restraining the ability to creatively comply. IV. CONCLUSION

The rule of law developed as a constraint on, inter alia, the legal privilege that had been enjoyed by the government and social elite. In modern civil society it is now large corporations that benefit from such a privilege, predicated on the unique structural qualities granted by company law frameworks around the world. As previous chapters have demonstrated, this privilege facilitates creative compliance, which undermines the integrity of the legal and market systems that corporations operate within whilst creating significant fiscal consequences for wider society. We are thus met with a claim that corporations should comply with the spirit, not simply the letter of the law in order to maintain the principle of

89 For example, the corporate characteristics discussed in R Kraakman, J Armour, P Davies, L Enrique, H Hansmaan, G Hertig, K Hopt, H Kanda, M Pargendler, W Ringe and E Rock, The Anatomy of Corporate Law, A Comparative and Functional Approach 2nd edn (Oxford University Press, 2009), 1–18.

Conclusion  143 e­ quality that they otherwise transgress. However, this is a difficult argument to make. On what basis can we claim that a problem of inequality is met with a similarly unequal application of compliance standards? This chapter has argued that, notwithstanding the need for a formal definition of law, the existence of legal privilege justifies a claim that corporations, unlike their fellow citizens who are not so privileged, should be subject to an obligation to maintain the metanorm of equality. One benefit of this rule of law analysis is that it helps to define where the boundaries of compliance obligations should fall. Whilst there has been significant demand for spirited compliance and a prohibition of abusive or aggressive tax avoidance there has been no guidance as to ‘where the boundary should be drawn’.90 Applying the meta-legal principle of equality helps to draw those boundaries, namely by delineating the obligation by reference to the need to mitigate this privilege. To ensure equality in the operation of the law and thereby help to maintain the integrity of the legal and market orders. This chapter concludes (when taken together with Chapter 5) the normative argument in favour of spirited compliance (the first four chapters outlining the current landscape of, and explanations for, the compliance crisis). It did so by examining the relationship between equality and compliance, suggesting that the requirement for the equal application of law, properly understood as a metalegal principle of society, imposes an obligation on corporations (as well as the state) to maintain its principles. The following chapters now start to turn to the question of reform. First, Chapter 7 considers an important question regarding corporate behaviour, one with significant and wide-reaching effects. That is, if we accept that creative compliance is an illegitimate standard to pursue and whilst appreciating that it is a practice driven by powerful corporate norms, why is it that the individuals who implement corporate decisions fail to assert their own personal norms and views? That is, if individuals within an organisation consider the practice to be unacceptable, why don’t they do anything to stop it? How is it that (as Chapter 4 showed) corporate norms can dominate personal ones so absolutely? In examining these questions, we are faced with a difficult realisation, one with potentially far reaching consequences. Namely, to what extent can the architecture of the firm itself influence individual conduct? Put another way, to what extent does responsibility lie with the player or the rules of the game itself?

90 M Levi, ‘Legitimacy, Crimes and Compliance in “the City”: De Maximis Non Curat Lex?’ in Justice Tankebe and Al Liebling (eds) Legitimacy and Criminal Justice, an International Exploration (Oxford University Press, 2013), 163.

144

Part III

Barriers to Reform

146

7 A Person without Personality: The Fiduciary Ladder of Corporate ‘Personhood’ [T]he law has facilitated, and technological developments have motivated, an enormous growth of a new kind of person in society, a person not like you and me, but one which can and does act and one whose actions have extensive consequences for natural persons …1 James S Coleman

W

hy is it that corporations, imbued with legal personality and acting through individuals, nevertheless pursue conduct that is antithetical to values of personhood?2 Specifically, why do individuals within a corporation implement creative compliance strategies that are premised on the corporation’s social norms, even when they are in conflict with their own? As Chapter 3 explained, creative compliance is driven by a profit maximising norm, namely the axiom of company law that the overriding objective of a corporation is shareholder wealth maximisation.3 Nevertheless, this norm, reflected in directors’ fiduciary duties, is not absolute. Corporate boards have broad managerial discretion and therefore the question arises as to why directors, who are otherwise apparently law-abiding citizens, have allowed profit-maximisation to determine compliance strategies that the public clearly consider to be unethical? Given significant, and recent, efforts to enhance corporate responsibility, it is regrettably prudent to note from the outset that such myopic decision making is not a relic of the past. A sobering case in point is the decision undertaken by Rio Tinto in 2020 to destroy two ancient caves in Western Australia, solely to gain access to an additional eight million tonnes of iron ore (its annual exports from Australia

1 JS Coleman, The Asymmetric Society, (Syracuse University Press, 1982), 9. 2 For example, conduct that pursues profit maximisation above values such as fairness, ­equality and ‘doing the right thing’. These values are often protected by individuals through non-legal ­behavioural constraints, which limit self-interested behaviour that undermines the values of society. 3 This reflects the dominant Anglo-American norm that the corporation ‘is carried on p ­ rimarily for the profit of the stockholders’ Dodge v Ford Motor Co 170 NW 668, 684. This principle is reinforced by the suite of shareholder governance rights discussed in ch 3, Section III.

148  A Person without Personality exceeded 327 tonnes).4 The company decided to proceed n ­ otwithstanding that it had apparently received a report prior to the excavation that put them on notice that the caves were of ‘the highest archaeological significance.’5 Scandals such as these (and the numerous examples that exist before it) necessarily raise the question of what it is about the corporation and an individual’s relationship with it that allows this to happen? As Chapter 4 explained, the reason for this seemingly atypical individual decision making is that an individual officer effectively subsumes any potentially conflicting personal norms to those of the corporation. However, this still leaves the question of what it is about the corporate environment that allows this dominance to occur so absolutely, even in the most egregious of ­situations? In exploring this question, this chapter considers the impact that the architecture of the firm itself has on individual behaviour. As shall be seen, the answers to this enquiry have profound consequences, with implications for our understanding of personal responsibility that extend far beyond the realms of tax compliance. By exploring the interplay between corporate structure and corporate decision-making this chapter puts forward three, cumulative, hypotheses as follows. Section I explains how separate personality and limited liability coalesce to achieve the ‘complete’ separation of shareholders from the corporation.6 This section emphasises the importance of both the legal and economic separation of shareholders, which causes them to act as mere ‘functionless rentiers’.7 Thereafter, Section II suggests that this emancipation leads to significant changes in the shareholder demographic and increases shareholder passivity; with the result that shareholder wealth maximisation becomes a proxy for members’ interests. This proxy then distorts the application of directors’ fiduciary duty to ‘promote the success of the company for the benefit of its members as a whole’.8 Specifically, the definition of ‘company’, traditionally taken to encompass the entire shareholder body9 both present and future,10 is instead interpreted as the interests of the ‘market’ represented by short-term profit maximising objectives. Section III draws on empirical research in social psychology (in particular Stanley Milgram’s famous research in this area) to show how this profit-maximising objective is then able to pervade corporate strategy, and displace personal norms, due to the structure of an internal decision-making hierarchy that this 4 BL Sydney, ‘Rio Blew up Aboriginal Caves to “Get More Iron Ore,”’ The Times 8 August 2020 www.thetimes.co.uk/article/rio-tinto-apologises-for-blowing-up-culturally-significant-aboriginalcaves-5f9gd52xs (accessed 8 August 2020). 5 ibid. 6 It is this requirement for both legal and economic emancipation of shareholders that means that this book is concerned with public, listed corporations, which can be contrasted with private companies where shareholders are legally, but not economically, emancipated. 7 See P Ireland, ‘Defending the Rentier: Corporate Theory and the Reprivatization of the Public Company,’ in J Parkinson, A Gamble and G Kelly (eds) The Political Economy of the Company (Hart Publishing, 2000) 141, 146. 8 Companies Act 2006, s 172. 9 Greenhalgh v Arderne Cinemas Ltd and Others [1951] Ch 286, 291. 10 Gaiman v National Association for Mental Health [1971] Ch 317, 330.

Separate Personality, Limited Liability  149 chapter terms the ‘fiduciary ladder’. This hierarchy has a powerful behavioural impact, creating a relationship of authority and obedience. The psychological consequences of this for an individual are significant, their focus is reduced to one of mere obedience in respect of the tasks given to them and their perceived liability for those tasks is similarly constrained.11 As a consequence, this serves to insulate individuals within the firm from the reputational repercussions of their actions such that ‘normal moral principles become inoperative’.12 The result of these three phenomena is that the corporation, imbued with legal personality, is bereft of the non-legal behavioural constraints (including values such as fairness and morality) that are commonly associated with personhood, whilst insulating individuals from any meaningfully perceived responsibility for actions undertaken in their corporate capacity. As such, the corporation is able to pursue creative compliance strategies, driven by a profit maximising norm and unrestrained by potentially conflicting individual norms. Section IV concludes the substantive parts of the chapter by explaining why the fiduciary ladder is a particular phenomenon of the public corporation, in contrast to other actors such as private companies, partnerships and individuals. In doing so, it provides further justification for the claims made in the previous chapter that, due to their unique legal privilege, we can legitimately hold public corporations to a different standard of compliance than these other actors. I.  SEPARATE PERSONALITY, LIMITED LIABILITY AND THE REIFICATION OF THE CORPORATION

The paradigms of separate personality and limited liability are well known. Since the mid-nineteenth century it has been a ‘fundamental principle’13 of company law that corporations have a personality separate from their members14 and that shareholder liability is limited to the amount unpaid on any shares held by them.15 This section is not an exhaustive analysis of these principles, which have (at times) been divisive and raise many interesting, normative, questions.16 11 R Kelman and L Hamilton Crimes of Obedience (Yale University Press, 1989), 16. 12 ibid. 13 See Owners of Cargo Laden on Board the Albacruz v Owners of the Albazero (The Albazero) [1977] AC 744, 807; and Adams v Cape Industries Plc [1990] Ch 433, 476. 14 Salomon v Salomon & Co Ltd [1897] AC 22. 15 Companies Act 2006, s 3; Art 2, Sch 3 (Model Articles for Public Companies), The Companies (Model Articles) Regulations 2008 (SI 2008/3229) (the ‘Model Articles’). 16 See Cataldo. ‘Limited Liability With One Man Companies and Subsidiary Corporations,’ 18 Law & Contemporary Problems (1953) 473–504 (as to ring fencing subsidiary liability); R Posner, ‘The Rights of Creditors of Affiliated Corporations,’ (1975–1976), 43 University of Chicago Law Review 499–526, 506 (as to the inability of involuntary creditors to privately negotiate limited liability); RE Meiners, JS Mofsky and RD Tollison, ‘Piercing the Veil of Limited Liability,’ (1978) 4 Delaware Journal of Corporate Law 351, 360 (looking at the relationship between limited liability and corporate creditors); FH Easterbrook and DR Fischel, The Economic Structure of Corporate Law, (Harvard University Press, 1996), 41 (as to the technical ability to achieve limited liability through contract).

150  A Person without Personality Instead, it draws on the historical development of separate personality and limited liability to demonstrate how these fundamental features of corporate design caused shareholders to become completely separated from the corporation, transforming their relationship with it. This historical analysis illustrates the importance of both the legal and economic separation of ‘ownership’17 and control,18 such that the corporation became an entity not simply independent from its members but ‘effectively cleansed of them’.19 Incorporation by registration was first made available to the general public pursuant to the Joint Stock Companies Act 1844 (the ‘1844 Act’).20 In doing so, members of the public could avail themselves of the benefits of the corporate form, although confirmation that incorporation conferred separate personality was not definitively settled until the seminal case of Salomon v Salomon & Co.,21 which as Chapter 2 explained is arguably the best known case of creative compliance in corporate history. The grant of separate legal personality allowed corporations to exist in perpetuity, free from ‘the burdens of death and ageing’,22 and created a suitable vehicle for limited liability.23 Thus, the 1844 Act started the process of transforming the corporation from the original, chartered companies that required special Acts of Parliament or Royal Charters to the transnational corporations that exist today. It also performed an important ideological function as separate personality started to disjoin the corporation from its members and justified the grant of significant benefits to an otherwise artificial entity 17 For ease, this chapter adopts the traditional reference to shareholders as ‘owners’ of the corporation. However, it is difficult to maintain that modern shareholders can legitimately be classified as owners. See R Sappideen, ‘Ownership of the Large Corporation: Why Clothe the Emperor,’ (1996) 7 Kings College Law Journal 27; P Ireland, ‘Company Law and the Myth of Shareholder Ownership,’ (1999) 62 Modern Law Review 32; J Hendry, P Sanderson, R Barker and J Roberts, ‘Owners or Traders? Conceptualizations of Institutional Investors and their Relationship with Corporate Managers,’ (2006) 59 Human Relations 1101. 18 The separation of ownership and control was, of course, a characteristic identified by Berle and Means in their seminal work: A Berle and G Means, The Modern Corporation and Private Property, (first published 1932, Transaction Publishers, 2010). Meanwhile, Paddy Ireland has written extensively on the importance of both the legal and economic separation, see Ireland, ‘Defending the Rentier’ (n 7), 141; PW Ireland, ‘The Rise of the Limited Liability Company,’ (1984) 12 International Journal of Sociology of Law, 239, 245; P Ireland, ‘Capitalism Without the Capitalist: the Joint Stock Company Share and the Emergence of the Modern Doctrine of Separate Corporate Personality,’ (1996) 17(1) The Journal of Legal History, 41. 19 Ireland, ‘Capitalism Without the Capitalist’ (n 18), 41. 20 The 1844 Act extended incorporation by registration to joint stock companies, the precursor to the modern public company. It was the Companies Act 1862 that extended registration to the equivalent of the modern private company. 21 [1897] AC 22. 22 M Bovens, The Quest for Responsibility, Accountability and Citizenship in Complex Organisations (Cambridge University Press, 1998), 16. 23 The 1844 Act also aligned the legal form of the corporation with is economic one. Prior to 1844, the joint stock company was identified by its economic form, typically that it had a large, dispersed body of investors who had freely transferable shares. The legal form of the joint stock company largely reflected the modern form of partnership, whilst the speculative nature of shares at this time also ensured that shareholders performed a significant oversight role. On this, see JB Baskin, ‘The Development of Corporate Financial Markets in Britain and the United States, 1600–1914: Overcoming Asymmetric Information,’ (1988) 62(2) The Business History Review 199; Ireland, ‘Capitalism Without the Capitalist’ (n 18).

Separate Personality, Limited Liability  151 premised on ‘legal and moral conceptions of the corporate individual’.24 The corporation thus started to take shape (and become accepted) as an independent economic actor, detached from both its managers and shareholders.25 Notwithstanding the significant impact of the 1844 Act, its importance for the separation of ownership and control must be kept in context. Whilst shareholders continued to be exposed to the debts of the corporation (and potentially each other) it was clear that they would remain closely involved with its management, restricting those who were willing (or able) to invest capital. Therefore, it was the limitation of shareholder liability pursuant to the Limited Liability Act 1855 that enabled the onset of shareholders’ economic separation, a development so transformative that it has been described as ‘the greatest single discovery of modern times’.26 By effectively extending these unique legal characteristics to the general public, external investment could now be made to an independent entity that was not only able to incur its own liabilities but, importantly, it also bore sole responsibility for them.27 The true impact of the 1844 and 1855 Acts was realised with the complete, economic, separation of shareholders from the corporation, which came with the development of a liquid stock market at the end of the nineteenth century.28 The capital markets gained confidence in the early twentieth century when the public saw that equities could be ‘investment-grade securities’ and that all market participants could act as ‘prudent investors’.29 Furthermore, a liquid stock market enabled corporations to realise their purpose of raising capital from a large (and diverse) number of investors,30 whilst providing shareholders with the comfort that they were able to transfer their shares ‘cheaply and efficiently’.31 The development of the stock market also gave investors the protection of being able to diversify their investment portfolios to hedge against the risks of u ­ nderperformance by any one company. 24 S Bowman, The Modern Corporation and American Political Thought: Law, Power, and I­ deology, (Penn State University Press, 1996), 3. 25 Separate personality also facilitates innovative corporate structures that are now utilised to implement creative tax structures. 26 President Nicholas Murray Butler of Columbia University as cited by Cataldo, ‘Limited ­Liability’ (n 16), 473. 27 Save in limited cases where the corporate veil could be pierced. See cases where the corporation is considered to be a ‘shame or façade’: Gilford Motor Co Ltd v Horne [1933] Ch 935; Jones v Lipman [1962] 1 WLR 832; Woolfson v Strathclyde DC (1978) 38 P & CR 521; Adams v Cape Industries plc [1990] BCC 786; Trustor AB v Smallbone & Others (No 2) [2001] 2 BCLC 436; also exceptional cases where an agency relationship is upheld: Smith, Stone & Knight Ltd v Birmingham Corporation [1939] 4 All ER 116, Re F. G. (Films) Ltd [1952] 1 WLR 483. 28 The timing of the emancipation of shareholders is reflected in the annual number of incorporations, rising from an average of: 500 each year between 1856–1865; 1,500 between 1880–1886; and 6,700 per annum between 1909–1914. Figures cited by: Ireland ‘The Rise of the Limited Liability Company’ (n 18), 245. 29 W Werner, ‘Management. Stock Market and Corporate Reform: Berle and Means R ­ econsidered,‘ (1977) 77 Columbia Law Review 388, 400. 30 H Manne, ‘Our Two Corporation Systems: Law and Economics,’ (1967) 53(2) Virginia Law Review 259, 260. 31 Meiners et al, ‘Piercing the Veil’ (n 16), 364.

152  A Person without Personality The establishment of strong capital markets meant that functionally, shareholders became separated from the corporation and they were able to invest in companies ‘qua investor’,32 free from the demands of management and the burdens of property ownership. It was at this point of complete legal and economic separation that shareholders transformed from traditional owners to mere ‘functionless rentiers’.33 Shareholders became fully emancipated from the corporation; they no longer needed to monitor the firm to mitigate their risks. Instead, they could simply sell their shares, exercising the right of ‘exit’ (namely, share sale) over ‘voice’ (that is, governance).34 This separation was also reflected in the changing nature of the share.35 No longer was the share treated as an aliquot part of the corporation’s assets but was reconceptualised as a right to dividends and to assign title.36 The reality is that the general incorporation statutes did, as the court confirmed in Salomon, create a separate legal entity. However, they did not fully separate that entity from its members. Rather, it was the economic separation, which came when shares transformed from an interest in the company to an interest in profits, which completed the reification of the corporation.37 Shareholders were abstracted from the firm, no longer closely aligned with corporate management, rather they were able to diversify their investments, with the objective of simply increasing financial returns. In doing so, the separation laid the foundations for directors to act with a relative freedom from shareholder oversight (save for their ability to exercise the right of exit) and subject only to an overriding objective to promote the success of the company. As the next section demonstrates, over time this objective has become supplanted (if not displaced) by a practice of promoting the potentially more homogenous interests of the ‘market’. II.  REDEFINING THE BENEFICIARY: FROM ‘COMPANY’ TO ‘MARKET’

The complete emancipation of shareholders marked a profound paradigm shift in the exercise of managerial discretion. In particular, the short-term interests38 32 Manne, ‘Our Two Corporation Systems’ (n 30), 261. 33 Ireland, ‘Defending the Rentier’ (n 7), 146. 34 On this, see A O Hirschman, Exit, Voice and Loyalty (Harvard University Press, 1970). 35 Early cases considered that shareholders had a direct interest in the property: Buckeridge v Ingram (1795) 2 Ves. Jun 652. This view was challenged in the seminal case of Bligh v Brent (1837) 2 Y. & C. Ex 268 although mixed judicial treatment following Bligh was eventually settled in Borland’s Trustee v Steel Brothers & Co Limited [1901] 1 Ch 279, 288 which held that a share is the ‘interest of the shareholder in the company measured by a sum of money, for the purposes of liability in the first place, and of interest in the second’. 36 For a comprehensive analysis of the common law development, see Ireland ‘Capitalism without the Capitalist’ (n 18); D Rice, ‘The Legal Nature of a Share,’ (1957) 21 The Conveyancer 439. 37 P Ireland, I Grigg-Spall and D Kelly, ‘The Conceptual Foundations of Modern Company Law,’ (1987) 14(1) Journal of Law and Society 149, 153. 38 Namely, a focus on short-term results at the sacrifice of concern for long-term value creation, see CFA Centre for Financial Market Integrity/Business Roundtable Institute for Corporate Ethics,

Redefining the Beneficiary: From ‘Company’ to ‘Market’  153 of current investors superseded the orthodox focus of directors’ duties, namely the long-term interests of the company. This section examines how this immediate interest of the ‘market’39 managed to become an ‘entrenched feature’40 of corporate decision-making and thus became the prevailing and driving focus of the ‘corporate fiduciary ladder’, a phenomenon that is discussed in Section III. A.  Shareholder Wealth Maximisation as a Proxy for Rentier Shareholders The reification of the corporation had a transformative impact on the shareholder demographic and behaviour. In particular, the changing nature of the share (from an ownership interest to a financial instrument) saw a rise in the late twentieth century41 of institutional investors, who had dramatically different governance perspectives to their predecessors.42 The outcome of this changing profile is that investors largely evaluate corporations by reference to the company’s share price (and more specifically earnings per share)43 rather than the underlying value of the business. In adopting this approach, shareholder conduct and the concomitant market response is driven, in part, by short-term fluctuations in share price, with the effect that managerial attention is similarly focussed. ‘Breaking the Short-Term Cycle: Discussion and Recommendations on How Corporate Leaders, Asset Managers, Investors and Analysts Can Refocus on Long-Term Value,’ (2006), 3 www.cfainstitute. org/en/advocacy/policy-positions/breaking-the-short-term-cycle (accessed 9 August 2020). 39 The ‘market’ being the representation of the aggregate opinion of investors. See Department for Business Innovation and Skills, The Kay Review of UK Equity Markets and Long-Term Decision Making: Final Report, July 2012, para 2.18 (the ‘Kay Review’). 40 Sir George Cox, ‘Overcoming Short-termism within British Business: The Key to Sustained Economic Growth,’ 26 February 2013, 6 www.yourbritain.org.uk/uploads/editor/files/ Overcoming_Short-termism.pdf (accessed 9 August 2020) (the ‘Cox Report’). 41 This change largely manifesting from the 1960s and culminating in the 1990s. See the Kay Review (n 39), 29 and P Myners, ‘Institutional Investment in the United Kingdom: A Review,’ (2001) (the ‘Myners Review’), ch 1, 27–38. 42 The largest institutional investors are pension funds and insurance companies (see Kay Review (n 39) ch 3 and the Myners Review (n 41), 5). Mutual funds (companies that issue shares to an individual and then invest in a diverse portfolio, enabling smaller investors to participate in a range of companies) also play an important part in shareholder behaviour and, in particular, the promotion of short-termism. For a helpful definition of the various types of institutional investors see LV Ryan and M Schneider, ‘Institutional Investor Power and Heterogeneity,’ (2003) 42 Business & Society 398, 400–404. 43 For a helpful definition of earnings per share (‘EPS’) see M Moore and E Walker-Arnott, ‘A Fresh Look at Market Short-Termism,’ 2014 (41)(3) Journal of Law and Society 416, 425: ‘As the name suggests, this figure is essentially calculated by dividing the company’s total earnings or net income (minus total fixed dividends payable to preference shareholder) over the period by the number of its ordinary shares that are in circulation. Accordingly, where a company’s net quarterly income is £10 million, and the company has 2 million ordinary shares in circulation, then its quarterly EPS will be £5. In the hypothetical example, this £5 figure will (theoretically at least) be representative of the amount of earnings accruing to each individual ordinary share of the company over the period. In this way, the EPS figure (theoretically) enables the shares of companies with often radically differing business characteristics and growth profiles to be compared by investors in a like-for-like manner, on the basis of a unifying objective criterion of perceived shareholder wealth (or ‘value’) creation.’

154  A Person without Personality Historically, the increase in institutional investors influenced the predominance of short-termism in three important ways.44 First, institutional investors are financial intermediaries who owe a duty to their own clients (for example, the pension fund holder). Thus, the ultimate beneficiary of the investment sits at the end of a chain of interests, involving fund trustees and managers, each of whom have their own priorities. This chain of interests creates a system of ‘ownerless capitalism’,45 whereby the corporation and its beneficial owner are abstracted from one another. Second, but related to this fiduciary position, the fund managers who make the investment decisions within the chain are constrained by an obligation to ‘enhance the value of the assets entrusted to [them] by [their] clients’.46 This is a very distinct, and not always analogous, duty to that of a director. For fund managers, their primary concern is to increase the performance of their fund, which has several potential consequences. For some, it might involve a necessity to sell their holdings and a disincentive to pursue the costs of active corporate governance (informed by a perspective that passivity by fund managers is a ‘safer’ option to activism).47 For others, it means that although institutional investors can, relatively, be more engaged than other shareholders (due to the size of their holding) they are nonetheless primarily motivated by maintaining the relative value of their fund. Finally, this obligation to increase the fund value is evaluated in relative, not absolute terms; provided a fund outperforms its competitors then the fund managers have discharged their duties.48 This measurement of success is often undertaken against short-term timescales, notably financial reporting deadlines.49 The culmination of these three factors is that institutional investors operate within an environment that is to a degree pervaded by a short-term imperative. All that said, when looking at modern market developments, institutional investors can be seen to hold their positions for a relatively longer term (and be more invested in management) than a new cohort of traders. Namely, day traders who, as the name suggests, adopt extremely short-term, intraday, trading strategies to maximise returns. This emergence of extreme short-termism is further accommodated by technology that enables high frequency trading,

44 The holdings of institutional investors have reduced in recent years although they still represent an influential proportion of investors and therefore remain the focus of corporate governance reform, such as the Financial Reporting Council’s UK Stewardship Code (July 2020) www.frc.org. uk/investors/uk-stewardship-code (accessed 9 August 2020). 45 Cox Report (n 40), 21. 46 BlackRock, cited in PIRC, ‘Stewardship and the Stakeholder Economy: Perspectives on the Role of Shareholder Engagement in the UK Economy,’ 18. 47 B Black, ‘Shareholder Passivity Reexamined,’ (1990) 89 Michigan Law Review 520, 533. See also the Kay Review (n 39), para 6.39. 48 On this see the outcome of the empirical work undertaken by Hendry et al, ‘Owners or Traders?’ (n 17), 1110, and 1116 identifying the ‘obsession’ of fund managers with ‘relative ­performance.’ See also the Cox Report (n 40), 21 and the Kay Review (n 39), para 6.34. 49 Corporate reporting for quoted companies is mandated by the Financial Conduct Authority’s Disclosure Rules and Transparency Rules. In particular, see DTR 4.1–4.2.

Redefining the Beneficiary: From ‘Company’ to ‘Market’  155 designed to make profit on short-term price fluctuations rather than the substantive value of the firm.50 Taken together, this dispersed and detached cohort of shareholders, many of whom are now adopting automated trading technologies, gives rise to particular behavioural consequences. Specifically, it exacerbates collective action issues and engenders rational apathy. That is, from a governance perspective (and outside of the influence of a small number of particularly large shareholders), the influence of any one shareholder’s vote (or even a collection of them) is likely to be minimal. As a consequence, for most shareholders the cost of actively engaging with corporate management outweighs the economic benefit, making ‘active’ governance economically irrational. Adopting this economic analysis, the rational action for disgruntled shareholders is to sell their shares on the now liquid market rather than exercise their voice through governance mechanisms.51 From a compliance perspective (leaving to one side the general governance concerns that this gives rise to), the impact of this rational apathy is important. It means that shareholders generally express their views through market activity; promoting the response of the market as the primary form of communication to the board. This pre-eminence of the generic ‘market’ was recognised by Hendry et al52 whose empirical work found that managerial attention was not only focussed on investor relations but that in this regard, reference was consistently to the ‘market in general, rather than to the company’s investors in particular’.53 The implication for corporate management is clear; the board becomess less concerned about the (relatively low) risk of shareholder activism but the more likely threat of exit (share sale) and the concomitant market response. Thus, shareholder interests (and the focus of directors’ duties) come to be represented by a homogenous market norm of wealth maximisation, which is largely determined by reference to an earnings per share calculation. When looking at managerial behaviour, this market pressure to promote short-term share valuation is reinforced by a number of direct personal repercussions. Financially, directors’ remuneration structures are increasingly linked to market performance, either through contingent bonus arrangements or stock options.54 Moreover, significant share sales will ­ eventually 50 Kay Review (n 39), paras 2.22 and 5.15. See also L Dallas, ‘Short-Termism, the Financial Crisis, and Corporate Governance,’ (2011) 37 Journal of Corporation Law 265, 297–302. 51 F Easterbrook and D Fischel, ‘The Corporate Contract,’ (1989) 89 Columbia Law Review‘ 1416, 1443: ‘investors are rationally uninterested in votes, not only because no investor’s vote will change the outcome of the election but also because the information necessary to cast an informed vote is not readily available’. See also F Easterbrook and D Fischel, ‘Voting in Corporate Law,’ (1983) 26 Journal of Law & Economics 395, 402 (on the relationship between collective action issues and shareholder passivity). 52 Hendry et al, ‘Owners or Traders? (n 17). 53 Ibid, 1120. 54 On the relationship between directors’ remuneration and corporate performance, see M Jensen and K Murphy, ‘Performance Pay and Top-Management Incentives,‘ (1990) 98(2) The Journal of Political Economy 225. On the relationship between executive remuneration and executive risk-taking, see L Bebchuk, A Cohen and H Spamann, ‘The Wages of Failure: Executive ­Compensation at Bear Stearns and Lehman 2000–2008,’ (2010) 27 Yale Journal on Regulation 257.

156  A Person without Personality engage the market for corporate control, leaving the corporation at risk of a takeover, which generally puts the incumbent board’s appointments at risk.55 It is not surprising therefore that this relationship between financial incentives and short-termism was found to be prevalent by the Cox Report, which concluded that management behaviour ‘is focussed on short-term delivery, reinforced with remuneration schemes with powerful incentives based on short-term results’.56 Operationally, this short-termism is also fuelled by the rigorous financial reporting requirements that a listed company is under. That said, the board is motivated not only by personal incentives that are tied to market performance but an understanding that ‘just as managers’ compensation suffers if they miss their internal targets, CEOs and CFOs know that the capital markets will punish the entire firm if they miss analysts’ forecasts’.57 Thus powerful, and pervasive, incentives exist for directors to focus on managing the market, rather than the long-term value of the corporation, such that ‘earnings management’,58 often with a focus on short-term results is ‘considered an integral part of every top manager’s job’.59 B.  Distorting Fiduciary Duties; the Changing Status of the ‘Company’ Beneficiary As we have seen throughout this book, multiple aspects of a corporation’s normative environment (be it the perceived ideology of the market, incentive structures or shareholder behaviour) have served to narrow the corporate objective. It is perhaps not surprising therefore that the empirical work discussed above showed how managerial intention is increasingly focussed on the singular needs (or demands) of an amorphous market, interpreted to be the unwavering and exclusive pursuit of short-term profit maximisation. In this way, a director’s fiduciary duty to ‘promote the success of the company’60 has become similarly distorted neglecting, as we shall see, the discretion it vests in directors to consider a range of interests when discharging their managerial authority.61 55 H Manne, ‘Mergers and the Market for Corporate Control,’ (1965) 73(2) Journal of Political Economy 110, 113 (see also the description of ‘earnings per share’ based bonus payments in practice at 266–267). 56 Cox Report (n 40), 23. Job security and reputation are also closely aligned with achieving financial targets, see J Graham, C Harvey and S Rajgopal, ‘The Economic Implications of Corporate Financial Reporting,’ (2005) 40 Journal of Accounting and Economics 3, 12. 57 MC Jensen, ‘Agency Costs of Overvalued Equity,’ (2005) 34 Financial Management 5, 7. 58 That is, undertaking actions that ‘smooth’ the financial reports of the company thereby meeting the expectations of investors. Examples include deferring losses/costs to subsequent reporting periods. See Moore and Walker-Arnott, ‘A Fresh Look’ (n 43), 11–12; Dallas, ‘Short-Termism’ (n 50), 278–281. 59 Jensen, ‘Agency Costs’ (n 57), 8. 60 Companies Act 2006, s 172. 61 Werner, ‘Management’ (n 29), 389. See the empirical study of David Collison, Stuart Cross, John Ferguson, David Power and Lorna Stevenson in which the majority of corporate respondents

Redefining the Beneficiary: From ‘Company’ to ‘Market’  157 A director’s duty to promote the success of the company is, as Chapter 3 showed, primarily a duty to increase the long-term value of the corporation for the benefit of its members (subject to shareholder direction to the contrary).62 This is, unequivocally, a duty to maximise shareholder ‘value’, with the Companies Act 2006 eschewing a broader pluralist or stakeholder approach. Nonetheless, it would be wrong to suggest that this precludes directors from exercising their authority in a way that considers other interests.63 Indeed, as company law scholars will know, when the Companies Act 2006 codified directors’ duties it introduced the concept of ‘enlightened shareholder value’. That is, in discharging this duty directors are required to have ‘regard’ to a non-exclusive and broad range of stakeholder interests (such as the impact of any decision on corporate reputation as well as employee and community interests).64 The discretion (indeed duty) to have regard to stakeholder interests (albeit with no corresponding obligation to take action) is bolstered by judicial determinations that have made it consistently clear that the court will not, in the absence of mala fides, interfere with directors’ decision making.65 Moreover, it is important to recall that in the context of this obligation, directors owe their fiduciary duties to the company,66 which is generally accepted to mean the benefit of all shareholders67 both present and future.68 Thus, contrary to managerial perception, there is significant scope for the board to take into account a wide range of factors when setting corporate strategy. It would therefore appear to be other factors within the corporation’s normative environment (notably perceptions, rather than the realities, of company law and market ideology combined with commercial and market pressures), and not the Act itself that have been the catalyst for this narrowing of the corporate objective. This transition of directors’ attention from their legal duty to increase the long-term value of the company, to the market demands of short-term earnings per share, has a powerful practical impact. A survey of over 400 US finance executives found that more than 80 per cent would reduce discretionary spending to meet targets whilst over 50 per cent would delay starting a new project, even at a cost to the company, if this would meet earnings expectations.69 felt that Companies Act 2006, s 172 required ‘maximising share price in the short term’. Association of Chartered Accountants, Shareholder Primacy in UK Corporate Law: An Exploration of the Rationale and Evidence, (Research Report 125), 8. 62 Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 255, cited in Ministerial Statements, Companies Act 2006, Duties of Company Directors, June 2007, 7. https://webarchive. nationalarchives.gov.uk/20090609024504/http://www.berr.gov.uk/files/file40139.pdf (accessed 9 August 2020). 63 People’s Department Stores v Wise [2004] SCC 68. 64 Companies Act 2006, s 172(1) (a–f). 65 Carlen v Drury (1812) 1 Ves & B 154; Re Smith & Fawcett [1942] Ch 304; Regentcrest plc v Cohen [2001] BCC 494. 66 Companies Act 2006, s 170; Percival v Wright [1902] 2 Ch 421. 67 Greenhalgh v Arderne Cinemas Ltd and Others [1951] Ch 286, 291. 68 Gaiman v National Association for Mental Health [1971] Ch 317, 330. 69 Dallas, ‘Short-Termism’ (n 50), 280.

158  A Person without Personality Seen in this light, the decision to adopt a wealth maximising, but creative, approach to compliance is unfortunately unsurprising. An approach embodied in the, albeit inaccurate, claim that ‘there was probably some law against’70 not adopting a creative standard of tax compliance. III.  THE CORPORATE FIDUCIARY LADDER

The dominance of a profit maximisation norm within the corporate community is familiar to many. However, when matters such as this are discussed in the abstract many of us would like to believe that, notwithstanding psychological and sociological debates as to the influence of norms (Chapters 3 and 4), the power of economic incentives (Chapter 4), and the pressure of perceived market ideology (Chapter 5), that ultimately if we were faced with an ethical challenge at work that we would do the right thing. That those officers responsible for corporate scandals are somehow just bad apples (incidentally this would make for an awful lot of bad apples). That we would have the perspective and presence to resist those pressures and stand up for our values. Yet, I cannot guarantee that we would. In fact, to a large degree I would wager that we would not. People, ‘good’ people, do not and have not, sometimes in the most egregious of situations. The question that this section considers is why. Chapter 4 explained how the cognitive dissonance that arises when acting in conflict with our personal norms triggers a psychological reaction that, conversely, causes us to seek to legitimise the action in question. This section considers the prior question of why an individual is able to act in that way in the first place. Specifically, it considers how the architecture of the corporation facilitates a decision-making hierarchy, which I term the ‘fiduciary ladder’, that enables the profit-maximising interests of the ‘market’ to displace the personal norms of individuals working within the corporation. In doing so, it shows how the architecture of the firm puts an individual in an authority hierarchy where they perceive the scope of their decision making to be reduced to one of mere obedience, insulating them from the repercussions of, and responsibility for, their actions. A.  The Structure of the Fiduciary Ladder Ronald Coase recognised the hierarchy of power that exists within a corporation in his seminal work The Nature of the Firm.71 In his article, Coase defines 70 N Kumar and O Wright, ‘Google boss: I’m very proud of our tax avoidance scheme,’ Independent (13 December 2012) www.independent.co.uk/news/uk/home-news/google-boss-im-very-proud-ofour-tax-avoidance-scheme-8411974.html (accessed 8 August 2020). 71 (1937) 4 Economica 386.

The Corporate Fiduciary Ladder  159 the firm as a centralised system of management, governed by an entrepreneurcoordinator (in a modern corporation, the board of directors) who directs a subordinate workforce.72 In this regard, Coase drew a distinction between the internal structure of the firm, characterised by a linear and centralised authority, with that of the wider market that it operates within (which as we saw in Chapter 5 operates as a polycentric and spontaneous order, utilising the price system to support relationships of barter and exchange).73 In adopting a ‘real world’74 analysis of the firm, Coase described the inherently subservient role of firm employees. His observation was an important one at the time, challenging the perception that, much like the market itself, the relationship between employer and employee was one of parity, based on supply and demand. In contrast, Coase recognised that the essence of a relationship within a corporation was one of control, not exchange.75 In doing so, he argued that a defining characteristic of the firm was that the central entrepreneur (board) could direct the employees within it, subject only to broad limitations detailed in the employment contract; that a workman does not change departments because of relative prices, he transfers ‘because he is ordered to do so’.76 In his analysis, Coase had recognised the internal command and control structure that the modern corporation operates on (and that supports the fiduciary ladder detailed below). That is, Anglo-American employment relations are premised on a historical relationship ‘of service’.77 The so-called (and archaically termed) ‘master and servant’ roots of the British employment relationship are pervasive and profound, notwithstanding their repeal in 1875.78 They inform both the express and implied duties of the employment contract, granting to the employer full direction and control over the employee.79 Moreover, this foundation underpins the psychological contract80 between the parties and drives the 72 This can be contrasted with the origins of the firm itself, being a vehicle designed to reduce the transaction costs that would otherwise arise each time a particular market input was required. Thus, it has been suggested that a corporation would more accurately be described as a nexus for contracts, rather than the more popular nexus of contracts. See J Armour et al (eds) The Anatomy of Corporate Law: A Comparative and Functional Approach 2nd edn (Oxford University Press, 2009), 6. 73 RH Coase, ‘The Nature of the Firm,’ (1937) 16(4) Economica 386, 387. 74 ibid. 75 ibid, 393. 76 ibid, 387. 77 This can be contrasted with the contractual legal origins of employment relationships in continental Europe, on which, see S Deakin, ‘Legal Origin, Juridical Form and Industrialisation in Historical Perspective: The Case of the Employment Contract and the Joint-Stock Company,’ (2009) 7 Socio-Economic Review 35. 78 For an analysis of modern authorities on the ‘master and servant’ nature of employment relationships, see Geys v Société Générale, London Branch [2012] UKSC 63. 79 M Moore, Corporate Governance in the Shadow of the State (Hart Publishing, 2013) 47. 80 That is, the employee’s perception as to their complete obligations to their employer. See D Rousseau, ‘The “Problem” of the Psychological Contract Considered,’ (1998) 19 Journal of Organizational Behaviour 665; S Middlemiss, ‘The Psychological Contract and Implied Contractual Terms: Synchronous or Asynchronous Models?’ (2011) International Journal of Law and Management 32.

160  A Person without Personality perception that the ‘intent of employment law seems to be to make the employee as much as possible an extension of the employer’.81 Critics of this analysis (echoing the sentiments that Coase had refuted in the Nature of the Firm) suggest that employees, like other contracting parties, may simply withdraw their services; that the worst that an employer can do is litigate or terminate the employee’s contract.82 However, this is where the importance of Coase’s ‘real world’ model of the employment relationship arises. Regardless of technical or legal possibilities, in reality, there is a significant gulf between the contractual entitlements of the employee/employer relationship and the reality of the means available to employees. In particular, the entrenchment of employees both within their employer firm and their industry more generally, significantly restricts employee mobility. Thus, the employment relationship is one of high dependency and, as a result, employees have relatively limited career mobility (likely needing to stay in situ until they secure alternative employment). As a result, a hierarchical relationship of command and control style authority exists within the firm, which whilst one of its core characteristics, has significant implications for personal responsibility and the ability (or willingness) to challenge managerial decisions or directions. A key objective of this hierarchy is that it facilitates what I term the ‘­corporate fiduciary ladder’. That is, an internal decision-making ladder (save for the top rung, which is represented by external shareholders and that is, as we saw above, now largely supplanted by the amorphous ‘market’). This ladder operates to effectively push the now artificially narrowed corporate objective of wealth maximisation, represented by the even narrower metric of earnings per share, down and through all levels of the corporation. The importance of the structure of this ladder is the relationship of authority that exists between each rung, the consequences of which are considered in the next section. However, to help frame that discussion, it is helpful to first consider the structure of the ladder in more detail. A legal entity necessarily has to operate through agents83 and for a large listed corporation this entails a vast network of individuals, the most senior of which are the directors; occupying the Coasean position of co-ordinator entrepreneur.84 As the previous section discussed, directors are bound by their fiduciary duty to promote the success of the company (a duty that is applied in

81 S Masten, ‘A Legal Basis for the Firm,’ (1988) 4 (1) Journal of Law, Economics and Organization 181, 188. 82 A Alchian and H Demsetz, ‘Production, Information Costs, and Economic Organization,’ (1972) 63 American Economic Review 777, 777. 83 Aberdeen Railway Co v Blaikie Bros (1954) 1 Macq 461, 471. 84 The modern corporation operates through a complex network of business units, ­specialisms and divisions. This chapter considers the normative impact of operating across a corporate hierarchy more generally and therefore does not engage in a detailed organisational analysis of managing corporate conglomerates. On this, see J Bower, ‘Planning Within the Firm,’ (1970) 60(2) The A ­ merican Economic Review 186.

The Corporate Fiduciary Ladder  161 practice to mean the interests of the market), which includes an uncompromising obligation of loyalty to their beneficiary. In discharging this duty, the board has primary responsibility for setting corporate strategy,85 which given the distortion of directors’ duties from ‘company’ to ‘market’ interests (often backed by concomitant personal incentives), is generally set to promote a narrow profit maximising focus. Thus, the top rung of the ladder is the shareholder body, represented in most cases by the proxy of, effectively, earnings per share. The second rung, immediately below it, is the board of directors who set corporate strategy to meet that singular market objective. To implement corporate strategy, the board sets broad objectives for senior management to achieve, although commonly leaves the operational decisions of how to actually achieve these objectives to the management teams to decide.86 Therefore, senior executives (who are the third rung of the ladder) have the autonomy to operate as decentralised centres of management (an autonomy that is important when considering responsibility in the next section).87 In turn, the senior management teams provide their employees (the fourth rung and beyond) with more detailed instructions on the work that is needed to meet the overall corporate strategy. Thus, decision-making within the corporation is exercised via a hierarchy, starting with the interests of the market and filtering through the internal levels of the corporation. This hierarchical structure creates an edifice of fiduciary obligations, a corporate ‘fiduciary ladder’, supported by the internal, contractual, command and control structure.88 In this way, directors’ duties (driven by market norms) become verticalised and are embedded throughout the corporation; that is, from the board to managers and managers to employees. Action is undertaken by each rung of the ladder simply because the rung above them directed them to do so (underpinned by an employment relationship, which is similarly based on principles of command and control). Thus, the broad fiduciary duty that binds directors (and has, arguably, been distorted by them) extends down a hierarchical ladder premised on the internal control structure first identified by Coase. The beneficiary of the ladder, which effectively dictates the actions of the firm, is now the faceless ‘market’ interested in one outcome: earnings per share.89

85 Article 3 Model Articles (n 15). 86 A fiduciary is not able to delegate his responsibility, save with express authority. Directors have such authority pursuant to Article 5 Model Articles (n 15). See also: Ex parte Belchier (1754) 27 ER 144; Dovey and the Metropolitan Bank (of England and Wales) v John Cory [1901] AC 477. 87 Werner, ‘Management’ (n 29), 399. 88 Herbert Simon describes a hierarchy as ‘a system that is composed of interrelated subsystems, each of the latter being, in turn, hierarchic in structure until we reach some lowest level of elementary subsystem’. See H Simon, ‘The Architecture of Complexity,’ (1962) 106(6) Proceedings of the American Philosophical Society 467, 468. 89 Note that organisations that adopt a more horizontal or decentralised structure still act, ­ultimately, within the parameters of an authority structure. Further, the autonomy that such h ­ orizontal, organisational models grant tends to relate to decisions concerning product or service design (and delivery) rather than cultural, compliance or fiscal policies.

162  A Person without Personality Notwithstanding the profit focus of the ultimate corporate beneficiary, one challenge still remains in attributing creative compliance decisions soley to this dominant metric of success. Namely, that the fiduciary ladder is nevertheless comprised of individuals. Moreover, individuals who do not seem particularly predisposed to unethical conduct in the personal lives. On this basis, it would be reasonable to expect that personal norms would prevail in the event of conflict with those of the corporation. Yet, regrettably, numerous corporate scandals exist to demonstrate that this is not the case.90 The next section explores the psychological impact of the fiduciary ladder to help explain why we continue to witness these repeated corporate scandals and why personal norms are seemingly perpetually subsumed to those of the corporation. B.  The Psychological Consequences of the Fiduciary Ladder The importance of the fiduciary ladder, predicated on relationships of authority and obedience, is profound. When acting as a constituent part of an authority relationship, a person’s identity (and therefore concept of responsibility) can, as we shall see, shift significantly. As they are now occupying a position of obedience, an individual loses their sense of autonomy, effectively becoming task focussed and limiting their sense of responsibility to simply performing the task requested of them. In this way, the relationship of authority ‘obviates the necessity of making judgments or choices’91 such that ‘normal moral principles become inoperative’.92 In particular, a person no longer feels the usual sense of responsibility to evaluate the task before them, simply to implement it. The consequences of authority relationships are sobering, as evidenced by Milgram’s famous ‘shock study’, which demonstrated that ‘behaviour that is unthinkable in an individual who is acting on his own may be executed without hesitation when carried out under orders’.93 In brief, Stanley Milgram’s study was structured to identify the point at which people would defy authority given a clear moral imperative. The experiment involved three participants: the subject (referred to as the ‘teacher’ and who was the only genuinely naive participant in the research), the learner (an actor) and the administrator/researcher (also an actor). The subject had responded to an advert asking for volunteers for a study on memory. On the day of the 90 See, eg, the decision of Manville executives to conceal the risk of asbestosis from their employees, notwithstanding the fatal consequences. On which, see: R Sims, ‘The Challenge of Ethical Behaviour in Organizations,’ (1992) 99(7) Journal of Business Ethics 505, 506; M Weingarten, ‘Asbestos Litigation from an American Perspective,’ (2009) 4 Journal of Personal Injury Law 253. 91 Kelman and Hamilton, Crimes of Obedience (n 11), 16. 92 ibid. 93 Z Bauman, Modernity and the Holocaust (Polity Press, 1989), 154. Bauman is, of course, writing in a very different context. However, his insights into the application of the findings of the Milgram experiment are highly instructive and applicable to individual behaviour within an organisational setting.

The Corporate Fiduciary Ladder  163 experiment the subject and the learner were met by the researcher (who wore a white laboratory coat as a symbol of authority) and asked to draw lots to determine their roles in the experiment. This was, of course, staged so that the genuine subject would always play the role of the teacher. Once the roles had been allocated the learner and teacher (subject) were taken into a second room where the learner was strapped into what was described as (and physically resembled) an electric shock machine. This was done in full sight of the subject. The subject was then taken to a different room, from which the learner was no longer visible, and instructed to ask the learner a series of questions via an intercom system. Every time the learner got a question wrong the subject was asked by the researcher to inflict one in a series of electric shocks of increasing severity. The shocks (which of course were not real) were administered by the subject engaging a switch from a long row of switches on the dashboard in front of them. Each switch represented a different voltage and the switches were clearly labelled to show that they increased to a potentially fatal voltage of 450 volts. Each time a shock was given the learner would respond with audible and increasing cries of pain.94 Nevertheless, on the basis of a person in a white coat instructing them to do so, 65 per cent of participants continued to inflict the strongest shock of 450 volts.95 Milgram’s work provided sobering evidence of the influence of authority on a person’s behaviour. Provided an authority figure is seen to be legitimate,96 a majority of people were willing to comply with their demands, regardless of their personal norms or the clear harm that they believed was being caused.97 What was striking about Milgram’s work was the low bar to establish this authority, simply a white coat in a laboratory setting. In contrast, within the firm, this authority is established in multiple ways including the voluntary acquiescence by an individual to the chain of command,98 the express terms of the employment relationship, the incentive structures that reward adherence to the authority and the social norms that endorse the roles and hierarchies within the firm structure. 94 See: S Milgram, Obedience to Authority: An Experimental View, (first published 1974, rev edn, Pinter & Martin, 2010), a detailed explanation of the experiment is at 9–10. 95 S Milgram ‘Behavioral Study of Obedience,’ (1963) 67(4) The Journal of Abnormal and Social Psychology 371, 376. 96 The legitimacy of authority is important (ibid 140). When Milgram varied the experiments so that another apparent member of the public (who was in fact an actor) instructed the subject to administer the shock every participant refused, see Milgram, Obedience to Authority (n 94), 106. Within a corporate structure, the legitimacy of authority is clear and supported by regulatory norms. Moreover, the corporate authority’s instructions adhere to a legitimate overarching ideology of profit maximisation, which is also reflected in corporate regulation. On the importance of a justifying ideology, see Milgram, Obedience to Authority (n 94), 143. 97 Milgram, Obedience to Authority (n 94), 168. In coming to this conclusion, Milgram rebuked suggestions that his experiment simply facilitated the realisation of people’s inner (suppressed) desire to engage in violent conduct, the so-called ‘aggression theory’, see Milgram, Obedience to Authority (n 94), 166–178. See also Kelman and Hamilton, Crimes of Obedience (n 11), 16. 98 This voluntary participation is psychologically important as it creates a ‘sense of commitment and obligation which will subsequently play a part in binding the subject to his role’. Milgram, Obedience to Authority (n 94), 142.

164  A Person without Personality Thus, returning to the fiduciary ladder, the consequences of Milgram’s finding are clear. Once a person steps into a corporate role, regardless of the rung of the ladder that they occupy, they assume an identity (to different degrees but an identity nonetheless) of obedience. This position of (relative) subservience to an authority then profoundly, even if subconsciously, reframes their sense of obligation. There is no longer a genuine sense of personal responsibility to evaluate the consequences of their actions, rather the scope of their duty is now one of obedience and a focus on ‘how smartly and effectively the actor fulfils whatever he has been told to fulfil by his superiors’.99 In this way, individuals within the fiduciary ladder occupy what Milgram described as an ‘agentic state’,100 where they effectively become an ‘instrument for another person’s wishes’.101 In this state an individual, unburdened by moral responsibility, ‘becomes something different from his former self, with new properties not easily traced to his usual personality’.102 That is, they are able to adopt and implement the authority’s norms because they ‘do not see themselves as personally responsible for the consequences of their actions’103 acting as ‘merely extensions of the authority’.104 In sum, when occupying an agentic state an individual feels ‘responsible to the authority directing him but feels no responsibility for the content of the actions that the authority prescribes’.105 Regrettably, as we have seen countless times, this comprehensive outsourcing of moral responsibility ‘is the most far-reaching consequence of submission to authority’,106 leading Bauman to conclude that ‘collective perpetuation of cruel acts is made all the easier by the fact that responsibility is essentially “unpinnable”’.107 Bauman’s hypothesis is supported to a large degree by Milgram’s findings. When reading the transcripts of the initial tests (Milgram’s research has been repeated many times over the years, with largely similar outcomes) the question of personal responsibility was determinative of the subject’s actions. During the electric shock experiment, individuals who questioned the morality of the request were easily satiated by the researcher’s response that ‘no permanent harm would be caused’. Having been reassured by the authority figure, there were no follow up questions (for example concerning the affliction of pain more generally). Moreover, the acceptance of personal responsibility (or otherwise) was determinative as to whether an individual ‘disobeyed’ the researcher by refusing to continue with the experiment. Generally, ‘disobedient’ subjects accepted full, personal, responsibility and refused to assign any responsibility to the learner



99 Bauman,

Modernity and the Holocaust (n 93), 159. 162; and Milgram, Obedience to Authority (n 94), 134–136. 101 ibid, xviii. 102 Milgram, Obedience to Authority (n 94), 145. 103 Kelman and Hamilton, Crimes of Obedience (n11), 16. 104 ibid. 105 Milgram, Obedience to Authority (n 94), 147. 106 ibid, 10. 107 Bauman, Modernity and the Holocaust (n 93), 163. 100 ibid,

The Corporate Fiduciary Ladder  165 or the researcher.108 This can be contrasted with the ‘obedient’ subjects who continued the experiment until the end, including one who, when questioning the ethics of continuing, asked the researcher whether he ‘accepted all responsibility’. On being reassured that this was the case the subject proceeded to administer the maximum (and potentially lethal) amount of volts.109 Milgram’s work focussed on individuals, where there was the potential for personal responsibility and a degree of proximity between the subject and the learner on whom they thought they were inflicting pain. Nonetheless, even under those conditions the imposition of a temporary authority (and obedience) relationship was sufficient to have a striking impact on personal behaviour and the willingness to uncritically follow directions. In the corporate community, this risk of obeying instructions ‘without question even though the behaviour they engage in may entail great personal sacrifice or great harm to others’110 is exacerbated, as the architecture of the firm is such that it creates a social, legal and cognitive distance between the individual and the subject of any externalities or harm that their conduct might cause.111 This separation helps to insulate an individual from the impact of their actions, granting them the comfort ‘of unnoticing the causal link between his action and the victim’s suffering’.112 Perhaps less obviously, this distancing between a subject and the consequences of their actions has a second important consequence. Namely it allows an individual to have greater alignment with, and loyalty to, the authority figure above them in the fiduciary ladder. Thus, the hierarchy leads to ‘an evermore profound and unbridgeable chasm between the actors (i.e. members of the organisation) and the objects of action’.113 It is a sombre warning that this chasm (and alignment) arose in the extreme conditions of Milgrim’s experiment, where the authority relationship was temporary (no subject was present for more than one hour) and the consequences of the individual’s actions severe. Translated into a corporate setting, where authority relationships develop over years, backed by social and financial sanctions that generally reward obedience over disobedience,114 we start to see the profound impact that these psychological phenomena can have. 108 See the transcripts of the experiment involving ‘Mr Renseller’ as the subject, Milgram, Obedience to Authority (n 94), 52 and Gretchen Brandt (at 87), both of whom accepted personal responsibility for their conduct and both of whom refused to carry on. 109 See Fred Prozi’s transcripts: Milgram, Obedience to Authority (n 94), 77 and those of an unnamed subject at 162. The majority of ‘defiant’ subjects considered themselves responsible for their conduct whereas for ‘obedient’ subjects the majority considered the researcher to be responsible: see Milgram, Obedience to Authority (n 94), 205. 110 Kelman and Hamilton, Crimes of Obedience (n 11), 16. 111 Milgram, Obedience to Authority (n 94), 37–41. Milgram tested this theory by undertaking a series of modified experiments that varied the proximity between the subject and the ‘victim’. The original research placed the subject and the victim in different rooms (remote-victim) whereas variations had them, inter alia, in the same room (proximity) and also required the subject to force the hand of the victim onto the shock plate (touch-proximity). ibid 33–35. 112 Bauman, Modernity and the Holocaust (n 93), 155. 113 ibid, 156. 114 On the role of rewards more generally, see Milgram, Obedience to Authority (n 94), 139–140.

166  A Person without Personality One final point regarding the operation of the fiduciary ladder should be made clear. Namely that Milgram’s findings apply, quite worryingly, across all rungs of the ladder.115 When we discuss authority relationships in this section, we are not simply concerned with the most junior employees outsourcing responsibility to their immediate superior. Rather, each rung of the ladder can ‘see themselves as having no choice [but to obey] as long as they accept the legitimacy of the orders and of the authorities who give them’,116 including when those orders are given, implicitly if not expressly, by the market. It is thus that we see a multinational organisation make the decision to destroy caves first occupied by Aboriginal people 43,000 years ago, all in the pursuit of profit.117 C.  Responding to the Fiduciary Ladder Understanding the behavioural impact of the corporate structure in this way provides both an ethical imperative for corporate reform together with a deeper understanding of the changes needed if we are to respond to the problem of creative compliance. The GAAR seeks to manage corporate compliance by simply focussing on restricting the compliance strategy itself. However, as this chapter (together with Chapters 3 and 4) has sought to demonstrate, corporate compliance strategies are borne from the norms, and unintended protections, which arise from the broader corporate regulatory framework. Thus, if we are to achieve any substantive reform in this field, we need to challenge the deeper causes of the problem. Milgram drew an analogy between the agentic state and being asleep.118 That is, an interruption in the authority relationship can reverse the insulation offered by the hierarchy (as it can wake someone from sleep). Within his experiments Milgram identified that this interruption can come from, inter alia, peer dissent, plurality of instructions and distancing the source of authority. Earlier parts of the book have shown that the most effective ‘interruption’ for responding to the compliance crisis is likely to be a change in the corporation’s normative environment. That by changing the social norms that legitimise creative compliance

115 Of note is that this psychological insulation also involves out-sourcing down the ladder. For example, directors can rely on the fact that specific management decisions are made by the decentralised senior management teams (to whom directors delegate responsibility). J Coffee, ‘“No Soul to Damn: no Body to Kick”: An Unscandalized Inquiry into the Problem of Corporate Punishment,’ (1980) 79 Michigan Law Review 386, 398. For example, the management of GE, when facing price fixing charges, pointed to a directive that its executives were required to sign expressly forbidding violations of anti-trust rules. However, the targets and incentives set by management created an environment where such collusion was, at best, highly likely. See Bower, ‘Planning Within the Firm’ (n 84), 193. 116 Kelman and Hamilton, Crimes of Obedience (n 11) 16. 117 Sydney, ‘Rio Blew up Aboriginal Caves’ (n 4). 118 Milgram, Obedience to Authority (n 94), 157.

Contrasting Other Actors  167 and, as we have seen in this chapter, the distortion of the corporate objective, we might then be able to embed more targeted policies that are designed to engage some (or all) of Milgram’s recommendations. We return to what some of these policies and approaches might be in the following, and final, chapter. IV.  CONTRASTING OTHER ACTORS

This chapter suggests that public corporations are uniquely predisposed to adopt creative compliance strategies on the basis that the structure of their decisionmaking mechanisms insulates the corporation and their employees from responsibility. This section responds to one potential objection to this theory, namely that these corporations are no different to other significant economic actors or organisations and should not therefore be held to a higher compliance standard than they are. In particular, it considers the position of high net worth individuals, private companies and partnerships. In contrasting these other actors, the key point of distinction is that none of them are protected by (or subject to) the operation of the fiduciary ladder. That is, in all cases there is a human decision-maker to ultimately take responsibility for the act or omission complained of. In the case of an individual acting in their personal capacity they are, of course, easily identifiable and ordinarily responsible for their decisions. In the event that they transgress moral norms or breach regulation, the individual is generally held to be culpable and subject to both formal and social sanction (or censure). That said, the case of the individual entrepreneur or high net worth individual acting in a purely personal capacity is rare. The very necessity of the corporation arises as its objects ‘are beyond the reach of the members as individuals’,119 and thus individual capitalists ordinarily act through a corporate vehicle. As such, creative compliance rarely involves an individual acting qua individual. Moreover, when acting in a personal capacity (without the protection of the corporation) the fiduciary latter does not exist as the individual concerned cannot use the corporate architecture, or decision-making hierarchy, to shield themselves from public or moral culpability. However, a similar argument applies to private or closely held companies, which are often ‘owner-managed’ meaning that the shareholder and director are usually the same person. As a consequence, the shareholders are legally but not economically emancipated from the corporation. Again, notwithstanding the insertion of a separate legal entity, this ‘human’ presence (and alignment) has a dramatic impact on the risk profile of the company. Moreover, it is critical when considering the sense of individual responsibility for transcending social norms; the ability to outsource moral responsibility for corporate decisions simply does not exist. 119 A Chayes, ‘The Modern Corporation and the Rule of Law,’ in E Mason (ed) The Corporation in Modern Society (Harvard University Press, 1961), 34.

168  A Person without Personality The difference between corporations and partnerships is more nuanced although premised on the same distinction, namely that the decision-makers within the partnership remain visible from a reputational perspective. Historically, only general partnerships were available,120 which meant that all partners were jointly and severally liable for the obligations of the firm.121 This personal liability precluded the operation of the fiduciary ladder as ownership and control remained unified and ensured that partners’ personal risk appetites were reflected within the decision-making process. The high visibility of individual partners, both in terms of risk and reputation meant that the firm’s decisionmaking process was nevertheless imbued with the personal traits that are often missing from corporate decision-making. The personal nature of the partnership is powerfully demonstrated by the fact that traditionally the partnership could be dissolved on notice by one partner122 or upon the exit of a partner through death or bankruptcy.123 As partnerships developed, they started to emulate the economically desirable characteristics of the corporation, culminating in the creation of the limited liability partnership (‘LLP’).124 An LLP has separate legal personality125 and the members’ liability is limited to the extent set out in the LLP deed entered into between them.126 Section I of this chapter demonstrated the importance of separate personality and limited liability on the creation of the corporate fiduciary ladder and thus it would be a natural conclusion to suggest that the LLP shares this decision making structure. However, there is one important difference: LLPs rarely have the concomitant separation of ownership and control. The partners of the LLP are invariably the managers of the LLP (for example, large law firms).127 Thus the fiduciary ladder does not exist to shield the owner/managers from reputational damage, either within the firm or from external scrutiny. In this sense the historical development of partnership principles continues to influence the use and operation of partnerships and the attempted emulation of the corporate form is insufficient to define the LLP within the same class as a corporation.

120 Partnership Act 1890. 121 ibid, s 9. 122 ibid, s 32. 123 ibid, s 33. 124 Limited Liability Partnerships Act 2000. 125 ibid, s 1. 126 ibid, s 5. 127 The traditional requirement that law firms operate as partnerships are premised on the exact notions of the fiduciary ladder that exists within large corporations. That is, by operating through a partnership there was an identifiable ownership structure of individuals who were bound by professional ethics (and regulatory oversight). A discussion of this principle can be found in: Sir D Clementi, Review of the Regulatory Framework for Legal Services in England and Wales: Final Report, (December 2004), 113.

Conclusion  169 V. CONCLUSION

This chapter has sought to demonstrate how understanding the existence of the corporate fiduciary ladder can shed light on why the corporate compliance crisis has arisen and, moreover, why behavioural change in corporations is so difficult to achieve. The answer, in high-level terms, is that it helps to explain why it is that the corporate person lacks the substantive attributes that we expect of natural ‘personhood’ and why the ethics of individuals within the firm are so readily displaced. By understanding the influence of corporate architecture in this way, we are better positioned to structure a holistic approach to creative compliance; one that addresses the causes of this behaviour, not simply its effects. Single-issue regulation that responds to specific concerns will, no doubt, have some impact on current compliance scandals. However, creative compliance is, by its very nature, a disregard for the normative value of regulation; it simply views compliance as a pricing exercise. Thus, if we are to achieve any substantive reform in this field, we need to challenge the deeper causes of the problem. As this chapter (together with Chapters 3 and 4) have sought to demonstrate, one of those causes is the powerful normative and psychological impact of corporate law and architecture, which coalesce to both legitimise creative compliance and insulate corporate decision-makers from the reputational consequences of their actions. The result of such impunity is that the dominant shareholder wealth maximising norm, which also informs personal benefits is able, ultimately, to determine corporate strategy and shape individual actions in deeply profound and powerful ways.

170

Part IV

Reform

172

8 It is Called Capitalism: Towards a New Market Integrity The conception of freedom under the law that is the chief concern of this book rests on the contention that when we obey laws, in the sense of general abstract rules laid down irrespective of their application to us, we are not subject to another man’s will and are therefore free.1 Friedrich Hayek Liberty not only means that the individual has both the opportunity and the burden of choice; it also means that he must bear the consequences of his actions and will receive praise or blame for them. Liberty and responsibility are inseparable.2 Friedrich Hayek

T

his book is about corporate compliance. But, really, it is about people and rules (and how they interact). It is about how the rules of capitalism have been subtly, but importantly, misunderstood and how ‘artificial’ rules can have a powerful impact on personal rules of behaviour, values and ethics. In short, it is about how people are, in fact, (on the whole) good and how prosperity (on the whole) does not have to be bad. These are comforting observations to make but they do then raise slightly less comfortable questions, namely if this is the case (which I sincerely believe it is) how is it that we live in a society where these messages seem to be lost, if not entirely distorted? Moreover, what can we (and should we) do about it? Reassuringly, as Chapter 3 demonstrated, as challenging as these questions are, their current answers are by no means inevitable and in this final chapter I reflect upon how we might consider reform moving forward. By bringing together insights from company law, sociology and social psychology the book has sought to provide a new perspective on the question of ‘what next?’ Corporate scandals have persisted for too long and, as the recent Rio Tinto example in Chapter 7 demonstrates, continue to do so. The repeated and, by now too familiar, cycle of corporate scandal, followed by public outcry, which is met with a targeted regulatory response only to be followed by another scandal has proven to be insufficient to address the problem of corporate c­ ompliance

1 FA

Hayek, The Constitution of Liberty (first published 1960, Routledge Classics, 2006), 134. 63.

2 ibid,

174  It is Called Capitalism: Towards a New Market Integrity (and indeed corporate decision making more generally), ­highlighting the pressing need for a change in approach. One objective of this book is to suggest that this change should be predicated on the fact that these scandals should not, and can no longer, be dismissed simply as the pursuit of profit authorised by individual ‘bad apples’. Whilst in some instances that might be the case, there are too many examples of otherwise law-abiding and seemingly ‘ethical’ individuals becoming embroiled in corporate wrongdoing to suggest that this somewhat binary explanation is accurate. Rather, what this book has sought to demonstrate is that the question of corporate decision making is the product of a complex network of relationships and influences (of which profit maximisation is undeniably a significant part) that must be understood if we are to achieve meaningful behavioural change. This final chapter brings those observations together, reflecting on their implications for both the individual and the state, whilst offering areas of focus for future reform. In drawing this book to a close, Section I reflects on the two broad themes of the earlier chapters. First, it returns to the relationship between compliance and the social orders that civil society depends upon. By appreciating that responsible compliance and profit maximisation enjoy a symbiotic, rather than antithetical relationship, we can start to build the foundations from which to structure reform. As noted earlier in the book, this is not to say that capitalist market ideology is not without its flaws (indeed no system is). Rather, it is to recognise that some of the perceived challenges of the market are not a fair or accurate representation of classical thinking. Moreover, that this misconception is not simply a point of pedantry but in fact serves to exacerbate some of the challenges that characterise the current compliance crisis (not least the potentially antagonistic relationship between corporations, the public and the state). Second, it considers why it is that corporations and, more specifically, their officers act in the way that they do. That is, notwithstanding widespread public consternation and condemnation, why do corporations persist in adopting creative compliance strategies, given the damage that they cause to the public purse whilst undermining trust in the corporate and market communities. The ­corporate objective (and concomitant pressure) of profit maximisation is, of course, one part of the answer but is arguably too simplistic on its own. In particular, it fails to provide a satisfactory account of why it is that individuals are so seemingly willing to eschew their own personal norms, values and ethics, to implement those of the corporation (even when these do not align with their own). In recognising the remarkable impact that social norms, company law and the very architecture of the firm itself has on individual behaviour we are forced to ask ourselves to what extent is an individual truly free to act? As a corollary, what does this mean in terms of responsibility, both for the individual and the state in developing policies for reform? Against that background, Section II considers what this interplay between responsibility, freedom and the law has moving forward. Adopting Erhard,

Responsibility, Freedom and the Law  175 Jensen and Zaffron’s definition of ‘integrity’,3 namely the need for both ‘completeness’ and ‘trust’, it suggests that creative compliance undermines the integrity of social order. That is, by undermining the predictability and order that is derived from spirited compliance, our social and legal architecture is incomplete, missing the vital component of trust for it to function properly. Drawing on insights from social psychology that are explored in earlier chapters, this second section concludes by reflecting on some of the ways forward for reform. I.  RESPONSIBILITY, FREEDOM AND THE LAW

This book opened with Eric Schmidt’s claim that creative compliance, namely the pursuit of profit over regulatory intent, was justified within a capitalist market economy. As the book went on to show, those three words encapsulated not only deeply held and damaging misconceptions about market ideology but alluded to the individual need to justify decisions that had been made in line with them. This section reflects on these two key aspects of the compliance debate namely the relationship between market ideology and compliance and, thereafter, the behavioural drivers that allow individuals to adhere to corporate norms even at the expense of their own. In doing so it considers the consequences of these themes, most notably the implications that they raise for personal freedom and, as a corollary, both individual and state responsibility. A.  Market Order, Integrity and Freedom Ostensibly, creative compliance seems to align perfectly with capitalist ideology. It is a standard that embodies profit maximisation at the expense of others, including the public purse at a time of significant austerity, and epitomises the highly individualistic mentality that is seemingly reflective of liberal thinking. Understood in this way, the question is not why do corporations creatively comply but why are we even talking about it? The reason, as Chapters 5 and 6 explored, is that this view reflects a damning and damaging misconception of the classical liberal ideology that the market economy is in fact predicated on. It adopts an ‘everyday liberalism’ that conflates libertarian thinking with those of their classical liberal counterparts, obscuring the vital differences between the two schools of thought (and indeed others on the liberal spectrum). Most notably, it neglects the critical importance that classical liberals placed on social cooperation and the architecture of support 3 See W Erhard, MC Jensen and S Zaffron, ‘Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics and Legality,’ (March 23, 2009). Harvard Business School NOM Working Paper No 06-11; Barbados Group Working Paper No 06-03; Simon School Working Paper No FR 08-05.

176  It is Called Capitalism: Towards a New Market Integrity that was needed to maintain it. As Chapter 5 explained, the methodological individualism adopted by classical liberals simply reflects the need to understand the motivations of the individual as the smallest unit within a larger collective. It does not advocate an unbridled selfishness as some may believe. It is this neglect of the importance of cooperation that is critical to the current debate. Without understanding the centrality of social cooperation, we not only perpetuate a narrow and reductive norm (the importance of which is considered in the next section) but this also obscures the very particular structure of rules that is needed to facilitate it. In particular, the framework of general rules of behaviour that allow a spontaneous (rather than planned) order to emerge. Without this spontaneity, coordinating a complex social system is simply not possible and thus protecting this unique architecture is critical for the success and prosperity of society as a whole. Whilst this architecture is considered in more detail in Chapter 5, at its core is the need for the relative predictability of behaviour within the system itself, derived from the protection and predictability afforded by the rule of law and, specifically, the principle of equality before the law. It is this critical need, and the pivotal role of equality, that helps to distil the role of compliance and, more importantly spirited compliance, within classical liberal ideology. By understanding the true tenets of classical liberalism, we can appreciate its remarkable function in society (in particular, the coordination of complex social systems that are beyond deliberate design) and therefore the need (notwithstanding its challenges) to protect it. This perspective also shows us how creative compliance, far from aligning with its principles, in fact undermines one of its central pillars. In this way, we can start to see the harm that creative compliance causes to the market, undermining trust not only between market participants inter se but also between the market and the public as a whole. One repercussion of this is that it triggers the cycles of reactionary regulation outlined at the start of this book (and explored in Chapter 2). This cycle serves to further undermine the market architecture as regulation increasingly moves away from general rules of behaviour (protecting the relative freedom for individuals to act within that framework) towards the increased use of more targeted legal instruments and demands. It is by unpacking these misconceptions of liberal ideology that we can find normative support for spirited compliance (namely as an important bulwark to protect the market order), whilst establishing a conceptual framework for reform (through the rule of law and, specifically, the principle of equality before the law). Moreover, in so doing, it distils the systemic harm that creative compliance can cause to the market orders that corporations depend upon (and ironically rely on in support of creative practices). As the next section shows, changing this perception of the harm generated by creative compliance is a critical component in the process of changing the normative landscape, itself a crucial first step in achieving effective and sustainable reform.

Responsibility, Freedom and the Law  177 B.  Freedom, Choice and Responsibility Whilst it is clear that corporate ideology (albeit predicated on misconceived foundations) is perceived to support creative compliance, what is less clear cut is why the individuals who implement decisions on a corporation’s behalf would do so. As Chapters 3 and 4 explained, our behaviour is largely a product of our social norms and it is these norms that provide the baseline for social meaning (and, as a consequence, social sanction in the event that we diverge from them). Indeed, the power of norms is such that Bicchieri described them as the rules we live by (rather than those that we are asked to live by).4 Yet given this power of norms, and the clear public dissatisfaction with the 2012 scandals (and others), why do individuals when acting in their corporate capacity seem so willing to favour corporate norms over their own? There are, of course, personal incentives that will help motivate this behaviour (such as bonus and promotion arrangements that serve to align personal and corporate interests) but when looking at the egregious nature of some of the acts undertaken by corporate officers, this is too simplistic an answer. Therefore, what is it about stepping into the corporate world that allows its norms to dominate ours as individuals so absolutely? In exploring this question, the book offers two key insights. First, and as discussed in Chapter 7, the architecture of the firm creates an internal hierarchy (the fiduciary ladder) that embeds a relationship of authority and obedience. It is this relationship of obedience that has a profound impact on personal behaviour (which has been repeatedly shown to be the case in the worst of circumstances)5 and that transforms an individual’s sense of responsibility. In particular, a person can become task-focussed, with their sole remit being interpreted as implementing (or obeying) the instructions they are given, not evaluating and challenging them. In this way, an individual is able to undertake (and indeed feels obligated to undertake) a task, even if it doesn’t align with their personal views. Moreover, this task is performed without any sense of personal responsibility. The nature of the fiduciary ladder is such that the tasks that are transmitted through it represent the norms of the top rung of the ladder. In the modern public corporation that is the shareholder body. As Chapter 7 explains, this cohort is now largely represented by the somewhat amorphous market, itself represented by the proxy of earnings per share. Thus, objectives and norms that are conveyed down the fiduciary ladder are, generally, myopically short term and profit focussed. As each rung of the ladder is, effectively, able to outsource moral responsibility for their specific conduct at no point does any level of the firm take complete moral responsibility for the consequences of the decision in question. 4 C Bicchieri, The Grammar of Society, The Nature and Dynamics of Social Norms (Cambridge University Press, 2006), ix. 5 R Kelman and L Hamilton Crimes of Obedience (Yale University Press, 1989).

178  It is Called Capitalism: Towards a New Market Integrity Of note, is that this includes the board of directors who themselves are able to look to their shareholders as justification, explaining that creative compliance is simply called capitalism and that there is ‘probably some law against’6 doing anything else. However, once a person has acted in accordance with the instructions of their authority, this does not mean that they can entirely avoid the consequences of contravening personal norms. Rather, as Chapter 4 explains, this creates a cognitive dissonance that in turns triggers a specific range of psychological responses. In particular, there is a need (as we have seen) to either justify the behaviour in question or ignore (or challenge) any conflicting evidence. These responses, somewhat ironically, serve to embed and rationalise creative compliance, strengthening the norm and contributing to the habitualisation of the standard both within an individual corporation and, more worryingly from a systemic perspective, across the wider corporate community. It is by understanding the influence of norms that a critical question emerges, namely the extent to which a person can be said to be truly free to act. If compliance is, as Chapter 3 discusses, the product of norms (and indeed we see how norms can operate to effectively automate certain behaviours) to what extent does someone have genuine autonomy over their decision-making? If an individual lacks freedom of action, if their choice is a technical one rather than something more meaningful, to what extent are they or should they be responsible? Moreover, when looking at structuring policies for reform, what responsibility does the state have to manage these unintended consequences, some of which stem from the law itself (for example, we see the impact of the Companies Act 2006, section 172 throughout the book). II.  RADICAL INTEGRITY

Whilst regulation is a critical component of any toolkit for reform, including for its expressive function (that is, its normative proclamation of what is considered right or wrong), we have seen, repeatedly, that on its own it is not enough to move corporate behaviours towards more spirited standards of compliance. One of the reasons for this is that a legal instrument will never be able to address all issues or eventualities and the regulatory gaps that will inevitably remain need to be filled by the legal subject themselves. Moreover, without changing the construction of compliance (discussed in Chapter 3), even the express terms of any regulatory instrument are likely to be construed in a creative manner. Thus, what is needed (and this was outlined in Chapter 3) is a change to the normative environment that corporations operate within. This environment 6 N Kumar and O Wright, ‘Google boss: I’m very proud of our tax avoidance scheme,’ Independent (13 December 2012) www.independent.co.uk/news/uk/home-news/google-boss-im-very-proud-ofour-tax-avoidance-scheme-8411974.html (accessed 8 August 2020).

Radical Integrity  179 currently serves not only to legitimise creative compliance but inhibit the introduction of any new injunctive norms (such as calls for spirited compliance), creating a powerful barrier to reform. To be clear, this book is not suggesting that we transform the profit maximising focus of the firm. Rather, that we consider ways in which the normative ordering7 adopted by the corporate community can (or should) be reconsidered. With such normative change, we are able to create an environment where targeted efforts at reform are likely to be more effective. What is needed, is a commitment to ‘radical8 integrity’. A.  Towards a More Radical Integrity We saw in Chapter 5 how trust (namely the reasonable predictability of market participants’ behaviour) was fundamental to the success of the market order, indeed of any complex, social system. However, creative compliance, which as we have seen effectively allows corporations to ‘manipulate’ the law regardless of the intention of regulators, fundamentally undermines this predictability as we are no longer able to look to the rules of the market as a guide to our expectations of others. In this way, one important aspect of the system is lost, threatening the integrity9 of the market (and other social) orders that society depends upon. The importance of integrity is not simply as an ideal to achieve but it is fundamental to the proper functioning of the market, a point that can be helpfully visualised if we look to the definition offered by Erhard et al. That is, integrity is ‘a state or condition of being whole, complete, unbroken, unimpaired’.10 Thus for a system such as the market to have integrity, all of the components of that system need to be present and complete.11 By way of analogy Erhard et al draw on the example of a bicycle wheel, to show that if you remove spokes from the wheel it is no longer whole and the integrity of the wheel is diminished.12 Without integrity, the system is no longer capable of producing the desired outcome, resulting in a diminution of performance and, in the case of a social 7 C O’Reilly, ‘Corporations, culture and commitment: Motivation and social control in organizations,’ (1989) 31(4) California Management Review 12. 8 Drawing on Posner and Weyl’s reflections of the use of the term as going back to the roots of a matter (in the case of this book, to the roots of classical liberalism and the rule of law). See EA Posner and EG Weyl, Radical Markets, Uprooting Capitalism and Democracy for a Just Society (Princeton University Press, 2018), xiii. 9 Integrity is used here in both definitions of the term. Both as to the ‘honesty’ or ‘morality’ of the system but also as to it being ‘complete’ or ‘whole’. As to the latter, the assertion of this book is that without spirited compliance the system is incomplete and, as is discussed in ch 5, is liable to failure. On the integrity of a system more generally, see W Erhard, MC Jensen and S Zaffron, ‘Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics and Legality,’ (March 23, 2009). Harvard Business School NOM Working Paper No 06-11; Barbados Group Working Paper No 06-03; Simon School Working Paper No FR 08-05. 10 Erhard et al, ‘Integrity: A Positive Model’ (n 9), 2. 11 ibid, 21. 12 ibid, 40.

180  It is Called Capitalism: Towards a New Market Integrity system (and depending on the severity of the issue), the likelihood of regulatory intervention.13 Moreover, the less effective the system, the less trust there is in it and, in the case of the market, the less trust the less effective it is, thus creating a self-perpetuating cycle of behaviour.14 Yet, we cannot mandate trust. Not in the sense that is needed here. The very challenge of creative compliance (as seen in Chapter 2) is not only the manner in which corporation’s comply with the law but how they also fill the inevitable gaps that are left by it. Rather, what is needed is a higher-level understanding of an individual’s legal obligation, one that acts as an overlay to regulatory requirements to set the standard of compliance that applies in each and every situation. Fortunately, as Chapter 6 explains, this overlay exists, namely in the rule of law and, more specifically, the principle of equality before the law. Thus, whilst there is an existing obligation to ensure that the operation of the law is such that it applies equally to all, the clear challenge that we currently face is embedding it within corporations’ normative environment. B.  A Roadmap for Reform It is when looking at a potential framework for reform that our understanding of the behavioural drivers that influence compliance decisions, particularly those undertaken by individuals whilst acting in their corporate capacity (a distinction explored in Chapter 4) becomes critical. We have seen, repeatedly, that simply trying to mandate the desired behaviour (for example by penalising the adoption of abusive tax structures) is unlikely to achieve the holistic change that is needed. Rather, we need to engage the wider corporate landscape to manage the normative environment that corporations operate within and that currently promotes wealth maximisation so absolutely. As a first step, and as Sunstein’s work demonstrated, we need to challenge the perception of the harm caused by creative compliance. Currently, it is clear that creative compliance is seen to be in perfect alignment with the corporate objective, indeed by some it is seen as a practice to be proud of. Very few perceive that it risks causing damage to the market and other social orders, notwithstanding that it has already triggered significant reform efforts. However, the importance of challenging this perspective has been demonstrated in other sectors, which have shown how quickly behavioural change can occur (what Sunstein describes as norm cascades),15 once our belief in the harm caused by a particular practice (and therefore the social meaning attached to it) has changed. For example, we saw a rapid and global change in smoking in public places once the risks of passive smoking were accepted as a reality.

13 ibid,

42 and 44. 30. 15 CR Sunstein, ‘Social Norms and Social Roles’ (1996) 96(4) Columbia Law Review 903, 909. 14 ibid,

Radical Integrity  181 Chapters 1 and 5 demonstrated (respectively) the fiscal and systemic harm caused by creative compliance and there is a significant amount that can be done around education in this space. To help inform the approach taken, it is instructive to draw upon the substantial amount of evidence that suggests that people overestimate the conduct of others, in this context16 namely the view that ‘everyone is doing it,’ which exacerbates both the feeling of inequality that exists as well as the sense of ‘missing out’ if a corporation doesn’t follow suit.17 Accordingly, information campaigns would do well to challenge the accepted norm of creative compliance by publicising the number of people that appear to pay their taxes in full. It is by promoting this information (and building on Cialdini’s findings discussed in Chapter 3), that we draw attention to positive descriptive norms, helping to increase the salience of the norm of spirited compliance over that of the current dominant norm of creative compliance. As to content, education and information strategies that focus on sharing not only the harm of creative compliance but also the positives of spirited compliance, could go a long way to changing the normative landscape. For example, notifying corporations (and, importantly, their employees) of the real impact of creative compliance, such as how many hospitals could be built if people adopted more spirited compliance practices. These types of campaigns help to reduce the distance between action and effect, which bolsters the agentic state that Milgram identified. It is by bringing the consequences of corporate action into an individual’s focus, that we can start to challenge the ease with which personal responsibility is effectively deferred to those on other rungs of the fiduciary ladder. Indeed, the importance of ensuring individuals are included within any reform proposals is critical if we are to ‘interrupt’ the agentic state that leads to a reductive view of personal responsibility, namely one of mere obedience.18 Milgram’s work suggests that the existence of peer dissent would help encourage others within the firm to act in a similar way. Yet without significant change this can become a circular problem in a corporate setting. Therefore, it is critical that we help create the space and confidence for such dissent to act as a catalyst for future change. One way of doing this is to ensure that the normative change based on perceived harm is structured to speak to all levels of the fiduciary ladder. Going back to the earlier examples in the book, we wouldn’t feel constrained to speak out if someone started smoking in the office because we are clear it is a shared norm (and that we would be supported by others). Similarly, we need to instil this level of confidence around compliance and providing evidence as to the (spirited) conduct of others is one way of doing this. 16 R Thaler and C Sunstein, Nudge (first published 2008, Penguin Books, 2009), 72. 17 The potential impact of this approach was seen in Australia, albeit in reverse, where a number of corporate tax avoidance schemes were highly publicised. In response, the greater the awareness that corporations were not paying ‘their share, the more non-compliance increased’. See B Torgler, Tax Morale and Compliance, Review of Evidence and Case Studies for Europe (2011) The World Bank Policy Research Working Paper No 5922, 22. 18 S Milgram, Obedience to Authority: An Experimental View, (first published Tavistock ­Publications, 1974, rev edn, Pinter & Martin, 2010), 157.

182  It is Called Capitalism: Towards a New Market Integrity We have seen that norms and social meaning are both context and role dependent. Recall the example in Chapter 3 about whether a person has a glass of wine with friends on a Saturday night in contrast to the same person having a drink in their capacity as a school teacher whilst on a school trip. Both context and role are, on one level, fixed identities. Either you work for a corporation or you do not, you are a finance director, or you are not. However, this insight gives us an important perspective on narrative, which attaches meaning to those ‘fixed’ roles (as Chapter 4 considered, this is also important when looking at the regulatory relationship). In this regard, we start to see the imperative (including at a policy level) for changing the narrative around the market, the corporation and those acting on their behalf. If we continue to adopt the language of the ‘evils’ of capitalism, corporations and corporate officers, this is likely to be a hinderance not only to a cooperative regulatory relationship but also to the sense of identity that corporations and their officers start to embody. One final observation should be made regarding the architecture of the firm. As discussed in Chapter 7, the hierarchy of the firm is one of its core functions and reform of the hierarchy per se is neither suggested nor necessarily desirable. However, what is clear is that we need to create opportunities to break the psychology of obedience and the lack of responsibility that this gives rise to. As set out above, narrative and education are core features of this, but it is likely that procedural tools could be surprisingly effective. For example, Milgram’s work found that the presence of a third party and the expression of dissent (as noted above) were factors that helped to disrupt the link between authority and action. Therefore, introducing more opportunities for independent review, access to independent advisors and creating circumstances for reflection on the consequences of an action (removing the distance between cause and effect discussed in Chapter 7) are all matters for consideration. For example, accounting declarations (using similar principles to those introduced by Sarbanes-Oxley), multi-party decision retrospectives and review processes outside of a particular department all provide opportunities to interrupt an agentic state. III. CONCLUSION

Capitalism is facing a compliance crisis, but it does not have to be. The current creative approach adopted by the corporate community is not inevitable and, as this book has shown, it is capable of change. Whilst the social norms and perceptions that underpin the perceived legitimacy of creative compliance are understandable, aligning with a dominant rhetoric of market ideology, they are nonetheless the product of social construction and are therefore reassuringly capable of social reconstruction. In exploring the corporate compliance crisis, this book had two broad aims. First, to reflect upon some of the widely held views of the market and ask whether these were correct. Accepting that no system of governing a large-scale

Conclusion   183 economy will be perfect, is our market economy as flawed as people suggest? Does it simply produce ‘amoral calculators’19 (in the form of the multinational corporation) necessitating nothing short of a wholesale change? Or, is there something else at play? In looking at this question this book suggests that our familiarity with the market order has (without denying its challenges) allowed us to take for granted its nonetheless remarkable contribution to society, not least the ability to order a global and dispersed community. That said, these benefits are not enough, on their own, to justify unacceptable externalities such as creative compliance. However, in Chapter 5 we see that the norms relied upon in justification of reductive compliance strategies are, in fact, misconceptions of the ideology that the market is predicated upon. Rather, if we return to the true roots of classical liberalism, we find a system that far from advocating an unbridled individualism, promotes (and depends upon) social cooperation, trust and the rule of law. Second, the book explored the question of why it was that people seemed to adopt such atypical behaviours within a corporation and what the repercussions of this are. When we look at the sheer number of corporate scandals it cannot be that they are all simply the product of, to use earlier terminology, ‘amoral’ individuals. In which case, this necessitates that we ask ourselves what is, to my mind, a deeply troubling and pressing question. That is, what is it about the corporation as an artificial legal entity that can have such a profound impact on the judgment and behaviours of the very real humans that operate on its behalf. As this book has shown, the very architecture of the firm itself, operating within a powerful normative environment, has the capability to result in individuals engaging in behaviour even though it ‘may entail great personal sacrifice or great harm to others’.20 This consequence, in part the product of the rules that we operate within (legal and normative) is profound and of the utmost importance. It raises fundamental questions of freedom and therefore responsibility, both of the individual and of the state (when considering the need for, and scope of, law reform). However, as this book has shown, there is a way forward. One that can be found if we return to first principles of classical liberal ideology, which has ­freedom and cooperation at its core, demonstrating how these are coterminous, not mutually exclusive. It is a system that values the rule of law and equality, not as rules to be avoided or creatively complied with, but as fundamental principles that support individual freedom and market cooperation. It is from this respect for, and subsequent spirited compliance with, the law that true freedom and therefore responsibility can ultimately emerge. Understood in this way, compliance is called capitalism after all. 19 R Kagan and Scholz, ‘The “Criminology of the Corporation” and Regulatory Enforcement Strategies’ in Blankenburg and Lenk (eds) Organisation und Recht. Jahrbuch für Rechtssoziologie und Rechtstheorie vol 7 (VE Verlag für Sozialwissenschaften), 357. 20 Kelman and Hamilton, Crimes of Obedience (n 5) 16.

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Index ‘agentic state’ (Milgram), 164 Asch conformity experiments, 86–7, 88 authority: duality of, 82–3 individual citizens’ compliance with, 82–3 legitimacy of, legitimacy-based compliance, for, 76–7 legitimate, exercise of, 78–82 non-state, acquiescence to, 82 obedience to, (Milgram’s study), 162–3 ‘respect for people’s rights’, 80 sources of, 82 state’s exercise of, 77–8 authority relationship: individuals and, 165 interruption in (Milgram), 166 personality identity and, 162 behaviour: corporate see corporate behaviour corporate compliance, 66–7 creative compliance and, 121 individual see individual behaviour norms and, 51–4, 55–6, 63–4 predictability of, 76, 81, 110, 118, 120–3 shareholders’, 155 taxpayers see taxpayer behaviour board of directors, 160–1 duties of, 160–1 moral responsibility, 178 Bribery Act 2010, 36 ‘capital loss scheme’ (Ramsey), 27–8 (case law) Cialdini, Robert, on littering, 55–6, 64 citizens: individual see individuals state and citizens and spirited compliance, 9 classical liberalism, 102–6 freedom and, 106–8 freedom of the individual and, 107–8 ideology, 175–6 society, in, 176 thinking and order in society, 112

Coase, Ronald: corporate fiduciary ladder, on, 158–60 employment relationship, 160 firms’ employees, on, 159 cognitive dissonance, 89–92 concept of, 89–90 Festinger on, 89 reduction of, 90–1 companies, directors consider short-term value of, 157 Companies Act 2006: maximising shareholder value under, 157 section 172 and shareholder wealth maximisation norm, 59–60 compliance, 41–64 corporations’ creative approach to, 93–4 creative see creative compliance decisions, individuals’ implementation of, 77 definition, 43–4 degeneration cycle, 92–4 deterrence-based see deterrence-based compliance factors affecting, 66 interpretation of, latitude for, 41 legitimacy-based see legitimacy-based compliance legitimacy-based theory of motivation and, 73–4 motivation of, 65–95 narrative and, 5–8 process, trust, in, 81 social construct as, 48–9 social order and, 174 spirited see spirited compliance strict, is not ‘discharge of the duties of good citizenship’, 26 technical, responsibility for controlling, 22–3 conformity experiments (Asch), 86–7, 88 consent: civil society, participation in, and, 138 corporate citizens and, 138

196  Index cooperation, 176 freedom and, relationship between, 117–18 individualism and, 111–12 corporate: decisions and deterrence-based compliance, 69 groups, tax structuring by, 141–2 management, shareholders’ communication with, 155 ‘personhood’, 147–69 responsibility, individuals’ discharge of, 84–5 roles, people’s identity of obedience in, 164 corporate citizens: consent and, 138 corporate compliance and, 9–10 corporate decision-making, 84–5 corporate fiduciary ladder, 16, 158–67, 177 Coase on, 158–60 importance of, 167 psychological consequences of, 162–6 rungs of, 161 structure of, 158–60 wealth maximisation and, 160 corporate norms, 53–4, 177 homogeneity of, 57–62 individuals’ acceptance of, 85–6 salience of, 85–92 corporate structure, GAAR on, 36, 37 corporations, 61–2 creative approach to compliance, 93–4 decision-making see corporate fiduciary ladder ‘Double Irish Dutch Sandwich’ and, 140–1 enforcement authority, relationship between, 71–2 individuals, relationships with, 148 jurisdictions, choice of, 139 multiple legal personalities and, 140–1 norms, influence of, 54 partnerships and, differences between, 168 risk management and, 141 separate personality and limited liability of, 149–52 shareholder wealth maximisation norm, role under, 61 spirited compliance and, 10–13, 54, 63, 102 see also firms corporations and compliance degeneration cycle, 92–5 Cox Report (2013) on short-termism, 156

creative compliance, 6, 22–3, 26 behavioural predictability and, 121 causes and consequences of, 10–11 centrality of the person and, 44 consequences of, 8–10 corporate, norms’ influence, 54 drivers, in compliance degeneration cycle, 92–3 environmental norms and, 6–7 financial perspective of, 8–9 GAAR on, 38–9 Google and, 3–4 harm caused by, 180–1 illegitimacy and, 94–5 legitimisation of, 83–92 market order eroded by, 123 regulatory responses to, 7 restraint of, 27–8 (case law) rule of law and, 124–5 social construction of, 43–9 social meaning, interpretation of, 45 social norms as product of, 45–6 spirited compliance and, 15 strategies, individuals’ implementation of, 88–9 trust and, 122 creative compliance practice, 19–40 case law, 20–3 development of, 20–5 decision-makers: neutrality of, 79–80 self-interested and deterrence-based compliance, 68–9 decision-making: corporate see corporate decision-making corporations, in see corporate fiduciary ladder directors’ and judicial determination, 157 deterrence and compliance and motivation, 73–4 deterrence-based compliance, 67–71, 73–4 approaches to, 67–8 capitalism and, 68–9 corporate decisions and, 69 lack of resources, effect of, 72 legal obedience and, 69 self-interested decision-maker and, 68–9 social order and, 72–3 taxpayer behaviour and, 69–71

Index  197 Dicey, AV, on rule of law, 128 directors: company short-term value considered by, 157 decision-making, factors in, 157 remuneration of linked to market performance, 155 directors’ fiduciary duties, 156–8 maximising shareholder value, 157 ‘discharge of the duties of good citizenship’, strict compliance is not, 26 Double Irish Dutch Sandwich (tax scandals), 30, 31–2, 35, 140–1 corporations and, 141 double reasonableness test, 34, 35 Dwenger, N, on taxpayer behaviour, 70 electric shock experiment (Milgram), 162–3, 164–5 employees: employer, extension of, as, 159–60 withdrawal of services, 160 employer, employees as extension of, 159–60 employment: relations, American and British, 159 relationship (Coase), 160 enforcement authorities and corporations, relationship between, 71–2 Enron scandal, 23–4 equal right, citizen’s, and freedom of the individual, 109 equality, 125, 129 definition, 130 distributive, 130–1 law and, 126–34, 137–9 meta-principle as force for compliance, 136 overarching standard, as, 135 paradox, 124–43 rule of law and, 129–32 rules of and market participants, 121–2 substantive, 130–1 equality as a meta-legal principle, 135–7 ‘gap-filling’ ability, 136–7 primary legal principles and, 135–6 ‘expressive dimension’ of actions, 44–5 Festinger, L, on cognitive dissonance, 89 financial incentives and short-termism (Cox Report), 156 firms: definition (Coase), 158–9 employees of, Coase on, 159

hierarchy of, 182 see also corporations free market economy characteristics, 4–5, 113–22 freedom: citizens’ freedom to act, 100 (case law) classical liberalism tradition, in, 106–12 cooperation and, relationship between, 117–18 freedom of choice: norms and see norms and freedom of choice Sunstein on, 62 freedom of the individual, 107–9 citizen’s equal right and, 109 classical liberalism and, 107–8 Friedman, M, on increase of profits, 106 fund managers’ duties, 154–5 General Anti-Abuse Rule (GAAR), 7, 33–9 ‘abusive’ tax arrangements, treatment of, 34–5 corporate compliance and, 166 corporate structures, on, 36, 37 creative compliance, on, 38–9 creative tax structures, on, 35–6 implementation of in UK (2013), 33 language used in, 57–8 panel rulings, effect of, 34 regulatory design, on, 37–8 Google, PAC inquiry and response, 3–4, 65–6 government: intervention, libertarians’ view of, 103–4 personal freedom, role in, 110 group conformity and individuals, 87–8 habitualisation in communities, 46–7 harm, creative compliance causes (Sunstein), 123, 180–1 Hayek, Friedrich, 15, 100, 102, 108–24, 128–40 rule of law, on, 128–9, 133–4 social welfare provision, on, 132 ‘high norm salience’ (litter), 55 idea-constructionism, 48–9 identity of obedience, people’s, in corporate roles, 164 illegitimacy, creative compliance and, 94–5 incorporation by registration, 150–1 individual behaviour: norms’ impact on, 56–7 rationalisation of, 90

198  Index individualism, 112 cooperation and, 111–12 methodological, 176 spirited compliance and, 112 individuals: actions of, and rules and structures, 7–8 authority relationships of, 165 centrality of the person and creative compliance, 44 compliance decisions, implementation of, 77 compliance degeneration cycle and, 92 compliance with authority, 82–3 conflicting information, avoidance of, 90–1 corporate norms, acceptance of, 85–6 corporate responsibility, discharging, 84–5 corporations, relationship with, 148 creative compliance strategies, implementation of, 88–9 freedom of see freedom of the individual group conformity and, 87–8 over-rationalisation by, 91 PAC investigation, response to, 66 personal responsibility and, 165 right to be heard, 79 tax structuring not possible by, 141–2 Inland Revenue’s taxation of transactions, 28 (case law) institutional investors, 154–5 institutionalisation of constructs, 47–8 integrity: functioning of the market and, 179–80 new market, 173–83 radical, 178–82 interests, short and long-term, 152–3 intra-group convergence, 46–8 ‘inversions’ (tax avoidance scheme), 30–1, 32 Joint Stock Companies Act 1844 (the 1844 Act), 150–1 judicial anti-avoidance doctrine, 25–30 knowledge: collation and communication, market’s role of, 113–15 price mechanism conveys through, 115–16 law: corporations’ compliance with, 180 equality and, 126–34, 137–9 expressive function of, 57–9 social and undesirable norms and, 58

lawful conduct, constraining, 134–9 legal obedience, 137–8 deterrence-based compliance and, 69 see also legitimacy-based compliance legal privilege: definition, 140 inequality of, 139–42 legitimacy: spirited compliance and, 73, 75, 84, 95, 103 undermining (compliance degeneration cycle), 93–4 legitimacy-based compliance, 74–6 decisions, motivation for, 75–6 legitimacy of authority, 76–7 procedural justice and, 76 stages of, 76–7 voluntary, 75 legitimacy-based theory of motivation and compliance, 73–4 liberalism: concept of, 99–100 ‘everyday’, 105–6 philosophies of, 105, 105n rule of law, classical liberal view of, 133–4 libertarians’ view of government intervention, 103–4 limited liability: partnerships (LLP), 168 separate personality of the corporation and, 149–52 littering (Cialdini), 55–6, 64 Locke, J, on rule of law, 127 market: central control of, 117 economy and self interest, 108–9 functioning of and integrity, 179–80 knowledge collation and communication role of, 113–15 participants, equality of rules for, 121–2 self-interest, pursuit of, 104 market order, 113–18 creative compliance erodes, 123 polycentric systems and, 116–18 rules for, 120–1 May, C, on classical and liberal rule of law, 133–4 meta-principle, breach of (creative compliance), 136 Milgram, Stanley, electric shock experiment, 162–3, 164–5

Index  199 Montesquieu, CL de Secondat, on rule of law, 127–8 moral responsibility, outsourcing of, 164 motivation and deterrence, 73–4 narrative and compliance, 5–8 norms, 49–57, 178 behaviour and, 51–4, 55–6, 63–4 cascades (Sunstein), 48 context and role, dependence on, 182 corporate see corporate norms corporate compliance, influence on, 54 corporations influence on, 54 definitions, 50 descriptive, 50 duality of, 84–5 environmental, and creative compliance, 67 freedom of choice and taxes and subsidies, 62–3 individual behaviour, impact on, 56–7 influence of, 178 injunctive, 50–1 interaction between descriptive and injunctive norms, 54–7 norm-based social sanctions, 52 personal, 84, 178 shareholder wealth maximisation see shareholder wealth maximisation norm social see social norms Sunstein on, 62 types of, 50 undesirable and law, 58

price mechanism, knowledge conveyed through, 115–16 primary legal principles and equality as meta-legal principle, 135–6 procedural justice: concept of, 78 legitimacy-based compliance and, 76 person’s right to be heard, 79 pillars of, 78–82 profits, increase of (Friedman), 106 property rights and liberal society, 110–11 Public Accounts Committee (PAC) (UK), Google inquiry and response, 3–4, 65–6

order: architecture of, 119–21 planned, features of, 119 spontaneous see spontaneous order over-rationalisation, 89–92 individuals, by, 91

Ramsay construction, 7n, 22, 26, 27, 28, 29–30 (case law) regulatory: design, GAAR on, 37–8 relationships, 71 ‘respect for people’s rights’, authority’s, 80 Rio Tinto, corporate responsibility example (2020), 147–8 rule of law, 126–9 classical liberal view of (May), 133–4 creative compliance and, 124–5 Dicey on, 128 equality and, 129–32 formal (thin) conception of, 132–3 Hayek on, 128–9, 133–4 Locke’s formulation of, 127 Montiesquieu on, 127–8 pillars of (Dicey), 128 state and non-state actors, 137 substantive (thick) conception of, 133 rules: conduct, of, social order, for, 120 equality of and market participants, 121–2 structures, and, individuals’ actions, impact on, 7–8

partnerships: corporations and, difference between, 168 limited liability (LLP), 168 personal freedom, government’s role in, 110 personal identity and authority relationship, 162 personal responsibility: electric shock experiment, in, 164–5 individuals and, 165 polycentric systems and market order, 116–18

sanctions: shaming, 53 social, 54 value of, 73–4 Sarbanes-Oxley Act 2002 (US), 7 creative compliance escalates after, 24–5 criticism by industry of, 24 self interest, 103–4 market economy and, 108–9 market’s pursuit of, 104 societal development and, 108

200  Index senior executives’ objectives (corporate fiduciary ladder), 161 separate personality and limited liability of the corporation, 149–52 share, nature changes, 153 shareholder value maximising: Companies Act 2006, under, 157 directors’ fiduciary duties and, 157 shareholder wealth maximisation, 153–6 shareholder wealth maximisation norm, 56, 59–62 Companies Act 2006, section 172, and, 59–60 corporations’ role under, 61 shareholders: changing behaviour of, 155 corporate management, communication with, 155 emancipation of, 151–2 nominee, use of, 21 (case law) short-termism, 154 Cox Report (2013) on, 156 financial incentives and, 156 social: constructionism, 43–9 meaning, creative compliance’s interpretation of, 45 welfare, provision of (Hayek), 132 social constructs, 49 compliance as, 48–9 social judgment, 52–3 corporate behaviour and, 53 social norms, 177 creative compliance as product of, 45–6 law and, 58 spirited compliance and, 38 social order: compliance and, 174 deterrence-based compliance and, 72–3 rules of conduct for, 120 voluntary, 112 social sanctions: corporate behaviour and, 53 norm-based, 52 society: civil, participation in, and consent, 138 classic liberalism in, 176 development of and self-interest, 108 liberal and property rights, 110–11 order in society and classical liberal thinking, 112

special purpose vehicles (SPVs), 23 spirited compliance, 100, 124–6 citizen and state and, 9 corporations and, 10–13, 54, 63, 102 creative compliance and, 15 individualism and, 112 legitimacy and, 73, 75, 84, 95, 103 social norms and, 38 spontaneous order, 119–20 complex systems and, 118–22 state: citizen and state and spirited compliance, 9 exercise of authority by, 77–8 interference limited, 109–11 stock markets, development of, 151 Sunstein, CR, 41–2, 85, 87 freedom of choice, on, 62 harm, on, 181–2 norms, on, 62 systems, complex, and spontaneous order, 118–22 tax: deductible annuity paid as salary, 21–2 (case law) evasion, 70, 84 planning solutions, artificial, 29–30 (case law) scandals, 30–2 structures, creative, GAAR on, 35–6 subsidies and taxes, 62–3 tax arrangements: ‘abusive’, GAAR’s treatment of, 34–5 definition, 33–4 tax avoidance, 22, 25–32 corporation’s, as incidental right, 100n (case law) definition, 25 ‘inversions’, 30–1, 32 legislation, 33–9 permissible and impermissible, 28 (case law) tax regulation: courts’ approach to, 26 technical compliance with, 25–30 (case law) tax structuring: corporate groups, by, 141–2 individuals, by, 141–2 taxpayer behaviour: deterrence-based model of compliance, 69–71 Dwenger on, 70

Index  201 Thaler, R, 85, 87 transactions: ‘commercial’ concept of, 28–9 (case law) Inland Revenue’s taxation of, 28 (case law) trust, 180 compliance process, in, 81 creative compliance and, 122

truth, 5–6 Tyler, Tom, 14–15 legimacy-based compliance, on, 74–5 wealth maximisation and corporate fiduciary ladder, 160 WorldCom scandal, 23, 24

202