Hal Weitzman on What’s the Matter with Delaware?

Hal Weitzman on What’s the Matter with Delaware?

By Hal Weitzman

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The legal home to over a million companies, Delaware has more registered businesses than residents. Why do virtually all of the biggest corporations in the United States register there? Why do so many small companies choose to set up in Delaware rather than their home states? Why do wealthy individuals form multiple layers of private companies in the state? This book reveals how a systematic enterprise lies behind the business-friendly corporate veneer, one that has kept the state afloat financially by diverting public funds away from some of the poorest people in the United States and supporting dictators and criminals across the world.

Why did you want to write about Delaware?

HW: Delaware plays a critical role in the capitalist system, one that’s largely unexplored, at least, outside of scholarly journals. The state has fewer than one million residents—its population is about the size of the Tuscon or Grand Rapids metro area—but 1.6 million companies are registered there, including about two-thirds of the US’s biggest public companies. Most are out-of-state companies that have little more than an official registration in Delaware but do no real business there. Delaware has an effective monopoly on these sorts of out-of-state incorporations.

All this means that most of us interact with Delaware companies at least once a day, whether it’s Google and Amazon, Facebook or Twitter, Visa or Mastercard, Verizon, AT&T, T-Mobile or Sprint, Tesla, Chrysler or General Motors, Walgreens, Walmart or CVS. Delaware is everywhere.

Delaware is the closest thing America has to a registrar of corporate births, marriages, and deaths—companies are formed there, they go there to seek legal approval for mergers, or to have legal disputes with each other, and they go to file for bankruptcy. Delaware is for corporate life-events.

At the same time, there are hundreds of thousands of small, often anonymous private companies registered in Delaware, some of which have been used for wrongdoing.

As a journalist, I was trained to find seemingly “small” stories that were examples of bigger narratives. Delaware is a perfect example. It’s at the crossroads of a range of global trends—shell companies, money laundering, kleptocracy, international crime, bribery and corruption, inequality, tax dodging, “dark” markets such as art, and the lack of transparency in public decision-making.

And Delaware has the perfect cover story. Unlike what appear to us to be exotic locations such as the Cayman Islands, the British Virgin Islands, Panama, Bermuda, Cyprus or Luxembourg, Delaware is, let’s face it, pretty unexotic. That makes it an ideal place for bad actors to hide.

As a writer, rather than trying to tackle these huge complex global stories, Delaware gave me a physical location to ground the reality of how corporate wrongdoing actually happens, and why America has found it so hard to address.

Why are so many companies registered in Delaware?

HW: The reason is more complex than most people think. If people have a view on that question, they tend to lean on a single reason. Some people say it’s because of the Chancery Court, the court that handles business cases, and its large body of case law that makes judgments more predictable than in other states. Some say it’s due to the extreme ease and low cost of setting up companies. Some say it’s because Delaware is a tax haven. Some attribute it to corporate anonymity, how business owners don’t need to identify themselves. Some experts will even tell you that many people who register companies in Delaware don’t really know why, they just do it because they know other people who’ve set up companies there.

All of these are valid responses, which means there is no single, simple answer. That makes sense—the 1.6 million Delaware-registered companies range from Google, Amazon and Tesla to Joe Shmoe LLC, so their motivations wouldn’t be the same. Some are undoubtedly attracted by the court system, some by privacy and anonymity, some because they are just told that if you want to file outside your home state, or if you’re a foreigner looking to set up a US operation, you should do it in Delaware.

In its marketing materials, Delaware emphasizes the appeal its Chancery Court and its dedicated Division of Corporations, which operates at the speed of the private sector. But it has resisted any attempt to require it to ask the owners of registering companies to identify themselves, on the grounds that that would drive registrations to more lightly-regulated states. So even Delaware obliquely admits that anonymity is a big part of what attracts company owners—after all, the overwhelming majority of the companies that form in Delaware are private LLCs, rather than corporations, which have much more onerous public-reporting requirements.

Having said all that, if there is one overarching theme of what makes Delaware so attractive, it’s probably efficiency. You can set up a company in Delaware in just 30 minutes with minimal documentation. If you want to get a library card, you need to turn up in person and show a valid ID, but you can set up Delaware companies on the internet without giving any verified information. Setting up a holding company in Delaware can help make a company more tax-efficient, enabling it to avoid paying state corporate tax by funneling profits through the holding company. And if they do go have to go to court, the cases are handled much faster and more efficiently than anywhere else. Even the corporate lawmaking process in Delaware has been streamlined, because 27 lawyers effectively write the rules and the state legislature passes them without debate.

I’m all for efficiency and reducing red tape, but it begs the question, what is the cost of this efficiency? There is a chronic lack of transparency and oversight. Identities are not verified. Legislation is not scrutinized. State governments are starved of tax revenue. And all this has enabled and abetted tax-dodging, money laundering, the flow of dark money into our political system, and the trafficking of people, drugs, and arms.

How widespread is the use of Delaware companies for nefarious ends?

HW: Because owners of companies are not required to identify themselves, no one knows. The lack of information is quite shocking. Last year I asked the Delaware Secretary of State’s office what proportion of companies registered in the state were foreign-owned. They told me that they do not know, and that there is no way of knowing.

You don’t have to be a radical, anti-capitalist liberal to be concerned about this lack of transparency. Transparency is good for capitalism and for the functioning of free markets. Transparency aids capital formation, facilitates price discovery, and enables effective regulation. It helps markets work better, makes them more sustainable, and provides critical data for investors so they can allocate their capital as efficiently as possible. Transparency also helps democracy work better, by giving voters, for example, information about who is funding political campaigns.

By contrast, the current lack of transparency makes it easy to hide the political money trail from voters, and hampers US foreign policy. For example, it undermines America’s attempts to put a stranglehold on Russian oligarchs, since we have no idea if they control companies registered in the United States.

What we do know is that there has been a string of illicit acts in recent years connected to Delaware companies: corruption, kleptocracy, and even child-sex trafficking. I detail a lot of these in the book. There is also a significant amount of legal but ethically questionable behavior, such as tax-dodging and hiding financial assets.

But we can never know the true extent of the problem. It’s a mystery as to whether the cases that have come to light are the tip of the iceberg or a rogue element. Delaware wants to portray the abuse of corporate entities as an aberration; the classic “few bad apples” argument. I agree that most companies registered in Delaware are probably doing nothing illegal or nefarious. But the way in which Delaware has enabled and defended corporate anonymity has allowed bad actors to use the system unhampered.

It seems odd that we are required to accept such wrongdoing as simply the price we have to pay for the system, particularly when there is such an obvious solution—force the companies to tell us who their owners are, and verify the information, as we do for folk who want a library card. Rather than bad apples, think about it like eggs—after all, there are a lot of “shell companies” in Delaware. (Apologies for that.) Well, Delaware’s defence of the current system is a bit like your local store telling you that their egg salad is “97% shell free.” Would you want to eat that egg salad, knowing there was a 3% chance you might eat some egg shell? Would you accept that as an unfortunate by-product of making egg salad? Would you be satisfied if you were told that we can’t list the ingredients because it would add a reporting burden to the egg-salad industry? The lack of transparency has aided and abetted those who would abuse corporate structures, even if it is only a small minority of the overall business community.

Who benefits from the system?

HW: The incorporations industry and associated revenues account for 40% of Delaware’s state revenues. Much of that is made up of the annual fees that Delaware-registered companies have to pay to remain “in good standing.” These fees have helped insulate Delaware from the general trend among US states of falling corporate income tax revenues over the past 70 years. In fact, Delaware collects more in corporate fees than 42 US states take in corporate income tax. At the same time, because of a tax dodge known as the Delaware Loophole, companies registered in Delaware can avoid paying state corporate taxes in the states in which they actually do business, denying other states of much-needed revenue.

Thanks to this income stream, Delawareans have the second-lowest tax burden among all states in the union, and the US’s fourth-lowest property-tax rate. If you include all the money that companies located outside the state contribute directly to its state revenues, Delaware residents only end up paying 50 cents for each dollar of service they receive.

The main beneficiaries, however, are the corporate lawyers who argue the cases in front of the Chancery Court and in Delaware’s bankruptcy court. Delaware lawyers charge the highest average hourly rate of any lawyers in the US—above California, New York and Washington, DC—and enjoy lower taxes and a much lower cost of living. As William Cary, a former SEC chairman, observed, they “enjoy a lucrative Wall Street practice in a comparatively pastoral setting.”

Is Delaware unique?

HW: No. Several other US states try to attract corporate registrations, and allow anonymous corporations, but none has made a significant dent in Delaware’s domination of the industry.

Four factors make Delaware different. First, the industrial scale of the incorporations business. Secondly, how important it is to the local economy. Thirdly, the power that gives this tiny state in setting the rules for what we expect from corporate leaders. And fourthly, Delaware has also played an outsized role in fighting against attempts to force it to collect information about the real owners of registered companies, defeating numerous attempts in recent decades to introduce more transparency to the system.

Because of its reliance on the industry, Delaware can appear more like a financial-services firm than a state. In many respects, it resembles a platform company like Amazon or Facebook, providing the legal infrastructure for businesses to operate. Like Amazon and Facebook, Delaware has been reluctant to police those who use its services. But whereas other platform companies have been forced to apply behavioral standards, Delaware has largely avoided the pressure to do so. Even when it backed reform in 2021, it did so in such a way to avoid taking any responsibility for collecting the ownership information itself. Instead, companies will have the additional burden of registering at the state level and then identifying their owners at the federal level.

What do you think should be done?

HW: I make four suggestions in the book, two relating to the issue of anonymous companies, and two relating to how the corporate code gets made in Delaware.

The US passed legislation last year to oblige companies for the first time to identify their true owners to the federal government. This is a huge step forward, but the rules—which are still being finalized—are likely to contain some loopholes. For example, trusts may be exempted. So the first proposal I make in the book is to close that loophole.

The registry of company owners will be visible to the federal government and law enforcement only. I worry about the ability of government to be able to verify and investigate the information provided, so my second suggestion is to make the registry public, so the media and transparency groups can help with that task, as well as to publicize the use of companies for strictly legal but ethically questionable behavior.

Thirdly, thinking about how the rules get made in Delaware, I suggest that the Delaware lawyers who effectively write the laws on corporations should be more transparent about their deliberations and explain clearly to the legislature why changes need to be made to the corporate code, in an effort to improve democratic oversight.

Finally, US companies have been telling us for several years now that they exist not just to make profits but to benefit society as a whole. With that aim in mind, I propose that the Delaware bar expand the group of lawyers who write the corporate code beyond the attorneys who represent company managers and shareholders to include lawyers representing the interests of workers, customers, and environmental groups. That could help hold them accountable to their stated goals.

These are all pretty modest goals, but they would be a good start on the road to a healthier balance between efficiency and transparency in our economic system.

Hal Weitzman is executive director for intellectual capital at the University of Chicago Booth School of Business, and editor-in-chief of Chicago Booth Review. He also teaches MBA students and business executives at Chicago Booth. A former Financial Times editor and foreign correspondent, he is the author of Latin Lessons. Twitter @HalWeitzman