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Christopher Alkan calculates that the US approach of extending the scope of its laws beyond its own territory will eventually backfire.

Politicians normally have to content themselves with making laws for their own jurisdiction. But Uncle Sam seems eager to legislate for the rest of the world too.

The latest manifestation of this legal imperialism has been FATCA – the Foreign Account Tax Compliance Act. The rule forces financial institutions all over the world to seek out US ex-patriots and hand over their information to the American tax authorities. This detective work on behalf of the US may cost foreign banks about $30bn, says Ernst & Young.

Legal scholars fear such high-handed legal tactics are being used with growing frequency by US policy-makers to enforce their will – whether through economic sanctions against enemies or in regulating international business practices. “The United States appears to be losing patience with the idea that other nations need to be consulted and negotiated with,” says Andrew Morriss, a professor at Alabama University Law School. “Time and again the United States has simply asserted that people elsewhere must comply with its laws. Since foreigners don’t vote, that is undemocratic and it is also at odds with the idea that each state should decide its own destiny.”

Of course, extra-territorial laws have an upside too. Some of the most imperial US laws allow victims of human rights abuses to pursue their tormentors in US courts. But sadly, the credibility of such helpful legislation is called into question by the more self-interested statutes.

Scholars agree that extra-territorial laws should be used sparingly, if at all. The most basic tenet of international law, ever since the 1648 Treaty of Westphalia, has been that any state’s jurisdiction stops at its borders. Where interests collide, governments should resolve conflict by negotiation, resulting in treaties or less formal pacts. More recently, the UN charter stated that the organisation is “based on the principle of the sovereign equality of all its members”.

For most nations it is easy to stick to this rule. The limits of their economic and financial power mean that even countries such as France and Germany lack the heft to enact laws that others must comply with. “If France, for example, attempted to impose its will in this way – threatening to cut off economic relations with any nations that refused to cooperate – there would be a good deal of laughing and France would end up losing a lot of money,” says Mark Calabria, at the libertarian Cato Institute. “As the world’s behemoth, America is in the almost unique position of being able to make threats that everybody has to listen to.”

The c. $15tn economy of the US still accounts for about a fifth of global output, according to data from the IMF. That is more than twice the size of its nearest rival, China, which churns out a tenth of the world’s goods and services. Even this statistic fails to do full justice to the power of the US. Its stock market represented roughly 45 per cent of the market capitalisation of global stocks, as of 2011, at roughly $24.3tn. It also boasts the world’s deepest and most liquid bond markets. The result is that no serious financial institution can afford to be locked out of the US and no large nation will risk being excluded from the US export market.

The US has frequently taken unfair advantage of this upper hand. A notable example has been so-called secondary economic sanctions. For the US, it is not enough to bar its own firms from trading with international bad boys such as Cuba and Iran. In a classic example of secondary sanctions, the Helms-Burton Act, of 1996, penalises foreign companies dealing with Cuba. It even allows former Cuban citizens whose property has been confiscated by the communist state to sue almost any entity engaged in trade with the country.

Such legal arrogance provoked worldwide opposition. “The European Union has objected to the US enactment of such nakedly extra-territorial legislation on legal grounds and has worked to block these sanctions’ implementation,” according to a 2011 Harvard Law Review article.

Undeterred by the strong adverse reaction to Helms-Burton, President Bill Clinton followed up with the Iran-Libya Sanctions Act, also in 1996. This imposed sanctions on any foreign entity that invested more than $20m to support the development of the oil sector in either country. A similar spirit lay behind a new set of sanctions against Iran signed by President Barack Obama in 2010, which the Harvard Law Review article described as an effort to regulate the European petroleum industry.

Another dubious US innovation was the Foreign Corrupt Practices Act of 1977, which punishes those bribing foreign officials. On the surface, this seems hard to object to. Clamping down on graft and the suborning of government employees is clearly a worthwhile goal.

The question, says Morriss, is whether global standards of business conduct should be defined by US politicians and judges. “There are plenty of grey areas here,” he says. “There is no consensus around the world about exactly what corruption is. Many states have a culture in which gift exchange is expected. The US has no right to lay down rules for the whole world.”

There have been efforts to develop an international standard, led by the OECD and the UN, but the OECD convention has not been approved by nations including Indonesia and China. As the Harvard Law Review states, these countries “never consented to the extra-territorial enforcement of US anti-corruption laws within their borders”. Meanwhile, the UN Convention Against Corruption, of 2003, directly asserts that efforts to stamp out graft should be “consistent with principles of sovereign equality”. A strong case can be made that the Foreign Corrupt Practices Act violates the notion of sovereign equality.

Many consider FATCA an even more offensive abuse. As with secondary sanctions, FATCA reaches beyond the US borders to impose obligations on bodies in other countries. Financial institutions that refuse to collect and hand over the data required by Uncle
Sam are slapped with a draconian 30 per cent withholding tax on all transactions with Americans – steep enough effectively to bar them from dealings in the US. “In past international tax agreements nations would negotiate to share information, with each side giving something,” says Allison Christians, a professor of tax law at McGill University, in Canada. “FATCA tried to bypass this diplomatic process and make every financial institution in the world directly answerable to the United States Internal Revenue Service.” It is rather like deputising every bank worldwide as a US tax collector.

Worse still, the requirements of FATCA often flatly contradict the laws of other lands. “A bank in Canada is forbidden by law from passing on its account holder information to other outsiders – whether that is Google or the US tax collectors,” says Christians. “So that means that, under FATCA, to avoid being barred from the US an institution must either get its customers to waive their legal privacy or the law must be changed. This is a blatant intrusion.” The US has offered no similar automatic information to foreign governments in return.

Finally, FATCA insists on higher standards for foreigners than for US banks. The law requires overseas institutions to identify the beneficial owners of accounts or assets in which Americans hold a stake. But no US institution has to live up to such exacting standards. “The states of Delaware and Nevada have been churning out anonymous limited corporations,” he says. This double standard leaves open the suggestion that cynical motives are at play. “What America has done is essentially to impose an incredible burden on everybody else and so give its own institutions a competitive advantage,” says Morriss. “It is like forcing British banks, for example, to carry heavy weights while running a race with them. This looks like part of New York’s effort to beat London.”

Some extra-territorial laws have more benign intent. This is particularly true with human rights. One such law is the Alien Tort Statute. In a trend-setting 1980 case – Filártiga v. Peña-Irala – US courts upheld the right of a foreign couple to sue a Paraguayan government official who had allegedly tortured their son to death. The Harvard Law Review has argued that such laws can “support core values of the international order” and provide a “new mechanism to enunciate and enforce international human rights law”. Even this statute has been criticised by some governments, including Germany, as an encroachment on national sovereignty.

Overall, there is a risk that the fondness of Congress for extra-territorial laws will backfire. The first concern is that such imperious legislating will harm the reputation of the US. “This is the very opposite of soft power,” says Calabria. “The notion that America ignores the normal process of negotiation, when possible, undermines the nation’s diplomatic clout.”

More worrying still, it sets a precedent that emerging nations may be tempted to follow . While the US still stands as a lone superpower, China is gaining ground fast. “It is very dangerous for the US to establish the precedent that extra-territorial laws are an acceptable form of diplomacy,” says Morriss. “It will make it extremely hard to object if China decides to adopt a similar strategy as its economic strength grows.” At present growth rates, China’s output could exceed that of the US as early as 2018. Even if it takes a little longer, it is clear that China will be in a much better position to throw its weight around over the coming decade.

The EU could also become more aggressive in projecting its legal principles. Its economies account for 25 per cent of the global economy and almost all large financial institutions need to be represented in the EU. It is already in a position to insist on its own equivalent to FATCA if its member nations could agree. In short, the US would be wise to use the legal weapon of extra-territoriality
infrequently. The technique is only really legitimate when promoting standards of behaviour upon which most nations can agree – such as prohibitions on torture and genocide. But to use it as an alternative to painful diplomatic negotiations is not just lazy and arrogant, it is also dangerous. “Before too long America may find itself the victim of extra-territorial laws rather than a beneficiary,” says Morriss. “Perhaps only then will the folly of America’s current approach become clear.”

Christopher Alkan is a US-based financial journalist