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Money offshore: What the Paradise Papers reveal about Duke's endowment

Recent revelations from the Paradise Papers have shed light on investments and investment tools used by Duke University’s endowment. 

The New York Times reported that as recently as 2015, Duke owned shares in Ferrous Resources, an iron mining company in Brazil. The report indicated that investment funds connected to Duke held more than two million shares in the company. 

At a meeting of the Advisory Committee on Investment Responsibility Tuesday evening, its chair—Lawrence Baxter, William B. McGuire professor of the practice of law—said that Duke has owned an “extremely small” stake in Ferrous Resources since 2007 and has been declining since.

According to the New York Times report, Duke is also one of many universities using so-called offshore “blocker corporations” as part of its investment practices to avoid paying taxes on certain investments. 

Ferrous Resources

Ferrous Resources is involved in mining operations in Minas Gerais, a state known for its iron-ore mining in Brazil.

In 2010, the company announced plans to create an iron slurry pipeline in the region, but there was considerable pushback against the project, leading to its discontinuation. According to The New York Times, a 2010 environmental study found that more than 100,000 people could be affected by dust, soil degradation and poor water quality as a result of the pipeline.

Paul Baker, professor of earth and ocean sciences, said that the mining industry in Minas Gerais has been controversial. He cited the 2015 spill of 50 million tons of mud and mining waste after a dam owned by Vale SA burst. Baker said Vale has yet to take responsibility for their actions.

“It is a disaster prompted by economic activity but of a magnitude equivalent to those disasters created by forces of nature,” said Izabella Teixeira, Brazilian Minister of the Environment, at the time. 

The incident killed at least 12 and injured at least 75, and the residue that leaked from the pipeline contained toxic heavy metals and chemicals such as arsenic and mercury. 

Alexander Pfaff, professor of public policy, economics and environment, pointed to a 2017 article discussing the dangers of mining in the Brazilian Amazon.

The piece found that mining had increased forest loss up to 70 kilometers outside of the mining area. The total amount of deforestation it found due to mining in the area was 11,670 square kilometers between 2005 and 2015, which the study says represented nine percent of all forest loss in the Amazon during that interval. 

Baker said that he did not necessarily think there was any ethical problem with Duke being invested in Ferrous, so long as the company does not have a particularly egregious track record. 

“To me, we use iron. We use every element on the periodic table and I don’t have a problem with investing in the companies that get them out of the ground,” he said. “We shouldn’t invest in companies with a terrible track record, but that doesn’t seem the case here. It seems they came out of the blue.”

What are blocker corporations?

Nonprofits often use blocker corporations to avoid paying taxes on certain investments, said Holland West—founder, manager and principal at strategic services firm Topsail Insights, who has created several blocker corporations as an attorney.

Nonprofits’ endowments are typically tax-exempt. However, they can be taxed on what is known as “unrelated business taxable income” when they invest in a hedge fund or private equity firm that borrows money for its investments. 

But corporations are not “pass-through entities,” West said. A nonprofit can invest in a blocker corporation, which then either invests in stocks directly or in another hedge fund. The corporation pays the tax, not the investor. 

“The best way for a university to invest in a hedge fund is to invest indirectly, through a corporation that invests in the hedge fund,” wrote Richard Schmalbeck, Simpson Thacher and Bartlett professor of law, in an email. “That way, the debt incurred by the hedge fund is not attributed to the university, because the interposition of the corporation 'blocks' the attribution of the debt.”

Schmalbeck noted that such blocker corporations are usually found in “tax havens,” countries where no or very little corporate tax is owed. He emphasized that the Internal Revenue Service has upheld the use of these practices.

According to The New York Times report, a Duke fund—the Gothic Corporation—uses a blocker corporation to invest in a Cayman Islands private equity fund called Genstar Capital Partners V HV. The Gothic Corporation is a wholly owned subsidiary of the Duke Management Company (DUMAC).

The report did not say who created the blocker corporation, but West explained that blocker corporations are often created by financial managers, and then that universities or nonprofits can invest in those corporations. 

Neal Triplett, president of DUMAC, declined to comment. 

Although several people at the ACIR forum expressed concern that this practice is unethical, West said it flows naturally from of the goal of a university or nonprofit endowment. It makes sense for entities that are normally tax-exempt to attempt to preserve that status when making different investments, he said.

“One of their fiduciary duties should be to minimize the tax on an otherwise non-taxable entity, because the more money you pay on tax the less money goes to the university, or financial aid, or to whatever it may be,” he said. “That is the purpose of the blocker corporation.”

Baxter and other ACIR members shared similar beliefs about the use of such arrangements. 

Michael Schoenfeld, vice president for public affairs and government relations, told The Chronicle that the University is not parking money overseas—the endowment is a perpetual fund that the University draws from annually. Each year the University spends 5.5 percent of a three-year rolling average of the endowment, he said. 

West also said it made sense for these blocker corporations to be overseas, because the high tax rate in the United States would ultimately mean the blocker can return less money to the nonprofit.

Schmalbeck noted that some of the fault for this practice can be attributed to Congress. He wrote that in 1969, Congress precluded charitable organizations from using borrowed money in their investments, which prevents them from investing in hedge funds and the like. This was originally intended to prevent nonprofits from essentially renting out their tax exempt status to private firms. 

But whereas hedge funds don’t usually face a corporate income tax in the first place, the rules mean a university must use a blocker corporation to invest in a hedge fund without the tax burden. 

“I think the best way of thinking of this is that the rules are overly restrictive when it comes to alternative investments like hedge funds and private equity funds, but at the same time they have this easy avoidance maneuver,” he said.

Is ACIR enough?

On Tuesday, members of the Duke community attended a meeting to express their concerns about how Duke uses blocker corporations and about its investment in Ferrous Resources. 

ACIR was formed in 2004 by the Board of Trustees to provide hear feedback from the University about DUMAC’s investments and to make recommendations for when Duke should take a stand on a particular investment issue. In the past, they have encouraged divestment from companies that do business in Darfur and have heard concerns about conflict minerals and fossil fuels. 

The committee is composed of faculty, administrators and student representatives from Duke Student Government and the Graduate and Professional Student Council. Members sign a non-disclosure agreement with DUMAC to have access to information about the University’s direct investments. The committee generally reviews DUMAC’s portfolio once per year and can request information about specific holdings as concerns arise, Baxter explained. The committee also receives a list of controversial investments the University holds from DUMAC. 

“We heard about this as recently as you,” Baxter said, referencing the use of blocker corporations.

Baxter noted that Ferrous Resources was not necessarily bad, but that it was worth studying further. 

“The one thing that worries me is that the mining issue starts looking a lot like conflict minerals,” he said. “We need to learn more about that. I’d never heard of Ferrous Resources until that article so we need to know what is it, is it something that is effective, is it something that if we withdraw from it the miners lose their jobs or is it so iniquitous—I just don’t know.”

Sophomore Gino Nuzzolillo attended the ACIR meeting and was surprised by the committee’s response. 

“So the committee that’s supposed to be advising the Board of Trustees and DUMAC on investment responsibility did not know about Duke’s investment in Ferrous Resources until six days ago?” he asked. 

ACIR can only see what’s in the University’s direct holdings, which comprise a small part of the total endowment, Baxter and Schoenfeld indicated. Much of the rest is in managed funds, or what Schoenfeld called “funds of funds.”

It might not be easy for DUMAC to know where all the University’s indirect investments—for example, through blocker corporations—are at every given moment, Baxter said. This is true given how frequently investment positions can change. 

But Baxter said DUMAC might have the right to ask the blocker corporation or other indirect investment vehicle about their holdings. Based on his work on blocker corporations, West said that the nonprofit or university likely receives a sectoral breakdown of stocks from the blocker corporation at specified intervals. 

This does not mean, however, that the blocker corporation would give the university a list of its specific holdings, he said. He also explained that it is theoretically possible for a university to not know they have a stake in a company, even though their policy might prevent them from directly investing in that company. 

“I’m sure there are situations where the investment manager gives limited reports,” he said. “I’ve never seen anyone say we will not give any information.”

A university could also look at the blocker corporation’s investment thesis to decide whether to invest in the first place. 

Jim Cox, Brainerd Currie professor of law and ACIR's former chair, wrote in an email that DUMAC takes allocating its funds seriously in order to have a "crisp" understanding of where it is invested.

"Using a southern expression, DUMAC is not in the business of 'buying a pig in a poke,'" Cox wrote. 

Some in attendance expressed concerns about the meeting’s publicity. Although Baxter said the forum had been scheduled several months in advance, an email announcing the forum only went out to members of the University community Tuesday morning. 

“This was not publicized well,” Nuzzolillo said. “It was not publicized well to students and I would venture to guess that folks before that email [Tuesday] morning had no idea the meeting was happening let alone what this committee was.” 

Tracy Futhey, vice president and chief information officer for the Office of Information Technology and an ACIR member, noted it was the second most people she had seen at such a forum. 

One attendee was concerned that Duke’s socially responsible investment guidelines had not been updated since 2004 and were rather vague. Baxter said he would welcome having that conversation. 

Persistently through the meeting, it became clear that members of ACIR did not have all the answers to questions posed by the audience. Audience members were curious to know by what ACIR’s next steps regarding studying Ferrous Resources would be. 

Baxter wrote in an email to The Chronicle that he was planning a public forum in the Spring so DUMAC can explain how it makes its investment decisions. He also called for members of the University community to submit “reasoned and fact-based memos” that can be considered and discussed by ACIR and said they may consider adding a comment feature to the website. 

Editor's Note: This article was updated at 10:35 a.m. to include Cox's comments.

Adam Beyer | Digital Content Director

Adam Beyer is a senior public policy major and is The Chronicle's Digital Strategy Team director.


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