The Bermuda backlash. (View from the Hill).

CEOs contemplating offshore reincorporation as a tax haven are paying heed to clouds gathering in capitals and in Washington that could complicate offshore aspirations.

The backlash began when it was disclosed that Enron used subsidiaries in the Caribbean to hide debts and create artificial tax losses. But it was the effort by The Stanley Works in New Britain, Conn., to reincorporate itself in Bermuda that put the issue on front pages.

Stanley Works CEO John Trani told investors that reincorporation would save the toolmaker $30 million in taxes, following examples set by Tyco International, Ingersoll-Rand and nearly 20 other companies. More than half of that savings could go to Trani, whose pay is tied to company performance. On May 9, Stanley Works won a shareholder vote approving the move, but union officials called it rigged, and Connecticut Attorney General Richard Blumenthal went to court to overturn it, arguing that management made misleading statements beforehand. The company agreed to hold a revote later this year.

Much more is at stake than balloting technicalities. With memories of September 11 still vivid, the economy in delicate health and mid-term congressional elections approaching, Stanley Works sparked a national debate.

"Stanley Works has the potential to become the poster child for public outrage about overseas moves to avoid taxes," says Blumenthal. "It may become a symbol for a much broader public reaction and for congressional action as well."

"The issue is not about taking tax dollars away from the United States," Trani responds. "It's about reducing the company's global tax rate to remain competitive."

But Blumenthal says there are bigger issues, like the reduction of shareholder rights. "It has corporate governance implications that prevent shareholders from holding management accountable," Blumenthal argues. "The lawsuit we brought against Stanley Works would have been impossible if it had been in Bermuda."

At least six pieces of anti-offshore legislation have been introduced since March. Democratic Congressman Richard Neal of Massachusetts was the first to introduce a bill directing the Internal Revenue Service to treat a company that "expatriates" lust as it would one that was still based in the United States. Neal says he believes more than 300 members of the House will support his bill if Republicans allow it to reach the floor. It's similar to a measure introduced in the Senate by Max Baucus of Montana and Charles Grassley of Iowa, the top Democrat and Republican, respectively, on the Senate Finance Committee. Individual members of Congress have also proposed a moratorium on companies moving offshore, to allow time to grapple with the question of reforming America's tax system.

The Bush Administration's view, as articulated by Treasury Secretary Paul O'Neill, is that American CEOs are moving offshore because American tax rates harm their competitiveness against foreign rivals. "I don't think anyone wants to wake up one morning to find every U.S. company headquartered offshore because our tax code drove them away," wrote O'Neill, prefacing a 30-page report.

The May 17 report explained the complexity of drafting effective legislation when there are so many techniques for going offshore. A company can leverage U.S. operations through inter-company debt or by transferring intangibles and tax liabilities to a foreign country, for example. Hearings were scheduled for June (at press time no results were available).

What ultimately could prove more damaging to Caribbean dreaming would be cold feet among big investors. Many institutional shareholders were caught off guard by sudden earnings reversals at offshore-based Global Crossing and Tyco (at press time, Tyco's stock was hit again when CEO Dennis Kozlowski resigned under indictment for personal tax evasion).

One intriguing development is that the California Public Employees' Retirement System, or CalPERS, the nation's largest pension fund, voted against Stanley Works' move south. "We felt uncomfortable with the fact that there might be anti-shareholder provisions in Bermuda," says a CalPERS spokesman, Brad Pacheco.

CalPERS won't say if the "no" vote is the beginning of a pattern of opposing offshore moves or if it's limited to Stanley Works. But CalPERS often sets trends among big investors. If that happens, an investor pullback from the shares of offshore expatriates could prove more powerful than new legislation.