Friday, July 29, 2016

The 1MDB Scandal - An Overview

Happier Days

This post is based upon the 20 July 2016 complaint filed by the US Department of Justice (DoJ) against Red Granite pictures. (the “Red Granite Complaint” or the “Complaint”), producers of The Wolf of Wall Street.    I will cite sources paragraph numbers rather than page numbers as “sourcing” for various points.

The Red Granite Complaint is one of at least fifteen other complaints filed to secure the civil seizure and forfeiture of assets alleged to have been purchased with the proceeds of an alleged misappropriation of approximately US$3.5 billion from Malaysia’s state-owned strategic investment and development fund, 1MDB.
The DoJ is making the individual complaints available at this website.   Also note the powerpoint with pictures of some of the assets.  Link here. 

This post will set the stage for subsequent posts here at Suq Al Mal.  Because SAM focuses on the GCC banking sector, those posts will look at GCC parties involved in transactions with 1MDB where those parties’ behavior raises questions –at least to AA.  Of course, if past is prologue, then you know that AA will not be able to resist the urge to venture beyond the GCC if something interesting catches his eye.
Before I begin one very important note.

The US DoJ has filed complaints.  The parties mentioned in the complaints have not been convicted of any crime, nor have they had a chance to neither respond to the charges made against them, nor have their responses and the original complaints tested by the judicial process.  At this stage all that can be said is that allegations have been made.  Please bear that in mind as you read this post.
According to the Complaint, the misappropriation of funds from 1MDB took place from 2009 through 2013.  The DOJ identifies three phases named for the vehicles purported to have been used in the theft.
  1. The Good Star Phase (2009-2011)                US$1 billion 
  2. The Aabar Investments BVI Phase (2012)     US$1.367 billion
  3. The Tanore Phase (2013)                               US$1.2 billion   
The Good Star Phase (Para #8 and Paras 40-112)

In 2009 1MDB signed a joint venture agreement (JVA) with PetroSaudi International, a privately owned Saudi-registered firm, to develop properties in Argentina and Turkmenistan. 

According to the JVA, 1MDB was to contribute US$1 billion in equity to the JV. 
The Complaint alleges that in late September the Malaysian fund made payments totaling US$1 billion, but that US$700 million were transferred to an the Swiss account of Good Star, a company actually controlled by Malaysian LOW Taek Jho. 
In May 2011 and October 2011 an additional US$330 million was transferred to Good Star, ostensibly advances under a murabaha facility extended by 1MDB to the JV.
The Aabar Investments PSJ BVI Phase (Paras #9-10 and 112-226)

During 2012, 1MDB raised US$3.5 billion in bonds (arranged and underwritten by Goldman Sachs) and guaranteed by 1MDB as well as IPIC, an Abu Dhabi state-owned investment fund. 

The Red Granite Complaint alleges that US$1.367 billion of the bond proceeds were diverted to a Swiss bank for the account of Aabar Investments PSJ in the British Virgin Islands.  
Despite the similarity to an IPIC subsidiary Aabar Investments and Aabar Investments PSJ, the company in the BVI was not owned by IPIC or Aabar.  Curiously, according to Para #115 of the Complaint, the directors of the BVI were H.E. Khadem Abdulla al Qubaisi (Managing Director of IPIC) and Mohamed Ahmed Badawy Al Husseiny (CEO of Aabar).
Funds were later allegedly transferred from the BVI account to an account controlled by TAN Kim Loong, described by the Complaint as an associate of Mr. LOW.  Funds were used to acquire assets and transfers were made for the personal benefit of officials at 1MDB, IPIC, and Aabar.
The Tanore Phase (Para #11 and Paras #227-290)

The Complaint alleges that US$1.2 billion was diverted from a US$3.0 billion third Goldman Sachs arranged bond issue in 2013, which in part was to fund investments with Abu Dhabi in the Abu Dhabi Malaysian Investment Company (ADMIC). 
The US$1.2 is alleged to have been transferred to an account in Singapore for Tanore Finance Corporation, a company alleged to be ultimately controlled by Mr. LOW.  This amount inter alia is alleged to have provided funding to Red Granite for the production of The Wolf of Wall Street.
What Were They Thinking

For the sake of making a few comments, I will assume that the Complaint is accurate.  That is, that roughly $3.567 billion was misappropriated from 1MDB.    
As of 31 March 2014, 1MDB’s financials show roughly MR51.4 billion in total assets or approximately US$15.7 billion.

US$3.5 billion represents almost twenty-three percent of total assets. The size of the fraud is immense not only in dollar terms but as a percentage of assets. 
How did the perpetrators think a fraud of this size would go undetected?

In the future, assets booked to disguise the defalcation would prove worthless and have to be written down or written off.   This would have been very visible not only because of the amounts of the write-downs/write-offs but perhaps more importantly by their relation to the fund’s equity.
As of 31 March 2014, 1MDB had equity a shade over MR 2.4 billion (US$747 million), roughly twenty percent of the US$3.5 billion that is alleged to have been stolen.  Thus, even a partial write down would wipe out equity.

Often in such “operations” the proceeds of new misappropriations are used to partially cover the previous ones.  That is, for example, funds from the Aabar Phase would have been used to cover the Good Star Phase misappropriations, justified by a statement that the PSI/1MDB JV projects were not proceeding according to plan and to prevent further losses “prudent” management was terminating the JVA.  An amount could be written off ostensibly as costs incurred without necessarily ringing alarm bells. 
Or was there something else at play here besides simple greed and less than adept defalcation skills?

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