Dubai and L'Affaire Abraaj - Realism Amid Emotion and Financial Fairy Tales

Perhaps Better to Wait Till the Dust Settles to Get a Clearer Picture?

As you might expect, in the wake of the Abraaj scandal, financial journalists are examining the impact on GCC markets and in particular Dubai. 

Nicholas Parasie at the WSJ took a look at Dubai earlier this week.  “Once Billed as a Financial Haven in the Middle East, Dubai Turns Investors Wary”   

As usual, I have a slightly contrarian view which I’d like to convey by responding to quotes from his article. The point of this exercise is not to cast doubt on the article, but use several of the points mentioned to highlight areas of difference. 

“Investors are questioning whether Dubai’s young financial center can police itself as the meltdown of its marquee private-equity firm highlights broader concerns about placing money in the region.”

That’s a perfectly natural human reaction.  I’ve got a problem so first let’s identify all the people who let me down and are responsible for my misfortune.  Perhaps, but perhaps not, I’ll eventually get around to examining my own behaviour. 

There’s another element.  Realistically, where is that well-policed market that Dubai should measure up to? That sought after “haven”? 

The Bernie Madoff scandal, the dot.com bust, the almost a Second Great Depression, Lehman, Libor all occurred in what are generally described as the “mature” “well regulated” markets in the OECD.  These scandals are widely attributed to regulatory and corporate governance failures which is the central “charge” against Dubai in L' Affaire Abraaj. 

Given the dollar magnitude and number of these scandals relative to those in Dubai, shouldn’t investors be questioning the ability of these “Western” markets to police themselves much more than questioning Dubai? If not, why not?  

Should Dubai be held to a higher standard?  If so, why?  

“Dubai was supposed to be a rules-based haven in the Middle East’s opaque financial world, but fears about corporate governance and conflicts of interest are rising."

I suppose if one didn’t look too closely but rather relied on the promotional advertising alone one might have imagined that Dubai was a “rules-based haven”.  But one would have had to be pretty oblivious.  It's like reading "The Art of the Deal" and thinking that the chap on the cover is America's #1 DealMeister.  In both cases your credulity would have gotten the better of the facts. 

I know that for some—usually bankers and investors--ten or fifteen years in the past is an age unknown probably before recorded time.  

But back in 2004 Ian Hay Davison, Chairman, and Philip Thorpe, CEO, both of the DFSA were summarily sacked. Ian by mobile phone.  Philip was "escorted" from the DFSA’s offices.  Both “lost” their jobs because they had the temerity to suggest that the real estate transaction for the Gate was freighted with conflicts of interest among certain high “personalities”.   Read it here.  If you read it in the Torygraph, you know it must be true. 

After the Dubacle--which in itself might have suggested causes more than just irrational real estate exuberance--, a number of high ranking officials were relieved of their positions.  One chap, the former head of the DIFC, was “encouraged” to return “bonuses” that were alleged to have been improperly obtained. There is of course more but those are two rather glaring examples.  A good rule of thumb is that if you suspect there are ethical issues at a regulator or in government departments or corporations, you should be wary of ascribing high standards to the jurisdiction.  Focus like this can simplify your due diligence greatly.  

“Unlike in the West, where corporate executives are often held accountable by supervisory boards, “there are no checks and balances in the Middle East in some companies,” she said.”  The “she” in this quote is Alissa Amico, a Paris-based former executive at the Organization for Economic Cooperation and Development.

Quite!  As to the “developed” Western markets, there are “checks and balances” indeed but mostly on paper. Rarely do independent board members take action to prevent corporate malfeasance.   In some cases, they appear to aid and abet it. See Hollinger. See Enron whose board composition on its face ticked every box in good corporate governance.  See Volkswagen and dieselgate.  For more on supervisory board failures in Germany read this article from Handelsblatt. 

The clear lesson here is that corporate structures and rules while a necessary condition are not sufficient to prevent malfeasance. People are the critical variable that make these structures and rules effective. If they are wanting, the entire structure fails.     

“The longer it waits, the more Dubai’s ability to attract foreign capital could be at risk, said Oliver Schutzmann, chief executive of Iridium Advisors, an investor-relations firm.” The “it” in this quote is the DFSA.

No doubt immediate action might satisfy investors who no doubt are looking for vengeance. 

But a proper investigation needs to be conducted to determine the extent of the malfeasance, if any, and the parties involved.  

MF Global collapsed in late 2011.  In 2013 the US CFTC filed charges against the former Chairman and CEO that involved allegations of “misuse” of client funds similar to allegations against officers of Abraaj.  

There are risks to too-quick action.  

1. Failure to punish all those, if any, who should be punished.  
2. Failure to punish for all offenses.  The DFSA would look rather incompetent if it later turned out that there were transgressions more serious than “borrowing” client funds at Abraaj and that it failed to punish these. 
3. Or if in the rush to take action, it inadequately prepared its case and wrongdoers, if any, were subsequently acquitted.  

As well, while vengeance may be  satisfying, it won’t result in investors being made whole.  Rather cold comfort for Mr. Jaffar: I’ll get a jail sentence against Brother Arif, but I still won’t get my US$300 million.  

It’s perfectly natural for investors who have suffered a loss or think they have to get quite emotional and thus irrational.  

Sadly, there’s often a tendency for others to get caught up in these emotions of the moment. Cooler heads are needed, but few are found. 

1. False comparisons are made.  Dubai compared with the mythical conflict-of-interest free well-policed Western markets.  
2. Double standards are applied. Dubai must be purer than Caesar’s wife.  
3. Dire end of the world or end of the market predictions are made. No one will invest here anymore.  But why didn’t that happen after Hay/Thorpe, Bin Sulaiman, et al.? Or after the Dubacle?  Or in Bahrain after TIBC, Awal, GFH?  Or in Kuwait after TID and Global?  Or in KSA, after the typical SAMA response to prefer local banks over foreign in the TIBC and Awal affair? Or in the USA after the Almost a Second Great Depression? 
4. Fundamental issues can be missed.  Nuances lost.  What really makes a market investable?  A fancy building, some imported be-wigged English-law judges, an impressive rule book? Or are other things more important?  
5. Remedies are prescribed before there's enough information for a thorough diagnosis.  We really don’t know exactly the extent and type of malfeasance in L'Affaire Abraaj.  Is it equivalent to MF Global or Bernie Madoff?  Who was involved?  Yet, hobby horses are trotted out from the stable and vigorously ridden.  Sometimes very specific prescriptions given.
6. Sometimes meaningless platitudes are given.  Meaningless because they are not specific.  “Regulators and boards need to step up their game.”  Or perhaps “work smarter not harder”.  Indeed, if only the UK had “stepped up its game” in the World Cup, they would have won.  If Abraaj had “stepped up its game”, no doubt it would have realized the sale of K-El and there wouldn’t have been a cashflow problem.  
7. Can we be that far away from a suggestion to use Blockchain to “disrupt” old patterns of corporate governance? In some places it promises the disruption of courts. Why not corporate governance?  Let's step boldly forward together to the “bleeding edge of leveraging the Blockchain space to disrupt the existing paradigm of corporate governance”.

Corporate Governance: It's Your Responsibility Too – Some Inconvenient and Uncomfortable Truths

Hate to Be Contrary But You Have A Responsibility for Corporate Governance

Warning:  This post contains some inconvenient and uncomfortable “truths” about your responsibility for corporate governance.  To make corporate governance work, you actually have to do something more than whinge about the failings of others.  Or issue calls for vague enhancements to corporate governance like calling on firms, auditors, regulators, and others to “step up their games”.     

Corporate governance generally focuses on roles and responsibilities of the board of directors, external auditors, and regulators.  Shareholders’ roles and responsibilities are not sufficiently discussed.  You can see this in the “founding document” of corporate governance the Cadbury Report (1992) which was sparked by perceptions of corporate misgovernance in Robert Maxwell’s companies. 

Typically the role of shareholder is summarized in a single sentence:  

“The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place.”  

This post argues that there are clear defects in that formulation and more importantly shareholders’ responsibilities exceed those outlined therein.  If corporate governance is going to be built on this slender reed alone, should we expect brilliant results?  

First to the defects. 

As a practical matter, the shareholders’ role in “appointing directors and auditors” is generally to vote on the candidates proposed by the board of directors.  Often there is a nominations committee of the board generally structured to be “independent” of executive directors (e.g., senior management) that recommends candidates to the full board (which includes executive directors).  There’s a great deal of reliance on “independence” of the nominating committee here.  

In general boards have not demonstrated a lot of “independence”, but perhaps they are when we're not looking.  Or perhaps not.  The full board then decides whether to approve the candidate.  There’s a potential conflict of interest in this arrangement. The full board includes executive directors.  Management may therefore have a significant role in hiring those who are supposed to monitor its performance.   

But there’s more.  

Generally the board only recommends a single candidate for a position.  If there are 6 director slots open, shareholders get to vote on six candidates. If it’s time to appoint auditors, one firm is proposed. Shareholders have all the choice given voters in “democratic” elections in one-party states.  On a positive note for shareholders, a “no” vote doesn’t usually lead to unhappy consequences. In either case it is “take it or leave it” which probably explains why the directors’ recommended candidates win, except in extreme cases.   

There are two reasons for this state of affairs. 

1. As a practical matter how would shareholders—usually an unwieldy large number--select potential board members or auditors?  Do they have the skills, contacts, knowledge?  How would consensus be achieved among shareholders over their competing candidates?  If consensus cannot be reached, there could be a plethora of candidates which could be as problematic as having only one candidate. 
2. While individual shareholders generally have a right to nominate directors, the directors’ candidates have a much easier road to election.   If you look at a typical US proxy, shareholder resolutions are included in a separate section with management arguments as to why these should be rejected. When a hedge fund or other professional investor wishes to get its own slate of directors elected, it typically hires third parties to draft, print, and mail its own proxy to each shareholder.  Why does it incur this not inconsiderable expense? It doesn’t believe that management will give its slate a fair shake in the management proxy.  It can’t wait until the meeting to propose directors and make its case because “management” proxies will already have been voted for directors and most shareholders skip the AGM.  They do give management representatives the right to vote their shares, but realistically are management representatives going to vote for the insurgent slate of directors?   
3. In some jurisdictions, if a shareholder owns 10% or more of the stock of a company, that shareholder can name a director and there is no requirement for other shareholders to support.  Differences in cumulative versus non-cumulative voting rights also affect the election of directors.  
4. But in general shareholders’ oversight through the election of directors is more theoretical than real. 

Given the very practical limitations on shareholder selection of directors and the numerous cases of board “failure” in corporate governance, including by ostensibly “independent” directors, shareholders need to do more to protect their interests and to foster good corporate governance.   

This is key because people are the critical variable in good corporate governance.  It wasn’t Enron’s corporate governance structure that caused problems at Enron. It was people. 

Let’s run through what the “more” shareholders must do by way of questions.  

These will allow you to check just how real your commitment to corporate governance is.  Are you Augustine of Hippo or St. Augustine of Hippo?  

Do Corporate Governance Principles  Inform Your Investment Behaviour?

Let’s assume that indeed you are firm believer in corporate governance. Or at least claim to be whenever there is corporate governance failure. 

Among the good practice principles you endorse is that the roles of chairman and chief executive officer be separated and that the chairman be an independent director, not an executive of the firm. Do you refuse to invest in corporations where the roles are combined? 

Suppose your principles also include a requirement for strong risk controls and non-manipulation of markets.  If your bank holdings include one that like Sea World has “whales”, do you refuse to invest or divest your holdings?      

How many of your firmly held corporate governance principles can a firm violate before you take concrete action?   

Remember that the road to corporate governance failure is a slippery slope.  It begins with a first bending of one rule and eventually the breaking of more.  If the firm is highly profitable, can you easily justify poor corporate governance?  Sure they lost US$ 6 billion but they still made a profit. 

In applying your corporate governance principles, do you allow yourself more slack that the CEO of a firm?  You wouldn’t tolerate his breaking even a single rule, but you can let your own principles slide a bit and perhaps even quite a bit, depending on profitability.  

Do You Perform Proper Due Diligence Before Investing?

Do you read more than the glossy pitchbook they give you?  Consider more than the cut of their suits and flash of their MontBlanc cuff links?  Read beyond the gushing appellation “Goldman Sachs of the GCC” or similar in the local press.   Or a shrieking recommendation delivered by Brother Jim on the TV?  

Does that due diligence include checking on corporate governance?  And situations that might cause corporate governance to fail, i.e., distressed financial conditions? 

Do You Know How to Perform Due Diligence Properly?  

Have you bothered to learn how to do due diligence on an investment?

Do you know the tricks used to enhance the presentation of performance in sales pitches?  When you were presented with financial performance, did you check what standards were used for reporting?  A good rule:  No GIPS no investment.  Were there model portfolios included?  Projections to the past:  “Using our strategy on a proforma basis, over the past 10 years we would have earned an IRR of 35%”.  What they don’t say is:  Of course, we didn’t, but it sure looks good.  And if we pick the right time period, we can find a sweet spot IRR.”  

If they're lying to you or stretching the truth in their pitches, what should infer about their ethics and their corporate governance?  

Do you know a bit about financial statements so you can at least spot if cashflow is not in line with reported income?  Would you have noticed that despite Dubious Gas’s reported income, the KRG and Egypt weren’t paying DG what they owed it?  

Understand that under accrual accounting, there can be different methods of recognizing the same transactions both on the balance sheet and the income statement? 

Do you know what the role of auditors, regulators, stock markets are? And what reliance you can or cannot put on them to look after your interests?  

Know what to look for in corporate governance structures, if you're looking for one that is complete and well-structured?  

Do you know the “red flags” of corporate distress?  As stated in my previous post, unless a firm is set up as a criminal enterprise, corporate misgovernance is more likely to occur when management is dealing with a serious problem than when things are going well.  

Some practical examples, before investing in one of Abraaj’s funds, did you look to see where their parent, the management company, etc were incorporated?  Did you understand that offshore companies in the Cayman Islands and other similar jurisdictions are lightly regulated (first euphemism of this post and in a long time)?  Did you ask why? A plausible answer might have been tax planning, but the flag of light regulation should have caught your eye.  

Did you ask for audited financials?  A good but not necessarily foolproof way to check if the firm is in financial distress.  The sort of “occasion of sin” that might lead to corporate misgovernance.   It's also a good way to check on the business performance.  If the funds they manage are performing well, that is, have a flow of exits and good returns, the bonanza of carried interest fees should show up here.  

But they might have told you: “No PE firm publishes financials.  We’re a partnership.  Our partners don’t want their remuneration disclosed.”  Did you know that Charterhouse Capital Partners and associated companies publish financials and that you can obtain a copy at Companies House?  You don’t get individual details but you get an aggregate number.  

Ask about performance of their funds?  If you had asked about their flagship “infrastructure” fund (IGCF) you might have noticed rather dismal performance as Arkad has pointed out. The delay in closing the “sale” of Karachi Electric might have caught your eye. You might have noticed that the GOP wasn’t paying K-El.  Or that K-El had been in Abraaj’s portfolio for some time. Might you have wondered about their wisdom in plunking down a whale-sized amount to invest in power in the subcontinent?  Or wondered what made this investment different from others in the subcontinent?  Enron Dabhol.    

If you looked at that fund’s investments, you might wonder, as Sabah Al-Binali did, why a Private Equity firm was buying listed stocks and what this meant about their stated investment mandate and adherence thereto.   Assuming it was a pure private equity fund, if they won't keep to the mandate, what other promises might they not keep?

What Post-Purchase Investment Monitoring Do You Perform? 

The Abraaj scandal came to light because a few investors saw something that raised red flags and they acted on that information.   

Do you read the company’s financials and investor presentations carefully and not just rely on company press releases or puff pieces in the press for your monitoring?   Local press analysis often being little more than a regurgitation of the press release.  

Do you look for changes in behaviour or reporting by the firm that are red flags of potential problems? 

Do You Exercise Your Corporate Governance Rights?  

Do you attend the annual shareholders’ meeting?  Ask questions you have from your post-purchase monitoring?  Listen to the questions of other shareholders and management’s responses?  React and participate? 

Where there are proxy materials, do you actually read them?  Do you vote your proxy?  Do you do more than “tick” yes on the management recommendations?    

In some jurisdictions there aren’t proxies. Some of this information is in the audited annual report.  Or in separate corporate governance reports.   

If you've got a problem with information provided have you ever complained in the AGM (with auditors, representatives from the MOIC or equivalent, and directors present) that information in financials and disclosures is insufficient.  Ever make similar complaints in writing to your stock market or local regulator about insufficient, unclear or misleading disclosures?    

CONCLUSION 

At this point I imagine that some of you are thinking.  

But this is hard work. It’s unrealistic.   We don’t have the skills or time to do all of this. The auditors, the board, the regulators should do their jobs properly and we won’t have to.  Quite!  Police and neighbors should be keeping watch to prevent burglaries.   I shouldn’t have to lock my door. 

Or wait just a minute, AA.  Are you seriously arguing that if we do this, there won’t be corporate misgovernance?  

No!  But you may make it harder.  You may create an environment that encourages other shareholders to take similar actions.  

You may deliver a very clear message to board members that you are watching.  Auditors, regulators, the MOIC may be awakened to action.

On the other hand, you can decide that this is too much and not really your responsibility. You can remain among the sheep. That entitles you to bleat on-and-on about corporate misgovernance whenever you’re sheared.   

Corporate Governance -- Easier Said Than Done

In the wake of the distress at Abraaj, there have been the usual calls to enhance corporate governance.  

As the title above indicates, AA has a contrarian view.  

In particular, I want to address two assumptions that seem to be held regarding this topic: 

1. If only we adopt certain measures, we can greatly reduce and perhaps even eliminate instances of corporate misgovernance.  
2. When corporate governance fails, the tendency is to blame third parties never oneself.  This “shifting” of responsibility seriously detracts from enhancing corporate governance. 

Corporate governance or lack thereof is the result of the interplay of three factors:  

1. Governance systems 
2. People 
3. Situations 

GOVERNANCE SYSTEMS 

The primary focus in the pursuit of good governance appears to focus on establishing systems, perhaps because the difficulty of controlling the primary factor in corporate governance—people— is realized to be difficult. 

These systems are designed to: 

1. Establish “rules of the road” for conduct generally in the form of codes of conduct or ethics.   
2. Create organizational structures and limitation of personal authority/segregation of duties to (a) prevent individuals from exercising unfettered control over the corporate entity and (b) provide multiple review mechanisms to “catch” bad behaviour that has slipped through the ethical and  organizational “nets”.  

Rules establish standards of conduct.  Basically, these can be summarized as follows.  Don’t cheat, lie, or steal from the company’s owners and other stakeholders.  Don’t use your position to take advantage of the company’s owners or other stakeholders.  Discharge your duties as a faithful agent. Pretty simple and obvious “stuff”.   Presumably, this is the sort of moral sense we’d expect from board members, officers, and employees of a firm.  

And well might ask why do we need to tell people to be ethical unless we assume we’ve hired some pretty low lives.  Does any ethical person think it’s right to steal or lie?  

So if they’re so self-evident, what’s the need?  

1. Ideally they provide clear unambiguous rules of conduct.  If insider trading is properly defined, to use one example, then there is little room for debate on what constitutes insider trading.  They also provide an inventory of responsibilities. 
2. They can address gaps or ambiguities in the law or governmental regulations.  Also they can hold the board, officers, and employees to higher standards than mandated by the law or government regulations.  
3. If crafted properly, they provide a legal basis for the termination of employment or other service.  If you find a “bad apple” you’ll want to get him or her out of your barrel ASAP.  

Examples of organizational structures and procedures (exercise of authority) are segregation of duties, including management of key review functions, dual control, requirements for independent directors, an independent chairman, etc. 

Review functions are both internal and external. Internal review includes internal audit, compliance, risk management, etc.  External review includes external auditors, including requirement for rotation of firms or audit partners; government regulation (chiefly for financial sector entities).

In some cases firms or governmental regulatory agencies have “whistleblower” programs for individuals to report inappropriate behaviour.  

But these measures while necessary are not sufficient.   

And unless there are glaring deficiencies, the benefit of adding additional measures is often likely to be marginal.  Using AA’s wayback machine, here’s a post from 2009 which shows that sometimes enhancement to existing measures can be theoretically useful.  

PEOPLE

No matter how good the system, if those charged with implementing it don’t follow it for whatever reason, corporate misgovernance can occur.  People are the critical variable. 

To set the stage, some examples of system failures due to people:  

1. Wells Fargo had a fairly developed whistleblower program.  It received numerous complaints about unauthorized opening of customer accounts and credit cards.  There was no discernable impact on firm behaviour.    
2. Enron had a 65 page corporate ethics manual, which if it were followed to the letter, would have prevented much, if not all, of its inappropriate behaviour.  
3. For more examples, take a look at the Breeden report on Hollinger International.  Richard C. Breeden, former head of the US SEC, and his law firm have prepared other reports on corporate mis-governance, e.g., MCI,  WorldCom.  

Typically, an attempt is made to address the “people issue” by establishing “fit and proper” criteria for owners/partners of unlisted firms, board members, and senior managers; limitations on numbers of boards board members may serve on; requirements for a number of independent-of-management board members; and possession of relevant skills and experience. 

Enron had a distinguished Board: 15 independent directors, including a former regulator, a former British MP, a distinguished former accounting professor who served as head of its audit committee.  

If you were looking for the ideal board which on its face has all the “right” people–qualified with years of practical experience and as outsiders ostensibly independent—and every Corporate Governance box "ticked", Enron’s Board would be a very strong contender.  Yet, as per press reports, Enron’s Board “suspended” the Company’s Code of Ethics to allow the CFO to be a shareholder in an Enron-related offshore entity.  Articles here and here.  

Enron’s Chairman/CEO had a reputation for promoting corporate governance and ethics.  See the first page of the Enron Code of Conduct.   Read his stirring speech at a 1999 the University of St Thomas in Houston. 

What went wrong? 

People are not perfect.  

Laziness, self-interest, incompetence, a propensity to “go along to get along”, fear of displaying one’s ignorance, etc. are typical traits that lead to governance and other problems.  Add to that an increasing sense of entitlement at the senior that one deserves more and more.  In short human nature.

Efforts to fundamentally change human nature do not have a track record of success.  Nor do those that focus solely on changing behaviour.  

The Soviets brought the power of the state to bear in an attempt to create a new and better Soviet man.  Jamal Abdul-Nasser and his colleagues a new Egyptian, freed from the legacy of colonialism, and what was perceived to be the dead hand of tradition.  Various religions have sought to modify behaviour and have wound up neither achieving widespread practice of right thought, right speech, or at a minimum right action.   

Those working on corporate governance enhancement have to recognize (a) the limitation of the perfectability of man and (b) that enhanced systems will not solve the people element in corporate governance problems.   

That doesn’t mean that one doesn’t try, but that one needs to have a sense of practical limitations.  In short we will not eliminate corporate misgovernance.

SITUATIONS 

In extreme cases, corporate entities are set up as “criminal enterprises” from inception.  Systems may be put in place but there is no intent to adhere to them.  

In noncriminal corporations, there is an intent to adhere to control systems.  Much corporate mis-governance occurs in response to distressed circumstances.  These situations are the real tests of ethics.  

It’s easy to be ethical when the money is rolling in and the corporation is doing well.  

AA has not once been tempted to rob a 7-11.  But if my imagined investments in Dubious Gas went to zero (my entire portfolio), I lost my job, and couldn’t access money, I might like Jean Valjean steal to feed my family.   

The same in the corporate world.  

If an investment firm had an ongoing cash shortage and needed money to continue operations but couldn’t get it immediately from legal sources, might its managers decide to temporarily “borrow” some client funds to bridge a cashflow problem that they’ve persuaded themselves is a temporary state of affairs?  

No doubt making the argument that preserving the firm also preserves clients’ assets, doesn’t disrupt financial markets leading to economy-wide problems.  And also considering carefully the impact of failure on their reputations as well as the loss of the perks of their positions.  

It’s in these cases that people will try to subvert systems.  Often they can do so and do so for a long time.  

Interestingly, when corporate misgovernance occurs, opprobrium is generally directed at those whose misgovernance is followed by collapse of their firm.  

In other words, the market seems distinguish between two situations: “successful” misgovernance (not bad) and “unsuccessful” misgovernance (unconscionably bad).  

Misstating financials is considered a fairly serious breach of corporate governance.  

At the outset of the Latin Debt Crisis, all US money center banks and some large regionals were insolvent based on a proper valuation of their Latin Debt.  Not a single one of these banks produced accurate financials.  The Government and external accountants either were woefully ignorant of the true state of affairs or colluded in the charade.  Eventually, the banks were able to work their way out of insolvency with a helping hand from the US government.  

Enron mis-stated its financials.  Lehman misstated elements of its financials.  Sunbeam as well.  All crashed and burned.  The Boards and senior officers of Enron, Lehman, Sunbeam and other companies were pilloried for corporate malfeasance.    Their auditors were charged with dereliction of duty.  In one case a major auditing firm was destroyed.

On the other hand not a single word of opprobrium was directed at the banks or their auditors over the Latin American debt crisis.  

What’s the takeaway here?  

1. For non-criminal firms, one can’t predict the response to corporate distress.  What level of distress will cause the system to bend and then break?  To cause normally ethically sound people to relax and then abandon their standards of conduct?  How can one devise a governance system that prevents that from occurring?  
2. Some corporate mis-governance is apparently good, i.e, if the firm survives.  It’s a natural response of someone in a distressed situation to imagine all sorts of “good” reasons to justify breaking the rules.  

RESPONSIBILITY SHIFTING 

A general reaction to corporate governance problems is that management failed, the board failed, the auditors failed,  regulators failed.  Indeed, they may have.  

But there is additional culpability.  What about other stakeholders and market participants?  If they adopt this very convenient view that they are innocent victims, then corporate governance is the responsibility of others. If one has no responsibility, then one need take no action, other than complain about the turpitude, avarice, and incompetence of others.  

The next post will deal with the apparently inconvenient and uncomfortable responsibility of other market participants to promote corporate governance.

Damas - New AED 614 Million Agreement with Abdullah Brothers

Damas announced on Nasdaq Dubai that it had revised its agreement with the Abdullah Brothers regarding the amounts they owe to Damas.

One key item is the fixing of the price of the 1,840,250 grams of gold the Brothers stole from the Company at AED 256 million.

Presumably, this has been set so that Damas is not disadvantaged.

Setting the amount owed is a key step.  Collecting it may prove a bit more difficult.

International Leasing and Investment Company - Attempt to Stack Board?

Al Qabas has a follow-up to their earlier report of the resignation of 3 directors at ILIC.  See earlier post on that topic here.

1. The Company has supposedly written to the MOCI requesting that it approve the replacement of Mr. Mohammed Al-Jasser with Mr. Basil Al Mutawa (a relative of Mr. Bassim Al Mutawa one of the major shareholders).  If this is approved then Abraj Holding/Boubyan Bank would not be represented on the Board despite AH's 32.3% share in the Company.  Boubyan has made a loan to Abraj and its representation on ILIC's Board was no doubt a way of looking after its interests in the collateral.
2. Also the Central Bank is said to have approved ILIC's 2008 financials which reportedly show a loss of US$120 million with the result that shareholders' equity was reduced to US$45 million.  Loans are said to remain at 2007's level:  US$600 million.  The CBK has, it is said, reservations on the financials.  And the auditors are refusing to give an opinion.
3. The two directors from the Islamic Development Bank are still tendering their resignations given their concern that the actions being taken are not in the interest of rescuing the Company.  Official bodies are reported to have rejected charges levied against the two directors as inventions and levied by parties who want to take control of the Company without involving other shareholders.
4. When the 2008 financials are released various infractions will be disclosed.  It's said that the auditors have concerns about the use to which loans were put.
5. The same parties behind the Board machinations are reported to be trying to block Mr. Faisal Al Zamil (Kuwait's representative on the IDB Board) from assuming a position in executive management  in the Company in order to enable them to put in someone who will look after their interests.
6. Finally creditors are said to be disgusted with the developments at the Company.

As I mentioned earlier, IDB and Abraj Holding, control over 60% of ILIC and should be able to take control of the Board.  If the Central Bank can finalize ILIC's financials, then the MOIC can call for a shareholders' meeting and presumably the majority of shareholders can vote in their own candidates for the Board - at least a majority.

The Investment Dar - Rumor of Restructuring Bombshell: Request for 50% Hiarcut

Major Al-Musallam Rides to Glory

Before we go further to be very clear this is an account which neither the Company, the Central Bank or the creditors have confirmed.
Update:  TID has denied this story.

Al Qabas reports that TID has submitted a completely new restructuring plan to the Central Bank of Kuwait which calls for lenders to forgive 50% of the existing debt, i.e. KD500 million.   According to the report, lenders were not consulted or advised prior to TID sending the proposal to the CBK.

What's going on here is anyone's guess.

Mine is that the Company and the lenders are jockeying from (what I think is) the fallout from the Ernst and Young report.  As you'll see below. TID and its lenders appear to have been discussing alternatives /modifications to the original plan. From the Al Qabas account these seem predicated on the fact that the Company cannot repay all the debt.  The unpayable quantum seems around a 50% or so.

I suspect that Ernst and Young came back with a very negative assessment of  TID's ability to repay in full and, thus, case serious doubt on the Company's ability to continue as a going concern.  As you're aware, the Financial Stability Law is designed to give protection to viable companies.  It is not intended as a mechanism to provide legal cover for disguised liquidations.  If I'm right (and as Umm Arqala will tell you that's a rare occurrence), a report like this would have thrown quite a large "wrench" into things, complicating the CBK's acceptance of the already agreed restructuring.  How could the Central Bank recommend to the Court that the Company be allowed under the FSL under such circumstances?

I'm also guessing this occurred prior to the end of the first four month period the CBK had for evaluation of the suitability of the original plan and of TID to enter finally under the FSL.

What leads credence to both assumptions are reports in the article that the lenders have floated some  proposals or modifications of their own and the timing of those negotiations.  One was the conversion of  roughly half the debt to equity with some preservation of the rights of the existing shareholders.  Presumably, the lenders could quite easily make the argument that if a debt conversion were required, the old equity has been lost .  And thus the old equity holders should be wiped out.  Their proposal is reported as more generous, though it's not clear what percentage they would allow the old shareholders in the post conversion equity.  Leaving 10% or 20% might for example be considered highly generous by the lenders and an "outrage" by the existing shareholders.  Negotiations on this proposal supposedly took place between July and September.  The story goes that TID's Board went back on a tentative agreement because some of the existing major shareholders did not want their equity interests diluted.  (Unclear to me how you dilute something worth nothing.  There's also a hint here that the major shareholders are very important people.   And, if you know Al Q's politics, you might suspect they are pointing the finger at regal personages).

As a second alternative, the lenders suggested taking some assets in exchange for the debt.  The article says  that E&Y determined that this proposal was acceptable under international principles.  Dar supposedly made a counter offer that brought things back to zero. 

At this point, the two sides are in a deadlock.  I think that TID's proposal (assuming the report is accurate) is more a negotiating tactic than a viable proposal.  Rather it is an attempt to break the logjam by setting forth a maximum position.  One they probably know both the lenders and the Central Bank would have a hard time accepting.  What this proposal does, though,  is shift the parameters of the debate.  While lenders may reject a 50% discount, it may be harder to avoid some meaningful haircut - particularly, if the choice is bankruptcy.  And in order to get itself out of having to make a decision that may prove wrong or hurt its and the country's reputation, the CBK may be inclined to lean on the parties to compromise.  TID has just set one bound on the compromise.

It could be that they are trying to play for time - hoping for a miracle.  Realistically playing for time  hurts all parties - TID, the lenders, Islamic Banking, and Kuwait.  But maybe that's the goal - to maintain the status quo.

The article describes the choices in front of the Central Bank as:

1. Issue a conditional acceptance of the proposal subject to conformity with accounting principles and the agreement of the lenders.  (Or in other words neatly pass the buck.  Or is that the dinar? As Al Q elegantly puts it, getting the lenders to agree may be very difficult given the Company's breach/violation of the existing agreement.  That raises AA's first law of underwriting and due diligence "know your customer".)
2. Reject the proposal.  In which case it's expected that TID will sue the CBK in an attempt to confuse the issue and buy more time.  As Al Qabas elegantly puts it الى ما لا نهاية . (Probably not a first choice. More likely is forcing the Company and its creditors back to the negotiating table.  Or putting them in a situation where they will decide the fate of TID, if that fate is to be bankruptcy).
3. Push the lenders to bankrupt the Company - which will lead to all sorts of negatives for all parties and harm the financial sector, Islamic Banking and the reputation of Kuwait. (I'm guessing not an alternative high on the CBK's list).
4. Convert TID to a holding company.  This would remove it from Central Bank supervision so that the lenders can apply the restructuring deal agreed.  Also the CBK's June ratios would not apply.  (This seems to me to be a bit of red herring.  The CBK can grant an exemption to TID as a finance company from the regulations.  Supposedly the lenders will reject this because they don't think the administration of the company is really interested in solving the problem.  The lenders have on more than one occasion made it quite clear what they think about management's ethics.  They began by asking the CBK to place a minder in the Company.  Then they pushed for the appointment of a Chief Restructuring Officer).
5. Force TID back to the negotiating table with the lenders to find a solution and return to the original plan.  (This seems contradictory.  The original plan is probably moot at this point.  I think the lenders are going to have to accept some changes - and these will be against their interests.  From the report of the alternatives they've offered already it seems pretty clear that they've accepted this - even if it was no doubt reluctantly.  The CBK may well force the parties back to the negotiating table but there will be a new deal.  Perhaps the CBK could impose a time limit for reaching an agreement using as the deadline some date prior to the date it's required to give a recommendation to the FSL Court).
6. Give TID an exemption from the new ratios saying the old plan was devised based on Central Bank advice to the lenders and thus it's not fair to change the rules on them.  As per the article, TID has apparently been saying that the original restructuring plan doesn't conform with the CBK's  "new rules".  The implication being the plan must be modified.   (I don't think that the CBK new rules are the real issue here.  The sticking point is TID's ability to pay and to continue as a going concern.  If the new rules were the only point, then I think the CBK would have given the exemption.  This could be quite easily fudged as an agreed plan to implement the new rules. And so it could be presented not so much as an exemption but a granting of additional time to achieve the goal.  When the debt is paid in full, TID will clearly be in compliance).
7. Exit TID from the FSL and leave it to its fate.  (The CBK probably doesn't want to be the one who puts down this dog.  Better to have the lenders do so.  The "trick" is to find a way to put the parties in a situation where they either come up with a solution or fail - a way which keeps the CBK's hands pristine.  The time limit for the CBK to give its recommendation to the FSL Court is a neat escape hatch.  If the parties haven't agreed by then, the CBK can tell the Court it cannot make a recommendation.  The Court should then refuse to allow TID final entry into the FSL.  Since this is the last extension allowed, the matter is out of the CBK's hands.  Nature and the courts then take their course.  That should be quite a frightening thought for the lenders .  As they stare into the abyss  of almost a complete loss, all sorts of discounts and compromises may become possible).

Finally to close out this post, a recap from the Creditors' Committee official letter to the Central Bank rejecting TID's new plan "in whole and in detail":

1. TID's proposal makes a gift of the money of others (the lenders) to the Company and strengthens (supports) the rights of equity at the expense of the lenders who have not received a single fils since the beginning of the crisis but only promises.  (But they were some really nice promises. Perhaps, even said with one's hand on the Qur'an).
2. TID's proposal is contrary to international and global practices (customary usage) and puts the lenders in the situation of a fait accompli with the proposal being put forward without their agreement or consultation.
3. TID's management is "hitting" (harming) the interests of the creditors and shareholders.  Therefore the lenders reject the idea of a discount which is unjust.
4. The Committee considers that TID's proposal ignores the repayment schedule already agreed.  10% in Year 1, 20% Year 2, 20% Year 3, 30% Year 4 and 20% Year 5.  (There seems to be an argument of a breach of faith here.  And, yes, while the lenders may be thinking of a breach of the agreed business contract for the rescheduling, AA also is thinking that in this context the term applies as well to  religion).
5. TID's proposal prefers (in the sense of giving priority) the shareholders over the lenders contrary to what was agreed previously.
6. The Company has wasted the shareholders' money hiring financial and legal advisors and wasted the banks time negotiating the past 18 months.  

This has been a bad situation from Day #1.  The passage of time has not made things better.  It's likely to get worse.

The lenders face a real dilemma.  Do they compromise to try and get back as much as they can?  Or at some point do they just bring down the house of cards?  With 18 months of time on their hands, lenders may have built rather hefty provisions against this name.  That may give them a bit more negotiating room.

The Central Bank is in the most uncomfortable of positions.  It's got to be hoping that third parties or events are dispositive and that it doesn't have to make a difficult decision.