A tale of three funds

Written by: Ogier Posted: 13/11/2020

CraigCordle_OgierApr19bryan-verneuil-smith_ogier_jul20From fraud to unforeseen financial crises, there are any number of reasons why funds collapse. Ogier Partners Craig Cordle and Bryan de Verneuil-Smith take a look at three high-profile cases and explore the lessons for directors and fund managers

The reasons behind the collapses of 1MDB, Carlyle and Abraaj and the high-profile cases that followed them are very different, but in each case the lessons that can be learned are broadly similar – and rooted in robust corporate governance.

1MDB (1Malaysia Development Berhad) was founded in 2009 as a Malaysian state investment fund, established to develop the nation’s tourism and green energy by the then Prime Minister, Najib Razak.

It raised billions of dollars from the Middle East and leading banks such as Goldman Sachs, ostensibly for infrastructure projects. 

However, the US Department of Justice has alleged that from 2009 to 2014, $4.5bn was diverted to shell companies and offshore accounts to enrich corrupt government officials. 

The money was spent on an array of eye-watering purchases, including $275m on luxury goods including watches and jewellery, $100m into funding Hollywood movie production The Wolf of Wall Street and $85m in Las Vegas gambling. 

A number of techniques were used to defraud the creditors. Funds were transferred back and forth through different legal entities with the same beneficial owner to obscure the nature, source, location and control of the original funds. 

Bank accounts whose names mimicked those of legitimate companies, such as BlackRock, were created and money was transferred into the client accounts of US law firms to avoid due diligence/anti-money laundering checks.

1MDB’s articles of association allowed the management team to control transactions in priority to the board of directors. The board was kept in the dark regarding the key details of deals and, on other occasions, management ignored instructions and queries from the board.

Ignorance no excuse

While it appears that management hid its fraudulent actions from the board – and the structure of the company allowed management to do this – ignorance does not exonerate directors from breaching their duties. There are criminal investigations in more than 10 jurisdictions, including the US, Singapore and the UK. 

Carlyle Capital Corporation (CCC) was an investment fund set up as a Guernsey company by the US private equity group Carlyle. It went into insolvency in 2008, losing all of its $1bn of capital. CCC had invested mainly in US residential mortgage-backed securities (RMBS).

The directors were accused of breaching their duties to CCC because they failed to insist or recommend that CCC take urgent steps to sell down its RMBS assets or to raise additional equity capital or conduct an orderly winding down of CCC from the end of July 2007.  

Ogier acted for three of the defendants in the Royal Court of Guernsey, which concluded (and the conclusion was upheld by the Guernsey Court of Appeal at which Ogier acted for the investment manager) that there was no breach of the duty of care of the directors or the investment managers. 

It also ruled that, without the benefit of hindsight, their actions had been rational and reasonable. The failure was beyond the control of any board of directors and the result of unforeseen and unforeseeable circumstances. 

They were cleared of all 187 charges brought by the liquidators.  

The Abraaj Group was the largest private equity investment house in the Middle East and at one point purported to manage more than $14bn in assets across emerging markets. 

In 2018, Abraaj Holdings, the holding company of the group, and Abraaj Investment Management, the central investment manager entity, were placed into provisional liquidation, after a group of investors commissioned an independent audit into the alleged mismanagement of its $1bn healthcare fund. 

According to PwC, the liquidator of Abraaj Holdings, the group’s expenditure exceeded its revenue for years and debt was used to fund the operating expenses.
 
Pleadings filed by the US Department of Justice and the Dubai and US regulatory authorities included allegations that money from certain funds had been misused to try to alleviate cashflow problems and that assets had been overvalued and investors’ funds misappropriated to hide the dismal financial condition of the group accounts. 

The allegations also cited weak governance, especially a lack of adequate oversight controls.  

Two Abraaj Group companies were fined a combined $315m for deceiving investors and misappropriating funds. 

The founder denies intentional wrongdoing and is fighting extradition to the US on charges of the theft of hundreds of millions of dollars and misrepresenting the value of the Abraaj Group’s holdings. 

Funds red flags

Ogier acts in respect of a substantial Abraaj fund and, particularly, for its independent director appointed during the immediate fall-out of the Abraaj collapse.

These three funds collapsed for different reasons but red flags, which could indicate problems in the management of any fund, were apparent from the allegations (or judicial findings), including:
• One dominant individual in a key decision-making role
• No clear management structure and no chain of accountability (or any such processes not adequately adhered to)
• Poor communication between those running the fund, its investors and other relevant parties
• Delays in responding to requests for clarification and responses inadequate or lacking in any substantive independent verification
• Defensive or secretive senior management
• Too much emphasis and focus on the outcome for the fund, rather than the process of running it.

Maintaining strong corporate governance is vitally important. The board of directors must be involved in the checks and balances of decision-making to prevent management misconduct and the misappropriation of assets. 

In light of the directors’ fiduciary obligations to the fund, the board of directors should always be the ultimate decision-maker, not management.

Good corporate governance will provide directors with a strong defence when funds collapse due to unforeseen financial crises and they are sued for having allowed the fund to collapse.

Fund directors concerned that their funds are approaching the zone of insolvency, should seek independent legal and accountancy advice to mitigate the risks of facing allegations for having breached their duties. 

Early transparency with the regulatory authorities of funds and managers that are facing difficulties is also of paramount importance. Fund managers and directors should:
• Ensure decision-making is subject to systematic (and, where appropriate, independent) checks and balances
• Insist on visibility on cash flows and the deployment of drawdowns 
• Ensure there is fund manager due diligence and that it is kept up to date
• Where appropriate and possible, obtain external third-party reviews of valuations
• Maintain good and timely communications with all relevant parties and investors 
• Consider undertaking periodic governance reviews conducted by an independent third party
• Ensure cohesive and contemporaneous records are kept of all meetings and decisions.

While the intention is not to stifle the ability of fund managers to do what they do best, they should seek to conduct their affairs defensively. 

The courts, regulators and investors will always have benefit of hindsight when reviewing a fund and its manager’s actions, and so managers are well advised not to overlook the importance of maintaining strong governance procedures.  

For further information or to find out more about our investment funds expertise, go to www.ogier.com or contact one of our team. 

This advertising feature was first published in the October/November 2020 edition of Businesslife magazine


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