1MDB and the Importance of Sovereign Fund Governance

The following post comes from Sheri Kindel:

Since 2009, debts created by a state investment fund in Malaysia, called 1MDB, have created controversy and recent calls for Malaysia’s Prime Minister, Najib Razak, to step down. The funds were allegedly used to bankroll the prime minister’s 13th general election campaign in 2013 by making overpriced purchases from a subsidiary of Genting Group. According to the Wall Street Journal, Genting then made a donation to a charity foundation called Yayasan Rakyat 1Malaysia (YR1M). During his campaign, the prime minister announced that YR1M would donate a large sum of money to local schools which were not in a poor neighborhood but whose support would be crucial to win votes in the area.

Meanwhile, Jho Low, 33, who has been friends with the prime minister’s stepson for 16 years and persuaded Najib to set up 1MDB, has also recently been getting a lot of attention. Low became friends with Riza Aziz, the prime minister’s stepson, while studying in London and grew close to Aziz’s mother, Rosmah Mansor. Najib became chairman of the board of advisers of 1MDB, a close friend of Low’s father became a director, and two of Low’s friends became staff members.

Since then, Low bought multi-million dollar properties in the U.S. on behalf of Aziz, who is now a film producer. However, Low denies any real estate transactions for the prime minister’s family, adding he never “engaged in any wrongful conduct regarding any financial matters for the prime minister and his family.” The sale of an apartment in New York involved shell companies connected to Low and Aziz to keep the transactions at arm’s length. Reports of the purchase identified two residents of Switzerland as the property owners, but these names were traced back to a shell company owned by Low. He later declared and is still adamant that the property was bought by a trust benefiting his family, but someone involved with the purchase recalled Low saying that he was buying for a group of investors with the main investor being the family of Najib. After three years, the apartment was sold to Aziz’s shell company for cash at a value nearly 40% greater than Low’s purchase price. This wasn’t the only property deal between the two. In Beverly Hills, Low bought a mansion for $17.5M and similarly turned around and sold it to Aziz.

Irwin Winkler, an executive producer of “The Wolf of Wall Street” described Low as the face of the financing for Red Granite Pictures, a Los Angeles based film production, finance, and international sales company. Aziz publicly announced the principal financer for Red Granite was Mohamed Admed Badawy al-Husseiny, chief executive of an Abu Dhabi government-owned company, Aabar Investments. Aziz denied the use of Malaysian money in Red Granite films, and Husseiny claims his investment was “personal money.”

Low claims that Najib is the final authority to approve or deny any 1MDB deal, transaction, and investment. Even though Low has no official role or title in 1MDB, multiple employees stated that he is regularly consulted for decisions. When asked about his involvement, Low admitted that he occasionally provided his views on various matters, but has never received compensation. Numerous documents have since emerged that tie Low to dealings with 1MDB, including a statement that finances on a deal would come from the Malysian government investment funds.

When asked about Najib, 1MDB, and the major purchases, Low declared that he is simply getting attention for being a young kid who made a lot of money and spent it partying. Najib made a public statement that Low “has never worked for 1MDB and all decisions and dealings of 1MDB was done by the management and board of directors.” Despite their declarations, there are documents establishing Low’s involvement in the prime minister’s affairs, including a joint venture project. A $700M “loan repayment” program was set up for 1MDB to pay back money loaned as part of a joint venture agreement with PetroSaudi. The money that supposedly repaid the loan was actually directed into a Swiss bank account controlled by Low. Soon after, that money was used to buy out Taib Mahmud’s UBG bank in Sarawak that failed to be sold on the open market. In 2011, 1MDB publicly pulled out of the PetroSaudi joint venture and the fund now claims the money was returned to 1MDB.

Until now, Low described himself as a friend of people with money coming from a “fairly OK family.” As the media began asking questions, Low recounted he was born with it himself. In an interview with the Wall Street Journal, Low reported that his grandfather made a fortune in mining and liquor investments in Thailand, but this wealth does not explain the vast amounts of resources spent so quickly and the power accumulated at such a young age.

1MDB’s information technology department is currently wiping clean all employees’ computers and smartphones hard drives. The company claims they are preventing the loss of information through any system breach, but skeptics claim they are dumping company records before lawyers can get their hands on them.

These events demonstrate the need for good governance controls with sovereign wealth funds and sovereign development funds. Since many funds experience a substantial amount of movement of large sums, the money must be closely monitored with purchases detailed to the board for tracking and security measures. By not tracking the money or by approving deals prematurely, cash can be spent before fund members even realize it was taken out. The trail would stop there. However, with stronger internal regulation of sovereign funds or a system of approving spending and maintaining records, individuals would be less likely to spend public money on private matters. In this case specifically, 1MDB should follow Low’s investments directly to determine where money is coming from and going to. Additionally, the fund could implement a strategy for multiple board members to sign off on deals and rotate through the members so it doesn’t seem like foul play with the same individuals working together. Low has recently acknowledged that he can no longer remain silent as to his involvement with 1MDB. With all the current news reports, Low must answer the questions he has been avoiding.

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