Lessons from 1MDB

Members of the board of 1MDB — a Malaysian federal strategic investment fund — and top Malaysian government officials plus private citizens allegedly illegally syphoned and laundered billions from the fund. Here’s how they escaped controls and lined their pockets.

1Malaysia Development Berhad (1MDB), the Malaysian sovereign wealth fund described by then-U.S. Attorney General Jeff Sessions in December 2017, as “kleptocracy at its worst,” started off as a “Malaysian strategic development company,” according to its website, which has since been shut down. At the very core of the 1MDB scandal was the “less than satisfactory corporate governance and internal controls,” as reported by the former Malaysian Auditor General Ambrin Buang in the 1MDB audit report. The result? 1MDB officials illegally drained and laundered billions from the fund “through a complex web of opaque transactions and fraudulent shell companies with bank accounts in countries ranging from Switzerland and Singapore to Luxembourg and the United States,” according to Sessions.

It all began in February 2009 with the incorporation of the Terengganu Investment Authority, a state-owned sovereign wealth fund. Soon after, 5 billion ringgit (about US$1,217,450,000) was raised from a bond issue. By the end of July 2009, the federal government had taken over the Terengganu Investment Authority and subsequently renamed it 1Malaysia Development Berhad. Henceforth, the Ministry of Finance wholly owned 1MDB, and made it a federal strategic investment fund that invested billions of ringgit in Malaysia’s energy, real estate and hospitality sectors. (See 1MDB: Giant ponzi scheme or strategic investment fund? by Jose Barrock, Kinibiz Online, March 26, 2013.)

1MDB was structured like a typical Malaysian publicly listed company with a board of directors and was subject to domestic regulators such as the central bank and the securities commission. However, 1MDB wasn’t a typical Malaysian publicly listed company. As a company wholly owned by the Ministry of Finance it was required to have a board of advisors chaired by the finance minister. Despite having more corporate governance mechanisms than publicly listed companies, the breakdown of these mechanisms contributed to executive fraud at 1MDB.

This article studies the 1MDB scandal from the perspective of the “Crime Triangle of Routine Activity Theory” — an environmental criminology theory — and focuses on its board of directors and board of advisors plus Malaysian regulators and law enforcement agencies. The underlying rationale of environmental criminology is that the immediate environment is a key determinant of human behavior. As such, each crime is a result of the interaction between people and the situations they’re in. (See the book, Environmental Criminology and Crime Analysis, by Richard Wortley and Lorraine Mazerolle, Social Science, 2008.)

Crime Triangle of Routine Activity Theory

The central premise of the Crime Triangle of Routine Activity Theory is that a crime event occurs when a motivated perpetrator makes contact at a given time and place with a suitable target when a capable controller isn’t present. (See Social Change and Crime Rate Trends: A Routine Activity Approach, by Lawrence E. Cohen and Marcus Felson, American Sociological Review, volume 44, number 4, August 1979.)

The controller has an indirect influence on the crime occurrence and hence has the potential to prevent the crime. The controllers are: 1) a handler to prevent the perpetrator from committing the crime, 2) a guardian of the target who might deliberately or inadvertently reduce the likelihood of crime and 3) a manager who monitors the place to influence access and the behaviors tolerated in that place. (See the diagram below.)

Diagram: Crime Triangle of Routine Activity Theory (Source: Super controllers and crime prevention: A routine activity explanation of crime prevention success and failure, by Rana Sampson, John Eck and Jessica Dunham, Security Journal, volume 23, issue 1, February 2010.)

A crime can occur when one or more controllers shirk their duties and fail in their roles. To ensure that controllers fulfill their roles, super controllers are needed to regulate the conduct of controllers. (See Super controllers and crime prevention: a routine activity explanation of crime prevention success and failure, by Rana Sampson, John Eck and Jessica Dunham, Security Journal, volume 23, issue 1, February 2010.) Of course, the effectiveness of both the controllers and super controllers in preventing the crime depends on them fulfilling their roles.

The Crime Triangle of Routine Activity Theory applied to corporate governance explains that employee fraud can occur when an employee (perpetrator) steals an asset (target) at the organization (place). In an organization, management plays the role of the handler, guardian and manager. Management refers to specific individuals in a management role or a level of management that’s usually higher than the position of the employee who perpetrated the fraud. In turn, the super controllers are management at a level that’s higher than the handler, guardian and manager. (See A tale of two triangles: comparing the Fraud Triangle with criminology’s Crime Triangle, by Grace Mui and Jennifer Mailley, Accounting Research Journal, volume 28, issue 1.)

For example, when a warehouse clerk (perpetrator) steals inventory (target) from the warehouse (place), the handler is the clerk’s immediate supervisor. The inventory manager is the guardian of the inventory and the warehouse manager is the manager of the warehouse. The super controllers are the immediate superiors of the handler, guardian and manager. In a “flatter” organization, the super controllers could be the executives and board of directors.

In the case of executive fraud in publicly listed companies, super controllers can include external parties, such as the central bank and securities commission. Even with the presence of external super controllers, it could still be difficult to detect executive fraud because executives have the position and authority to cover and hide their tracks.

We’ll focus on 1MDB’s super controllers and how they abetted executive fraud or raised red flags.

1MDB Audit Report

“The best corporate governance practices can contribute to improvements in a company’s efficiency, transparency, and accountability in achieving its objectives; and enables a company’s operations to be properly managed. However, the 1MDB Group’s corporate governance and internal controls were less than satisfactory.” — executive summary of the 1MDB audit report.

Soon after the release of the report in 2016, the government classified it as “secret” under the Official Secrets Act 1972 by the then government because of allegations that billions of ringgit had been misappropriated from 1MDB. Here are the report’s highlights:

1) Between 2009 and 2015, several important high-value investments were made by board resolution without in-depth discussion and valuation. Several high-risk investments were entered into hastily. The board of directors reported to the Public Accounts Committee on Jan. 19, 2016 that discussions were held before resolutions were made.

2) In some instances, 1MDB executives provided incomplete or inaccurate information to its board of directors before an important decision was made when in fact, executives had acted without board approval.

3) In some instances, 1MDB executives provided inaccurate or conflicting information to various relevant parties.

4) 1MDB executives made several investment-related decisions that were conflicting or without fully adhering to board/shareholder decisions.

The report stated that the audit’s results were limited because 1MDB submitted late (or not at all) some original and important documents for the purpose of verifying transactions and as audit evidence. The important documents that 1MDB didn’t submit included the 1MDB Group Management Account dated March 31, 2015, and bank statements from foreign lenders.

Also, the auditors were unable to access computers, notebooks and servers at 1MDB to retrieve data for cross reference and analysis, so the auditors couldn’t verify the agency’s actual financial position, operations and related transactions.

Ambrin Buang and the Audit Department of Malaysia presented the report to the parliamentary Public Accounts Committee which then recommended, inter alia (among other things), the resignation of 1MDB’s board of directors and the dissolution of its board of advisors effective May 31, 2016, to facilitate governance changes and asset transfer. (See 1MDB board quits, advisory board to be dissolved, by Gho Chee Yuan, The Edge Financial Daily, May 5, 2016.)

Internal super controllers

The board of directors

In executive fraud, the board of directors is the handler whose role is to prevent executives from perpetrating fraud. The audit report highlighted that 1MDB executives acted without board approval, misled the board with incomplete or inaccurate information, and didn’t adhere to board decisions or acted contrary to board decisions.

In its early days, two board members were alleged to have resigned in protest over 1MDB’s joint venture with PetroSaudi International. (See The RM7 bil PetroSaudi caper, by P Gunasegaram, Dec. 19, 2015.) This joint venture was 1MDB’s first order of business after the Ministry of Finance assumed control. 1MDB executives, headed by then-CEO Shahrol Halmi, entered into this joint venture without board approval.

In 2015, Xavier Justo, a whistleblower and former employee of PetroSaudi, gave more than 90 gigabytes of data from PetroSaudi, including 227,000 emails related to the joint venture between PetroSaudi and 1MDB, to independent journalist Clare Rewcastle Brown. Brown published these 1MDB findings, and many others, in her online publication, the Sarawak Report, which raised the heat for 1MDB and Malaysian officials. (See Lone brave journalist exposes 1MDB corruption: An interview with Clare Rewcastle Brown, by Sarah Hofmann, CFE, Fraud Magazine, and 1MDB: The inside story of the world’s biggest financial scandal, by Randeep Ramesh, The Guardian, July 28, 2016.) Brown published 199 articles in 2016 alone in the Sarawak Report and brought her findings to major global newspapers.

After the two board members resigned, 1MDB quickly replaced them, but no one else resigned, which could reflect that the revised board had no known objections to executive decisions. Over time, 1MDB executives engaged in riskier and more elaborate financial schemes. (See 1MDB loans to PetroSaudi put nearly RM6 billion at risk, by P Gunasegaram, March 28, 2013, Kinibiz Online.) A contributing factor to such boldness to engage in these schemes arises from the failure of the board of directors to question executive decisions. The board had shirked its duties, and hence failed in both its roles as the handler over the executives (perpetrator) and as super controller.

The board of advisors

As a company wholly owned by the Ministry of Finance, 1MDB had a board of advisors that was supposed to be an added internal corporate governance mechanism. This board would’ve been the super controller over the 1MDB executives and its board of directors. It could’ve minimized the potential for executive fraud, but it shirked its duties and failed in its oversight role.

The chair of the board of advisors was the then finance minister, Najib Razak, who at that time was also the prime minister. Article 117(c) of 1MDB’s memorandum and articles of association requires the “written approval of the Prime Minister for any financial commitment (including investment), restructuring or any other matter which is likely to affect the guarantee given by the Federal Government for the benefit of the company, the national interest, national security, or any policy of the government.” (See 1MDB’s memorandum and articles of association suggests PM Najib a key decision maker -Rafizi, by Cynthia Blemin, The Edge Markets, May 27, 2015.)

In his three roles — prime minister, finance minister and chair of 1MDB’s board of advisors — Najib should’ve had knowledge of 1MDB’s dealings. Concurrently holding three important positions raises the issues of conflicts of interest that are similar to a chief executive officer who concurrently is the chair of the board of directors. (See 10 reasons why Najib is accountable on 1MDB, by P Gunasegaram, Malaysiakini, April 11, 2016.)

The other Malaysian members of the board of advisors included a former second finance minister, a former chief secretary to the government, a chief secretary to the Najib government and the-then secretary general to the Ministry of Finance, Mohd Irwan Serigar. The remaining four board members were foreigners. The two Middle Easterners on this board would later partner with 1MDB in the billion-dollar Bandar Malaysia development. (See The colourful family and friends of 1MDB, by Khairie Hisyam, Kinibiz, Dec. 15, 2015.)

The effectiveness of the 1MDB board of advisors in curbing executive fraud is questionable because the board of advisors had never met. According to Irwan Serigar Mohamad, the Treasury secretary-general, the 1MDB board of directors didn’t seek advice from the board of advisors. (See 1MDB advisory board never met, Treasury chief reveals, by Zikri Kamarulzman, Malaysiakini, April 8, 2016.) Also, another member of this board resigned after 1MDB ignored his repeated requests over six months for details on 1MDB’s state of affairs . (See Ex-1MDB advisory board member says he quit after requests for details ignored, by Nabihah Hamid, the Malaysian Insider, Sept. 7, 2015.)

In the context of the Crime Triangle, the board of advisors was ineffective in its role to curb executive fraud because it couldn’t discharge its duties. At the same time, the question arises as to whether the board of advisors, especially its chair, could’ve proactively enforced the requirement for 1MDB board of directors and executives to furnish details of its state of affairs.

External super controllers: regulators and law enforcement agencies

In contrast to the failure of 1MDB’s internal super controllers to prevent executive fraud, its external super controllers — i.e. Malaysian regulators and law enforcement agencies — didn’t shirk their duties but carried out their roles despite obstacles. Their collective efforts in raising red flags played a critical role in exposing the 1MDB fraud.

In February 2015, the parliamentary Public Accounts Committee requested that the then Auditor General Ambrin Buang audit 1MDB. In July 2015, the then Attorney General Gani Patail set up a special taskforce that included the Malaysian Anti-Corruption Commission, Bank Negara Malaysia (the central bank), the Attorney General’s Chambers and the police. (See AG sets up task force to probe 1MDB, says top cop, The Malaysian Insider/The Edge Financial Daily, March 10, 2015.)

By the end of July 2015, Attorney General Gani Patail was replaced, and the Cabinet was reshuffled. (See Gani Patail replaced as attorney-general shocker, Malaysiakini, July 27, 2015, and Cabinet reshuffled, AG replaced, PAC probe into 1MDB postponed, by Hamzah Hamid, Astro Awani, July 28, 2015.)

The reshuffle included the replacement of Deputy Prime Minister Muhiyiddin Yassin, who questioned 1MDB publicly, and the appointment of four members of the Public Accounts Committee to Cabinet positions. (See Muhiyiddin dropped, Zahid named as DPM, Malaysiakini, July 27, 2015.)

Soon after, the newly appointed Attorney General Apandi Ali advised that the special taskforce was no longer needed and disbanded it. He also condemned the U.S. Department of Justice’s action against 1MDB as politically motivated. (See 1MDB task force no longer needed, says MACC, Malaysiakini, Aug. 5, 2015, and DoJ action over 1MDB politically motivated – Apandi, by Bernama, Astro Awani, June 27, 2017.)

The Malaysian Anti-Corruption Commission continued its investigations into 1MDB despite the disbandment of the special taskforce. Its then deputy chief commissioner Mohd Shukri had to flee to the U.S. after receiving threats for his investigation into 1MDB. (See MACC chief trailed after fleeing to U.S. for safety, The Sun Daily, May 23, 2018.)

In April 2016, the central bank, with consent from then Attorney General Apandi Ali, fined 1MDB 15 million ringgit for failing to fully comply with the Financial Services Act 2013. This included the failure to fulfill the requirement for 1MDB to repatriate monies remitted abroad following the revocation of three permissions granted by the central bank to 1MDB between 2009 and 2011. Further, 1MDB failed to submit required evidence and documentation to justify its failure to fully comply with the repatriation order. [See Bank Negara reveals 1MDB was fined RM15m, by Bernama, Aug. 17, 2018, and Statement on 1Malaysia Development Berhad (1MDB).]

Lessons on governance

The primary lessons on governance from the 1MDB case relate to its board of directors and board of advisors. First, the chair of the board of advisors was a politically exposed person (PEP) who at that time held both the finance minister and prime minister portfolios. A PEP represents a greater risk of involvement in bribery and corruption. The new Malaysian government addressed this risk by restricting the prime minister from holding other ministerial posts, especially the finance minister. (See How UK Bribery Act affects you, Corruption Watch, Aug. 13, 2012, and After criticism, Dr M gives up education portfolio, Free Malaysia Today, May 18, 2018.)

Second, the resignation of individual members of both boards at different times were red flags, especially when these board members had raised concerns over 1MDB’s dealings. Comparatively, the revised boards didn’t seem to respond to the riskier and more elaborate schemes the executives engaged in over time. When board members shirk their duties to exercise oversight over executives, executive fraud will be easier to perpetrate, cover and hide. Then the question arises as to whether board members, individually or collectively, benefited from executive decisions that were fraudulent in nature.

Finally, external super controllers ensured that 1MDB adhered to relevant laws and regulations and penalized 1MDB when it failed to do so.

Epilogue

In the historic Malaysian general elections on May 9, 2018, Malaysians voted out the 61-year-old Barisan Nasional (National Front) government in favor of the Pakatan Harapan (Coalition of Hope) led by former Prime Minister Mahathir Mohamad. Within days, current Auditor General Madinah Mohamad declassified the 1MDB audit report. (See Malaysia’s opposition pulls off shocking election win by Al Jazeera, May 10, 2018, and 1MDB audit report now declassified, says Auditor-General, by The Edge Markets, May 15, 2018.)

Former Auditor General Ambrin Buang retired in February 2017, and the new government appointed him chair of the Special Committee on Procurement, Governance and Finance and appointed former deputy MACC chief commissioner Mohd Shukri to lead the anti-graft agency. (See “Ambrin Buang: Malaysia to begin investigations into defence ministry projects, by Samantha Ho, The Edge Markets, July 16, 2018, and Former MACC deputy Shukri Abdull will be new anti-graft chief, by Chester Tay, The Edge Markets, May 17, 2018.)

The 1MDB lead investigator from the central bank has come out of retirement to become the new central bank Governor. The newly formed Public Accounts Committee has begun investigations on 1MDB. (See Nor Shamsiah promises to maintain monetary and financial stability as BNM Governor, by Chester Tay, The Edge Markets, June 22, 2018, and Former AG Ambrin to be first witness in PAC’s 1MDB probe, by Tarrance Tan and Memananthani Sivanandam, The Star Online, Nov. 12, 2018.)

Najib is facing multiple charges for money laundering, criminal breach of trust and abuse of power. He has pleaded not guilty. (See Former Malaysian PM charged with money laundering, abuse of power, by Rozanna Latiff and Liz Lee, Reuters, Sept. 19, 2018, and Najib claims trial to CBT, abuse of power, by Ho Kit Yen, Free Malaysia Today, July 4, 2018.)

Mohd Irwan Serigar, former secretary general to the Ministry of Finance and former member of the 1MDB board of advisors, has been charged for criminal breach of trust. He was jointly charged with Najib, and both pleaded not guilty. (See Najib, Mohd Irwan charged with misuse of govt funds, by Rahimi Yunus, The Malaysian Reserve, Oct. 26, 2018, and Prosecution to call 70 witnesses in Najib, Mohd Irwan’s trial, by Bernama, Malaysian Reserve, Jan. 8.)

Attorney General Apandi Ali, who was appointed by the Najib government, was put on leave and his contract terminated. (See Senior lawyer: Government can terminate contract of A-G, The Star Online, May 14, 2018.)

Arul Kanda, 1MDB’s former CEO and executive director, was charged with abetting Najib in the alleged tampering of 1MDB’s audit report. He has pleaded not guilty. (See The colourful family and friends of 1MDB, by Khairie Hisyam, Kinibiz, Dec. 15, 2015, and Arul Kanda claims trial over 1MDB audit report, at by Ho Kit Yen and V Anbalagan, Free Malaysia Today, Dec. 12, 2018.)

On Jan. 29, the Malaysian government launched a comprehensive five-year National Anti-Corruption Plan that aims to “rid Malaysia of corruption.” Important changes include the establishment of a separate parliamentary-select committee to oversee the Malaysian Anti-Corruption Commission and placing the National Audit Department under Parliament. Previously the prime minister had the constitutional power to appoint the auditor general.

Another important initiative is stopping political appointments to boards of government-linked companies and preventing political interference in the appointment or removal of the chair and board members of these companies. (See Dr Mahathir: National Anti-Corruption Plan a warning, guide for all, New Straits Times, Jan. 29; Hoping to be rid of ‘kleptocracy’ label with NACP, by The Star, Jan. 30; and Minimum penalty for graft, anti-lobbying law among highlights of National Anti-Corruption Plan, by Free Malaysia Today, Jan. 29.)

The Malaysian National Anti-corruption Plan aims “to uphold the rule of law, to improve the government’s efficiency, transparency and accountability based on good governance. It is aimed at creating a clean business environment for Malaysia.” At the launching ceremony of this plan, Prime Minister Mahathir Mohamad said, “This plan was developed to achieve the aspiration of Malaysia to be known for its integrity and not corruption.” (See PM wants Malaysia to be known for integrity, not corruption, by Bernama, Jan. 29.)

Investigations and court cases relating to 1MDB continue in several countries as we learn more from the “world’s largest kleptocracy” case.

Grace Y. Mui, Ph.D., CPA (Australia), CPA (ASEAN), ACFE Educator Associate, is principal research consultant and co-founder for Thye & Associates in Selangor, Malaysia. Contact her at gymui@yahoo.com.

Huat Lai Thye, CPA (ASEAN), is co-founder and principal consultant for Thye & Associates in Selangor, Malaysia. Contact him at thye_hl@yahoo.com.