Abraaj Group Scandal and Collapse: Corporate Risk Management Homework

Corporate fraud has increased over the years as dishonest company managers deceive investors and financial authorities about the actual performance of their organizations. In many of the organizations where corporate fraud took place, employee tips played a significant role in detecting the sharp practice. Although internal audits are effective, the individuals involved in the scandalous business practices manage to bribe their way out of any detection that can be realized through the audit process. In the Abraaj Group Scandal, it was discovered that the firm had mismanaged its $1 billion healthcare fund following years of deceiving investors about its actual performance and profitable status.

The once profitable private equity firm in the emerging markets was fined $315 for deceiving investors and embezzling their funds in a well-orchestrated plan to cover the losses by raising funds. It all started in 2018 when some of its limited partners including the Gates Foundation expressed their concerns over the firm’s mismanagement of funds, compelling them to appoint an auditor to oversee the investigation. Abraaj’s Chief Financial Officer (CFO) and the CEO resigned from the private equity firm in light of the new findings. Later in the same year, the firm registered a new debt of $1.1 billion, which was distributed evenly to unsecured creditors and secured creditors (Clark, 2019). In 2019, Sev Vettivetpillai was arrested before the Dubai Financial Services Authority fined Abraaj $315 million for its deceitful business practices. Founded by Arif Naviq in 2002, the firm was liquidated in 2019, following his arrest and that of other senior executives to raise its debt capital.

A Summary of the Key Causes that led to the Abraaj Scandal

Before its liquidation in 2019, Abraaj ventured in different investment portfolios that included private equity, private credit, real estate, and impact investing. However, before exploring the different factors that contributed to the scandal, there are three pertinent questions that should be asked to understand the fall of the once successful Abraaj Group. Firstly, concerns have been expressed on why it took so long for legal action to be taken against the key proponents that embezzled investor funds through deceitful business practices. Secondly, when employee tips emerged in 2018 and received by different stakeholders including audit consultants, why was the governance of the firm not changed to reflect the company’s interest in securing the investor funds? Lastly, it is surprising that whether the once profitable Abraaj Group that managed $14 billion in investor capital was a fraud since its inception (Clark, 2019). These questions and concerns expressed by market experts form an important part of this research because of their ability to cast light on the scandalous nature of the Abraaj Group.

In 2017, some of the affiliate partners linked to Abraaj Group received anonymous tips about the deceitful business operations that were ongoing at the private equity firm. The claims revolved around the company’s decision to inflate its investment value to attract unsuspecting investors hoping to raise the embezzled funds. While the content of the anonymous email had numerous grammatical errors to avoid revealing the identity of the sender, various stakeholders engaged the private equity firm to confirm the allegations. In response, Abraaj Group convinced Hamilton Lane, one of the investors, who in turn invested $100 million towards Fund VI (The Economist, 2019). Surprisingly, the response to the anonymous tip shared via email from investors saw the fund double its investment after a series of consistent efforts aimed at assuring investors about the potential returns. Before Abraaj’s collapse, Fund VI had accumulated $3 billion, which was half of its target investment from its different clients. Abraaj’s founder had a unique personality that differentiated him from other investment managers in the equity market. His general outlook was convincing and easily attracted high-yield investors to partake in his wide portfolio of investment products.

Risk Assessment

It should be noted that Abraaj’s fiscal mismanagement was largely attributed to its books and revenues that consisted of high management and performance charges, which were more than the bloated cost of operation. Instead of declaring the losses to investors, the firm borrowed to seal the gap and retain its healthy financial outlook, which acted as bait to lure more investors to its different investment products. Between July 2017 and March 2018, Abraaj’s operating costs were capped at $41 million, a fact that was discovered during the liquidation process (Kerr, 2018). In 2016, the firm’s management had anticipated a solution that would solve its financial problem by selling its assets in Pakistan, which totaled $1.8 billion. The lack of transparency between the firm and its investors created a loophole that hindered individuals from making informed decisions regarding their financial investment. According to America’s Securities and Exchange Commission (SEC), the Abraaj Group transferred more than $230 million from its health fund to the firm’s bank account (Arabian Business Industries, 2019). The firm’s founder, Navqi lied to his investors about the inability of different investments to yield profits and attributed the adverse outcomes to the unpredictable market scenarios.

Nonetheless, the Bill and Melinda Gates foundation and World Bank engaged external investigators to explore the operational performance of the firm in 2017. Later in February 2018, the Abraaj Group responded to the news break about its financial health and scheduled for a temporary liquidation in the Cayman Islands where it was incorporated (Kekem, 2019). While Naavqi maintained his innocence throughout the investigations, the revelations compelled investors to push for a liquidation to recover their initial investment from the embezzled funds. Despite the company’s efforts to return the funds it owed to its different investors, Abraaj has a deficit of more than $1.2 billion it owes creditors. $300 million out of the more than $1.2 billion owed to creditors was attributed to wrongful business transactions, an outcome that explains the limited feasibility recorded in one of the most profitable equity firms in the emerging markets (Derhally, 2019). While many firms have stopped investing in Africa and the Middle East market, a lot can be learned from the dubious management styles adopted by the Abraaj Group.

      Impact
      0

Acceptable

1

Tolerable

2

Unacceptable

3

Intolerable

      Little or No Effect Effects are Felt but Not Critical Serious Impact to Course of Action and Outcome Could Result in Disasters
Likelihood

 

Improbable Risk Unlikely to Occur        
Possible Risk Will Likely Occur        
Probable Risk Will Occur        

 

Fig 1.0 A risk analysis matrix

0 – Acceptable – little to no effect on the business
1 – Tolerable – effects are felt but do not seriously effect the business
2 – Unacceptable – causes major disruption to the business
3 – Intolerable – business may not recover

From this analysis, Abraaj’s overall performance had reached an intolerable status that led to its collapse due to lack of investor confidence in its different investment products.

Risk Response

Following the emergence of anonymous reports from employees and other stakeholders, Abraaj’s top management should have stepped in to mitigate the looming crisis and develop a perfect solution that resolved the underlying issues. When developing a risk response strategy, organizations focus on identifying ways the risk can be avoided, mitigation plans, and acceptance (Keshk, Maarouf, & Annany, 2018). Likewise, corporations explore various approaches that can be used to transfer the risk to third-parties such as insurance companies to overcome the impact of the unexpected outcomes on investor confidence.

Fig 2.0 A risk response strategy.

An Evaluation of Abraaj’s Response to its Risk Exposure

Given the inability of the private equity firm to avoid the risk, it filed for provisional liquidation at the Cayman Islands where it was incorporated. While accepting the risk does not necessarily implicate a company’s ignorance or inability to avoid a risk, company managers should develop viable solutions that address various issues affecting their operational performance. In this case, the Abraaj Group failed to develop a solid mitigation plan, which would have facilitated its avoidance of risk by transferring the risk to a third party institution such as an insurance company (Reuters Staff, 2019). The lacking transparency and honesty between the company’s top executives and investors expose the equity firm to a series of risks that reduced its options and ability to secure the investment fund.

It is widely believed that the collapse of the Abraaj Group was triggered by its governance weaknesses. Leadership plays a critical role in guiding organizations towards a trajectory where they can accomplish their desired goals and responsibilities. Instead of registering the incurred losses and sharing the information with investors, the Abraaj Group borrowed even more, exposing the private equity firm to a financial hole that led to its collapse. Importantly, the lack of investor confidence in Abraaj’s ability to manage investor funds contributed largely to its exit from the profitable equity market (Martin, 2019). Surprisingly, many of the investments made by Abraaj Group in North and Sub-Saharan Africa remain profitable after the liquidation process. Following increased scrutiny from the SEC, the nature of interactions between limited partners and investment managers has become of concern in the competitive private equity market. Currently, limited partners are now advocating for increased independence in the process of asset valuation to incorporate their views in the day-to-day operations in the private equity firms.

Alternatively, corporations can incorporate different risk response mechanisms to overcome challenges that stem from the growing mismanagement at the executive level. Notably, company managers can introduce accountability strategies that influence the general perspectives held by employees towards the company approaches. Importantly, increasing the incentives that can be accessed by employees creates a perfect opportunity to focus on the deliverables and disassociate from any incidents that can trigger unwanted outcomes. In the same vein, organizations should use the accountability measures to instill a high level of discipline that encourages backing up of information to avoid any misreporting. Hiring external consultants creates an enabling environment to detect potential risks that can affect the company’s public image and outlook in the contemporary business environment. Therefore, maintaining honest and transparent interaction with stakeholders creates an important context that eliminates any mistrust that reduces investor confidence.

The adoption of early warning systems allows firms to create mechanisms that identify potential risks and convey the information to different stakeholders. In the private equity market, firms should hire employees who are capable of scanning the different risks and developing viable recommendations that can be used to improve the outcomes. Given that many of the risks that led to the collapse of the Abraaj Group were related to its weak governance systems, firms should appoint qualified personnel who can become part of the company’s advisory to ensure that effective decisions are made in regards to the changing business environment.

Conclusion

Although internal audits are effective, the individuals involved in the scandalous business practices manage to bribe their way out of any detection that can be realized through the audit process. In the Abraaj Group Scandal, it was discovered that the firm had mismanaged its $1 billion healthcare fund following years of deceiving investors about its actual performance and profitable status. Importantly, risk governance requires organizations to constantly review risk identification strategies, mitigation, and reporting and monitoring to overcome any trust issues resulting from the deteriorating investor confidence. Weak governance structures at the Abraaj Group contributed largely to its inability to maintain investor confidence and respond to the changing needs of individuals in their immediate environment.

When it was apparent that the Abraaj Group was no longer profitable, the firm’s leadership sought a provisional liquidation from the Cayman Islands where it was incorporated. However, the growing mistrust between the firm and its investors led to its dissolution because of the dishonest and non-transparent interactions between the organization and its stakeholders. The desire to operate a non-performing private equity firm behind the shadow of a profitable entity compelled the top executives to embrace unorthodox business practices such as lying to investors about the actual performance of the firm. Likewise, the organization operated under a backdrop of dishonest and deceit, which influenced the collapse of the once profitable private equity firm in the global emerging markets.

 

 

References

Arabian Business Industries. (2019, August 18). Abraaj collapse: What’s been learned, who’s charged? Arabian Business Industries, Retrieved from https://www.arabianbusiness.com/banking-finance/425558-abraaj-collapse-whats-been-learned-whos-charged

Clark, S. (2019, July 30). Private-Equity Firm Abraaj Is Fined a Record $315 Million in Dubai. The Wall Street Journal, Retrieved from https://www.wsj.com/articles/private-equity-firm-abraaj-fined-a-record-315-million-in-dubai-11564476002

Clark, S. (2019, June 13). Abraaj Founder Arif Naqvi Accused of Misappropriating More Than $250 Million in New Indictment. The Wall Street Journal, Retrieved from https://www.wsj.com/articles/abraaj-founder-arif-naqvi-accused-of-misappropriating-more-than-250-million-in-new-indictment-11560458572

Derhally, M. (2019, June 19). Abraaj executives fleeced firm in deception founder said was like playing poker. The National News. Retrieved from https://www.thenationalnews.com/business/abraaj-executives-fleeced-firm-in-deception-founder-said-was-like-playing-poker-1.876273

Kekem, S. (2019, July 16). Fall of Abraaj jolts African private equity. African Business, Retrieved from https://african.business/2019/07/economy/fall-of-abraaj-jolts-african-private-equity/

Kerr, S. (2018, September 18). Private equity: inside the fall of Abraaj. Financial Times, Retrieved from https://www.ft.com/content/31ab6f82-a79a-11e8-926a-7342fe5e173f

Keshk, A. M., Maarouf, I., & Annany, Y. (2018). Special studies in management of construction project risks, risk concept, plan building, risk quantitative and qualitative analysis, risk response strategies. Alexandria engineering journal57(4), 3179-3187.

Martin, M. (2019, July 31). Collapsed Abraaj Fined Record $315 Million by Dubai Watchdog. Bloomberg, Retrieved from https://www.bloombergquint.com/business/dubai-regulator-fines-collapsed-buyout-firm-abraaj-315-million

Reuters Staff. (2019, June 11). Dubai issues new financial centre insolvency law after Abraaj collapse. Reuters. Retrieved from https://www.reuters.com/article/us-emirates-dubai-bankruptcy-idUSKCN1TC1QU

The Economist. (2019, May 18). The biggest collapse in private-equity history will have a lasting impact. The Economist, Retrieved from https://www.economist.com/finance-and-economics/2019/05/18/the-biggest-collapse-in-private-equity-history-will-have-a-lasting-impact

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