It's been quite a while since I last posted anything on my blog as I was swamped with my daily work. Now that I have some time to spare, I decided to write something on the recently published PAC report on 1MDB where the audit fieldwork was performed by the Auditor General Department of Malaysia. The report was 110-page long, cover to cover so I guess that was the longest document I have ever read in recent times.
My observation on that report was it's as if I'm back in college taking the Audit or Ethics paper and if the report were to be an exam question, it would read like this: "Based on the report, please highlight the weaknesses in internal controls and governance of 1MDB and provide suggestions for improvement", and I think it's quite easy to score because the weakness in governance are plenty and very clear. My write-up today aims to summarise the key issues highlighted in the PAC report.
There were a few occasions where 1MDB management had disobeyed the Board of Directors orders in various transactions such as:-
a) The Board of Terengganu Investment Authority (TIA, predecessor of 1MDB) had disagreed with the plan to subscribe to an Islamic Medium Term Note (IMTN) worth RM5 billion and had resolved on 22 May 2009 that any dealings related to the IMTN be halted, including suspending the CEO's authority in the dealings of the IMTN. However, 3 days later TIA's CEO at the time, En. Shahrol Azral (now Dato) had signed the IMTN Subscription Agreement with Ambank. This is clearly a case of disobeying the Board of Directors and a governance issue since Dato Shahrol didn't have any authority to enter to any agreement with regards to the IMTN.
b) The Board of Directors via a resolution signed by the Terengganu Menteri Besar on 27 May 2009 also had dropped Dato Shahrol as a member of TIA's Board of Directors. However, another resolution on the same date was issued to cancel the earlier resolution to drop Dato Shahrol from TIA's Board.
2. Setting up of joint venture between 1MDB and Petrosaudi International Ltd.
Based on the report, it was shown that the decision to set up a joint venture between 1MDB and Petrosaudi International Ltd. was reached even before the Board meeting on 18 September 2009. In addition, the report also revealed that the JV company, 1MDB Petrosaudi (BVI) Ltd. was also registered on 18 September 2009, which is the same day as 1MDB's Board meeting. This is clearly a mockery of governance because 1MDB management had decided to do a JV with another company without seeking prior Board approval.
On 28 September 2009, a JV agreement was signed between 1MDB. 1MDB Petrosaudi (BVI) Ltd. and Petrosaudi Holdings (Cayman) Ltd. Upon the AG's review, it was noted that Petrosaudi Holdings (Cayman) Ltd. was also registered on 18 September 2009. This begs the question of why do a JV with a newly-set up company. Further reading of this report also shows that Petrosaudi has other offshore-registered companies such as Petro Saudi Turkmenistan 1 Ltd. (registered in Jersey) and Petro Saudi Ltd. Inc. (registered in Panama). Why is this company having so many offshore companies? What are they trying to hide actually?
3. Obscene gearing ratio
1MDB was set up with an initial capital of RM1 million and as at 2014, the total debt that it has accumulated is approximately RM 42 billion, which brings the debt to equity ratio to 42,000 TIMES, I repeat 42,000 TIMES. Further review of its financial statements show that the revenue for 2014 is just about RM 4.3 billion or 10% of total debt accumulated. This begs the question on why the need to take such a huge debt from various sources when the revenue to service the debts cannot be matched. Also, the history of debt settlement and repayment shows that the settlement is also made using debt through the usage of Revolving Credit or Term Notes.
While we do acknowledge that the use of debt is for acquisition of power assets and properties, the revenue generated does not commensurate with the amount of debt owing, resulting in more debts that need to be taken to service existing debts.
An auditors' key role in ensuring the true and fair view of financial statements involves asking questions. This is to ensure key information and assumptions are presented accurately and fairly to users of financial statements. During 2010 to 2014, there has been 3 auditors which had audited 1MDB's accounts namely Messrs. EY, KPMG and Deloitte. While changing auditors is not wrong per se, the fact that they changed 3 audit firms in the span of only 4 years shows that there may be big disagreements between 1MDB's Board and the auditors.
Firstly, EY based on their 2010 Audit Plan had requested to review the due diligence report prepared by 1MDB's management to assess the fair value of assets and liabilities of the JV company at date of acquisition. EY had raised their concerns and request during 1MDB's Board meeting on 5 April 2010.
EY had requested further supporting documents to ascertain the value and ownership of assets of the JV company. This is actually a normal process in any audit. Auditors will continue requesting supporting documents and not rely solely on management representation, especially verbal ones. EY's adamant attitude in requesting further supporting documentation had agitated 1MDB's management and led to their dismissal by the Board on 15 September 2010.
Messrs. KPMG was appointed as 1MDB's auditors effective from 15 September 2010, subsequent to EY's dismissal as the company's auditors. During their audit, KPMG had requested the following documents to ascertain the fair value of 1MDB Group's investment in Bridge Global Segregated Portfolio Company (SPC) through Brazen Sky Ltd. (BSL):-
a) Verification of investment ownership of Bridge Global SPC through BSL by BSI Bank SA Geneva;
b) Documents related to legal due diligence to verify that Bridge Global SPC has been legally incorporated, and to ascertain its legal structure for accounting purposes;
c) Legal opinion from lawyers with regards to Bridge Global SPC's structure to ascertain BSL's ownership for accounting purposes;
d) A Net Asset Value (NAV) Report in Bridge Global SPC as at 31 March 2013 and relevant supporting documents to show how NAV was acquired; and
e) Bridge Global SPC's financial statements as at 31 March 2013.
Despite the above request, 1MDB had only given verbal representation regarding the investments. KPMG obviously was not satisfied with this explanation and continued to pursue for documented evidence on the above transaction.
1MDB's Board in its meeting on 9 December 2013 had been informed that KPMG was not satisfied with the management's explanation and proposing a meeting to decide whether the information given to the auditors thus far was sufficient as audit evidence. If the auditors decided that the info was not sufficient, KPMG will issue a qualified report.
The increased rift between 1MDB's management and KPMG had led to the removal of KPMG as the company's auditors through a Board resolution dated 31 December 2013 to remove KPMG from office.
The above findings show that it is indeed peculiar for a company to change audit firms (not audit partners) within such a short period of time. Also, it is indeed mysterious that a significant company like 1MDB cannot keep its accounts straight. In fact, for the 2015 results 1MDB has requested a 6-month extension up till June 2016 to present its 2015 financial statements.
There are so many red flags highlighted in the PAC report, and while I do agree that the ex-CEO, Dato Shahrol Azral should be brought to book for his wrongdoings and gross mismanagement of 1MDB, other key players including members of the Board of Directors and Board of Advisers should also be answerable to the fiasco that has happened. As 1MDB is a company under the Ministry of Finance (MOF), the Finance Minister himself should have answers as to what happened.
Yes, the Minister's signature may not appear in any of the company's Board resolutions. But to be fair, he was the first person to be aware of the proposal for setting up a joint venture through the letter sent by Tarek Obaid, which he then forwarded to 1MDB management for further action.
The report has been tabled. Now it's up to the relevant authorities to take action. Let's see how the next scene of this drama unfold.
And yes, to those of you who are interested to read the full text of the PAC report you may follow the link here: https://drive.google.com/file/d/0B2Xjo976uu8FRWJTdEVaUWR3eHM/view
Cheers and wassalam everyone,
Disclaimer: The above write-up is the personal opinion of the author based on his understanding of the report. For a more clear and detailed picture of the report, please visit the above link provided.