|18 April, 2019

Multi-regulatory jurisdictions a growing investor risk

Dr. Sabah al-Binali is an active investor and entrepreneurial leader. Dr. Al-Binali is CEO of Universal Strategy, vice-chairman of Abu Dhabi-based The National Investor and chairman of its Investment and Strategy Committee.

Website: http://musings.al-binali.com/

The goal of a regulator is to nurture investor trust in order to attract their business.

Abraaj, the private equity investment management group, was accused last year of alleged fraud via the co-mingling of investment funds. The details of the ongoing accusations reached a new level this month as Arif Naqvi, Abraaj’s founder and CEO, and Mustafa Abdel-Wadood, a former managing partner, were indicted by the U.S Securities and Exchange regulator (SEC) and the U.S. Department of Justice (DoJ). The question of how this could have happened is raising some challenging questions for regulators globally.

Name arbitrage

Financial services firms regularly use multiple jurisdictions to optimise their operations for the benefit of their clients. There is nothing illegal or unethical about this in and of itself. Ethical grey areas are entered, however, when the legal entities formed in each of these jurisdictions share similar names. For example, in the Abraaj issue there are at least four relevant entities: Abraaj Holdings Limited (AHL), Abraaj Capital Limited (ACL), Abraaj Investment Management Limited (AIML) and a group of related legal vehicles that use “Abraaj Growth Markets Health Fund” as part of their name and are usually collectively referred to as the “Abraaj Healthcare Fund” or the “Healthcare Fund”.

This can create confusion for investors trying to understand who is actually regulating the management and the fund that they are investing in. This “name arbitrage” was crystallised in a recent media release by the Dubai Financial Services Authority (DFSA), the regulator for the Dubai International Financial Center (IDFC), in which it made clear that it regulated ACL solely and not AIML, which is the company named in the SEC indictment. The problem with the DFSA’s position is that it is true but is not consistent with the SEC’s view.

The letter of the law and the spirit of the law

The SEC does not fully agree with the DFSA’s position. Point 6 of the SEC’s indictment naming AIML as a defendant in a fraud case acknowledges AIML as an exempt reporting investment advisor with the SEC, but adds that “[AIML] is a UAE-based and Cayman Islands-incorporated exempted, limited liability company, and wholly owned subsidiary of Abraaj Holdings.” It continues in point 9 to describe AH as “a UAE-based, Cayman Islands-incorporated exempted limited liability company”.

The 2017 application by AIML to register with the SEC confirms1 that the books and records of AIML are held by the DFSA-regulated ACL, and that AIML controls or is controlled by ACL, and that they share employees and the same physical location.

It will take the courts to decide the letter of the law with regard to which regulator is responsible for which entity, and who perhaps who should be held accountable for the actions of the Abraaj group companies and funds. However, investors are unlikely to ignore the spirit of the law as they see it as the formal links between AIML and ACL appear to pile up.

Regulatory cooperation

In a statement sent to media this month, the DFSA stated that it “can confirm it is communicating with the SEC, with whom it has a long-standing mutual assistance relationship, and other relevant local and overseas authorities on this matter”.

The problem with this statement is that on April 10, the day that Arif Naqvi was arrested, an article was published in which the DFSA’s lead regulator stated “I think the actions we took were appropriate, but one of our lessons learnt is to better communicate our actions to the market, to address public concerns”.

Such a statement seems at odds with the then impending arrest of Naqvi. In particular, it is not clear how the DFSA can conclude that the actions it took were appropriate with an impending indictment of two of the most senior Abraaj executives by arguably the leading regulator in the world.

Last week’s DFSA media report also states that “[Investors in Abraaj’s Health Care Fund ] are located in New York, and contributions to the Health Fund were transmitted from US bank accounts” and this gives the SEC oversight in this case. However, Abraaj’s SEC filing shows that one of the Health Fund’s two custodians is Commercial Bank of Dubai, based in Dubai, UAE. The DFSA does not make clear if it has determined that no funds related to the Healthcare Fund passed through the Commercial Bank of Dubai, or whether it is liaising with the Central Bank of the UAE to get a clearer picture.

Regulation without enforcement

The DFSA is in a difficult position, as it makes clear in its media report, clarifying that it oversees the conduct of firms in the DIFC and has the power to apply administrative sanctions but does not have a criminal jurisdiction and therefore the power to indict companies and people or to make arrests. For the DFSA to describe itself as overseeing, and not regulating, DIFC-based firms is glaring. The DFSA is hinting that even if it was responsible for Abraaj’s alleged misconduct it would not have had the ability to take criminal action.

Although the DFSA does not have the ability for criminal enforcement, that does not absolve it of its oversight responsibilities, and it is not clear that the case that it makes of not being responsible holds water. The lack of a criminal jurisdiction, however, does make clear that the DFSA, as a young and evolving regulator, needs to be proactive in its growth strategy. The DFSA is clear that it will indeed look for lessons learnt. The question is will it do this in a timeframe that is acceptable to the clients of DIFC firms?

Investor trust

The legal, regulatory and logical arguments will play themselves out. What the DFSA is not addressing is the image it is trying to portray of a world-class regulator. Investors are not moved by the minutiae of legal arguments, they care about the picture that is painted for them. Abraaj has always been presented as a Dubai private equity firm. The World Economic Forum’s annual meeting, commonly called Davos, describes Naqvi as “Founder and Group Chief Executive, the Abraaj Group, United Arab Emirates”. When the most well-known and best-attended financial forum in the world describes Abraaj as a UAE company then it should come as no surprise that this belief is held by investors.

The goal of a regulator is not to regulate. That is simply a means to an end. The goal of a regulator is to nurture investor trust in order to attract their business. The identification of the Abraaj Group with Dubai should have led either to oversight by the DFSA of the whole group or to a more timely and proactive approach to clarify to the investor public the nuances of multiple jurisdictions of an asset management group that employs the same name in its major companies and funds.

If the DFSA is to fulfill its goal of supporting the DIFC in becoming a global financial centre it cannot take a sedate approach, which is an option for more mature markets in which global investors have had decades, if not centuries, of experience. A little more urgency is called for.

Any opinions expressed here are the author’s own.

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