The Case of Goldman Sachs and 1MDBJanuary 28th, 2016 by Kara in Case Studies
By: Audrey Zhang
In August 2005, anti-corruption officials began investigating 1Malaysia Development Berhad (1MDB) for alleged graft, triggered by reports that almost US$700 million from the lucrative deals issued for 1MDB by Goldman Sachs ended up in the pockets of Malaysia’s Prime Minister, Najib Razak. SPI investigates the alleged corruption claims and the ethical implications of Goldman’s involvement.
Goldman Sachs and 1MDB: The Players
Goldman Sachs Group, Inc. – A leading global investment banking, securities, and investment management firm, founded in 1869. Ranked #88 on the World’s Most Valuable Brands list by Forbes, the firm provides a wide range of financial services—including strategic advisory assignments, risk management, and investment and lending—to a diverse client base such as corporations, financial institutions, governments, and high-net-worth individuals. The firm maintains offices in all major financial centers around the globe, with its headquarters on Wall Street, and is considered one of the most prominent financial giants of today.
1Malaysia Development Berhad (1MDB) – a strategic development company, wholly owned by the Malaysian government, established to drive strategic initiatives for long-term economic development of the country. It focuses on strategic development projects in the areas of energy, real estate, tourism, and agribusiness. Through forging global partnerships and promoting foreign direct investment, 1MDB seeks to “lead market-driven initiatives to assist the Government in propelling Malaysia towards becoming a developed nation that is highly competitive, sustainable and inclusive”.
Najib Razak – the sixth and current Prime Minister of Malaysia, and President of the United Malays National Organization (the leading party in Malaysia’s ruling Barisan Nasional coalition). He was elected on a platform of economic liberalization measures, including cuts to government subsidies, loosening of restrictions on foreign investments, and reductions in preferential measures for ethnic Malays in business. In 2009, Prime Minister Razak announced the expansion of the Terengganu Investment Authority (TIA) – a sovereign wealth fund aimed at ensuring economic development for the state of Terengganu – into a federal entity called 1Malaysia Development Berhad.
Goldman Sachs advised 1MDB on multiple ventures, including the purchases of energy assets Tanjong Energy, Genting Sanyen Power and Jimah Energy Ventures at dubiously high prices. The scandal, however, revolves around three bond sales that Goldman arranged between 2012 and 2013, totaling US $6.5 billion. This section gives a brief explanation of bonds, and the role of investment banks in the transaction.
A bond is a debt security, which allows a government, municipality, corporation, federal agency, or other types of issuers to borrow large amounts of money usually more than a single average bank can provide. These bonds are issued to a public market, where thousands of investors can lend the borrower a portion of the capital needed, while collecting a rate of interest during the life of the bond. The maturity date is the date on which the issuer (borrower) needs to repay the amount borrowed to the lender (the investor). Bonds are known as fixed-income securities, because an investor knows the exact amount of interest collected if she holds the security until maturity.
An investment bank serves as an intermediary between the organization issuing the bonds and the investors who wish to purchase them. The bank is an underwriter for the bonds – assuming the risk of buying the newly-issued bonds from the corporation or government unit, then reselling the bond to the public or to dealers who then sell them to the public. The investment bank generally prepares required documents for Securities and Exchange Commission (SEC) filing, helps set a price for the issue, and takes the lead in forming an underwriting group which spreads the risk of the new issue to a larger number of participating investment bankers. This arrangement improves the likelihood of selling all of the newly issued bonds. The investment bank earns a profit, based on the difference between its purchase price and the selling price. The difference is called the underwriting spread. The bank also has the option of not underwriting the new issue, and instead simply acts as a sales agent, marketing the bonds to investors and only purchasing enough bonds to meet the buyer demand. In this case, the bank receives a commission on the bonds sold. Goldman’s played the former role in the 1MDB bond deals.
Goldman’s involvement with 1MDB began when the company was still a state-level sovereign wealth fund called the TIA. Goldman Sachs and Boston Consulting Group advised the TIA in its early days, helping it raise 5 billion ringgit (US$1.3 billion) through selling 30-year Islamic bonds in 2009. Guaranteed by the federal government, the bonds were sold at a discounted price that effectively yielded bondholders a high of 7 percent in interest, an especially bad deal for a government-owned company. As the former Prime Minister Mahathir Mohamad asks, “Who approved such terrible terms for a loan to a government-owned company?”
Two months after this deal, the Najib administration took over the TIA and renamed it 1Malaysia Development Berhad, expanding the strategic development company into a federal entity. Najib stood in front of global investors, promising a “1Malaysia”, where Malaysians of different races would work together to turn Malaysia into a developed nation by 2020. Najib surely aimed high, riding on the optimism of Malaysians at the time, yet from the get-go, the dealings of 1MDB were shrouded in mystery.
Just two months after the expansion, 1MDB established dealings with PetroSaudi International with the help of a well-connected Jho Low—the son of a wealthy Malaysian businessman, cobbling together a $2.5 billion joint venture. Under the guidance of Roger Ng, Goldman’s head of Southeast Asia sales and fixed-income trading, and Tim Leissner, then Goldman’s co-president for Southeast Asia based in Singapore, 1MDB also forged especially close ties with Goldman.
In December 2009, Goldman won a license from Malaysia’s Securities Commission to set up fund management and corporate finance advisory operations in the country. It announced plans to open an office in Kuala Lumpur during the first half of 2010. Leissner released a statement that “The future outlook for Malaysia’s capital markets and its asset management industry is very positive and through our local presence we look forward to playing a larger role in their development.”
With Goldman as advisor, 1MDB acquired Tanjong Energy Holdings from Malaysian billionaire T. Ananda Krishnan for US$2.2 billion in March, 2012. Former Prime Minister Mahathir would later criticize this purchase: “The prices paid for [Tanjong Energy were] well above market price.” Since the power plant was nearing expiration of its license, the price of purchase would have been next to nothing if 1MDB had waited until the licenses expired.
Two months later, Goldman acted as underwriter for the sale of 10-year bond notes with a 5.99 percent yield, from which 1MDB raised US$1.75 billion. This was the first of three bond deals that would spark the corruption scandal.
In August of that same year, 1MDB purchased Genting’s domestic power-generation assets for 2.4 billion ringgit under Goldman’s advice—a steep price for a power company. 1MDB defended the price it paid for the company, stating the price was based on “advice received from independent valuation advisers”. If by “advisers” the spokesman meant Goldman, it was far from “independent”, as Goldman would benefit financially if the transaction was completed. Genting later reported a 1.9 billion ringgit gain on this sale, implying the value for its stake was less than one-fifth what 1MDB paid for it. A few months after the sale, a unit of Genting called Genting Plantations Bhd. donated about US$10 million to a Najib aligned charity, which soon got involved in spending that appeared to help Mr. Najib retain power in the May 2013 election. The charity, along with others linked to the government, was revealed to having spent millions before the voting in the swing state of Penang, including donating two million ringgit to local schools serving communities that are not demographically poor.
In October 2012, 1MDB raised US$1.75 billion by selling 10-year bonds yielding 5.75 percent. Five months later, it raised another US$3 billion by selling 10-year bonds yielding 4.4 percent. Goldman Sachs underwrites both transactions. Overall, the three bond issues between 2012 and 2013 raised a total of US$6.5 billion, with Goldman earning an impressive 9.1 percent of the profits raised (US$590 million), almost 4 times the typical rate for a quasi-sovereign bond at the time. Partly earned from the underwriting spread—buying bonds at a discount and then selling them at a higher price—this total is almost as much as Malaysia pays each month on its debt.
Then, in 2014, 1MDB reported financial results for the fiscal year, reporting that debt surged 16 percent, to a total of US$11 billion. Since then, Najib and the Malaysian government have been caught in a whirlwind of allegations, while disasters (the disappearance of Malaysia Airlines Flight 370 and the crash of Malaysia Airlines Flight 17) plagued the government.
Around the same time, the Sarawak Report began a series of exposés of 1MDB, claiming to have obtained documentation showing how Jho Low and several business associates siphoned US$700 million from 1MDB’s partnership with PetroSaudi Holdings, which was registered in the Cayman Islands.
In February 2015, 1MDB reportedly missed two repayment deadlines for debt owed to a group of domestic lenders, after getting at least one extension. The lenders, led by Malayan Banking Bhd. and RBH Capital Bhd., had earlier demanded 1MDB to repay the loan before the end of February or risk going into default. The loan was finally settled in advance of the due date, although it wasn’t clear whether billionaire Ananda Krishnan, who had guaranteed the loan, put up the funds. Mr. Krishnan had guaranteed the 2012 loan as part of the agreement to sell Tanjong Energy Holdings to 1MDB. The tension only gets worse from there. In March 2015, 1MDB got US$250 million in standby credit from the Ministry of Finance. In May, the Abu Dhabi-based International Petroleum Investment and its Aabar Investments unit agree to provide US$1 billion to 1MDB so it can pay off US$957 million of a Deutsche Bank-led syndicate loan. As public pressure grew, the Malaysian auditor general, the parliament’s public accounts committee, the central bank, and the police have all focused investigations on 1MDB, digging into reports of corruption and misconduct.
On July 3rd 2015, documents from government probes reported that investigators believe almost US$700 million in cash moved through various state agencies, banks, and companies linked to 1MDB, before eventually ending up in Najib’s personal accounts. In August 2015, anti-corruption officials began investigating this state investment company for alleged graft. Najib claims he never took these funds for personal use, and threatened to sue the paper. Although reports have not been finalized, these documents shed some light into the non-transparent dealings of 1MDB, alarming citizens in a country with a long history of struggles against “corruption and economic disappointment”. The current full-scale inquiry by agencies ranging from the Public Accounts Committee to the Anti-Corruption Commission would surely unearth much more of the rotten dealings made by 1MDB. The Federal Bureau of Investigation and the US Justice Department have also launched separate investigations to examine Goldman’s role in the series of 1MBD transactions.
Goldman acted as underwriter for three 1MDB bond deals:
May 2012: The sale of 10-year bond notes with a 5.99 percent yield, from which 1MDB raised US$1.75 billion.
October 2012: The sale of 10-year bonds yielding 5.75 percent raising a total of US$1.75 billion for 1MDB.
March 2013: The sale of 10 year-bonds yielding 4.4 percent raising another US$3 billion for 1MDB.
Overall, the three bond issues between 2012 and 2013 raised a total of US$6.5 billion, with Goldman earning an impressive 9.1 percent of the profits raised (US$590 million), almost 4 times the typical rate for a quasi-sovereign bonds at the time.
According to an SCMP report, the commission represents a huge commission for fixed-income underwriting. For the March 2013 US$3 billion bond issue, Goldman earned fees of nearly US$300 million, equivalent to a 10 percent service charge. The average fee for underwriters in 2015 was 1.32 per cent on US high-yield junk bonds rated below sovereign issues. These startlingly high commissions and service fees for underwriting the bond issues raise eyebrows and one can reasonably suspect Goldman of unethical treatment of its client, 1MDB for the following reasons:
- Goldman egregiously overcharged the client. If this is true then Goldman sorely lacked the virtue of honesty in dealing with its client. Goldman also failed in carrying out its fiduciary duty of putting the client’s interest first. Even though Goldman says it presented the client with various options on how to sell the bonds, the bank should have pushed the less expensive and equally efficacious method with greater conviction
- Goldman also failed in its fiduciary duty of putting the client’s interest first when it allowed the client to sell the bonds at above market prices. The first and second bond issues yielded 5.99 and 5.75 percent respectively. These were nearly 400 basis points above Treasuries and about 250 basis points more than the rate on Malaysia’s sovereign Islamic dollar debt due July 2021. Quasi-sovereign bonds due in seven to 10 years yielded 2.3 percent on average.
- The bank failed in assessing its conduct and reputational risk correctly. One should wonder what Goldman’s role was in creating this mess, especially taking into consideration the curious nature of the bond deals. Why would 1MDB be willing to pay an unusually high commission to Goldman, and why did Goldman agree to raise such a large amount of money for a quasi-sovereign entity? Furthermore, with the highly enticing yield of the bonds (the cheapest bond was about 100 basis points higher than other A-minus-rated bonds at the time), 1MDB could have easily sold its notes directly to institutional investors through a global offering rather than use Goldman as an underwriter. The fact that a government-linked company was so eager to engage in inexplicably expensive fundraising through Goldman should have raised alarms within the bank’s own transaction approval process.
Advising on the Purchase of Assets
Goldman acted as investment banking advisor to 1MDB for the following purchases:
March 2012: Acquisition of Tanjong Energy Holdings from Malaysian billionaire T. Ananda Krishnan for US$2.2 billion. The power plant was nearing expiration of its license and the purchase price would have declined substantially if 1MDB had waited until the license expired.
August 2012: Purchase of Genting’s domestic power-generation assets for 2.4 billion ringgit, a steep price for a power company.
Analysts agree 1MDB overpaid for these two power generating companies. The question then is whether Goldman was incompetent or corrupt when it advised its client on the value of these companies. If the latter, then Goldman once again lacked the virtue of honesty when it allowed its client to pay much more than those companies were worth. If the former, then its reputation as a top investment bank staffed with high intellects is questionable.
General Ethical Considerations
The outcry over the state of 1MDB’s finances has reached a level that the Prime Minister’s position may be at stake. Although there is no evidence that Goldman had any idea of the corruption that permeated 1MDB, or the US$700 million that ended up in Najib’s private accounts, someone in Goldman’s risk or compliance unit should have looked into the dubious deal. Or perhaps questions were raised at the time, but the economic rewards were high and difficult to forego especially for ethical reasons. Goldman apparently chose (enormous) fees over reputational or conduct risks.
To add further suspicion, Prime Minister Najib’s wife, Rosmah, has a close friendship with Leissner’s wife, Kimora Lee Simmons. Simmons, the US model/actress and ex-wife of Russell Simmons, has various photographs on her website of her and Leissner and the Prime Minister’s family. Her friendship with Rosmah, who has been criticized for controversial habits such as spending US$400 on a home visit by a personal stylist, makes reasonable minds wonder whether Leissner, and therefore Goldman, was in on the scheme from the beginning. Again, reputational risk was not assessed correctly.
Ultimately, it comes down to ethical obligations of financial institutions. Should they simply be profit-generating entities that pay attention to ethics only when convenient? Or should they adopt and implement serious conduct rules to avoid implications in morally wrong actions that affect other people?
In the 1MDB case, the Malaysian public could have been saved from years of government corruption had Goldman taken ethical considerations into the decision. Banks have fiduciary responsibilities towards their clients, and should prevent debt accumulation when those clients cannot financially afford heavy debt service payments. Goldman should incorporate a system for weighing reputational risks alongside purely financial ones, revising its regulations instated by the bank’s Business Standards Committee in 2010 to avoid future implications in scandals like this one.
Although Goldman suffered somewhat from the scandal, finding it difficult to land new clients in Malaysia, it still remains a respectable institution, ranking #23 on Fortune Magazine’s “The World’s Most Admired Companies”.
Baer, Justin and M. Lamar, “U.S. Examines Goldman Sachs Role in 1MDB Transactions.” Wall Street Journal. Accessed January 19, 2016. http://www.wsj.com/articles/goldman-entangled-in-malaysia-fund-scandal-1444795262
“Bond Basics: What Are Bonds?” Investopedia. Accessed September 20, 2015. http://www.investopedia.com/university/bonds/bonds1.asp.
Bowring, Philip. “Goldman’s Role in the 1MDB Controversy.” Asia Sentinel. Accessed September 24, 2015. http://www.asiasentinel.com/econ-business/goldman-role-1mdb-controversy/.
Chew, Elffie, and Yoolim Lee. “The Scandal That Ate Malaysia.” Bloomberg.com. Accessed September 20, 2015. http://www.bloomberg.com/news/articles/2015-07-21/malaysia-s-najib-razak-feels-heat-as-state-owned-1mdb-melts-down.
“Goldman Sachs and 1MDB.” Free Malaysia Today. Accessed September 20, 2015. http://www.freemalaysiatoday.com/category/nation/2015/07/22/goldman-sachs-and-1mdb/.
“Goldman Sachs Group Inc.” Accessed September 19, 2015. http://topics.nytimes.com/top/news/business/companies/goldman_sachs_group_inc/index.html.
“Goldman Sachs Group on the Forbes World’s Most Valuable Brands List.” Forbes. Accessed September 19, 2015. http://www.forbes.com/companies/goldman-sachs-group/.
“Goldman Sachs Group – World’s Most Admired Companies – Fortune.” Accessed September 24, 2015. http://fortune.com/worlds-most-admired-companies/goldman-sachs-group-23/.
Guy, Peter. “Goldman Tested the Limits of Banking Morality with Huge Fees from 1MDB.” South China Morning Post. Accessed September 23, 2015. http://www.scmp.com/business/banking-finance/article/1855746/goldman-tested-limits-banking-morality-huge-fees-1mdb.
Ng, Jason, and P. R. Venkat. “1MDB Settles $550 Million Loan From Malaysian Lenders.” Wall Street Journal, February 13, 2015, sec. Markets. http://www.wsj.com/articles/1mdb-settles-550-million-loan-from-malaysian-lenders-1423828609.
Russell, Edward. “Goldman Sachs Receives Malaysia Licenses.” FinanceAsia. Accessed September 20, 2015. http://www.financeasia.com/News/162398,goldman-sachs-receives-malaysia-licenses.aspx.
“Why Is 1MDB so Stupid, Asks Dr M – The Malaysian Insider,” 12 2015. http://www.themalaysianinsider.com/malaysia/article/why-is-1mdb-so-stupid-asks-dr-m.
Wright, Tom. “1MDB Defends Price Paid in Genting Deal.” Wall Street Journal, June 24, 2015, sec. Markets. http://www.wsj.com/articles/1mdb-defends-price-paid-in-genting-deal-1435147466.
———. “Web of Entities Spent Ahead of Malaysia’s Tight Election.” Wall Street Journal, June 19, 2015, sec. World. http://www.wsj.com/articles/web-of-entities-spent-ahead-of-malaysias-tight-election-1434689755.
Xie, Elffie Chew Ye. “Goldman Said to Earn $500 Million Arranging Malaysia Bond.” Bloomberg.com. Accessed September 20, 2015. http://www.bloomberg.com/news/articles/2013-05-08/goldman-said-to-earn-500-million-arranging-malaysia-bond.
 “Goldman Sachs Group Inc.”
 “Goldman Sachs Group on the Forbes World’s Most Valuable Brands List.”
 “About Us What We Do”
 “Goldman Sachs and 1MDB.”
 “Bond Basics.”
 Chew and Lee, “The Scandal That Ate Malaysia.”
 Russell, “Goldman Sachs Receives Malaysia Licenses.”
 “Why Is 1MDB so Stupid, Asks Dr M – The Malaysian Insider.”
 Wright, “1MDB Defends Price Paid in Genting Deal.”
 Wright, “Web of Entities Spent Ahead of Malaysia’s Tight Election.”
 Haer, “U.S. Examines Goldman Sachs Role in 1MDB Transactions.”
 Xie, “Goldman Said to Earn $500 Million Arranging Malaysia Bond.”
 Chew and Lee, “The Scandal That Ate Malaysia.”
 Ng and Venkat, “1MDB Settles $550 Million Loan From Malaysian Lenders.”
 Chew and Lee, “The Scandal That Ate Malaysia.”
 Guy, “Goldman Tested the Limits of Banking Morality with Huge Fees from 1MDB.”
 “Goldman Sachs and 1MDB.”
 Guy, “Goldman Tested the Limits of Banking Morality with Huge Fees from 1MDB.”
 Jasin, “Mass Protests Sweep Malaysian Capital As Anger At Goldman-Backed Slush Fund Boils Over | Zero Hedge.”
 “Goldman Sachs Group – World’s Most Admired Companies – Fortune.”