Roughly four years after the collapse of the private equity firm, Abraaj Group, Dubai’s financial regulator has provisionally fined its founder, Arif Naqvi, $135.6m for misleading investors about the use of their funds. Abraaj was once seen as a trailblazer for the industry, providing a path for foreign investors into global emerging markets operating across Africa, Asia, Latin America, Turkey, Central Asia, and the Middle East. Before its collapse, it managed around $14 billion in assets across emerging markets in different funds focusing on different sectors and markets. The collapse of Abraaj––which at its peak was one of the largest emerging markets investors––has sent shockwaves through the region’s financial industry, consequently undermining the Middle East’s regulatory overlook of pooled-investment vehicles.
Dubai Financial Services Authority previously fined two Abraaj group entities almost $315m for deceiving investors, misusing investor money, and carrying out unauthorized activity in Dubai International Financial Centre. Naqvi was central to an attempt to cover up a $400m shortfall across two of Abraaj’s funds by borrowing money for the purpose of producing bank balance statements to mislead investors and auditors. He also arranged a $350m loan from a private individual to make Abraaj appear solvent. The fine, however, as indicated by officials, is unlikely to be paid given the administrators’ inability to raise funds to pay back creditors, who were owed more than $1bn amid Abraaj’s collapse––as Naqvi comingled assets through different funds along with the asset management arm and used limited partners’ funds inappropriately. The shortfall in funds and Naqvi’s cover-up through debt was due to Abraaj’s failed transaction to sell a $1.77bn stake in K-Electric to Shanghai Electric Power. The collapse caused industry executives to be critical of the Dubai authorities for their inertial response during the crisis, claiming that they had failed to protect the financial hub from reputational damage.
After Dubai Financial Services filed claims against both Abraaj Group as a company, and personally against its largest shareholder, Naqvi, the Securities and Exchange Commission (SEC) also filed a claim against Abraaj and Naqvi for defrauding the funds they advised, which had US-based limited partner-investors. This was in violation of the anti-fraud provisions of Section 206 of the Investment Advisers Act of 1940 which prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices in connection with the conduct of an investment advisory business. But perhaps just as consequential for Naqvi is the Dodd-Frank Act, which provides extraterritorial jurisdiction to U.S. federal courts regarding actions or proceedings brought by the Commission or the United States for violation of section 206 of the Investment Advisers Act.
However, despite the extraterritorial reach of the Advisers Act and the U.S. federal courts, both U.S. investors and other investors from the region are not safeguarded. For example, although the SEC filed a claim against Abraaj and Naqvi, enforcement of that claim remains elusive as Naqvi currently resides in the United Kingdom and is fighting an extradition case to the U.S. to stand trial. Thus, extraterritorial jurisdiction and enforcement of judgments serve as a barrier for safeguarding the interests of U.S. based investors.
Therefore, investors seeking to invest in the Middle East or any emerging market through a private investment pool in places such as Dubai will want more holistic and stringent approaches protecting them. The SEC’s extraterritorial reach is not enough for U.S. investors. Dubai and its Financial Services Authority would need rules and disclosure requirements similar to those required by the SEC. This will restore investor confidence in the Authority as a safe-guarder of their interests in the region, especially after having witnessed the world’s biggest private-equity insolvency as per the WSJ, and the Authority’s subsequent inertial response during the collapse of the firm. For example, the Financial Services Authority could look to the SEC’s recent move to require more private companies to routinely disclose information about their finances and operations. Applying such strict rules and enforcement could potentially prevent the “future Abraaj” from committing fraudulent activities with regards to its funds and provide peace of mind to investors.
Access to capital within emerging markets can sometimes be scarce, especially for risky investments such as start-ups, projects that have significant barriers to entry, or investments that develop the economy. An additional layer of risk with loose pooled investment vehicles will consequently affect foreign investment and development and further damage the Dubai Financial Center’s reputation as a safe haven for investors. If Dubai wants to retain its position within the Middle East and emerging markets, it needs to make an effort to have its new regulatory efforts noticed.