When Investing East Goes South

    The Cautionary Tale or Impact Investors

    Investing in sustainability projects across the world is in an exciting proposition to many, potentially being both profitable and ethical – though it is not without its pitfalls. The sector is ripe for scams and abuses of trust by thoroughly unethical confidence artists. After speaking to victims of such a scam, we looked for other instances of fraud or scandals in the impact world, seeking the lessons that can be shared.

    With the explosion of interest in investing more sustainably worldwide, an exciting and practically entirely new industry has sprung up in the past decade, both on the investment side and on the supply side. Entrepreneurs, investment firms and service providers, both new and established, now offer a wide range of products, projects and technologies that benefit the environment, society and investors.

    The rapid development of this investment area has taken place in fits and starts in a process of trial and error gradually incorporating the practical, technical and legal dimensions required for it to stabilise and self-correct. Meanwhile, it has also attracted fraud, scams, and rip-offs from enterprising confidence tricksters eager to exploit emerging normative trends, investor enthusiasm, and lack of relative know-how in the face of new, untested opportunities.

    Emerging markets, for instance, where there is often much poverty, weak legal systems, and the need for infrastructure offer well-meaning investors looking to make a positive difference by investing in sustainability. These markets can also provide fertile ground for perpetrators of scams to peddle services or projects based on their superior knowledge of an area or region, or to set up shell enterprises under seemingly plausible auspices that can consequently be hard to trace, investigate and bring to justice.

    Mainstream investment vehicles, such as unit-linked funds, which only claim to be sustainable without clearly demonstrating their sincerity, have also become branded as ‘greenwashing’ by investors that are increasingly aware of the practice. The term ‘impact washing’ applies to funds that over-use the term ‘impact’ to describe the positive externalities of their investments. But beyond the realm of organised (and often regulated) investment schemes, impact opportunities can also lure investments in a more direct and also less transparent form.

    Outline of a Swindle

    In a recent case, a group of investors fell victim to the machinations of one, particularly unscrupulous individual. NordSIP spoke to some of the victims to understand what happened and how their experience can help others not to fall prey to the same type of scheme. The victims and the alleged scammer will remain anonymous due to an ongoing process of litigation, and all the names in this section have been disguised to protect their identity.

    The investors, Ben, Steve and Caroline* were largely educated individuals working for large corporations, and far from financially illiterate. They invested, in stages, in a project in Indonesia due to a desire to invest sustainably – helped along by the persuasiveness and charm of their interlocutor, the self-described project manager, Christopher Heart*. With initial financial modelling for that project promising high returns, the investors decided to sink in more, increasing their exposure to over US$1 million. A similar amount was invested in a second project in Indonesia. Companies were set up to service each project under the auspices of Heart’s holding company in Singapore.

    Ben, Steve and Caroline started raising questions when they noticed that Heart kept on pursuing new projects simultaneously when plans for the initial projects that they had invested in still awaited implementation. Giving him the benefit of the doubt, the victims initially surmised that Heart was simply overreaching. However, subsequent behaviour would suggest a lack of seriousness from the outset, and likely the deliberate intent to mislead outright. In the meantime, updates provided to investors were positive and there were always tales of exponential growth, given the need for “green infrastructure” and environmental services.

    Meanwhile, and hitherto unbeknownst to the investor trio, Heart had been successfully prosecuted in the spring of 2019 in Singapore over a different project which took place in Myanmar and took in a few hundred thousand US dollars. The deception in Myanmar was on a smaller financial scale than the Indonesian projects, but was even more heinous, as it was promoted to help Karen refugees displaced by the civil war they have been fighting with the Burmese military since for the last half decades. In 2017, the project manager had approached a highly respected leader of the ethnic Karen people, offering to develop a community for the Karen in his area in Burma. The Karen leader agreed, seeing it as an opportunity to improve the lot of his long-suffering people, many of whom have been languishing for decades in refugee camps in Thailand. Heart raised US$ 300,000 from investors by the end of 2017 using the Karen leader’s good name to promote the project, which doubled as sustainable and was intended to create jobs. The investors all assumed they were contributing to a worthwhile humanitarian project.

    Unfortunately, the results never materialized, and Heart became unavailable. A number of the investors sued and the court in Singapore sided in their favour. The Karen leader was especially angry over the deception and issued an official warning stating that the defendant had “cheated the Karen people and we see him as a professional liar” who was “worse than the Burmese military regime,” vowing to arrest the defendant if he ever sets foot on Karen soil.

    Eventually, Heart also distanced himself from the Indonesian projects, both of them barely started. He physically absconded the jurisdiction of Singapore where his holding company was, with all the money from the investors gone. Ben, Steve and Caroline along with a few other victims are still attempting to make sense of everything that happened, with some in legal pursuit, and some not. In this case, legal challenges are particularly arduous, expensive, and difficult, given the extent and breadth of the fraud across numerous jurisdictions.

    As we learn of this tragic tale of a real desire to invest in a good cause being met with deceit, we decided to find out how to help others not to fall prey to similar ill-intentioned scammers. Two other famous impact scandals can also provide perspective, making for good cautionary tales.

    Arif Naqvi & the Abraaj Group

    Founded in 2002 by Pakistani businessman Arif Naqvi, the Abraaj Group specialised in emerging market private equity investments and positioned itself as a pioneer of impact investing. Over more than a decade, the company grew to include offices in 25 countries across 6 continents, which the company claimed, accumulated assets under management of over US$13 billion. One of Abraaj’s funds, the now infamous Growth Markets Health Fund counted US$1 billion in assets, including investments from the Bill and Melinda Gates Foundation and the World Bank.

    In this case, the intention to commit fraud might not have been the original motivation of Abraaj’s founder. But cash flow issues arose over time and, like in the instance of Baring’s rogue trader Nick Leeson, small short-term temporary “fixes” ballooned out of control, eventually taking the firm down. In the Abraaj case, the costs of the structure had become so large that the fees from the funds alone were not enough to make ends meet at the operational level. The firm, therefore, ‘borrowed’ from the fund, which in turn borrowed to fund investments, ultimately accumulating up to US$1.1 billion in debts that couldn’t be repaid.

    In late 2017, a group of investors, including the Bill and Melinda Gates Foundation, eventually hired consultants to investigate the fund managers on suspicion of mismanagement. Soon thereafter the funding hole was identified, and the entire fraud unravelled. In April 2019, Founder Arif Naqvi was arrested in London and subsequently released on a bail of £15 million to remain in house arrest. He was also condemned (in absentia) to three years in prison by the United Arab Emirates for financial fraud. The management of the healthcare fund was taken over by US-based private equity giant TPG.

    Bill McGlashan & Operation Varsity Blues

    Somewhat ironically, this other infamous impact fiasco took place within the ranks of TPG, the hailed saviour of the Abraaj healthcare fund. In this case, the damage was merely reputational and less costly to investors. Bill McGlashan was previously a managing partner at TPG Growth who had helped the famous U2 singer, Bono, together with eBay billionaire Jeff Skoll, launch The Rise Fund, a $2 billion portfolio of investments committed to creating “social and environmental impact” that leads to “meaningful, measurable, and positive change.”

    After a sequence of personal decisions led by exceptionally poor judgement, he was subsequently arrested and charged with conspiracy to commit mail fraud. McGlashan was one of the people involved in the 2019 college admissions bribery scandal known in the US as Operation Varsity Blues. It transpired that McGlashan had paid a ‘fixer’ $50,000 to falsify his son’s ACT scores and that he allegedly discussed a bribe of $250,000 to gain admission for his son at University of Southern California (USC) through a “side door”. The day after his arrest, he was replaced at TPG and James Coulter, co-founder of the firm, took over the management of the Rise Fund. While investors were offered the opportunity to redeem their investments, Bono decided to stick with it.

    This case clearly shows that even famous investors are not shielded from mistaking sincerity for hypocrisy, but the Raise victims didn’t suffer a meaningful financial loss in this particular investment. The reputational risk by association to certain scandals remains and, especially for large public pensions that are under the scrutiny of national press, to trust an individual’s good heart is far from enough to make a sound investment decision, especially in the impact space.

    The Classic Mechanisms of Impact Scams – Exploiting FOMO

    As in the alleged Indonesian scheme, some or most of the money ends up in the pockets of less scrupulous individuals (directly or indirectly) in impact scams. The use of kickbacks is a classic approach: the company buys a service but overpays for it, and the manager then gets a kick-back on the side from the service provider. These arrangements are very difficult to uncover and to prove. But the manager can use much simpler tricks to steal money from the company – especially if they are the company’s sole executive director. Some tactics are similar to the ones used by the Christopher Heart. “These are the last two bonds and they won’t be around for long!” or “This opportunity won’t last – it’s now or never!” The fear of missing out (FOMO) is a human bias at work in every market in the world since time immemorial. Scarcity and time pressure are unavoidable, and scammers know that well. The blending of the principles of impact investing, the call for “doing well by doing good”, makes these tactics perhaps even more difficult to detect and easier to fall for.

    The investors may more readily believe in the honesty of a protagonist when the announced intentions of the project seem so beneficial for society. The reason most people were stunned when McGlashan was arrested was the contrast between his words and what he had done. “Businesses go extinct if they don’t get on the side of authentic good,” he declared in Davos in 2019 as cited by Vanity Fair. “We need to hold ourselves humbly accountable” and deliver on the promise of impact investing: that business can “solve these otherwise intractable problems that we are facing.”

    In some cases, what starts as a promising venture can turn sour when the ambitions of the founders take precedence over their fiduciary duty to their investors. The largest scandal in the impact world to date is certainly the story of the Abraaj Group, which, like the Rise Fund, involved prominent but also highly skilled investors, such as the Bill & Melinda Gates Foundation and the World Bank’s IFC.

    Seeking the Help of Experts

    For any individual or institutional investor considering the impact space, the first questions shouldn’t be whether to invest in a particular project, but why and how to invest to achieve the desired impact. Putting together an impact strategy is crucial in order to obtain the right results over time. Ensuring investors priorities and investment opportunities are aligned is not always evident, particularly for newcomers. One solution might be to seek inspiration from the framework of existing investors such as the Impact Investing Due Diligence Guide offered by the J.W. McConnell Family Foundation.

    Once they have defined their goals, many foundations or family offices choose to rely on the expertise that comes with investing through impact funds or other such facilities. While these products may not be readily available to retail investors, it may be worth considering approaching impact specialists when investing larger sums.

    Sadly, fraudsters sometimes also hide behind fund investments. Therefore, relying on so-called experts is not a guarantee in itself, as in the Abraaj case. However, the rules and regulations surrounding the products that can be marketed and sold to individual investors and even institutions are increasingly stringent, protecting them from falling prey to outright fraudsters. It is therefore recommended to stay away from exotic or informal investment structures, even if they might seem less costly or more flexible.

    Beware the Impact Discount

    To come across an amazing investment in a region or sector that we have no particular expertise in should, unfortunately, always be taken with a pinch of salt. Too often, when financial gains for relatively small investments seem attractive it is likely that they are either misrepresented (purposely or not) or that the risks are grossly underestimated (or hidden). This is especially true when the projects incorporate a large element of social benefits.

    Why such a cynical view? The reality is that there are many experts scouting the world for the perfect impact investment. Foundation, impact funds and of course, many of the Western economies’ Development Financial Institutions (DFIs) have the mission to do exactly that, at varying degrees of profitability, and in various sizes. In fact, seasoned impact investors confess that in parts of the world, such as sub-Saharan Africa, for example, the sub-market returns that are acceptable to DFIs and large charitable foundations make it difficult to find investments priced competitively compared to those in developed markets, for the same risk.

    If an investment opportunity sounds too good to be true, it probably is. Understanding why the program hasn’t already been funded without you will be crucial from the onset. The first test before even considering an investment of the sort will be to obtain a satisfactory answer to the following question: “Why is this investment promising such a high return, when it’s doing so much good for other people?” And most importantly, “Why am I the only lucky person with the privilege to invest in such an amazing opportunity?” Or to use impact lingo, “What is my additionality to this project?”

    Recognizing the Challenge of Due-Diligence

    Provided the investment passes the first smell-test, a thorough due diligence process is always a necessary step before investing. The work involved isn’t for the faint-hearted, however. It requires time, resources and expertise that often come at a lofty price. In its Guide for Impact Investment Fund Managers, the Global Impact Investment Network (GIIN) provides a list of 16 distinct areas that due diligence needs to cover. In addition to the areas included in any private equity investment, such as the legal due diligence and the financial management strategy or the governance structure and the integrity and background checks, the accent on the environmental and social due diligence is obviously even more crucial in the impact space.

    Irene Mastelli, a consultant with a long-term experience of evaluating managers, especially in the impact space is familiar with the challenge of due diligence. “The greatest challenge is to do one due diligence – the financial, responsible investment and impact perspectives are inextricable,” she explains. “The responsible investment aspect can be considered a mere sanity check for traditional investments. ‘Does the investment reach a minimum bar?’ was the usual question. Embedding the responsible investment question into the investment due diligence process brings enormous value, but it’s exceptionally tricky. It requires a deeper knowledge that goes beyond traditional business evaluation where the main focus is financial profitability and solvency. Impact investing involves a multitude of stakeholders and the process is paved with trade-offs. Most actors that come from the non-profit sector or advocacy outfits recognise that positive impact almost always comes at some cost.”

    In practice, whether in or out of the impact space, almost no level of checks is sufficient if the manager or founder has bad intentions and is fundamentally dishonest. The best scam artists have a prodigious capacity to tell outrageous lies without a second thought. They can be convincing, putting together a seamless, coherent series of lies that add up to a web in which investors get caught until it is too late, and can easily trick unsuspecting partners who only know them superficially. In addition, they will often associate themselves with businessmen, politicians, or other successful or famous people, and with successful projects or companies so as to obscure their own lack of legitimacy, leveraging the reputation of others to appear more successful than they are.

    A verifiable track record should also help limit the risk of outright fraud, though this too can be subject to manipulation or cherry-picking. Especially for smaller projects relying mostly on one or a few individuals, integrity and background checks should be a top priority. References from past projects are a crucial element and any lack thereof should be considered a red flag. Swindlers are usually serial swindlers. Any holes or prolonged sabbaticals on a resumé may be indications that track-records for these periods have been tainted. Too many justifications and accusations of other parties should also raise concerns.

    Covenants, Independent Oversight & Legal Terms

    One way to help de-risk a venture is to introduce milestones and covenants, as well as independent oversight to enforce them. Again, the use of expert advice could be a great asset when designing such clauses in an investment contract. Covenants represent clauses that protect investors while a project is ongoing. There can be conditions set for portions of the investments to be released at different stages and transparency requirements that can make it more difficult for a project manager to deceive investors. A high number of constraints to accessing the money will likely deter an unscrupulous entrepreneur who has the wrong intentions at the onset. However, skilled scammers may get away with those as well through artful dissimulations and forgeries.

    Covenants, as well as independent oversight, are especially crucial when investing in remote projects such as in emerging markets. Maintaining oversight on an entrepreneurial project as an external investor is always tricky, let alone when it is happening half-way across the world, where legal frameworks and governance structures can turn out to be a lot looser than expected. For the investors of the Indonesian project, one of the lessons was also to ensure that disputes should be settled in their home country as opposed to the country where the project is undertaken, for example.

    What to do When the Horse has Bolted

    For Ben, Steve and Caroline and the misfortunes of their Indonesian investment, the lack of options offered to them after Heart disappeared with their money was one of the salient points of their cautionary tale. Having decided to invest, even with a careful weighing of the risks, and especially with a new, untested company, it isn’t easy to factor in the consequences, should something suspicious happen or money disappear. Investors like Ben, Steve and Caroline can find themselves unprepared and, as a result, unable to take appropriate action rapidly enough, when confronted with a scam.

    Many individual investors also underestimate the burden of legal fees that need to be paid upfront, with no guarantee of recovery. The legal process is daunting, and many of the victims will ultimately refrain from engaging in legal procedures. Individual investors who have already lost a significant sum of money in the scam will be reluctant or unable to sink more money in legal proceedings when they are not guaranteed that it will bring back their original loss. While the fraudster may eventually get caught, the money may have long been spent. The tendency of victims to just walk away is one of the facts that serial conmen exploit.

    Beyond its cost, those choosing the rocky road proposed by the law should know that the journey from identifying a scam to winning a case in court can be very long. Legal claims on the manager and on the company (debt, equity, guarantees), evidence of wrongdoing, different laws in each jurisdiction, are only a few of the complexities on the way. A limited liability company generally works as a legal shield and shields the shareholders, but also the directors to a large degree, from legal consequences. To prosecute company directors for the money that a company owes, creditors must prove criminal conduct, for which the hurdle is generally higher than for civil cases.

    The Short of it

    ‘There is never trust without loss,’ according to the Basque proverb. ‘Do not trust a person who claims to be honest, and never trust exaggerated friendliness,’ warns a Chinese saying. Investing for good is a noble intention, but investors would be ill-advised to treat impact investments any differently than any other hard-nosed cash opportunity when it comes to assessing its risks.

    It is also the responsibility of the investment community and service providers involved in the promotion of impact opportunities to uphold the utmost level of ethics, authenticity and honesty to ensure that impact will really take off and become mainstream. Remember that fraudsters or unserious project managers need to leverage the reputation of others to remedy their lack of legitimacy. It is therefore of the utmost importance that reputable actors in the impact world remain vigilant to avoid giving credit where none is due. Sometimes, merely admitting the presence of suspicious individuals among the ranks of well-meaning investors is enough to give the impression that they have been vetted.

    *pseudonyms – any resemblance to the names of real persons living or dead is purely coincidental

    Image by Sushuti from Pixabay

    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA is Editor-in-Chief for NordSIP and Managing Director for Big Green Tree Media. She has 18 years of experience in the asset management industry in Stockholm, London and Geneva, including as a long/short equity hedge fund portfolio manager, and buy-side analyst, but also as CFO and COO in several asset management firms. Aline holds an MBA from Harvard Business School and a License in Economic Sciences from the University of Geneva.

    Latest Posts

    NordSIP Insights Handbook

    What else is new?