Wednesday, September 8, 2010

I am the Great Barazi! Dr. Omar.... you are getting sleepy.... very sleepy... I'm now going to snap my fingers and when I do, you will pay me.

So I know I’m kind of a block behind the parade on this but I just got done reading the latest broadside from the good ship DIFIC against the HMS Barazi off the coast of Dubai. It seems like fairly weak soup to me. Most of the DIFCI response is taken up with a lengthy chronology of the various memos that went back and forth between the various members of the DIFCI management team and tries to clear up who knew what when. In my last post I ignored this but now I have paid much closer attention. This is a little more complicated than I would like because the court makes the letter from DIFCI public but not the attached exhibits so it is not possible to follow the evidence trail directly. Having read it now I think my initial instinct to disregard it was correct.

DIFCI goes through the lengthy chronology in order to show that in the first two drafts of the investment bonus memo he makes reference to a net income of $200 million. Between the first and second drafts Bisher was sent the unaudited financials which showed that the net income was a loss of $87 million and the second draft was not amended to reflect that. This is the core of their argument that Barazi misrepresented the financial condition of DIFCI. They go on to claim that Barazi knew all along that the DIFCI was in serious financial shape and provide an email he sent to that effect.

This doesn’t make a lot of sense to me. At no point in any of the memos does Bisher suggest paying out bonuses on net income. Instead he suggests paying out bonuses based on realized gains. Considering the business that DIFCI was in this makes some sense. They were running an investment fund containing investments which were highly illiquid either because they were in private companies or else such massive stakes in public companies that they could not be disposed of. To pay yourself based on the performance of a investments that you may not actually be able to monetize might not be best. So I can see the reasoning behind paying themselves based on realized gains rather than net income.

The net income reference was made for the purpose of comparison with the realized gains and was made before the unaudited financials were available. It is true that the second draft was not amended to take into account the new information in a subsequent draft all reference to net income was dropped. Note that this would not have affected the thrust of the memos because they were being paid on realized gains. The relevance of the loss of $80 million has to be taken in context. This is on a multi-billion dollar investment portfolio and the loss was the result of an accounting change. While I think it had some relevance I think it would make as much sense to pay them zero based on the $80 million as it would to pay them $30 million on the $200 million. In any case they were paid on the realized gains of $60 million, a figure which is not disputed at all by the DIFCI. Also at no point did Bisher seek to conceal the $80 million loss, the DIFCI makes a point of saying he signed off on those numbers. Had he attempted to conceal that and paid himself on the basis of false returns that really would have been fraud but DIFCI does not allege this because it did not occur.

As to the allegation that Barazi knew the DIFCI was in hot water at the time of the bonus the evidence they provide is pretty slim. They show an email pleading for additional funds from mid-November 2008. The final memo on the 2007 bonus issue was in July of that year and the most relevant documents were finished by April. Of course everyone knows what happened in September of 2008, Lehman brothers defaulted and the markets went over a cliff. To say that the financial position of the DIFCI post-Lehman should have influenced the 2007 compensation decisions which were made in March seems to me be kind of a stretch. Something may well have been amiss in the finances of the DIFC in the spring of 2008 but the DIFCI response does not show it.

The DIFCI leads their response by denying that “the claimant can not absolve himself from the liabilities arising out of his conduct with respect to the procurement of the 2007 investment bonus on the basis that Dr. Omar authorized that bonus.” It then quotes the handbook saying that management cannot be indemnified against moral turpitude or other misconduct. In the following paragraph they say that “Barazi was not a passive recipient of the bonus” and point out that he played an active role in determining it. This is the weakest part of the case and also the most central.

It is true that Barazi was not a passive participant. This is because, as the DIFCI points out, there was no established methodology for compensating the managers of DIFCI for their performance. Barazi was asked by Dr. Omar to come up with one. They allege that his methodology constitutes moral turpitude and therefore a fraudulent attempt to compensate himself. As mentioned above the centrepiece of this argument is that a change in net income was not reflected in the memo until its third version. I argue that this is not relevant for two reasons. First the net income played no role in the calculation of the bonus and therefore failing to change the memo to reflect the change in net income until the third version does not constitute moral turpitude as the change would have had no effect on the calculation. Also the $87 million loss was never concealed from anyone including Dr. Omar.

Far and away the most important reason that it doesn’t matter is the point they themselves make that the DIFCI “lacked a clear cut methodology.” What that really means when combined with the fact that compensation was “at the sole discretion of the chairman” is that Dr. Omar did not need to refer to anything but his own fancy in order to compensate himself and Barazi. He could have rocked out of bed one day, walked into the office and said “Bisher, that’s a great haircut. I’m going to pay you $10 million.” Or “That was some fine singing at karaoke last night Bisher, here’s $5 million.” Heck, we should be happy that they made any effort to come up with a plausible methodology at all.

The DIFCI ties itself in a pretzel when it argues that Bisher established a questionable methodology and then further argues that he did not properly follow that methodology which it has already alleged was questionable. The fact of the matter is that because of the way DIFCI and the DIFC were set up there was no requirement for a methodology whatsoever. The mysterious workings of the mind of Dr. Omar were all that were needed to pay them out. As a result the only practical way for Barazi to have fraudulently acquired his bonus would have been for him to put Dr. Omar in a hypnotic trance and fraudulently induce him to write him a check. I wouldn’t put it past Bisher to do that but I think it would be really hard to prove in a DIFC court.

Speaking of Dr. Omar and due process what does the DIFCI say with regard to the unspoken allegation in the previous Barazi response that no legal proceedings were brought against Dr. Omar to compel him to disgorge his bonuses? In paragraph 41 the DIFCI says “the defendant notes that Dr. Omar has returned $13,600,000 in bonuses he received from DIFC.” Interesting, there seems to be no mention of legal proceedings. Presumably this would mean that the proceedings used to get Dr. Omar to disgorge this bonus were extra-legal. There’s another word for that, “extortion.” But I’m sure Barazi is really quite familiar with that term right now. This will indeed be a very interesting case if it goes to trial.

Personally I think the DIFC should drop the suit, pay Barazi him his severance conditional on the completion of the forensic audit. If they have real evidence of actual fraud they should charge him with that, not go back and forth with him over whether or not he is entitled to severance based on whether or not he used a proper methodology when no methodology was required.


Abu 'Arqala said...

There is I think a flaw in the argument for basing bonuses on just realized investments.

If that were the rule, then wouldn't management have an incentive to never sell a bad investment?

Perversely, they would sell NBK and hang on to Damas.

The central problem in the case as you point out is the absence of a clearly stated methodology for bonuses. And of the very minimum of common sense corporate governance.

That raises a very fundamental question.

If the DIFCI could not get those rather elementary points straight, what in God's name were they doing in the investment business at all?

Ken said...

Quite right, it does provide a perverse incentive. I understand it but I don't necessarily agree with it. You have to kind of pick your poison between paying someone on realized gains and incenting them to not take losses or on mark to market P&L which incents them to mark aggressively. There isn't really a good answer. particularly when the investor takes such an arms length approach to governance as the folks who created DIFC apparently did.

In light of the outcome I think it is clear that they should never have been in the investment business.

Anonymous said...

It was abundantly clear even before the crisis that they should not have been in the investment business! Their behaviour in business dealings was deplorable for "investment professionals". And DFSA let them get away with it. As as an investment entity, and not a family or holding company, DIFCI should have been regulated as a Category 2 principal trading entity.

And honestly Ken, sometimes you do think too much like an investment banker, ie, not a normal person. Thinking like a real person, if you make a dud investment, you don't get a bonus. Regardless of what you call "only accounting entries", there is a good reason for revaluation!! Ie, at least ONCE a year you are held accountable for dumb decisions. And like was said before, Bisher knew, the Finance Manager knew - ie, the critical people knew they were in the poo, but hey - let's get some of that liquidity while it remains into our pocket! I'm just SOOOOO sorry that DIFC can't afford a real lawyer at the moment... My legal grad could put a better argument together in half a day.

Anonymous said...

BUMP...anyone home???

Shamcy said...

People, this really is a closed case. If Barazi was sued anywhere in the US, he would have won in a week. How could anyone blame Barazi for what he did? He broke no rules. He did everything by the book, which happened to be a book of blank pages but that wasn't his fault was it?
If Dr O's or Barazi's jobs were offered to any of you, knowing that there was no user manual and knowing that you could captain this ship the way you wanted, I bet no one would have turned it down either. Am I right or am I right ?
Like Ken said, if the audit reveals no irregularities, pay Barazi and move on.
I would love to know the details of Dr O's surrender of the $13 million. That should make for an interesting reading.

Shamcy said...

@Abu If basing bonuses on realized gains was unacceptable then that should have been made clear by the employer. It's not Barazi's fault his employer decided that basing bonuses on realized gains was the wrong thing to do, after the matter. This whole thing smells like an escaping goat.

Anonymous said...

Ken, dude, your blog is getting sleepy, very sleepy. Too busy these days to share the love?

Anonymous said...

so either ken is in the dungeons of the UAE state police or he decided to give up on this blog. where are you ken??

jack Gregory said...

Quick question- I'm wondering if I could get any opinion(s) from you abt. the book "Escape from Dubai"- specifically its factual content, what level of blame the author might actually be responsible for, or if I can take it at face value. I'm searching for other reviews, but you seem like you'd have an informed take on it. If you've read any of it, of course.
I would've emailed this question, but didn't see that option- thanks! My email address is jack1atmedotcom

Anonymous said...

I'm disappointed Ken, you've not commented on the wonderful world of "Out of Court Settlements" which have again benefited Mr BB in September 2011, and so off he rides into the sunset (or Syria, whichever is worse, but should someone say karma?). So sad, to think we could have seen a great example made of poor governance, but the DIFC again is slow and scared. Sigh - we'll have to wait until.... did anyone say Damas.....???

Anonymous said...

Shamsy - you poor deluded soul. BB was the CEO, in charge of creting all such policies, etc. Soooo, let's see, "hmm, let's not bother creating anything which actually commits me to anything, nor my staff (who also received big bonuses, DF??) and let me do what I want". Since when do public servants have ferraris and yachts?

Anonymous said...

Jack - the book is bogus, just a nice fairytale.