1MDB Moved Billions Out of a Sovereign Fund Through Bond Deals
A Malaysian state investment fund raised money in international markets and much of it disappeared. The banks that arranged the transactions earned extraordinary fees.
The Fund
1Malaysia Development Berhad was established as a state investment fund intended to finance development projects. It raised money in international capital markets, principally through bond issuance.
Substantial portions of the money raised were subsequently diverted through a network of accounts and shell entities, and used for purposes including real estate, artwork, and film financing entirely unrelated to development.
The Fees
The element most relevant to finance is how the bonds were sold. Goldman Sachs arranged bond offerings for the fund and earned fees reported at several hundred million dollars.
That is far outside the normal range. Underwriting fees on sovereign or quasi sovereign bond issues are typically a small fraction of a percent. Fees approaching or exceeding several percent on such transactions are extraordinary.
An abnormal fee is information. It usually indicates either unusual risk being absorbed or unusual service being provided, and both merit an explanation.
The Structure That Enabled It
The transactions were structured as private placements underwritten by the bank rather than as conventional syndicated public offerings.
In a public offering, a syndicate of banks distributes bonds to many investors, pricing is transparent, and fees are competitive. In a private placement where one bank purchases the bonds and resells them, there is far less price transparency and the arrangement can be completed quickly and quietly.
Speed and discretion were presented as the justification for the fees. Those same properties reduced the number of parties who might have asked questions.
The Outcome
The matter produced criminal resolution for the bank, including a guilty plea by a subsidiary and payments in the billions of dollars across jurisdictions, alongside individual prosecutions. Malaysia's political landscape was reshaped by the scandal.
Assets purchased with diverted funds were seized in several countries, including property, a yacht, and artwork.
The Control Question
The institutional issue was how transactions of this kind passed internal review. Investigations described compliance concerns being raised and not resulting in the transactions being stopped.
The structural difficulty is familiar. Compliance functions that can be overruled by revenue generating businesses provide documentation rather than protection. Whether a control is genuine depends on whether it can actually prevent a transaction, and on whether the people exercising it are insulated from the revenue consequences of doing so.
The Analytical Signal
For anyone examining a transaction, the transferable point is that fee levels carry information. A fee dramatically above market for an apparently routine transaction indicates something unusual, and the explanation should be specific and verifiable.
The same applies to unusually favourable terms in any context. When a counterparty accepts economics that appear irrational, the rationality is usually somewhere you cannot see.
The Bottom Line
1MDB raised money through structures that minimised scrutiny and paid fees far above market for the privilege. An unexplained fee is a question, and here the answer was in the structure rather than the service.