Guest blog: Corporate (Mis)Governance in Malaysia (& Japan)

Written by: Dr Vivien Chen (Monash University) & Preeti Sze Hui Lo (USydney law student and CAPLUS intern)
[Introduction by Luke Nottage: A Nikkei article of 3 April 2019 highlights how activist investors are increasingly calling for shakeups of corporate boards across Asia, especially in Japan since 2014, but also China, Singapore, South Korea and Hong Kong. It also reports how the Asian Corporate Governance Association has downgraded Japan from 4th ranking in 2016 to 7th ranking in 2018, and upgraded Malaysia from 7th to 4th. Is that switch justified?
Perhaps Japan is being judged too harshly for the recent Toshiba and Nissan (Carlos Ghosn) scandals, or the 2012 Olympus saga, despite the country introducing new Stewardship and Corporate Governance Codes from 2015. Perhaps too much weighting is given in rankings or assessments for the numbers or proportions of independent non-executive directors on boards. This is despite mixed evidence about whether corporate performance has generally improved or other expected benefits have accrued as independent director requirements have become an increasingly popular reform across other Asian economies, as reviewed in the chapters on Australia and Japan in my 2017 co-edited book.
And what about Malaysia? Even the largest 100 listed companies, based on their formal disclosures, don’t score too well on the ADB-supported ASEAN Corporate Governance Scorecards – although they seem to be improving. Around 40 percent of all listed firms remain government-linked companies (GLCs), in sharp contrast to Japan (as illustrated in Figure 4 of this 2018 OECD report on Asian stock markets), but government ownership can be problematic especially when the same political party (like UMNO until last year) remains in power over extended periods. Some good news from a 2018 book by UMalaya Prof Edmund Gomez et al is that since the Asian Financial Crisis in 1997 there are far fewer appointments of (ex-)UMNO politicians to the boards of GLCs and the various government-linked investment companies or sovereign wealth funds that invest in them and other listed companies. Directors and CEOs are increasingly professionalised. The bad news is that many may still rely directly or indirectly on the Minister of Finance for appointments, and so might be expected (like good butlers!) to anticipate the Minister’s preferences. The risk of conflicted interests grows if the Minister of Finance is also the Prime Minister, as was the case for Dr Mahathir Mohamad after the AFC (1998-2003) and especially Najib Razak (2008/9-2018) until UMNO remarkably lost the general election last year. Part of the reason for that election loss was the collapse of 1MDB (1Malaysia Development Berhad), a sovereign wealth fund established by Najib when he became Prime Minister in 2009.
One guest blog posting below, by this semester’s CAPLUS student intern Preeti Lo, highlights some of the warning signs that all was not well with 1MDB, linking to her PDF timeline of key events in that scandal drawing partly on a book by Wall Street Journal authors (“The Billion Dollar Whale“, 2018). The other posting, by Monash University’s Dr Vivien Chen, outlines her forthcoming article on challenges afflicting corporate governance in Malaysia more broadly and especially when it comes to enforcing directors’ duties. They provide useful context to my ongoing research, supported by the Sydney Southeast Asia Centre, extending to Malaysia (and Thailand and Cambodia) a previous analysis of the proliferation and realities of independent directors in Asia.]

1. The Implications of Political Economy for the Enforcement of Malaysian Corporate Law (Dr Vivien Chen)
1Malaysia Development Berhad (1MDB), the Malaysian state-owned company, has been at the centre of money laundering investigations internationally. The debacle has been criticised by the US Attorney-General as ‘kleptocracy at its worst’ [Reuters, 5 December 2017]. Billions of dollars are claimed to have been misappropriated through questionable transactions, leaving the company struggling to pay its debts. Evidence indicates that the impugned transactions were entered into by 1MDB’s board of directors in breach of their fiduciary duties to act in good faith in the best interest of the company. The magnitude of the scandal raises questions as to how a Malaysian company was able to be used as a vehicle for fraud despite the existence of regulatory safeguards, modelled largely on Anglo-Australian regulations, aimed at protecting the company from misappropriation of corporate property.
My recent article investigates the enforcement of directors’ duties in Malaysia through an empirical investigation of judicial decisions from 2008 to 2015. It draws on the Australian experience to illuminate differences in the manner and extent of enforcement. The study canvasses the private and public enforcement of directors’ duties, and considers alternative mechanisms that serve as substitutes for the enforcement of directors’ duties.
At first glance, Malaysian corporate law and its safeguards against misconduct by directors are comparable to benchmarks of international standards. Nonetheless, the investigation reveals that enforcement of directors’ duties is consistently weaker in Malaysia than in Australia. My research seeks answers as to why Malaysian laws have lacked effectiveness in safeguarding against corporate fraud.
Evidence suggests that the inextricable relation between politics and business in Malaysia underpins the way in which mechanisms for enforcement of corporate law operate. Privatisation and redistribution policies have brought about the synthesis between politics and business in Malaysia and, consequently, the Malaysian corporate environment is dominated by political connections [as shown by Prof Gomez et al in Minister of Finance Incorporated (2018)].
The influence of politics on the governance of Malaysian companies occurs through multiple channels. The first and most direct method of influence is through the state’s ownership of controlling blocks of shares, the second is through state-linked institutional investors, while a third channel of influence is fostered through relationships between controlling shareholders and political patrons. The benefits offered in the form of contracts and licences provide incentives for controlling shareholders to comply with state policy and the preferences of political patrons. These structures together with limitations in the independence of the judiciary and regulators have engendered political influence over the private and public enforcement of directors’ duties.
Political interference in law enforcement processes was evident in the 1MDB debacle. Investigations were obstructed at multiple levels, witnesses were threatened and evidence was suppressed. Following the general elections in May 2018 which brought the Najib administration to an end and ushered in a new government, investigations into the 1MDB saga have begun with a renewed vigour. Nonetheless, systemic issues such as the lack of judicial independence remain, and scandals such as the Bumiputra Malaysia Finance Ltd case in the 1980s indicate that political interference in law enforcement processes is not a recent phenomenon.
The findings of this research have broader implications for the trend towards international convergence in corporate law that has centred primarily on formal law. They highlight the need to consider the significance of corporate ownership structures and political economy for the effectiveness of corporate law modelled on regulations from Western liberal democracies. Various countries in Southeast Asia and Northeast Asia share similarities to Malaysia’s political economy in several ways. These include substantial state or political involvement in business and limitations in the separation of powers and independence of enforcement authorities. The findings of this research demonstrate the superficiality of formal convergence, illustrating the deeper differences in the effectiveness of reforms in practice when law interacts with the context in which it operates.
2. Timeline and Warning Signs for the 1MDB Scandal (by Preeti Sze Hui Lo)
(a) The resignation of 1MDB board’s Chairperson
Tan Sri Mohd Bakke Salleh, a respected businessman who was appointed by former PM Najib resigned twice from his position as the Chairman of 1MDB. Salleh first resigned in April 2009 but was later reappointed. He resigned again due to the PetroSaudi-1MDB deal (‘the first heist’ in this Timeline PDF) because US$700 million provided for the deal by 1MDB’s bond issuance were unaccounted for. Salleh had pressured PetroSaudi to return the money to invest in the joint venture with 1MDB. Salleh also ordered an independent audit of the assets that PetroSaudi was supposed to have funnelled into the joint venture. However, Jho Low (the key young driver behind 1MBD’s establishment) managed to convince Najib (as head of 1MDB’s advisory board) to overrule Salleh’s demands. Salleh became dissatisfied with the new sovereign wealth fund’s management and resigned for the second time.
(a) The firing/ resignation of 1MDB’s former auditors
Three out of the Big Four accounting firms were connected with the 1MDB scandal.
Ernst & Young (EY) was the first auditor that 1MDB hired in 2010. EY was fired within the same year because they refused to sign off on 1MDB’s accounts as they were concerned about the deal between PetroSaudi and 1MDB.
In September 2010, KPMG became EY’s replacement and signed off on 1MDB’s accounts until they were also eventually fired in 2014. KPMG began to voice doubts about 1MDB’s $2.3 billion Cayman Island investments, and would not sign off on 1MDB’s accounts until evidence was provided. This $2.3 billion was shown to be derived from 1MDB’s sale of its interest in a PetroSaudi Subsidiary in 2012 but was in actual fact laundered money that was siphoned by Jho Low and other associates.
Deloitte became 1MDB’s third auditor in 2014 and signed off on their 2013-2014 financial year accounts after Jho Low disguised the source of the $2.3 billion fund investment. Low not only got Aabar (the subsidiary company of the International Petroleum Investment Company in Abu Dhabi) to guarantee the $2.3 billion in funds, but he also conspired with his associate to convince Deloitte of the ‘legitimate existence’ of the $2.3 billion. Low and his associates had 1MDB ‘redeem’ the money that they transferred into the Cayman Islands fund by dispersing the redeemed funds into various offshore accounts until the money eventually was ‘circulated’ back into the Cayman Islands fund. This scheme allowed 1MDB to eventually ‘redeem’ a total amount of $1.5 billion from the non-existent $2.3 billion after laundering the money for five consecutive cycles. Deloitte resigned as auditor in 2016, when international authorities started to investigate 1MDB, Jho Low and former PM Najib for misappropriating funds and other issues.

Author: Luke Nottage

Prof Luke Nottage (BCA, LLB, PhD VUW, LLM LLD Kyoto) is founding co-director of the Australian Network for Japanese Law (ANJeL), Associate Director (Japan) of the Centre for Asian and Pacific Law at the University of Sydney (CAPLUS), and Professor of Comparative and Transnational Business Law at Sydney Law School. He specialises in international dispute resolution, foreign investment law, contract and consumer (product safety) law.