An ongoing investigation into the financial scandal involving NMC, the biggest private provider of healthcare in the United Arab Emirates (UAE) and a previously listed FTSE 100 company, has taken the financial world by storm. The big scale fraud of over USD 6 billion of hidden debts, according to the latest reports, has raised several concerns over the practices that led to this catastrophe. Reviewing governance practices are central to figuring out what went wrong.
The story behind the biggest scandal involving a FTSE 100 listed company
NMC was founded in 1975 by Dr. BR Shetty, an Indian entrepreneur who emigrated to the UAE. Despite its humble beginnings, NMC, headquartered in Abu Dhabi, found its way into the FTSE 100 in 2012. This was considered a great success for Shetty as well as for the emerging market of the UAE.
In December 2019, Muddy Waters, a hedge fund, raised some concerns regarding possible fraud and theft after noticing inconsistencies in the company's accounting. As a result of these concerns, the Financial Conduct Authority (FCA) launched an official investigation on February 27, 2020. NMC's shares were temporarily suspended from trading on FTSE 100, while its CEO Mr. Prasanth Manghat was removed from his position as CEO by the Board.
Initially NMC was forced to admit fraud of USD 2 billion in debt, which was eventually increased to a staggering USD 6.6 billion, according to the latest report released on March 23, 2020. Following the discovery of NMC's debt, one of its biggest creditors, Abu Dhabi Commercial Bank, filed a criminal complaint against the company for approximately USD 1 billion of owed funds. The High Court of England and Wales responded to Abu Dhabi Commercial Bank's complaint by appointing the restructuring firm Alvarez & Marsal as the administrators of all NMC's clinics and services and replaced the entire Board. By the end of April 2020, NMC was permanently delisted from FTSE 100. Moreover, the FCA is also investigating Ernst Young (EY) over the auditing of NMC in 2018 for potential implication in the scandal.
Corporate Governance practices come into question
Boards of Directors are intermediaries between the shareholders and management of a firm. Boards decision-making roles include monitoring and evaluating company's performance, hiring and firing the company's management, and nominating new Board members, just to name a few. Boards of Directors are considered trustees of investors interests and are required to have sense of good business judgement when executing their duties. Therefore, it is very important for companies to have the suitable Board members to protect the shareholders' investments.
NMC's Board Expertise and Skill Matrix (2018)
Note: This figure illustrates the skills and expertise of NMC's Independent Directors (INED) in 2018. All the data used in this figure is available in the CGLytics platform.
Understanding the skills set of NMC's previous Board
The figure above shows the expertise and skills of the Independent Directors (INEDs), who sat on the Board in 2018. Attention is drawn to NMC's INEDs lack of financial expertise. The Audit Committee of 2018 comprised of four members, one of whom left in the early part of March 2018 and only one with financial expertise. Moreover, the latest appointed chairman of the Audit Committee in March 2018 (and up until 2020), did not qualify as an accountant and neither has he worked as a principle in a financial position in the past. Therefore, he did not have the financial expertise to govern the auditing committee1. It is also noteworthy that the member with the financial expertise was also the previous chairman of the Audit Committee and more interestingly a past partner at EY; the Independent Auditor of NMC.
It becomes clear therefore that the Board's lack of financial expertise and the Audit Committee Chairman's lack of financial knowledge must have played an important role in prohibiting the correct functionality of the Board that might have eventually led to the financial catastrophe of NMC.
Note: This table presents data for NMC's Board characteristics, which is collected by CGLytics.
Looking at the characteristics of NMC's Board, it is revealed that NMC's Board size in 2018 and 2019 was equal to 11. For 2018 and 2019, two of the Board members were joint chairs for both years, namely the founder who was considered Non-Executive Chair (dependent) and an Independent Non-Executive Chair, three members were Executive Directors and six were Non-Executive Directors, of whom only one is dependent while the rest are independent.
The average age of NMC's Board is close to 57 for both years. Gender diversity includes three women sitting on the Board in 2018 and two women in 2019. Between 2018-2019, most of the Board of Directors were non-nationals2 with a percentage equal to 73%. The average tenure of the Board is six years which reveals that the Board in both years were not particularly stale. Finally, 55% of NMC's Board (referring to all the members of the Board) were independent across both years. In addition to the dependence ration, the UK corporate governance code states that "at least half the Board, excluding the chair, should be Non-Executive Directors whom the Board considers to be independent", according to which 55% the Board of NMC, excluding the Chairs, is independent. As it appears from the data described, there is no significant indication that these Board characteristics may have led to bad governance.
What could have been the problem then?
Taking a closer look, an important fact comes to surface: NMC is headquartered in Abu Dhabi and was listed on the FTSE 100 index. Therefore, this company should not necessarily be treated as an average FTSE 100 company. Without a doubt we must take into consideration that the UK and the UAE are two entirely different countries; the former a developed economy while the latter is considered an emerging economy, not to mention having different legal systems, corporate governance codes, culture and norms. Looking at the Board characteristics of NMC, with this in mind, a few facts come to light that may have impacted corporate governance monitoring, avoiding this disastrous event.
Over the last decade, the increasing flow of capital around the world has forced many emerging economies to increase corporate governance in order to attract foreign funds. Moreover, many companies changed their board composition by adding more foreign directors in order to attract foreign capital, as foreign directors mitigate the agency problem between domestic and foreign shareholders in favor of the foreign investors.
Nationality of directors during 2018-2019
Note: The data used in this table is collected by CGLytics.
Observing NMC, the data indicates that 66.67% of its INEDs are foreigners, equating to two-thirds of the board. When the core sector of NMC, healthcare, does not typically rely on foreign sales, this generates questions. Is the high percentage of international INEDs merely there to serve the purpose of raising foreign capital? Raising foreign capital may have been achieved but at the same time weakened the Board's governance and monitoring of activities.
International directors sometime lack the local knowledge of regulations and requirements. Furthermore, the greater the distance the foreign directors are from the foreign company, the less monitoring pressure is put on executives, which could allow executives to act irrationally and not in the shareholders' best interests. Despite the fact that the dependency ratio of NMC's Board is 5% above the threshold of the UK governance code, in countries where Corporate Governance is not well established - as in the UAE for example - this may play a significant role in negatively affecting the monitoring of the INEDs. Thus, combining all the above, we can conclude that the Executives together with the dependent members of the Board could have easily dominated the Board's decision-making.
In legal systems that have a weaker legislation, companies' are expected to have more concentrated ownership. The top three institutional investors of NMC are foreign companies with spread ownership stakes. The addition of foreign directors have legitimated the company to the foreign investors, but the institutional investors may have overseen the fact that the company is based and operating in the UAE, an emerging economy with a corporate governance system still under development; in no way on par with the UK Corporate Governance regulations or that of other developed economies. Therefore, the combination of the (physical) distance of the institutional investors and the assumption that the corporate governance system in the UAE is as strong - an additional reassurance created from NMC's listing in FTSE 100 - could have very well affected the external monitoring of the NMC in a negative way.
With the ongoing investigation into NMC, we cannot be certain as to the exact reasons that led to the current state. Nevertheless, we can say that a combination of bad decision-making and other factors relating to corporate governance played a significant role. The lack of financial expertise of the INEDs along with the wrong composition of the Audit Committee, plus the prioritization of attracting foreign capital via the FTSE 100 and including foreign directors, may have resulted in the executives dominating the Board. We can ultimately conclude from the NMC's hidden debt that the Board and their INEDs did not perform their corporate governance and monitoring adequately, proving detrimental to NMC.
Using data and analytics found in the CGLytics software platform, companies, investors, proxy advisors and service providers efficiently analyse and spot governance risks and red flags in seconds.
1. Definition of financial expertise defined by CGlytics can be found here: https://audit.cglytics.com/documents/cg_guideline_expertise_20181123.pdf?ts=1575895304
2. Nationals are considered to be members who are from UAE.
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