The first part of the US-based Government Accountability Project (GAP) report, published last week in the Sunday Times FT, examined the Lanka Marine Services (LMS) privatization. GAP is a 30 year old non-profit public interest group that promoted government and corporate accountability and is the top whistle blower protection organization in the US.
This section looks into the privatization of Sri Lanka Insurance Corporation (SLIC) following the June 2009 judgment by the Supreme Court which named several high ranking past and present public officials as having been involved in the corrupt transaction. The GAP report gratefully acknowledged the research and contributions to this paper of Consultants 21 Limited, Colombo, Sri Lanka, www.consultants21.com.
Vasudeva Nanayakkara, petitioner in the SLIC case rejoices after the SC verdict |
SLIC
The GAP report states that on June 4th, 2009, the Supreme Court of Sri Lanka reversed the privatization of SLIC after determining that the company’s sale had been improperly concluded six years ago. The Court expressed its opinion strongly, writing that the improper way in which the sale of SLIC took place “shocked the conscience.”
Documents produced for the Court show that the Sri Lankan Finance Ministry transferred a prosperous, tax-paying public enterprise to private hands under pressure from the IMF, the World Bank and the Asian Development Bank (ADB). In fact, the fraudulent transaction was carried out in apparent compliance with guidelines formulated through a US$15 million technical assistance loan from the World Bank.
Moreover, the private enterprises that bought controlling interests in SLIC were holding companies whose beneficial owners were concealed behind the anonymity allowed to Special Purpose Vehicles (SPV’s) incorporated in the tax haven of Gibraltar.
The GAP report states that finally, the monetary value of SLIC was artificially lowered using a bogus evaluation method concocted by compliant auditors from PricewaterhouseCoopers (PwC). Like the scheme used to devalue the worth of LMS prior to privatization, this process also excluded a government asset evaluation specialist, who might have safeguarded the public’s interest by placing more realistic prices on the assets’ value. In short, corrupt officials handed over an under-valued, revenue-producing public enterprise to companies controlled by Harry Jayawardene, who already held substantial interests in Sri Lanka’s most prosperous and profitable companies as well as in Sri Lanka’s largest private commercial bank.
Supreme Court Judgment
The GAP report states that in its judgment, the Supreme Court sets out in detail the duplicity and conspiracy behind the sale of SLIC. High-level Treasury officials, in collaboration with auditors and private interests, formulated a multi-phase scheme to defraud the Sri Lankan public and appropriate a viable and profitable state-owned enterprise for a price that represented only a fraction of its true value.
Tender Board
The first step toward privatization was the establishment of a Steering Committee, which Milinda Moragoda, as the Minister of Economic Reform, Science and Technology, appointed on January 21st, 2002. Moragoda set out the need to privatize SLIC in a memorandum written to the Cabinet on February 28, 2002: ‘The company lacks the management and technical skills to compete effectively in the market. The company needs insurance expertise and upgrading of its technology to increase capacity and efficiency of its operations.’
Subsequent assessments showed this assertion to be patently false. According to its audited records, SLIC as a public enterprise was ‘the market leader in insurance’ in Sri Lanka. The year prior to its privatization, the company had recorded a net profit of approximately US$10 million and had paid US$3.5 million in taxes to the Sri Lankan Treasury.
Despite the fact that SLIC was a profitable functioning enterprise,the Steering Committee set for itself a pressing timetable for privatization, In the course of the Supreme Court hearing it emerged that the pace of privatization was, in fact, unrelated to the financial state of SLIC but had instead been stipulated by the IMF reform agenda, to be completed in 2002. Further, court documents revealed that the rapid sale was a condition of a private sector development loan from the ADB the same year. The pressure was unwarranted as the Court pointed out in its judgment. The sale of SLIC took place at possibly the worst moment in the decade for such a transaction.
Less than one year before, the September 11th attacks on the US had severely depressed the value of insurance corporations around the world by demonstrating that even an apparently impregnable asset like New York’s World Trade Centre was vulnerable to devastation. Under instructions from the Steering Committee, however, N.Pathmanathan, the Deputy Secretary to the Treasury formed a Tender Board to accept bids for SLIC. The Board was named without approval by Cabinet which was illegal, and Pathmanathan was himself named chairman. This was the body that would select the winning bidder.
Undervaluation of the SLIC
The GAP report says that despite the poor timing for the sale of a public insurance company, the Treasury officials behind this transaction took steps to lower the value of SLIC further. They commissioned PwC to assess the value of the company and the auditors based their estimate on the ‘historical book value’ of the land, buildings, plant and equipment: US$2.3 million. A more conventional method of valuation would base calculations on the market value of the assets, however, which was estimated at US$18 million despite depressed circumstances. PwC thus undervalued the physical assets of SLIC by more than US$15 million.
In addition, PwC underestimated forecasts of the after-tax profits of the company for the year 2002 by over 70%, according to the judgment, and the auditors’ estimate failed to include the brand value of SLIC.
Despite what Moragoda had written to the Cabinet in January, SLIC had a positive record of over 40 years standing in Sri Lanka which the buyer identified in his technical proposal as one of the attractions of the share purchase: ‘The products introduced by SLIC are trusted over competitor products in the life business. SLIC, due to its financial strength and prudent management of funds, has gained the most financially stable insurer status in the island.’ As a result of using the book value of physical assets rather than the market value, dramatically lowering the revenue forecasts for the year 2002 and dismissing completely the brand value of SLIC, PwC presented a valuation of SLIC for sale that grossly understated the worth of the company in favor of the buyer.
Selection of the Buyer
Having already manipulated the constitution of the Tender Board, the GAP report states that the selection of the favoured buyer was the final step in the scheme. The Board stipulated that to be eligible, bidders must represent foreign institutional investors because, like many privatizations in developing countries, a major objective of the process was to increase foreign direct investment in Sri Lanka. In keeping with this stipulation, the parties named as the buyers at the moment of sale were Milford Holdings, incorporated in Sri Lanka on March 31, 2003 and Greenfield Pacific EM Holdings, an SPV incorporated in Gibraltar on March 28th, 2003.
The purchasers argued that Greenfield Pacific EM Holdings represented the foreign institutional investors and the TEC accepted their assertion without verification. From an examination of the documents submitted however, the Supreme Court concluded simply: ‘There was no plan or proposal to get a foreign investor to fund the acquisition.’ By concealing the identities of the owners of Greenfield Pacific EM Holdings, local investors obscured the fact that this sale did not represent an increase in foreign investment in Sri Lanka. On the contrary, as the court concluded: ‘The institutional investors are local investors.’
This financial sleight-of-hand occurred because the TEC, operating in collaboration with PwC and ultimately the Tender Board, allowed it. The Supreme Court unequivocally states in fact, ‘The TEC has not made any endeavour to ascertain the identity of the institutional investor referred to in the PwC report and the foreign investor referred to in the Financial Bid.’ Further, the Court wrote:
“The beneficial owner of the money brought into the country by Greenfield Pacific Ltd. is concealed behind a series of corporate veils, thereby making it difficult to ascertain the real beneficial owner of such money.”
Having concluded this dubious procedure in the interests of a purchaser finally identified as a consortium run by Harry Jayawardene and acting in collusion with Ernst & Young, finally, the new controllers of SLIC retrospectively restated the accounts of the enterprise. Auditors transferred approximately US$30 million of current assets to the category of fixed assets and then asserted that the Jayawardene group had overpaid for SLIC. To complete the deal, Ernst & Young subsequently facilitated the demand for a refund of US$20 million from the Treasury of Sri Lanka.
Nullification of the Sale of the SLIC
The court found that ‘The Tender Board acted without jurisdiction and accordingly it had no legal authority to perform any function with regard to the shares of SLIC.’ The contract with Milford Holdings and Greenfield Pacific EM Holdings Ltd. was therefore declared null and void. The contract annulled had been signed by Faiz Mohideen, a Deputy Secretary of the Treasury who had also served as the government counterpart for the World Bank’s ERTA Project.
Role of the World Bank
The illicit sale of SLIC took place behind the backs of a technical assistance team from the World Bank financed by the Bank’s concessional lending arm, the International Development Association (IDA). The ERTA, approved in December 2002, explained its support for privatization in Sri Lanka using the same broad and ambitious terms the Bank, like the Fund, has employed for more than 20 years: “The implementation of the government's economic reforms will in turn expand the role of the private sector in the economy and put the country on the path of higher economic growth and faster poverty reduction.”
The Implementation Completion Report (ICR) for the project written five years later is more modest about the project’s goals but still claims that the Bank’s performance was ‘satisfactory,’ while the borrower’s was ‘moderately unsatisfactory.’ The claim made by the ICR, however, is misleading. In fact, no performance associated with the loan and the activities that evolved from it could be construed as ‘satisfactory.’ At the outset, a core ERTA project component violated the World Bank’s Articles of Agreement (Art. 5, Sec. 6), which read: ‘The Association and its officers shall not interfere in the political affairs of any member; nor shall they be influenced in their decisions by the political character of the member or members concerned.’
In Sri Lanka in 2002, Bank officials knew that privatization was politically unpopular although in all likelihood they did not realize that significant transactions were fraudulent. Rather than eschewing political action as dictated by the Articles of Agreement, however, and examining the policy and its potential for fraud, the Bank designed and tried to implement a mass communications program favourable to privatization and financed by US$1.5 million in project funds: The main issues that are likely to be controversial in this operation include the attempts to privatize previously publicly operated utilities or SOE’s [State-Owned Enterprises – e.g. SLIC]. Controversy can be tempered by effectively using the mass communications component to undertake meetings with groups opposing the reforms, such as the unions, while building popular support by explaining to the public at large what the objectives of the reforms are.
In effect, then, the World Bank charged the Sri Lankan population US$1.5 million to convince itself to support a privatization program that a majority of people strongly opposed for reasons that, in lightof what transpired, were well-founded.
While the ICR does not challenge the legitimacy of the project’s propaganda component, despite the Bank’s statutory prohibition of interference in the political affairs of its member states, the report does recognize the strategy as a costly boondoggle characterized by extraordinary naïveté. According to the ICR, the project contracted foreign English-speaking consultants who could not communicate directly with 90% of the non-English speaking Sri Lankan population.
When the government changed in 2004, the consultants were immediately terminated. In sum, the mass communication strategy was illegitimate, ill-conceived and poorly executed, resulting only in lucrative contracts for a few well-connected consultants and in that context, privatization of SLIC discreetly proceeded until 2009, when it had to be reversed.
After the fact though, the Bank cannot claim that its management was unaware of corruption in PERC and the Finance Ministry. As Chairman of PERC in 2005, Nihal Ameresekere had warned World Bank president Paul Wolfowitz about suspicious dealings in the Ministry. Moreover in December 2006, a special Commission of Public Enterprises (COPE) had filed a report with the Parliament on corruption in the privatization and share sale process that received broad press coverage.
According to the COPE report, not one of the 98 privatizations that occurred after 1994 had benefited the state enterprise transferred to private ownership. Nonetheless in May 2008, just two months before the Supreme Court handed down its decision that the LMS share sale was illegal, the World Bank approved a ‘Public Sector Capacity Building’ Project based on these claims: “Important improvements have been implemented in the ports and petroleum sectors, initial reforms have been made in the Ceylon Electricity Board, and the Sri Lanka Insurance Corporation has been privatized – all of which have met with relative success. These measures will contribute to continued economic growth.”
Among the ‘improvements’ to the ports and petroleum sectors of course, was the privatization of LMS. In this 85-page document, the project appraisal mentions corruption and fraud as relevant considerations one time. Overall, the discussion continues about public sector reform as if nothing were known about its pitfalls. Within 14 months of the release of this document, the Supreme Court decisions reversing the two privatizations referred to here would be handed down.
Investigations and Prosecutions
The GAP report states that until very recently, the government’s actions stopped with the Supreme Court judgments in both post-privatization cases. The Supreme Court confined itself to sanctioning and reversing executive and administrative actions that came under its jurisdiction but it went no further.
The attorneys representing the two complainants in the reversals demanded that the CID investigate and prosecute suspects in terms of the Penal Code and Public Property Act. On June 15th, Presidential Advisor Vasudeva Nanayakkara, one of the complainants (petitioners), requested that the Court inform the authorities of its findings in order that they might take legal action against those responsible for the fraudulent sale.
Then on July 3rd, Milinda Moragoda, the former Minister under whose jurisdiction the illicit transfers of LMS and SLIC had occurred was named Minister of Justice and Judicial Reforms in Sri Lanka with authority over the Attorney General, who directs the CID to carry out criminal investigations.
The announcement of the appointment by the government caused a public outcry because it showed the extent of explicit and unabashed high-level corruption.
The GAP report stated that civil society organizations and the ethical public servants who brought the lawsuits that resulted in the Supreme Court decisions have advocated for transparency and accountability in government. In Sri Lanka however, it seems that only the issue of accountability is still relevant as the corruption itself is perfectly transparent. Moragoda, for example, has moved seamlessly from one ministry to another, stopping off in court and at the World Bank on his way. For apparent criminal conduct there are no investigations and no penalties.
GAP stated that while both the SLIC and LMS represented substantial losses for the public sector in tax revenues when they were privatized, it cannot be argued that these losses alone made the difference in the budget deficits of Sri Lanka. If, however, the officials and businesspeople responsible for such transactions are not sanctioned in any way and can openly display their contempt for the distinction between public resources and private wealth, then it is safe to assume that these cases are only indicative of the true level of corruption and fraud among the elite in both the public and private spheres of Sri Lanka. In this environment continued lending on the scale of the IMF standby arrangement is irresponsible and continued silence by the World Bank on the issue of corruption in public sector ‘reforms’ in the country is indefensible. |
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