Private equity’s biggest Ponzi scheme

Simon Clark is frustrated. The Wall Street Journal reporter is five months removed from the publication of his well-received book on Abraaj Group, a private equity pioneer turned Ponzi scheme, but tells me the industry has turned a blind eye to the cautionary tale he co-authored with Will Louch.

What he's saying: "The book has been widely read. I've been invited by academic institutions to talk about the issues raised, and one of the major limited partners has privately asked for a conversation. But, largely, the private equity and impact investing industries still don't want to even utter the word 'Abraaj,' ... ostriches with their heads in the sand, hoping to whole thing will go away."

Backstory: Abraaj was one of the world's most celebrated PE firms. Backers included the U.S. and U.K. governments. Its leader, Arif Naqvi, was a Davos regular who preached the gospel of impact investing in emerging markets; almost always with a mention of his own rags-to-riches bio, a jet-setting billionaire born of very modest means in Pakistan.

• Naqvi also appears to have been a crook, allegedly stealing money from Abraaj and its investors. He'd fill the holes he created by raising new capital, with fundraising bolstered by falsified valuations. If that failed, he'd surreptitiously borrow money so that Abraaj's bank accounts looked "full" in quarterly statements sent to LPs.
• Naqvi's con was first called by an investment officer named Andrew Farnum at the Bill and Melinda Gates Foundation, which had committed $100 million to an Abraaj healthcare fund. In short, Farnum noticed that capital calls weren't being matched by actual investments, and he then caught Abraaj in a lie about where they money was being kept.
• Clark and Louch also played a major role, enabled by a whistleblower who was seemingly ignored by LPs.

Two big takeaways from the book, a page-turner that could be stuffed into stockings:

1. A lot of LPs fell down on the job. If Farnum found the fraud, others could have too. It's a big reminder of how so much of private equity is based on trust, despite the billions of dollars at risk. The lack of other large-scale frauds may be more by luck than by design.
2. Naqvi's key insight was that many investors are uncomfortable with the amoral nature of textbook capitalism. He promised that Abraaj would make money while doing good, a combo so intoxicating that red flags were ignored.

The fallout: Abraaj investors have stayed quiet, contributing to Simon Clark's consternation. Some of it is surely due to embarrassment. Some is at the request of law enforcement, including American officials who have spent years trying to get Naqvi extradited from the U.K., where he's under house arrest.

• One tangible industry change, per a source familiar, is that LPs are now paying much more attention to the individual relationships between private equity and accounting firms. There were some personal ties between Abraaj and KPMG, although the accounting giant insists that it too was defrauded.

The bottom line: "I do believe impact investing can help solve some of the world's problems, so the pitch itself isn't necessarily bogus," Clark says. "But the bigger the promise an investor makes, the bigger the questions that should be asked of them."