Risky Russky Business
By Dr. Rachel Ehrenfeld @ FrontPageMagazine.com
Wednesday, June 28th, 2006 @ 11:59PM
Russia is neither capitalist nor democratic.
The West’s need for Russia’s energy and cooperation regarding Iran, Iraq, China, and the “War on Terrorism” will likely lower the standard demanded for a full membership in the G8 group, to allow Moscow’s ascendance to the rich nations’ club, at the St. Petersburg meeting in July.
“In the six years since he pledged to uphold democracy as a ‘dictatorship of law,’ President Vladimir Putin has increased the role of the police and security services in governing Russia and wielded the power of the courts for political ends,” says the Director of the London based Foreign Policy Centre, Stephen Twig. Indeed, according to the former director of Communist Romania’s intelligence service Lt. Gen. Ion Mihai Pacepa, while “the Soviet Union had one KGB officer for every 428 citizens. Putin’s Russia has one FSB-ist (Federal Security Service) for every 297 citizens.”
This huge increase in security personnel did little to control the rising corruption that plagues Russia. On the contrary; more state agents demand more bribes from Russian citizens and foreigners doing business in Russia.
In 2005 alone, Russian businesses paid an estimated $316 billion in bribes, about 20 percent the country’s GDP that year, according to a report by the Moscow based Indem Foundation. And corruption is not limited to business; Russian citizens are forced to pay bribes to receive basic services that the government is supposed to provide for free. Want your driver’s license in the near future? Your passport ready before your flight takes off? Your marriage license? Pay up.
Russia’s president, Vladimir Putin recognizes corruption as the major obstacle to economic growth. In his State-of-the-Nation Address on May 11, 2006, he noted: “ one of the most significant traits of our internal political life is the low level of trust of citizens towards specific institutions of government and big business.” On June 13, he elaborated: “we have never ceased this fight against corruption and intend to carry it on permanently and to make it more strict, effective and consistent.“ But according to Kirill V. Kabanov, director of the National Anti-Corruption Committee: “In Russia, it is always the case some people are found at the lower or middle level, while no one at the top is.” He sees Putin’s recent comments, the dismissal of some government officials for alleged corruption, and the resignation of the prosecutor-general, as “just a P.R. campaign and nothing more.”
On June 15, 2006, Russia launched another strike against democracy when fourteen Duma members, representing Russia’s five Duma factions, submitted amendments to ban any public political criticism by individuals and organizations including demonstrations against the government.
“While Russia’s Constitution enshrines the basic principles of democracy, the current policies of the Kremlin are undermining them in practice,” concludes June 13, 2006, Freedom House report, “Nations in Transit 2006.” In fact, Russia’s growing energy wealth is used not to strengthen democratic institutions, but to fuel corruption.
Vladimir Putin’s government, fortified by massive oil revenues, seems determined to reverse what little democracy Russia achieved since 1991. “The transition has been from a one-party state to a one-pipeline state,” noted Ivan Krastev, chairman of the Centre for Liberal Strategies, in Sofia, Bulgaria.
It is about time for U.S. President George W. Bush, to look again at Putin’s soul to understand the Russian’s take on democracy.
“Democracy should be adequate to the current status of the development of Russia, to our history and traditions,” claims Putin. Russia’s increasingly restrictive domestic policies, media control, mounting corruption and poor implementation of the rule of law, challenge its democratic development and limit the progress of Russia’s free market.
Putin seeks to secure his state’s role in global energy markets, and further control energy production and prices. On March 1, Putin declared, that “global energy security” is the most pressing issue facing the G8 and the world.
On May 22, 2006, he announced a Russia-Kazakhstan venture to expand capacity at Orenburg’snatural gas refinery, for 50 percent Russian ownership in the facility. Reasserting Russia’s energy might, Putin aide Igor Shuvalov stated: “We are prepared to provide Europe with oil and gas on a long-term basis, and we are taking on the role of the leader…We will continue our expansion whether our European partners like it or not.”
On June 13, 2006, Russian natural resources minister Yuri Trutnev announced further restrictions on foreign oil companies. The new restrictions, which would consolidate Russia’s control of its energy and other resources, resulted in harsh criticism by Vice President Dick Cheney, who accused Russia of using its energy resources “as tools of intimidation or blackmail.”
Nonetheless, the Russians pursue their agenda. On June 21, the Russian Presidential aide organizing the July St. Petersburg summit announced: “Russia will not ratify the EU’s Energy Charter, which it signed in 1994.” The Europeans dependent on Russian oil and gas argue that Russia should ratify the treaty, but judging from the way the negotiations are going, Russia is likely to get its way. Moreover, since ”Russia is a very critical partner in Iraq, in North Korea, dealing with Iran,” according to the White House, chances are also good that the U.S. will not pressure Russia to make any significant concessions, thus playing into Putin’s hand.
The West’s growing criticism of Putin’s policies caused the last president of the Soviet Union, Mikhail Gorbachev to come to the rescue of the former KGB official now presiding at the Kremlin. Interviewed by The Times, on June 25, Gorbachev warned, “Russia is not anyone’s domain… The Presidents and Prime Ministers at the G8 can raise whatever they want. But the more it is seen that the West is putting pressure on, the more it will strengthen President Putin because, in essence, his position is very close to the aspirations of the people.” Gorbachev went on to criticize the U.S. and the European Union for attempting to intervene in Russia’s internal affairs. He concluded: “we do not work according to a calendar set either in the White House or in the European Union. We have our own schedule.”
To make Russia’s opaque markets more palatable to potential investors and to the Western political “partners” its leaders are meanwhile holding at arm’s length, Russia is now paying millions to the New York-based PR firm, Ketchum. Considering Russia’s level of corruption, the PR firm faces a daunting task.
Putin, as G8 president for 2006, claims to rule a developing capitalist economy. But upon gaining power in 2000, Putin told Russian businessmen that “The state wouldn’t question whether they’d acquired their companies legally, as long as they started investing their profits at home rather than stashing them in foreign banks.” As for Russia’s political future, Putin declared: “The state must be where and as needed; freedom must be where and as required.”
Confronted with criticism over its increasingly restrictive policies Russian Economics Minister German Gref boasts that direct foreign investment in Russia grew 100% in the first quarter of 2006 alone. Last year, in 2005, the London market for Russian global depositary receipts (GDRs) rose 166%, to $226 billion; “much of this activity was in shares of Russian companies such as Lukoil, Gazprom, and Unified Energy Systems,” according to Global Finance.
However, potential investors should beware. A recent report from the Council on Foreign Relations on “Russia’s Wrong Direction,” warns “that anyone can become vulnerable when the state bureaucracy, either at the president’s direction or merely with his support, decides to seize private assets.” Western doubts regarding Russia’s accession to the World Trade Organization (WTO) reflect those concerns.
But the Russians do not seem to care. First Deputy Prime Minister Dmitry Medvedev said on June 2, 2006, that Russia should retain control over strategic companies, according to Itar-Tass. Medvedev, a likely contender for the Russian presidency in 2008, admits the government is “not the most efficient proprietor.” However, he insists that Russia should control companies “vital for the country,” including defense, atomic energy and natural resource giants like Gazprom, whose board he heads. Indeed, on June 16, the Duma voted to grant a monopoly on gas exports to a state-owned company, which happens to be Gazprom.
Although Medvedev said that companies in other industries “can and must become private property,” he added that the government could “enlarge its role in certain companies for a certain period [whenever] necessary to put the companies in order.” “Private” in Russia does not really mean private.
Putin’s version of democracy and capitalism seems to extend to Russian corporate understanding of free markets.
Take the common fraudulent Russian business practice to force false bankruptcies, to effect hostile takeovers: according to Dr. Alexander Radygin, from Moscow’s Institute for the Economy in Transition, Russia’s corrupt legal system supports this practice. For example, companies that buy accounts payable and promissory notes of a targeted business – change identity. The “new company” then takes the unpaid bills to bankruptcy court, where it demands and obtains the assets of the targeted business. This is how 23 Moscow department stores were taken over.
This practice, as well as bribery, money laundering, and wire fraud, were allegedly also used by one of Russia’s largest conglomerates, Alfa -Eco, according to a federal racketeering lawsuit filed in New York’s Southern District, on June 8, 2006, by Bermuda-based IPOC (International Growth Fund). IPOC alleges that Alfa group and several of its representatives engaged in a variety of illegal activities to steal IPOC’s assets, defraud the U.S. Treasury, and American investors. The lawsuit further alleges, that Alfa and its representatives did this not only to enrich themselves but also to control the Russian telecommunications market.
In addition to the RICO lawsuit, IPOC hopes to retrieve from the parent company, Alfa Group, a Megafon stake now worth $1.7 billion. This, however, is not just another business dispute; the lack of transparency that characterizes Russia’s businesses has in this case alone led to at least five international arbitrations and several lawsuits and countersuits in six countries, without resolving who has rights to the shares.
The closely held $20 billion-plus Alfa-Eco seems to represent Russia’s business- ethic practices. It was founded in the Soviet Union in 1988, during Gorbachev’s perestroika. “Its core business was computer sales, producing and selling devices for ecological control of products, tea production, as well as selling carpets and consumer goods.”
Today, the Alfa empire has Russian, European, Asian, Caribbean and U.S. branches and offices are managing companies in banking and finance, oil and gas, mobile telephone service, construction material, commodities, food processing and supermarkets. Its subsidiaries include Alfa Capital Markets, Alfa Bank, Tyumen Oil, Altimo, Perekriostok Group and countless others. Alfa’s Chairman Mikhail Fridman, 42, who was ranked by Forbes list of the richest as No. 50, owns 40 percent. Alfa also “controls three international corporations that are publicly traded in the U.S.”: VimpelCom and Turkcell are traded on the NYSE, and Golden Telecom is traded on the NASDAQ.
To maintain good relations with the Kremlin, Fridman, who served as an economic adviser to President Boris Yeltsin, gathered around him central Russian figures past and present. Alfa President Pyotr Aven, for example, was trade minister in Yegor Gaidar’s 1992 government, and reportedly remains Putin’s close friend. Similarly, Leonard Vid, former U.S.S.R. First Deputy Head of the Gosplan central planning committee, was for at least five years Chairman of Alfa Bank’s Executive Board responsible for legal divisions, interest committees and representation in Russia’s federal government and Central Bank.
To improve relations in Washington, and to advance its business opportunities in the U.S., the IPOC complaint alleges that the Alfa Group retained the services the prestigious lobbying firm Barbour Griffiths and Rogers and the PR services of Hill & Knowlton.
The IPOC lawsuit against Alfa Group is not the first one to allege that the Russian conglomerate engages in racketeering. On May 25, 2006, Norex Petroleum, a Cyprus company with Canadian shareholders, was granted permission to begin discovery against Alfa Group in the U.S. District Court for the Southern District of New York. Norex charges that Alfa Group and its many affiliates wired millions through U.S. banks, created an illegal slush fund, avoided U.S. and U.K. taxes, and fraudulently seized the oil-producing assets of Norex’s Yugraneft subsidiary, through a Russian “court-approved takeover.”
In Russia, such court “approved” takeovers, observes Alexander’s Oil and Gas Connections, “usually involve bribing regional judges to provide the necessary legal pretext to send in armed guards,” after which “oil and profits are pumped out to the new owner’s affiliated companies.” Those are among the allegations in a February 2002 Norex lawsuit against Alfa in New York. This, according to Norex, was done in violation of the Racketeer Influenced and Corrupt Organizations Act (RICO).
Alfa’s victims, Norex alleges, include Harvard University’s Endowment Fund and American owners of the Chernogorneft American Depositary Receipts (ADR) “terminated” in October 2003. Meanwhile, in June 2003, Alfa agreed to sell half of a new BP-TNK joint venture to British Petroleum for $6.75 billion, thereby allegedly defrauding other Chernogorneft investors. According to the Wall Street Journal, Fridman specifically asked Putin to approve the “multibillion-dollar deal that would give foreigners 50% of what would be Russia’s third-largest oil producer.”
Also, Norex alleges, that Alfa acted against U.S. interests by violating the U.S. and international laws, through illicit oil trading with Iraq. Norex based its allegations “mostly on the UN Volcker commission report and the US Senate investigation findings regarding TNK, Crown, Alfa-Eco and some other related companies in the paying of kick backs to the Sadam Iraqi regime.”
According to a 1,000-page, September 2004 CIA report by Charles Duelfer, “The Iraqi embassy in Moscow assisted, among other deals, a Russian company called Alfa Echo in signing contracts for importing oil from Iraq.” After September 2000, Duelfer reports, all companies in the oil-for-food (OFF) program paid illicit “surcharges” to Iraq. Furthermore, the Volcker Commission reported to the United Nations that at least two Alfa subsidiaries conducted at least 15 transactions involving more than 100 million barrels of oil worth at least 2 billion dollars. Indeed, the committee wrote, “About 2.8 percent of the Iraqi oil exported under the Programme was sold through Alfa Eco, [which] was the fourth largest purchaser of Iraqi oil ….”
In one instance, Volcker reported, Alfa paid more than $300,000 in kickbacks for 10 million barrels of oil worth more than $249 million. In November and December 2001, Volcker data shows that Alfa paid at least three other kickbacks totaling $1.73 million. Of $2,351,880 in total Alfa oil trading kickbacks to Iraq, the Volcker commission reports, more than $2 million in cash was paid “ through the Iraqi Embassy in Moscow .” Alfa transferred another $312,719 through other defendants in Norex’s complaint.
Illegal oil surcharges generated at least $229 million for Saddam Hussein, according to October 2005 testimony from Michigan Senator Carl Levin. But the oil-for-food program generated at least $1.5 billion in illegal payments on “humanitarian” goods. Here, too, the Volcker commission discovered illicit Alfa kickbacks on “humanitarian” shipments of milk, sugar, tea, detergent, wheat, rice, pulses, laboratory gases, measuring and control instrumentation, and other items.
Norex also alleges that Alfa illicitly traded oil-for-sugar with Cuba, thus violating the Helms-Burton Act (Trading With the Enemy Act), “in relation to their facilitation of payments to Cuba, through the sale of Russian oil, in exchange for Cuba’s provision of supplies to the Russian Federation and of facilities by which the Russian Federation could engage in covert surveillance of the United States (the “Oil-for-Sugar” and “Cuba Rez” Programs).”
In addition, Norex alleges, “the Illegal scheme included various Defendants (from the Alfa group) paying millions of dollars in kickbacks to Saddam Hussein’s Iraqi regime through the United Nations’ corrupted “Oil-for-Food” program.”
If Norex and IPOC prove their cases against the Alfa Group and win in U.S. courts, the outcome could further impede already shaky U.S. relations with Vladimir Putin’s increasingly autocratic regime.
Radygin of Moscow’s Institute for the Economy in Transition describes yet another “standard” Russian method to separate rightful shareholders from their assets, helped by corrupt police. The MDM group hostilely took over Nevinnomysky Azot chemical company. It bought shares, bribed the Tax Police to have the company’s Director General arrested, convened an early shareholder meeting, and paid the police to block shareholders from the meeting. Large Russian companies also practice such methods. For example, Radygin says the Alfa Group used similar tactics to take over Rostov’sTaganrog metallurgical plant. They too used police services and private security to control the plant.
The most radical steps to control Russia’s economy, as well as its politics, were taken by Putin when he imprisoned Mikhail Borisovich Khodorkovsky and took his oil company Yukos, once Russia’s largest, away. Khodorkovsky is locked up in Siberia, and his company was auctioned by the state to Rosneft, the state-owned company. Yukos is now asking to block Rosneft’s sale of about $10 billion in the Russian’s oil company’s shares. “There is a serious risk that the offering … would constitute the sale … of criminal property,” says the Yukos complaint. Indeed, global investors should consider the behavior of the Russian state behavior, as well as that of its corporations as a stern warning of the kind of treatment foreigners, can expect from Putin’s Russia.
To counter the mounting criticism of Russia’s growing repression of individual and corporate rights, control of the media, limitations on Non-Governmental Organizations, and rising corruption, and to ward off U.S. objections about Russia’s ascension to the World Trade Organization, Russia passed new laws corresponding with WTO regulations.
On June 26, the Moscow daily Kommersant quoted Kremlin sources saying that the U.S. agenda at the G8 meeting is “to advance American business interests in Russia and to reach an agreement on Iran.” But Kommersant’s sources inside the Kremlin also cautioned, “Whether or not that works out will depend on the U.S. position on democracy, energy security and the situation in the CIS.”
Submitting to Russia’s demands will further weaken the U.S. efforts to stop Iran from developing nuclear weapons. As Lt. Gen. Tom McInerney noted: “Specifically concerning Iran, Russia is not our ally and is probably our enemy.”
Moreover, allowing Russia’s membership in the WTO at the time when corruption exceeds that of the Soviet era will not only weaken the credibility of the G8 but also allow Russian companies – many state-controlled (directly or indirectly) – to use their vast fortunes to corrupt international businesses, enhance their and Russia’s fortunes while further impeding democracy.
Dr. Rachel Ehrenfeld, author of Funding Evil; How Terrorism is Financed and How to Stop It. She is director of the American Center for Democracy and member of the Committee on the Present Danger. Alyssa A. Lappen, a Senior Fellow at the ACD, contributed to this article. She is a former editor for Forbes, Corporate Finance, Working Woman and Institutional Investor.