eXile on Russian privatization

Doug Henwood dhenwood at panix.com
Sun Oct 17 20:12:18 PDT 1999


[from Johnson's Russia List]

the eXile October 16, 1999 www.exile.ru Privatized: Your Guide to Stipping Russia's Assets By Matt Taibbi

In the early nineties a group of reputable American archeologists announced their intention to travel to Mongolia to search for the tomb of Genghis Khan. They were being funded by a stockbroker from Chicago who'd had a childhood fascination with the Khan, and had even modeled his business philosophy, or so he said, on the Mongol military style. It was his dream to decorate his briefcase with some of the Khan's effects.

At the time I had some money saved up, and I decided to try to join the expedition. Before I left, I interviewed an archeology professor at Harvard University to get some background on the archeological side of the venture. Unfortunately, there was no archeological side of the venture. As the Harvard man told me, the whole expedition was a sort of joke in the academic community.

"The only surviving evidence of the resting place of Genghis Khan indicates that he was buried with his horse, 'under a great tree'," he told me. "Mongolia is the size of Alaska. It's had a lot of trees over the years. They'll never find that fucking thing, and they know it."

I was shocked. "Then how can they justify going to look for it?" I asked.

He laughed. "They're intellectuals," he said. "They can justify anything!"

LAST WEEK, a New Jersey-based law firm filed suit on behalf of a Russian metals company called Avisma against a group of American investors, including styrofoam magnate Kenneth Dart and former American aid honcho Jonathan Hay. The suit charges that Hay, Dart and other co-defendants violated America's RICO statutes-- our federal racketeering laws-- when they took over a transfer-pricing scheme designed to plunder Avisma, a scheme originally designed by the previous owner of Dart's stake, Bank Menatep.

Dart Management denies Avisma's allegations, but neither side disputes the existence of the original Illegal Scheme, as it is called in the lawsuit. Filed by the Russian-American law firm Egorov Puginsky Afanasiyev and Marks, the suit provides a rare glimpse into the nuts-and-bolts reality of Russian "capitalism" in the mid-to-late nineties. It is a snapshot of the true face of privatization, which, as it turns out, was little more than a means of opening a gate to let wolves in to feast on the carcass of Russian industry.

By extension, the Avisma case is also an illustration of one other thing. By showing just exactly how far Russia's major economic players were from practicing anything like genuine competitive capitalism, it gives us an idea of what great lengths all the Westerners who did business with banks like Menatep must have gone to, to turn a blind eye to what was really happening in this country in the years before the crash.

At the time Menatep sold its stake in Avisma to Dart, the U.S. government was issuing an editorial announcing that Russia was "on the right road", and that its economic news was encouraging. The oligarchs were enjoying a honeymoon of sorts with the Western media and business world; Vladimir Potanin was on his way to being lauded in the Washington Post as a "baby billionaire", and Boris Russian Privatization at a Glance

1. State, with urging and guidance of West, announces privatization of company (Company A).

2.Scary mobsters bribe/threaten privatization official, take controlling stake in Company A with mere promise to invest.

3. Scary mobsters make offer that directors of new holding can't refuse.

4. Scary mobsters induce another of its privatized properties-Company B-- to sell raw materials below cost to offshore company X, controlled by scary mobsters.

5. Scary mobsters induce Company A to buy those same raw materials above cost.

6. Offshore company X returns profits from cost-fixing transaction to scary mobsters.

7. Company A is induced by scary mobsters to sell product below cost to Offshore company Y.

8. Offshore company Y sells stuff at market cost to "unsuspecting" Western importers.

9. Offshore company Y returns profits from price-fixing transaction to scary mobsters.

10. Scary mobsters funnel its gazillions in profits through Offshore company Z to "unsuspecting" reputable Western bank.

11. Scary mobsters taught to walk upright and wear ties, invited to speak at universities in same city as "unsuspecting" reputable Western bank; lauded as market-friendly champions of "efficiency".

12. Reputable Western bank sends gazillions of profits to scary mobsters' secret account in Switzerland.

13. Scary mobsters lease private jet, fly to the Hague to strike merger deal with major Western energy conglomerate.

14. Investors hear of mergers, speculate heavily on Russian stock market; expats in Moscow cash in.

15. Privatization hailed as a success.

Berezovsky was laying the foundation for a future invitation to speak at a Harvard Symposium. Money was flooding into the Russian stock market. George Soros had gone in with Potanin to buy a stake in Svyazinvest; Western academics and economists were tripping over each other to commend the successes of privatization.

Many of the things that were written at that time sounded much like this passage from the Moscow Times, culled from its review of a book on the fifth anniversary of the privatization effort:

"Yet mass privatization actually happened, and it has changed the landscape. Since 1992 the government has managed to fulfill much of its privatization promise. Eighteen-thousand large and medium-size businesses have been sold, and 45 percent of the work force is now in the private sector. This is no mean feat considering how little else was accomplished during those early years of reform."

All it takes is one close look at the Avisma suit to realize how grotesquely inappropriate all of this enthusiasm was. Like the Genghis Khan archeologists, it turns out that Westerners who came to Russia to do business could justify anything, so long as it was in the name of legitimizing a rich partner. Here is what we were justifying-- one close-up look, by means of the Avisma case, at the real mechanism of the privatization "miracle":

Step 1 Guys With Guns

All Russian money-making schemes during the privatization era started off with one constant-- a group of scary guys with guns. They were the economic dynamo that privatization's masterminds chose as replacements for the "inefficiency" and "uncompetitiveness" that they claimed fueled state-run industries.

It is important to remember that in the early days of privatization, before the loans-for-shares auctions, stakes in public enterprises were often auctioned away not for cash, but in exchange for promises to invest a certain amount of money. The winners seldom hurried to fulfill their investment obligations. The deciding factor in these early auctions was usually the favor of the privatization officials running the process. They were usually bribed, intimidated, or both.

Once the auction was over, the new bosses would arrive on-site at the company drooling and snarling, call in the company directors (who at the time, remember, were roundly vilified in Western privatization rhetoric as recalcitrant "Red Directors"), and start laying down a series of offers they couldn't refuse. Papers were produced that would shortly thereafter contain either the directors' brains or their signatures. Invariably the directors chose a bribe over the bullet and signed off on what was usually a master plan to bleed their own companies to death.

In the Avisma suit, the guys with guns make their fist appearance in the following manner:

"In the mid-1990's, Menatep Bank, a Russian bank, and/or its parent, affiliates, subsidiaries and/or principals (collectively, "Menatep") obtained a controlling interest in Avisma."

2. The Feeding Frenzy

Remember that part of the movie "Goodfellas", where the family boss Paul Cicero becomes a partner in the Bamboo Lounge restaurant? The restaurant owner had cut Paulie in when he needed protection against Joe Pesci, but once he had Paulie as a partner, he was fucked: the family maxed out his credit lines for profit, and once the joint was bankrupt, they burned it for insurance money. They brought booze in the front door for credit at $200 a case, and sold it right out the back door for cash at $100 a case. It didn't matter, it was all profit.

This is all Russian industry has been in the last five or six years or so. In the Avisma case, it was the Paulie Cicero scheme exactly: they brought in raw materials through the front door at $200 a case, and sold finished titanium sponge out the back door at $100 a case. It didn't matter, it was all profit-- for Menatep. Here's the way it was described in the suit:

"Under the Illegal Scheme, Menatep induced Avisma to sell titanium and other products at below-market prices to TMC, which then resold them on the international market at substantial profit; prior to the Illegal Scheme, Avisma had sold its products directly to Western customers.

"As a further part of the Illegal Scheme, Menatep arranged for TMC to sell raw materials, such as ilmenite (which is used to produce titanium sponge) to Avisma at above-market prices; before the Illegal Scheme, Avisma had purchased ilmenite directly from producers, mainly from the Ukraine."

To keep the companies functional and still ensure their kickbacks, bosses like Menatep had to cut corners. Normally this came in the areas of worker compensation and taxes.

A recent article by Yuliya Latyina in Sovershenno Sekretno describes the Menatep method in detail. Having taken over Yuganskneftegaz, Samaraneftegaz, and Tomskneft, Menatep found itself ruling three companies with a combined workforce of 76,000. Its latest plan for staff reductions, Latyina reports, would leave only 25,000 workers in the three companies. The remaining workers were to be transferred to independent state-run service companies, which would die shortly thereafter. Furthermore, the social guarantees for all of the workers were to be transferred to the local government in Yugansk, in exchange, the paper reported, for making the Yugansk mayor's repair company the primary contractor for the Menatep companies.

The new bosses' zeal for laying off workers was widely applauded in the Western media as evidence that the new Russian capitalists were better managers than their predecessors, who kept bloated workforces that weighed down company margins. In fact, however, privatization-era layoffs were normally intended not to increase competitiveness-- since there was no competition-- but to guarantee the mobster/boss's returns.

Not long ago I interviewed Pulitzer Prize-winning reporter Steve Liesman of the Wall Street Journal. We had an argument over whether or not privatization had been a good thing. I mentioned that there was an enormous number of workers who were not getting paid their wages where they once had been, and that this was obviously a negative.

"Yeah," he snapped, "but not getting paid for what kind of work?"

"Well, for instance," I said. "Mining coal."

"Mining coal that was needed?" he sneered.

The answer to that question is yes, it was needed-- not for any compelling economic reason, but because the directors of the coal companies, and their bosses, needed it in order to get rich selling it at below-market prices. If the coal really wasn't "needed", no one would have been mining it. In the same way, Menatep "needed" Avisma's titanium sponge.

In retrospect, it was only due to Western free-market enthusiasts' inherent hostility towards working people, and their impatience to praise the firing instinct, that the New Russians were (and still are) able for so long to masquerade abroad as right-thinking capitalists.

Non-payment and layoffs were never about competitiveness in this country. They were about slavery -- about protecting things like the size of the kickbacks TMC was able to pay to Menatep. The size of that kickback was only peripherally affected by the market. Mainly it was about how much milk they could get out of the cow without feeding it.

3. Go West

Once the guys with guns had the director on board with the front-door/back-door transfer pricing scheme, all that remained was to pay a bunch of Westerners to handle their money.

In the Avisma case, the allegation goes as follows:

'Upon information and belief Peter Bond, the principal of TMC, managed and coordinated TMC's fraudulent sales of ilmenite to and purchases of product from Avisma, set up and oversaw the offshore accounts through which proceeds of the Illegal Scheme were funneled, and arranged for the kickback payments to Menatep.'

It was at this stage of the process that the West really lost its mind. People who were close enough to privatization to see what was really going must have been flabbergasted by the amounts of money companies like Menatep were making. It was easier than drug money-- the cold-blooded, risk-free extraction of profits from Russian enterprises held hostage.

Suddenly the tables were turned. Even the most rapacious of Western marketeers suddenly found themselves feeling like the the father who teaches his teenage son the facts of life, only to discover six months later that his boy is using the house every afternoon to hold orgies and pubic-hair-shaving parties with his high school's cheerleading squad. Suddenly Dad looks at his heavy-legged middle-aged wife, considers the cheerleaders, and decides he wants in with junior. But how? He's too old and too square to join the main party. No, what he has to do is wait for his son's leftovers-- and that's precisely what happened with Avisma.

According to Latyina's article, Menatep and its chief, Mikhail Khodorkovsky, completely lost interest in companies like Avisma once loans-for-shares came around. Who needs titanium sponge when you can have petroleum? So he comes up with a plan: liquidate all the previous "holdings", i.e. the half-milked carcass companies won in earlier privatization processes, and funnel all the cash from their sales into a bid for a spot in the petroleum aristocracy.

The only question was, to whom could they sell the old holdings? Menatep didn't pay cash for its stakes in them, and no other Russian would, either. Answer: Westerners. They've got money, and if you sweeten the sale enough for them, they just might go for it.

In the Avisma case, the method by which Menatep sweetened the deal for the consortium of Dart Management and the New York-based Andersen group was only revealed through an accident. Much later on, after Dart already had bought into Avisma, he and the offshore company TMC fell into a dispute over the distribution of profits-- that is to say, kickbacks. In a moment of what appears to be extraordinary hubris, the Dart consortium actually went to court, in the Isle of Man, to attempt to retrieve what it considered to be its rightful share from TMC.

They were emboldened in this move by the knowledge that court proceedings in the United Kingdom are not public record: only the interested parties have access to the documentation. Unfortunately for Dart and his partners, they made the mistake of bringing in Avisma as a co-plaintiff in the suit, as a means of strengthening its case. Avisma therefore gained access to the Isle of Man court proceedings which it ultimately used to file its own suit against Dart.

The following sequence of the suit cites the Isle of Man transcripts to describe the process by which Menatep seduced its Western buyers. Incidentally, according to an eXile source, the "Bank" named in this sequence is the Austrian Creditanstalt. Bank spokesman Sergei Zenkin declined to comment for the this article:

'The pleadings in the Lawsuit, from which the quotations below are taken, recount that in 1997, the Defendants were approached by a Western investment bank (the "Bank"), which is based in Austria and maintains an office in the United States.

'Representatives of the Bank, including an American citizen, informed the Defendants that Menatep had decided to sell most of its shares in Avisma and solicited the Defendants to purchase Menatep's shares, with the intent that the shares would later be sold or tendered to VSMPO, a large Russian company that used titanium sponge in the manufacturing of titanium ingots, bar, rods, and other products, in order to create a vertically-integrated titanium company.

'Before purchasing shares in Avisma, the Defendants learned of the Illegal Scheme by which a "significant proportion of the profits derived from the sale of Avisma's products was taken off-shore" as a result of Avisma selling its titanium at an "undervalue" to TMC "for the benefit of, and distributed to or to the order of Menatep."

'The Bank explained to the Defendants that if they purchased the shares of Avisma from Menatep, they "would not only acquire [Menatep's] majority shareholding in Avisma, but also the right to the profits which [Menatep] was accruing through TMC."'

In essence, Menatep told Dart that it would retain the machinery of the extortion racket-- including, one must assume, the favor of whatever bribed officials were doing Menatep's bidding at Avisma-- if it paid cash for the stake. Much as Dad would have to get into to junior's cheerleader party, Dart jumped at the chance, and overpaid. According to the affidavit, the Western consortium paid $86 million for the stake. Khodorkovsky later that year made his bid for the VNK oil company.

The Dart group, much like, we now learn, the Bank of New York did its own Russian dealings, managed to keep a steady flow of Russian money coming in once they got involved with Avisma. But they weren't the only Westerners to get into the act. When the Americans fell into their dispute with TMC, they needed counsel. According to the suit, counsel told them they couldn't win it alone:

'Upon information and belief, the Defendants were advised by their counsel that Avisma, and only Avisma, had such standing, and, thus, Avisma must be a party to the Litigation; the Defendants therefore recommended that Avisma engage counsel to participate in the Litigation.

'The Defendants took care to ensure that Avisma would be represented by counsel who would help them in their efforts to secure the kickbacks for themselves, and would not inform Avisma of its rights against the Defendants or encourage Avisma to pursue claims against the Defendants themselves for their part in the Illegal Scheme.'

A source has told the eXile that the Law Firm in question here is Chicago-based McDermott, Will, and Emery. The suit alleges that the firm signed on as Avisma's counsel at the same time that it was on a retainer to one of the other-co-plaintiffs, the Anderson group:

"The Law Firm, which had an undisclosed conflict of interest in representing Avisma and Andersen at the same time, never advised Avisma as to its rights against the Defendants -- even though the Law Firm had offices in the United States, England, and Russia and should have been well-qualified to advise Avisma about the violations of American and Russian law by the Defendants described in this Complaint."

Spokeswoman Amy Negrelli of the firm's headquarters in Chicago has so far declined comment on the story.

With a major Western investment bank, a major investor, and a major law firm involved, all that remained was for a big shot from the aid community to get in. When the Russian metals magnate VSMPO bought an interest in Avisma and attempted-- whether out of desire to clean things up, or a desire to gain the money for itself-- to put an end to payouts to the Dart group from TMC, the Dart group mobilized. A share swap had given the defendants a stake in VSMPO, and when the latter made their move to oust them from Avisma, the former responded by moving to take over VSMPO. According to Bruce Marks, the attorney for Avisma on this suit, the defendants used their votes as shareholders to get three Americans elected as directors. One of those, he said, was the former head of the Moscow office of the Harvard Institute for International Development, Jonathan Hay.

"I was there, in Berezniki, when Hay was elected," Marks said. Hay has so far declined comment on this story, but the mere presence in this story of the former chief arbiter of the American aid effort here in Moscow should be shocking enough to anyone who ever had any illusions about the privatization effort.

Granted, Hay has been out of the game for a while -- kicked out of HIID for investing in Russia through his girlfriend, and now, reportedly, under grand jury investigation by the U.S. Attorney's office for suspected conversion of government funds. In his place, disgraced and staring down the barrel of a federal indictment, I'd probably go for the first get-rich quick scheme I could find, too. On the other hand, staring down the barrel of a federal indictment, I might also want to avoid working my way into lawsuit affidavits that have me teaming up to violate RICO laws with styrofoam magnates with Belize citizenship.

But that's the whole thing about temptation. It makes you do dumb things. And as the Avisma story and the Bank of New York story show, there was plenty of temptation fueling the ill-considered enthusiasm for the privatization effort.

At first, at the outset of the privatization effort, it didn't seem like temptation-- just wishful thinking. Many Westerners in the middle of the decade looked at the Potanins and the Berezovskys and the Khodorkovskys of the Russian business world, saw how much money they were making, and they wanted to believe... well, they wanted, on some vicarious level, to believe these guys would get away with it.

"Yeah, I suppose it was a kind of wishful thinking," said Stanford professor Bernie Black, an early proponent of privatization. "You'd see a guy who got his start in somewhat dubious ways, and you sort of hoped he'd turn it into a legitimate operation." Referring to Potanin, he said, "In that case, you had a guy who at least was smart enough to say the right things. You had to feel positive about that."



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