Corruption Watch: May 3, 2002

By Roman Kupchinsky

Hermitage Capital Management Limited filed two lawsuits on behalf of minority stockholders in a Russian court on 15 April against the auditing firm PricewaterhouseCoopers (PWC), accusing it of producing "false and misleading audits" of OAO Gazprom that covered up questionable financial dealings by Gazprom, Russia's gas monopoly. Hermitage is a western investment company that is incorporated in the Channel island of Guernsey and operating in Russia. PWC has been the auditor for Gazprom since 1996.

The lawsuit focuses on Gazprom's relations with Itera, a privately held Russian gas company registered in Jacksonville, Florida, and charges that Itera bought gas fields from Gazprom for below market value under Gazprom's earlier management and engaged in different scheme's that kept Gazprom's stock value low.

The lawyer representing Hermitage's investment vehicle, Rilend, is Aleksandr Dobrovinskii, said to be the most expensive lawyer in Russia.

PricewaterhouseCoopers denied allegations by William Browder, the head of Hermitage and the grandson of Earl Browder, the former head of the Communist Party of the United States, stating that they are "completely unfounded" and that PWC has "met all applicable legal and professional standards" according to "The New York Times" on 16 April.

"The New York Times" also reported that while minority investors agreed with "the substance of Mr. Browder's claims" some questioned his motives. "Mr. Browder is lobbying for a seat on the Gazprom board and might be using the court case as part of a public relations campaign."

Coming on the heels of the Arthur Andersen/Enron scandal in the U.S., the lawsuit by Hermitage seemed perfectly timed to take advantage of the distrust of auditing firms by the public and the courts and thereby further Browder's bid for membership on Gazprom's board of directors.

Hermitage alleges, according to "The Wall Street Journal Europe" of 16 April, that PWC's audit "covered up" debts that Itera owed Gazprom, and failed to recognize "losses of $87.4 million that Gazprom suffered in a gas-trading deal with Itera." In an interview with "The Wall Street Journal Europe," Browder said that he was "trying to reform Gazprom."

In the same issue of the newspaper, a partner at a competing auditing firm vying for the Gazprom account -- which is valued at about $15 million a year -- stated that Gazprom: "is just a hugely complicated and difficult company to get your hands on. I don't think you hear any of the big five saying 'look what a bad job Pricewaterhouse has done' because I think we all wonder, 'Geez, what would we have done if we'd been there?"

Rilend's lawyer, Dobrovinskii, when asked about the amount of damages that could be awarded to Hermitage, told "The Moscow Times" on 16 April that the "sky is the limit."

Critics of Dobrovinskii and Browder point to the fact that the methods used in this and earlier cases they were involved in are tantamount to "Greenmail," a sophisticated form of blackmail. It is used by corporate raiders who buy into a company and then threaten to sell off parts of the company, thus making money and destroying the company.

On 5 November 2001, Hermitage, representing minority stockholders, lost a lawsuit in a Moscow court on the merger of the Volzhanka chocolate company, the sixth-largest chocolate producer in Russia, with Konfi in Yekaterinburg, Zarya in Kazan, and United Confectioneries B.V. In an article in the "Russia Journal," 16-22 November 2001, Michael Calvey, the managing partner at Baring Vostok Capital Partners, which owned 50.4 percent of Volzhanka, stated that Hermitage: "is greenmailing, or, in other words, is using legal technicalities to exert maximum pressure on the majority shareholder, so that Barings is forced to pay a higher price then the asset's current value in order to put an end to the court battles."

Calvey added: "If investors like Hermitage are able to...throw dirt on others without suffering any legal consequences, it will make it more difficult for minority investors to defend their rights against factual abuses."

In 2001 Browder initiated a suit against the management of Sberbank and the Russian Central Bank. Were these attempts at reform or greenmail? In the Sberbank case, Hermitage sued Sberbank for attempting a new stock emission, claiming that these shares would be sold at below market value to "friends of management" and thus lower share prices. Sberbank claimed that they needed to issue more stock in order to meet regulatory requirements to the amount of capital in their reserve fund. The suit was settled out of court with two minority shareholders from Hermitage being elected to the Sberbank board of directors.

Charges of greenmail are not new to the world of Western investors in Russia. "The St. Petersburg Times" on 8 June 1999 printed an extensive feature story about Kenneth Dart, who has also been a corporate raider in Brazil.

According to this feature story, Dart is a billionaire heir to the Dart Container Corp., which manufactures foam cups. Dart gave up his U.S. citizenship in 1994 and moved to the Cayman Islands, taking on joint Irish and Belize citizenship. Brazil, which had defaulted on $50 billion worth of debt, was coming to an agreement with its creditors. Sensing that an agreement would soon be reached, Dart bought up $1.4 billion worth of the defaulted debt for $375 million. However, Dart was not happy with the restructuring deal Brazil had worked out, seeing that it would severely discount the debt be owned. He threatened to pull out of the deal if he was not offered more favorable terms. In the end, his stake was devalued from $1.4 billion to $980 million. He made 161 percent on the deal, a mere $605 million.

Dart then turned his attention to Russia. The Chubais voucher privatization program was the great opportunity for investors and Dart went for it. He turned his attention to minority shareholder rights and went after subsidiaries of Yukos Oil and Sibneft. Dart pursued Yukos and won a court decision in Samara on 28 June 1999 when the court overturned the issuance of new shares of Samaraneftegaz, a subsidiary of Yukos. However, a Yukos spokesman stated that the decision was biased since the judge was a law student of Dart's local Russian attorney. In the 30 June 1999 issue of Russia/Central Europe Executive Guide, a Yukos spokesperson is quoted as saying: "Mr. Dart defends private property all right, but only his own and only at a profit...Make him an offer and see where his principles go."

In the Sibneft fight, Dart charged that Yukos and Sibneft were engaged in asset stripping and unfair share dilutions. Yet he accepted a deal that diluted his stake in the company, but gave him an extra 1.5 percent holding and a seat on the board for his representative, Michael Hunter.

In the Hermitage case, all the audits conducted by the Russian Auditing Chamber, as well as the professionals of PWC found the Itera-Gazprom relationship to be legal. Investment professionals such as Browder and his firm "Hermitage Capital Investments Limited," however, have disputed this. His lawyer, Dobrovinskii, will present Hermitage's case in court.

Is Hermitage Capital acting in the best interests of "minority shareholders" or is it using pressure on PriceWaterhousecoopers to place William Browder on the board of Gazprom?

The following are excerpts of remarks by E. Anthony Wayne, the Assistant Secretary for Economic and Business Affairs, in his testimony before the House Appropriations Committee, the Subcommittee on Commerce, Justice, State, the Judiciary, and Related Agencies. Loudoun County, Virginia, 23 April.

Thank you for the opportunity to participate in today's discussion on intellectual property rights policy and enforcement.... The protection of intellectual property rights is critically important to [U.S.] prosperity and economic leadership...

More and more, our trading partners are beginning to understand that their future growth and development depends in large part on their becoming active players in the global knowledge-based economy. They also are coming to appreciate that strong intellectual property protection is necessary to create an attractive investment climate. In short, economic self-interest is becoming a very important factor in enhancing intellectual property protection overseas. Our trading partners' actions to improve intellectual property protection and enforcement benefit their companies and our companies.

Recent statistics about our own economy are illustrative of the importance of intellectual property rights. The copyright industries (including software) now account for about 5 percent of our GDP, and this sector has grown at twice the rate of the rest of the U.S. economy.

Intellectual property protection is an important tool for countries at every stage of development, and a proven incentive for domestic and foreign investment, technology transfer, economic growth, and high-paying jobs in every area of technology...

Although the trends for effective intellectual property protection are positive, significant challenges remain. A key focus of this year's Special 301 review, under the chairmanship of the Office of the U.S. Trade Representative (USTR), has been the growth of piracy of optical media (music CDs, video CDs, CD-ROMs, and DVDs).

This pernicious form of piracy spreads quickly and can infect entire regional markets unless strong and effective measures are taken to prevent illicit operators from setting up shop. But it can be stopped if governments are willing to act.

For example, when the pirates moved into new, illicit fields of opportunity in Ukraine, the department and our embassy in [Kyiv] began working intensively with USTR, other government agencies, and the private sector to press the government of Ukraine to close down pirating facilities. For a time, our joint efforts were somewhat successful, but the commitment of the government of Ukraine unfortunately did not last. Last year's designation of Ukraine as a "Priority Foreign Country" and the imposition of trade sanctions send a strong signal that we will not tolerate wanton piracy of our intellectual property...

Bulgarian Dian Hristov Pankov, 34, was detained in southern Italy on 22 April after seven kilograms of heroin were found in vehicle he was driving, the Bulgarian news agency BTA reported on 23 April.

The drug was wrapped in 13 packs. Early estimates put the retail price of the drug at several million euros.

Police in the region's capital, Bari, suspect that the consignment was to be delivered to a criminal organization based in the city's northern parts. According to police, this is the first consignment of heroin seized in the Puglia region to come not directly from Albania but via a Balkan route controlled by the Russian mafia.

Russian border guards discovered a drugs cache in a section of the Qala-i-Khum border detachment in Tajikistan on 22 April, the Asia-Plus news agency reported. The guards seized 3.21 kilograms of hashish from the cache. Meanwhile, according to the Tajik Interior Ministry's press center, staff at the Department for Combating Illegal Drug Trafficking have detained a group of drug dealers in Dushanbe. Over 9 kilograms of heroin was seized from them during an inspection, Tajik television reported on 23 April.

The Moscow garrison military court sentenced the former finance chief of the main military budget and financing department of the Russian Defense Ministry, Colonel-General Georgii Oleinik, to three years in prison without stripping him of the right to hold certain positions, Interfax reported on 29 April.

Oleinik will be placed at the first detention center of the Moscow interior department.

The court found the general guilty of abuse of office, which was said to have caused grave consequences during the transfer of $450 million to Ukraine as payment for material and technical resources for the Russian Defense Ministry.

The court believes that although the agreement on the money transfer was signed by former Defense Minister Igor Rodionov, as well as by another six top Russian and Ukrainian officials, Oleinik was to look into the legitimacy of this agreement, although he did not participate in the work on it. The court believes that the general should have taken measures "to prevent damage to the Defense Ministry and the state," however he failed to do this.

The court has noted that "being concerned about negative implications for his service, that is acting on career grounds, Oleinik deliberately violated the procedure for money transfer abroad." Oleinik signed a payment order to transfer $250 million and $200 million when there was no signed agreement on the delivery of material resources between the central department for material resources and the external economic relations of the Defense Ministry and the Unified Energy Systems of Ukraine. In both cases the agreements were concluded "postfactum" after the payments had been made. The court noted that without the Russian Central Bank's permission for the currency export and making payments before the contract was signed, Oleinik also violated legislation on currency regulation.

HOW THE RUSSIAN ARMY SOLD ITS ARMS

By Roman Kupchinsky

A report in "The Moscow Times" on 22 April described how Russian army officers sold armaments to the Irish Republican Army. "The Federal Security Service (FSB) has alerted British military intelligence that Russian army officers were selling arms to the IRA, the British "Sunday Telegraph" reported.

A team of senior IRA commanders flew into Moscow last fall and purchased at least 20 AN-94 assault rifles from "renegade Russian special forces officers." Neither Russian FSB officials nor the British Defense Ministry wanted to comment on this report.

Russian military expert Pavel Felgenhauer told the "Sunday Telegraph" that "If Chechen rebels buy their weapons in Russia, why can't the IRA." Soon afterwards, Radio Rossiya reported on 24 April that a group of military service personnel were arrested in the town of Belogorsk, in the Amur region, for trying to sell explosives. The soldiers were caught trying to strike a deal.

The police discovered 105 electric detonators and 50 kilograms of explosives. According to experts, this amount of explosives could blow up a multistorey building. The investigation has so far established that the explosives were being sold under the guise of scrap from military firing exercises. The soldiers were asking several thousand dollars for the material.

These are not new developments. Officers and enlisted men in the Russian armed forces have been selling weapons to any buyer on the market since the collapse of the USSR. They have sold to Chechens, thus making them complicit in the deaths of their Russian army comrades. Criminal gangs have bought arms from them. They have facilitated the sale of arms to Africa and the Middle East, especially to countries which have been embargoed by the UN and by doing so have contributed to the murder of thousands of civilians in these countries. Yet few, if any, have been sentenced for this activity by Russian courts.

Russian illegal arms traffickers are walking the streets of Moscow (in reality riding in their brand new Mercedes 600s) and giving interviews to the Russian media with total impunity, and, as some observers have noticed, with an arrogance and disregard for law rarely seen elsewhere. This despite Interpol alerts for their extradition based on international treaties which the government of the Russian Federation has signed. Who is responsible for protecting these wanted criminals from justice?

In 1996, the United States Air Force Institute for National Security Studies provided a grant for Dr. Graham H. Turbiville, Jr., a senior analyst with the Military Studies Office, office of the deputy undersecretary of the army for international affairs, and former chief of the Defense Intelligence Agency's Soviet/Warsaw Pact Strategic Operations Branch, to prepare a research study entitled: "Weapons Proliferation And Organized Crime: The Russian Military and Security Forces."

In his study, Turbiville found that: In January 1991, UN personnel enforcing the arms embargo against Iraq found substantial quantities of Russian arms and other military items hidden on a Russian (Soviet) merchant ship in the Red Sea.

In East Germany, the sale of individual weapons by Soviet troops became notorious in the late 1980s and continued throughout the troops phased withdrawal. On a larger scale, an underground trade of heavy equipment ranging from armored vehicles to MiG aircraft has also been reported. This included some 81 tons of ammunition in early 1994.

In 1995, Russian presidential advisors Emil Pain and Arkadii Popov assessed, in a February 1995 report, that Chechen President Djokhar Dudaev acquired arms by "buying them from smart traders in military and other criminal actions by officials in Moscow..."

This weapons trade by Russia's military continues unabated to this day as current news reports indicate:

In February 2002, Russian Viktor Bout gave an interview to Ekho Moskvy, denying that he was a wanted arms trafficker. At the same time, the head of Russian Interpol was giving a press conference about 200 meters away, saying that Interpol's Russian section did not have any idea where Bout was hiding. Bout was the object of an Interpol alert on the basis of a Belgian arrest warrant for arms trafficking into Africa. He was not merely a run-of-the-mill trafficker, Bout was a major player in the international illegal arms sales business. Despite the Interpol Red Alert for him, the Russian MVD and FSB have not arrested him and turned him over to Belgium (see "RFE/RL Security and Terrorism Watch," 22 February 2002).

The evidence on Bout had been collected by the United Nations and presented to the UN Security Council on 26 October 2001 (Report of 26 October 2001, S/2001/1015). In this report to the Security Council it is stated: "Victor Bout and his partners, without the knowledge of the authorities in the Central African Republic, had produced many false permits for Centrafrican Airlines." These flights by Centrafrican were used to smuggle weapons. This was totally ignored, it seems, by the Russian government, their law enforcement agencies, and President Vladimir Putin. The UN investigation evidence showed that Bout was the main organizer of illegal arms sales to Liberia and other embargoed countries.

Bout's collaborators were arrested; one in Italy -- Aleksandr Minin, is in prison in Torino. Minin, a friend of Bout's and of many Ukrainian officials, has, it seems, become a "pentiti," "one who repents," in Italian. He apparently is telling Italian officials which Ukrainian citizens and officials were working with him.

The other Bout conspirators are in Belgian jails, among them Sanjivan Ruprah, one of Bout's closest colleagues from his African deals.

The Center for Public Integrity, a respected nongovernmental organization in the U.S., published a special investigative report on its website (http://www.public-i.org) on 31 January which linked Bout to arms sales to the Taliban and Al-Qaeda.

"Victor Bout, the Russian arms trafficker whose clandestine sales of weapons of war to some of the bloodiest regimes and rebels in Africa were exposed by the United Nations, had another secret client: he sold millions of dollars of arms to the Taliban in Afghanistan."

According to Belgian intelligence documents obtained by the Center for Public Integrity, Bout earned $50 million in profits for selling weapons to the Taliban in the late 1990s. Another European intelligence source independently verified the sales, and intelligence documents from an African country in which Bout operates -- obtained by the Center -- claim that Bout ran guns for the Taliban "on behalf of the Pakistani government."

COMMENTS WITHHELD

"[Iraqi] President Saddam Hussein received a written letter from President of Belarus Alexander Lokashinco (sic) on bilateral relations and ways of strengthening them. This came when President Hussein received on Tuesday Belarusian President's personal envoy, Deputy Chairman of Belarusian Presidency Office Mr. Lionid Kozik. The letter included [the] Belarusian President's greetings and best wishes to President Hussein on his Birthday and his high appreciation for President Hussein's brave heroic stands defending the national interests of the Iraqi people and the Arab nation. The letter also included Belarusian President's hearty wishes to President Hussein for happiness, good health and success in leading Iraq and achieving its legitimate aims and aspirations." -- Report from the Iraqi News Agency, 24 April 2002.