Strategic Sectors Law Update – First Commission Meeting of 2013 and Amendments to Law

On April 19, PM Medvedev held the first Foreign Investment Commission meeting of 2013. At the outset, Medvedev noted that Russia received over $50 bln in FDI inflows over the course of 2012. This statement is drawn from Central Bank of Russia (“CBR”) data, whose measurements often differ from other sources. For example, the OECD measured 2012 FDI inflows into Russia at $31.3 bln, while UNCTAD put the figure at $44.1 bln. By any measure, however, Russia experienced a decrease – ranging from 8 to 17 percent depending on the source – of FDI inflows in 2012. This is somewhat important because Kazakhstan and Ukraine received substantial increases of FDI inflows in 2012. And although those two countries receive much less FDI than Russia, they both have higher FDI as a % of GDP than Russia (i.e., a more ‘saturated’ FDI market). The downward trend is worrisome to Russia because it has yet to fulfill its potential as a recipient of FDI and has made foreign investment (particularly FDI) a linchpin of its economic modernization program.  Interestingly, Medvedev reported that the Commission has thus far issued decisions for $3 bln worth of deals, which amounts to anywhere from 6 to 10 percent of all FDI.

Deals Reviewed at the Commission Meeting

To date, the following deals were publicly reported as having been considered by the Commission at the meeting:

  • Polymetal Acquisition of Ural-MPG - the Commission approved the acquisition by Polymetal International plc of Ural-Metally Platinovoy Gruppy (Урал-металлы платиновой группы).
  • Asseco Poland Purchase of R-Style Softlab - the Commission approved Asseco Poland S.A.’s purchase of R-Style Softlab, a Russian developer of automated banking systems. The Softlab deal was covered by the SSL because Softlab works with encryption products.
  • Republic of Kazakhstan Gains Share of Urals Electrochemical Plant - the Republic of Kazakhstan received approval to acquire a 25 percent stake in the Urals Electrochemical Plant, which works with nuclear energy.
  • Abbott Proposed Purchase of Petrovaks Pharm - perhaps the most interesting story was the deal that was not approved. Specifically, American pharma giant Abbott was prohibited from acquiring Petrovaks Pharm (Петровакс Фарм), a manufacturer of vaccines. The deal between Abbott and Petrovaks was concluded in mid-2012. Abbott planned to use the acquisition as a way to localize production in Russia, where it currently does not have any factories. Coincidentally, the denial of Abbott’s application opens the door to a Russian pharma company – Farmstandart (Фармстандарт) – which is reportedly also seeking to acquire Petrovaks. Most importantly, this the first time that a the acquisition of a pharmaceutical company was denied on the basis of strategic, national security concerns. Petrovaks manufactures three medicines: Longidaze (treatment for connective tissue problems), Polyoxidonium (an antiflu treatment), and Grippol (a flu vaccine). Presumably, the denial of Abbott’s application was based on Petrovaks’ role in manufacturing Grippol.

Proposed Amendments to the Strategic Sectors Law (“SSL”) The Commission also addressed proposed amendments to the SSL, which have already been submitted to the Duma. I have created a copy of the SSL, which shows the amendments in redline format. Here is a summary of the main changes:

  • Tax Resident Exemption Clarification - in a previous post, I evaluated an earlier change to the SSL, which was intended to exclude from the law’s application transactions involving companies under the control of the Russian Federation and citizens/tax residents of the Russian Federation. The goal of the change was to exclude the many deals involving offshore entities ultimately owned/controlled by Russian businessmen and the government. Unfortunately, a wording error by then-President Medvedev’s team resulted in an ambiguous/incomplete remedy. The Medvedev team’s error consisted of one word – between (между) – immediately preceding the list of organizations to whom the law was intended not to apply. My understanding is that this word had the legal effect of limiting the exemption to transactions literally between the various entities indicated, rather than all transactions involving any of these entities. Thus, for example, if Rosneft would have purchased BP’s stake in TNK-BP via an offshore entity, it would have had to apply for approval by the Commission. My sources in Moscow tell me that the между problem was raised with Russian officials responsible for the previous amendments, who acknowledged the error but added that it would be unacceptable to point out the mistake because it came from the President. The pending amendments address the issue by deleting the между from the relevant section.
  • Definition of Control Broadened - the amendments broaden the understanding of ‘control’ over a strategic company to include situations where a written or oral agreement has been made to vote a certain way at meetings of shareholders, board of directors, etc. (bloc voting agreements).
  • Food Sector Excluded from Law - the law excludes the food/drink sector from the law. That sector had previously fallen under the law’s coverage via the ‘infectious agents’ category, as many food companies work with bacterial cultures related to dairy products, which are considered ‘infectious agents’.

TRM Comments on Meeting and Amendments

The Commission meeting and proposed amendments are remarkable in a few ways. At the outset, there is a continued recognition from the FDI numbers that Russia is (a) not returning to its pre-crisis FDI inflow levels and (b) not fulfilling its potential and stated goals in attracting foreign investment. Indeed, Medvedev implicitly conceded as much in his opening statements about how 2012 “was, of course, not very easy” in terms of foreign investment. So, the natural follow-up question: what is Russia doing to reverse these trends?

The Abbott decision does not bode well for several reasons:

  1. National Security Concept: in my opinion the vaccines industry is not unequivocally and inherently related to “national defense and state security.” Yes, people need vaccines to be healthy, and a country is incapable of self-defense if all of its citizens are dying or in the hospital because they lack access to vaccines. But there is no direct military application, such as the production of weapons or defense measures against biological weapons. That said, there is a way to look at having unquestioned and unlimited access to flu vaccine as a ‘state security’ issue – imagine a scenario where there isn’t enough Grippol at state pharmacies for Russian citizens in the midst of a deadly flu pandemic. In such a case, the Russian government would want to have as many pressure points as possible to apply to the manufacturer of Grippol, and Russian ownership = more pressure points. Still, this is a much broader concept of ‘national defense and state security’ than was promoted during the drafting of the SSL, and can be grouped with similar moves, such as the last-minute inclusion of media, internet, and fisheries.  
  2. Warning Shot to Western Pharma Companies: the decision also seems to me like a shot across the bow of western pharmaceutical manufacturers, who have experienced increasing pressure from the Russian authorities over the past several years. The pressure has included highly questionable interpretations of Russian antitrust law by the Federal Anti-monopoly Service (“FAS”) with respect to whether a given pharma company occupies a ‘dominant’ market position. In past cases, FAS has defined the ‘market’ to consist of one pharma company’s patented drug – even if competing treatments exist – which by definition means the pharma company the occupies a dominant position. Market dominance allows the FAS to deploy much more comprehensive and severe controls on a pharma company – e.g., interfering with the company’s right to choose its own business partners. More recently, the Russian government has proposed a requirement that government agencies and companies procuring a product may select a foreign source only if there is no equivalent product made in Russia (i.e., similar to ‘Buy American’ provisions of U.S. spending bills). Russian lawyers that I have spoken to indicated that this measure – although applicable to multiple categories of goods – is aimed primarily at western pharmaceutical companies. Now, the Abbott decision seems like another hostile message, even those ready to localize production.
  3. Written Law/Public Statements vs. Practical Realities: the Abbott case also underscores one of the central risks to doing business in Russia: the gap between written laws/regulations and public pronouncements welcoming investment, and the reality of coming up against local competitors with powerful connections and a paranoid government that has embraced the timeless Russian tradition of turning within in the face of threats, real or imagined.

Finally, the draft amendments reiterate the issues illustrated by Abbott. Namely, it took a nearly two years to eliminate one erroneously-placed word from the 2011 amendments, simply because flagging the issue with the president’s office was a nonstarter. Moreover, the only other substantive limitation of the SSL’s coverage found in the amendments relates to yogurt makers, who probably should not have been included in the first place. Indeed, one gets the sense that the Russians are experts at generating a never-ending stream of new laws, amendments, clarifications, etc. But even where changes to the written  law are significant – and they are not in this case – the underlying reality of everyday practice remains the same or grows worse. The unmistakable impassivity of Russian decision makers when facing one of their main economic/modernization challenges is discouraging.

As always, we end with a video of Medvedev from the meeting:

Posted in Business, Business and Economy, Economic development, economics, Foreign direct investment, foreign investment, Government of Russia, Law, legal update, legislation, pharma, russia, strategic industries

Should You Hire a Corrupt Manager in Russia?

That’s the provocative question raised by Prof. Maxim Mironov of IE Business School in a new paper, which I came across via this post at the Wall Street Journal. In short, Mironov concludes that yes, on occasion, it is worthwhile to hire a corrupt manager based purely on financial performance. Specifically, Mironov finds a positive correlation between smaller firms with corrupt managers and higher revenue growth. As a firm grows, however, the effect disappears (an important distinction WSJ failed to note). More on why this may be the case later.

What I find most interesting about Mironov’s work is its reliance on a large corpus of statistical data in order to make insights about individual behavior. This is not quite ‘big data’, but it is a similar concept and often tends to be perceived as having a more authoritative weight than analyses relying on other sources of information. Of course, the data is only as good as the model you plug it into, a concept that seems lost among the celebrations that liken big data to a contemporary Tower of Babel.

Mironov’s Model – Propensity to Corrupt

At the heart of Mironov’s analysis is what he calls an individual’s Propensity to Corrupt (“PTC”) – essentially, a score indicating how likely it is a given individual will pay a bribe.  How does one gather data that represents a statistical sample and breaks down on at the individual level? Mironov’s answer is driving records. Specifically, he first calculates the expected number of recorded traffic violations for each drive based on demographic variables. He then calculates the difference between the expected number of recorded violations and the actual number of recorded violations for a particular driver. The resulting number is that driver’s PTC (Mironov calculated the PTC for over 3 million Muscovites).

As you can see, the underlying assumption of the PTC is that, in aggregate, the most likely explanation for drivers having significantly less recorded traffic violations is that they paid bribes to traffic police to avoid an official fine. Mironov concedes, however, that it may also be due to “other unobservable characteristics related to driving safeness” (i.e., safer drivers have less traffic violations). But presumed corrupt payments are also an “unobservable characteristic”. This is where the data’s reliance on the model is made clear: the PTC is only as strong as the assumption that less violations generally equals more bribes.

Measuring PTC Effect on Firm Performance 

Next, Mironov tests whether PTC correlates with firm performance, where he correlates individual driving histories with employment records of the top five highly paid employees at Russian companies (in order to ensure that he is measuring the PTC of the firm’s management, and not rank and file employees). He then looks at those companies’ financial performance, both in terms of reported earnings and bank receipts. Including the latter measure avoids companies that underreport earnings to cheat on taxes, which you might expect from a company with corrupt managers. As mentioned above, he finds a positive correlation between PTC of top managers and a company’s revenue growth – both reported and in terms of bank receipts – for smaller companies.

Mironov also looks at the PTC for members of certain government agencies, and identifies the geographic jurisdiction of these agencies. He then measures the effect that PTC of a given agency has on firm performance in the jurisdiction. Unsurprisingly, he finds that more corrupt government agencies (i.e., higher PTC) are negatively correlated with revenue growth of firms within the agencies’ jurisdiction. In other words, contrary to the “efficient grease” theory of corruption cutting through red tape, bribe-seeking authorities tend to suppress economic growth at the individual firm level.

Explaining the Results

Mironov’s Explanation – Entrepreneurial Self-Selection 

To his credit, Mironov’s favored explanation for his findings is both unexpected and novel. He argues that, in a corrupt country such as Russia, creative/talented people with high moral/ethical standards prefer other professions to entrepreneurship. I am not sure I am completely convinced by this analysis, although we do know that “bureaucrat” has become the most desired job among Russians, for obvious reasons. So perhaps business attracts individuals with a higher PTC to begin with, which means businessmen with higher PTC are more motivated to be in their chosen profession, and thus perform better regardless (i.e., correlation of PTC with firm performance does not equal causation).

Predictive Value of Traffic Corruption

Another issue is that Russian traffic police are consistently ranked as one of the most corrupt institutions in Russia. Russian traffic police are also notorious for stopping vehicles for almost non-existent violations in order to hunt for bribes. In this situation, a driver may have a whole host of pressures pushing him towards paying a bribe to avoid a ticket (especially in the case of a shakedown) aside from a desire to avoid a legal impediment.

bribe requestors

Thus, it is debatable whether observed traffic corruption has any predictive value with respect to other forms of corruption (e.g., to obtain a building permit, win a contract).

Why Only Small Firms?

More importantly, Mironov’s results only applied to smaller firms, with revenues of USD 1.55 million or less, and particularly applied to firms with revenues between USD 117-217K (see graph).

ptc and rev growth by firm size

Why would smaller firms be more likely to reap the benefits of corrupt managers? There are several possible explanations:

  • With less revenues to speak of overall, the boost provided by an expedited building permit or electrical connection provide a proportionally greater boost to smaller firms as compared to mid-sized and large firms. In other words, smaller firms benefit from corrupt managers to a greater extent the same way they benefit from charismatic managers to a greater extent – the effects are magnified.
  • Smaller firms that have comparatively more interactions with government officials are in a ‘growth’ phase because they are opening new facilities, bidding for new tenders, importing more goods, etc. Thus, higher growth results in more bribe demands, which require more corrupt managers. Here, high growth and corrupt managers have a symbiotic relationship.
  • Smaller/medium may also face more corrupt demands overall than their larger peers. Indeed, the most recent data from the World Bank’s Enterprise Surveys indicates that medium enterprises (20-99 employees) are much more likely to be expected to give gifts to secure a government contract, secure an electrical connection, or obtain an operating or import license.    
  • Larger firms may also be deeper into its corrupt relationship with government officials, and perhaps with a greater number of officials. Rather than the demands ceasing once payment is made, companies pay a continually greater share as they grow until their obligations to corrupt officials create a natural limit to high growth.

Other Considerations

There are other considerations that should give companies pause before embracing corrupt managers. The obvious one is that bribery is illegal under Russian law, and most foreign companies have laws in their home countries prohibiting bribery abroad. Also, although bribery is common in Russia, it is not socially acceptable (and in fact has become less so over the past four years). Thus, a manager willing to engage in corrupt behavior is signaling a general openness to violate general ethical/moral principles, including those that  protect the company (e.g., theft). A morally ambiguous manager’s behavior will set the standard for employees down the line, and the result in many cases will be a rotten culture that is not easily eradicated. 

Posted in bribery, bribes, bureaucracy, Business, compliance, corruption, officials, rule of law, russia | 1 Comment

War on Corruption – What to Make of the Latest Scandals?

Update: for the Russian speakers, today Kommersant put up an excellent resource on its website, with an infographic on the latest scandals and corruption generally, and links to articles on everything I cover below. Of particular interest – the total financial losses collectively inflicted by the major scandals amount to RUR 57 billion (roughly USD 1.85 billion), a number that is about equal to the GDP of Liberia.

As Russia observers have probably noticed by now, several high-level corruption scandals have recently emerged in rapid succession, rattling elites and analysts alike. The major scandals are:

  • Anatoly Serdyukov, Minister of Defense: Serdyukov was fired after a dawn raid of a real estate company involved in the privatization of Defense Ministry land near Moscow. The former Head of the MOD Property Department – Evgeniya Vasilyeva – has been been arrested and charged with committing fraud of a high degree as part of a criminal group (she is also reportedly Serdyukov’s mistress). Officials from the various companies involved have also been arrested. Most recently, Serdyukov was forced out of his position as chairman of the board at Rostekhnologii.
  • Rostelekom Boss Raided: the homes of Alexander Provotorov, the chief executive of Rostelekom, and Konstantin Malofeyev, a minority shareholder, were raided in November. It was later reported that Malofeyev is under investigation for illegally receiving – through his company Marshall Capital Partners – $200 mln from VTB credit. Provotorov is only a witness in the case. Later reports, however, suggested that Provotorov and Malofeyev could come under scrutiny for contracts awarded to a ‘favored’ contractor – Infra Engineering – which is in fact beneficially owned by Marshall Capital and top Rostelekom management. These allegations were contained in a complaint to the Federal Antimonopoly Service on November 21 – just two days after the raids on Provotorov and Malofeyev’s homes.
  • Former Minister of Agriculture: the former Minister of Agriculture (2009 – May 2012), Elena Skrynnik was accused at the end of November of involvement in a fraud during her tenure as head of Rosagrolizing (2001-09). The allegations involve three contractors that issued false invoices purporting to have delivered equipment to farms and factories. The money was then transferred to offshore accounts. Another former official – Oleg Donskikh – has also been accused of involvement in the scheme. For her part, Skrynnik has denied the allegations and returned to Russia voluntarily (she was in France when the allegations were released on state-owned TV). Also, others have come forward to her defense, claiming that the alleged losses caused by the false contract scheme did not occur until after Skrynnik had left Rosagrolizing. Her cause, however, was not helped by a series of photos released by Komsomolskaya Pravda, which showed her wearing multiple watches that cost anywhere from EUR 40-50k, and otherwise not looking very much like someone (a) living on a government salary and (b) engaged in serious work on behalf of the Russian people (in her defense, it was her birthday party).
  • St. Petersburg Pipe Scandal: in late-November, a massive operation involving 200 investigators was launched in St. Petersburg against a ‘criminal group’. According to investigators, “tens of officials” from city government committees and municipal entities engaged in a widespread fraud related to the repair of the city’s heat supply system. Contractors hired by the city officials to perform the work procured broken and unqualified pipes for the system, using forged certificates of quality to avoid detection. The monetary damages caused by the fraud are estimated at RUR 3 bln (around USD 97.5 mln). The silver lining to this scandal is that the investigation was personally initiated by the Governor of St. Petersburg, Georgy Poltavchenko. Poltavchenko reportedly even escalated the issue to investigators in Moscow after he was not satisfied with the work of St. Petersburg investigators. Another interesting side-note: one of the individuals arrested in the raid was Andrey Kadkin, the business partner of Arkady Rotenburg, a childhood friend of Pres. Putin whose wealth has grown exponentially during the Putin era.
  • GLONASS Corruption: in early November, the MVD announced a criminal case based on the theft of RUR 6.5 bln (approx. USD 211 mln) related to construction of the Russian GLONASS system (the Russky version of GPS). Subsequently, the General Constructor of the GLONASS system, Yury Urlichich, was fired from his post by Vice-PM Dmitry Rogozin. Interestingly, Head of the Presidential Administration, Sergei Ivanov, told the press that he knew about the issue as far back as 2010, but could not discuss it publicly because he did not want to interfere in the investigation. Fittingly, the latest launch of a GLONASS satellite was cancelled in early December due to “technical problems” with the acceleration unit on the satellite.
  • Chairman of Permsky Krai Administration: the Chairman of the Permsky Krai administration, and former Deputy Head of Ministry of Regional Development, Roman Panov, was arrested in early November for his involvement in a scheme to defraud regional funds amounting to approximately RUR 93.3 mln (approx. USD 3 mln). Panov and his co-conspirators allegedly organized public tenders for engineering and technical maintenance of facilities construction for the upcoming APEC summit. They then ensured that firms controlled by them won the tenders, to which the funds were transferred. The work, however, was never performed and in fact very same contracts had earlier been completed by other companies.

And these examples are just what happened in the last month. Indeed, sources from within the investigative agencies claim that they have been given “carte blanche” to go after corrupt bureaucrats, regardless of rank. The MVD sources did not elaborate on the nature of the “signal” they received from the Kremlin – whether it was an implicit approval by omission or an explicit directive to step up the war on corruption (although they are most likely referring to the Serdyukov revelations being made public on the state TV channel Russia 1). Unnamed administration officials confirmed that MVD received a signal that the “administrative resource” would not be used to put any corruption investigations on ice. The case against Skrynnik, however, is cited as an example – apparently the investigation was completed several years ago, at which point it began to “accumulate dust” until the allegations were made public last month. The same principle may apply to the GLONASS case as well, which apparently has been under investigation since at least 2010. Putin himself stated publicly that the corruption investigations will be “pursued to completion in accordance with the law.”

The volume of new scandals in such a short time and the level of the officials involved are unprecedented in the Putin era. Naturally, this caused domestic and foreign observers’ heads to collectively explode in trying to explain what is happening. Here are the main theories:

  • PR Stunt Gone Wrong/Right – the first theory is that the revived war on corruption is really a PR stunt by Putin, perhaps aimed at boosting sagging ratings, which has spiraled out of control as different clans have started taking advantage of it to settle scores and jockey for position. Alternatively, Putin actually wants to “clean house” and is using the war on corruption as a smokescreen. Ordinary Russians, indomitable cynics, agree with this theory (at least with respect to the Serdyukov case). Ironically, 66 percent of Russians also approve of Serdyukov’s firing.
  • Neutralizing Navalny – other observers – especially Russian liberals – have argued that Putin’s new embrace of the war on corruption is designed to co-opt the opposition, which has made corruption a signature issue. Putin’s goal, however, is not to actually fight corruption, according to this school of thought. Rather, they claim that Putin is trying to reconcile the contradictions between his two pillars of support: (i) the Russian people, a majority of which both support him but likewise are outraged at corruption; and (ii) the members of the bureaucracy, who use their positions as both an official and unofficial source of income. In this artful metaphor, if Putin leans too far towards one pillar, the greater the risk that the other pillar will collapse. So Putin needs to appear to be taking serious action against corrupt officials, all while maintaining the support and cooperation of political elites and the bureaucracy.

Meet the New Boss?

One significant fact about these corruption cases – they are all under the still-young tenure of Vladimir Kolokoltsev, the Interior Ministry head who replaced the deeply hated Rashid Nurgaliyev in May of this year during the cabinet reshuffling following Putin’s resumption of the presidency. Kolokoltsev served in the Moscow police from 1982 to 2001, where he spent most of his time fighting organized crime, and then transferred to the Central Federal District. In 2009, Kolokoltsev was promoted to head of Moscow MVD after an off-duty Moscow police officer went on a drunken rampage in a Moscow supermarket.

Before returning to Moscow in 2009, however, Putin appointed Kolokoltsev head of the Orlov Oblast MVD in 2007. Interestingly, while in that position Kolokoltsev brought a number of criminal cases against regional officials – including two vice-Governors – and affiliated businessman, all of whom were thought to be at the bottom of a pyramid that had Orlov Governor – Egor Stroev – sitting on top. As one Orlov City Council Deputy put it, “You could say he threw out the representatives of the criminal world by the ears, as well as the bribe-takers from the team of the former governor.” Indeed, many observers say that the corruption scandals surrounding Stroev hastened his fall from power – he resigned “of his own volition” in February 2009. Shortly after, then-Pres. Medvedev summoned Kolokoltsev back to Moscow, where he served until being tapped to head the Interior Ministry this summer.

Kolokoltsev’s background suggests he does not come from any of the various “clans”, but rather is Putin’s own man because he owes his career to Putin. Indeed, this was the conclusion in a report/presentation released earlier this year entitled  Politburo 2.0  and generated a lot of attention in Russian political circles. Discussing the “new blood” in the current Putin administration, the author of the report stated that Kolokoltsev “personally connects” with Putin, “not with the group of Security Council Secretary Nikolai Petrushev.”

The implication of Kolokoltsev as Putin’s man – not unlike Medvedev – is that the anticorruption drive unfolding at the moment is precisely what Putin wants, regardless of his motives, and contradicts the theory that a clan war has “spun out of control.” If so, does this signal the return of Putin the chess master, and does it validate – from the pragmatic perspective of an authoritarian technocrat – his decision to return to the presidency? Indeed, it is difficult to imagine Dmitry Medvedev ever successfully presiding over the prosecution of such high-level officials.

Posted in bribery, bribes, bureaucracy, clans, corruption, criminal law, Dmitry Medvedev, mvd, Putin, Rostekhnologii, russia, siloviki, Vladimir Putin, war on corruption | 1 Comment

Strategic Sectors Law Update – Third Commission Meeting of 2012

On November 28, 2012, PM Medvedev chaired a session of the Commission on Foreign Investment, the third time the Commission has met this year.

Changes to Russia’s Business Environment

In his prepared remarks, Medvedev noted Russia’s recent improvement in the World Bank’s Doing Business rankings, which evaluate the ease of doing business with respect to several areas (e.g., trading across borders, construction). Russia was ranked 112th out of 185 countries this year, rising from 118th place last year. As Medvedev himself noted, “[i]t’s modest growth, but growth all the same.”

Medvedev highlighted changes to Russia’s tax system, where Russia displayed particularly significant improvement over the past year, moving up 30 spots on this measure alone. Russia also improved modestly in the area of dealing with construction permits, where it has performed remarkably poorly ever since the rankings started keeping track.

Unfortunately, Russia’s rankings fell in the categories for trading across borders and protecting investors. The fall in trading across borders may be a side-effect of changes to the customs code over the past year, and resulting hiccups related to implementation. The negative trend for protecting investors, however, is more concerning especially because this is one of the highest-profile problem areas with Russia’s business environment, both for domestic and foreign investors. Also worth noting is the lack of change in Russia’s ranking for getting electricity, where it ranks at an abysmal 184/185. Russia’s laughably complicated construction and electricity procedures are especially frustrating in light of the frequent accidents related to violations of safety standards. The poor rankings also illustrate that many of the deficiencies of Russia’s business environment are ‘low-hanging fruit’ that can in principle be fixed with minimal legal and regulatory disruption.

Proposed Strategic Sectors Law (SSL) Amendments

After the meeting, FAS Head Igor Artemyev summarized several proposed amendments to the SSL. Specifically, the amendments include the following changes:

  •  Bacteriological Food Products: in the past, there have been some major foreign investments in Russian manufacturers of dairy products (e.g., Coca-Cola purchase of Nidan, Danone purchase of Unimilk). These deals required approval from the Commission because Art. 6.3 of the SSL included “activities connected with the use of infectious disease pathogens” (i.e., including bacteria cultures used in production of dairy products like yogurt). Foreign investors will no longer be required to obtain the Commission’s approval for companies involved in the use of “Third and Fourth hazard category” bacteria (the least dangerous categories).
  • Offshore Rule Expanded to Regions: the recently adopted federal rule – which was a part of the 2011 amendments to the SSL – excludes from the SSL’s scope any foreign investments made by offshore entities (i.e., non-Russian legal entities) that are controlled by “tax residents of the Russian Federation” (TRM’s analysis of this provision, here).
  • 75 Percent Rule: foreign investors already owning 75+ percent of a strategic enterprise will no longer have to apply for approval from the Commission if they wish to increase their stake up to and including 100 percent.
  • Permit Extension: foreign investors that have already been issued a permit (typically with a 2-year term) to invest in a strategic enterprise, may at the end of the term request that the permit be extended from 2 to 5 years without obtaining approval from the Commission (it appears that the extension is requested from and granted by FAS directly).
  • “Coordinated Actions” Principle Eliminated: as the SSL was drafted by FAS – the regulator responsible for enforcing Russian antimonopoly law – it originally contained various references to the principle of “coordinated actions” (согласованные действии), from Art. 8 of the Law on Competition. Coordinated actions are essentially analogous to collusion – e.g., an agreement between one or more companies to set a price floor for goods that they all sell. The confusion arose from Art. 8.8 of the SSL, which required applications for foreign investments to include details on coordinated actions having “substantial influence on the activity of a strategic enterprise.” Also, Art. 13.6 of the SSL permitted FSB investigators to evaluate “coordinated actions” by a foreign investor and third parties, specifically to see whether they are aimed at establishing control over a strategic enterprise. Including these references to coordinated actions implied that control over a strategic enterprise under the SSL could be obtained by a foreign investor acting in a mutually beneficial way with a third party. Naturally, such a principle could lead to absurd results where a Russia co-investor’s ownership would be imputed to the foreign investor simply because the two act in a collaborative manner in relation to the strategic enterprise.

According to Artemyev, the government expects the new SSL amendments to be introduced into the Duma within the next few weeks, and adopted and signed into law within the next six months.

Deals Reviewed at the Commission Meeting (as of publication)

  • Pacific Andes: at the last meeting in August, the Commission took note of Pacific Andes Int’l Holdings Ltd., a HK/PRC company, which allegedly obtained control over several Russian fishery companies (specifically, those harvesting Pollock). At the August meeting, the Commission instructed unspecified “ministries and governmental agencies” to undertake “certain measures to bring operations of these companies in line with the current law of the Russian Federation.” At the meeting on November 28, the Commission determined that Pacific Andes’ acquisitions were illegal because they were made in noncompliance with the SSL (Pacific Andes did not apply for Commission approval).
  • Telenor-Vimpelcom: the Commission recognized the validity of all deals involving Norwegian telecom Telenor’s acquisition of shares in Russian telecom Vimpelcom. Telenor originally raised its stake in Vimpelcom from 25 percent to 36.6 percent, making it the company’s largest shareholder. It later raised its stake to 39.5 percent through an option with JP Morgan, and then 42.9 percent through an option with Weather Investments. Altimo – the telecom division of Russian conglomerate Alfa Group – complained that Telenor’s exercise of its options violated shareholder agreements, while FAS went to court claiming that the share purchases resulted in Telenor’s acquisition of control over Vimpelcom, and thus should have been approved by the Commission. The Commission and FAS later conditioned retroactive approval of Telenor’s share purchases on there being parity between the Russian and foreign Vimpelcom shareholders. In November 2012, Altimo purchased an additional 5.95 percent of Vimpelcom shares, bringing its total to 47.85 percent, at which point the FAS withdrew its claims against Telenor.
  • Gharysh Sapary: the Commission approved the acquisition of 23 percent of Kosmotras (Космотрас) by a Kazakhstan state-owned company, Gharysh Sapary (Гарыш Сапары), which is working on a joint Russian-Kazakh-Ukrainian project, Dnepr (Днепр).
  • Russian Sea: the Commission approved the acquisition of OAO “Arkhangelsky Tralovy Flot” (ATF) (Архангельский траловый флот) by OOO “Russian Fishing Company” (Русская рыбная компания), which is a subsidiary of Group of Companies “Russian Sea” (ГК “Русское море”). The deal, which came about through a privatization auction, was approved because the shareholders of Russian Fishing Company are Russian citizens.

As always, we end the post with some video from the meeting:

Posted in Business and Economy, Dmitry Medvedev, duma, Economic development, FAS, federal laws, Foreign direct investment, foreign investment, Government of Russia, Law, legal update, legislation, offshore, Russian economy, strategic industries

The Engineer’s Plot

Apologies for my absence from blogging over the past few months. I’ve been traveling and generally busy with work. I promise to provide some update on the strategic sectors law and Russia’s anticorruption efforts soon. In the meantime, here is a classic – the episode ‘The Engineer’s Plot’ from Adam Curtis’ documentary, Pandora’s Box. It’s all about the strange results of the planned economy under the Soviet Union (spoiler alert: Magnitogorsk was modeled after Gary, Indiana).

Video | Posted on by

Strategic Sectors Law Update – Second Commission Meeting of 2012

On July 30, 2012, PM Medvedev chaired a session of the Commission on Foreign Investment. This is the second Commission meeting of 2012, but the first chaired by Medvedev. In his remarks, Medvedev largely rehashed Putin’s presentation at his last Commission meeting, specifically describing the general situation of foreign investment in Russia.

Below is a list of deals that, according to public sources, were considered at the meeting:

  • Astrakhan, Chita, and Tomsk Airports - the Commission approved the acquisition of shares in OOO “Aeroport Tomsk”, OAO “Aeroport Chita”, and OAO “Aeroport Astrakhan by T.S. Trans Siberia Co. Ltd. (Cyprus),which is believed to be affiliated with Roman Trotsenko, founder of Aeon Corporation and former President of state-owned United Shipbuilding Corporation (“USC”). Aeon Corporation’s airport holdings are in turn owned and managed by Novaport. T.S. Trans Siberia won an auction to purchase a majority of the Astrakhan airport held by the Federal Property Management Agency (Rosimuschestvo) late last year (it’s unclear whether similar auctions were held for the other airports).  The interesting thing about T.S. Trans Siberia is that it is not entirely clear who owns it. According to Izvestia, in the Cypriot corporate registry, two owners are listed: Golburn Trading Ltd. and Mittelmeer Nominees Ltd. The actual owner of Golburn is Anatoly Matveenko, about whom little is known aside from his frequent affiliations with companies owned or controlled by Roman Trotsenko or Trotsenko family members. Mittelmeer Nominees – the other 50 percent owner of T.S. Trans Siberia – is reportedly a nominal owner. The real owner is in fact another Cyprus company – Legniton Ltd., which is apparently owned by Saut Mynbaev, the Minister of Oil and Gas of Kazakhstan, and two other Kazakh businessmen. These individuals also allegedly own Meridian Capital, which in turn owns 50 percent of Novaport (the other 50 percent reportedly controlled by Trotsenko). Formally, Novaport has one owner: yet another Cyprus company, M.M. Airport Management Company Ltd. Trotsenko, for his part, abruptly resigned from USC last month, apparently resulting from a dispute with Vladimir Lisin, who replaced Igor Sechin on the USC board. Trotsenko will reportedly move into a new position as advisor to Sechin on the Rosneft board.
  • TNK-BP Purchase of Refueling Complex at Sheremetyevo – the Commission approved LLC TNK-Sheremetyevo – a subsidiary of TNK-BP Holing – acquiring a 74.9% stake in ZAO “Toplivozapravochny Kompleks Sheremetyevo,” a jet fuel storage and refueling operator for $200mln.
  • Telenor Dispute - FAS reported on its attempts to negotiate with the shareholders of Vimpelcom on resolving violations of the Strategic Sectors Law. FAS reportedly agreed to withdraw claims that the Norwegian Telenor illegally increased its stake in Vimpelcom under one condition: a Russian citizen must head Vimpelcom. So far, this offer does not seem to have settled the dispute.
  • Chinese Fishing Scofflaws - the Commission took note of Pacific Andes Int’l Holdings Ltd., a HK/PRC company, which has allegedly obtained control over several Russian fishery companies (specifically, those harvesting Pollock). At the meeting, the Commission instructed unspecified “ministries and governmental agencies” to undertake “certain measures to bring operations of these companies in line with the current law of the Russian Federation.”
  • Iranian Sanctions Evaders - the Commission also reviewed an issue involving Iranian companies that reportedly established control of OAO “Astrakhan Port,” in violation of sanctions imposed on Iran. The Commission stated that documents are being prepared to file a lawsuit in order to hold the transactions void.
  • Helivert-AgustaWestland Deal - for some reason, the Helivert joint venture was mentioned at this Commission meeting, even though it was already approved at the previous meeting.

Comments

First, this being PM Medvedev’s first Commission meeting, the amount of bad news dealt with at the meeting is significant. It’s almost as if they decided to discuss the Helivert deal – which was approved at the last meeting – in order to brighten up the mood. My personal guess is that Putin left all of the unsavory issues for Medvedev to deal with.

Second, it is worth noting that not a single “genuine” foreign direct investment was approved/announced at the meeting – if memory serves, Putin always had at least one deal to hold up as an example of the Strategic Sectors Law facilitating investment into Russia.

Third, the airports deal involving the multitude of Cypriot companies is yet another shady deal involving offshore companies controlled by Russian government officials/oligarchs. The structure of these deals, which often involve the sale of government shares, suggest that privatization is alive and well in Putin’s Russia, and is just as non-transparent as in the Yeltsin era.

As always, we end with some video from the meeting:

Posted in Business and Economy, Dmitry Medvedev, economics, FAS, fish, Foreign direct investment, foreign investment, goskorporatsii, infrastructure, Law, legal update, Medvedev, offshore, oligarchs, russia, Russian economy, state corporations, strategic industries, Vedomosti

Legal Update – New Law on “Foreign Agent” NGOs

On July 21, Pres. Putin signed the much-discussed amendments to the Law on Nongovernmental Organizations (or, Noncommercial Organizations as their called in Russian). Given the back-drop of protests and other opposition activity, the new law generated more interest than usual, both in Russia and abroad. Indeed, both Russian activists and the U.S. State Department criticized the law, and many Russian NGOs have pledged non-compliance with its provisions. The NGO law has been in the works for a long time, with Pres. Putin warning NGOs from receiving foreign funds as early as 2005. At that time, Putin justified his position by stating, “He who pays the piper calls the tune” (Кто платит, тот и заказывает музыку). Coincidentally, this same phrase was invoked by Sen. Konstantin Tsybko and again by Putin, during consideration of the current NGO law (as well as by Putin spokesman Dmitry Peskov during a New Yorker interview last year, regarding state funding of television stations). Vedomosti Opinion editor Maxim Trudolyubov wrote an interesting piece on the “piper principle” that infuses Putin’s thinking.

What is in the NGO Law

Most important, the NGO law is not itself a stand-alone law, but rather a number of amendments to existing legislation. The NGO law is thus organized into four substantive sections, each amending a different, existing Russian law. Below is a summary of the amendments, broken down by the existing laws they amend:

Article 1 – Amendments to the Law “On Public Associations”

  • New Registration Requirements – in order to obtain legal status, a public associations must register with the Russian government. This registration process now includes a requirement that the public association declare its inclusion on the list of NGOs serving as a “foreign agent.” A public association serves as a “foreign agent” if it receives money or other property from foreign sources and engages in political activities (more on this in the “On Noncommercial Organizations” section below). A public association must also inform the federal registration body, in a form and time determined by that body, about the volume of money or property received from foreign sources, the purposes for which this money/property was intended, and the actual uses of the money/property.
  •  Limitation on Activities Prior to Registration - public associations serving as a “foreign agent” and participating in political activities must register prior to engaging in said political activity. Informational materials (i.e., on size/sources/purposes/expenditures of funds) must be provided on a quarterly basis.
  • Money Laundering / Terrorism Hook – the NGO law adds a requirement that the federal agency responsible for monitoring money laundering the financing of terrorism in Russia inform the federal registration body when a public association is in non-compliance with Russian law, either at the federal registration body’s request or on its own initiative.

Article 2 – Amendments to the Law “On Noncommercial Organizations”

  • “Foreign Agent” Provision – the heart of the law. This new provision defines and NGO as “serving as a foreign agent” when it (1) receives money or property from foreign governments, international organizations (e.g., UN, World Bank), foreign organizations, foreign citizens, stateless individuals, or Russian citizens receiving money or property from the aforementioned sources, and (2) engages in political activities (aside from political parties). An NGO is deemed to be engaged in political activities when, regardless of the goals stated in its charter documents, the NGO organizes and participates in political acts, aimed at influencing decision-making by public authorities, intended to change government policy, or intended to shape public opinion with respect to government decision-making or policy. Political activity does NOT include activity in the following fields: science, culture, art, health, social support, defense of motherhood/children, support for the disabled, environmental protection, philanthropy, and volunteerism.
  • Registration Requirement – similar to the public association requirements, NGOs serving as “foreign agents” must register as such.
  • Accounting Provisions – the NGO law subjects NGOs serving as “foreign agents” to mandatory statutory audits. Such NGOs also must submit a variety of documents and information to the government, including: sources, purposes, and actual uses of foreign money/property (quarterly basis); the composition of board/management bodies of the NGO (every 6 months); and an auditor’s report (yearly). The state entity to which these documents are provided may publish this information on its website or provide them to the media.
  • Audit Provisions – the NGO law also provides for planned and unplanned audits of NGOs serving as “foreign agents.” Planned audits may not occur more than once a year.  Unplanned audits, however, can be conducted on the basis of one of several circumstances: (1) expiration of the period within which an NGO is supposed to correct an alleged violation; (2) receipt of information from applications/declarations by citizens or mass media indicating that a “foreign agent” NGO is “extremist”; (3) receipt of information from government agencies that a “foreign agent” NGO is violating Russian law; or (4) an order issued by the head of the state authority responsible for overseeing “foreign agent” NGOs.
  • Suspension of Activity – if a “foreign agent” NGO fails to register with the state authority, it is prohibited from participating in mass/public rallies and from using bank deposits except to pay for day-to-day expenses and taxes.
  • Money Laundering / Terrorism Hook – same as section above
  • Public Warning – NGOs serving as “foreign agents” must include a warning label stating as much on any materials distributed through the mass media (including the internet).
  • Religious Organization Exemption – the NGO law explicitly exempts religious organizations “registered in the established legal framework” from the new “foreign agent” provision
  • State Corporation Exemption – the NGO law explicitly exempts from the “foreign agent” provision: state corporations (государственные корпорации), government companies (государственные компании), and NGOs created by them, and government and municipal institutions (государственные и муниципальные учреждения).
  • Business Groups Exemption – the NGO law explicitly exempts employer associations (объединения рабодателей) and chambers of commerce (торгово-промышленные палаты) from the “foreign agent” provision

Article 3 – Amendments to the Criminal Code of the Russian Federation

  • Illegitimate NGO Creation – a new criminal violation, for creating an NGO that threatens violence to or the health of citizens, carries with it a fine of up to RUR 300k or 4 years imprisonment. Creating an NGO that urges citizens to not perform their civic duties (гражданские обязанности) or other illegal acts carries a fine of RUR 200k or three years imprisonment. Participating in the activities of either of the previous two types of NGOs carries a fine of RUR 120k or 2 years imprisonment.
  • Willful Refusal to Comply with “Foreign Agent” Requirements – willfully refusing to comply with the requirements of the “foreign agent” provisions of the NGO law carry fines of up to RUR 300k or imprisonment or corrective labor (исправительная работа) of up to two years.

Article 4 – Amendments to the Law “On Combating Money Laundering and the Financing of Terrorism”

  • Obligatory Monitoring of Foreign Donations – foreign donations exceeding RUR 200k (around $6k) are now subject to obligatory monitoring.

Analysis

Based on the text of the NGO law, it is difficult to disagree with the law’s critics, who claim that it amounts to a wholesale attack on Russian civil society. The Bellona Foundation – an Environmental NGO based in Norway – wrote a detailed post on how the NGO law would affect organizations like itself, and some useful analysis as well. Other useful English-language analyses can be found here and here

Expansive Coverage

One point that stands out is the broad range of activities to which the NGO law could apply because of the expansive definition of “political activity.” Moreover, the NGO law contains an inherent contradiction in that it applies to NGOs regardless of their stated goals, while creating a categorical exception for a host of organizations of a religious, business, scientific, etc., nature. Thus, it is not clear whether a religious organization, by definition, is not subject to the “foreign agent” provision, or if it could be subject to that provision if it is found to be a religious organization that also happens to engage in political activity. My guess is that the latter applies.

Exceptional Exceptions

The exceptions themselves are fascinating and perhaps reveal something about the mindset of the Russian political elite. Aside from exempting state corporations – wouldn’t knowing the foreign sources of their funding serve the public interest? – the choice of expressly exempting religious organizations and business lobby groups is interesting. First, it is notable that the Russian orthodox church is one of the most trusted institutions in Russian society, and likely receives significant funding from abroad. Second, Russia is still trying to prove to foreign investors that it is a great place to put their money. Thus, the NGO law’s explicit exemption of these groups from the “foreign agent” provision seems like a “divide and conquer” strategy aimed at nudging these groups towards siding with the current regime over the opposition. But, as noted above, the NGO law still likely applies to religious and business groups engaged in “political activities,” making this a Faustian bargain indeed.

U.S. Law Copy?

Unsurprisingly, the negative reaction to the NGO law has generated replies that the law is an “exact copy” of the U.S. Foreign Agents Registration Act (FARA) (this is a good example of Russian “whataboutism“) . The Russian Legal Information Agency (RAPSI) already pointed out some differences between the two laws. Perhaps the most important distinction, however, is to which types of political activity the two laws apply. Whereas the Russian NGO law applies to political activity generally, so long as the NGO receives foreign funding, FARA applies to “political activities for or in the interests of … [a] foreign principal.” In other words, the U.S. government must demonstrate that the person or organization receiving the foreign funding is engaging in political activities on behalf of the source of that foreign funding in order for FARA to apply. One would assume that the Russian government would wholeheartedly accept a similar foreign principal-local agent nexus requirement, given that it believes opposition NGOs are acting on behalf of the State Department and other foreign interests.

“Piper Principle” Policy – Recipe for Failure

Perhaps the most telling fact about the law is the conspiratorial worldview it reflects, in which any foreign funding – even from, e.g., the UN – is equated with nefarious purposes. To be sure, Russia should have – and does already have – laws aimed at preventing improper influence on its government, including from abroad. But there is no evidence that (1) NGOs receiving foreign funding are systematically doing the bidding of foreign masters or (2) that the law could not be narrowly tailored to address only instances where an NGO acts on behalf of a foreign principal. Given the context in which it was adopted, it is more likely that the NGO law is aimed at deligitimizing legitimate critiques of Putin and the power vertical. The easiest way to accomplish this is through bureaucratic harassment and using the “foreign” label, which is actually quite popular with most Russians.

The problem with this strategy is that Russia cannot – to borrow another folk saying – have its cake and eat it too. As Russia’s leaders know, the modernization of its economy requires more interactions abroad, not less – both in terms of trade and investment. By fueling jingoistic attitudes to serve short-term political goals, Russia’s leaders will undermine the country’s long-term development goals.

Posted in Law, legal update, legislation, NGOs, russia, state corporations | 4 Comments