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

Strategic Sectors Law Update – First Commission Meeting of 2012

Last month, then-PM Vladimir Putin chaired his final meeting of the Commission on Foreign Investment Oversight (at least until 2024 barring any change to the makeup of the Commission). Indeed, the Commission meeting was one of the final significant acts by PM Putin, at least judging by his public calendar. There is a certain degree of historical symmetry to timing of the meeting: then-Pres. Putin signed the Strategic Sectors Law in the last three days of his presidency in May 2008. Perhaps because this was his final meeting – or perhaps due to the lack of applications to discuss – Putin opened the meeting with some general remarks on the application of the law over the past four years:

“As a matter of fact, a new mechanism has been created and tested for attracting foreign investment and granting foreign companies access to operate in strategic sectors of the Russian economy. Since it was formed four years ago, the commission has considered more than 140 applications from foreign companies and investors. An overwhelming majority of those applications has been approved.”

In some ways, Putin’s observations are correct. The SSL did fill a legal/regulatory void that existed prior to its enactment, which meant that ‘strategic’ investments were subjected to informal negotiations and political interference (the Siemens-Power Machines case being the most famous example). On the other hand, Putin’s comments are premised on a belief that the list of strategic industries is as narrow as possible. Surely more foreign companies would invest in Russia’s media and fishing industries if they were not deemed ‘strategic’. Moreover, based on media reports of Commission meetings, we know that many – if not most – of the applications reviewed by the Commission have in fact been submitted by offshore entities controlled by Russian oligarchs (including Putin friends Timchenko et al). Thus, to say that the SSL is a mechanism for attracting foreign investment is a bit of a stretch, and Russia still has a lot of ground to cover in improving its investment climate.

Some other interesting statistics on the Commission’s work over the past four years:

  • 140 applications have been considered by the Commission
  • 132 applications received preliminary approvals, 26 included preliminary obligations
  • 8 applications were denied, and 26 applications were abandoned by the applicants
  • 38% of applications related to the extractive industries sector
  • 21% of applications related to companies with encryption licenses
  • 11% of applications related to natural monopolies
  • 10% of applications related to companies that work with infectious agents
  • 9% of applications related to media companies
  • 6% of applications related to companies active in the defense sector

Applications Reviewed at the Meeting

Below are several of the deals that have been publicly reported so far.

  • Changi Airport Group (CAG) - the Commission approved the Singaporean CAG’s acquisition of 30 percent of the shares of Sochi International Airport (Международный Аэропорт Сочи), Krasnodar International Airport (Международный Аэропорт Краснодар), and Anapa Airport (Аэропорт Анапа) from Oleg Deripaska’s holding company, Basic Element (Базовой Элемент). Interestingly, the approval was subject to several obligations on the part of CAG to maintain the secrecy of certain airport operations and to immediately comply with any orders in the event martial law is declared. Indeed, the Russian Ministry of Defense came out in opposition to CAG’s acquisition of shares in the Sochi and Anapa airports because they are used for defense purposes, in addition to civil aviation.
  • AgustaWestlandthe Commission approved AgustaWestland’s (Italy) acquisition of 50 percent of the shares of Helivert (Хеливерт), a Russian helicopter company. The purpose of the deal is to form a joint venture for the production of AW139 civilian helicopters in Podmoskovye, Russia.
  • Othersthe Commission also reportedly approved Norilsk Nickel’s acquisition of Taymyr Gaz (Таймыргаз) and “a number of deals by TNK-BP”, although the details of these transactions are not available.
More recently, the Russian government announced plans to include internet companies (e.g., Yandex) in the list of ‘strategic’ companies, thereby requiring government approval of acquisitions of shares in those companies by foreigners. Naturally, such a move will not be not only draw the ire of foreign investors but also raise eyebrows considering the role the internet has played in recent opposition protests (not to mention that it is coinciding with a movement among like-minded countries to ‘regulate’ the internet via a UN entity).
As always, we end the post with VVP’s opening remarks to the Commission meeting:

Update: as expected, PM Medvedev will chair the Commission going forward, according to Order No. 888-r issued today. The members of the Commission will be as follows (new members in bold):

  • PM Dmitry Medvedev (Chairman of Commission)
  • First Dep. PM Igor Shuvalov (Dep. Chairman of Commission)
  • Igor Artemyev, Head of FAS (Secretary of Commission)
  • Andrey Belousov, Minister of Economic Development
  • Alexander Bortnikov, Head of FSB
  • Arkady Dvorkovich, Dep. PM
  • Sergey Donskoy, Minister of Natural Resources
  • Sergey Kiriyenko, General Director of Rosatom
  • Alexander Konovalov, Minister of Justice
  • Denis Manturov, Minister of Industry and Trade
  • Nikolai Nikiforov, Minister of Communications
  • Alexander Novak, Minister of Energy (previously on Commission as Dep. Min. of Finance)
  • Vladimir Popovkin, Head of Roskosmos
  • Dmitry Rogozin, Dep. PM
  • Vladimir Selin, Head of Federal Service for Technical and Export Control
  • Anatoly Serdyukov, Minister of Defense
  • Anton Siluanov, Minister of Finance
  • Maxim Sokolov, Minister of Transportation
  • Vladislav Surkov, Dep. PM

I don’t recommend reading too much into this, but it’s worth pointing out that the new members of the Commission are 9 out of the 19 (i.e., not a majority). Also, there are now 19 members of the Commission, versus 18 under PM Putin. This is accounted for by the addition of Maxim Sokolov, Minister of Transportation, to the list. All things considered, the new members belong to the vaguely-defined ‘pro-investment’ crowd, notably Dvorkovich and Siluanov.

Posted in foreign investment, Medvedev, Putin, russia, strategic industries | 2 Comments