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Trust, but Check


In commerce, no sphere - including investment - is invulnerable to fraud. Nevertheless, awareness of risk areas may help a businessman avoid falling victim to fraud. Under Russian law, Western companies spe- cialising in risk management cannot deal indepen- dently with issues of security in Russia and countries of the CIS. By law, only Russian companies may be licensed to engage in the security or detective busi- ness. Consequently, Western agencies seek the servi- ces of private Russian firms working in the area of commercial security. Here is Yury Nosenko, Chair- man of the Committee for Security of the Moscow Government and General Director of ZAO 'Infocon', with more details on the specifics of their business.

Last year, Moscow hosted the First International Con- ference on fraud entitled 'Fraud and Counterfeiting in Russia: Prevention and Combat'. ZAO 'Infocon' was the general sponsor and one of the organisers of this confer- ence. Based on the results of the conference, the Intermin- isterial Commission for the Fight against Fraud and Coun- terfeiting in the Area of High Technology was established by Resolution of the Mayor of the City of Moscow. This commission is headed by First Deputy Premier of the Moscow Government, Valery Shantsev. The commission endeavours to create a database of informa- tion on companies that have been involved in fraudulent transactions, to constantly monitor the black market economy, to conduct special investiga- tions, to coordinate the efforts of governmental law-enforcement agencies and private security companies, and to develop propo- sals for Government measures against fraud.

Can we fight this disease in Russia?

Y. N.: We can, and we must. Fraud is not a phenomenon in Russia alone. It has existed since the very beginning of society. Moreover, it will exist as long as crime exists. Essentially it is endemic to any country with low living standards, of which Russia is one.

It is difficult to envisage large-scale fraud being arranged by anything other than a criminal organisation. Traditionally, Western security companies represent an organised criminal hierarchy in the form of a pyramid - i.e. there is a boss, the president, at the top, then his deputies, colonels, soldiers, and street fighters. Crime in Russia has nothing to do with this classical hierarchy, which still dominates the minds of some Western criminologists. Our crime may be pictured in the form of an hourglass, with a concealed part and a legalised part. Both are flowing one into the other. In the case of fraud, we have always to deal with the legalised part of organised crime.

How do you see 'protection of investments' from the point of view of your business?

Y. N.: What I mean by 'protection of investments' is first- ly the minimisation of risks pertaining to investing in specific projects in Russia and countries of the CIS. In Russia, we have only started putting together elements of a state information system, which will allow us to have at our fingertips reliable information on firms, banks, joint ventures, their founders and their financial state. In addi- tion, Russian private investigation companies will become part of this system. Currently, Russia's present law does not prevent fraud, to put it mildly. A business- man who is about to close a contract cannot check the legitimacy of his contractual partner, or whether the part- ner is able to execute his contractual obligations. This is because the Ministry of the Interior covers only acts of fraud already committed. Besides, under current law pro- vision of unreliable information to a contracting party is not a criminal offence. Today, private security companies are endeavouring to prevent the consequences of such shortcomings in the law. These companies specialise in prevention of fraud and other criminal activities.

What measures do you think may lower the risks related to working in Russia?

Y. N.: First of all, a comprehensive evaluation of your potential partner's reliability in terms of economic indi- cators, risks of material and financial investments in specific regions and projects, and situational analysis in these regions and areas of business. These measures will help investors to: make an in- formed decision on the expediency and conditions of business relations with their partner; evaluate the real feasibility and financial risks involved in specific commercial projects; establish the solvency of their partner and guarantors; assess creditworthiness; establish the availability and level of business connections in advance, which may affect the promotion of a particular project.

Today it is easier to prevent fraud than to punish it afterwards. In Russia, 99% of fraud cases go without penalty. Only cases of fraud in business that can be easi- ly penalised are readily discovered. However, even when you have punished the culprit, the related financial loss- es cannot be recovered. Many Western companies have left Russia for this reason.

Could you give specific examples?

Y. N.: I have several examples. The first shows the effec- tiveness of the preventative measures that we took in the interests of an investor, one of our clients. Having bought 40% of the stock of one of the Volga Shipyards back in 1999, one Western company invested $15 mln in the modernisation of their machinery and equipment by opening a line of credit with a monthly allowance of $1 mln lo $3 mln. Everything was fine for two years.

Work was done through their two Russian associates, who were co-owners of the shipyard. Then a quarrel broke out between them which resulted in a conflict. The acting General Director decided to transfer some of the funds due from the investor (about $3 mln) to an off- shore account in Cyprus and then to leave the company. It was only thanks to the fact that we received this infor- mation quickly that we could act and properly advise our client to suspend the line of credit until further notice. In this case, we protected the interests of our client. I could give you other such examples, but they are less remark- able than the cases where investors ignore, or simply neglect, the necessity to run a check on their partners.

In 1998, a Canadian firm, a world leading company manufacturing glass fibre products using the most modern technology, acquired the controlling stock (40%) of one of Moscow's Region-based plants manufacturing bottles. They introduced their representatives onto the Board of Direc- tors, opened an agents office in Russia, and transferred $1.5 mln into the plant's account. They then paid $300,000 to the Region Administration as an entry fee to participate in bidding, and dispatched technical equipment worth $5 mln from Canada. When the equipment arrived in Moscow loaded in 21 rail wagons, it turned out that the Canadian firm no longer owned the controlling stock, a new General Director and a new Head Accountant had been appointed, and their shareholding had fallen from 40% to 30%. By re-entrusting via third party companies, 10% of the stock had become the property of an offshore company registered in the Isle of Man. The equipment had to be returned to Canada, and the investor turned to arbi- tration. Having lost the lawsuit twice (even though the company had a 100% win scenario), the investor asked for our services. Working hand-in-hand with the law-enforce- ment agencies, we spent an entire year reclaiming the 10% of the stock. This complicated - from a legal point of view - fraud was conducted by one of the criminal groups that controlled one of the Baltic seaports: $1.5 mln was trans- ferred from the plant's account to purchase seaport cranes.

Here is one more story that was much talked of in Moscow, St. Petersburg and Ekaterinburg. It clearly shows what a total lack of care, and excessive trust in a new part- ner, on the part of a Western company can lead to.

A Russian food importer, who had gained a reputa- tion as a reliable partner, received goods worth $3 mln from Western companies on consignment terms. These Western companies also leased equipment and transport to the Russian importer. Some estimates show that by August 1998 the total amount of bank and trade loans had exceeded $20 mln. Under cover of the August 1998 crisis, the company suspended its operations, and its president began a game of hide-and-seek with his credi- tors. The firms comprising the holding simulated bank- ruptcy, the money being consolidated into separate accounts and then into offshore accounts. In despair, the banks and creditors had to seek the services of law- enforcement agencies and Russian private companies. It subsequently turned out that not every creditor had suf- ficient legal grounds to settle the matter in court, as they had no signed contracts with the holding at all (and could only produce invoices and receipts as proof of the outstanding debt) or the contracts drawn were in mate- rial breach of current law. Further, the President of the holding company was registered neither as a shareholder nor as an officer of the holding, thus making it impos- sible to bring a lawsuit against him in court. Neverthe- less, we were able to satisfy some of the claims of the creditors.

One more example. At the request of a foreign insu- rance company, we conducted an investigation into the theft of $25 mln that was transferred from Europe to a Russian commercial bank as a prepayment for supply of oil. The oil was never delivered, but the money vanished into thin air. Based on the information we received ini- tially, the money was transferred from Russia to the USA.

In the course of a three-month investigation, we disco- vered that the money was split into several parts, each of which was transferred from one account to another in a long chain, at the end of which shares were bought in the name of false identities. Thus, the fact of fraud was estab- lished, which was used as grounds for the court proceed- ings. The court's ruling was that there was no insurance case.

What are our perspectives? How long do you think Russia will bear the stigma of being one of the most criminalised countries in the world?

Y. N.: I believe that Russia cannot work wonders, and a civilised market will not be created for several years. A modern industrial nation cannot do this overnight.

It takes time and patience. Positive trends are evident in every aspect of Russian life. This is especially true with the arrival of a new presidential team. Despite many mistakes and much criticism, we are moving ahead. The main thing is that laws, law-enforcement institutions, and democratic institutions are being improved. Our development is ham- pered by bureaucratic officialdom, acting against a back- ground of excessive government regulation and general weakness of managerial infrastructure, which significantly delays the positive solution of existing problems.