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CDI Library > Johnson's Russia List

Johnson's Russia List
 

 

Febuary 8, 1998    
This Date's Issues: 3046  3047 

Johnson's Russia List
#3047
8 February 1999
davidjohnson@erols.com

[Note from David Johnson:
1. Reuters: Russia sinks in debt, IMF rescue on hold.
2. Elizabeth Davis: RE 3044 - Ekman - $50 billion.
3. AFP: Dogfighting, latest hobby of the "new Russians."
4. RFE/RL: Paul Goble, Down To Subsistence. (USIA poll on
poverty in Russia).

5. Washington Post: Daniel Williams, To Counter Antisemitism,
Artist Aims at Russians' Funny Bone.

6. Reuters: Caspian woes, low oil price put pipeline in doubt.
7. Ethan Burger et al, BUSINESS LOSSES IN RUSSIA: THE INEVITABLE
SEARCH FOR ACCOUNTABILITY AND DEEP POCKETS.]


*******

#1
ANALYSIS-Russia sinks in debt, IMF rescue on hold
By Brian Killen

MOSCOW, Feb 8 (Reuters) - Russia is sinking in a quagmire of foreign debt,
but the International Monetary Fund (IMF) is not yet ready to come to the
rescue and analysts say a compromise may not be reached until the debt
payments crunch intensifies.
First Deputy Prime Minister Yuri Maslyukov, quoted by Interfax news
agency, said the government would draft a policy memorandum for the IMF
this week, outlining anti-crisis plans. He also thought a Fund mission
could return to Moscow next week.
But the IMF's top Moscow representative, Martin Gilman, told Reuters it
was difficult to predict when the next mission would be or when IMF
Managing Director Michel Camdessus might visit.
``I think there is appreciation on the Russian side, as well as on our
own, that there is no time to lose,'' Gilman said.
The IMF's latest mission to Moscow ended on Saturday after two weeks' of
talks failed to result in an agreement on an economic policy programme
which would lead to new IMF credits and help Russia to restructure its
debts to other lenders.
``What we're looking for is a comprehensive policy package that the IMF
and the international community can support and that would be convincing
for the Russian population as well as the international community,'' Gilman
said.
``The mission will come back as soon as all these issues are clarified
sufficiently and we feel on both sides that we are within striking distance
of an agreement,'' he added.
But Russian officials remained sanguine about the prospects for receiving
$4.6 billion from the IMF in April or May to pay back money owed to the
Fund itself this year.
``The government has announced these dates long ago and we are basing our
policies on this,'' Maslyukov's spokesman Anton Surikov said.
``The pattern of payments of our debts indicates that such a timeframe
would be acceptable for us. There is no rush and no panic here, nor will
there be,'' Surikov added.
Analysts said Russia and the IMF might eventually be forced to reach a
compromise as big foreign debt payments come due and Western allies of
Russia pressure the Fund to close a deal.
``The pressure is going to come with time as Russia has to make various
payments and has difficulty financing the external debt servicing,
including money to the IMF over the next few months,'' Brunswick Warburg
research head Peter Boone said.
``That's going to bring both sides closer together,'' he said.
Russia's total foreign debt, excluding interest, is about $145 billion.
This year's payments should total $17.5 billion, but only $9.5 billion is
budgeted for and the government is pinning its hopes on restructuring
agreements.
``There are fairly large payments coming due in July to the IMF and
others, so I would say they really have to have an agreement by the
summer,'' Boone said.
One Western diplomat said he didn't yet see the will among creditors for
a debt restructuring. ``I'm not sure the payment dates will be adhered to,
but the West may find it preferable to let things slide, to have a kind of
moratorium.'' he said.
The diplomat said new credits made little sense. ``The IMF conditions
were clearly not met and there's little sign they will be any time soon.
The money probably would have disappeared again as rapidly as the last
tranche.''
Gilman said the government had to take steps to bring the fiscal
situation under control, improve revenues, control spending, introduce
better tax administration, restructure the banking system and elaborate a
monetary programme.
Russia's State Duma (lower house of parliament) approved this year's
budget draft on Friday in a fourth and final reading. It now goes to the
Federation Council, the upper chamber, on February 16-17. 

*******

#2
From: "Elizabeth Davis" <EDavis@marykay.ru>
Subject: RE: 3044 - Ekman - $50 billion
Date: Mon, 8 Feb 1999 

I can't help but take this opportunity to make my first comment on Johnson's
List. Although I have now been resident in Moscow for the last three years
and an "obsessed" observer of Russia for twelve years before that, I must
say that I am absolutely staggered by the recent reports of $50 billion in
STATE RESERVES being sent to off-shore managers. Saturday's Moscow Times
reported that Viktor Gerashchenko, current head of the Central Bank, was
called before the Duma on Friday to explain the off-shore "management". His
response can be captured in the three main points he used to explain the
reasons that the Central Bank itself set up the off-shore management company
("WHO ARE THE SHAREHOLDERS?"!): 1) to receive a higher return by avoiding
taxes (!!); 2) to hide assets that might conceivable have been frozen by
London and Paris Club creditors during periods of difficult debt
restructuring talks (!!!); and 3) to protect funds loaned to Russia by the
IMF (!!!!!!). (I recommend that the Saturday article plus the Saturday
editorial on this topic be submitted to the List for all readers). To my
shock and amazement, it appears that no one at the Duma OR IN THE PRESS
(Western or Russian) asked Gerashchenko, "WHERE IS THE MONEY NOW?"

I have now searched the internet news sites (New York Times, Financial
Times, BBC, etc) and have found NO articles on this topic; no comment from
the IMF; no comment from London or Paris club creditors. Also, while the
local news stations barraged viewers all weekend with images of Alpha force
troops "attacking" Sibneft, NO mention on any station was made of the $50
billion or where it is now. At the moment I feel like a lone voice in the
fog trying to comprehend why no one out there in the real world is
interested in the fact that a country begging for debt forgiveness and more
IMF funds (not only begging but arrogantly assuming the receipt of such
funds in the 1999 approved budget) has admitted to moving the wealth of the
nation to an off-shore tax shelter. Am I missing something here or isn't
this a bit more than simply another "Russian corruption" story?! Why is
there no savvy investigative journalist following up on who the
shareholder's of FIMACO are? Where is the commission profit? Where is the
statement of returns on the reserve funds? WHERE IS THE MONEY AND WHY ISN'T
IT BEING USED TO: pay pensions, state wage arrears, the army, the navy, the
strategic rocket forces, etc etc etc.!?! Wouldn't $50 billion have been
enough to set up that currency board that Soros recommended back in
pre-crisis late July/early August 1998 - didn't he suggest around $30
billion as a minimum amount? Oh right, Russia rejected that idea because it
couldn't stomach the idea of independent "outsiders" managing the money
supply. 

I would greatly appreciate further comment and ANY other news on this
scandal. Isn't it just possible that the Beresovsky et al crack-down is
really just a diversion to distract us from the fact that Yeltsin himself
was then and is still in charge and thus must have been party to any
decisions on Central Bank reserves? Couldn't this story be the big one?
The one that says simply that the whole big apple is rotten, that the
government itself and its "independent" Central Bank have robbed the country
of its economic future for another generation or two? 

********

#3
Dogfighting, latest hobby of the "new Russians"

MOSCOW, Feb 8 (AFP) - No "new Russian" capitalist feels dressed these days
without his mobile telephone, foreign limousine, and now his pitbull
terrier specially trained for dogfighting.
The "sport" is banned in many countries, but it remains legal in Moscow,
and aficionados are numerous. For the very rich, the new elite who have
benefitted from Russia's anarchic lurch into capitalism, the pitbull is the
dog to have.
One arrogant-looking 31-year-old plutocrat turned up recently at Moscow's
pet market wearing a coat worth hundreds of dollars and a heavy gold chain
round his wrist.
In tow was his five-year-old son and wife Galina, who explained: "We're
looking for a pitbull. It's a dog I like, they are strong and brave."
She added: "My husband will look after it because he wants to train it
for fighting. We also want a pitbull to protect our son."
Every weekend a score of breeders come to the market to sell their killer
dog puppies for prices varying according to the pedigree but sometimes
reaching several hundred dollars.
One, a breeder for six years, said he lived by the trade, keeping a dozen
pitbulls in his suburban trade.
"Since ten years ago, when the first pitbulls appeared in Russia, their
numbers have grown enormously," he said. "Now there are more than 2,000 in
Moscow, and in spite of everything breeding them still makes money."
His wife added: "Our customers are the wealthy, the new Russians," she
said. "For them, these dogs are more than a pet. they are a reflection of
their lifestyle -- business in Russia is tough, and the dog becomes a
symbol of prestige."
Fights are staged in public but also in secret, among small groups of
owners, where large sums are wagered.
Alexander Semenyovski, an organiser and judge of such combats, said
nearly 100 were held last year. In one of them, staged by new Russians,
bets exceeded 14,000 dollars.
The fashion has also reached the provinces. Arkhangelsk, a city of
400,000 in the far northwest, has around 100 breeders and two tournaments
of pitbulls, which attract whole families, are staged annually.
One owner in Arkhangelsk said one room of her apartment was reserved
exclusively for her pitbull, named Lektor, which had a tendency to attack
people. "I am the only person to enter the room," she said. "I like
pitbulls but I would never let my daughter, aged seven, alone in the flat."
In Moscow public fights take place in a corner of the Serebrany Bor park,
an island in the Moscow river. At least one dog dies in combat every weekend.
Here again, families go to watch. One 31-year-old father said he often
took his daughter, aged five, adding: "We mustn't hide bloodhsed from our
children.
"Life is a battle and they must get used to it. The strong survive, the
weak are killed." 

********

#4
Russia: Analysis From Washington -- Down To Subsistence
By Paul Goble

Washington, 8 February 1999 (RFE/RL) -- Nearly three out of every four
Russians now grow some or all of their own food, a measure of the ways in
which they are attempting to cope with their ever-increasing impoverishment. 
That figure, one that gives a face to Russian poverty, comes from a U.S.
Information Agency-sponsored survey of more than 2,000 residents of the
Russian Federation. 
Conducted in September-October 1998 and released last month, this poll
not only helps to answer "just how bad" poverty in Russia now is but
equally importantly undercuts some assumptions about how Russians are
dealing with their economic difficulties. 
The poll's findings about subsistence farming are perhaps the most
striking. More than half of all Russians -- some 55 percent -- currently
grow approximately half or more of their food in private gardens, at their
dachas, or on other plots of land. 
Only 27 percent, the poll found, do not grow any of the food they consume
-- and that in a country whose population remains more than 70 percent urban. 
But that is just one of the ways Russians are trying to cope at a time
when only 50 percent of Russian adults are employed, and only one in four
of those who are employed are being paid on a more or less regular basis. 
Not surprisingly, many Russians are turning to family and friends. Some
57 percent of those polled had borrowed money and another 52 percent had
accepted assistance of one kind or another from family or friends in the
six months prior to the poll. 
But most expressed fear that this source may be drying up. Fewer than 40
percent said they assumed they could count on this source of alternative
income if times become even worse. 
Russians are not turning to two potential sources of income that many
have assumed they are using to keep afloat. 
As the USIA report notes, "contrary to popular accounts, the substitution
of barter for wares overall is not that prevalent." And workers not paid on
time are not making money "in a flourishing second economy." 
With regard to barter, the survey found that in the six months prior to
the poll only 27 percent of those working had received goods in lieu of
wages and that in half of these cases, that was a one or only two-time event. 
And the survey found such wage substitutes are doing little to help those
not being paid on a regular basis. Some 35 percent of workers who have not
been paid or paid more than a month late "never receive payment in kind,"
the report said. 
With regard to the question of second jobs, the USIA survey failed to
find much evidence that Russians are using second jobs to supplement their
incomes. 
While some may have underreported their participation in such jobs owing
to concerns about taxation, 82 percent said they do not have a second job.
Only 10 percent said they have a regular second job, and only six percent
indicated they sometimes do. 
Moreover, most of these jobs provide relatively little income.
Forty-three percent of those with such jobs say it provides them with less
than 25 percent of their income; only 16 percent say that it provides more
than half. 
Given the assumptions many have made about the role of the second economy
in Russia, the USIA survey intriguingly found that those not paid regularly
are no more likely to have a second position than those who are paid on time. 
That lack of individual entrepreneurism in much of the Russian labor
force was reflected in one other finding of the USIA-sponsored poll. It
found that large majorities of working Russians were unwilling to leave
their current jobs even if they are not being paid on a regular basis. Most
believe that it would be difficult if not impossible to find an equivalent
position quickly, if at all. 
And all are aware that the government is unlikely to provide them with
any unemployment benefits in the interim. Indeed, two out of three
unemployed Russians today have never received any such benefits. 
Given such concerns and difficulties, Russians are turning toward
subsistence, an obvious survival strategy and one that represents an
unspoken call for help from the outside. 

******** 

#5
Washington Post
8 February 1999
[for personal use only]
To Counter Antisemitism, Artist Aims at Russians' Funny Bone
By Daniel Williams

MOSCOW—Artist Vadim Kruglikov has undertaken the formidable task of
laughing antisemitism out of Russia.
To that end, he mounted a startling tongue-in-cheek exhibit of hate
mythology at an art gallery here late last month in hopes of confronting
Russians with their deepest prejudices -- and at least provoking a chuckle,
if not outrage.
At the Gelman Gallery, tucked away in a basement in central Moscow,
spectators were able to gaze on a hodgepodge of displays based on
anti-Jewish legends and hate-generated pseudoscience. There were large
graphs purporting to show Jewish professions -- 90 percent of KGB agents
are Jews, according to one. Another described how the Moscow subway was
designed by Jews to run under key strategic installations, including the
planetarium!
On display in the "Truth About Jews" exhibit was a jar of ground frogs'
feet, snake heads and female hair -- "a mixture that does not burn" -- used
to poison Christian wells; a bottle of blood said to be used in making
matzo; and a letter supposedly celebrating the success of a Jewish tavern
owner in getting Russians drunk on vodka. (The letter is actually composed
of random letters from the Hebrew alphabet.) 
The centerpiece of the exhibit was a sculptural representation of a
19th-century tale about a Belarusan boy who was rolled around inside a
barrel with nails driven into the sides -- to collect blood for Judaic
ritual purposes.
Nasty stuff, all of it, but Kruglikov insists there is method to his
rough satire. "I have always been angered by these fantasies. Then I
decided to make a joke out of it," he said.
Russia is engaged in another of its periodic surges of antisemitism. Late
last year, far-left politicians in Moscow and a few provinces blamed Jews
for Russia's economic troubles. They spoke in a transparent code, wondering
aloud why there are so many "non-Russian" names in government and among
tycoons prominent in the country's banking oligarchy and media companies.
The Communist Party and its allies in parliament blocked a resolution to
condemn Communist legislator Albert Makashov for suggesting that Jews
should be rounded up and jailed. In December, Communist Party leader
Gennady Zyuganov said that he had nothing against Jews but that Zionists,
"operating stealthily," were trying to take over the world.
Last week, in an interview with the nationalist newspaper Zavtra,
Zyuganov said that remarks by Makashov and others were "a tough response to
the destructive actions of forces that have occupied our country."
Public opinion surveys differ on the extent of anti-Jewish feeling in
Russia. One, carried out last year by sociologist Lev Gudkov, estimated
that 6 to 10 percent of Russians are aggressively hateful of Jews and that
another 15 percent are "passively" antisemitic. Thirty percent said they
have nothing against Jewish acquaintances but worry about Jewish influence
in government and culture.
In November, the Public Opinion Fund took a poll in which 83 percent of
respondents said they oppose antisemitic remarks, while 43 percent
criticized the unwillingness of parliament to censure Makashov.
President Boris Yeltsin, Moscow Mayor Yuri Luzhkov and other Russian
leaders have criticized antisemitic expressions, but no one has taken up
the issue as darkly or imaginatively as Kruglikov.
"I had been thinking about putting on [the] exhibit even before the
Makashov statements, but his words got me going," said Kruglikov, whose
father is a Jew. "I have been angered and perversely fascinated by the
fantasy of the authors of anti-Jewish myth. I decided, why not put it on
display?"
Kruglikov's father told him tales of repression in post-World War II
Russia, and Kruglikov himself ran into antisemitism among officers during
his stint in the Soviet army. In everyday life, he confronts a milder
version, in which associates raise questions about about the prominence of
Jews in Russian life. 
"I have to endure drunken conversations trying to explain why Jews are
everywhere," he said in an interview at the gallery. He was wearing what he
called anti-antisemite sunglasses: No one can see in, and he can't see out.
He fretted that his exhibit was not attracting spectators with
anti-Jewish sentiments. He had trusted to television and newspaper reports
to whip up controversy; he even invited Makashov, who did not respond. "I
don't want to preach to people with whom I agree," he said.
One day, a few spectators wandered in among TV cameras and inquisitive
reporters to gaze at the odd wares. The risks of trying to make an ironic
point on such a sensitive subject were evident. An elderly man gazed at
vandalized Russian Orthodox icons -- put on display as "proof" of Jewish
anti-Christian activities -- and said: "I don't think it was right to
deface the icons, even for this cause."
A Jewish retiree, who declined to give his name, said he thought that the
myths portrayed were too painful for joking. "Look," he said, "the people
who believe in these stories won't understand the joke. Or they'll just say
it's another attack on Russia. And the ones who know this is false don't
need to be shown it."
Kruglikov did not dispute the critique. "There are risks, but it is
riskier not to get these things out in the open," he said. He wished, in
fact, that he could have created more offbeat examples.
"Some Russians believe that Jews are mutant extraterrestrials," he said.
"I couldn't decide how to depict that."

*******

#6
Caspian woes, low oil price put pipeline in doubt
By Lawrence Sheets

BAKU, Feb 8 (Reuters) - Low world crude oil prices and doubts about total
Caspian reserves have put on hold plans for a major pipeline linking
Azerbaijan with world markets, sources close to the project say. 
U.S., Azeri and Turkish officials continue to put a brave face on their
high-profile lobbying efforts to get a pipeline built from Baku to Turkey's
Mediterranean port at Ceyhan. 
Even before world crude prices dropped to near record lows, some foreign
oil companies who would have had to finance the project, valued at up to $4
billion, balked at the cost and suggested an option going only to Georgia's
Black Sea coast. 
The U.S., Azeri and Turkish governments oppose that for what they say are
strategic and environmental reasons. 
When price woes and Caspian reserve doubts are added in, it is becoming a
question of when and if the pipeline will become a reality. 
``Right now we are just trying to keep the idea of a pipeline alive,''
said a source close to the negotiations involving Azerbaijan's state oil
company SOCAR, members of the $11 billion BP Amoco-led AIOC consortium and
regional governments. 
``There isn't any realistic hope of getting the project started this year
as has been planned,'' said the source. 
The Azerbaijan International Operating Company (AIOC) would need the
pipeline to export planned increases in output over the next few years. 
A joint AIOC/SOCAR working group was due to make a recommendation on the
route last year and construction was to have commenced this year. 
Any talk of a deadline has been abandoned, however, and the source said
AIOC officials working on a draft recommendation are now being funded only
on a quarterly basis, rather than annually as before, reflecting the doubts. 
AIOC peak output is expected to hit 700,000-800,000 barrels per day (bpd)
in 2007-10. 
But questions have arisen as to AIOC's output timetable. Its big ``phase
one'' plan to push production from current levels of 70,000 bpd to 300,000
bpd in 2002 is on hold -- a delay which AIOC attributes to price concerns. 
For now, two smaller pipelines linking Baku with Russia's Novorossisk and
Georgia's Supsa are more than sufficient to handle the 105,000 bpd level
AIOC says it will hit this year. 
Other international consortia working in Azerbaijan have so far not come
up with the kind of test drilling results which would justify a big
pipeline, underlining questions as to total Caspian recoverable reserves. 
A $3 billion Pennzoil-led group is closing down after its test wells did
not turn up economically viable crude reserves; a second group is widely
expected to close up shop later this year. 
There are more than a dozen other consortiums working in Azerbaijan, but
most are still in the early stages of geophysical and seismic research,
with any production likely to be years away. 
U.S. officials who have led the effort to promote Baku-Ceyhan, which they
say will promote ``energy security'' by diversifying Caspian export routes,
have continued to promote it but now concede the project will be delayed. 
``I believe there can be an agreement within the next year,'' Richard
Morningstar, U.S. special envoy on Caspian issues said last week. 
U.S. Energy Secretary Bill Richardson also acknowleged last week that it
might take until the end of 1999 to reach some sort of agreement on a
Caspian pipeline. 
But many oil company officials in Baku are sceptical that a decision can
be reached that soon. 

********

#7
Date: Fri, 05 Feb 1999 
From: "Ethan Burger" <ethansb@rulg.com> 
Subject: Fw: Deep Pockets Article

You may want to include the attached article (in some form) in the David
Johnson List. I should note that the article was in part inspired by all
the materials I receive from you.

Alternatively, next week you might just to reference it and note that it
will appear on the Web Site of the Russian - Ukrainian Legal Group at
www.rulg.com.

A version of this article appeared in the East/West Executive Guide, Vol.
No. 9, January 31, 1999.
http://www.wtexec.com

<Side bar:
In the view of some, the Russian financial crash was triggered in part by
the Asian financial crisis and the resulting nervousness of fund managers,
but it also had its own significant indigenous factors. What is
unique about the situation in Russia is the role that the U.S. and Western
governments (and multinational institutions) had in advising the Russian
government on its transition from communism to "reform" and the prominence
of American professionals and investors in the Russian economy. Although
per capita foreign direct investment in Russia has been low compared to
countries like Poland and China, Americans were
among the leading foreign investors in Russia.>

BUSINESS LOSSES IN RUSSIA: THE INEVITABLE
SEARCH FOR ACCOUNTABILITY AND DEEP POCKETS
SEARCH FOR ACCOUNTABILITY AND DEEP POCKETS


Joe R. Reeder, Partner, Patton Boggs LLP
Steven M. Schneebaum, Partner, Patton Boggs LLP
Ethan S. Burger, Senior Counsel, Russian - Ukrainian Legal Group, P.A. 
Geoffrey K. James, Of Counsel, Russian - Ukrainian Legal Group, P.A., 

I. Introduction 

Not so long ago, business was bullish on Russia. Moscow was
experiencing a construction boom driven by multinationals and local
entrepreneurs demanding office space. In 1996, the Russian stock market
was up about 120% ; it continued to climb in the first quarter of 1997.
Foreign mutual funds specializing in Russia were among the best performers.
Returns on Russian state bonds (GKOs) routinely exceeded 100%. Overall,
Russia was a hot emerging market. 
Long-held hopes about Russia nourished this dynamic, notwithstanding
considerable evidence that the country had yet to establish the rule of
law, a critical prerequisite for any state to become a true market economy.
The end of Communism, inexhaustible and ready-to-be-tapped natural
resources, a well-educated population, and seemingly insatiable consumer
demand for western products suggested a market primed for foreign commerce
and ready to generate endless profits for investors. 
By mid-1997, however, Russia was already showing signs of political
gridlock and economic stagnation. The anticipated boom could not be
sustained for several reasons: a continuing lack of political leadership;
absence of consensus on fundamental issues of land ownership, federalism,
and protection of domestic industry; and, most critically, the government's
chronic inability to collect tax revenues. Collecting taxes in Russia was
as much a bureaucratic complexity as it was a burden on cash-strained
entities. An example of bureaucracy can be found in some of the oil
companies who have to pay taxes to as many or more than 30 different tax
officials, ranging from local municipal authorities to national authorities.
The events of August 17, 1998 demonstrated to the West that the
weaknesses of Russia's economy are structural. On that day, the Russian
government devalued the ruble, defaulted on part of its debt, and ordered a
90-day moratorium on foreign debt payments. When account-holders
predictably, immediately, and en masse withdrew their funds, Russian bank
liquidity evaporated.
Further, the value of GKOs, which represented a major portion of bank
portfolios, was wiped out overnight. Compounding the problem "were forward
contracts ... into which Russian banks had entered with their Western
counterparts. Because GKOs are denominated in rubles, foreign banks sought
to protect themselves against the risk of a currency devaluation by buying
forward a ruble-dollar rate which would protect them.... Unfortunately,
the ruble fell so far that Russian banks have been unable to pay off the
forward contracts...." By the end of the year, in fact, the ruble had
plummeted from 6 to 21 to the dollar. The value of Russian equity
inevitably fell with it. 
Skeptics who previously had warned of pervasive corruption, capital
flight, lack of regulatory enforcement, hidden unemployment, and declining
industrial production, only to be branded anti-Russian "Cassandras," were
proved correct. It is safe to say that, in light of the arctic post-August
17 economic climate, future skepticism will not be ignored so readily.
Nonetheless, Russia's 1998 market crash presents to Western companies
and investors two types of opportunities, one to address losses suffered,
the other to seek future profits. Despite the current state of the Russian
economy, there will continue to be occasions for trade and investment.
But the events in Russia in 1998 should have made it all too apparent that
rigorous commercial and legal due diligence, this time performed by
knowledgeable and experienced professionals before entering that market, is
imperative. Lower domestic costs (e.g., for labor, machinery, property),
and a chastened psychology on the part of Russians as well as Western
investors, may be additional intangible benefits arising out of Russia's
economic crisis.
Retrospectively, however, there remains unresolved the question of
accountability on the part of the advisors to Western business executives
who suffered enormous losses: the lawyers, accountants, and consultants
from whom the investors had sought advice before venturing into the
post-Communist Russian market. Is there a theory of liability under which
traditional avenues for recovery -- litigation, arbitration, mediation --
might mitigate the financial injuries suffered in Russia? 

II. The Scope of the Damage 

The Institute for Economic Analysis in Washington estimates at $70
billion the overall losses on GKOs held by foreign and Russian investors.
The European Bank for Reconstruction and Development (EBRD) in London
projects at $169.50 million its own losses in Russia for the first nine
months of 1998. Estimates of American pre-tax commercial and investment
banking losses arising from activities in Russia exceed $1 billion. 
Anecdotal evidence suggests that only the most savvy and, perhaps, the
best politically connected, escaped unscathed. Goldman Sachs, which played
a prominent role in helping Russia to develop its bond market and to borrow
billions from foreign investors, successfully protected itself by closing
out its positions, worth hundreds of millions, just prior to the collapse
of the ruble on August 17. 
Yet as late as July 1998, Goldman Sachs arranged a $6.4 billion bond
swap, a transaction the firm touted to clients by buying ruble-denominated
securities. It reportedly collected a $56 million fee. The many
investors who lost money on that deal, which closed just a month before the
August 17 debacle, can be forgiven if they wish to scrutinize Goldman
Sachs's disclosures carefully for misrepresentations and omissions relative
to the true nature of the investment risk. 
Also of interest is the story of the $200 million lost on GKOs by a fund
manager from Texas named Dana McGinnis. He had invested after being shown
the equivalent of a Potemkin Village , beginning with a whirlwind, Morgan
Stanley-sponsored visit to Moscow in late 1994. To the detriment of his
investors, more than 100 of whom had invested a minimum of $1 million each
in his hedge fund, he apparently failed to keep himself apprised of
economic and financial developments in Russia and has since filed for
Chapter 11 bankruptcy protection. A week later, III Offshore Advisers
decided to liquidate a $450 million fund, largely due to losses suffered in
Russia. But the MORE common story was George Soros, whose Quantum Fund
lost close to $2 billion dollars betting on GKOs. 
Direct foreign investment also took a hit. In a September 1998 survey
of its members by the American Chamber of Commerce in Russia (AmCham), 72%
of the respondents stated that, as a result of bank restructuring and other
actions by the Russian government in connection with August 17, their funds
had become inaccessible. In addition, 58% reported non-payment of
receivables; the same number indicated a decline in demand for their
products or services; 28% reported the full or partial collapse of their
distribution network; and 36% were forced by the crisis to delay payments
to their own creditors. In a follow-up survey by AmCham, the 50
businesses responding estimated their losses, in the aggregate, at $500
million. 
To be sure, some companies did insure themselves against commercial
risk. But more often than not - particularly in cases of large-scale
direct investment using project finance - companies limited coverage to
political risk insurance from OPIC, the Multilateral Investment Guarantee
Agency (MIGA), Ex-Im Bank, or private insurers, only to suffer commercial
losses outside the scope of their policies.

III. What Gave Rise To Such Losses? 

When Russia still looked bright, Western executives and investors
concerned themselves primarily with issues of market penetration and
returns on investment, and generally believed that asset value and market
potential justified the risks involved. Mundane matters like the financial
and ethical reliability of joint-venture partners or the commercial
viability of acquisition targets and customers often were glossed over.
Frequently, Western businesspeople relied on information supplied by
Russian enterprises, but prepared by Western accounting firms, for
decisions on whether to enter a joint venture or licensing deal. When
Western accountants gave their imprimatur to the representations made by a
potential Russian partner, the information frequently failed to disclose
fully such details as the quality of the Russian enterprise's accounts
receivable or the insolvency of its own customers. Further complicating
the situation was an effectively demonetarized Russian economy, in which
46% of transactions were barter, 32% were based on promissory notes, and
only 25% resulted in an exchange of currency. 
Enthusiasm was fueled, too, by the political rhetoric emanating from
Western capitals and international financial organizations. The IMF, World
Bank, and EBRD, each for its own institutional reasons, tended to emphasize
opportunities while downplaying risks. World Bank Group President James
Wolfensohn, for example, who spoke of "drastically" improved results in
Russia, was highly confident: the Bank, he said, intended to make
available "real financial resources" for a "real commitment" to Russia. 
The West in general believed that Russian President Boris Yeltsin would
guarantee political and macroeconomic stability, even as foreign investment
transformed the country. The consensus was that the institutions and
attitudes necessary for a viable economy and civil society would spring up
spontaneously in Russia, if only the country had a stable ruble and low
inflation. 
Western investors who suffered serious losses in Russia are likely to
start asking some questions of the most basic sort. Satisfactory answers
to such questions as these are potentially embarrassing, but will be
decisive in determining whether, and how, an investor should consider
proceeding with any loss-recovery effort. 
· What was the process by which the decision was made to invest in a
country with a weak, inconsistent, or non-existent record of regulatory
enforcement, particularly in areas like taxes and customs duties?
· What was the extent of decision makers' and their advisors' knowledge
of the uncertainties surrounding Russia's legal and business environment,
particularly with regard to frequently changing laws, uncertain regulatory
enforcement, and regional differences?
· On what facts did the investor rely in evaluating the financial health
of the proposed Russian joint venture partner, customer, bank, or
securities broker? 
· Was the Western investor aware, before committing itself, both of the
remedies available in the event of a default and of the procedural and
practical hurdles in the way of pursuing those remedies? 
· To what extent did the Western company make its own assessment of the
expertise of the attorneys, accountants, and consultants guiding them in
their transactions? 
· To what extent did attorneys, accountants and/or advisors induce their
clients to believe in the stability of the legal and business environment
in Russia, and to what extent did they conceal actual or constructive
knowledge of the extent of corruption there?
· What was the understanding of the applicable standard of care as to the
professional advice and business judgment of management?
· What records does the Western investor have of specific representations
made to it concerning the risks posed by their deal? 

IV. Where To From Here? 

Western companies, banks, and investors have been evaluating what went
wrong, and are considering their futures in the Russian market. In some
instances, companies have withdrawn from Russia entirely. Others are
rigorously reassessing objectives, the means required to achieve them, and
the current economic, political, and legal realities. 
Regardless of what companies choose to do or not to do in Russia in the
future, however, they, their shareholders, fund managers, and bankers will
be reluctant simply to shrug off the losses already incurred if there is a
reasonable likelihood of a full or partial recovery. Depending on the
facts of each case, the attorneys, accountants, and business consultants
who played a role in commercial or investment transactions in Russia may
find themselves held to account for failing to meet the requisite standard
of care. 
In principle, clients in the West who, either directly or indirectly,
paid the fees, had every reasonable expectation of obtaining legal and
accounting professional services conforming to a Western standard of care.
In reality, however, many professionals offering advice on business
activity in Russia were either Western attorneys with a dearth of expertise
in Russian law - not a surprising phenomenon, given the profound changes
in the Russian legal system in the early 1990's - or local talent whose
chief asset was often proficiency in English, but who had only a weak
understanding of Western legal and business concepts and, therefore, of
their clients' needs. 
Dispute resolution clauses contained in contracts accepted by Western
investors offer an example of the intricacies with the potential to cause
serious mischief. Under Article IX of Russia's 1993 Law On International
Commercial Arbitration, a party is presumptively entitled to conservatory
measures (injunctive relief) from a Russian court even where the parties
had agreed by contract to resolve disputes through international
arbitration. Neither the Civil Procedure Code nor the Arbitration
Procedure Code, however, confers authority on the Russian courts to grant
conservatory measures unless they have jurisdiction over the entire case. 
Companies owed significant sums may choose to pursue their remedies for
losses in Russia aggressively by way of claims brought in local courts or,
if the contract permits, before an international arbitral tribunal.
There are considerable obstacles, however, to enforcing a judgment or
arbitral award. Where the defendant-debtor is a Russian company or bank,
it is likely to be insolvent, albeit sometimes with assets tucked away
offshore or transferred to hard-to-reach subsidiaries. 
Lehman Brothers' early and quick success in getting the British High
Court to freeze Inkombank and Uneximbank assets in the U.K. pending
resolution of a dispute over a default on forward contracts and swaps was a
rare exception to the general rule. Although there probably are
substantial Russian assets overseas, and while more banks are reported to
be ready to take legal action against them, one may assume that, by this
time, any potentially exposed assets either have already been seized or,
more probably, have been stashed in some other, even less accessible, place. 
Seeking means of recouping at least some of what investors lost will
result in one of several scenarios being played out. The underlying legal
theories in each case would be based in the conventional
contracts-negligence-fraud paradigm, depending on what the facts warranted.
Scenario I involves claimants with losses from commercial operations in
Russia who are not interested in remaining in the market, and who,
therefore, face no political impediment to filing suit against a Russian
entity for its default on a contract. The existence and known location of
assets to satisfy a judgment are obvious prerequisites to bringing a useful
claim, whether in Russia or in the West. 
Scenario II concerns claimants who may have suffered losses in Russia,
but who nonetheless see a long-term future there. They do not want to burn
bridges to Russian customers or joint venturers, and want to preserve their
ties to attorneys, accountants, and consultants. They may also fear the
consequences of certain facts' becoming public in the course of litigation,
as well as the legal uncertainties surrounding the applicable standard of
care, as well as questions of governing law, venue, and jurisdiction. 
Scenario III involves claimants with either operations or investment
losses in Russia who intend to continue doing business there, and/or who
know from the outset that their Russian defendant is in no position to pay
a judgment. Rather than pursuing their claims in a cumbersome and
unpredictable Russian court system, with no real prospect of recovery in
any event, they will explore the possibility that their attorneys,
accountants, and/or consultants may be found liable in a Western court on a
negligence theory, i.e., for malpractice and for failure to provide
adequate warnings as to the real risks of their investment in Russia. 
In Scenario IV, an investor - who invested directly or as a shareholder
of a Western company doing business in Russia - pursues company management,
which, in turn, looks to hold the professional advisors liable, via
third-party claims, for their respective failures to meet the standard of
care. Buyers of American Depository Receipts (ADRs), for example, may
have claims against accountants for their representations in statements to
the SEC regarding the financial health of a security's issuer, or for any
other report upon which they could anticipate that an investor would rely.
In the case of banks and pension funds, there may also have been breaches
of by-laws forbidding ownership of foreign equity on the basis of ADR-like
documents. 
Claimants of the type described in Scenario I will pursue their partners
in the normal way, through the courts of whatever jurisdiction in which
they can find valuable assets. Claimants in Scenario II may prefer
mediation, in order to obtain at least some relief while avoiding (or at
least reducing) embarrassment and the risk of harming later opportunities.
But those described in Scenarios III and IV may have rights to pursue
causes of action that have heretofore received little attention.

V. Mediation May Be the Most Effective Solution in Certain Cases

In light of the time and expense that litigation and even arbitration
represent, mediation - a potentially quick, discreet, "win/win" process in
which an independent third party helps the disputants to negotiate a
compromise agreement to resolve their differences - may offer a viable
alternative. Mediation differs from, and in this way is superior to,
adjudication and arbitration, in that, unlike a judge or arbitrator, the
mediator does not impose a resolution on the parties. The parties
themselves, on the strength of their own chosen willingness to be flexible
and a presumably clear-eyed assessment of long-term objectives, craft the
outcome to their dispute. It also is less disruptive both to commercial
relationships and business operations.
Mediation is particularly appropriate where the parties have commercial
and professional relationships they want to protect from the fall-out of
legal combat. Where a multinational uses the same accounting firm all over
the globe, it will be reluctant to destroy a possibly long-standing
relationship solely on the basis of substandard services that may have been
rendered in Russia. The risk that compromising, confidential information
may be leaked is an additional incentive for not litigating against the
company's lawyers, accountants, or consultants. 
Of course even where mediation is the dispute resolution method of
choice, a thorough factual investigation, and possibly the initiation of a
lawsuit, may be unavoidable. Attorneys, accountants, securities
issuers/dealers, fund managers and other professionals with malpractice
exposure may be prepared to enter seriously into any mediation effort only
when faced with a comprehensive assessment of their potential liabilities.

VI. What Would a Claim Against Professionals Look Like?

Negligence and fraud claims against professionals who provided advice on
investment in Russia which did not satisfy the applicable standard of care,
if brought in the U.S., benefit from familiar judicial and procedural
protections. In addition, United States law presents the additional
advantage of containing a better-stocked legal arsenal, including federal
and state statutes as well as common law principles. 
Claimants alleging misrepresentations or omissions in registration
statements and prospectuses, for example, can look to 15 U.S.C. § 77k,
which essentially holds accountants (among others) strictly liable, subject
to the twin caveats that the plaintiff must be able to show the materiality
of any misstatement or omission, and that the defendant be unable to
demonstrate that the decline in stock value was unrelated to it.
Plaintiffs need not establish scienter on the part of the defendant; a
material misstatement or omission suffices. 
Should the facts warrant it, a plaintiff may also look to 15 U.S.C. §
78j (and 17 C.F.R. § 240.10b-5), although these do require either actual
knowledge of material falsity combined with an intent to deceive investors,
or such recklessness that the intent to deceive may be inferred, as well as
the plaintiff's reliance. Statements in annual reports or no-default
letters could fall under this section.
Common-law negligent misrepresentation theories offer another route to
potential recovery from financial advisors and accountants. Where the
professional has breached his duty of care through common-law negligence,
he is liable. The plaintiff in such a scenario has to prove that there was
a breach of the duty of care, and that the breach caused injury. In the
event of a shareholder's claim, privity or a relationship approaching
privity must be shown. 
Nonetheless, while it is clear that any agreement for routine accounting
services implies that the accountant will at a minimum meet his
professional standard of care, the proceedings perk up considerably in
instances where an accountant can be deemed to have assumed a fiduciary
obligation vis-à-vis his client. Facts that may trigger such a heightened
duty include the providing of investment advice, recommendations for
complex financial transactions, structuring deals, and performing audits. 

VII. The Nature of the Professional Who May Now Be Liable

If Western investors in Russia were blindsided by the apparently sudden
downturn in fortunes there, this occurred at least in part because of the
attitude of some that "business is business," and that the intricate
nuances of a place like Russia were only secondarily, if at all, important.
The precipitous and sometimes even cavalier manner in which some Western
investors and companies leaped into the Russian market is reflected in the
scanty qualifications of the purported professional "experts" they chose
to guide them. 
Many Western professionals - lawyers, accountants and consultants -
claiming an expertise in Russia came in three varieties: (i) area studies
specialists and Russian-born individuals living in the West, with a close
knowledge of Russian culture but often with little business experience;
(ii) experienced international business types who simply saw Russia and the
surrounding countries as the next promising market to be exploited; and
(iii) ambitious and aggressive "Young Turks," without many years of
relevant experience, who, perceiving favorable market conditions and casual
management oversight, advanced projects - and took on substantial risks -
often without the vitally necessary due diligence.
The excitement, even the frenzy, of being involved in the transformation
of post-Communist Russia, along with frequently generous expatriate
benefits packages, brought an initial rush in the early to mid-90's of
Western professionals to Russia seeking a special niche. It is safe to
say, however, that they hardly could be deemed experts on Russia
notwithstanding their routinely holding themselves out as such. Without
real expertise in local customs, practices, and laws, then, and without a
Western pool of qualified, legitimate experts on whom to rely, Western
investors frequently were rolling the dice. And it should come as a
surprise to no one with experience that in Russia, as in most cases in
which gamblers play the game without adequate preparation, the house always
wins. 

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