Capital Flight Schemes

Russia’s national police agency, the MVD, conservatively estimates that $9 billion illegally flees the country each year. A study by the Institute of Economics of the Russian Academy of Sciences and the Centre for the Study of International Economic Relations at the University of Western Ontario, published this May, suggested that up to $70 billion disappeared in 1992 and 1993 alone. Other specialists argue that total capital flight in 1994–98 amounted to more than $140 billion and currently is running at more than $15 billion a year. Overall, some $350 billion in capital has fled the country since the fall of the Soviet Union, with nearly a third of it landing in the United States, intelligence sources told the U.S. News and World Report. And investigators believe that the flow of funds has accelerated since the crash of the ruble in August 1998. As Russian companies face bankruptcy, their motivation to preserve assets tends to vanish.

During an August 21 raid on the Bank of New York, U.S. federal investigators seized the files of Natasha Gurfinkel Kagalovsky, a senior vice president who supervised the bank’s East European division. She and the bank’s vice president in London, Lucy Edwards, were suspended. Ms. Kagalovsky is the wife of Konstantin Kagalovsky, Russia’s representative to the IMF in the early 1990s under Prime Minister Yegor Gaidar’s government. After Gaidar was replaced, Kagalovsky moved to Russia’s Bank Menatep, headed by Russian oil and banking baron Mikhail Khodorkovsky. Menatep snapped up a number of enterprises during Russia’s controversial "loan to share" privatization, including a controlling stake in the country’s second-largest oil company, Yukos. Menatep failed last year amid Russia’s financial crisis (see box on page 16). Kagalovsky is now deputy chairman of Yukos.

Investigators say Menatep and Kagalovsky increasingly are becoming a focus of the investigation. Federal and international law enforcement officials say they are looking into whether Kagalovsky helped construct a byzantine network of offshore corporations that politically connected or mob-linked Russians may have used to siphon hundreds of millions of dollars out of the country. Investigators say that sum may include part of foreign aid and funds pumped into Russia by the IMF to shore up the reeling Russian economy.

Yukos denies that it has been involved in transfer pricing schemes, but oil industry analysts calculate that its subsidiaries effectively lost hundreds of millions in revenue last year by selling its oil to the holding company at bargain rates. Yukos, like all petroleum companies battered by last year’s low world oil prices, itself reported a $79 million loss for 1998. A deal earlier this year scattered the ownership of Yukos’s two oil production companies among six separate offshore firms, from the British Virgin Islands to the windswept Pacific atoll of Niue in the South Pacific.

Elaborate shell games have become a dominant feature of Russia’s post-Soviet economy. Menatep’s own purchase of Yukos back in 1996 began with a flourish of thinly disguised deception by Kagalovsky. He said "an unknown company called Monblan" had won 85 percent of Russia’s second-biggest oil company. Menatep later admitted that Monblan was a subsidiary.

Secrets of New York Bank Accounts

Also under the scrutiny of U.S. federal and local investigators is Russian businessman Peter Berlin and his wife, Lucy Edwards. Berlin, British corporate records show, is listed as a director of Benex Worldwide Ltd., the company that kept several of the suspicious accounts at the New York Bank. Benex maintained close ties to Semion Mogilevich the alleged head of Solnetsevo, Russia’s largest organized crime group. Mogilevich has built a $100 million empire from arms dealing, extortion, prostitution, and other rackets. Before submerging in recent years, he lived in Budapest, Hungary, but is thought to have moved to Moscow in recent weeks. Mogilevich allegedly is the principal target of a strike force assembled in early 1998 by the U.S. government. The force is comprised of the FBI, the Treasury Department, the State Department, the Central Intelligence Agency, and the Hungarian Interior Ministry.

A senior U.S. government official said there were "substantial links" between Benex and YBM Magnex International Inc., a Newtown, Pennsylvania, maker of industrial magnets. Mogilevich was a founding shareholder of the company. Founded in 1994 by a Russian emigre scientist, YBM Magnex, a magnet and bicycle manufacturer, rose from an obscure penny stock to a multinational worth nearly $1 billion in less than four years. Its numbers astonished competitors and delighted stockholders. Net sales quadrupled from 1994 to March 1998, net income jumped ninefold, earnings rose by a factor of five, and the future looked just as promising. Benex became a distributor of YBM Magnex’s magnets. By March 1998 YBM was boasting of plans to become "the world’s leading producer of high-energy permanent magnets."

But six months later, in June of last year, YBM Magnex pleaded guilty to conspiracy to commit securities fraud and has since filed for bankruptcy-law protection. In December 1998 the company’s new board, composed of outside investors, admitted to U.S. authorities that there was evidence of YBM’s criminal wrongdoings, possibly involving links to organized crime. YBM had faked customer lists showing money laundering activity in accounts and business dealings in Eastern Europe and the Caribbean. (Money laundering means moving ill-gotten gains through a series of bank accounts to make them look like legitimate business proceeds).

Earlier this year, the FBI and other federal agents raided YBM’s world headquarters in Newtown. The confiscated documents suggest that Russian mobsters may have used the company’s Eastern European operations to launder millions in dirty money through a web of related enterprises.

The Budapest-based production facility of Magnex was established eight years ago as the property of the Mogilevich-controlled Arigo Ltd. Shortly thereafter its capital increased and it started to produce high-tech magnets. (As the Budapest-based World Economy Weekly reported, the shabby, run-down building that employed 200 people, one third of them Russian, did not reveal much about the hi-tech production, and hardly reflected the $80 million investments in the mid-1990s). "The products were sent back to the offshore company at Caiman Island and then reshipped to the CIS countries."… At least that is what the owners claimed.

A year ago the Hungarian company, now renamed Crumax Inc., decided to start a new investment with $20 million in order to increase production and build a new research and training basis. The Canadian investors vetoed the plan.

With the Money, Mogilevich Disappeared Too

Mogilevich disappeared from Budapest following a Hungarian-American coordinated raid. Officials confiscated documents and computers in his Budapest offices that well-informed sources link to the FBI’s New York investigation. The Hungarian authorities declined to discuss the results of these raids. The Hungarian tax police have extended an ongoing inquiry into companies controlled by Mogilevich.

Investigators in New York estimate $6 billion zipped through the Benex accounts in the short time since authorities began monitoring the transactions last fall. They told the New York Times that the Berlins may be involved in one of the largest money-laundering operations ever conducted in the United States. Some $4.2 billion passed through a single account in more than 10,000 transactions between October and March, the New York Times reported. The cash in question appears to have passed through European and U.S. banks before landing in an offshore account in the Channel Islands that was controlled by a Russian commercial bank.

Some of the accounts Berlin established at the Bank of New York weren’t regular deposit accounts but "micro/CA$H-REGISTER" accounts. These accounts are typically used by businesses for cash management purposes and are designed to make international fund transfers simpler. Account holders access their accounts and can conduct numerous transactions, including wire transfers and payment orders in foreign currencies, via a personal computer.

Were IMF Funds Hijacked?

The IMF said on August 23 that it was looking into reports of diverted funds but that it had made payments only to the Central Bank of Russia. IMF spokesperson Graham Newman pointed out that under the current standby credit IMF money is paid into the Russian government’s account at the New York Federal Reserve Bank and that these funds can only be used for repayments to the IMF. Earlier credits were paid into either the central bank of Russia’s account at the New York Federal Reserve, or its account at (Germany’s) Bundesbank, and were used by the authorities to build up reserves, help finance the budget, or pay international obligations.

The possible siphoning of funds from IMF credits to Russia comes at a time when an audit released this summer by Pricewaterhouse Coopers shows that Russia’s central bank funneled $1.2 billion in IMF money in 1996 to a firm it controlled called Financial Management Co., or Fimaco, in the Channel Island of New Jersey. The central bank hid that transaction from the IMF and later explained it was trying to keep the money beyond the reach of creditors. The IMF has lent about $20 billion to Russia since 1992. In July the IMF approved a new loan of $4.5 billion for Russia.

All this makes the ongoing IMF-Russia discussions even more complicated. Moscow’s IMF envoy, Mikhail Zadornov, told NTV television that negotiations, scheduled to last here until September 1, will concentrate on the 2000 budget parameters and Russia’s compliance with a tight fiscal policy agreed on with the IMF over the summer. The IMF wants Russia to aim for a primary budget surplus of 4 percent of GDP next year—a figure that excludes Russia’s foreign debt payments. Moscow ministers want the IMF to lower its sights, stressing that chronically poor revenue collection should improve only enough next year to meet a three-percent surplus.

Meanwhile, some members of Congress are launching their own probes into the matter. James Leach, a Republican from Iowa and chairman of the House Banking Committee, is planning a hearing, tentatively set for mid-September, on the role Western banks may have played in helping Russian money laundering, including an investigation of whether IMF funds have been siphoned. "Russian banks appear to be more platforms for insiders seeking to spirit money out of the country than intermediaries for domestic economic growth," Leach said in a press statement. At issue is whether foreign theft has been facilitated by self-serving banking practices in the Western world, including the United States.