Heyday of investing in Russia ends in scandal for U.S. bank

Economy suffers in dealings abroad

September 05, 1999|By Scott Shane and Will Englund | Scott Shane and Will Englund,SUN STAFF

Just three years ago, financial publications buzzed with news of the eye-popping returns available to intrepid investors in Russia. A Russian oil company's stock had jumped 40 percent in a week. Russian government bonds were paying as much as 200 percent interest. The value of the Moscow Times stock index had tripled in a year.

No U.S. company moved more aggressively into the promising but volatile Russian market than the Bank of New York. Despite its conservative reputation and 18th-century pedigree -- it was founded by none other than Alexander Hamilton -- the bank elbowed out competitors to seize Russian business.

It opened U.S. accounts for Russian banks, which were not permitted by U.S. banking regulators to open branches here. It moved swiftly to dominate the market in Russian stock offerings, assisting such Russian businesses as Inkombank, a major commercial bank, and Sibneft, a Siberian oil company. A bank officer boasted that the Bank of New York had been midwife at the sale of $10 billion worth of Russian stocks in just six months.

Since those heady days, the collapse of the ruble and the taint of corruption have cast a shadow over Russian business and its foreign partners. Inkombank was wiped out in last year's ruble devaluation amid rumors of missing millions. Sibneft was accused of using a detective agency to eavesdrop on Russian public figures, including the daughter of President Boris N. Yeltsin.

And now the Bank of New York is itself the target of a criminal investigation into money laundering. As much as $10 billion from Russia passed through the bank, and federal investigators believe that at least some of that money is linked to a well-known Russian crime boss.

"Here we have a very venerable institution that has a black eye, a very big black eye," said Jim E. Moody, former deputy assistant director of the FBI, who launched the bureau's fight against Russian organized crime. "Something happened, and the bank apparently didn't exercise due diligence."

The Bank of New York, which has fired two Russian-born employees and suspended another, says it is cooperating with the federal investigation, first reported Aug. 19 in the New York Times.

Banking analysts in the United States and Russia suggest that most of the money that churned through the Bank of New York accounts was revenue diverted from a broad array of businesses rather than proceeds from such crimes as prostitution, drug-dealing or extortion.

The tentacles of the Russian mob reach into many places, but probably can't extract $10 billion, some analysts say.

The bad news is this: Capital flight is probably more pervasive and more damaging than the Russian mob.

Russian businesses understandably want to protect their earnings by placing them in havens abroad. But in doing so, they are likely to violate Russian currency laws, cheat stockholders and employees, illegally avoid taxes, and deprive Russia of cash badly needed for investments.

It is only by working with foreign banks that such maneuvers are possible. And even in the heady days of Western optimism about investing in Russia, American and European banks were being used to get money out of the country.

Dominating ADRs

The Bank of New York, for example, worked with Russian businessmen to issue "American depository receipts," essentially a vehicle to allow foreign investors to buy Russian stocks. The ADRs, traded on U.S. stock markets, offer investors convenience and confidence that they really own shares in a real company in Russia. The bank quickly dominated the business.

But while their purpose was to steer money into Russia, the ADRs proved to be an efficient way to circulate money abroad, according to banking analysts in Moscow.

Someone could walk into a brokerage in Moscow, put down $500,000 in cash, and purchase some ADRs, which are more liquid than ordinary Russian stocks.

Later on, the ADRs could be sold abroad, with the proceeds being paid into a foreign account. "When you sell it, there's no way for the Russian Central Bank to track it," said Margot Jacobs, an analyst with United Financial Group in Moscow.

No evidence exists that the Bank of New York's ADR program is linked to the money-laundering allegations. But Russia's Federal Securities Commission announced last week that it was launching an investigation into companies that listed ADRs through the Bank of New York.

Getting money abroad

There are all sorts of ways, of course, to get money abroad. One common method is to divert money through subsidiaries. A publicly held Russian oil company, for instance, sells oil at below-market prices to a subsidiary -- often outside Russia -- controlled by oil company insiders, which then resells it on the world market. The result is that shareholders are cheated, and company officers enriched.

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