Bankruptcy Fraud in Russia

Posted: July 22, 2013 at 5:48 pm, Last Updated: July 22, 2013 at 6:02 pm

By Aaron Beitman

Under the advice of Western experts, Russian officials in the immediate post-Soviet period embarked on a “shock-therapy” program aimed at stimulating market development.  Despite the best intentions of most of the actors involved, the early Russian experience with economic liberalism was particularly tumultuous.  Looking back on Russia’s transition to a market economy, it may be suggested that both the absence of a functioning market society and a government willing and able to support market institutions such as property rights, market development is a significant challenge.  Incomplete market institutions, significant government intervention, and widespread corruption have created significant challenges for the average Russian entrepreneur.

One legacy of Russia’s uneven economic transition, the privatization process, continues to present problems.  While transferring state-owned assets into private hands was clearly a necessary aspect of the transition, privatization saw the entry of criminal groups into legitimate enterprises with an intensity rarely observed.  As Louise Shelley indicates, privatization in Russia was accompanied by falsification of documents, violence against individuals seeking to acquire property, and the murder of investors attempting to acquire desired real estate.  Moreover, while most Russian citizens had little understanding of what privatization actually meant, a few canny entrepreneurs were able to capitalize and became fabulously wealthy.  These oligarchs have continued to play an outsize role in the Russian political system and economy, though nearly all have come under the control of the Kremlin.

Another legacy of Russia’s economic transformation is that particular fraudulent practices continue to be used by individuals seeking self-enrichment.  TraCCC-sponsored research by Nina Smorodinova, an investigator for the Saratov Regional branch of the Federal Drug Control Service and an affiliate of the Saratov State Academy of Law, sheds light on bankruptcy fraud, long a tried and true method for illicit self-enrichment in post-Soviet Russia.  In many cases, bankruptcy fraud works as follows.  In order to avoid paying off creditors, a company’s assets will be liquidated (assisted by falsified documents, corrupt officials, or outright violence) and control of the “liquidated” company will be passed to a third party, often actually controlled by the company’s original owners.  As Russian civil law releases debtors from obligations to creditors after bankruptcy is filed, criminals are incentivized to declare or force bankruptcy.

Moreover, numerous barriers to prosecutions for criminal bankruptcy make the practice all the more attractive.  In her report, Smorodinova moves the focus beyond the traditional locus of attention, Moscow, to Saratov, an important regional center that faces ongoing problems related to bankruptcy fraud.

Starting off broadly, Smorodinova trains her sights on the individuals often at the center of bankruptcy fraud, the “oligarchs.”  Interestingly, the term “oligarch” was first used as a reference to powerful business elites in 1996 by Alexander Solzhenitsyn, the famous author and social commentator.”  Specifically, Solzhenitsyn said that the individuals in question constituted “an enduring and insular oligarchy of 150-200 people.”  Smorodinova cites Russian academic A.A. Mukhin, who suggests that the main way of differentiating an oligarch from a powerful businessperson is that an oligarch uses media resources and seeks to exert political influence by creating networks within government agencies.  Also noteworthy is that the Russian academic legal literature offers a term that can be translated as “the powers that be.”  The literature defines this term as referring to “well-known people who occupy political and social positions connected to significant opportunities for guaranteeing their economic self-interest.”  It would seem, then, that oligarchs and “the powers that be” are appropriate synonyms. 

In terms of examples of oligarchic malfeasance in the Saratov region, Smorodinova details the case of OAO “Khimvolokno,” a once profitable company in the region that attracted unwanted attention from the Saratov regional governor at the time, Dmitry Ayatskov.  Under the leadership of general director Aleksei Bogdanov, OAO “Khimvolokno” achieved a profit margin of nearly 25% and profits of upwards of 4.7 billion rubles in 1995.  Management was able to expand its foreign operations by successfully entering markets in Germany, South Korea, Turkey, Switzerland, and a number of countries in Central Europe.  OAO “Khimvolokno’s” foreign operations netted nearly five million dollars, which put it in the sights of the shadowy holding company “Mikrodin.” Subsequently, Ayaktsov initiated a bankruptcy claim against Khimvolokno, while utilizing “administrative resources” to apply needed pressure.  As a result, the company, valued at 87 billion rubles ($2.6 billion), was stripped apart and eventually sold to a German firm for 100 million rubles ($3 million).  It was reported that the governor and his associates made 10 billion rubles ($300 million) off of the sale.

In order to develop a better sense of the impact of the criminal behavior of oligarchs in the Saratov region, Smorodinova surveyed nearly 350 residents of the region.  These included tax inspectorate and regional interior ministry officials, arbitrage (commercial) court judges, and representatives of the business community.  According to survey results, nearly 90% of respondents agreed that crimes committed by oligarchs were mostly economic, although these primarily economic crimes were often accompanied by other, more violent crimes.  70% of the respondents associated crimes committed by oligarchs with money laundering and more than 80% suggested that oligarchs bear almost no responsibility for crimes committed.  Overall, 95% of the officials surveyed indicated that they had come under pressure at one time or another from “the powers that be.”

 One of the businessman interviewed by Smorodinova noted that criminal bankruptcy couldn’t occur without bribes to judicial officials in the arbitrage courts.  Smorodinova suggests that the issue of corruption in the judicial system might be one of the reasons why most officials surveyed from the Saratov regional arbitrage court chose not to participate in the survey and those officials who did were particularly reserved in their responses.        

 In Smorodinova’s view, there are three main reasons why prosecution of bankruptcy fraud will remain difficult.  First, witnesses in these cases receive almost no state protection once they have agreed to testify.  This, unsurprisingly, makes potential witnesses think twice about working with prosecutors.  Second, the legal framework for prosecuting economic crimes is incomplete.  Third, collaboration between elites and organized crime makes prosecutions all the more difficult. 

 Future research should examine in more detail the specifics of how bankruptcy fraud occurs.  A recent effort by Olga Sukhorukova seeks to address this gap, but additional detailed understanding of this problematic criminal phenomenon is certainly called for.

Write to traccc at traccc@gmu.edu