#26 | January 14 - 28, 1998  

by Matt Taibbi

Gogol once wrote that Russians had a great instinct for charity. They form a charitable organization, fanatically devote themselves to a worthy cause, and collect a considerable sum of money. Then they throw a huge party on behalf of the organization which all but bankrupts the charity; the group's last official act, he wrote, is usually to bicker over which eligible relative receives the remaining five rubles.

There are a lot of these parties going on now in Russia with public money, but not very many of them that we know about involve partying Westerners and Western funding.

One that we do know about, though, is the Investor Protection Fund, a World Bank-sponsored program which has become the focal point of a conflict between new Finance Minister Mikhail Zadornov, the Duma, Federal Securities Commission chief Dmitri Vasiliyev, and First Deputy Prime Minister Anatoly Chubais.

At issue is 207 billion rubles ($34.5 million) that the Fund received at the end of last year as part of the Svyazinvest deal-the Fund receives 2% of all privatization income, and 207 billion rubles was its cut from the $1.8 billion share auction.

Zadornov wants that money for the state budget. He says he has nothing against defrauded investors-the people who are supposed to be receiving that 207 billion- but that the Fund's history suggests that the money might be better off in someone else's hands. He based his conclusions on a report by the State Accounting Chamber, which sent a report to President Yeltsin in September 1997 describing the Fund as the ultimate Russian charity party, only with Americans at the head of the table instead of Russians.

The Investor Protection Fund was formed in April 1996 under the auspices of the Federal Securities Commission, ostensibly with the aim of at least partially compensating victims of investment fraud in the first half of this decade-investors in pyramid schemes like MMM, for instance.

The mechanism for financing Fund operations, as State Accounting Chamber officials describe it, was somewhat complicated. In simple terms, the money that was actually supposed to be paid out to defrauded investors was to have come from privatization revenues, while salaries for Fund employees, furniture, rent, and other expenses were to be paid by the World Bank.

What actually happened, in the first eighteen months, was this: no defrauded investors got paid anything, the privatization revenues sat happily in a private, American, run mutual fund, and the World Bank salary money was voraciously eaten throughout by Russian and Western Fund employees. For eighteen months, it was about a five million dollar party. Then the Accounting Chamber wrote its report, and the bickering began.

In late July of last year, the eXile reported the most shocking aspect of the Accounting Chamber's Fund investigation-which was that not a single kopeck had been paid to a defrauded investor in the first year and a half of its existence, even though Western consultants involved with the Fund had been receiving their full salaries throughout.

But information that has come to light since the close of the Accounting Chamber investigation raises the Fund story from a humdrum tale of small-time corruption to a genuine slapstick comedy. If you have a sense of humor at all, you can't help laughing at how bumblingly cynical, greedy, and heartless the key players in the Fund story were- and you can almost admire them for getting away with it, as they nearly all have so far.

After the State Accounting Chamber sent a letter to President Yeltsin in late September of last year detailing a whole range of improprieties within the Fund, Yeltsin quickly sent off a short and ominous letter to Viktor Chernomyrdin which effectively demanded that Chernomyrdin immediately break Vasiliyev's balls.

"I request," the October 27 letter read, "that you review the activities of the Federal Social-State Fund for the Defense of Investor's and Shareholder's Rights and take active measures to correct the problems uncovered by the Accounting Chamber of the Russian Federation. B. Yeltsin."

Chernomyrdin must have done his job, because a little more than a week later, on November 6, Vasliyev sent a grovelling 10-page mea culpa to Chernomyrdin in which he simultaneously agreed to all the suggestions asked for the by the Accounting Chamber and tried pathetically to defend the Fund's record.

There is a lot that is strange and illogical in this jumbled document, but the most striking is Vasiliyev's means for excusing the Fund's failure to pay out any of the 22.5 billion rubles it had acquired over the course of its 18 months of existence. While it was true that the Fund had not actually compensated any defrauded investors, Vasilyev wrote, it had performed a valuable service by "receiving 27,192 letters, answering 17,143 telephone calls, receiving 25,440 visitors, and granting free legal advice to 2568 persons."

Accounting Chamber inspector Yevgeny Nikulishev, rereading Vasiliyev's letter, joked that even this excuse contained exaggerations.

"If you read carefully," he said, laughing, "you can't exclude the possibility that the bulk of the callers, letter-writers, and visitors are actually the same people just trying to get through using different media."

Vasliyev went on to list 8 critical measures that he planned to introduce in order to satisfy Yeltsin and the Chamber. Measure number 4 read, "Documents are being drawn up for a tender for the transfer of Fund holdings to a Russian Company in possession of the proper license."

This passage was clearly inserted to answer charges that Pallada had received its contract without a tender. Back in July, incidentally, Pallada press spokesman Vadim Soskov told the eXile that there had in fact been a tender for the Fund contract, only he "couldn't remember" who the competitors had been.

Yet no matter how you interpret the slippery present-tense form of Vasiliyev's sentence, it is in no way a denial of the Chamber's accusation about the absence of a tender, and in fact at least confirms absolutely the assertion that Vasiliyev never had any documents to prove that there ever was a tender.

Vasliyev in his letter also agreed to draw up incorporating documents for the Fund, which hadn't existed previously, to make a list of Fund employees, which hadn't ever existed, to provide a detailed list of Fund expenses, which had not ever been handed over, and to fire all leaders of Social organizations who were supposed to be lobbying on the behalf of defrauded investors but who had instead been put on the payroll of either ILBE or the Fund and kept quiet while no payments were made.

And yet, after tacitly admitting guilt to all of these wild improprieties, Vasilyev turned around at the end of the letter and complained to Chernomyrdin that "the conclusions of the Accounting Chamber are absolutely politicized." It was a conclusion that gibed nicely with a long passage at the outset of the letter, in which Vasiliyev himself defended the Fund on political grounds:

"The realization of a complex program for the defense of investor's rights, as well as the formation in April 1996 of the Federal Social-State Fund for the Defense of Investors' and Shareholders' rights, made possible the significant weakening of social-political tension in the population and wreck the plans of the leftist opposition to use the issue of 'defrauded investors' for its own political ends."

Translation: it was okay that the Fund hadn't actually compensated anybody, since its very creation had accomplished the sought political objective.

From this long letter by Vasiliyev it is clear that the Investor Protection Fund was never about paying privatization money to defrauded investors. Nonetheless, its creation prompted a huge amount of activity-activity that didn't actually accomplish anything, but activity nonetheless. What was actually going on? And why? To understand, you have to look closely at who was involved, and who was benefiting from the Fund's existence.

eXile readers looking for new insight into the recent failure of World Bank and IMF policies in Asia might learn something from the story of this Fund. According to Nikulishev, the Fund had already spent 5 billion rubles, or about $835,000, in salary payments alone by June 1997, while still waiting to pay out it first kopeck. In fact, one thing in the Chamber report that may have gotten Yeltsin's attention was that the Fund director, Yevgeny Kovrov, officially earned twice as much as Yeltsin himself-20 million rubles a month as opposed to 10 million rubles.

The World Bank, then, was asking Russia to borrow money to pay state workers high salaries to do absolutely nothing-a very strange policy given the Bank's stated goal of downsizing bulky state industries and promoting market liberalization.

But that wasn't all the Bank was doing. Having already approved $4 million in assistance to Hay's ILBE, it helped provide the financial base-and in some cases the start-up cash- for a small clique of friends, mainly Westerners, to make profitable careers in private business through service of the Fund. If the Bank knew all along whom it was entrusting to handle its $31 million, that's reason enough to explain why its development programs don't work hardly anywhere in the world. If it doesn't have enough sense to hire people who know how to cover up conflicts of interest, it can't expect to manage economies. And the Hay/ILBE axis, particularly with regard to the Fund, was incredibly inept at hiding its misuse of funds and conflicts of interest.

For one thing, after the Wall Street Journal reported this summer that Hebert had used ILBE fax machines, telephones, and even consulted with ILBE lawyers, Hebert wrote a response to the paper which prompted a correction. In the correction, Hebert answered charges that she had improperly used USAID-funded resources by saying that her company, Pallada, had only worked for several weeks in the offices of a the First Russia Specialized Depository, a program funded by the World Bank-not USAID. In other words, Hebert exonerated herself with AID by admitting to using World Bank-funded resources.

"The thing about Jonathan and his friends," said one former ILBE staffer, who asked not to be named, "was that they were book smart, but not very smart about things like this. They all thought they were invincible."

In any case, that both Pallada and First Russia (headed, incidentally, by a former HIID employee and Hay associate named Julia Zagachin) were creatures of the World bank-financed ILBE, and specifically the offspring of the $31 million Investment Protection loan, is not that hard to establish.

The Wall Street Journal has already reported that Hay's ILBE investment wing, ILBE-Consulting, had a 1.96% stake in Pallada, and that Hay and the wife of ILBE-Consulting director Mikhail Volkov were both part of the FSC advisory committee which made Pallada the first registered Russian mutual fund, despite applications from much better-capitalized organizations like Pioneer Group and Credit Suisse.

The paper also reported that Sergei Shishkin, an employee of ILBE, was actually nominal director of Pallada in several Moscow Registration Chamber documents filed by Pallada itself-and this at a time when Pallada was winning a key contract without a tender.

Nikulishev at the Accounting Chamber also now says he believes that both Pallada and First Russia were created simulatenously, with the foreknowledge that they would be the winners of the Investor Protection Fund contract. As evidence, he cites information which show that Pallada's American holding company, Boston Capital Management Group, and First Russia's holding company, Oasis Financial Services, have the same agent and legal address in Wilmington, Delaware.

Ann Martin of the Corporate Service Company, the Delaware agent for both, said that the fact that both companies use Corporate Service's address is not unusual, since the company acts as agent and nominal holder to tens of thousands of companies in Delaware.

And Soskov, the Pallada spokseman, denied that Pallada and First Russia have anything but a strictly commercial Fund-Agent relationship. "These are two completely different companies," he said.

But Martin also said that both companies were incorporated within days of one another. "Boston Capital was formed on May 6, 1996, and Oasis Financial Services was formed on May 8, 1996," she said. In short, both companies were formed at the same time and place, just a few weeks after the Fund was officially created.

The amazing thing about all of these small-time shenanigans, absurdly sloppy paper trails, and open conflicts of interest is that, despite the Accounting Chamber's report and the "measures" instituted by Vasiliyev, Hebert, First Russia et al still stand to become enormously rich off the Investor Protection Fund.

"If the Svyazinvest money stays in there, and the money from Rosneft and VNK [Eastern Oil Company] comes through, then we'll be talking about trillions of rubles under management at Pallada," said Nikulishev.

Although this story is a sad one, if taken from a defrauded investor's point of view, there is one very happy angle to it-the apparently endless love and reciprocity in the Hay-Hebert relationship. Jonathan Hay may have been ousted from HIID after he was caught investing in Russian securities, but his career didn't end there. When the eXile called Vasiliyev's office in an attempt to locate Hay for this article, a Vasiliyev spokeswoman reacted with surprise. "What are you doing calling here?" she said. "Call Pallada-that's where he works."

A call to the Pallada number 721-13-50-where a secretary answers the phone by saying, "Pallada,"-located Hay, who declined to comment on the story. Soskov later said, however, that Hay does not work at Pallada.

"Of course not," he said. "He works at a company called Iron Wood, which is not connected to Pallada."

As Hebert had in the August Wall Street Journal story, Hay made his only comment a righteous, wounded attack on his questioner. Hebert in August had said, "I find it unconscionable that the Wall Street Journal has acted on misconstrued facts."

The once-mighty Hay, formerly a reform leader with his finger on the pulse of Russia, only now ousted from HIID and buried at a remote extension in the bowels of his girlfriend's mutual Fund, still had pride enough to say last Friday, "I'm outraged by your irresponsible journalism. Your newspaper is irresponsible and most people see it as being so."

Hay attacked me for "printing lies" in my previous article about him, to which I responded that my information had come entirely from the Accounting Chamber.

"You consider them a reliable source?" he said.

Well...look at the graphic in this article: they were good enough for the President of this country. They were good enough for the front page of this week's Novaya Gazeta. They're a government agency- just like, incidentally, the American General Accounting Office, which once concluded that your Moscow HIID office improperly went away from the official USAID strategy of favoring legislation instead of executive decrees.

This story doesn't necessarily have an unhappy ending. According to Yelena Sorokina, assistant to Kovrov at the Fund, defrauded investors began receiving compensation "sometime in September." She couldn't say how much (a breed of ignorance she has in common with the Accounting Chamber, which doesn't have evidence yet that money has been paid out), but she knew the news was good. "I don't have any numbers for you," she said. "But I can tell you that people are calling us up and saying- 'Thankyou!'"