Moving Money, Making Money, and Parking Money Overseas: Front Companies in Offshore Jurisdictions

Abstract

The major challenge facing Russia and Ukraine today is the adoption and acceptance of internationally recognized business practices. Recent scandals, such as the Russian Bank of New York and the Ukrainian Pavlo Lazarenko cases, show that Russian and Ukrainian elites have sometimes engaged in unethical and criminal activities. The problem is not only in the ethical norms but in the very nature of economic relations in the countries. Russia and Ukraine, as well as many other countries in the region, will either opt for market driven prices, competition, and regulated markets, or they will face continued poverty, economic decline, and political instability. Private enterprise in post-Soviet societies emerged from nomenklatura socialism, a system of privileges and the exercise of autocratic power from the top down. Prearranged privatization, under-the-counter sales, double accounting, and monopoly of production by a few powerful tycoons have created a capitalism that is deeply flawed. Some scholars argue that it is not capitalism at all but something new, a virtual economy, a hybrid between Soviet capitalism and feudalism.1 The centralization of the Soviet era has gone, but what has replaced it is patronage dispensation by a few magnates-the so-called oligarchs. The elements of healthy entrepreneurship that had been the backbone of Russian and Ukrainian capitalism in the nineteenth century-free competition, hard work, savings, and investment-are barely present today. Instead, Soviet era monopolies turned themselves into private corporations, largely by nontransparent government fiat, without any competition or supervision, and they have accumulated enormous wealth that is hidden mostly overseas in private bank accounts. The 1990s will no doubt be remembered as a decade of pillage, capital flight, and criminalization of the economy, a great redistribution of property comparable only to the nationalization carried out by the Bolsheviks. Deeply uncertain about their grip on power, the post-Soviet elites have tried to relocate assets where they would be safe-in offshore bank accounts, in real estate in Western countries, and increasingly in investment in legitimate business in the West. raises a number of questions, regarding, for example, the role of offshore banks and other offshore companies in Russian[Ukrainian asset stripping, as well as the matters of capital flight and money laundering. There are essentially three stages in the process that need to be reconstructed: How assets were generated in quantities that allowed for large-scale transfers abroad The mechanisms that were used to shift earnings overseas The extent to which the shifted assets had criminal origins Moving Money: Offshore Businesses Export-import operations, offshore intermediaries, and international wire banking are the main channels for Russian and Ukrainian funds flowing abroad. The mechanism for shifting assets overseas is simple: Russian producers of an exportable commodity surround themselves with intermediary companies, including those offshore. They buy aluminum or oil from their own subsidiary at a low domestic price and sell it, also at a low domestic price, to offshore companies. By doing this, they pay low taxes on a low-priced commodity. Then the offshore company they own or control sells the commodity at the world market price, and the enormous profit stays in the West. Major Russian exporters of oil and gas, timber, and metals set up a complex web of intermediaries with the sole purpose of siphoning off revenue to offshore zones and Western banks. For example, Sibneft, a major Russian oil company, exports oil to its offshore affiliate, Runicom, at a low price. Runicom then sells the oil to Western consumers at the world price. As one analyst in Russia wrote: This is an absolutely standard procedure.... Practically all Russian exporters of oil do this. 'Slavneft' exports oil through `Slav-neft-Belgium,' Ukos through 'Rautenhold,' and Sidanko through `United Petroleum'2 A complex system of bank transfers is designed to obscure the origin of the funds generated by untaxed skimming of Russian national resources. …