Steven L Douglas
Action Research Project Proposal
The Games Russians Play:
What you need to know
To look back at my Russian business experiences from 1990 – 2000, they were anything but typical for an expatriate living a working in St. Petersburg. In thanks to a Russian partner I was introduced to the underworld of Russian business, more specifically the Mafia and occasional glimpses of deep-rooted corruption in the Russian Government. With no thanks to this Russian partner I was also introduced to transnational organized crime and honored with a memorable 8-hour interrogation by the KGB in February 1994.
A top lieutenant in the Russian Mafia Tombovsky Crime Family once told me the difference between a “Good Foreigner” and a “Bad Foreigner”. A good foreigner was what they called a foreign businessperson who came to Russia but had no timeframe set as to when he/she would depart. A bad foreigner on the other hand was classified as a foreign businessperson who came on short trips or a foreigner who came to work in Russia for a short period of time with a scheduled departure date. A majority of foreigners who came to Russia in the 1990’s were considered Bad Foreigners. The foreign partner that was looked upon, as a bad foreigner, was believed not to have a long-term interest in benefiting their Russian partners. The Russian partners were over anxious to find foreign partners for the explicit reason of gaining foreign capital for their enterprises. Following the beginning of privatization, most factories were in serious debt and cash poor, thus the reason for Russia to open her arms to foreigners.
I had many opportunities to watch, and analyze, business relationship between Russians and foreign visitors between the years 1990 and 2000. Soon following the financial crises of 1998 I created and organized the Foreign Commercial Consuls Club of St. Petersburg. Membership consisted of Commercial Consuls from most foreign countries with representations in St. Petersburg. This Club gave me a direct connection to representatives of many different countries and an invaluable opportunity to discuss with them their relations and feelings about the Russian market, culture and people. In early 2002, as an executive in Washington DC, I created a new organization called the Foreign Embassy Club of Washington DC which has membership of foreign diplomats from more than 25 of the area Foreign Diplomatic Missions. This newer Club allows me to continue my research on international relations. The founding members of this Club include the Embassies of the Russian Federation, Kazakhstan and Australia.
This Action Research Project is not about the Russian mafia or about organized crime. It is an explanation of what every foreign businessperson must be aware of before they attempt to enter the robust growing Russian economy.
Description of the Research Problem:
Just because a company is successful in their home market does not necessarily mean that the world is waiting on bended knee for them to come to their countries, unless of course they are willing to play by the local rules. Regardless of how well your product fits into a given market economy, you must understand the characteristics of the business culture, what I call “The Rules of the Game”, of your new market to have the opportunity to sell your products and make your investment profitable. This rule applies to the Russian Federation but there are a number of special steps foreigners must take before entering this sometimes volatile and dangerous market.
The Russian people love everything “American”, which is why American consumer products are in continuous and tremendous demand, from cigarettes (Phillip Morris) to blue jeans (Levi’s), beer (Budweiser) to chewing gum (Wrigley’s), diapers for babies (Proctor & Gamble) and fast food (McDonalds).
Russia has a special set of games that must be played before you are given access to the market. Unlike the USA, the government does not offer foreign companies any notable protections or security for their investments. I contend that no business can survive in Russian unless you have “krisha”; a roof; a protector that allows your company’s existence. “Krisha” normally refers to the mafia that offers you their specialized security services for a 25-30% commission on pre-tax revenues. This security includes protection of your facilities, distribution channels, transportation and personnel. To increase their commission share value the mafia has been known to disrupt production, distribution and transportation of potential or serious competitors including (but not limited to) harassing employees. Where in the early 90’s krisha predominantly referred to mafia protectors, it can now refer to government and/or mafia.
It is important to note that mafia rarely makes agreements directly with foreigners. In the early 90’s the only true protectorate was the mafia. By the mid-90’s this business security business changed to include local, regional and federal levels of government. Soon after the fall of the Soviet Union the new Federal Russian Government was too busy with national politics and priorities to get directly involved with foreign investor’s interests. In a short span of just 3-5 years this situation changed and local and regional governments were actively seeking foreign companies to open offices and manufacturing facilities in their perspective regions. In his final years as Mayor of St. Petersburg (formerly Leningrad), Mayor Anatolij Sobchak developed town meetings between his office and local mafia bosses. These mid-90’s town meetings eventually restructured the protection racket in St. Petersburg and the government became a new protectorate for large foreign businesses. This agreement between the Sobchak administration and local mafia assuredly offered benefits to both sides. The end result of this agreement was that the mafia would protect small to medium sized businesses, including trading companies, importers, exporters, restaurants, hotels and entertainment complexes including casinos and nightclubs. Depending on what part of the city you had your office also determined which mafia organization would protect you. Aside from regional distribution there were also understandings between mafia groups that hotels would be taken care of by the Tombovskaya Mafia and the Jewish Mafia would protect Casinos. The government would be in the business to protect large foreign MNC’s and foreign government sponsored programs.
As I mentioned earlier, the mafia rarely offered protection directly to foreigners. Small to medium sized foreign companies that entered the Russian market in most cases had Russian partners. This was a necessity since Russian laws were clear that you could not operate any sort of business on the Russian territory without official registration. The Russian partners were well versed in the game of krisha. Normally it was not necessary for a company to go looking for protection. In fact, the standard practice was that once a new office was opened, the local mafia would find there way to the office and make arrangements.
It is important that I note at this point, that Mafia protection was very structured. Mafia protection and payoffs were not made through series of threats in back alleys or covert locations. The Russian mafia organizations were well organized and had special companies created for making contracts with clients, keeping moneys paid on an official level. They even had the openness to hold negotiations in the lobbies of 5-star hotels in the city center. What makes this different than a company contracting for security services with a security specialist is that these agreements were forced upon you. The other more startling difference was that the mafia went way beyond the act of security, as I note in this ARP Proposal.
The larger foreign MNC’s entered the Russian market either by invitation from a potential Russian partner, by invitation of local and/or regional government administrations or by direct choice of the company itself. As I will explain in detail the option that offered the greatest long-term security was, and remains, having protection from the government. As will be discussed in this paper, many joint ventures ended in disaster for the foreign partners due to contract disputes with their Russian partners, lockouts, government interference, taxation, zoning laws and other schemes concocted by the Russian partners and their protectorate. This “interference”, on certain occasions, included physical assault and murder, depending on how high the stakes were for the Russian partners to gain absolute control over the ventures.
Having a small proprietorship or joint venture in Russia is like gambling in a casino. You must be prepared to lose everything you bring with you. When you do lose, which will eventually happen, you will most assuredly end up in court fighting to regain control of your investments and property. You must understand that Russia does not have a working court system. As I have told foreign businesses before, you can take a Russian to court and win your case but there is no working collection system to get paid on your judgments, unless of course you are willing to play the game and take the final step in the judicial process, Mafia Court.
Most foreign businesses that do go to court do not take this step. What they do is stop once the official Russian Arbitration Court announces its judgment. My former Russian partner entered our company into two separate Mafia Tribunals (now referred to as the Mafia Court). Fortunately we won both cases. We found that the Mafia Court system was a fair system. Perhaps we are prejudice in our thinking since we were the winners. To support my theory that most foreign business failures would have a better than good change to collect on their Russian Court judgments, if they utilized this unofficial Mafia Arbitration Court, I will devote a chapter of my paper on the workings of this special and mysterious element of unofficial Russian justice. The term “private debt collection agencies” (Donaldson 1996; Hertz 1997) has been used in reference to the mafia that is hired to collect moneys owed by one company to another. The term “Mafia Court” is not mentioned in any books I have included for this ARP.
For foreign companies that enter the Russian market using the government as their protectorate there is also a chance of being put out of business. In 1996 I established a new tradeshow management company in the USA with an office in St. Petersburg. My wife (a Russian citizen) established a sister company registered in St. Petersburg which allowed me to represent the US company in a physical office and to conduct business. Although this was technically a joint venture we had complete control over the business assets and operations without non-relative partners. Our “protectorate” was a bit different than typical mafia protection. Although we were classified as a small company we had official support from the local, regional and national government. Because of our high profile, local mafia chose to stay away from us. Our first 4 years ran without any problem because we had strong support from the Yeltsin administration.
Our successes changed abruptly at the end of 1999 with the election of Vladimir Putin. Putin completely restructured the political control and management of the Northwest Russian region and took most local and regional controls back to the Kremlin. He established a new regional authority that local and regional government needed to report to on everything they did. This regional authority reported back to the Kremlin and served as a new go-between between Moscow and the Regions. With this shift our contacts, non-financial protectorate, were out of power and useless to us. I made every effort to achieve the support of the new administration but this was a useless attempt and we found ourselves out of business by January 1, 2000. As I look back on these events I blame the results on two factors. The first, that Putin was disgruntled with the US Government following President Clinton’s withdraw of support of Russia following the World Bank scandals of 1998. Our company was the only American tradeshow management company in the region and once we lost our support, all support was shifted to our Russian competitors. The other reason was that we were not cash rich, a necessity to bribe local officials for their support. Although bribing officials can equate to having protection it is done without a structure or agreement. Payments for signatures were the most common methods of bribery without any form of protection. With the US withdraw of support in late 1998 followed quickly by the 1998 Economic Crises in Black August, it seemed like all of our regular foreign clients and new to market prospects put a block on Russian investment at least until after the New Millennium. Our only means of survival during these two tumultuous years were using our Russian side of the business to enlist participation in our events from Russian companies. Russian companies paid much lower participation fees than the foreign exhibitors, and more importantly paid in rubles, not dollars. Bribes were never accepted in ruble currency, only dollars. Although I lost my business I look back with great pride that we survived the period between Black August and the New Millennium.
A review of literature relevant to the research problem:
Many books have been written about Russia between 1990 and 2000 including “How To” books and special books about the Russian Mafia. Some of these books emphasize business as a major theme and/or discussion point. The books I have chosen to use for my ARP include (but are not limited to) Violent Entrepreneurs: The Use of Force in the Making of Russian Capitalism by Vadim Volkov (Cornell University Press, 2002) NOT available for review at this time; After the Collapse: Russia Seeks Its Place As a Great Power by Dimitri K. Simes (Simon & Schuster, 1999) NOT available for review at this time; How to Profit from the Coming Russian Boom: The Insider’s Guide to Business Opportunities and Survival on the Frontiers of Capitalism by R. Poe (McGraw Hill, 1993); From Nyet to Da: Understanding the Russians by Yale Richmond (Intercultural Press Inc, 1996) NOT available for review at this time; The Oligarchs – Wealth and Power in the New Russia by David E Hoffman (Public Affairs, 2002); The Russian Mafia: Private Protection in a New Market Economy by Federico Varese (Oxford University Press, 2001); Russian Etiquette and Ethics in Business by Lloyd Donaldson (NTC Publishing, 1995) and Russian Business Relationships in the Wake of Reform by Noreena Hertz (St. Martin’s Press, 1997); Bandits, Gangsters and the Mafia: Russia, The Baltic States and the CIS since 1992 by Martin McCauley (Pearson Education Limited, 2001); Doing Business in Russia: Basic Facts by Tankred G. Golenpolsky, Robert M. Johnstone, Vladimir A Kashin (The Oasis Press, 1995); Rebirth of a Nation: An Anatomy of Russia by John Lloyd (Michael Joseph Limited, 1998).
After reviewing seven of the aforementioned books I found no references to common problems that I have proposed in my ARP except perhaps for the book by Golenpolsky which is a businesspersons guidebook. All of the books I have noted above emphasize how corrupt Russia has become, that the mafia, or “mob” has taken over this capitalist society and turned it into a two-faced culture of Marxists (the masses) and Keynesians (the powerful elite). Martin McCauley was the only author of the seven books I was able to review for this proposal that actually spent time as a businessman in Russia but unfortunately his book concentrates on Moscow. No mention of my two case studies was noted in any of this material. If these books are deemed a good representation of literature on the subject, my paper should be a valuable addition to current literature on the subject of foreign business investment in the new Russian Federation.
A description of the proposed research methodology:
I will use this ARP to discuss my personal opinions, expressed above using two case studies. Although there would be obvious similarities between what they did in their Russian expansion, there are clear differences in how they played the Game and continue to play this game today. My two case studies are Philip Morris (Cigarette Manufacturer) and Subway Restaurants (Fast Food).
Philip Morris International, Inc. opened a representative office in Moscow in 1992. One year later they bought controlling interest in the Krasnodar Tobacco Factory. 5 years later they began construction on two new plants located in the Leningrad Region of Northwest Russia in Izhora and Kuban. According to a recent article Philip Morris to Invest USD 43 million on Expansion in Russia, (Russian Interfax St. Petersburg, September 25, 2002). Phillip Morris Russia anticipates that by the end of 2003 they will produce 80 billion cigarettes per year (4 billion packages of cigarettes equivalent). At the time this article appeared in the local Russian press Phillip Morris controlled a 22% stake in the Russian tobacco market with an expected increase of 3% per year. Their Russian operation is a sole-proprietorship with 100% ownership by the US parent company. Although there is probably special security that has been hired to protect their facilities, distribution, transportation and personnel these security are most likely employees of Phillip Morris, not a separate mafia or security organization. Phillip Morris has invested $500 Million in the Russian market since 1992.
The Subway Company opened their first Russian establishment as a joint venture with the leading fast food restaurant in St. Petersburg called OAO “Minutka”, in December 1994. Six months later, in June 1995 after Subway invested money to completely revamp the entire store, located on Nevsky Prospect the Russian partner seized control of the store. Subway took their case to the Russian Arbitration Court and reached a decision that could not be enforced. They then took their case to the European Arbitration Court and won their case there. What Subway does not understand, and they are not the only company who does not understand, is that the European Arbitration Court has no jurisdiction in Russia to enforce any judgments made. Had Subway played the Game and gone to Mafia Court, using other judgments as proof that they were right, they would have had a good chance of winning. Minutka would have no way of not fulfilling the demands of the Mafia Court decision. There is no bureaucracy or red tape that exists in Mafia Court. You do what you are told or you face serious and possibly grave circumstances. Subway has since opened a number of restaurants in Moscow and has learned from their earlier mistakes but continue to face an uphill battle due to a major downturn after the 1998 Economic Crises and a slow upturn over the last four years. Jim Ganziinger (President of Subway Russia) came to become a Subway franchisee based on a visit to Moscow in 1993 when he stood in the rain outside of a Moscow McDonalds where 5,000 customers were waiting on line. That site was his impetus to move forward as quickly as he could to establish his first restaurant in St. Petersburg. He jumped so fast that he was not aware from the outset that within six months he would lose his joint venture.
In my paper I will offer a detailed accounting of how both companies entered the market and where they are today. My research methodology will be to use published articles and reports on both companies that have been reported by Russian and non-Russian Press. I will also conduct interviews with executives of both companies.
How the research findings will be used and or disseminated
With prior agreement with the Director of BISNIS (Business Information Service of the Newly Independent States) my final paper will be submitted to the US Department of Commerce to be disseminated to all subscribers of their BISNIS Website (www.bisnis.doc.gov) to serve both as a warning as well as a suggestion on how to enter the Russian market, assuming my theories have not changed by that time.
- The Introduction (thecrooner.wordpress.com)
- My First Visit to the Soviet Union (stevenleesdouglas.wordpress.com)
- An Investigation into Russian Human Trafficking (sldouglas.wordpress.com)
- ‘The Russification of WikiLeaks’: Crowdsourcing the fight against Russia’s casual corruption (blogs.journalism.co.uk)
- Russia, Called ‘Mafia State,’ Regrets US ‘Cynicism’ – BusinessWeek (news.google.com)
- US embassy cables: Russia is virtual ‘mafia state’, says Spanish investigator (guardian.co.uk)
- An Investigation into Modern Religious White Slavery in the USA (sldouglas.wordpress.com)
- Russia Is ‘Mafia State,’ Prosecutor Said in Cable (businessweek.com)
- Russia Is ‘Mafia State,’ Prosecutor Says in Leaked U.S. Cable (businessweek.com)
- Chapter 12: Business, Mafia and Jazz (thecrooner.wordpress.com)
- Tajik president ordered to free jailed Russian pilot (rt.com)
- ‘WTO membership will boost Russian tourism’ (rt.com)
- 2012 Toyota Camry start production in Russia (inautonews.com)
- NATO ‘failing to adjust’ – envoy (rt.com)
- The Esimit Europa Project, an Ambassador of Cooperation Between the European Union and the Russian Federation (prweb.com)
- All-Russian Muftiate Favours Government Ban on Wahhabism in Russia (02varvara.wordpress.com)
- Table toppers Zenit and CSKA unable to break away (rt.com)
- $100 fine for Public Acts of Gayness in Russia (queerlandia.com)
- St Petersburg lawmakers consider fines for “gay propaganda” (gunnyg.wordpress.com)
- Activists Are Slamming This Russian Anti-Homosexuality Bill (businessinsider.com)
Who is “Big Brother”?
|“As governmental failures came to be more widely acknowledged, personal respect for law deteriorated. Politics and politicians became more blatantly profit-seeking… As the federal courts were seen to make law in their own idealized image, by natural extension individuals came to think of their own private criteria to discriminating between ‘good’ and ‘bad’ law.”By James M. Buchanan
The Limits of Liberty: Between Liberty and Leviathan
Chapter 10, pp. 172-3
(The University of Chicago Press, 1975)
The Judicial System of the Russian Federation was reformed and reorganized in the Constitution of the Russian Federation (1993). The framework of the Court System as prescribed in the Constitution was created using the basic framework of the existing system used in the United States of America. This fact is not surprising since it was the intention of the newly formed Russian Leadership to quickly establish the Russian Federation as a strong stable Global Democracy and what better example to duplicate than the leading Global Democracy, America. Russia was to become a Democracy that would soon join the World Trade Organization and be respected around the world as a good investment climate to foreign countries, MNC’s and non-state actors/investors.
This legitimacy was extremely important to the new government leadership since they were also the new oligarchy that controlled most of Russian industry, something they accomplished in a short period of two years through a swiftly enacted rule of Privatization. These politically aligned oligarchs new that they must have the support of a working Judicial System to protect their enormous new wealth.
Between 1993 and today, Russia has failed to be accepted into the WTO and continues to suffer from a non-working Judicial System. Certainly the system exists but as I will discuss in this paper, it lacks the ability to protect the innocent due to extreme corruption at all levels of the Court. During the last 10 years, the names of the Oligarchy have changed, but their original goal to legitimize the system to protect their riches, has failed due to their own controversial and mostly counterproductive influence and corrupt business practices.
I will discuss and analyze two cases studies from two very different perspectives. The first case involves a court dispute that took place in 1992, less than one year after the collapse of the Soviet Union and one year before the adoption of the Russian Federal Constitution. This court dispute took place outside of the official Russian Judicial System under the direct organization of the St. Petersburg (Russia) Mafia, known as “The Mafia Court”. The second case study is of a recent event that started in August 2002 with the leader of the Russian pulp and paper industry, Ilim Pulp Enterprises.
Case Study I: OAO “Russkij Les” vs. L&S Trading Inc.
In response to an earlier draft of this section my Russian Embassy source told me that this Part is entertaining and looks very much like the scenes from “The Godfather”. He noted that history repeats itself and that my comments were absolutely on target. The situation I am about to describe is a direct result of the inability of the legal system to enforce its rulings. After exhaustive research I have not been able to find any published materials about Mafia Tribunals or Mafia Court. No one can actually confirm or deny the existence of either of these phenomena except those that have been party to either of them. I therefore admit that what I will discuss in this Part is from my own personal experience having participated in two mafia tribunals and having been refused an opportunity to participate in Mafia Court.
I was a businessman living and working in St. Petersburg, Russia between 1990 and 2000. In the early 90’s soon after the collapse of the Soviet Union, even before the official establishment of the Federal Constitution Law on Judicial System of the Russian Federation (Dec 1996) there were arbitration courts but these courts had no means to enforce decisions. For this reason the courts were not very busy. The main reasons people used courts in the early 90’s were to get decisions on subjects directly related to legal issues where the Government was somehow involved. Where the courts were not used were for arguments between commercial entities. The only place commercial entities could argue against each other with a remote chance of collecting damages, were Mafia Tribunals. Having had a Russian partner with admitted ties to the Mafia of the early 90’s I found myself in my first tribunal in early 1992.
Soon after we started our timber export business (L&S Trading Inc.) Leonid, my former Russian partner, informed me that we were summoned to appear at a Mafia Tribunal that took place in the coffee shop of the Pulkovskaya Hotel in St. Petersburg, not too far from the Pulkovo International Airport. It was common practice for Mafia to meet at hotels in open view to public and the local police. The truth is that they felt it was less likely that someone would try to kill them in public near tourists. This would change in later years with a number of assassinations taking place in the coffee shop of the Sheraton Nevsky Palace Hotel on Nevsky Prospekt in downtown St. Petersburg.
One of Leonid’s suppliers (Russkij Les) accused him of not paying full price on a shipment he made to one of our buyers. Leonid obtained an old acquaintance of his whom he knew for many years that represented us. Prior to our arrival at the hotel we met in two separate locations in the backs of apartment complexes to meet the necessary people who would be a part of this meeting. Only after the 2nd rendezvous did we know where the actual meeting would take place. We then found ourselves at the Hotel.
As we walked into the restaurant we saw at least 30 Mafia seated in the cramped area of 100 sq. ft. with three distinct groups within the overall group. The least important were the plaintiff and the defendants. Most important were our “attorneys”. The third group was their bodyguards who were sitting further away from the table watching everyone else who passed near to us. I cannot imagine that any of the tourists visiting the café had any idea of who these people were.
The tribunal lasted approximately 2 hours. We were victorious at the tribunal and received certain compensations, which were settled with Leonid. The Mafia attorney for the plaintiff (our accusers) was named “Slava” who in fact was the 2nd most powerful Mafia boss in the City. The “judge” was dressed in a Nike sweat suit and was apparently the Godfather of the St. Petersburg Mafia. Sweat suits were a very common form of dress for the Mafia in those days. Later that year he was shot 10 times but survived the assassination attempt and moved to Germany.
The Mafia Tribunals of the early 90’s have evolved into modern day Mafia Courts, which follow a very stringent set of rules. For example you cannot apply to the Mafia Court until after you have already gone through the official Russian Arbitration Courts. You may ask, “If I have already gone through Arbitration Court, why do I need Mafia Court?” The answer to this question is the very reason why Mafia Court is so important and in fact a sought after and busy court system in today’s Russia. Sought after by Russian businessmen, not foreigners. The main problem associated with Arbitration Court is that if you win a settlement involving money you have no means to collect it. The Russian Court does not have a working collection system or a “Sheriff’s Department” who is available to insure that the winner can collect from the loser. There are no police you can turn to or any banks that will take a decision of the Arbitration Court seriously. Most foreign companies who go to Arbitration Court end up winning, but not collecting the judgments made by the courts. In effect they are really the big “losers” because they will not allow themselves to take the next step – Mafia Court. Their western values tell them that any association with “Mafia” is not acceptable. To ignore this is my justification that foreign companies should not be in Russia in the first place, if they are not willing to play the game the way it is designed. The “winners” are the Russian enterprises that leave the arbitration court with smiles on their faces knowing their foreign adversaries will never take the next step. As a leading consultant to foreign companies wishing to venture into the wild new Russian Federation I frequently recommended they not do so. In response to the question “Should we invest in Russia” I replied that if they were interested in investing time and money to sell their products to Russia or to purchase Russian products for exports then invariably my answer was “Yes.” If they were interested in establishing joint ventures then my answer was always “No.” This attitude did not change through the period until I departed Russia in mid-2000. Following a second Mafia Tribunal in early 1994 we reestablished our trading company with silent (Government) partners who insured that we would not find ourselves in further predicaments. As it turned out, my partner embezzled moneys from our company and the company was closed in early 1995.
Case Study II: Base Element vs. ZAO “Ilim Pulp Enterprises”
If you listen to the Russian news services in both the major cities of the Russian Federation you will read about assets being frozen in banks as results of court rulings and bailiffs, supported by police appearing at factories to allow access by new management after hostile takeovers. The most common problems with the Russian Arbitration System remain that competing sides frequently manage to obtain contradicting decisions from two different courts and the judicial process gets stuck. But these are only my own observations. The road to perfection is a long one. The police supports Court decisions but this does not guarantee the fulfillment of justice. The issue is more than just applying force; it is a problem of creating a “Rule of Law” culture in the business community and the society as a whole. Unless the majority of businesses learn to respect the rules of the court, the system will not work, regardless of how you support its rulings.
In comparison, the US Arbitration Court system would collapse if most decisions were opposed by the losing sides, sides willing to go as afar as it takes to have the decisions reversed, instigating blockades at entrances to factories, bribery of local politicians and finally contract hits by the Mafia. In retrospect it is an evolutionary process. With step-by-step reforms and more important education to the masses things will change in the right direction.
ZAO “Ilim Pulp Enterprises”, established in St. Petersburg in 1992 found itself under siege in April 2002, ten long years after it’s founding by Zahar Smushkin, an American educated Russian entrepreneur in the Russian Pulp, Paper and Timber Industry. In a span of 10 years, Ilim Pulp had purchased recently privatized mills including Bratsk Forest Complex (the largest producer of timber products in the Russian Federation), Kotlass Pulp & Paper Mill (the largest pulp & paper producer in Russia and Ustilimsk Pulp Mill. Collectively Ilim Pulp controlled the Russian pulp production market and by 2002 they were close to a USD1 Billion revenue company with a 30% profit margin.
The case of Ilim Pulp is a very good example of modern day Russian corporate takeovers. In this case the adversary is Oleg Deripaska, one of the richest oligarchs in the country. No one knew who he was 3 years ago but now married to the niece of the former President, Boris Yeltsin, he has quickly amassed support to create an enormous conglomerate. By the time this saga in Russia corporate history is complete Mr. Deripaska may no longer be who he is today. However, I would expect that Mr. Smushkin would survive the ordeal he is under since he has the apparent support of the President, Vladimir Putin.
A former minority partner of Mr. Smushkin (Smushkin reportedly owns 85% of the company) Vladimir Kogan and his “Banking House St. Petersburg” came together with Mr. Deripaska’s holding company “Base Element” and small investment company “Continental Management” and plotted how they can obtain controlling shares in Ilim Pulp Enterprises. Mr. Deripaska had already successfully taken control of the Russian Aluminum and metals markets and was now ready to enter the extremely valuable forestry and timber sectors of the growing economy. By the time he had seized shares in Kotlass Mill he had already taken control of the Bratsk Forest Complex in Siberia, also a holding of Ilim Pulp.
According to claims by Deripaska’s representatives, Ilim Pulp did not live up to its financial commitments that it supposedly agreed to when it purchased its assets thru Privatization. Deripaska found a small shareholder (although it has not been proven that this person owns actual shares of the company) 2,000 miles away from Koryazhma in a town called Kemerovo in Siberia. Deripaska convinced a local court judge to declare that Ilim Pulp no longer had legal rights to their assets and 61% of the shares in Ilim Pulp were released to the Russian Federal Property Fund and immediately sold off to Deripaska’s Investment company for USD100 million, 16% of the total value of the shares. Through this entire process Ilim Pulp insisted they had never been informed of the case before the local Kemerovo Court and would not accept what they deemed an illegal seizure of their enterprise.
As of October 21, 2002 Ilim has convinced a District Court to overturn the decisions of the lower court in Kemerovo and a new hearing is rescheduled for November 4, 2002. (As I will be writing this paper as the saga continues I will continue to update the story).
Part II: Who is Big Brother?
After reviewing various scholarly works regarding property rights, contract law, international relations and especially works on Russia, I have chosen to analyze my two case studies exclusively using The Limits of Liberty: Between Anarchy and Leviathan by James Buchanan (The University of Chicago press, 1975). Although this book comprises 10 chapters I will devote by analysis entirely to Chapter 8: The Punishment Dilemma (pp. 130 – 146).
The Limits of Liberty analyzes the United States as it was in the 60’s – 70’s. The Russian Judicial System is not discussed in this book at anytime yet his discussions in these short 35 pages have shown be what I believe to be the answer to why the Russian Judiciary does not work, cannot work and will not work for decades to come (…or does it?). In short, my analysis validates the important of the Mafia Court System as well as support why Deripaska assumed he could takeover Ilim Pulp Enterprises. If he eventually succeeds in his quest, which can only happen following the published date of this paper, it will happen because the court system does not work.
q Buchanan contends that the enforcement of law must be dictated by an internal source or internal peacemaker versus an external third party as suggested by Thomas Hobbes theory of Anarchy more than 300 years ago.
Mafia Court is an example of Hobbessian theory, an anarchic theory of justice. As I have suggested various times in this paper, the judicial system does not work, a system relative to Buchanan’s Keynesian ideology.
Deripaska vs. Smushkin is in a court battle using the Keynesian court system of Russia. If the court is fair, which it cannot be, then this argument should be resolved between both parties with the assistance of the arbitration court judiciary.
q Buchanan discusses “public good” versus “public bad” in terms of utility costs. What is good for the public means lower costs whereas public bad is more expensive for society. Public good finds a way to deter crime or not punish violators. To punish violators of crime means financing police, courts and penal institutions requiring great expense and which in turn is bad economics for the society.
Mafia Court, I contend, is “public good” because it is outside of the legal system. There is no direct influence on the public economically. The Mafia Court does not utilize or require a police force, court building (a hotel bar will suffice) or penal institutions since both parties agree to resolve their dispute at the time of the tribunal of court proceeding.
Although Case #2 will most likely not require penal institutions for either party it will entail many court hearings and extensive travel for the parties involved. The cost of the security forces of both parties, public relations, lawyers (advocates) will eventually cost both parties and the public millions of dollars in expenses. This case will be drawn out over a long period of time because the court system they are utilizing cannot come up with a judgment either side will respect or accept. Because the Kotlass Mill has ceased functions due to this takeover attempt the workers of the mill with lose salaries contributing to an increasing “public bad”.
q “Those who violate law see immediate gain; they try to compare the expected value of this gain against the expected and future costs that punishment involves. A decision to break law represents a trade-off between anticipated future loss and present gain.” (Ch. 8, p. 135)
As I read this statement I began to understand that Buchanan was about to tell me the answer I have tried to identify for the last two years. Russian criminals choose to break laws because they know that the immediate gain far outweighs the possible future losses, assuming they ever get caught. Something they do not anticipate will happen. Since there is no sure method of enforcing court decisions most law-breakers are not afraid of the system. If Deripaska and Smushkin accept the decision of the Russian court there will certainly be a big loser, if Smushkin is the loser. The aggressor in this case, the party that started the attempted takeover has nothing to lose which legitimizes his pursuit to obtain Ilim Pulp Enterprises as another feather in his hat. Without question Deripaska only has potential gain.
q Buchanan discussed the important of establishing punishments and their enforcements when the law is determined when the constitution is determined, prior to when the law is broken. The alternative, he mentions, is dictating punishments “ex-ante”, post-constitutional. He brings this ideology forward using his theory of the “hard man” versus the “soft man”. The hard man is more likely to establish strict punishments before laws are broken because he believes in retribution by lawbreakers. The soft man, on the other hand, is reluctant to push forth-early rules and regulations because he believes that he may one day become the potentially accused. Should this happen, he does not want to be victimized by a strict ruling he created at an earlier date.
I see the Mafia Court as the bard man even though I see individual Mafioso as the soft man. The Mafia Court believes in strict retribution because their underlying rule for existence is that the losing party must pay them the equal value that they must pay to the winning side. There are always two winners in Mafia Court: the winning party and the Court itself.
In the case of Deripaska and Smushkin both are “soft”. They both manipulated privatization to gain their riches. In my judgment neither side deserves to have their wealth or assets. Since Smushkin is far smaller than Deripaska in assets and wealth he might now think that he would be better off if the system were stronger and that the laws and enforcement were put into place in a constitutional timeframe versus post-constitutional.
q “To the extent that potential law violators predict with certainty that they will be subjected to punishment, the severity of the punishment itself may be reduced and vice a versa.” (Ch. 8, p. 139)
In the official court there are no severe punishments pre-established for crimes committed (I will discuss this more in my conclusion). The reasons for this are two-fold. A severe punishment would be a public bad, something the Russian court cannot afford. The second reason is that the Department of Bailiffs cannot enforce severe punishments due to lack of funding and personnel. In Mafia Court the accuser suggest the punishment. It is usually not server since the decision can be turned against them. As much as they want to win, they also do not want to lose. The cost of losing in Mafia Court far outweighs the cost of winning. As suggested earlier the court dictates the severity of punishment since they re a guaranteed winner regardless of the outcome.
In the case of Deripaska and Smushkin this argument is not very clear. The court decision will reflect whether or not Deripaska is right or wrong. If he is wrong he walks away and keeps his prior holdings. Smushkin is clearly the only possible victim since a loss world cost him a 1 billion dollar enterprise and more than a decade’s amount of work. Smushkin, unlike Deripaska, is not an oligarch. He has only the one business, Ilim Pulp Enterprises. He was not part of the government that wrote the 1993 Constitution nor is he related to the current government elite. Deripaska was an unknown in 1993 but his assets are clearly as result of political maneuvers and the fact that his wife is related to the former President of the country; the same president who create and signed the 1993 Constitution into law. If we were to consider that Deripaska is in fact the government elite then he is pursuing Ilim Pulp using a system he in fact created.
When I finished reading this chapter I sat back in my chair and I felt as if an enormous burden was lifted from my shoulders. The points discussed were not new to me but in reading Buchanan’s analysis, everything seemed to come into focus and I instantly came to my own realization that everything now made complete sense.
I entered the Russian market with vast international experience but with no understanding of the Russians. When I left Russia 10 years later I thought I new more than most foreigners. Now I can feel that I can offer you, the reader my new clear understanding of the most basic underlying reason why crime and punishment are the current and future lifestyle of the Russian Federation. Although my theory exemplifies Russia, it can be applied to any other society around the globe. I must admit that in the context of his discussions using the US as his topic that I do not agree that his theories were correct about the USA. However, had he been writing about Russia I would agree completely and to pay him homage for his brilliance. I do pay homage to James Buchanan and profoundly offer him my gratitude and thanks for this enlightenment.
Russia has existed for more than a millennium and its people are a result of more than 50 generations. They have lived through autonomies, royalty, communism and now a form of democracy but for all intensive reasons I consider that the leadership of the current Russia are misbehaved children, children who lack strict parental guidance.
The 1993 Constitution in its entirety was created and adopted for the benefit of foreigner’s beliefs in the new Russia. The new government, under the leadership of Boris Yeltsin was meant to be a lose, non-regulated society which would evolve according to he personal whims of it’s leaders. I considered using the term “control” versus leadership but I cannot say that the current President has controls since he appeared from nowhere to become President. Much like Deripaska, someone brought both Putin and Deripaska to power. This same “someone” or group of people may have also given Yeltsin his power. This question is the basis for another research project of the future. For the purposes of my conclusion I will refer to this “someone” as “Big Brother”.
The Russian Judicial System is the only law enforcement body in the Russian Federation. It is responsible for managing the law and formulating and instituting punishments for those that break the laws. This system fails in many respects:
- There are no clear definitions of what the laws are.
- There is not punishment agency capable of enforcing decisions of the courts, when they do have them.
- Every level of the judiciary is overworked, underpaid and suggestively corrupt.
It is actually a perfect working system. It works exactly the way “Big Brother” wants it to. It does not work for victims but it was not designed to.
In mid-1995 my secretary was arrested and incarcerated for 30 days in the main city jail in St. Petersburg. My partner was arrested and incarcerated one week later and spent a total of 45 days in prison. In both cases, neither was charged with a crime. They were guilty of what they were arrested for, signing a contract with a Moscow based vodka distributor using a false company as the buyer. They took delivery of the vodka, sold him but never actually paid for it. Had the court actually charged them with the crime, which would have been very easy to do since all the evidence was clearly against them, they would have had to appear in court and then sent to prison for a cost to the Court System. The idea of arresting both of them had nothing to do with why they were detained in the first place. They wanted to get them off the street into a secured location where they could question them about something entirely different. They had knowledge the system wanted to know. Rather than take a chance they would flee the city they detained them so they could question them.
In the 1990’s police regularly arrested people and incarcerated them for long period of time without charging them with crimes. Unless I am mistaken I believe they are allowed to keep someone as many as 30 days without charging them. There have been high profile cases however where people have been detained for years without being charged. This suggests to me that the Court is not designed to protect the rights of citizens but rather that if functions for the interest of “Big Brother” and members of his elite family.
If Big Brother allowed the Judiciary to work as the Constitution suggests it should, with a clear set of punishments in place, Big Brother would find most of his family in prison, including himself (or herself). Since this is the last thing he/she would want the court has not been given the autonomy and instructions it was designed to have, at least according to a democratized society. Since the system does not work against organized crime much like it does not work against corrupt politicos this would further suggest that Big Brother is the leader not only of the government elite but also the criminal establishment within the Russian society.
If I were to now analyze the judiciary under the former Soviet Union I would come to the solution that the current system is anarchic in comparison to the communist system. The current system allows greater freedom for the ruling class/elite and for those members of society under their protection. As the court protects the elite in also protects the criminal element, the mafia. Immediate gain far outweighs the cost of punishment for every major political figure in Russia as long as they are looked upon favorably. Reading the newspapers over the last 10 years there have been many murders of elite that have fallen out of favor. Rather than go to the cost of bringing them to court it seems as though justice by the bullet is easier and far less expensive for the State.
The current President has announced many reforms since assuming office but none of these reforms have amounted to an increase in arrests and punishments. They have not sufficiently deterred crime since they are both post-constitutional and limited in scope. The Russian elite is relatively young. It is my best guess that “Big Brother” (possibly Big Sister) is older and I believe this person has already picked a successor. The only way the current corruption will change is if an internal element within Russian society has the power to unseat “Big Brother” and his henchmen. Until this happens, nothing will change.
Russkij Les vs. L&S Trading
- “Murder without Prosecution” (Steven Douglas, Autobiography in process)
- Various interviews with an anonymous source at the Russian Embassy in Washington, DC
Base Element vs. Ilim Pulp Enterprises
- “Consolidation of Industrial Empires Reshaping Russian Economy” (Sabrina Tavernise, The New York Times, August 13, 2002)
- “FSC Accuses Ilim of Black PR Campaign” (Torrey Clark, Moscow Times, August 15, 2002)
- “Pulp Mill Fight Shows the Dangers of Success in Russia” (Geoffrey T Smith, Dow Jones Newswires, August 12, 2002)
- “Competition, Russian – Style at Disputed Kotlass Mill, Corporate Fighting is Bare Knuckle” (Guy Chazan, The Wall Street Journal Europe, August 12, 2002)
- “The Kotlass paper wars at Koryazhma” (Lucas Romriell, The Russian Journal, August 2002?)
- “Base Element Condemns Illegal Occupation of Russian Pulp & Paper Plant (PRNewswires, Moscow, August 9, 2002)
- “Ilim Pulp Reports favorable court decisions at heart of attempted hostile takeover” (PRNewswires, St. Petersburg, August20, 2002)
- “Base Element lobs accusations of a cover-up into Ilim Pulp Enterprises’ court battle for Kotlass” (PRNewswires, Moscow, August 28, 2002)
- “Court postpones decision on hostile takeover of Ilim Pulp” (PRNewswires, St. Petersburg, October 7, 2002)
- “Russia’s Ilim Pulp wins court ruling in takeover defense” (PRNewswires, St. Petersburg, October 21, 2002)
- “Zakhar Smushkin: we will not post our armed forces” by S. Novolobskaya (Russian Pulp, Paper and Board Magazine, October 2002 Issue)
- Various interviews with an anonymous source at the Russian Embassy in Washington, DC
Part II: Big Brother
- The Limits of Liberty: Between Liberty and Leviathan by James M Buchanan (The University of Chicago Press, 1975)
- 2. Violent Entrepreneurs: The Use of Force in the Making of Russian Capitalism by Vadim Volkov (Cornell University Press, 2002)
- 3. After the Collapse: Russia Seeks Its Place As a Great Power by Dimitri K. Simes (Simon & Schuster, 1999)
- 4. How to Profit from the Coming Russian Boom: The Insider’s Guide to Business Opportunities and Survival on the Frontiers of Capitalism by R. Poe (McGraw Hill, 1993)
- 5. From Nyet to Da: Understanding the Russians by Yale Richmond (Intercultural Press Inc, 1996)
- 6. The Oligarchs – Wealth and Power in the New Russia by David E Hoffman (Public Affairs, 2002)
- 7. The Russian Mafia: Private Protection in a New Market Economy by Federico Varese (Oxford University Press, 2001)
- 8. Russian Etiquette and Ethics in Business by Lloyd Donaldson (NTC Publishing, 1995) Russian Business Relationships in the Wake of Reform by Noreena Hertz (St. Martin’s Press, 1997)
- 9. Bandits, Gangsters and the Mafia: Russia, The Baltic States and the CIS since 1992 by Martin McCauley (Pearson Education Limited, 2001)
10. Doing Business in Russia: Basic Facts by Tankred G. Golenpolsky, Robert M. Johnstone, Vladimir A Kashin (The Oasis Press, 1995)
11. Rebirth of a Nation: An Anatomy of Russia by John Lloyd (Michael Joseph Limited, 1998).
12. Various interviews with an anonymous source at the Russian Embassy in Washington, DC
- The Introduction (thecrooner.wordpress.com)
- My First Visit to the Soviet Union (stevenleesdouglas.wordpress.com)
- KGB Interrogation in St. Petersburg (stevenleesdouglas.wordpress.com)
- An Investigation into Russian Human Trafficking (sldouglas.wordpress.com)
- An Investigation into Modern Religious White Slavery in the USA (sldouglas.wordpress.com)
- Newborn justice: Russian Constitutional Court celebrates anniversary (rt.com)
- Chapter 12: Business, Mafia and Jazz (thecrooner.wordpress.com)
- Tajik president ordered to free jailed Russian pilot (rt.com)
- How can a common US citizen defend and protect himself in today’s judicial system when mistakenly accused of crimes (wiki.answers.com)
- US puts up $5 mln for info on Russia most wanted (rt.com)
- Well that can’t be good. (doubleplusundead.com)
- Billionaire battle: Russians take feud to UK court (seattletimes.nwsource.com)
- Billionaire battle: Russians take feud to UK court (seattlepi.com)
- Chechen David vs. Russian Goliath (russianloyola.wordpress.com)
- Rivlin May Stop Pro-Democracy Bill on Judicial System (israelnationalnews.com)