By RAYMOND BONNERhttp://www.nytimes.com/library/world/europe/122699russia-phone-deal.html
December 26, 1999
A few years ago, when an American company was seeking a toehold in the newly privatized and potentially lucrative Russian telecommunications market, it cut a secret deal with directors and officers at the Moscow telephone company.
As part of the arrangement, which has raised legal and ethical questions and thrown a light on how some Western businessmen have operated in Russia, the American company, Global Telesystems, paid at least $65 million in stock and cash. Global paid the money to a company the insiders had set up in the Bahamas to avoid public scrutiny and taxes.
In exchange, Global Telesystems ended up with ownership of a Russian telecommunications company that generates millions of dollars a year in revenues by providing service to 150,000 Moscow customers, most of them businesses willing to pay a premium. The eight Russians who took part in the deal each walked away with about $9 million in cash and stock, tax free.
The Russian government says the phone company insiders committed fraud and tax evasion, and has opened an investigation, as have law enforcement agencies in countries where the insiders stashed their gains. Global Telesystems, a fast-growing company based in McLean, Va., says the transaction broke no Russian or American laws.
The Global Telesystems deal illustrates how Western business maneuvers may sometimes undermine Western governments' efforts to promote Russia's economic transformation.
Western business and political leaders have lectured Russians over and over, saying that if they want to attract foreign investment, they must adopt laws to protect shareholders' rights and improve tax collection. But the Global Telesystems deal resulted in the Moscow phone company's being defrauded of more than $200 million, based on the value of the phone lines and projected revenues, according to the Russian Ministry of Interior and Western investigators.
Other shareholders in the company, Moscow City Telephone Network, include the Russian government and a handful of investors in the United States, where its stock is also traded.
In America, the insiders' dealings would provoke shareholder lawsuits, corporate and securities law experts say. That is unlikely in Russia.
"Even if this was not illegal, the question is, was it ethical and smart?" said Jonathan Winer, who monitored money laundering and other international activities as a deputy assistant secretary of state before stepping down recently.
An American investment banker in Moscow described the Global deal as "only the tip of the iceberg," just one example of how Western companies have engaged in business practices in Russia that they would not try at home. Most of the cases, he and other executives said, remain carefully guarded corporate secrets.
Details on the arrangement between Global Telesystems and the phone company insiders emerge from documents filed by Global Telesystems with the Securities and Exchange Commission and information on the company insiders gathered by law enforcement officials in the United States, Russia and Europe. Global Telesystems was well positioned for opportunities offered by the new Russia, like the 1994 privatization of Moscow City Telephone. The American company had worked in the old Communist Soviet Union in the early 1980s, when the company was based in California and called San Francisco/Moscow Teleport.
It changed its name to Global Telesystems in 1995, and issued stock publicly two years later, with a $200 million initial offering.
Two months ago, Global Telesystems put its Russian and other Eastern European operations into a subsidiary, Golden Telecom, sold off 34 percent in an initial public offering and raised $144 million more.
One of Global's biggest backers, from its early days, has been George Soros, the international financier who has been active, commercially and philanthropically, in the former Soviet Union. Two years ago, Soros and his affiliate companies owned 26 percent of Global Telesystems, according to a company filing with the SEC, though he never played any management role at the company. His stake in the company is now about 7.7 percent, a spokesman for Soros said. It is still one of the larger stakes in the company after some institutional holders like Fidelity and Putnam Investments.
The spokesman said that Soros had not been aware of the deal between Global Telesystems and the Moscow City Telephone insiders until asked about it by The New York Times.
The insiders and Global Telesystems used three companies to carry out their deal, which made it more difficult for government officials to trace. They were Invest-Project, registered in Russia; GTS-Vox, registered in Britain, and Swinton Ltd., which was registered in the Bahamas, a haven for corporate secrecy and tax avoidance.
Investigators said there were eight shareholders of Invest-Project and Swinton. They included five top executives and directors of the Moscow telephone company -- the general director, Vladimir Lagutin, and four deputy directors, Said Alimbekov, Viktor Panov, Semyon Rabovsky and Sabiryan Shambazov.
None of these individuals nor Moscow City Telephone responded to requests for comment, including a fax with detailed questions. Swinton's American lawyer, Jacob Laufer of Manhattan, would not disclose the names of the Swinton shareholders. "The principals value their privacy," he said. He would not say what business Swinton was engaged in, but said it was "lawful and proper."
Similarly, the general counsel for Global Telesystems, Grier Raclin, said in a written statement that the transaction between his company and the phone company insiders "was totally aboveboard, legitimate and consistent with the laws and business practices in Moscow."
The first step in the deal was for Moscow City Telephone to award the insiders' company, Invest-Project, the contract to provide telephone connections for 150,000 Moscow customers. Exactly how much the insiders paid has not been made public, but investigators and one person familiar with the deal estimate that it was about $8 million.
Five days earlier, the insiders and Global Telesystems had already agreed to sell 95 percent of Invest-Project to GTS-Vox. Since Swinton wholly owned GTS-Vox, this meant they were merely transferring ownership from a company registered in Russia to one whose owners were hidden behind Bahamian secrecy.
The next step was for Swinton to sell 53 percent of GTS-Vox to Global Telesystems. For that, Global Telesystems paid with stock worth about $26 million. This translates into $3.25 million in stock for each of the Russian phone company executives.
Putting in telephone lines increased the profit because most of the lines went to businesses willing to pay a premium, as much as $500 for a connection, in addition to monthly service charges.
Revenues of Telecommunications of Moscow -- the new name for Invest-Project -- grew from nothing in 1995 to $16.5 million in 1996, $29 million in 1997 and $21.5 million for the first six months of 1998, according to Global's SEC filings.
From those revenues, the insiders and Global Telesystems paid themselves more than $7 million in dividends.
The final bonanza came last year when Global Telesystems bought Swinton's remaining interest in Telecommunications of Moscow for $40 million in cash. That produced a windfall of about $5 million for each of the phone company insiders and brought their total receipts on the deal to nearly $9 million each.
But when the insiders started moving their money around the world, they attracted unwanted scrutiny.
Swinton and each shareholder had an account at BankBoston. In September 1998, Global Telesystems paid $7.4 million into the Swinton account. Then Swinton quickly moved $895,000 into each insider's account, said a senior law enforcement official and another individual familiar with Swinton's financial activities.
The movement of so much money set off alarm bells at the bank, and it alerted federal authorities. The FBI and the U.S. Customs Service opened an investigation, and in November 1998, a federal judge in Boston ordered the accounts frozen. The bank would not comment.
But early this year, the U.S. attorney in Boston, Donald Stern, decided not to prosecute, said lawyers for the companies. Federal investigators, who thought they had a case of possible money laundering, were dismayed. "The case was not aggressively pursued," said one senior law enforcement official. An investigator from another federal agency said the case had been "prematurely closed."
Through a spokesman, Stern declined to answer any questions about the matter.
Attorneys for Swinton and Global said the case was closed, but the court record remains sealed. The New York Times filed a motion last month to have it opened, contending that keeping the record from the public violated the First Amendment. A hearing is scheduled for January.
After the Boston accounts were unfrozen early this year, the insiders quickly moved their money abroad, this time to Denmark, according to law enforcement officials in Europe.
Acting on evidence provided by the Russians, the Danes promptly seized the accounts, on the theory that the money had been fraudulently obtained, according to American and European officials.
Proceeds from the deal were also sent to Israel and Switzerland, and authorities there are still investigating, officials said.
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