Grey practices in the Russian business environment

This report was written by James Owen, Rosie Hawes and Charles Hecker,
Control Risks.

Published by Control Risks, Cottons Centre, Cottons Lane, London SE1 2QG. Control Risks Group Limited ('the Company') endeavours
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Grey practices in the Russian business environment
Introduction 1
What are grey practices? 1
Challenges to doing business in Russia 1
The day-to-day realities of working in Russia 3
One-day companies 3
Black cash 4
Obnalichivanie 4
Grey practices versus money laundering 6
The use of offshore companies 6
At the border 7
The way forward 9
Going from grey to white 9
Internal compliance and external engagement strategies 9
Where does Russia go from here? 10
 Introduction

For the purpose of introducing you to the theme of Control Risks’ latest Russia white paper, we
would like to ask you if any of the following statements look familiar:

We sell our equipment out of Western Europe to a company based somewhere in Eastern
Europe, and it’s up to them to get it into Russia. How it gets there, we really don’t know.

We have been using the same customs broker for years to get our product across the Russian
border, but sometimes we get invoices for brokerage services from companies with a different
name. Our broker tells us that these are his subsidiary companies, so we pay the invoices.

Our goods hit the market at a much higher price in Russia than they do elsewhere, and we’re
not sure why. Once the product is in country, it seems to disappear into a ‘black box’ and
come out the other end. We’re not sure what happens along the way, but we think our distributors
are involved.

These statements come from companies doing business in Russia. If any of them resonate
with you, then the topic of this paper will be of interest.

What are grey practices?

This paper looks at the ubiquitous (but not widely discussed) topic of what have come to be
called ‘grey practices’ in Russia. These are the pernicious, day-to-day schemes that erode the
integrity of transactions – the short-cuts, loopholes and financial sleights-of-hand that turn legitimate
business deals into regulatory minefields.

This paper is not about corruption. Grey practices certainly generate the cash that greases the
wheels of corruption, but the two issues remain quite distinct. Grey practices are, for example,
the company-level financial mechanisms that lie behind – and fuel – much of the embezzlement
and fraud in the Russian business environment. They are transactions that at first sight are not
clearly and explicitly illegal. In contrast to corruption (which under President Dmitry Medvedev is
now on the political agenda like never before), grey practices are viewed by many Russian
companies as simply part of ‘getting the job done’.

We do not want to exaggerate the risks of doing business in Russia. Despite the impact of the
financial crisis, the underlying strengths of the Russian economy continue to attract foreign
companies. Bear in mind also that the pitfalls of doing business in Russia are certainly not exclusive
to that country. When promoting governance and transparency, remember that Enron is easy to
pronounce in Russian.

Instead, we want to assist current and future investors in Russia to understand the complex problem
of grey practices. We hope also to help foreign investors navigate around the illegal and quasi-legal
practices that continue to present elevated levels of reputational, political, regulatory and
operational risks. Awareness of FCPA and OECD stipulations might be higher and more widespread
than ever, but many foreign companies still have far too little appreciation of their exposure to
malpractice in Russia, and thus to criminal prosecution in their home jurisdictions.

This is why it is all the more important for companies to institute high standards of corporate
governance in their businesses, and then to apply those standards to their partner companies,
too. Our purpose in this paper is to enable companies to operate safely and ethically in an
environment that their more cautious competitors might otherwise shun, and to take advantage
of the opportunities Russia offers with care and discrimination.

Challenges to doing business in Russia

Russia is not an easy place to do business:

• Just who you are doing business with is often unknown; beneficial ownership is not always
disclosed and is frequently obscured behind a complex network of offshore entities.

GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT PAGE 1

 • Red tape and bureaucracy is stifling, placing complex and occasionally impossible demands on
international companies. (This is one of the drivers behind the never-ending search for short-cuts
and loopholes.)
• Russia’s court system is still inefficient and vulnerable to influence, not least when a foreign company
finds itself up against an entity with political connections or undue influence over the judge.
• In the absence of sufficient legal protection, Russian companies are often compelled to secure
their property rights by relying on extra-legal measures or dubious links to the judiciary, politicians
or state officials.
• Russia is a ‘relationship country’; many government ministries and industry sectors operate virtually
as private clubs, where access is based on how long you have known the other members of the
club, and on cultural and social bonds often impenetrable to foreign companies.

Not all is bad – more and more Russian companies are embracing higher standards of corporate
governance, particularly in sectors open to foreign capital, such as consumer goods and financial
services. In overall terms, however, Russia’s business environment remains opaque. Talking
about transparency is still viewed by many Russian companies as a kind of lip-service used to
attract foreign investment, or for their owners to gain access to foreign exchanges.

This opacity has created the breeding ground for grey practices, which have flourished and, in
many respects, become accepted local practice. And, as the last 18 months have shown, the
global financial crisis has only exacerbated this trend: cash constraints, liquidity shortages,
bottlenecks in supply chains and longer payment terms have only encouraged Russian
companies to resort to the kinds of schemes and practices we shall now examine in more detail.

PAGE 2 GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT

 The day-to-day realities of working in Russia

Below is a step-by-step explanation of the most common grey practices that, in our experience,
foreign companies encounter during their day-to-day activities in Russia. This is not a comprehensive
A to Z of the myriad, complex financial schemes used by Russian companies. Rather, it is an
explanation of the most simple and widespread practices.

One-day companies

The majority of fraudulent practices in Russia rely on the services of a shell company or – from the
Russian – a ‘one-day company’ to obscure the link between the beneficiary and the actual fraud,
as we illustrate on page 5.

A one-day company is created by a company formation agent who provides ready-made entities
for individuals seeking to open a pre-licensed company without the bureaucratic hurdles of starting
from scratch. Certain banks also provide this service, though these tend to be the less reputable
players in the industry.

One-day companies have certain identifying features, which even a cursory review of Russian
corporate databases should bring to light. These factors, as we describe below, can act as invaluable
red flags to those seeking to better understand a potential business partner.

Mass-registration addresses

One-day companies in Russia are usually registered, along with hundreds of other companies, at
a mass-registration address. This practice can be used in more transparent jurisdictions for reasons
of simplicity and efficiency, or in keeping with those jurisdictions’ rules for company registration.
In Russia, this is rarely the case. Here, mass-registration addresses tend to be used to subvert
the business registration process or to exploit loopholes toward illegal ends.

In our experience, a physical inspection of a mass-registration address will at best confirm it as a

post office box and at worst as a bus station, swimming pool or another unrelated facility. A
mass-registration address is also a telling indicator that the company registered there most likely
conducts no real business of its own. A genuine entity should always provide a second or ‘actual’
( ) address to a business partner.

Stolen passport details

A Russian company must be registered against the passport details of its CEO (who is legally
responsible for the company) and its shareholders. In our experience, however, a legally dubious
company will typically purchase passport details from a student or pensioner only too pleased to
make a bit of extra cash. In other cases, a stolen passport is enough to get the job done.

Imagine the surprise of a pick-pocketing victim when he or she learns they are the CEO of several
hundred companies, any number of which might be under investigation for tax evasion or other
crimes committed in his or her name. Imagine as well the surprise of an international investor
when he or she discovers his customs broker is owned by a deceased individual residing in a
hairdresser’s salon. This instance also comes from a company doing business in Russia.

One-day companies and kickbacks

A one-day company can be used as a vehicle by a genuine company for any number of suspect
transactions involving government officials, the most common being:

• For the untraceable payment of bribes to government officials or to other companies in order to
secure a business contract. This can either be in the form of a payment from Company X for
‘consultancy services’ to a civil servant or to Company Y, also a one-day company, and owned,
say, by the civil servant’s wife. The involvement of a one-day company adds an element of
opacity and makes it harder to identify a relationship between a corrupt official and the company
actually awarded the contract.

GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT PAGE 3

 • To act as a fake participant in a tender. For example, if a quorum of four bidders is required in a
tender forum, one bidder can create three additional one-day companies to give the impression
of a quorum. (This is sometimes done in collusion with competitors, who take turns using this
practice to win bids.) It is also not unheard of for the government official running the tender to
use one-day companies to help protect his preferred bidder – the one that has promised him a
share of the proceeds.

One-day companies and tax evasion

The main goal of any tax evasion scheme is to maximise unreported revenue and keep profits in
company pockets. As in many countries, some companies and individuals in Russia avoid declaring
their genuine revenue to the tax authorities. While hardly an unusual practice, it still manages to
surprise many foreign companies operating in Russia.

The most common tax evasion schemes tend to involve paying bribes, exploiting loopholes in
legislation and using one-day companies. The latter are typically set up to conceal true income or
ownership, and are used in unregulated transactions. As the name implies, one-day companies
can be as quick to dissolve as they were to set up – by the time the tax authorities have
identified one of these companies, it will have long ceased to exist.

In Western Europe, common schemes tend to involve the over-reporting of costs and the pocketing
of the difference. Although such practices also occur in Russia, a more characteristic scheme
occurs when an existing company takes part in a fictitious transaction with a one-day company
that is never reported to the tax authorities. This is also known as obnalichivanie, which literally
means ‘turning into cash’, a scheme we discuss in detail below.

Black cash

Black cash is at the heart of many of the schemes we discuss here and is an everyday part of ‘doing
business’ for many Russian companies. It is used, for example, as a means to pay salaries and
other expenses off the books. Typically, only a small part of a given salary will be paid into regulated
bank accounts and appropriately declared to the authorities.

Black cash can also be used to finance undeclared transactions, including paying suppliers and
providing the company’s owners with cash-in-hand. This presents a serious problem to foreign
companies keen to ensure they receive clean payment from their partners. Some foreign companies
combat potential creditor issues by insisting on advance payment. However, this approach can
inadvertently offer a green light to entities seeking to dispose of their black cash.

The use of black cash leads to a significant disparity between a company’s declared accounts
and its actual turnover. It also means that a standard review of a company’s accounts can leave
much unsaid.

The current financial crisis has encouraged many Russian companies to rely even more on these
kinds of schemes. The Russian Tax Service reported a 40% drop in collections for the first seven
months of 2009 when compared to the same period in 2008, indicating a possible increase in the
levels of tax evasion and obnalichivanie.

Obnalichivanie

Obnalichivanie is one of Russia’s most common cash-generation mechanisms, and the target of
frequent tax evasion investigations by regulators. It is specifically designed to enable companies
to withdraw cash from regulated bank accounts and generate black cash to pay for services that
would otherwise be subject to taxation. The objective behind it is to replace highly taxed items
(salary or profit) with low taxed items, such as material expenditure.

PAGE 4 GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT

In basic terms, obnalichivanie works as follows: Company A employs the services of one-day
Company B, transferring to the company a sum based on a false invoice issued by one-day
Company B for ‘consulting’ or other intangible services. (The scheme relies heavily on the ambiguity
that often surrounds ‘intangible’ services such as marketing, consulting or legal advice.)

One-day Company B, working usually in collusion with a bank, will then withdraw this money as
cash, retaining a percentage for itself and the corrupt contact at the bank. One-day Company B
then returns the money to Company A, which will use it to top up salaries and make other
payments off the books.

This scheme can be further complicated when Company A involves other unsuspecting business
partners in the chain. In this case, Company A may ask their foreign partner to pay Company A’s
‘subcontractor’ directly. The foreign partner then transfers this money to one-day Company B and
thereby also gets caught up in this tax evasion scheme.

Usually within one to two years, one-day Company B is dissolved and its activities are transferred
to a new one-day company. This avoids attracting the attention of the tax authorities and, if it is
not too late, removes any traces of the true beneficiaries of one-day Company B.

Obnalichivanie flow diagram

OTHER COMPANIES USING SERVICES OF

ONE-DAY COMPANY B AND COMPLICIT BANK

COMPANY A

5. Cash provided to
Company A (taking a cut)

1. False invoice for

intangible services

ONE-DAY
COMPANY B

2. Company A asks
foreign partner to
pay invoice directly Company A can exclude the
foreign partner from this scheme 4. Bank gives cash to
and go direct to the bank One-day Company B
(taking a cut)

3. Foreign partner makes official bank

transfer to Company A’s account

COMPLICIT BANK
FOREIGN PARTNER

GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT PAGE 5

 The extent of the damage caused by obnalichivanie schemes should not be underestimated. In a
recent Moscow court case, a Russian commercial bank was initially accused of moving almost
$8bn in this way and was even condemned for threatening the stability of the rouble. (The court
later changed the charge, accusing the bank’s owner of making profits of about $380m for
providing this service.)

Grey practices versus money laundering

Russia is a member jurisdiction of the Financial Action Task Force, an international anti-money
laundering initiative, and has taken significant steps to demonstrate its commitment to fighting criminal
financing. The key Russian agency in this battle is the Federal Service for Financial Monitoring
(FSFM), which acts as Russia’s Financial Intelligence Unit (FIU), linking up with financial intelligence
units worldwide to combat money laundering. In July 2009, the FSFM publicly announced that
cases of the transfer of money abroad and obnalichivanie were decreasing in Russia. The FSFM
also stated that criminals are increasingly using real estate rather than the banking sector and trade
to launder their money, a twist on the pre-crisis ‘good news story’ of the Russian real-estate boom.

The FSFM conceded, however, that some of the most popular means to launder money in
Russia remain: the use of one-day companies, account fraud, and obnalichivanie merging criminal
and legal proceeds together in one legal entity. Such schemes require the witting – or unwitting –
participation of a second entity. This is where international investors can come unstuck. Banks
willing to turn a blind eye to the origin of funds cannot be relied upon to conduct rigorous know-
your-customer checks. Without conducting careful checks of potential suppliers, international
investors could thus be supplying goods in return for money obtained through criminal means.

There is often a link between the schemes used in tax avoidance practices by Russian companies
and the schemes used by criminals to launder the profits of their illegal activities. As a result, it
can be difficult to determine the origin of funds – whether they are genuine or illegal – and the
intentions of a company’s owners. Foreign companies should therefore be asking themselves
questions, and turning to their business partners for answers. For example, is your partner sending
money to a one-day company to generate off-the-books cash to pay employee salaries, or has
your partner obtained this cash through criminal means and is now seeking to erase the trail linking
this cash to his criminal activities? While both activities are illegal, they illustrate the shades of
grey that characterise so much of the Russian business environment.

The use of offshore companies

Some of the world’s largest and most respectable companies rely on the legitimate tax and other
advantages of offshore ownership. The political, security and economic uncertainties of 1990s
Russia and the threat posed by corporate raiding, however, created another advantage – the
safety of ownership under a foreign set of laws. What’s more, offshore jurisdictions and their sometimes
low disclosure requirements offer ample opportunity to obfuscate beneficial ownership, to spirit
profits abroad and to distance funds from their criminal origins, a process known as ‘layering’.

Offshore companies tend to be used by Russian companies for three main reasons:

1. To take advantage of weak disclosure requirements to conceal beneficial ownership: where

the beneficial owner is a public official who is barred from maintaining direct commercial
interests, or where there is a deliberate attempt to disguise the identity of a particularly
controversial shareholder.
2. For tax minimisation: to take advantage of an offshore country’s advantageous corporate
taxation rates.
3. For tax avoidance: Russian importers pay foreign suppliers via offshore entities so as not
to alert the authorities to the existence of such contracts.

It is worth noting that this could change with a new agreement between Russia and Cyprus, a
popular offshore jurisdiction for Russian companies. This agreement will remove a prior exemption
for taxation of capital gains from the indirect sale of Russian real property, and increases
information-sharing between the countries. It is not likely to come into effect before 2014.

PAGE 6 GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT

At the border

Most international companies come face to face with the might – and perplexity – of the Russian
bureaucratic machine at the border. Grey practices have their place here as well.

In 2009, www.doingbusiness.org, a joint venture between the World Bank and the International
Finance Corporation, ranked Russia a dismal 161st out of 180 countries in a study of the relative
ease of trading across borders, a damning indictment of the challenges that face most foreign
companies seeking to export their goods to the Russian market.1

Local customs brokers

Complex documentation and excessive bureaucracy frequently drive, and perhaps exist almost
solely to drive, foreign importers into the arms of local Russian customs brokers, who claim to be
able to cut through the red tape on their clients’ behalf. Exporters rely on these third-party
companies to provide a buffer between them and the local business practices targeted under the
FCPA or similar legislation. This is precisely how many highly respectable international
companies find themselves caught up in customs schemes carried out by their partners, their
customs broker or their own local office. Any of these players could be seeking to avoid paying duty
on imports or simply to avoid the administrative exhaustion associated with trying to follow the rules.

International companies need to scrutinise their local ‘fixers’ to ensure that illegal acts are not
being committed in their name or that they themselves are not being swindled. If it sounds too
good to be true, it probably is: a service that promises a smooth and quick transition of goods
across the border will often be based on grey practices, greased by a bribe. The FCPA also
importantly makes no distinction between a company paying a bribe directly, or via an intermediary.
The potential exposure to risks when working with a ‘fixer’ company is therefore extremely high.

Import-export schemes

At the border, dishonest customs brokers, usually acting in collusion with customs officials, can
seek to structure export and import contracts in order to falsify or distort the true value of these
contracts, and move the hidden, unreported value into their own pockets or offshore.

Customs evasion schemes rely on falsified or forged customs declarations. If a company has the
capacity to provide such documents to the Federal Customs Service, it is highly likely that they
are able to provide similar false documentation to a foreign partner. Unless this foreign partner
performs stringent checks on this documentation, it may remain unaware of its involvement in a
duty evasion scheme.

In our experience, the most typical violations at the border include both under-declaring and
misdeclaring goods:

• Under-declaring involves stating the quantity or value of goods imported as less than the true
value. Typically, the customs broker submits invoice documents that have been falsified, or
amended (usually) without their partner company’s knowledge.
• Misdeclaring goods involves falsifying the nature of the imported goods in order to pay less
duty. For example, high-value mobile phones may be declared as outdated technology in order
to avoid paying higher rates of duty.

These violations usually succeed due to the payment of bribes, ensuring a favourable relationship
with certain customs officers. This can be detrimental to the performance of other customs brokers,
who may be unwilling to secure favour through financial means.

1
The IFC identified that a standard shipment of goods typically requires 8 documents and 36 days at an average
cost of $2,150 per container in Russia, compared with figures of 8, 17 and $945 in India and 7, 21 and $460 in
China. Although this does not specifically relate to bribery, it does give rise to conditions fertile for bribery, with
importers ready to pay bribes to circumvent otherwise slow and costly requirements.

GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT PAGE 7

 The box below illustrates some real-life examples of these import-export schemes, including their
far-reaching implications.

Caught up in customs fraud – the case of Company A

Company A is a major international electronics manufacturer that exports hi-tech equipment

into Russia. It first established a presence in the country in the 1990s and had always
relied on the services of Customs Broker B to ensure the smooth passage of goods through
customs. The management of Company A had never questioned this relationship; it had
been set up by Company A’s local Moscow office; it also assumed that the use of a customs
broker was part of ‘getting the job done’ in Russia. A new auditor reviewed the books and
was surprised to discover that Customs Broker B had subcontracted its work to a further six
customs brokers.

Company A asked Control Risks to examine the relationship between these additional
companies, as well as the wider reputation of Customs Broker B in Russia. We identified
that Customs Broker B was widely known to pay bribes to certain customs officers in order
to bypass thorough customs checks. The amount paid as bribes was billed to Company A
as part of the standard services provided by Customs Broker B. The customs declarations
issued to Company A were also falsified. A review of genuine customs documentation
showed that Customs Broker B had not declared the true value of the electronic equipment
to Russian Customs, describing it instead as much older and significantly cheaper goods.
Customs Broker B did not share this saving with our client but provided them with false
invoices for much higher amounts.

As a result, not only was Company A inadvertently using a company prepared to pay kickbacks
to government officials, it was also being defrauded by the company itself. Our investigation
showed that unbeknown to Company A, it was involved in a complex tax avoidance scheme
whereby Customs Broker B asked that payments be made directly to its six subsidiary
brokers. A subsequent review of these companies found they were registered to ‘dead
souls’ – or totally unrelated individuals. One of these was a hairdresser in Siberia and
another had died several years before the company was created. (This was a very busy
dead person – he remained the registered CEO of hundreds of companies based at mass-
registration addresses). All of these companies had been created the previous year and
could be traced back to one company registration agent. The money paid by Company A
to these six companies was part of a tax avoidance chain that saw the six companies then
transfer this money back to Customs Broker B as cash. The transactions between the six
companies and Customs Broker B of course went undeclared to the tax authorities.

Customs Broker B’s ownership structure revealed that it was registered offshore in Cyprus.
Perhaps the ultimate injustice is that it was also rumoured that Customs Broker B was owned
by Mr X, the head of the sales department at Company A. Further checks in Russia
established that Mr X had bought Customs Broker B five years previously in his wife’s
name and had proceeded to use his insider knowledge of Company A’s processes to
defraud his employer.

Company A was therefore potentially liable for prosecution for the payment of bribes to
government officials and for participation in a tax evasion scheme. The company was also
being defrauded of considerable sums by one of its own employees. As a result, Company
A terminated its relationship with Customs Broker B and fired Mr X. It also instituted a
wider review of its supply chain operations and indirect import model.

PAGE 8 GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT

 The way forward

Going from grey to white

For many foreign companies in Russia, grey practices represent a daily headache and a renewable
source of reputational and legal risk. How, then, can international investors ensure they do
everything possible to mitigate these risks and avoid the regulatory pitfalls awaiting the naïve,
the foolhardy or the time-pressed?

Tougher market conditions and tighter international regulations have prompted many international
companies to examine their business models and market strategies in a different light. Many, for
example, are now considering making a big step toward taking much greater control over – and liability
for – their activities, by moving to a direct import model that by-passes the third parties, distributors
or agents they once relied upon. The thinking behind this is that if a company wants to achieve
transparency in their distribution channels, then it needs to ‘go direct’, and base itself onshore in Russia.

This goal is attractive for several reasons: first, it should prove cheaper and lead to higher margins;
secondly, the company that goes direct first should be able to capture the greatest share of the
market and then, as we outline on page 10, effect positive change in the market itself; and thirdly,
it should minimise a company’s exposure to reputational, political and legal risks. Most importantly,
perhaps, the direct import model represents something of a paradigm shift that would likely be
welcomed in government circles interested in cleaning up industries such as healthcare, which in
Russia is particularly prone to corruption and grey practices.

The direct import model is a strategy fraught with challenges, not least in the logistical demands
that setting up an ‘in-country’ distribution and warehousing network poses to foreign companies.
Going direct also does not entirely negate the need to work via intermediaries; someone still needs
to get the goods across the border. Nevertheless, it enables the foreign company to manage its
distribution strategy more carefully and, perhaps most importantly, puts a company employee
rather than a third-party distributor in the office of government officials running commercial tenders.
In the long term, this is a transformative step, one that can provide significant competitive advantage
to companies that take the lead.

Internal compliance and external engagement strategies

Everyone talks about corruption and grey practices as a problem, but very few admit that it is their
problem. Those who do tackle the problem do it variously. Some companies play on their size to meet
government figures, often in the full glare of media scrutiny. Usually, this is possible only for the
largest companies, and even then falls short of a sustainable strategy. Others seek safety in numbers,
by joining industry associations and by developing effective government relations programmes.

Perhaps the best way for companies to combat corruption and identify grey practices is for them to send
the right internal and external messages. All companies doing business in Russia should implement
– and enforce – strict internal compliance policies and codes of conduct. (Whistle-blowing lines
can be particularly effective in eliciting internal assistance in rooting out grey practices). Companies
need to take the initiative and review their structures, procedures, compliance and control measures.
They also need to conduct risk assessments to identify their potential points of vulnerability and then
ascertain – via GAP analysis – how to move their company from a position of vulnerability to best
practice compliance status. These policies require the commitment and buy-in of the CEO and senior
staff. They should also be understood at every level in the company hierarchy, not simply at corporate HQ.

Once a company has arrived at this point, it then needs to ensure that its compliance policies and
codes of conduct are reviewed on a regular basis and, most importantly, supported with training.
A zero-tolerance approach to corruption and grey practices, whether it is paying bribes for securing
preferential treatment or speeding up customs clearance, should be understood by every member
of the company. This can send a powerful external message to officials keen to extort bribes from
the company.

To send the right external message, companies also need to develop effective engagement
strategies. This means taking the proactive steps to understand the local operating environment
in Russia, including the reputation and standing of their various clients, partners and competitors.
Interestingly, sending the right external message can lead, as we illustrate, to higher standards of
behaviour in the market as a whole.

GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT PAGE 9

 Combating corruption, changing the rules of the game

Control Risks was approached by a multinational company that had been investigated by
the US Department of Justice in relation to its Russian operations. Our client requested
that we initiate a screening programme of several hundred of its distributors and counterparties
in Russia. Our programme subsequently found that approximately 50% of our client’s
counterparties presented a significant ongoing risk to their business. Many were one-day
companies, registered in the name of ‘dead souls’ and with no real economic activity or
track record. This posed an elevated risk both of non-payment (especially in worsening
economic conditions) and of involvement in illegal tax evasion schemes. Other counterparties
posed a risk to our client under the FCPA, as our research revealed potentially suspect
links to Russian government officials or employees.

Our client initially feared that screening its counterparties would lead to a loss of business
or a defection of its partners to the competition. In reality, the outcome was exactly the
opposite. Our client now reports that counterparties who pass the partner screening
programme are increasingly positive about being “part of the club,” and feel greater loyalty
to our client, its brand and its mission. This is entirely consistent with Control Risks’ experience
in Russia and elsewhere. Large international companies with strong brands can avoid ethically
and legally questionable business practices without driving away customers. One client
representative described the screening programme as a “game changer” and our client’s
Russian CEO regretted that “our biggest mistake was that we did not start doing this three
years ago.”

Where does Russia go from here?

Foreign companies in Russia can do much to minimise their exposure to the grey practices we
have examined in this paper. Internal compliance and external engagement strategies are crucial,
as is the innovative approach many companies are now taking to maximising their profits, but at
the same time reducing their legal and reputational risks.

That said, foreign companies’ exposure to fraudulent schemes cannot be eliminated altogether.
Grey practices flourish in an opaque business environment where personal relationships and
informal networks are often more important than the contracts and laws which underpin commerce
in more developed markets. Grey practices are also the mechanisms behind a wider and far
more systemic issue in Russia – corruption. They help to fuel what is today one of the country’s
most high-profile and intractable problems.

Corruption, a self-perpetuating and corrosive force, is deeply embedded in Russia’s state structures
and in the mindset of its public officials. Combating it is now on the national agenda like never
before, even if little progress will be made until Russia’s leaders match action to their rhetoric and
start to develop (among other things) a strong and fully independent judiciary, as well as credible
law enforcement with the necessary resources and teeth.

Against this backdrop, grey practices – the tax evasion schemes and fraudulent practices described
in this paper – receive scant attention. This should not be the case. Grey practices are part of the
reality of doing business in Russia for many foreign companies. They offer us a telling insight into
just how business works in the country, the patterns of behaviour, the pitfalls and dangers.

Russia presents a difficult, though not unique, set of challenges to foreign companies. The business
environment tests, more than most, the willingness of foreign companies to stay resilient in the
face of corruption and grey practices. This should not force them to pack up and leave, difficult
as it may be to bridge the gap between the local pressures and tighter regulation in home jurisdictions.
Many foreign companies are continuing to make a great success of their investments and operations
in Russia, particularly those that institute best practice internal compliance policies and – through
external engagement strategies – seek to understand the nuances of the local operating environment.
Foreign companies should take advantage of this market, but do so with care and discrimination.
The Russian business environment remains, despite everything, an attractive long-term investment.

PAGE 10 GREY PRACTICES IN THE RUSSIAN BUSINESS ENVIRONMENT

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