IMF ups the ante, demands government try and recover $15bn stolen from banks

IMF ups the ante, demands government try and recover $15bn stolen from banks
During the bank sector reforms over 100 banks were closed, but little has been done to recover the $15bn their former owners stole first
By Robert Homans in Los Angeles November 9, 2019

The Wall Street Journal reported on November 5 that in order for the IMF to approve a new standby loan agreement for Ukraine, Ukraine must comply with additional conditions, in addition to providing assurances that Privat Bank is not returned to Igor Kolomoisky, one of its former owners.  Ukraine now needs to show the IMF that it is going after money stolen by the owners of approximately 100 Ukrainian banks, including Privat.

According to the Wall Street Journal,” The IMF is holding up the next standby loan agreement, until it is convinced Mr. Zelenskiyy’s government will aggressively try to recoup an estimated $15bn stolen from more than 100 banks over the last decade, including Privat Bank.  The central bank (NBU) officials said in the interview that most of the $15bn was secreted out of the country through companies owned or controlled by shareholders, leaving ordinary depositors empty-handed.”  Most of the 100 banks in question were either shut down by the NBU or, as in the case with Privat, nationalized and continue to operate under NBU supervision with new management.

One of the ways that the former owners of Privat took money out of Ukraine was via 2 wholly-owned branches, one in Latvia and the other in Cyprus, that were treated exactly like Privat branches in Ukraine, plus they operated independently of Latvian and Cypriot banking regulations -  Once in Cyprus and Latvia, both EU Member States, the money can enter the Western banking system and become very difficult to trace.  

Although much of the $15bn may be un-recoverable, the IMF is correct to require Ukraine to actively try to recover money stolen by the former owners of these banks, and to make it a condition for the extension of any new credit.  The $5.5bn in un-collectible assets on Privat’s balance sheet were funded by retail deposits belonging to ordinary Ukrainians, much of it guaranteed by Ukraine’s Deposit Guarantee Fund (similar to the FDIC in the US).  The Deposit Guarantee Fund doesn’t have nearly enough money to satisfy all the guarantees.  Perhaps a review of the journal entries between Privat/Ukraine and Privat’s branches in Cyprus and Latvia, by qualified independent forensic accountants, would be a good place to start.

In addition to the $5.5bn that Kolomoisky stole from Privat’s retail depositors, the IMF should insist that NBU act against the personal guarantee that was extended by Kolomoisky, in return for a $1.9bn bailout provided to Privat by the NBU a few months prior to the NBU nationalizing Privat.  In this matter, Kolomoisky’s defense as I understand it, is that his personal guarantee was issued to the NBU under false pretenses.  That’s very hard for me to believe. I’ve been in the commercial finance business for over 30 years.  Personal guarantees that I have seen, and have used in my own transactions, clearly states the terms, the reason why the guarantor is giving the guarantee, and the remedies available to the beneficiary, in this case the NBU, if the guarantor doesn’t perform on his/her obligation.  In other words, the defense that I understand Kolomoisky is putting forward is beyond ludicrous. 

The $15bn that the IMF wants Ukraine to at least attempt to recover is just one example of the neglect that Ukraine, under previous governments, has exhibited in recovering stolen assets from outside Ukraine, especially since the end of the Revolution of Dignity in the Spring of 2014.  During this 5 ½ year period, there has been little or no effort to recover funds belonging to associates of former President Yanukovich, that may be contained in accounts that were frozen, at Ukraine’s request, shortly after the end of the Revolution of Dignity.  Two examples are in Latvia and Great Britain.

Latvia – At a conference I attended in Kyiv, in June 2018, an official from Latvia’s Finance Ministry reported that they had frozen accounts, totaling approximately $19mn, belonging to 2 Yanukovich associates.  Over the succeeding 4+ years since the accounts were frozen, Latvia had made repeated requests to the Ukrainian General Prosecutor’s Office to provide Latvia with proof that the money in the accounts was ill-gotten.  According to this official, during this 4+ year period Latvia has received no response from Ukraine to its requests.

Great Britain – In a more famous case, in the Spring of 2014, at Ukraine’s request, Great Britain froze an account belonging to Mykola Zlochevsky, the CEO of Burisma. The freeze was instituted in the Spring of 2014, shortly after Hunter Biden was named a Director of Burisma.  In September 2015, in a speech in Odessa Geoffrey Pyatt, former US Ambassador to Ukraine, called out Viktor Shokin, the former General Prosecutor, demanding that Shokin release information Great Britain had requested, that would show that the money in Zlochevsky’s account was ill-gotten.  In calling out Viktor Shokin, Amb. Pyatt was making a virtually identical request to Ukraine’s General Prosecutor that cost his immediate successor, Marie Yovanovitch, her job. Great Britain never received the information they asked for, and they had no choice but to release the freeze on Zlochevsky’s account.

In addition to proactively finding the $15bn of depositors’ money, the IMF should also require Ukraine to comply, on a timely basis, to requests for information from countries where frozen accounts belonging to Yanukovich’s associates are located.  After all, it was Ukraine that originally requested that the asset freezes be put in place.  As far as I’m aware, in the 5+ years since the end of the Revolution of Dignity, Ukraine has not responded to a single request for information, required to keep asset freezes in place or, more importantly, allowing countries to make determinations that the money was ill-gotten, and thereby allowing them to return the money back to Ukraine.  Instead, during this same period Great Britain, along with several other countries, had to release freezes on a number of accounts solely due to lack of response from Ukraine.

The General Prosecutor of Ukraine has the authority to release the information requested by countries that have frozen accounts belonging to Yanukovich and his associates.  During much of the period since the Revolution of Dignity the General Prosecutors that possessed this authority were Viktor Shokin and Yuriy Lutsenko.  These are the same officials with whom Rudy Giuliani has collaborated on behalf of his client.  Pres. Trump said that his concern about corruption in Ukraine was the reason why his administration withheld $400mn in US security assistance to Ukraine.  If Pres. If Trump is so concerned about corruption in Ukraine, he needs to look no further than the 2 individuals, Shokin and Lutsenko, with whom his lawyer is collaborating on his behalf.

Privatbank as a distraction 

Much attention has been paid to whether or not Pres. Zelenskiyy will cause Privat to be returned to its former owners, most prominently Igor Kolomoisky.  I don’t believe Kolomoisky wants Privat back.  Certainly, he wants to void his personal guarantee, and perhaps force Ukraine to compensate him for his equity in Privat, likely zero given the value of Privat’s assets, consisting mostly of loans to related companies owned by Kolomoisky that are considered un-collectable.  To Kolomoisky, Privat is most valuable as a distraction, diverting attention from the massive graft he is undertaking in other sectors of Ukraine’s economy where he’s active.  Here are a few examples, based on publicly available information as represented by the person who gave the information to me:

  • Sale of coal to Centrenergo, a state-owned electricity generator at high prices, and sale of power by Centrenergo to entities owned by Kolomoisky at low prices, giving an effective subsidy to Kolomoisky of UAH550mn since last July.
  • Ukrnafta, a company controlled by Kolomoisky, but owned by Ukraine’s State-owned natural gas supplier, Naftogaz (50%+1), has failed to pay rent on production to the State budget of $1.28bn.  
  • Ukrnafta paid $800mn to other companies owned by Kolomoisky for oil products that it never purchased.
  • Kolomoisky owes money to Ukraine, for the illegal takeover of UkrNafta (based on a decision by a London Court)
  • Use of transfer pricing in the import/export of manganese that has the effect of moving pre-tax income out of Ukraine at around $360mn/year

I understand, from the person who gave it to me, that all this information is publicly available, and verifiable.

Privat, by contrast, has little or no net worth, and no lender would provide the bank with debt funding that is necessary to increase leverage and return on equity.  If Privat ever was turned back over to Kolomoisky it may cause a bank run.  In other words, Privat is now a poor vehicle to perpetuate stealing and Kolomoisky, of all people, knows it.

As a friend pointed out, successful pickpockets create distractions, that allow them to rob their victims.  For Kolomoisky, Privat serves as such a distraction.

Corruption as 3-Dimensional Checkers – When I was a kid, my friends and I used to play 3-dimensional checkers. The game is played on 3 boards, each made of clear plastic, placed one above the other with small struts.  You could take your opponent’s pieces either horizontally, as in conventional checkers by jumping over the, or vertically, by going over your opponent’s piece located either directly over, or under, one of your pieces.  In Ukraine, corruption is a form of 3-dimensional checkers.  Here’s how it works, using the 3 plastic boards.

The Top Board - In this analogy, top board is made up of individuals like Kolomoisky or Firtash, collectively referred to as oligarchs.  Together, they control large segments of Ukraine’s capital stock, gas production, metals production, utilities, banks, etc. They have no interest in Ukraine as a functioning political entity, even though 73% of Ukraine’s voters in the last Presidential election wanted sweeping political change, including ending corruption.  Instead the occupants of the Top Board see Ukraine almost exclusively as a source of massive graft.  In addition to stealing from others on the 2 lower boards, they steal from each other.

The Middle Board – Government Institutions.  Since the Revolution of Dignity, Ukraine has made substantial progress in curtailing graft and corruption within government institutions, including what I have called the plumbing of corruption.  Examples include:

  • The National Bank of Ukraine (NBU) – In the 5 ½ years since the Revolution of Dignity the NBU has gone from not much more than an ATM for Viktor Yanukovich and his associates, to an internationally well-respected, and effective central bank. During this time, the NBU has shut down close to 100 banks, and has nationalized others, such as Privat.  Without the intervention of the NBU, there would’ve been far more than $15bn stolen from Ukrainian depositors.  By closing the banks, in effect the NBU is clogging the plumbing of corruption.
  • ProZorro – An automated system of government procurement, developed by Ukrainians, that has saved Ukraine close to $2bn annually.
  • Civil Service Reform – Applicants for government jobs must now take a civil service exam and, from there, applicants are moved to positions for, which they originally applied.  The objective is to eliminate cronyism.
  • E-Government – The Zelenskiyy Administration is beginning to initiate ‘E-Government,” similar to what currently exists in Estonia and Kenya, among other countries, where citizens can complete many interactions with the government on-line, such as forming a business, obtaining a passport, obtaining a driver’s license, etc.  This will substantially reduce personal interactions with government, and thus reduce opportunities for graft.
  • Governance of State-Owned Enterprises (SOE’s).  Many of the largest SOE’s now have professional management, with supervisory boards that includes Western experts.  Prior to its re-organization, Naftogaz was draining around $9bn/year from the State budget. Today, Naftogaz is Ukraine’s largest taxpayer.  The Zelenskiyy is beginning the process of either auctioning off SOE’s, or simply shutting them down and liquidating the assets.
  • Ministry of Health, under former Acting Minister Ulana Suprun.  Suprun enacted policies, including the “Money Follows the Patient,” that serves the purpose of reducing the flow of graft going to hospitals and drug distributors. Suprun also placed international organizations, Crown Agents and UNDP, in charge of drug distribution.

All of these developments began during the administration of former Pres. Poroshenko. Pres. Zelenskiyy and his team have promised to continue and strengthen them.

Two significant areas in the Middle Board that still need to be addressed include corruption in the judiciary and improved property rights.  Lack of a transparent and fully functioning judiciary allows substantial graft to continue.  Lack of property rights continues as a major source of theft.

The Lower Board – Graft and corruption that directly effects ordinary Ukrainians.  Examples include:

  • Theft of funds that were meant to replace the elevators in our building.
  • Harassment of small business owners by government officials looking for payment of bribes, in return for building permits, tax disputes and other reasons.
  • Schemes such as graft surrounding the required recycling of used motor oil, in Lv’iv.

If there is one reason why 73% of Ukraine’s voters wanted change, this is it. Unfortunately, because they usually focus on corruption and graft taking place on the top board, where the numbers are far larger, often there is very little appreciation among Western donors and experts for how lower-level corruption effects Ukrainian citizens, those in the lower board, and how lower-level corruption fuels the higher two boards.

The Vertical Game – 3-dimensional checkers is played vertically as well as horizontally.  To apply this analogy to corruption in Ukraine it is necessary to understand how the money flows between boards.  Two examples:

  • Privat Bank – Money is taken from depositors, on the lower level, and was used to extend credits to companies owned or controlled by Privat’s owners, at the top level, or simply moved outside Ukraine.
  • The “Roof” – The examples of lower-level corruption almost always involves payments by those who took the bribe, to individuals in the middle or upper levels, known in the post-Soviet world as the “Roof.” Proceeds from bribes paid to get building permits, to take one example, must be shared with superiors.  Proceeds from bribes paid to tax inspectors go up to regional tax inspectors, some of it to fund political activity that serves to perpetuate the system.

The importance of the progress Ukraine has made in improving transparency inside government, the Middle Board, is making it more difficult for perpetrators of graft to move proceeds of graft between boards.  To take one example, the nationalization of Privat cuts off a major source of graft for its owners.  However, without judicial reform and secure property rights, there is still substantial opportunity to move money from the lower level to the upper two levels.

Ukraine needs to move against the Top Board, which is why the new IMF conditions are so important.  Ukraine also needs to continue to improve transparency in government, especially although not exclusively judicial reform, that will reduce the ecosystem for corruption in both the upper and lower boards.  The new Anti-Corruption Court only has jurisdiction over top government officials.  It is left to the regular judiciary, much of it corrupt, to punish lower-level violators.

Corruption in Ukraine is dynamic. For corruption to be attacked successfully in Ukraine, it needs to be viewed holistically.  Western experts looking only at the top level won’t be effective in helping Ukraine attack corruption at all levels.  In other words, they need to begin to focus on graft associated with recycling of used motor oil, and theft of funds meant to replace ageing elevators.  This isn’t sexy, but it is, as we say using a term from American football, learning how to block and tackle.  To put it another way, the most important person in this process is the old lady with limited mobility, who must walk up and down stairs in our building when elevators don’t work.