The Minister, The Money Bags and the Money Launderer: a cautionary tale from Moscow

The possessor of money that has been criminally acquired faces a number of risks when he seeks to launder his gains. Chief among these is the risk that that the money launderers will run away with the money. The following case shows that this risk may be smaller than may at first appear.

The sanctions available to organised criminals to enforce their will are usually more direct than those used by law enforcement. Mexican drug gangs, for instance are reputedly prone to resort to disembowelling those that betray them ..pour encourager les autres.

The organised criminal is particularly vulnerable to betrayal, perhaps by a fellow syndicate member who is turned by law enforcement into a police  informer. This happened many times with the New York Mafia families. Likewise, the person who does business with a money launderer cannot discount the possibility that he will be an undercover  agent for the DEA or other agency. The corrupt bankers of BCCI and many other ostensibly august financial institutions have been brought to their knees by precisely  such a covert operation.

This bank appears to have been the last resort of the criminal class. It cannot be possible to know the nature of the contract, if any, between BCCI’s criminal clients and its chief money launderer, its head of treasury Ziauddin Ali Akbar. Money deposited with a bank has a promise of investment and return, but the contract between the laundering organisation and the criminal client is likely to be kept deliberately informal. Here was a den of thieves, where undisclosed payments took preference over contracts and brown paper envelopes took preference over statements of trust.

If one is engaged in a criminal enterprise, it might be assumed that the courts would also not be the enforcement option of first resort when the issue of theft or even  breach of contract arises. In the case of the law of equity one is of course hampered by the maxim he who comes to equity must come with clean hands..

However, there are cases which occasionally come to light where courts get involved. The case described below involves such a recourse, with a highly detrimental outcome. It shows that that the risk in selling money laundering services may in fact be greater than the risk in buying them. This is particularly true when the client, in this case Leonid Reiman, the Russian Minister of Telecommunications and IT,  has a hugely powerful political patron to shelter him.

The scheme presented here is incomplete. This is an on-going case, and the outcome may still differ from anything described below. What is absolutely clear is that the structures described and the processes involved are complex. They are a far cry from the typical description of money laundering, which involves the movement and transfer of cash to bypass banking or other precautions against money laundering. Here we see corporate finance and the laundering of securities where face values are huge and regulation more complex. Lawyers and corporate financiers are used here to export illegally a nation’s capital assets. Money laundering does not happen in isolation; and it will be contended here that networks and the political context determine a successful outcome.

Historical Context
This case is rooted in Russia’s recent economic experience. At the time that this fraud occurred, freeloading was rampant in the country’s state sector. Former KGB men, organised criminals and mobsters, oligarchs and their advisers were seizing an opportunity created through the power vacuum of the Yelsin years.

The quantity of Russian money demanding the services of launderers in the 1990s was quite extraordinary. Russia’s national police agency, the MVD, has conservatively estimated that $9 billion worth of illegal money was leaving the country each year. A study by the Institute of Economics of the Russian Academy of Sciences and the Centre for the Study of International Economic Relations at the University of Western Ontario, has suggested that up to $70 billion disappeared in 1992 and 1993 alone. Other specialists argue that total capital flight between 1994 and 1998 amounted to more than $140 billion and currently is running at more than $15 billion a year. Overall, some $350 billion in capital has fled the country since the fall of the Soviet Union, with nearly a third of it landing in the United States. The crash of the ruble in August 1998 accelerated the flow. As Russian companies faced bankruptcy, their motivation to preserve assets tended to vanish.

One instrument for the theft of Russian assets was Benex International. This became a an important cause celebre whose denoument occurred in New York. It involved organised criminals in Russia, including the daughter of President Yeltsin and the noted mobster Semion Mogilevitch. They exported the proceeds of state asset sales  and other criminally-obtained assets through a financial intermediary called Benex. Benex was run by Russians, Peter Berlin and Lucy Edwards, the latter an employee of the bank, who had access to the money transfer resources of a global bank in Bank of New York. Edwards reported to the bank’s head of Eastern European activities, Natasha Kagalovsky, who is married to Konstanin Kagalovsky, a colleague of the imprisoned oil industry oligarch, Mikhail Khodorkovky. Khodorkovsky’s contacts were instrumental in channelling illegal monies to the illegal money transfer agency. Benex was closed down in August 1999 and Berlin and Edwards charged in 2000.

An asset is created
So what of the players in the more recent offshore drama involving Russian telecommunications, referred to above? Leonid Reiman is one of Russia’s leading political figures. He had  served as general director of the St Petersburg Telephone company in the early 1990s. He was and is reputed to be a close friend of Vladimir Putin, who was Mayor of St Petersburg at the time that Reiman was also a key civic official. Reiman was known to Putin through Putin’s wife who had worked for the St Petersburg Telephone company.

The privatisation of this company followed the path of many Russian privatisations. Individuals in positions of power exploited weak legislation introduced during the laissez-faire period of former president Boris Yeltin’s in the early 1990s. Companies were created to absorb stakes held by the local authorities. But with little oversight, those stakes were moved abroad, most often to offshore locations where legal structures offered unusual degrees of secrecy. In spite of concern in some quarters that the state was losing control of its assets, the pilfering by powerful insiders proceeded unabated.

Reiman triggered a  process of privatising the St Petersburg phone company, creating a private company called Telecominvest in 1994 with the aid of his lawyer, Jeffrey Galmond. In the course of the privatisation, Reiman apeared to have acquired ownership of a large portion of the company.

His acquisition of the stock has not been fully explained or documented for understandable reasons. It would be alleged in subsequent litigation that he used his political position to steal the stock directly from institutions under his direct control in Russia. But others would say he acquired it at a market price from a third party for personal enrichment.

Galmond piloted the transfer of Telecominvest across many jurisdictions and companies. The company would be owned by Danish and Luxembourg vehicles, while the Russian state’s stake was reduced and Reiman’s increased.

The company made a particularly important stop-over in Germany. The German conduit for the assets was Commerzbank, a leading German institutional and  corporate bank. Commerzbank calls itself ‘the creative relationship bank for the successful German Mittelstand, for major corporates and institutions in Europe as well as multinationals from all over the world.’  Galmond introduced Reiman to the bank, and the bank’s manager agreed to make a public statement  to the effect that the bank had entered the Russian telecoms market on its own account.

In the course of negotiations, it would be made clear that secrecy in the transfer of beneficial ownership from Reiman to Galmand was essential. Reiman could clearly  not be seen to hold the stock himself. He would not only have to explain how he had bought the stock on a ministerial salary, but also how, as minister,  he could be a neutral arbiter  when he owned a large share of the sector. The appointment of Commerzbank as his proxy was very attractive to the Minister and his advisers.

Commerzbank appears to have been untroubled by its client’s request for a fictional ownership structure. Revelations made long after the events in question show that the bank knew that a document declaring Reiman to be the beneficial owner was in existence. This triggered an investigation of  the bank’s role by the German authorities. The bank’s head of Eastern European operations took responsibility and departed.

The asset’s final destination was Bermuda. Galmond had set up a mutual fund, of which he was declared the beneficial owner. This fund is called  IPOC International Growth Fund Ltd and it is said to have stakes in Russia worth $1 billion. IPOC is a mutual fund, but with a single investor-- an unusual structure in itself. The fund was initially run by Vidya Sharma, a convicted fraudster, who had served time in a German prison for fraud. Sharma was a far from reliable employee as later litigation would reveal he had been bribed with over $1 million to give evidence against IPOC.

Galmond’s colourful history was rather more historic. His father Norbert was born in Russia and called Porohoff but he changed his name when he left Russia. He initially went to Germany. He married a Danish woman and moved to Denmark. He subsequently engaged in many frauds in Denmark using false identities and was convicted. Press reports say he was an immense braggart, claiming to be a retired colonel from the US Special Forces, that he had served in the Vietnam War as a helicopter pilot and a drug-fighting expert and that he was rewarded by several medals. His son Jeffrey has been understandably unwilling to discuss his father’s professional career.

Paternity should not be allowed to discredit the practices of a legitimate businessman; Jeffrey Galmond can both spot strong and influential people and devise financial services to satisfy their needs. He is a long-standing friend of Leonid Reiman as well as an associate of many other Russian businessmen. Galmond is also linked with the privatisation of  the St Petersburg brewery company, where local mobsters linked to high profile Danish interests, including the Baugur group, are alleged to have stolen the assets.

The biter bit
Galmond had ridden the laundering roundabout with his IPOC fund for a number of years, no doubt earning considerable fees in the process, before his scheme hit an obstacle. This was the Russian oligarch Mikhail Fridman who decided to challenge his claim to ownership of a stake in a mobile phone company.

Fridman is the majority owner of a company called Alfa Group, which is today known as Altimo. Alfa  owns stakes in VimpelCom, in a mobile phone operator in Ukraine and in Russia’s fixed line operator, Golden Telecom. Fridman made one early fortune by selling an interest in his oil business (originally acquired from US commodities trader, Marc Rich) to BP Amoco for $6.75 billion. He is no stranger to controversy. His company faces a lawsuit from the Canadian energy company called Norex, which alleges that Alfa issued invoices for fabricated services that were performed by offshore shell companies. Alfa has also been accused of bribing Ukrainian officials and is black-listed by the European Bank for Reconstruction and Development.

Alfa Group is assisted by two controversial characters. The first is Pyotr Aven who has allegedly been engaged in various misdeeds, including drug trafficking. The other is Hans Bodmer >> who  allegedly worked with Fridman and Aven to send instructions to IPOC to wire money through banks in New York. Bodmer recently pled guilty to the criminal conspiracy to launder money and conspiracy to violate the United States Foreign Corrupt Practices Act in connection with a scheme to bribe foreign leaders.

Fridman is ably abetted  by Leonid Rozhetskin a former investment banker who managed the New York listing of mobile phone network operator VimpelCom, part of the Alfa stable of telecoms interests. Rozhetskin is also a colourful character. He is an American-educated  lawyer, who appeared on the cover of the Russian edition of Forbes, under the headline ‘The Most Dangerous shark in our waters.’

Rozhetskin’s activities threw a spoke into Galmond’s wheel. According to a suit brought by IPOC  vs Leonid Rozhetskin, Mikhail Fridman, Pyotr Aven, Alfa Group Consortium, Alfa Capital Markets Inc, Alfa Telecom (n/k/a Altimo) and Hans Bodmer in the United States District Court for the Southern District of New York, June 8 2006, Rozhetskin’s  company LV  Finance was touting around an option to buy a stake in a nascent Russian telecoms company called Sonic Duo. The funds were to be used as seed capital, and Galmond made an initial payment to LV of $15m in early 2001. He put further money into the business over the course of the year, bringing his investment to $40m. The result was the creation of a company called MegaFon which was formed by bringing together  IPOC and a communications company called TeliaSonera, a merger of Finnish and Swedish interests.

It should be noted that representatives for the defendants in this lawsuit have denied all its allegations.

The merging of a number of interests, particularly the involvement of established international companies, persuaded Rozhetskin, according to the  suit referred to above, that he could make rather more out of his bright idea than he had thought initially. He issued Galmond with repeated demands for more money and Galmond initially paid up. But when Rozhetskin asked Galmond for  some $60m to $70m on 23 December 2002 (as legal documents allege), Galmond drew a line. This was a substantial jump in the amounts demanded from Galmond, and he refused to pay up.

Rozetskin then devised a scheme to transfer the MegaFon asset to Fridman over the course of just ten days. IPOC’s indictment referred to above states that ‘a complex web of transactions took place in a bald attempt to steal IPOC’s funds and conceal their theft. The effect of this daisy chain of companies  and transactions was to transfer assets to Alfa Group, while also improperly retaining IPOCs funds. The co-conspirators went to great lengths to conceal their wrong-doing… using nine different companies to buy and sell Rozhetskin’s stake, all in ten days.’

Legal actions
IPOC went to war through the courts, apparently oblivious to the risk they were running that their own laundering scheme might be revealed. Many questions present themselves as to the decision to take this course of action. Did Galmond consult the minister before going to court? If he did not, should he have? How closely did the Minister manage Galmond, and to what extent did Galmond exploit the Minister’s vulnerability to exposure? These questions underpin the complex relationship between criminal client and professional launderer.

The federal racketeering lawsuit referred to above, alleges that ‘Both companies (ie Rozhetskin’s company LV Finance and Alfa) were aware of IPOC’s prior ownership rights, but rode roughshod over the agreement and fraudulently colluded to sell the same stake twice’. The lawsuit accused Fridman of colluding with Rozhetskin to steal IPOC’s interest  through money laundering and bribery.

Fridman retaliated by striking at the heart of the secret agreement between Reiman and Galmond. His representatives claimed that Reiman was IPOC’s ultimate owner and that Galmond had sourced money illegally to make down-payments on the stake in MegaFon.

Alfa has put huge resources into exposing the agreement between Galmond and Reiman. For example, it has hired a private detective company Diligence, whose UK operation is headed by Michael Howard, the former leader of the Conservative Party, to investigate the relationship between Reiman and Galmond. The accountants KPMG. This firm had been  hired by the Government of Bermuda to investigate the Russian connection. Bermuda had become sensitive to the controversy emanating from IPOC’s Russian stake and wanted to understand its background. It is now alleged that the private investigators posed as MI5 and CIA agents to obtain information about IPOC. It subsequently was claimed that a KPMG partner had been duped into giving the information about Galmond and the Minister by this relatively banale ruse.

Galmond’s  scheme unwinds
The investigation has uncovered a string of damaging documents. An accountants analysis of documents relating to the financial arrangement between Galmond and the Minister concluded that Galmond’s claim to be the beneficial owner of IPOC was not watertight. Indeed the accountants report says that Reiman could have become a beneficiary of IPOC ‘under certain circumstances’.

The document surfaced in the course of a hearing before the UK Privy Council, brought into the matter following hearings in a Bermudan court, and Galmond said, weakly, that he had not known such a document would be presented to court. He apologised to Reiman that his name had surfaced. Galmond said that he was concerned that information might be used against Reiman and that the Minister might file a law suit against him.

Documents also show that Galmond’s Denmark-based firm had sent a letter to a Liechtenstein bank in June 2002 describing Reiman as ‘the ultimate beneficial owner of IPOC’ as well as ‘the economic beneficiary’ of some Galmond-controlled companies. Galmond said the statements had been made by his staff in error. Liechtenstein police seized the document, seeing in it the solution to the IPOC mystery.

Reiman was also shown to be the beneficial owner of a trust called Meridium, set up in 1996. The trust had not featured in any of Galmond’s five depositions and affidavits, so its disclosure needed some explanation. Galmond was able to say no more than that it had not seemed very important as it had not paid Reiman any money.

Further documents showed Commerzbank’s complicity in the affair. One disclosed that Galmond had brought Reiman to a meeting with Commerzbank's chief executive, where the Russian discussed investing in telecom assets. Commerzbank began subsequently to claim to be the owner of Russian telecom assets that were secretly controlled by Galmond and his associates.

Commerzbank has denied doing anything improper, but David Hauenstein, a IPOC director,  has testified that he was present at a meeting attended by representatives of Commerzbank where it was claimed that the bank "had carried out due diligence on Leonid Reiman as the economic beneficiary." If this is true, the bank, at the very least, must have known of Reiman’s involvement.

The unravelling process jumped forward in May 2006 when a Swiss arbitration tribunal found that a high-ranking Russian official with responsibility for telecommunications was the sole beneficial owner of the fund, which gained the assets after the 1990s privatisations. According to one report, ‘The Arbitration court suspects that in Russia there exists a group of corrupted state officials working in the telecoms sector, who are acting in the interests of IPOC fund.’ The document further said that Russian state-owned companies had ‘funneled to dummy companies, secret trustee agreements and investment relations. After bringing these assets into allegedly public funds, they were apparently used to take additional stakes in Russian companies’.

Another blow was struck at the laundering scheme in February 2007, when Bermuda announced it was taking steps to liquidate the IPOC International Growth Fund with the eight affiliates, which were used to hold the IPOC assets. Bermuda’s Ministry of Finance  said that the action was being taken ‘to  address seeming breaches of our law and regulatory infractions.’

The wider picture shows a tax haven, used extensively by hedge funds and captive insurance companies, seeking to limit the fall-out from a case that was raising awkward issues about its governance. The tax haven exists to serve the interest of on-shore tax payers and corrupt political officials but mainstream governments are demanding more stringent management. The better havens realise that their role as launderers to the rich of the developed world is contingent on a low and unsullied profile. Greater  scrutiny into the use of secretive trusts for the protection of stolen or dubiously acquired assets is now inevitable.

Denoument in the Kremlin?
The assets of IPOC fund have been subject to multiple rounds of legal and regulatory investigation. But their rightful ownership is no clearer now than it was at the start. Galmond’s right to the MegaFon asset has been undermined by the analysis of numerous documents showing that the lawyer accepted that the Minister was the beneficial owner. Fridman’s right has been undermined by the apparent fraud perpetrated by Fridman’s associate Rozhetskin on Galmond, who in any event had only a dubious right to make the option arrangement.  Reiman’s right to the assets has never been tested (given that he has never claimed to own them), but his need for a launderer would suggest he did not believe he had obtained them straightforwardly.

The failure of these rights leads one to the conclusion that either the asset has no legitimate owner or alternatively that the only owner with a good claim is the Russian state itself. So is it possible that President Putin himself might yet step in as a Deus ex Machina to assert the right of the Russian state.

A number of factors cloud such an outcome. Nationalisation of the asset would upset his Minister who is the President’s friend and loyal ally. It would also make an enemy out of Fridman, the country’s largest owner  of telecommunications assets and one who is sometimes seen as close to controlling a monopoly position in telecommunications. But Putin has shown himself capable of re-nationalising assets in the energy sector and this route cannot be ruled out in the telecommunications sector.

Putin may of course not want to get involved at all and simply wait to see how the matter pans out in  the Bermudan courts. His final option is one of maximal involvement. Could he impose a solution, based on real politic rather than ownership rights. If wanted to placate both the Minister and the Money bags, he could insist that the asset be broken up and the equity split between the two parties.

But what of the lawyer who engineered the original laundering scheme to export the asset? Galmond provided the introduction to the German bank, Commerzbank, and then the Bermudan legal structures to allow his client to export the asset. He might expect loyalty from his powerful political client, whom he will have made hugely rich. Reiman’s stance towards Galmond is particular sensitive as he will face intense pressure from Putin to find a Russian solution by bringing the asset back home, or at least do some sort of deal with Fridman.

A role for Galmond in this home-coming looks unlikely. He seized his original opportunity during an earlier political era when Russia’s economic culture may, politely, be called ‘laissez faire’. Putin’s assertion of ‘national interest’ is likely to put a kibosh on the sort of financial structuring at which Galmond, the money launderer and financial fixer is so skilled.

The experience of Reiman and Galmond his launderer teaches us that fluctuations in political power pose a risk for those engaged in manipulating criminal markets. The money launderer, it seems, is no more than a provider of services to the possessor of the gains of criminal activity.  The criminal client has the power conferred by ownership. The money launderer is beholden to his client, who pays his fees. He is the pawn in a much larger game over which he has no control.

© Dirty Money Digest 2007