Spotlight on financial transparency in Russia

A riddle, wrapped in a mystery, inside an enigma.

“I cannot forecast to you the action of Russia” stated Winston Churchill in 1939.

For a period following the fall of Communism, Russia showed positive signs of embracing greater transparency, with the development of independent press and media, and the advent of the internet, which helped shed some light on murky politics and business developments.

Russia has long presented major opportunities for business, whilst also creating real challenges: vested interests, political connections, an uncertain legal system, and corruption can and have caught out unprepared investors. Doing business in Russia and avoiding these risks requires a thorough understanding of the background and reputation of potential business partners. But, after embracing transparency and openness in the 1990s, Russia, under President Putin, has returned to its more secretive ways of old.

The Russian government has been highly successful in gaining control over Russian television, media and internet providers, censoring investigative journalists, and muting opposition voices. Since the beginning of the Ukraine crisis, Russia’s last remaining independent TV station, TV Dozhd, has effectively been cut off from its audience; the founder of Russia’s main social network, Vkontakte, has been forced out of the country, and Boris Nemtsov, a leading light of the Russian opposition, has been murdered.

The internet – arguably the last bastion of independent information in Russia – was frequently used to provide a platform for free speech, activism and anti-Kremlin world views. However, as with broadcast and printed media, this too has now changed. In April 2014, shortly after Russia annexed Crimea, President Putin announced that the internet was a “CIA project”, and said that Russia needed to be protected from it. This claim was accompanied by a string of new laws which have decreased transparency and increased secrecy in Russia. These developments are set to make carrying out due diligence and conducting investigations in Russia all the more difficult.

July 2015: Russia’s “right to be forgotten law” comes into force, requiring internet search engines to remove “false” links

In July 2015, President Putin signed into a force a new law dubbed as Russia’s “right to be forgotten law“, which requires internet search engines to remove links to personal information considered “false” or “irrelevant”. The law is effectively a copy of legislation introduced by the EU in May 2014, inferring that there is a large amount of subjectivity in regards to when a link should be removed or not. This subjectivity is a huge problem in a country with such a weak legal framework. The introduction of the law has led to allegations of censorship, and predictions that Russia’s oligarchs and government officials will manipulate the new law to edit compromising information from their online biographies and past actions.

There are currently a wide range of sources that provide extensive data of what in Russian is known as “kompromat” (compromising information) on businessman and officials. Allegations of ordered killings, organised crime links, corporate raids, and large scale corruption are the norm in these digital narratives. Some of what is written is very probably untrue, and may have been promoted by business rivals – but much is likely to be accurate. Under Russia’s new “right to be forgotten law”, embarrassed officials may apply to have their internet history deleted, if there is no legal basis for the allegations posted to online forums. This poses a problem, as Russia in the 1990s had a very weak and corrupt legal system, meaning that the powerful, the rich and the well-connected were able to manipulate outcomes in their favour.

Standards of independence in the Russian court system remain low today, with a further risk that genuinely corrupt activities are further airbrushed from the public record. The potential removal of highly credible allegations from the public record further increases the risk that foreign businesses will not uncover material providing adverse information about the background of a Russian subject.

October 2015: a proposed new law is announced, restricting access to the public register of Russian property rights

Another concerning development is a new law proposed in October 2015 by the Russian FSB, which seeks to restrict access to the public register of Russian property rights. This register has long been used by anti-corruption activists to expose the secret mansions of high-ranking government officials who supposedly earn a standard government salary. The authors of the new law claim that requests to the register are made more and more frequently in order to access the personal details of an owner, rather than to ascertain information about the property itself. This, they claim, is for criminal or compromising ends. Previously, Russian officials had been able to retain anonymity when purchasing dachas, by registering their properties to offshore companies. With the introduction of “de-offshorisation” and Western sanctions, this has become increasingly difficult to accomplish.

The well-known opposition figure and anti-corruption campaigner, Alexei Navalny, responded to the new proposal by warning: “Corrupt officials cannot stop us taking pictures of their palaces, but they are trying to make it so it is no longer possible to make a formal link between civil servants and their property”. “Palaces” exposed by Navalny include a USD 15.6 million property registered to the new wife of presidential press secretary, Dmitry Peskov. Peskov, whose official annual salary is USD 147,000, was also recently photographed wearing a watch worth over half a million dollars. Using the public register, Navalny was also able to identify the USD 17.1 million Moscow mansion of former head of the FSB, Nikolai Patrushev. Perhaps Navalny’s most famous exposé, however, was in 2013, when he tracked down the enormous 2,000 square metre palace of former head of Russian Railways and friend of President Putin, Vladimir Yakunin.

The furore following this discovery forced Yakunin to sell the property in 2014. The introduction of this new law has been widely seen as a way for powerful Kremlin figures to avoid further embarrassment and future public scrutiny of their dubiously acquired wealth.

Carrying out due diligence to meet regulatory compliance obligations is becoming increasingly difficult in Russia

Foreign businesses investigating such individuals, or considering entering into commercial relationships with their companies, will find it increasingly difficult to obtain official information required to carry out due diligence in order to meet their regulatory compliance obligations. Interestingly, the UK, long a popular investment destination for Russian money, is moving in the opposite direction. Its plan to force disclosure of a property’s ultimate beneficial owner is primarily to prevent the laundering of suspect funds. With attention focused on much bigger issues, such as control over Ukraine and supporting President Assad in Syria, introduction of these new laws may pass with less scrutiny. Increased control over the internet can be justified to the population as necessary to deal with the threat of ISIS, or of the US trying to bring Russia to its knees with its “CIA project”.

Unfortunately, anti-corruption figures such as Alexei Navalny receive little support outside the liberal centres of Moscow and St. Petersburg. The closure of the public register of property rights is unlikely to concern the Putin-loving core of Russia’s electorate.

The new laws further damage transparency and openness in Russia, protect corrupt officials, and blur the backgrounds of Russia’s super rich. Russian officials will claim that they are merely following in the footsteps of the EU with their own “right to be forgotten law”. However, the intended use is likely to be more sinister in its aim. In the context of a media almost completely controlled by Kremlin loyalists, the new law is better seen as yet another tool to protect the interests of the Kremlin and its allies.

Foreign businesses seeking to understand the background of a potential Russian client or business partner should be aware of the increasing lack of reliable and unbiased information available in the public domain, and formulate a plan accordingly.