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By John Helmer, Moscow

A case that has been going through the courts in London for months, and will be argued afresh in November before the Supreme Court, Britain’s highest tribunal, reveals not only how easy it was for a group of alleged fraudsters to borrow $225 million from state-controlled VTB Bank. Also revealed is how VTB bank officials in Moscow ignored risk and security warnings against the loan from their subordinates in London, and channelled bank fees and commissions amounting to at least 10% of the loan through a fake consultant. That, the British courts have concluded, was an offshore entity intended to avoid Russian tax. More likely it was a kickback scheme to enrich the VTB bankers in Moscow making the loan approval. VTB’s misrepresentations on this and other scores have been judged to be so serious, the High Court has tossed out several claims by VTB, and charged the bank with “deliberate material non-disclosure” (aka lying, deceit).

Why VTB intends to reveal so much about its own banking practices in London without prosecuting the ripoff in Moscow is difficult to understand because VTB refuses to answer a single question about the case. The intimation is that VTB is afraid of launching a criminal or civil fraud case in Moscow for fear that prosecutors will turn up evidence that VTB bankers were in cahoots with the alleged fraudsters to share more than $20 million of the loan proceeds between them.

The fraud scheme alleged in the London courts is complicated. According to the court papers from VTB – in this case, VTB Capital, a UK subsidiary of the state-controlled bank headquartered in Moscow — it was the target of a conspiracy to steal about $225 million. This was negotiated during 2007 and finalized on November 27 of that year through a loan agreement. According to this, VTB Moscow loaned VTB (UK) the money, which in turn loaned it to a company called Russagroprom (RAP) to enable it to buy several milk-producing dairy companies.

The seller appeared to be a company called Nutritek, and the sale and purchase agreement exchanged the borrowed cash for shares in a company in the British Virgin Islands (BVI) called Newblade. It turns out that Nutritek, also registered in BVI, created Newblade as a special purpose vehicle to hold the dairy assets for their transfer to Russagroprom. Nutritek, it turns out, was owned by Nutrinvestholding, and that entity was owned by companies with similar names—Marshall Capital Holdings Limited, registered in the BVI, Marshall Milk Investments of Cyprus, and Marshall Capital LLC, a Moscow company.

In fact, according to the allegations by VTB, one man, Konstantin Malofeev, owned all of these companies, either on his own or in silent partnership with other Russians with more of a connection to the milk business than he had. That is to say, Malofeev owned both the sellers of the dairy companies, and he owned the purchasing company, Russagroprom. The rap sheet for the latter in court shows that it had been set up in May of 2007 for the express purpose of performing as the borrowing purchaser in the fraudulent chain. Russagroprom was owned by a Cyprus company called Migifa Holdings, which in turned was owned by something called Brentville Ltd., which was registered in BVI. The core allegation is that Malofeev controlled both chains of BVI companies and their various subsidiaries. The scheme alleged in court was that it was his idea to relieve VTB of $225 million to pass from one of his pockets to another.

Since the security of the transaction was based on a mistaken, badly inflated asset valuation by Ernst & Young, the allegation is that Malofeev intended to default on the deal, and divert as much of the loan as he could elsewhere. VTB has told the court it has managed to recover $40 million, so the deal appears to have been worth $185 million to Malofeev and his companies.

That’s the gross figure alleged. In order to persuade VTB Moscow to ignore the warnings from its London bankers against the deal, an unusually large amount of fees and commissions was paid to a company called Dalford Consultants Ltd, which had been registered in Belize, at the opposite end of the Caribbean Sea from BVI, just days before the $225 million was paid out. Dalford collected cash of $3.5 million and the cash equivalent of about 10% of the loan aggregate – about $22.5 million. Total, $26 million.

According to the court record, and the ruling of High Court Justice Sir Richard Arnold, Dalford was supposed “to provide various financial advisory services [to buyer Russagroprom] for a retainer fee of US$3.5 million and a success fee in the form of a derivative instrument linked to 10% of shares in the Dairy Companies. It is accepted by VTB that Dalford was controlled by VTB Moscow; that no services were provided or intended to be provided by Dalford pursuant to the agreement.” In short, it was a secret slush fund created by VTB for its own purposes. These may have been to avoid tax owed by VTB to the Russian treasury. They may have been to receive and hold the VTB bankers’ share of Malofeev’s good fortune.

The Ernst & Young valuation of the Nutritek milk producers was $366 million. Ernst & Young have defended their mistake by claiming they relied on Nutritek for their data. A subsequent accounting commissioned from Deloitte by VTB has reported the valuation ought to have been at least 30% lower. In retrospect, VTB is claiming the discrepancy is so large, the overstatement by Ernst & Young must have been deliberate – at least on Nutritek’s part. Whether that puts Ernst & Young in the dunce’s corner, or in the defendant’s cage, hasn’t been argued in the UK court.

The allegations and evidence, though now the subject of several preliminary High Court rulings, have yet to be tested in a trial. For this reason, Justice Arnold says “this evidence is incomplete, untested and in some respects highly controversial. It follows that my account is necessarily a provisional one” (sect. 4). Malofeev was asked to respond to the allegations and court reports. His assistant responded that Malofeev will respond “if he thinks that it’s necessary”. At publication time he hadn’t replied.

There has been a near-total Russian press blackout of the case and the allegations against VTB, as well as against Malofeev. In August of this year, Izvestia reported the bankruptcy of Russagroprom with Rb11 billion in debts ($355 million) and assets valued at just Rb6.3 billion ($203 million). At the start of September, there were reports that a UK freeze order, requested by VTB against Malofeev’s assets, was inconveniencing another deal he wanted to make.

In mid-September, Alexei Navalny issued a public report critical of the way VTB has been managing its state-supplied capital and loan funds. This 20-page document assigned two pages to the allegations against Malofeev and Justice Arnold’s November 2011 judgement, concluding “how such a sizable loan could be made with such little attention to due diligence is astounding.”

VTB responded publicly that Navalny’s report contained “false, biased and non-existent charges, prepared by amateurs”. Neither VTB nor Navalny has reported the June 20, 2012, ruling by three justices of the UK Court of Appeals. This endorsed the findings and rulings of Justice Arnold the previous November, and dismissed each of VTB’s appeals.

This judgement also provides more detail of how the Malofeev companies handled the VTB loan instalments, as they were disbursed during 2008, and were used by Russagroprom to pay interest falling due to VTB on the loan funds already paid. Russagroprom stopped paying the interest instalments in November of 2008, and VTB called it in default in January of 2009. The bank didn’t think of attempting to collect the security for the loan – that included shares and assets held by Newblade, Migifa, and Russagroprom — until the end of that year. By then VTB was looking at a shortfall of about $185 million.

The key document revealed in court is the report from VTB London to VTB Moscow, warning against lending Russagroprom the money in the first place. Here are excerpts cited by Justice Arnold:

“The structure risk is potentially high, as Credits [Committee of VTB] considers the transaction to be unsecured; the security package is of little tangible value. The pledge of shares by the Borrower for the subsidiaries is for 100% of the capital owned by the Borrower….
“The Facility structure includes guarantees from the Borrower’s intermediate holding companies (Brentville, the parent company of Migifa, the parent of Russagroprom). We have no financial visibility of Brentville, and we are not aware whether it has any other subsidiaries besides Migifa, or who the parent of Brentville is, besides being advised the ultimate beneficial owner is Mr Vladimir Alginin. Consequently, we consider the Brentville/Migifa guarantees as having minimal tangible value….
“Financial Risk High. Credit has limited visibility to financial information on all parties involved in this transaction. Russagroprom is newly formed and subsequently has no historical information. We have no financial visibility to Brentville, Migifa (borrower holding companies), or Mr Alginin, however the Business Information Report (BIR) states that Migifa is not listed as a parent company for any other legal entity besides Russagroprom….
“The historical balance sheets (unaudited management figures) will be key operating subsidiaries indicate that the price being paid for the company appears to be at a level significantly above the book value of the assets….”

The report suggests that VTB’s bankers knew the Ernst & Young valuation was inflated and an unreliable basis for calculating the security required for the loan.

However, Justice Arnold went on to conclude that the claims by VTB to pursue the case against Malofeev in the UK courts should be dismissed. The reasoning accepts that fraud has been committed, but that the jurisdiction in which to prosecute it is Russia, not England. “There is little dispute that the misrepresentations were made and mainly received in Russia. In my view they were primarily relied on in Russia, since it was VTB Moscow’s Credit Committee and Management Board which made the essential decision to enter into the proposed transaction in reliance upon those representations. VTB’s reliance was wholly secondary. While the loss suffered by VTB was sustained in England, the loss was sustained because of the inadequate security provided by assets in Russia which were the subject of the misrepresentations. Furthermore, as I shall discuss below, while the loss has been suffered in the first instance by VTB, the ultimate economic impact is felt by VTB Moscow. I therefore conclude that there is a serious issue to be tried between VTB and Mr Malofeev (sect. 183)… In my judgment, taking all the factors considered above into account, the natural forum is Russia (sect .195).”

This puts an end to VTB’s attempt to conduct its fraud case in London. The Court of Appeal judgement makes VTB’s chances even less likely. So the bank is making one last effort in the Supreme Court. But Justice Arnold virtually challenges VTB to initiate a criminal case in Moscow. “I am not satisfied that there is a real risk that VTB will not be able to obtain substantial justice in Russia for this reason. (sect. 213)…In my judgment the points made by counsel for the Defendants are again cogent. I am not satisfied that there is a real risk that VTB will not be able to obtain substantial justice in Russia for this reason. It is therefore not necessary for me to consider the further points made by counsel for the Defendants that there is nothing to stop VTB initiating a criminal investigation anyway, and that that would not lead to such an excessive delay as to amount to a denial of substantial justice (sect. 220).” These are findings the last bench of English judges isn’t likely to overturn.

As for the purpose of channeling fees and commissions for the loan transaction through Dalford, the Belize front company, Justice Arnold dismissed VTB’s contention that the operation was standard practice. “I do not understand his suggestion that this form of arrangement is common. If it was common, there would be no need to hide it.”

So nefarious was VTB’s conduct in using the Belize front, and then concealing it from the court, Justice Arnold ruled there was no justification left to preserve the worldwide freeze order (WFO) previously introduced to prevent Malofeev from hiding his assets from VTB. “Having concluded that there was a material non-disclosure by VTB, it is necessary to consider whether, if I was satisfied that this was otherwise a case in which it would be appropriate to continue the WFO, the WFO should be discharged on that ground or whether it should nevertheless be continued or re-granted. In my judgment the WFO should be discharged for the following reasons. First, the non-disclosure was deliberate. Secondly, I consider that the facts which were suppressed were significant with regard to the application for the WFO. Thirdly, I consider that, even if (contrary to the conclusion I have reached above) there is a real risk of dissipation, VTB’s case for a WFO is not a strong one given that (as discussed above) the main plank of that case has fallen away (sect. 254).”

On this point, the Court of Appeal damns both VTB and Malofeev, and leaves to the final hearing next month the decision on whether the freeze order against Malofeev will be dismissed. That will happen if the Supreme Court upholds the two lower court judgements dismissing VTB’s case, and sending it back to Moscow for remedy.

“If the question had arisen,” the Court of Appeal judgement says, regarding the enforcement of the freeze order against malofeev’s assets, “it would have been on the footing that VTB has a seriously arguable case for saying that Mr Malofeev had been engaged in a major fraud against VTB , by which VTB was persuaded to lend RAP $220 million to fund what was represented as a sale of assets worth substantially more than that amount, whereas in fact, first, the assets were worth a great deal less, and secondly the transaction was not a true sale, and moreover a substantial part of the proceeds of the loan (it can be assumed) disappeared into the complex web of corporate entities in various jurisdictions, including several offshore, for the benefit of Mr Malofeev, and maybe for that of others involved.”

“Furthermore, not only was the use of that web of corporate entities a significant part of the means whereby the fraud was committed, by concealing the true ownership of RAP, but it would also make it difficult for VTB to enforce any judgment that it was able to obtain. All of that is made out, but VTB has failed to establish that it should be allowed to bring proceedings on that basis against Mr Malofeev (and the other defendants) in this jurisdiction.”

“It seems to us that these propositions would have provided a strong starting point for a case in favour of the grant of a WFO. It could be inferred that a wealthy individual who uses such methods to defraud a bank in this way and on this scale might readily resort to similar methods to render his major assets proof against enforcement in response to proceedings being taken against him, at any rate if he had reason to fear that the proceedings might be pursued effectively.”

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