Mon, Nov 23, 2015

Business as Usual in Russia, Despite Political Headwinds

Surprising Economic Resilience

Rumors of the death of the Russian economy appear to be greatly exaggerated. Discussion of the investment climate for much of the last year has tended to focus on large, negative developments, in particular: the imposition of sanctions over the conflict in Ukraine; a precipitous drop in world crude oil prices; and a corresponding decline in the value of the ruble. These have certainly had a collective impact. Economic growth overall was largely flat last year, and the consensus is that some decline will occur this year.

On the other hand, recent news is much more positive. Slowly rising oil prices have brought both modest recovery in the value of the ruble as well as a renewed sense of cautious optimism that the worst is over. Most forecasters still expect 2015 to be a year of recession – with GDP expected to fall from anywhere between 2% and 4% depending on who does the analysis – but many have been reducing their predictions of the extent of the drop. Most also see a return to growth in 2016.

Moreover, as with any mild downturn, there are winners as well as losers. Those most affected by both sanctions and declining commodity prices have been in the oil and defense sectors. On the other hand, a cheaper ruble and Russian counter-sanctions have together bolstered local manufacturing and agribusiness industries as import substituters seek local suppliers.

Just as important, unlike in earlier downturns, international companies are staying put rather than fleeing from a perceived crisis. Firms such as Nestlé, Burger King and Ikea have reiterated their commitment to this market. In short, although economic conditions in Russia are currently difficult, they are within the normal ebb and flow of the ordinary business cycle.

Fraud Remains a Common Problem...

Economic conditions indicate that companies are engaged, for the most part, in business as usual. What we have been finding is that this is also the case for fraudsters.

Fraud remains a widespread issue in Russia. According to the latest survey conducted by the Economist Intelligence Unit for this year’s Global Fraud Report, 73% of firms discovered that they were victims of at least one fraud incident in the past year. Rather than expecting improvement, though, nine out of 10 Russian respondents to the survey reported that their firms became even more exposed to this threat over the past 12 months.

Corruption is an important part of the problem: over the years Russian respondents in our surveys have frequently reported some of the highest incidences of this crime of any country. This year is no exception, with one in five saying it had affected their businesses in the last year—the second highest figure among the countries surveyed in depth. Such findings are consistent with other data: for example, Russia finished 136 out of 175 in last year’s Transparency International Corruption Perceptions Index.

...and a Team Game

Beyond corruption, though, our surveys frequently throw up a range of different fraud problems. This year, for example, Russians reported the highest level of misappropriation of company funds (17%), whereas in the previous survey there were above-average figures for management conflict of interest (24%) and internal financial fraud (18%).

The problem is not that the type of fraud varies widely over time in Russia. Instead, the difficulty is that any one description may not fully encompass the most common type of malfeasance that we see in our investigations. In Russia, directly embezzling funds from a firm, especially a subsidiary, is actually fairly difficult. Rather, what we often see are local managers of multinational companies who work with suppliers or other outsiders to siphon off company funds.

In one typical case, for example, Kroll was approached by a Western telecoms firm which had received allegations of wrongdoing by senior management at its local Russian operating company. The effort began small—with an email review—but what we uncovered led to an investigation which needed to include over 60 interviews with staff, suppliers and clients, a forensic accounting exercise and external inquiries. In this instance, suppliers and managers were working together to inflate prices of services and jointly pocket the difference. As a result, the firm dismissed three of its senior managers and overhauled its local compliance procedures.

Management’s external collaborators are not necessarily suppliers. In another case, a well-known Western medical equipment manufacturer was concerned about links between its local management and key distributors. Kroll found that they were right to be: the Russian general director and certain other local senior executives were all involved in tainted transactions and had directly set up a number of the distributors themselves.

Finally, white collar fraudsters in Russia are also willing to use a range of partners in crime simultaneously. Recently, Kroll investigated the local management of a Nordic real estate investment fund, which engaged us to look for evidence of suspected wrongdoing and to confirm its estimated losses. We identified colluded transactions between former management and tenants, suppliers and service providers. Former management had evidently not acted in the best interest of the fund, instead taking opportunities to deflect cash out of the company. The evidence we found has since been supporting a civil recovery strategy.

Looking Ahead

Predictions about the economy are not always accurate, and Russia’s has its share of risks. A worsening of the situation in Ukraine and more extensive sanctions could spell trouble for the apparent incipient recovery. Nevertheless, those operating in the country are well advised not to be distracted by very real existing risks through fear of potential ones.

Among the former is fraud, in particular Russia’s particular form of white collar crime. Understanding the relationships between local managers and those interacting with the company in various ways is essential to combating this risk which is far more consistent than the ebb and flow of economics.


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