Many complain that Ukraine’s economy is closed to new entrants and that the entrepreneurial spirit has no place to grow in this country of 42 million people.
But in Ukraine, you can make millions of dollars with the flick of a pen.
The country’s byzantine accounting code and seldom-enforced audit procedures allow fraud to flourish, permitting bankers to mark up or mark down millions of dollars on their balance sheets, while fraudsters hide behind fake companies to seize property.
And all this occurs within a law enforcement environment where billions of dollars have disappeared from the country’s banks over the past three years and not a single person has been convicted.
Insiders say that the schemes are continuing unabated.
Unbalanced
The country’s biggest banks make use of one particular accounting scheme that allows them to value assets on their balance sheet virtually any way they like.
The scheme goes like this: A bank might have an asset, like a loan, worth Hr 1 million.
Under Ukrainian law, the bank has the right to valuate that asset on its balance sheet, Oleksandr Savchenko, a former deputy chief of the National Bank of Ukraine and rector of Kyiv’s International Institute of Business, told the Kyiv Post.
From there, the bank could mark down the Hr 1 million loan as only having a 50 percent likelihood of being repaid, halving its value.
The bank’s overall capital would then go down by half a million hryvnia.
“I could then say that I don’t have enough capital, and the state would give me more,” Savchenko said.
These schemes usually need to be approved by an external auditor. But recent events give reason to doubt the quality of their oversight work. For instance, the government nationalized PrivatBank in December, costing it $6 billion, after auditor PwC incorrectly valued loan collateral at the bank. The NBU suspended PwC’s bank auditing license in July.
Agroholding Mriya cost investors $1.1 billion when it collapsed, leading to litigation against auditor EY, alleging fraud.
As Savchenko pointed out, “99 percent of people won’t turn down an offer of $10 million.”
Roman Marchenko, an attorney at Ilyashev & Partners law firm, said that the scheme is fairly widespread in Ukraine.“Ukraine encountered the problem when banks received refinancing from the NBU, in order to get credit, but presented documents that were not completely correct and truthful,” he said.
‘Fundamental’ problem
The opportunity to use such schemes arises from flaws in Ukraine’s accounting standards, which Savchenko said had a “fundamental” problem.
Twenty years ago, the Rada moved to shift Ukraine’s financial system towards international financial reporting standards.
But parliament did not go all the way, and left local, Ukrainian requirements in place, resulting in Ukrainian banks and businesses having to file both Ukrainian and international audits.
“Everything was done with the exception of one standard,” said Savchenko, an economist who helped introduce the hryvnia in the early 1990s. “That was the computation and method for valuing a bad loan. Here, we did not take the methodology, the principles, and practice of international accounting standards.”
“It’s a big loophole for corruption, and is why Ukrainian banks need to do two audits,” Savchenko said.
One source in the central bank, who spoke on the condition of anonymity due to a lack of authorization to speak to the press, confirmed that the practice is relatively widespread.
“It’s been a common scheme at the state banks,” the official said.
Marchenko added that the legal consequences for fraud are harsh on paper but, in reality, almost nobody is brought to justice.
“Unfortunately, there has not been one real criminal case concluded from all this,” he said, while adding that falsifying asset valuation when a bank is receiving state loans would be punishable by up to eight years in prison, if the law were to be enforced.
Fraud ‘Ukrainian style’
In other cases, fraud can happen on a smaller scale — your business partner turns out to be a thief.
This can happen through various high-tech means.
Fraudsters will sometimes monitor negotiations between two companies as they intend to conclude a deal.
In one example, provided by attorneys from Kyiv-based law firm Arzinger at a seminar called “Fraud — Ukrainian style,” an agricultural firm was in the process of making a deal with a trader for the sale of its product.
All seemed to be going according to plan — the trader was set to transfer cash to the agricultural company in exchange for its products.
But after receiving the company’s bank details, nothing happened. The trader received no products, while the agro firm said it would not send any goods over until it got the money.
So what happened?
According to the Arzinger attorneys, fraudsters had manipulated the situation by monitoring the communications remotely, taking both companies’ information. At the critical moment, it impersonated one side of the deal, siphoning the cash into its account.
Arzinger partner Kateryna Gupalo said that few people check to make sure that emails sent under familiar-sounding names are actually coming from the person in question.
“People aren’t prepared to be fooled,” she said, adding that much of it comes down to the security of contractual agreements.
Another example discussed by the attorneys showcased a foreign investor that had put $15 million into a Ukrainian subsidiary, which owned a food product factory.
The company’s subsidiary hired a marketing firm to advertise their products, but then wound up the victim — the marketing firm countersued the subsidiary, winning a decision in a Ukrainian commercial court to drive the subsidiary bankrupt and then seize the firm’s property through a bankruptcy auction.
In that case, the director of the subsidiary had secretly agreed with the marketing firm to spend the cash from the foreign investor on fictitious advertising services. The marketing firm then claimed a debt from the investor’s subsidiary, suing it into bankruptcy and using the auction to seize the company.
“You need to know who you’re doing business with,” Gupalo added.
