We are mid-way through a five-part exploration of the recent the Department of Justice (DOJ) and Securities Exchange Commission (SEC) resolution of a Foreign Corrupt Practices Act (FCPA) enforcement action against the Russian telecom company, Mobile TeleSystems PJSC (MTS). The FCPA enforcement action came in at $850 million which makes it Number 3 in the Top 10 of all-time FCPA settlements. This series is examining the background facts of the case and provides a detailed review of the bribery schemes involved, the compliance failures of MTS and its actions during the investigation which contributed to the size of the penalty, the individual criminal prosecutions brought as a part of this action, the asset forfeiture actions filed by the DOJ by persons involved in this case and the key lessons learned by the compliance practitioner. Today I discuss the failures in the MTS compliance regime, the override of internal controls and local business unit management which facilitated the bribery schemes.

The companies and players:

1. MTS;
2. Uzdunrobita FE LLC (Uzdunrobita) which became a subsidiary of MTS in 2004;
3. Gulnara Karimova, daughter of the former President of Uzbekistan and Bekhzod Akhmedov, a former MTS executive based in Uzbekistan
4. Kolorit Dizayn Ink, (Kolorit) a Uzbeki advertising agency bought by Uzdunrobita;
5. Swisdorn Ltd. and Takilant Ltd., both shell companies owned or controlled by Karimova.

Purchase of Uzdunrobita

MTS desired to enter the Uzbeki telecom market, which it did in 2004 though the purchase of 74% of Uzbeki entity Uzdunrobita; which was 41% owned by a US company and 33% owned by Karimova. The remaining 26% was owned by Swisdorn, which was another shell company controlled by Karimova. MTS paid $100 million for Swisdorn’s interest and only $12 million for the US entity’s interest. In addition to this fraudulent payment to Karimova, there were mutual put/call options agreed to by the parties.

However, within two years the MTS call purchase option disappeared through negotiation and it became a unilateral put call for the sole benefit of Karimova through her shell company Swisdorn. This action was done fraudulently at MTS as the Information stated, “Certain MTS management did not obtain the approval of MTS’s Investment Committee or MTS’s Board of Directors for the amendment and only informed MTS’s Investment Committee after the amendment agreement had been executed.”

Conversely, MTS executives were becoming aware that Karimova owned or controlled Swisdorn and in “February 2007, the new executive began to raise concerns, including the FCPA risk MTS faced if Shell Company A was” beneficially owned by Karimova. His own open source investigation indicated that MTS could risk FCPA exposure through these arrangements with Karimova. He asked that a law firm perform a full due diligence investigation on Swisdorn. Moreover, “The new executive continued, “We need to re-check the previous transaction for acquisition of Uzdunrobita to make sure there are no risks of potential persecution for the purchase of shares from [Foreign Official] (if they were actually purchased from [Foreign Official]).” The new executive emphasized, “From the reputational point of view, we should exclude any association between MTS and [Foreign Official] – [a] profile is attached.””

The response from senior MTS management was to sideline this executive. The Information stated, “In response to the new executive’s emails, certain MTS management took steps to restrict further dissemination of the new executive’s concerns about the Foreign Official.” Further, as the “new executive insisted that MTS conduct additional due diligence, MTS hired a U.S. law firm to conduct due diligence on Shell Company A. In an effort to ensure that the legal opinion would be favorable, certain MTS management did not disclose certain relevant information to the law firm, including the crucial fact that certain MTS management knew that Foreign Official was the beneficial owner of Shell Company A.”

Because of these misrepresentations, the due diligence came back in a manner such that the transaction went forward. However, even in this step MTS was made aware of red flags. According to the Order, the original put option was “set at 26% of $145,000,000, or $37.7 million, plus five percent interest per annum for each year after the signing of the agreement until the put or call option was exercised.” Yet, this price was inflated up to $250 million by Karimova at the time the put call was exercised.

Purchase of Kolorit

In September 2009, Uzdunrobita entered into an acquisition that would satisfy a portion of MTS’s obligation to confer a $40 million benefit to Karimova. Uzdunrobita acquired 100% of the Uzbek advertising company Kolorit which Karimova indirectly controlled. There was no business justification for the acquisition as a non-core transaction for either Uzdunrobita or MTS because Kolorit had no telecommunications operations and MTS was not in the advertising business. Indeed, according to the Information, one MTS executive, “emailed certain MTS management a memo stating that “[t]he Third Party [Foreign Official] is making a demand that [MTS] pay $50 mln . . . .” “by acquiring an asset” whose value was “overstated,” which was “unattractive” to MTS’s “development strategy” and whose size would be “impossible to explain to the investment community.”

Moreover, this transaction not only had no business purpose, it was even antithetical to MTS. The Deferred Prosecution Agreement (DPA) stated, “On or about April 9, 2009, certain MTS management wrote Executive 1, stating that the KOLORIT “transaction is a toxic one” and that “I think that we need to get the transaction to [MTS’s Investment Committee]. Let [certain MTS management] and the [Investment Committee] members share liability.” To top this off, the Order stated, “$40 million for Kolorit, substantially more than the $23 million valuation of the company that JPMorgan had prepared at MTS’s request.”

Finally, the Information pointed out, “MTS’s Department of Strategic Planning for the August 10, 2009 MTS Investment Committee meeting, recommending rejection of the KOLORIT acquisition because the acquisition was not part of MTS’s “core business” and the estimate for advertising market development was “not realistic.” The memo explained, “Within [the] framework of qualitative analysis, it’s hard to imagine—within [the] framework of this poor country (171st rank in GDP – per capita (PPP) and 185th rank in inflation rate), just one outdoor local advertising company could cost 40 MUSD. This is a pure fairy tale!” Certain internal and external valuations of KOLORIT were significantly less than the recommended purchase price.”

 Purchase of 4G Licenses

To obtain these licenses MTS engaged a due diligence investigator to look into their holder Takilant. The investigator fairly easily discovered that “Takilant’s nominal owner had no telecommunications background and was a known proxy for Government Official A [Karimova], MTS ignored the information.” Additionally, “On August 29, 2008, the investigative firm reported to MTS that “Uzbek sources regard Takilant Ltd as being beneficially owned by the family of the Uzbek president. . . . Confidential sources close to, and knowledgeable about, Uzbek business and political circles, regard [the director of Takilant] as being a trustee of [Government Official A], a [relative] of the Uzbek president. Sources believe that [the director of Takilant] works for [Government Official A], being in charge of the latter’s fashion business and PR matters.” Additionally, “After receiving the firm’s findings, MTS conducted no further investigation and proceeded with the transaction.””

To fund the monies, it required MTS Board approval for the loan from the parent to the Uzbeki subsidiary to make the payment. Apparently, the Board was never informed about Karimova’s involvement or hidden interest in Takilant.

Charitable Donations

MTS continued making bribery payments to Karimova through donations to charities controlled by her. According to the Order, MTS also made payments to charities controlled by Karimova. These “payments were falsely recorded in Uzdunrobita’s books and records as advertising and non-operating expenses, rather than as charitable expenses.” The payments also failed to comply with appropriate internal controls as they were not approved internally by either Uzdunrobita or MTS until after payments were made. Finally, the donations “were not memorialized in agreements with anti-corruption representations.”

Tomorrow, I will consider the Indictments of Karmova and Akhmedov.

Mike Volkov and myself did a special FCPA Compliance Report bonus episode on the MTS settlement and Karimova indictment. Check it out here.

References and Resources:

1. MTS Deferred Prosecution Agreement (DPA);
2. MTS Criminal Information (MTS Information);
3. SEC Cease and Desist Order (Order);
4. Karimova and Akhmedov Indictment (Indictment);
5. Kolorit Dizayn Ink LLC Plea Agreement (Plea Agreement);
6. Kolorit Dizayn Ink Information (Kolorit Information);
7. The DOJ Press Release; and
8. The SEC Press Release.

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