Down and murky in Ukraine as opposition candidate arrested

By bne IntelliNews October 8, 2012

Graham Stack in Kyiv -

The arrest of opposition parliamentary candidate and financier Ruslan Demchak on money-laundering charges looks at first glance to be another example of mounting political repression ahead of Ukraine's parliamentary election. But Demchak may have fallen victim to a government tax crackdown rather than electoral politics and, according to bne enquiries, his bad luck may be another man's poetic justice.

Ukraine's State Tax Service announced September 3 that they had arrested the 38-year-old financier Demchak, owner of mid-sized Ukrainian Business Group, RD Bank and insurance and healthcare assets, in a rare move to prosecute a well-connected businessman for financial offences. Given such an arrest is so extraordinary, pundits have been quick to claim that the real reason for Demchak's arrest is his work for the political opposition: Demchak was running for parliament in a first-past-the-post constituency against prominent Party of Regions parliamentarian Hrihory Kaletnik, head of the Rada's agriculture committee. And Kaletnik's son Ihor is head of the even more influential State Customs Service, making the Kaletnik family one of Ukraine's most powerful political dynasties.

This is also Demchak's version of events. "From the minute of my registration as a parliamentary candidate pressure was brought on me from competitors," Demchak said in a statement following his arrest. "First of all, they registered a clone candidate Andrei Demchak to deceive voters and take votes off me. A few days later, a smear campaign was launched against me in the media. They started to harass my wife and children with the aim of forcing me to retire from the electoral race. Because I refused to do so, I was arrested during one of my meetings with voters."

Then on September 7 a Kyiv court ordered Demchak's custody to be extended for two months. "Everything is being done to prevent me from continuing the election campaign," Demchak responded. The tax service denied any political component.

Following the jailing of key opposition leaders Yulia Tymoshenko and Yury Lutsenko in the last year on what are widely regarded as politically motivated charges, arrests of lower level political opponents would be a sure sign that Ukraine was slipping towards Belarus standards of authoritarianism. "Demchak's arrest was definitely a result of his parliamentary candidacy, since it was only after announcing his candidacy that he was arrested," argues Vladimir Fesenko, head of the Penta Center for Applied Political Research.

It is regarded as Ukraine's major achievement that it has held successive free and fair elections, following the Orange Revolution that overturned rigged presidential elections in 2004, but fears are growing that the parliamentary election on October 28 could see an end to this.

Mud-slinging or money-laundering?

Demchak's downfall has just accelerated. According to a Demchak aide, as quoted by Ukrainksaya Pravda, as a condition for his release from detention by November 3, Demchak has now agreed to withdraw his candidacy and to sell his bank, RD Bank.

But while the timing of Demchak's arrest seems prompted by his candidacy, this does not mean the charges he faces are trumped up. An official complaint against Demchak was filed by two MPs to the General Prosecutor's Office on August 18, apparently providing the basis for his arrest. According to the complaint, Demchak was "rendering services in converting non-cash funds into cash funds via participants on the securities market" - ie. running what is known across the former Soviet Union as a "conversion centre".

A conversion centre is an informal financial facility converting companies' booked funds into off-the-books cash, on an industrial scale and for an approximately 10% commission. The cash then goes to fuel Ukraine's shadow economy, estimated at around 50% of total GDP, in particular by paying salaries "in envelopes" and thus avoiding payroll taxes. Ukraine's security service puts the total volume of such "converted" funds at around $7.5bn per year, according to a report leaked in 2011. Two staple tools of conversion centres are fictive securities transactions and fictive import-export operations.

Demchak's structures have rejected any financial wrongdoing on their part. "RD Bank (member of Ukrainian Business Group) has never and does not engage in laundering funds and any other illegal operations and activity," the bank said in a statement.

But bne has obtained independent confirmation that Demchak ran conversion centres, from a source in the central Ukrainian town of Zhitomir. The source, 53-year-old Anatoly Rupeta, accuses Demchak of being a leading operator of conversion centres in Ukraine over a number of years.

Blast from the past

Rupeta tells bne he is fighting trumped-up criminal charges of large-scale fraud brought against him by Demchak's structures, after he inadvertently stumbled across the operation of a massive conversion centre.

According to Rupeta, his troubles started in 2007 when the previous owner of the small Zhitomir firm he was running, the head of a local bank's foreign currency department, died in a car crash. It quickly transpired, according to Rupeta, that the deceased bank executive had been involved in one of Demchak's conversion operations, via the bank where he worked. And unknown to Rupeta, the firm he had taken over from the bank executive in good faith was at the heart of the scheme, which involved foreign currency accounts at the bank Rupeta says he knew nothing of. "Only days after the car accident - in December 2007 - Ruslan Demchak came to me and explained the whole scheme, drawing a diagram to show me exactly where I stood," says Rupeta, who retains Demchak's sketch to this day.

According to Rupeta, the scheme that Demchak described had processed $56.9m in 2006-07. "Demchak told me that if I and the widow of the bank executive did not return $2m in money - which I obviously did not have - he would arrange for criminal charges to be brought," he says, explaining that Demchak needed to bring criminal charges against him to build a case for freezing the widow's assets.

Rupeta tells bne that Demchak's conversion scheme worked via a $2m foreign currency credit line held by the deceased bank executive, which was secured by guarantees provided by local companies. Offshore firms would transfer dollar funds from Latvian and Lithuanian bank accounts as advance payments on non-existing foreign trade contracts with the Ukrainian companies. The local companies then transferred these funds to pay down the executive's credit line. The executive then received cash payouts on the credit line, which were then distributed via Demchak's structures to the scheme's customers across Ukraine. "And there were a number of people at the bank with similar credit lines," says Rupeta.

According to Rupeta, Demchak made good on this threat to have criminal charges brought when one of the top managers in Demchak's Ukrainian Business Group (UBG) filed a complaint to police against Rupeta. Demchak's manager held power of attorney for a UK company, Corpmark Impex LLP, that had transferred funds to Rupeta's company Magnolia. Corpmark Impex LLP, as well as Panamanian and New Zealand firms, also transferring funds to Rupeta's company, all featured the now notorious Latvian nominee directors such as Erik Vanagels, Stan Gorin, and Voldemar Spatz, whose names feature in thousands of companies and numerous Ukrainian economic crime cases, including Highway Investment, a company that bne investigations has shown to be involved in the suspicious sale of an over-priced rig to the state oil and gas firm Naftogaz Ukrainy. "The UBG manager even claimed in court he is a personal acquaintance of Spatz," says Rupeta.

According to court documents, prosecutors allege that Corpmark paid Rupeta's firm Magnolia $6m for a delivery of granite that never happened, with the $6m made as a 100% advance payment, despite the fact Rupeta had signed no contract. "When I point out that I am unknown among local granite producers, the prosecutors say this only proves that fraud was intended from the start," he says.

Valery Fedichin, partner at leading Kyiv law firm OMP, casts doubt on the case. "It is very unlikely that a legitimate UK company would transfer $6m to a Ukrainian company without a written contract, and especially the whole contract amount in advance," he says. "Besides, a Ukrainian resident cannot do a foreign trade transaction without any paper work due to Ukrainian foreign exchange controls. So the resident itself would normally be concerned to sign a formal contract."

Facing the worst

Rupeta counts himself lucky not to have been shut up in pre-trial detention for the four years that the criminal proceedings have lasted. But the worst is still ahead - Rupeta is facing a jail sentence of 10-14 years, with a court decision and sentencing expected within the coming year. Ukrainian courts convict 95% of all accused.

For Rupeta, Demchak's arrest on money-laundering charges ironically represents a last chance to avoid jail. "The UK company Corpmark Impex itself is long since dissolved," says Rupeta, "but the Ukrainian courts will continue to grind until told to stop. Even if Demchak has only been arrested for political reasons, because he got in someone's way, there is poetic justice in this, considering how he set me up."

Demchak via his press secretary denied any connection to the alleged activities and conversion centres.

Kommersant Ukraine reported October 5 that Demchak's bank RD Bank is now up for sale. The most interested party is a leading Ukrainian political dynasty, though not the Kaletniks this time, but the Klyuev brothers Andrih and Serhiy, secretary of the National Security Council and a member of the National Bank supervisory council respectively, with combined wealth put at $300m by Forbes. According to i>Kommersant Ukraine , Demchak's bank may be small, but it is attractive to the Klyuevs and others as a national leader in cash handling and cash distribution services.

Down and murky in Ukraine as opposition candidate arrested

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