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. Last Updated: 07/27/2016

MMM's Legal Loophole

Three months after MMM slashed the value of its securities and closed its doors, the government and casual observers are still straining to discover what laws, if any, the company breached.


MMM was only the loudest Russian financial scandal of recent years, and certainly not the first. It has since been followed by the closure or suspension of several investment companies, Tibet among them. These are unlikely to be the last.


The scandal is not that MMM and others have acted illegally but, on the contrary, that what they have done does not contravene the law. The reason for this is rooted in the Soviet-era formalism that continues to pervade Russian legislation.


Institutions in the West are defined not by self-described titles but by reference to the economic substance of the investment options they offer. The law then designates which of those investment options may be offered solely by licensed institutions and in what manner. In Russia, this is not the case.


Russian law defines an institution according to how it is registered or licensed. In practice, this means that even where the law sets out rules regulating the activities of certain types of institution, such regulatory schemes are entirely optional and apply only to those companies choosing to be licensed as a regulated company.


An investment fund, for example, is defined by law as an entity registered as an open joint-stock company and licensed as an investment fund. Therefore, if you wish to operate an open-ended investment fund in Russia that will sell shares to individual investors and repurchase them based on a daily calculation of net-asset values, you need to register a Russian open joint-stock company, obtain an investment fund license, and comply with applicable capital structure and investment rules.


Alternatively, you can run an MMM-type scheme, which requires no license, and imposes no rules on investment or disclosure. So long as your MMM-style fund is registered as a limited company, instead of an open joint-stock company, and you skip obtaining an investment fund license, there is no formal basis under Russian law to deem your self-styled fund to be an "investment fund" for regulatory purposes.


This approach harkens back to the Soviet days, when the ruling presumption was that anything not specifically permitted is prohibited.


This logic was so persuasive in the Soviet legal system that in the notorious Sinyavski-Daniel propaganda trial in the 1960s, when one of the dissidents on trial stated in his defense that he was a writer pursuing literary and not political aims, the judge retorted that if the defendant was a writer he should be able to present a Writers' Union membership card. No doubt, Tolstoy himself would not have been deemed a writer in the former Soviet Union without the appropriate card.


The pernicious longevity of this logic promotes the activities of organizations like MMM and Tibet. Until legislators replace their awe of licenses, registration and stamps with an understanding of the workings of the market, such companies will continue to thrive.





Leonid Rozhetskin is a graduate of the Harvard Law School and a native of St. Petersburg, now in private practice in Moscow.