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. Last Updated: 07/27/2016

Investing, Pentagon-Style, Part 2


The Philosophers' Stone

So perhaps RAMEC is salvageable. The DEF has not always been so lucky.

Electronic equipment includes miniscule amounts of precious metals like gold, palladium, silver and copper. In 1997, the DEF set aside $7.7 million to build a plant south of Moscow in Kaluga capable of extracting those precious metals from tons of electronic scrap each year. The plant Ч dubbed Metallurgichesky Zavod Ametist Ч was to be built by Valme Industries, an ailing French company in the European scrap-sifting business.

Nordin said the DEF had hired the KPMG consulting firm to evaluate Valme as a partner. KPMG reported that Valme was fading fast. It had built a business in the 1960s recovering gold and such from electronic circuitry Ч back when such circuitry was cruder. As Europe grew more high-tech, Valme began to look East, to the Soviet bloc, where engineers still packed gobs of precious metals into electronics.

"We knew Valme was in trouble," Nordin said. "KPMG told us: Without [the DEF's MZA project] they were dead, with it they were fine."

Armed with that urgent knowledge Ч and also with hope that the European Bank of Reconstruction and Development, a veteran of high-risk Russia investing, was on board Ч the project moved forward. "The [MZA] project is funded in part by the EBRD, which is providing more than $14 million of the $23 million," announced the DEF's 1997 annual report.

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The description of MZA was accompanied by a photograph of gleaming bars of pressed gold and a quote from Yury Guzhavin, the Russian partner in the affair, to the effect that the DEF would bring to MZA "the business experience that we need."

MZA was to employ 100 people who used to work in the military-industrial complex. Spending $23 million in public money to establish 100 new jobs works out to $230,000 per job. Had MZA turned out as billed, U.S. foreign aid critics might be now skeptically crunching those numbers Ч perhaps as part of President George W. Bush's review, announced last week, of U.S. military conversion programs in Russia Ч and then dubbing MZA one of the more expensive job-creation programs in history.

But things never got so far. The DEF put $5 million into Valme's hands so it could build the plant Ч but Valme expired and those millions went right back out the door to its creditors. The EBRD put in nothing and watched from afar. What had happened?

The DEF defensively picked up the story in the following year's annual report. (The DEF has not published annual reports for 1999 or 2000. Publishing such a report is required by the U.S. law establishing the DEF's original grant.)

MZA, the DEF's report explained, was killed off by a tag-team of villains: the ruble devaluation and the EBRD.

"The [MZA] project was brought to the DEF and sponsored by the EBRD," the report says. But then, the EBRD began playing dumb. The report complained of "the [EBRD's] delaying tactic of repeatedly requesting additional information" about MZA, and blamed such stalling for, among other things, Valme's business problems.

Eventually the ruble crashed, the report says, making MZA "uneconomical to continue." The report says the DEF has sent EBRD a $500,000 bill representing money spent "on due diligence matters and project start-up on the recommendation of the EBRD."

There are problems with the DEF's official explanation of how it lost millions in MZA. For starters, the devaluation of the ruble could only have made a raw materials extraction project like MZA more economical, not less.

The ruble devaluation would have reduced all ruble costs associated with building and running the gold-sifting plant Ч while it would not have affected the dollar-pegged revenues to be earned from selling that gold.

If MZA had been a winner before the 1998 ruble crash, it should have been far sexier afterward.

'If You're So Smart, Why Are You Broke?'

The real problem with MZA is that it was a loser all along. E-mail traffic in and out of the DEF's offices in the summer of 1998 Ч copies of the e-mails were provided by Maly Ч sounds dispiritedly certain on this point.

Consider this from investment officer Mike Rhodes of the DEF, here berating the French partners Valme for making lazy and unrealistic predictions about MZA:

"My (your) problem is that you have not been able to do ANYTHING to prove to us or EBRD that the supply is there, that you know the suppliers, that you are capable of bringing in the supply, that you understand the Russian scrap market," Rhodes wrote to a Valme official in a June 19 e-mail, a copy of which Maly supplied.

"If we had real supporting documentation for the numbers in our [business] plan, as we do for EVERY OTHER PROJECT that the DEF invests in, we would not be in this mess right now."

This Valme official had just assured Rhodes that "Valme knows its trade better than many others." Rhodes replied witheringly, "If you know your trade so well, why are you bankrupt?"

Rhodes went on to challenge Valme's assertion that it can truck 1,500 tons of scrap from across Russia to the Kaluga recovery plant with just two trucks. His back-of-the-envelop math suggests a need for at least six trucks.

Even then, Rhodes writes, he doesn't really see where the scrap is coming from. "Our lack of a clear supply plan is a really poor situation," Rhodes wrote. "If I were considering this project all over again right now, for this reason alone, I would walk away."

'Well-Meaning, but Naive'

So there's no clear supply of scrap, and even if there was, the e-mails show sharp disagreements over how much gold or palladium one could squeeze out of it. Valme is going bust back home. And on top of all this, world gold prices are sinking: Nordin says now that the DEF was banking on the idea that gold, already at record lows in 1996, would not go lower. But it did so steadily throughout MZA's brief life span Ч from an average of $387.87 per ounce in 1996 to just $292.90 in 1998.

Never mind. A week after taunting the Valme team as bankrupt and stating that his preference would be to just "walk away," Rhodes put on a brave face. He e-mailed EBRD senior banker Susan Goerans that the DEF "has decided no longer to fight with" a consultant it had hired "to provide us a written [due diligence] report on the MZA project."

Rhodes wrote that the consultancy firm DEF had hired, Simplified Solutions, "is currently focused on other engagements," and so was only offering verbal comments about whether MZA was viable. Rhodes admitted that this was "an unacceptable situation," but insisted the MZA project was still a go. He said the DEF had done its own additional research, had incorporated its reluctant consultant's verbal comments and was ready to write its own due diligence report.

Two weeks later, Elizabeth Ames, another DEF investment officer, was in London for a July 6 meeting with Goerans. Her mission: to get the EBRD to put in that $14 million. It did not go well. E-mails Ames wrote afterward suggest the EBRD was getting skittish.

"What does it mean when your own consultant won't commit their findings to paper?" Ames quoted Goerans as having asked. In parentheses, Ames offered her own answer: "It means you're doing business in Russia, where there's a different import to words on paper, and that the consultant doesn't get paid." When Goerans persisted, Ames wrote that she had replied, "I'd be happy to give her our consultant's phone #, in no way are we blocking access to his expertise."

Goerans declined to be interviewed, and neither Ames nor Rhodes could be located for this article.

EBRD spokesman Richard Wallis said the EBRD's team walked away from MZA convinced DEF managers had been "well-meaning but naive."

Whatever the DEF managers wrote in their annual report about grand $23 million partnerships with the EBRD, Wallis added, "I certainly don't think we ever gave any commitments in writing Ч the sort that would be required to make such an investment, and that the DEF should have required before moving forward [to invest its own $5 million]."

A representative of the EBRD who did not wish to be named added that in handling MZA, "the DEF was trying hard to save costs, to do everything themselves, and did not hire outside [legal] counsel" to advise them.

That echoes Maly's letter to the State Department's Taylor: Among his many criticisms, Maly complained that "Nordin, who has a graduate degree in Russian studies and is a CFA [certified financial accountant] Е largely thought himself capable of doing without a lawyer." (Pity the DEF: In 1995 and 1996 it's being berated for spending too much on lawyers; a few years later it's accused of spending too little.)

Nordin said in interviews that he always sought appropriate legal advice. He said this had been documented by investigations into the DEF's work. Otherwise, he said, the DEF board would not have allowed Nordin to remain in charge to this day of handling the investment portfolio.

'Unwinding' MZA

Having sunk $5 million into the quest for the Philosophers' Stone, the DEF's alchemists now busied themselves trying to get it back. But it was not meant to be. Almost all of the DEF's $5 million for MZA represented loans to Valme Industries. Some of them were backed by guarantees from a British insurance company called LIM. Nordin said the DEF had also hired KPMG to check out LIM, and KPMG gave it a clean bill of health Ч but that the Russian financial crash nevertheless brought down LIM, too.

That meant trying to scrape back some of the lost $5 million from the bankruptcy sell-off of Valme. Ultimately, the DEF got nothing.

There is a final $15,000 footnote. That is the amount Nordin says the DEF loaned to the Russian face of MZA, Guzhavin Ч the man who had so enthused about "the business experience" the Americans brought to the table.

"Mr. Guzhavin got sick. He needed a heart operation. We gave him an advance," Nordin said. "Then the [MZA] deal fell apart. He couldn't repay the loan. We had to get out of this bad deal, and he helped us unwind it. So he worked off his loan doing that."

The DEF Goes Big-Time

But forget all of that. Nowell, in that Chicago Tribune look forward, also spoke of telecoms. And it was a telecom joint venture with the Railways Ministry that was the DEF's most ambitious endeavor Ч and most spectacular failure.

All of the utility monopolies in Russia are racing to get into the telecommunications business. The argument is that if you have rights-of-way along railway tracks, or natural gas pipelines, or the wires of the electric power grid, you can cheaply lay fiber-optic line Ч and get a whole second business. It's the great telecommunications land rush.

The Railways Ministry has entertained a half-dozen such projects, and the flavor of the day is Trans-Telekom, a ministry-owned company that will lay the cables with Russian government money.

But early on, there was a drive to get Western investors to pay for it. In 1996 the Railways Ministry struck a $420 million deal with AT&T and New York-based Communications Development Corp. Via a 50-50 joint venture called MPS-Telekom, the Americans and Russians would wire up the nation. The DEF was a junior partner in this, putting in a few million dollars in return for a little equity.

Then AT&T got distracted by the spin-off of its Lucent Technologies, and dropped out of the deal. CDC followed it out the door soon after Ч and the DEF purchased the American half of MPS-Telekom, for about $6.3 million.

The DEF had just bought itself into a punishing investment schedule. Documents provided by the Railways Ministry show that the DEF was on the hook to come up with $420 million over a five-year period: $56.5 million in 1996, $116.5 million in 1997, $159.5 million in 1998, $67.5 million in 1999 and $20 million in 2000.

The DEF had nowhere near that kind of cash. But Nordin said he had an understanding with the Railways Ministry that the deal would be rejiggered Ч that his team would be given time to rework the plan and shop it around among the AT&Ts of the world.

In the meantime, the DEF put in another $3.3 million, and MPS-Telekom began pilot projects hanging hundreds of kilometers of fiber-optic cable.

Nordin said his team came up with a viable plan and even had the World Bank's investment arm, the International Finance Corp., interested. But when the DEF submitted the plan to the Russians, they got a clipped letter in return Ч informing the DEF it was far behind its investment schedule, so all bets were off.

Going for a Double Play

The ensuing spat, which has never been reported, played out at the highest levels of the American and Russian governments. The DEF managed to mobilize the U.S. Commerce, Defense and State departments, and then-Secretary of State Madeleine Albright was prevailed upon to raise MPS-Telekom in a discussion with then-Prime Minister Yevgeny Primakov. Nordin said the DEF was asking for either a green light to go forward, or its money back.

U.S. Ambassador James Collins is among those who tried to broker a deal between the DEF and the Railways Ministry. Asked a few months ago about MPS-Telekom, Collins said the dispute was mostly resolved and the Russians "were trying to do the right thing." But he also put MPS-Telekom in a list of a handful of investments by Americans Ч a salmon fishing camp near Murmansk, the Subway sandwich shop in St. Petersburg Ч that are notorious among expatriates as cases of blatant expropriation.

It certainly sounds like a case of expropriation in the DEF's 1998 annual report: "Because of the enormous potential value of the MPS-Telekom venture, the Russian partner Е has executed a series of delaying actions designed to force [the DEF] out."

Sorting out MPS-Telekom also involved hiring Valery Serov, the former deputy prime minister Maly says was paid in brown envelops, as a lobbyist. Railways Ministry officials shared letters Serov wrote to then-Deputy Prime Minister Alexei Bulgakov, lobbying him to put the Communications and Property ministries, and not the Railways Ministry, in charge of MPS-Telekom.

"[Nordin was trying to] get rid of a structure [the Railways Ministry] he couldn't agree with," said Sergei Pryanikov, an adviser to Railways Minister Nikolai Aksyonenko.

Pryanikov suggested Nordin thought he had "better contacts" at the Communications and Property ministries.

Serov declined to comment on his chosen tactics, but Nordin offered a possible explanation: He said Serov had already suggested the railways and gas monopolies were wrong to assume they had rights-of-way along their pipes and tracks. Nordin said Serov was probably going for a double play Ч getting MPS-Telekom sorted out and getting ownership of the rights-of-way defined.

'He's a Spy, It's on the Internet'

Railways Ministry officials tell a very different story. Pryanikov says the DEF fell behind on its investments, and then began demanding a new deal and stirring up a scandal.

Pryanikov has never met Nordin, and only came to the MPS-Telekom problem late in the day. But he and his colleagues say they are now convinced the DEF was really a U.S. government covert operation working against Russia. Asked what kind of covert operation, Pryanikov was hazy. But he insisted, "I'm convinced [Nordin is a spy]. I've seen some data and looked into this."

Pressed about that data, Pryanikov and Vyacheslav Smirnov Ч another adviser to the minister and a vice president of Trans-Telekom Ч divulged their source as "the Internet," where Nordin's resume is posted.

"It's confirmed, he is an espionage agent, but retired," said Smirnov, adding, "But you know they say you only leave the espionage business feet-first."

Nordin and Nowell are both former U.S. Army Rangers who studied Russian affairs together at Harvard. They have been good friends since they were occasional roommates in graduate school, and Nowell remembers helping to paint Nordin's grandmother's house. In fact, Nowell said one reason he took the post as DEF CEO was so that he could hire Nordin and work with him again.

Nordin also studied the Russian military and Russian financial markets at the Rand Corp., where he worked on a doctorate in public policy analysis. Rand is a California-based think tank that does a lot of work for the U.S. intelligence community. Nordin's dissertation at Rand was: "Liar's Poker, Russian Style Ч Regulatory Issues in Russia's Public Equity Markets."

To Pryanikov and Smirnov, this adds up to a pair of CIA agents, even if they did help each other paint Nordin's grandmother's house. At one point in the spat over MPS-Telekom, Pryanikov said, a group of deputy ministers even discussed "kicking back" against Nordin's full-court press Ч "by letting a paper like MK [Moskovsky Komsomolets] or Kommersant have the story: An American spy, retired, tries to seize control of [Russian] infrastructure, he doesn't pay, he brings pressure to bear."

Asked if they were spies, Nordin and Nowell offer both flippant and thoughtful answers. Nowell jokes about Nordin's "secret decoder ring," and Nordin about secret agents who post their resumes on the World Wide Web. But both also say they knew the work of conversion was politically sensitive, and that they did everything they could not to provoke suspicions or bad feelings.

In the end, this was also the instinct of the Russians. Pryanikov said the deputy ministers decided not to bother calling MK, and instead to try to get the DEF back its money. A turning point was apparently a lunch between Nordin and a Trans-Telekom vice president at the Harvard Faculty Club in 1999, during the annual U.S.-Russia Investment Conference.

Trans-Telekom eventually bought up more than 600 kilometers of fiber-optic cable the DEF had already laid down, plus supporting technical documentation, for $8.6 million. Nordin and the Railways Ministry are still quibbling over some of that documentation, but mostly the matter is resolved. The DEF got away with a loss of about $1 million.

'If Only I Spoke English'

Oleg Gapanovich, the DEF's man in St. Petersburg, was arguably the fund's most highly qualified expert on "konversia" Ч conversion of military industry to civilian use. As a delegate to the Congress of People's Deputies in 1990, he headed parliament's commission on the military-industrial complex and conversion. And in an earlier incarnation, during the Cuban Missile Crisis, Gapanovich headed a team of Soviet military officers responsible for four nuclear warheads. His job would have been to arm the warheads before a potential launch. Thankfully, the launch orders never came, and Gapanovich went on to a successful military and engineering career as a ship designer. But ever since he has been fervently convinced of the need for cordial U.S.-Russian relations and for at least some level of demobilization.

The job at the DEF, then, suited him well. But like Maly, Gapanovich came away disappointed. "As to bad management, I'd agree," he said in an interview. Gapanovich even wrote to a member of the DEF's board of directors to lay out his concerns. But Gapanovich is at great pains not to have his letter associated with Maly's. He worries Maly's crusade has gone too far, and he spoke with distaste of Maly and the DEF management collecting dossiers against each other built upon donosy Ч the word used to describe tattletale reports filed with the old KGB. Moreover, Gapanovich prefers to defend Nordin, while Maly attacks him. "Richard [Nordin] didn't have any assistance in technical matters, in economics. And he had to carry the burden for all. They all, every time, waited for Rich," Gapanovich said. At times, Gapanovich blames himself for not being more help. "If only I spoke English," he sighed. (Nordin, by the way, speaks fine Russian.)

Gapanovich remembers Nordin and Nowell as very excited about MPS-Telekom. "They thought MPS-Telekom would be very profitable. They made video presentations about it, and went to [investment] conferences in America and England," he said.

The idea as Gapanovich remembers it was that a sexy telecom project was just what the DEF needed to sell its private fund. "We needed some loud project to show Ч and MPS-Telekom was that thing, it was huge, it would make people say 'Whoa! I get it!'"

So they signed a contract, but quickly fell behind schedule with investments. Gapanovich said he believed the contract was "designed to have such hooks," and bemoaned that "Richard had no one to read or study the contract. There were lawyers, but you have to look at the contract from the point of view of seeing ways you could get caught."

Saddest of all to Gapanovich is that good, solid defense conversion projects have gone unrealized Ч first the fund was too slow off the ground, then too busy getting into and out of messes with RAMEC and MZA, then too excited about its monster telecom project, and now it is basically dormant. That leaves a widow Gapanovich's (and also Nowell's) favorite project: Vektor, a Novosibirsk biological agent factory the DEF team only got access to in mid-1998.

Vektor has historically produced, among other things, anthrax. Now it has a business making children's yogurt drinks, and was hoping the DEF would help it move into pharmaceuticals production. Gapanovich says the DEF was all set to help Ч right up until the fund slipped into hibernation. Matthew Maly's web site. Matthew Maly states his case. Richard Nordin's resume.