How MMM Exploited the 'Legal Illegality'

The president and the prime minister have criticized it and the Finance Ministry says unequivocally it is a pyramid scheme. But so far, no one has declared the operations of the MMM joint-stock company illegal and few in the government seem to know if they can.


MMM chief Sergei Mavrodi is under arrest, but none of the charges lodged against him refer to his core business -- the sale of tens of billions of rubles of MMM shares based on promises that could never have been kept.


Rather, officials have charged him with tax evasion in one small corner of his empire, a subsidiary called Invest Consulting, and with resisting a search. Indeed, on Thursday, Mavrodi ordered MMM to restart its operations from his prison cell, according to an Interfax report.


The glaring absence of any allegations against MMM itself raises the question: Is running a pyramid scheme legal in Russia?


In the murky area of Russian law answers are elusive. Some say MMM broke a series of existing regulations, from insider trading to failing to maintain a stock register. Others, including Finance Ministry officials, say that while MMM may have tiptoed along the edge of legality, it does not appear to have broken the juridical plane.


Riding on the answer to this question is a judgement on the government's claims that it was helpless to stop the company from taking in millions of Russian investors.


Between the two opinions is a uniquely Russian school of thought best called the legal illegality. It goes like this: MMM might have broken laws, but enforcement is so poor and the laws so badly written that prosection would be impossible and the scheme might just as well have been legal. What is clear is that Mavrodi carefully constructed his business and ran his operation in such a way as to get around legal impediments.


"My opinion is MMM used all the drawbacks in the Russian legal environment and maximized them," said Sergei Skaterchikov, general director of the Skate Press Consulting Agency. "It's not very easy to punish MMM for these technical violations, even though there are some obvious reasons why MMM should be punished."


Alexander Borisov, spokesman for the Moscow Tax Police, said in an interview that officials are now investigating MMM. He said "it was possible" charges related to the company could be filed although he did not say when. Specifically, the tax police want to know how many shares MMM sold and if the company paid taxes on that amount.


But breaking tax regulations is illegal in any business and Borisov said it is up to the Finance Ministry to decide if the company is breaking securities laws.


So far, however, the Finance Ministry has said it finds nothing wrong with MMM's operation.


In fact, one Russian stock broker who was a member of a committee advising the State Duma on new securities regulations said the group of experts specifically decided not to recommend outlawing pyramid schemes because it was too difficult.


Last year, the ministry licensed MMM to issue 991,000 shares at a nominal price of 1,000 rubles each. But under Russian law, the word "issue" is misleading. There are technically no physical stocks to hold. Share ownership exists only in the registration books of the company that issued the security.


Indeed, according to Richard Bernard, an attorney in Moscow with Milbank Tweed Hadley & McCloy, Russian law prohibits the issue of bearer stocks, which do not require registration.


Yet the Finance Ministry in 1993 set a precedent that became the model for MMM and other companies, Skaterchikov said. It approved a request by AVVA, the alliance of major Russian automobile manufacturers, to issue a certificate that could be exchanged for shares.


Such certificates increased the liquidity of the stock -- the ease with which it can be bought and sold -- thus giving the shares more value. A host of share certificates have followed in AVVA's footsteps, but their place in Russian law is unclear.


So while the Finance Ministry limited the number of shares MMM could sell, there was apparently nothing to limit the number of certificates.


"We cannot stop the issue of these papers, just as we could not stop the signing of a contract," Deputy Finance Minister Sergei Alexashenko said in an interview.


The MMM share certificate indicates that it is not an actual share. The title is "Certificate of Shares." And on the back, the fine print tells the holder that he or she has the right to sell or exchange "the shares named in this certificate."


Two questions are key at this point: What is the certificate, and how many did MMM issue? If the certificate is the same as a share then MMM may have violated a series of laws surrounding legitimate securities. The company could then be charged with failing to keep a proper share register of certificate holders, failing to pay stock transaction taxes and quoting shares without a brokerage license, according to Bernard.


More important, if the certificate is a share then MMM violated laws limiting the number of shares it could issue.


Yet if the certificate were not considered a share, it would be unclear what laws apply.


The real answer to MMM's legality may be more simple, however. One belief is that the government has consistently denied it was touching MMM, as opposed to the subsidiary Invest Consulting company, in order to avoid the wrath of millions of disappointed MMM shareholders. The Finance Ministry is about to adopt a series of new securities regulations for the future, on top of the ones it has yet to enforce -- perhaps hoping to prove its point that the existing laws were inadequate to deal with MMM.