Russia’s cigarette king practices strategic giving

Introduction

In post-Soviet Russia, the right connections can mean success in business. And in the country’s lucrative retail tobacco trade, Igor Kesaev has set a new standard for success.

Kesaev runs the multifaceted Mercury Group, with interests in everything from weapons manufacturing to real estate. Now he’s also Russia’s cigarette king, with an unprecedented 70-percent share of the distribution business, selling the popular brands of some of the world’s largest tobacco companies, Philip Morris International, Imperial Tobacco and Japan Tobacco International.

Last fall Russian Prime Minister Vladimir Putin outlined a new policy for reducing smoking: tobacco advertising will be totally prohibited in 2012; there will be no smoking inside some public buildings and on public transportation; and by 2015, excise taxes can go up 10 times the current levels. This, the government has said, helps Russia comply with the World Health Organization’s international treaty on tobacco control. But ties Kesaev has forged with key government agencies, through strategic charitable contributions, have Russian anti-tobacco activists and government transparency advocates skeptical that they can win meaningful smoking reforms and curb government spending on tobacco-related death and disease.

Dmitry Yanin, head of the Confederation of Consumer Associations, which promotes tobacco-control policy, said the relationships between cigarette distributors like Kesaev and Russia’s security services weaken tobacco reform efforts in Russia.

The country today “is profitable for tobacco business — distributors, producers — but not for reducing the number of smokers,” Yanin said.

Around the world, anti-tobacco activists are gaining ground against Big Tobacco, pushing tough new controls in many countries. But nations like Russia pose a challenge because of their ample smoking populations, potential legions of new smokers, and governments that have appeared to be open to the influence of skilled lobbyists.

With smoking rates leveling off in the U.S. and much of Europe — especially among men — international cigarette makers are focusing lobbying and political work on developing nations and emerging markets like Russia. These nations have provided Big Tobacco a rich source of new revenue.

Global health statistics put numbers behind the smoking trend. Between 2005 and 2030, 175 million people will have died because of tobacco-related illnesses. Developing nations will account for 77 percent of those deaths.

Per-capita smoking in Russia is among the highest in the world. Russia is the world’s fourth-largest tobacco consumer — behind China, the U.S., and Japan — burning an estimated 400 billion cigarettes each year. According to the World Health Organization, some 44 million people smoke in Russia, 39 percent of the adult population. According to the Public Chamber of Russia, an oversight agency, smoking kills about 400,000 Russians each year. The chamber said these deaths rob Russia of about 3 percent of its annual GDP — approximately $36 billion.

Despite growing anti-tobacco activism and official Russian government policy now tilted against tobacco, Mercury’s Megapolis cigarette distribution business has thrived.

In six months of interviews and reviews of government and industry documents, the International Consortium of Investigative Journalist found that since 2003, Russia’s leading tobacco distributor has donated at least $7 million to a charity, the Monolit fund, run by former officers of the nation’s powerful security services. Former officials of those services also have taken positions in Kesaev companies.

The gifts are legal. Monolit provides financial assistance and care and housing for retired security service officers and military personnel.

But government transparency activists question the donations to security service funds. Are they giving just to gain an air of protected status in Russia’s rough-and-tumble business environment?

“Selling tobacco is very profitable, and, as you know, everything profitable in Russia one day can become the object of corporate raid. That is why donations to security service funds are like an insurance policy,” said Elena Panfilova, director of Transparency International-Russia’s Center for Anti-Corruption Research and Initiative.

The trouble with these charities, Panfilova said, is that they are like “black holes” of information, only lightly regulated and difficult to monitor.

There are 26 such funds, just in Moscow, with ties to federal security services and law enforcement, according to Scrin, a firm that tracks Russian companies. In 2007, a fund linked to the Federal Protective Service, which is responsible for protecting the president and prime minister, was among the charities that received $50 million in donations from a subsidiary of Transneft, the government-owned oil and gas pipeline builder, according to a company financial statement.

Anatoly Shiryaev, a spokesman for Kesaev and Mercury Group, conceded that security services and state agencies are influential in the Russian business community. But in an interview with ICIJ he rejected transparency activists’ suggestions that his company has given to the Monolit fund to ensure a business advantage.

He said Mercury has advanced because of its professional management. “We don’t see a relationship between sponsoring Monolit and doing business. The real work and care of the fund is addressed to those whose fathers were killed for their duty to protect us. Our civic duty is to help widows and orphans.”

Gennady Gudkov, a legislator in Russia’s State Duma and deputy chairman of the Committee on Security, said improving transparency of security service funds would help clear the air of suspected corruption over the funds. Gudkov retired as a colonel from the FSB.

“In general I don’t see anything bad in financial aid to officers, who protect us and die for their duty,” Gudkov told ICIJ. “But everybody must be able to check on how money is spent and who stands behind the contributors. In Russia it’s often the case that strange, unknown companies contribute millions of dollars to security service funds, and nobody knows who the beneficiaries are.”

Transparency can be improved by tightening government controls over those funds, Gudkov said.

“Doubts about security service funds are not groundless, if we take in account conditions of Russian business with [suspicions of] corruption,” he added. “On the other hand, I know a lot of good examples, where businessmen have really helped veterans and families of perished officers.”

Exclusive distribution deals

In 2008 media reports estimated the value of Russia’s tobacco distribution was $12 billion. One distributor, SNS, controls 20 percent of the market. It was established in early 1990s by Oleg Smirnov, Sergey Nesterenko and Oleg Salo, former classmates at the Moscow Military Academy of Strategic Missile Forces. SNS has contracts with British American Tobacco.

Alexander Lioutyi, a spokesman for BAT-Russia, said the company did not consider SNS’ government ties when it signed the exclusive contract. Lioutyi said that working with just one distributor in a region is more efficient.

Mercury Group, which describes itself as “a major diversified holding company established in 1991 by Igor Kesaev, president and controlling shareholder,” had 2007 revenue of about $8 billion from its interests in oil, construction, real estate and distribution of retail goods.

Forbes ranks Kesaev 54th on its list of richest Russian businessmen, with an estimated fortune of $1.8 billion.

Kesaev, 44, was born in the republic of North Osetia. Not long before the collapse of the Soviet Union, he started out in the insurance business and rose to become head of the board of directors of a Moscow bank.

Mercury owns Megapolis, which employs 13,000 people and distributes cigarettes through more than 170 branches. Kesaev is also a partner with the Moscow city government in the oil conglomerate Sibir Energy PLC. Another subsidiary, OJSC V.A. Degtyarev Works, is among Russia’s top 20 military equipment manufacturers.

But tobacco is 90 percent of Megapolis’ business, according to the company’s website. Late in 2010, Megapolis entered the Ukrainian market by acquiring more than half of two tobacco distributors that have exclusive contracts with leading multinational cigarette companies.

The company’s rise to the top in tobacco distribution has come from hard work and strategic business moves, said Mercury spokesman Anatoly Shiryaev. He cited one example: In 2007 the company acquired a number of Russian tobacco-distribution firms, pushing Mercury Group’s market share from 55 percent to at least 70 percent.

“The concentration and optimization of the tobacco distributing business went on market conditions and according to the law,” he added.

Strategic donations

In 2003 Kesaev became honorary president of Monolit, a nationwide fund for former security services officers.

Why does a Russian tobacco businessman spend millions of dollars to help retired FSB officials and military officers?

“First of all you must remember that tobacco companies spend money on charities all around the world,” said Elena Panfilova, the transparency activist. “They are not idiots and understand what kind of products they sell. If necessary they can always say that they help children, orphans and disabled persons. Security service funds are popular because many Russian businessmen come from those same services.”

Vladislav Petrov, a retired FSB colonel, is executive director of Monolit. He also heads the board of directors of OJSC Turboholod, an energy industry equipment supplier. That company, according to its own documents, is 57-percent owned by the firm LLC Consensus-R, which is owned by Kesaev.

Petrov heads the board of directors of another Mercury subsidiary, Frunze Sanatorium. Another director of that company is Viktor Patrushev, whose bother Nikolay in 1999 replaced Vladimir Putin as FSB director. Viktor Patrushev is also listed as an advisor to the Russian Border Guard Service.

Another former security official listed as an adviser to Mercury Group is Vladimir Anisimov. Anisimov drew criticism after his participation in the operation that ended in the deaths of hundreds of hostages in the Beslan School crisis in 2004. After he left the FSB, Russian media accounts said Anisimov and other officials were allegedly subjects in a probe of a network that was suspected of smuggling clothes from China. That investigation was later dropped.

Alexey Kim, spokesman in Russia for Philip Morris’ sales division, would not comment on Mercury’s connections with security service and state agencies. Megapolis “satisfies our requirements for distribution and logistics,” Kim said.

Mercury spokesman Shiryaev acknowledged that many retired officers work for Mercury Group, but said they were not hired out of charity.

“Retired officers have very good potential, they are the most organized and disciplined part of our society,” Shiryaev said. These former security service officials “don’t play the role of the group’s guards. Our business is well protected in the framework of legislation.”

Odd time for donations

Shiryaev told ICIJ that Monolit’s mission is economic, medical, social and cultural support of retired officers and their families.

Despite the good intentions, Kesaev’s donations to Monolit came at awkward financial times for his companies.

A 2007 company financial statement said that directors of Mercury subsidiary OJSC V.A. Degtyarev Works — which specializes in Kalashnikov automatic rifles, anti-tank missiles and portable air-defense systems — voted not to pay dividends to shareholders because of a loss of $4 million in 2006. During that same meeting directors approved a gift of $6 million to Monolit.

The same happened in 2009 with OJSC Sovinteravtoservice, another Mercury subsidiary and one of Russia’s largest transport companies. A financial report said the company did not pay dividends in 2008, the same year more than $1 million was donated to Monolit.

Shiryaev told ICIJ that Mercury Group’s donations to Monolit hurt no outside interest because the charitable fund’s major support comes from one source, controlled by Kesaev.

By 2009, Monolit assets stood at $8 million, according to the Scrin business tracking firm. Monolit was by then so active with the FSB that it underwrote the purchase of two apartments used as homes for agency personnel.

Monolit is not the first security fund Kesaev has been active with. According to a Russian commercial registry, Kesaev was among the founders of the National Noncommercial Fund for the Support of Law Enforcement in St. Petersburg. Another founder of this fund was Valeriy Sokolov, a retired FSB colonel and member of an influential Russian family. His son is an adviser to the Russian Security Council, while his wife works for Vladimir Putin’s Community Liaison Office.

Shiryaev said Kesaev left the fund in 2003, before he turned his charitable attention to Monolit.

The military connection

Mercury Group’s relationships inside the Russian federal government go beyond the FSB. The company is a partner in the arms business with former high-ranking officials in the Ministry of Defense.

Sergey Khetagurov chairs the board of Mercury Group subsidiary and military equipment manufacturer, OJSC V.A. Degtyarev Works. Khetagurov was once prime minister of the republic of North Ossetia, and then was deputy minister for civil defense and emergencies and head of the migration service. After his public service, Khetagurov joined Kesaev’s Mercury Group.

Another military veteran, Nikolay Svertilov, is a board member at OJSC V.A. Degtyarev Works — which sells military equipment in Africa, Asia and the Middle East through the Russian government’s military goods export agency. According to a 2010 company report, Svertilov once headed Russia’s Main Missile and Artillery Directorate of the Ministry of Defense.

According to the federal register of Russian government contracts, Kesaev’s OJSC V.A. Degtyarev Works booked 97 deals from 2007 to 2011 — worth more than $10 million — with Russia’s Ministry of Defense, the Ministry of the Interior and the federal prison guard service.

In Russia, said government reform activist Elena Panfilova, the kind of connections Kesaev has can make all the difference in the business world.

“When we speak about transparency of business, we forget the main principle: The main goal of business is to earn money,” Panfilova said. “In this sense if a distributor is able to protect you [from government interference and competitors] it is a perfect business strategy. Everything else is just details.”

Roman Anin is an investigative reporter for the Moscow-based weekly, Novaya Gazeta. He authored the International Consortium of Investigative Journalists’ look at Russia’s troubled tobacco-control record in November, 2010. Inga Springe, of Latvia, contributed to this report. She is a visiting journalist with ICIJ and a Humphrey Fellow at the University of Maryland’s Philip Merrill College of Journalism.