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Russia is still building pyramids

C Shutterstock-Gajus crop.jpgRussians regularly lose their savings in the pyramid schemes flourishing throughout the country. And the government is doing – can do – nothing about them.

 

August 1994 was marked in Russia by the fall of the massive MMM pyramid scheme. The number of people who lost money in the scheme, which separated the Russian public from their savings, with promises of fabulous interest rates (it is impossible to give an exact figure as the company’s ‘shares’ doubled in value every fortnight) is put by various sources at between 5m and 15m. The ‘Union of MMM Shareholders’ estimates that they lost a total of £50 billion; and this pyramid was followed by many others that took three billion roubles (£37m) out of Russians’ pockets in the same decade. One would have thought that they would have learned their lesson. But no.

180% annual interest

On 17 September 2014, panic spread through the Russian internet: the offices of the large Russinvest microfinance company, with branches in 33 cities, all shut down within an hour.

‘My family had several accounts there, adding up to nearly 2m roubles (£25,000),’ says Yelena Bystrova, one of the company’s depositors. ‘We were promised a 15% per month return, which comes out at 180% a year. We had borrowed the money in the first place, thinking we would buy a flat with the first year’s interest, and now we don’t know what to do. My father is threatening to hang himself.’

When asked whether the 180% interest rate didn’t seem unrealistic, Yelena says she doesn’t think of herself as a financially literate person: she was just tempted by the offer and decided to take it up. According to official Ministry of Internal Affairs figures, that makes her one of 19,634 people to fall for the scam. Some lost a few thousand roubles when Russinvest closed down, others several million, with a total figure of five billion roubles (£61m).

Interestingly, just before it disappeared, Russinvest ran a big PR campaign in the media. The CEO of one of Kirov’s largest papers, with a circulation of 167,000, even wrote a long piece about the pleasure he had had working with the company.

Kirill Loginov, who worked for Russinvest, told me what happened on 17 September. ‘Olga Dallakyan, our finance director, turned up at the office. She removed every kopeck we had there, plus our laptops, and said, “Go home, we’ve closed down.” Then she got in her car and drove off. We didn’t even get our employment record books back.’ Loginov also said that his office colleagues had put money into the company, and collectively lost 1.5m roubles (£18,000).

The police are now investigating Russinvest’s sudden closure; and its CEO Anvar Navuillin was supposedly arrested in Saratov, but then it turned out that the arrested man was just a front – a homeless person who several years ago allowed Navuillin to use his passport details for 5000 roubles (£60). The police are not optimistic about their chances of finding him or returning depositors’ cash, which they believe has already been spirited out of Russia.

One of many

Russinvest is only one example out of many. The Interinvest microfinance company closed down in May this year, after promising depositors 10% interest per month; and its 25-year-old owner Stanislav Lapshov allegedly ran off with 15.5m roubles belonging to more than 200 people. He is now wanted for fraud.

‘It is legally impossible to tell a fraudulent microfinance company from a bona fide one.’

And on 4 June the offices of two other firms operating in six cities, which had been advertising interest rates of 5% paid out every ten days, also closed for business, along with their guarantor company. No one knows how many people lost their money, but according to the police, 13m roubles (£160,000) disappeared in the Perm region alone.

All in all, according to the register of microfinancing institutions, 670 such operations of this kind closed between 2011 and 2014 because of illegal business practices. ‘It is legally impossible to tell a fraudulent microfinance company from a bona fide one,’ says lawyer Aleksei Svetlovsky. ‘It’s obvious to everyone that you can’t pay annual interest of 180%, but there is nothing in the law to limit interest rates. So the police can only operate retrospectively, charging criminals with fraud after the public’s money has already been stolen.’

And then they do it again...

On 10 January 2011, Sergei Mavrodi, the man who had set up the MMM pyramid scheme that collapsed in 1994, announced a new one: MMM-2011. It works on the same principle as the old scheme: you put in some cash and a month later you can withdraw it with interest. At present Mavrodi is promising a monthly return of 50%.

Sergei Mavrodi, founder of MMM in court in 2012 for failing to pay a 1000-rouble fine. Sergei Mavrodi, founder of MMM in court in 2012 for failing to pay a 1000-rouble fine. (c) RIA Novosti/Andrei Stenin

Unlike in 1992, MMM-2011 has been presented as a financial pyramid from the start. The project’s site even contains the warning: ‘This is a pyramid. If you join it, you can lose all your money at any moment.’ ‘This way we can’t be accused of fraud,’ Mavrodi’s associate Andrei Perminov tells me. ‘We don’t promise anyone anything and tell them honestly that their cash might disappear at any time.’

The interesting thing about MMM-2011 is that as a company it doesn’t exist. When Mavrodi set up this new pyramid he didn’t register it as either a legal entity or a voluntary organisation, calling it instead a social network. Its structure is indeed reminiscent of a social network: it has no central administration, only members at a number of levels: those who recruit ten new members, those who recruit a hundred and those who recruit a thousand. There is also no strict hierarchy: anyone can invest whatever they like and withdraw it with interest when they want. On the new scheme’s site it is its most active members who decide the interest rate for the next month. Mavrodi himself is described as a mere consultant, and he denies taking any profits out of the scheme.

‘There’s no law against pyramids – in fact they don’t even exist as a legal concept.’

‘It’s all perfectly legal,’ says Perminov. ‘It doesn’t break a single law. People simply voluntarily exchange their own money with others, without any guarantees or promises. What could be illegal about that? That’s why it has been in existence since 2011, and nobody can close it down. What law could it break? So it’s a financial pyramid – so what? There’s no law against pyramids – in fact they don’t even exist as a legal concept.’

He is right. In August 2013, Russia’s Ministry of Finance drafted an amendment to the law on fraud, which would make ‘the organisation of a financial pyramid a crime punishable by up to ten years in prison and a fine of up to 1m roubles. The draft was presented to the government for scrutiny but the Cabinet sent it back for revision, and nothing has been heard of it since.

In May 2012, however, the police in a district of the Novosibirsk Region did charge Sergei Mavrodi with aiding and abetting an illegal business. A local member of the MMM-2011 scheme claimed that Mavrodi had offered him financial advice and money to use for advertising and information materials. However, the case was closed by the regional police authority, which couldn’t find anything illegal in Mavrodi’s actions. It’s worth mentioning, though, that in 2012 he set up yet another structure – MMM-2012, which exists in parallel with MMM-2011 and differs from it only in the fact that depositors’ money is held not in roubles but in the imaginary currency of ‘mavros’ (1 mavro is coincidently equal to 1 rouble). The investor hierarchy has also disappeared, and the scheme is now presented not as a social network but as a friendly society.

There are no official estimates of the number of investors in each of these two schemes, but our information suggests that MMM-2011 has about 120,000 members, and MMM-2012 about 70,000.

Direct marketing Russian style

Another common means of parting Russians from their money is direct marketing (MLM). MLM companies come in two distinct types: the first (bona fide) type actually sells goods; the second merely attracts new members. The two types can also be distinguished by their geographic location: most trading firms are based in Europe or the USA (Avon, Oriflamme etc.), whereas the other kind are generally in Asia.

The most successful companies of this type on the Russian market are Tiens Group Corporation and Quest International (Qnet), whose annual turnovers are £2.9 billion and £1.65 billion respectively. Formally, both these companies sell own-brand goods, but in fact their employees’ profits do not come from this source. Earning money in Qnet works in the following way:

1) You buy at least 60,000 roubles worth of the company’s products (this is called ‘joining the business’)

2) You bring two more people into the company (they must buy goods to the same amount)

3) Those people then introduce two more people each

This pyramid can grow to infinity. For each two people introduced, the person who has introduced them receives $250 (£160), and particularly keen members can theoretically earn a decent amount of capital. But in fact it doesn’t work that way.

Only 14% of those in the pyramid can get their 60,000 roubles back, and even fewer can make a profit.

The first weakness is that at any stage you might not find two friends prepared to buy goods for what is, for the average Russian, a lot of money. In this case the growth of the pyramid stalls and the flow of money ‘upwards’ drops, according to the number of links at the ‘stalled’ level. If a whole ‘layer’ fails, as it usually does on the second or third level, then the whole scheme collapses. As a result, a minimum of seven people, not only do not make any money, but lose what money they had; and the company has hundreds, if not thousands, of such ‘defunct’ pyramids – that’s how Qnet’s bosses make their money.

The second problem is the structure of the business itself. As with any pyramid, it is the last people to join – the levels with the most members – that receive the least benefit, or indeed none at all. In some pyramids, people on the second lowest level may still make some money, but in Qnet even those on the fourth level from the bottom can only just break even, and begin to make a little money. A simple calculation reveals that only 14% of those in the pyramid can get their 60,000 roubles back, and even fewer can make a profit.

The psychology of pyramids

‘My school friend Yulia invited me to join Qnet two years ago,’ says Kirill Privalov, a languages student at Moscow State Pedagogical University. ‘She phoned me and said that she had found a prestigious job and needed an assistant, although she wouldn’t tell me any more about it on the phone. I turned up the next day for an interview at the address she gave me. Yulia met me and took me into an office, where another young man of about 30 appeared; he then interviewed me. I realised straight away that he was a psychologist, because he was using neuro-linguistic programming methods on me – constantly telling me how successful and rich I would be and gesticulating in such a way that I couldn’t take my eyes off his hands. At a certain point in all this I began to trust him and it was only after I emerged onto the street that I realised that he had almost pulled me into a pyramid.’

Kirill’s friend Yulia, he told me, had been involved in Qnet for a year. She had stopped going to classes, had been thrown out of university, and more or less lost contact with her friends. But the main thing was that, despite going into debt to pay for Qnet seminars, she had only managed to recruit one other person, so had seen no return on her ‘investment.’

The second Asian MLM company, Tiens Group Corp., works in the same way, and has, according to the company’s own figures, over 200,000 members in Russia (Qnet has around 40,000). ‘There cannot be any legal claims against these firms,’ says lawyer Aleksei Svetlovsky. ‘A number of former members of these pyramids have asked me for help, but the papers are all in order: according to the agreements between the company and individual members the money was used to buy its goods. Although the goods are usually of dubious quality – Tiens, for example, sells “medications that cure cancer in 98% of cases.” In fact, this stuff is probably not a cure for anything, otherwise it would be known about all over the world.’

Fertile soil

‘Unfortunately, Russia is pretty fertile soil for unscrupulous financial operations,’ adds Andrei. ‘In the first place, the very concept of a financial pyramid, let alone liability for creating such a thing, does not yet exist in Russian law. In the second, the state has no mechanism for a preventive strike against these conmen. You wouldn’t need to remove the assumption of innocence: you just have to establish a ceiling for interest on investments. Anyone can see that a promise of 180% per annum has to be a scam. But no one can do anything about it until the punters have already lost their cash.’

We teach our children about macro-economics; American children learn how to set up their own business.

Another possible approach to combating the swindlers would be to involve the education establishment. ‘In this country, economics is still not taught in every school,’ says teacher Dina Sabitova, ‘and that has an effect on the public’s financial literacy. And even those textbooks and learning modules we have don’t do their job. We spend our lives teaching our pupils about macro-economics: oil prices, the economic development of various countries and so on. Whereas in the USA, children are taught how to take out a bank loan; how to set up their own business – and how not to fall for conmen’s tricks. In other words, in America children learn practical, concrete things. And we need to do the same.’

Standfirst image: (c) Shutterstock/Gajus

About the author

Ivan Zhilin is a journalist for Novaya Gazeta.


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