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Cracks in Russia’s Grand Plan

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TIMES STAFF WRITER

When a little-known investment fund financed by U.S. taxpayers bought a stake in the historic Lomonosov Porcelain Factory last year, it seemed a constructive way to help the recovery of Russia’s beleaguered economy.

Instead, it has proved to be the Americans’ undoing. Today, the factory that once made tea sets for the czars is a battleground where Western investors and Soviet-era managers fight over the shape of Russia’s economic future.

In a precedent-setting decision last month, a St. Petersburg court ruled that the factory was illegally privatized six years ago when workers were given shares in the company. The court declared that Lomonosov will be renationalized and that all of the firm’s shareholders will be stripped of their holdings.

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The ruling sent shivers through the boardrooms of foreign investors who have spent billions of dollars acquiring shares in former Soviet enterprises privatized over the past nine years.

“The issue was clearly that management did not want Westerners to control their company,” said Alistair Stobie, vice president of the USA-Russia Investment Fund, which, along with investment house Kohlberg Kravis Roberts & Co., acquired slightly more than 50% of the factory. “They see it as a hostile takeover.”

Although the government has taken over a handful of other privatized companies because the owners did not fulfill their obligations, the Lomonosov ruling marks the first time a court has renationalized a company whose new majority owners had acquired their shares on the secondary market in compliance with the law.

The saga of the Lomonosov ownership battle illustrates how Russia’s privatization program--originally sold to the public as a fair way of redistributing the country’s Communist-era wealth--has helped keep control of the economy in the hands of a favored few. It also demonstrates that Russia, while anxious to have foreigners’ money, has no intention of allowing outsiders to exercise authority over former state enterprises.

Privatization of the former Soviet empire’s vast holdings is the foundation of Russia’s attempt to create a market economy; it is also at the heart of the corruption that has plagued Russia in the 1990s.

With the collapse of the Soviet Union, well-connected businesspeople and former Soviet officials acquired control of major industrial enterprises through rigged auctions and insider deals. Airlines, oil companies and mining concerns were divided among Kremlin favorites who bought companies worth billions of dollars for a small percentage of their value.

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Unlike the porcelain factory sale, these privatization deals have not been challenged by the State Property Ministry.

For foreigners, the St. Petersburg case also highlights Russia’s inability to establish a fair and unbiased legal system--an essential element of a democratic society that, among other things, would protect the rights of shareholders who invest in Russian companies.

The justice system is so warped that the court handed back the porcelain factory to the same group of managers that it ruled had illegally privatized the company in the first place.

Former Official Warns of an Investor Exodus

If the court action stands, it will send yet another message to Western investors that Russia is not the place to put their money.

Dmitri V. Vasiliev, who recently resigned as chairman of the Federal Securities Commission, warned in a letter to the State Property Ministry that the Lomonosov case “creates an extremely dangerous precedent and will be a real shock to investors, including foreign investors, and can provoke their mass exodus from Russia.”

Two major foreign companies are already waging fights to hang on to acquisitions made in Russia before the country’s 1998 currency devaluation and debt default. London-based BP Amoco is attempting to preserve its $517-million investment in Sidanko, an oil company that has been declared bankrupt. Similarly, a group headed by American businessman Kenneth B. Dart is trying to prevent oil giant Yukos from issuing shares that would dilute its 10% interest in Yukos subsidiaries.

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The USA-Russia fund is searching for a compromise with the State Property Ministry that would preserve the organization’s $4.25-million stake in Lomonosov, but the government agency is hanging tough: It secured a separate court ruling that banned the investors from convening a shareholder meeting as planned early this month.

To many Russians, the porcelain factory is a cultural treasure that should never have been allowed to fall into Western hands. Much loved in Russia, Lomonosov’s hand-painted items are also popular abroad. The factory’s museum--owned by the government but closed to the public--is packed with priceless exhibits.

“The factory is an object of national heritage,” said Lomonosov Director Yevgeny Y. Barkov. “And our point is, if it’s an object of national heritage, then it should be owned by the state.”

In fact, the porcelain plant has been subsidized by the state for nearly all of its existence. Never in its long history has it made a profit--at least officially.

The Imperial Porcelain Factory was founded by Empress Elizabeth, daughter of Peter the Great, in 1744--even before the start of the Industrial Revolution in England. Its function was to make dinnerware, tea sets and objects of fine art for the czars and their families.

The factory on the Neva River became known throughout the world for the high quality of its workmanship and design. During the reign of Catherine the Great, one of its biggest product lines featured porcelain images of the empress.

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In 1917, the factory was nationalized by the Communists, who used it in much the same way the czars had. Renamed the Lomonosov Porcelain Factory, it became famous for its socialist art and high-quality propaganda. Soviet leader Leonid I. Brezhnev loved to give visitors likenesses of himself made by Lomonosov.

In 1990, as perestroika spread across the Soviet Union, the factory’s managers saw the opportunity to privatize the company; they entered into an agreement to lease the factory’s equipment, with the option to buy it later.

The factory’s labor collective acquired title to the company in 1993 but never paid for the equipment even though hyper-inflation had dramatically reduced the debt.

Ownership of the company was divided among current and retired employees; workers with longer tenure or more important posts received more shares. While top managers got no more than half a percent each, they retained control over the factory’s operations.

‘We Were Sitting on a Treasure Box’

Enter Sergei P. Voronkov, deputy chief equipment designer and chief critic of the factory’s management.

Voronkov knew there was a ready market for Lomonosov porcelain in the West, even as the plant was routinely having trouble paying salaries.

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Like other factories in Russia, it sometimes paid its workers with the products they made. The 50-year-old craftsman realized that something was seriously amiss when he received a tea set for his pay, took it to a flea market and sold it for three times its listed value. He began to allege that management was bartering and selling products, for a nominal return, to middlemen who then sold the porcelain abroad at Western prices. Revenues from these sales, he charged, were being diverted by the factory’s managers.

“We were literally sitting on a treasure box, but at the same time we had to live from hand to mouth because our meager wages were always delayed, sometimes for several months,” he said. “It was easier for them to do their shady trade when the plant was lying on its side and not attracting much attention.”

Voronkov began agitating among his fellow shareholders, urging them to exercise their rights and call a shareholder meeting. He wrote and distributed leaflets, but his co-workers remained passive.

“They are mostly nice and honest people,” he said, “but they have worked too long with porcelain and have become like soft pieces of obedient clay that the management can easily mold after their own fashion.”

Voronkov left Lomonosov in 1995. He says he quit; Lomonosov officials say he was fired.

“He is a guy who talks a lot and works little,” said Deputy Director Galina D. Agarkova.

Voronkov had trouble finding a job and offered to sell his 218 shares back to the company, but the company was not interested, he said.

Outside the factory, there was great interest in Lomonosov shares, but the company was protected by an unusual clause in the privatization agreement that permitted only existing owners to purchase shares.

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One Russian brokerage, operating under the name Rendezvous, had a plan to break into the market. All it needed was a disgruntled employee willing to give it one share as a present. In April 1998, Voronkov presented Rendezvous with the share it needed, making it a legal shareholder. Soon after, the firm bought his remaining shares.

For the first time, the door was open for outsiders to begin buying up the factory.

By the summer of 1998, Lomonosov was months behind in paying salaries, and the workers were worried. In August, when the government devalued the Russian currency, the ruble, and froze foreign debt payments, panic set in. Outside the factory, Rendezvous distributed leaflets offering to buy shares at 25 rubles apiece--the equivalent of about $2 at the time. Many workers began selling.

Rendezvous gave shares to other brokers and brought them in to join in the acquisition. Ultimately, nearly 70% of Lomonosov’s stock ended up in the hands of 10 obscure Russian companies registered in Cyprus and other offshore havens.

Some of those companies offered themselves for sale, circumventing the ban on outsiders buying into Lomonosov. Among those interested was the USA-Russia Investment Fund. Financed entirely by the U.S. government, the fund is charged with helping Russia by investing in medium-sized businesses and encouraging American investors to follow suit. So far, it has spent $120 million buying shares in Russian firms.

The Lomonosov factory--which is still capable of producing museum-quality pieces--looked like a perfect opportunity. With a ready market in the West, it seemed to be a business with great potential--and one worth saving.

The USA-Russia fund bought 25.45% of the company at a price of $31.45 a share, a huge profit for Rendezvous and its sister companies.

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Kohlberg Kravis Roberts, one of Wall Street’s biggest buyout specialists, matched the fund’s purchase with its own acquisition of 25.45% of the company. Together, the Americans held a majority stake in the factory. Another 32% of the company was acquired by a Dutch firm and an American businessman.

Barkov, a 42-year employee who took over as director in 1996, warily agreed to meet with representatives of his new co-owners last March. The USA-Russia fund promised to invest $2 million in the company, but Barkov was not impressed. He dismissed the offer as mere talk and barred the new majority partners from participating in managing the company.

Soon, the USA-Russia fund said it had received evidence that valuable trademarks and goods were being stolen from the factory. The fund filed a complaint with Russian prosecutors. Barkov angrily denies the allegations, which remain under investigation.

In response, factory management asked the State Property Ministry to overturn the original 1990 privatization agreement. The managers argued that their own takeover of the company was illegal because they had never paid the government for the leased equipment as promised.

The ministry agreed that the factory had been illegally privatized and took the case to a St. Petersburg arbitration court, which also agreed and ruled that the company should be nationalized a second time.

“It’s back to 1917, but this time it happened without demonstrations or red flags,” said Barkov, who will stay indefinitely as Lomonosov’s director.

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The factory’s 1,800 employees--most of them women who are paid less than $80 a month--are divided in their view of the ownership fight.

Workers who were worried about possible layoffs or longer hours under foreign management are relieved to be back under state control. Others recognize that a return to government ownership will mean little investment and little change in the way things are done. Some who loyally held on to their stock during the sell-off are angry that their shares also have been nationalized without their being compensated.

“They deprived me of my private property,” protested Marina A. Samkova, 37, a decorator at the factory for 14 years. “Foreign investors lost their thousands of shares, and I lose my 130 shares.”

The workers who came out ahead--at least in the short run--are those who sold their stake and aren’t facing the uncertainties of new ownership.

“I sold my shares, and my situation is not so bad,” said Yelena L. Donets, 29, a 10-year employee who received $500 and purchased a refrigerator. “If I had bought shares, I would be unhappy.”

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Sergei L. Loiko of The Times’ Moscow Bureau contributed to this report.

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