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Original Letter of concern

Re: Defense Enterprise Fund by M. Maly

July 15, 1999

PRIVATE AND CONFIDENTIAL

Matthew Maly (http://www.matthew-maly.ru/) tel. in Kiev, Ukraine (044) 234-3858 (home) 243-7300, (office) July 15, 1999

Mr. Bill Taylor Room 4419, Department of State Washington, DC 20520 Fax. (202) 647-2636

Dear Mr. Taylor:

This letter is identical to the one I sent on July 2nd, 1999 to Ambassador Morningstar at the above address. On the advice of your office I am faxing this letter to your attention as I understand that now the subject I am about to discuss, the Defense Enterprise Fund, falls under your jurisdiction.

I have been employed by the Defense Enterprise Fund ("DEF") and now by its management company, Global Partner Ventures ("GPV" or "the Company") for the last three years, and I would like to direct your attention to a catastrophic situation with the DEF's investments. I estimate that virtually all DEF's investments are in deep trouble, and some of them are now worthless. I have formed an opinion that DEF's current troubles could be, to a very large extent, attributed to serious wrongdoing committed by DEF/GPV's senior management, and primarily by GPV's Head of CIS Operations, Richard J. Nordin, Jr. ("Nordin"). Moreover, DEF/GPV's senior management may have violated US law.

As you probably know, DEF's investments are currently managed by GPV, a private company that, to the best of my knowledge, is owned by DEF's President (John Nowell), Senior Vice President (Richard Nordin), and the Chairman of DEF's Board (Randolph Reynolds), so that DEF's senior management and that of GPV consists of the same people. It appears that the current DEF problems are, to a large extent, caused by a conflict of interests between DEF and GPV.

While I have good reasons to believe that all DEF's projects are in trouble, and that, no matter what project you choose, you will find a pattern of gross violations on the part of DEF/GPV senior management, I will direct your attention only to three DEF projects, the projects where I am most certain of my allegations, and at the same time the projects that offer the most serious and glaring examples of DEF/GPV senior management's failure to perform. I am sure that DEF/GPV's own internal records the claims that I made in the following table:

 

Name of Project Investment made ($US million) Potential loss as of today Comments
MZA 7.5 7.5 Lack of project due diligence, transfer of around $5M to a bankrupt French company, glaring failure to evaluate technology, failure to listen to an advice of an expert. Duty to perform due diligence essentially transferred to a potential partner, EBRD, in hope that EBRD would invest in GPV. Unsecured personal loan of $50K to Russian partner later reportedly disguised as "consulting fee".
MPS-Telecom 9 9 This is a project requiring $200 million to complete, and, as DEF had an obligation to help raise this money and failed to do so, the deal is in trouble. Management shuffle in the DEF deal team caused lack of oversight. Up to $500K reportedly paid to a Russian consultant, a former high ranking government official.
Ramec 6 3 Russian partner reportedly misappropriating $3 million to open a restaurant.

Below, I will give you a list of what Nordin did or did not do to achieve such a record. But before that, I would like to propose to you my theory as to why Nordin ended up with this record.

Please note that I say "Nordin" because I have no knowledge whatsoever with respect to any action by Mr. Nowell or Mr. Reynolds. The only thing that I could say about Nowell and Reynolds is that it was their duty to know what Nordin was doing. If indeed, Nowell and Reynolds are Nordin's partners in GPV, then this becomes yet another aspect of their potential involvement with this matter.

To understand Nordin's alleged business strategy, we need to recall that his strategy was taking shape at the time when the Russian stock market boomed and Russia seemed to be destined for huge growth. Nordin obviously thought that this was the time to invest, but all he had was DEF money. The solution was clear: he needed to raise a large private fund, as everybody else was doing at the time. But Nordin and Nowell were former Army officers and had no track record as venture capital investors. Of course, Nordin could do exactly as he was required by the terms of his DEF employment: invest the money the best way he could. But in this case, he would have had to wait five to seven years for the returns on his investment to come in, and he would miss the boom. Thus, the solution was to invest the DEF money as fast as possible, to gain the track record necessary to raise a private venture capital fund while the Russian boom was still on. It should be emphasized that all of the above was publicly stated by Nordin on many occasions and "invest the DEF money fast" was a stated DEF policy. It was also publicly known from the very beginning that the goal of the management was to raise a large private fund. This could have been a workable strategy had the Russian boom continued, but it turned into a bust.

First, Nordin, Nowell, and Reynolds were obligated to have the best interests of DEF in mind. Yet, to the best of my knowledge, these three individuals are partners in GPV, their private company. Now, GPV was a sure bet to receive the outside management contract to manage DEF. But for that DEF had to be "fully invested". Thus, it was in the best interest of GPV to have DEF's money fully invested, while it was in the best interest of DEF to have its money wisely and prudently invested.

Second, DEF money was supposed to be invested with the former Soviet military enterprises and bring profit to the US Treasury. Yet, this money was used primarily to create for Nordin an image of a "fast investor", and to serve as nothing more than a stepping stone to Nordin's own private fund.

If Nordin's private fund, GPV, were able to raise the money, it could conceivably have helped the failing DEF projects with GPV-generated funds and resources. But GPV was not able to raise new money and add necessary management resources to salvage its hastily made DEF investments, and the DEF investments started to collapse.

It appears that there has been a serious conflict of interests as Nordin used DEF money to further his interests as a partner in GPV to the detriment to the owner of DEF -- the Congress of the United States.

I believe that DEF own internal records will provide ample evidence to show that Nordin, either deliberately or negligently, established a pattern of investment behavior that resulted in the inferior performance of investments Nordin made on behalf of the DEF. This behavior amounted to:

 

  1. Failure to do sufficient due diligence (MZA)
  2. Failure to exercise proper control over invested funds (Ramec, MZA)
  3. Failure to heed sound business advice (MZA)
  4. Provision of a private loan to a Russian partner, later disguised as a consulting fee (MZA)
  5. Failure to have a staff lawyer, preparation of legal documents with insufficient legal advice
  6. Failure to hire competent investment staff
  7. Improper use of DEF funds for housing expenses
  8. Failure to properly supervise projects and make decisions on time.

a. Failure to do sufficient due diligence

In MZA project, Nordin transferred about $5 million to a bankrupt French company, Valme, though its financial position could have been easily ascertained. To the best of my knowledge, this money was lost.

Also in MZA project, DEF failed to check the claims Valme and/or EBRD made about Valme's technological know-how. Moreover, at the earliest stage of the project, Nordin disregarded an expert's opinion that stated that the project was not feasible. As a result, DEF invested more than $7 million in total into a project that indeed turned out to be unfeasible exactly in a manner that the expert predicted. DEF simply trusted EBRD and Valme in hope that EBRD would invest in GPV. Thus, DEF money was used (and lost) because Nordin wanted to advance the goals of GPV.

b. Failure to exercise proper control over invested funds

Nordin transferred $3 million to his failing computer assembly project, Ramec, his only project in St. Petersburg. Yet, it took Nordin a long time to discover (even though at the time Nordin employed five people in his St.Petersburg office, and had several well qualified Russian accountants on his St. Petersburg and Moscow payroll), that his Russian partner in Ramec used these $3 million to open a restaurant.

c. Failure to heed sound business advice

In the MZA project, a project to obtain gold and other precious metals from electronic scrap, Nordin has obtained a sharply negative assessment of an expert. Yet, Nordin invested in the project anyway, only to find out that that the expert's assessment was right. It is reasonable to assume that Nordin may have deliberately failed to inform the Board of the expert's sharply negative assessment.

In another project, Nordin reportedly gave an Israeli businessman, Mr. Vladimir Furman, about $250 thousand, making him a partner on a project, and Furman reportedly transferred this money to Israel, so that the money is probably lost. What's more, Furman is reportedly suing DEF for damages. Yet, I had met Furman back in 1985, and reported to Nordin that Furman is likely to be an extremely unreliable partner. Again, Nordin did not simply fail to do due diligence on Furman: he disregarded and might have concealed from the Board adverse information about Furman that was known to him.

d. Excessive willingness to make private loans to Russian partners

Granted, the potential Russian partners come to the DEF without financial resources of their own, but Nordin showed lack of caution in his willingness to give them unsecured personal loans, reportedly, up to $50K, thus putting DEF in a position of dependency vis-a-vis its Russian partners. The loan documents reportedly contained no realistic repayment terms, severely complicating DEF's relationship with its Russian partners.

To the best of my knowledge, a personal loan was given to Mr. Guzhavin (MZA project, reportedly, $50K). When it became clear that Guzhavin would not be able to return the money, a post-dated consulting agreement was reportedly prepared to cover the DEF's expenditure. As Guzhavin reportedly did not do any consulting, this loan turned out to have been a gift. Note that later on, when Guzhavin apparently was no longer involved with the DEF-financed project, charges of tax evasion, currency law violations, and currency smuggling, were, according to a DEF internal document, filed against him.

A personal loan was reportedly also given to a principal Russian partner in Sukhoy-Nafta Project, Mr. Yuri Dzneladze.

Also, a DEF Russian partner on two projects is Mr. Yevgeny Kamnev. Nordin rented an apartment from him for $100K a year. It might be argued that this complicated the relationship between partners.

Here again it is worth reminding that these are US Government funds.

e. Failure to have a staff lawyer, preparation of legal documents with insufficient legal advice

DEF's legal advice was originally provided by a firm Steptoe and Johnson, but as a Steptoe's partner sits on DEF's Board of Directors, Nordin discontinued this relationship. Since then, Nordin, who has a graduate degree in Russian Studies and is a CFA, largely became his own lawyer. He did occasionally involve an outside lawyer, Mr. Michael Mopps of Squire Sanders & Dempsey, but largely thought himself capable of doing without a lawyer. Nordin also occasionally used two Russian lawyers introduced to him by me.

It should also be noted that DEF/GPV never instituted a good filing system for its legal documents, and may have lost or misplaced some original documents, such as signed protocols.

f. Failure to hire competent investment staff

Russia and the other countries of the CIS offers one of the toughest and least structured business environments in the world, and that means that employees of a western investment fund operating in the CIS must be very competent professionals. I am not in a position to professionally evaluate the investment staff people that Nordin hired, but the burden of proof is on Nordin, and Nordin would find it very hard to defend the performance of his hires Mr. Michael Aven, Ms. Elizabeth Ames, and Mr. Dennis Montz, all of whom have now been fired. And this is not three names out of a hundred: this is three out of six.

g. Improper use of DEF funds for housing expenses

Nordin has a housing allowance that reportedly is $150K per year. He reportedly took this allowance for three years in advance and bought himself an apartment in Moscow for $400K. Only then did Nordin discover that the apartment needs up to $400K worth of repairs, which he reportedly also borrowed from DEF.

Please note that all the Russian employees of the Fund were recently given Impending Termination Notices that Nordin explained by the difficult money situation at DEF/GPV. I have not, as of the date of this letter, received any indication concerning my own potential dismissal, but livelihoods of twenty Russian employees are being jeopardized to repair Nordin's apartment.

h. Failure to properly supervise projects and make decisions on time

Nordin consistently simply failed to participate in the decision making process, even though he carefully structured the Company in a way that would make him the only decision-maker. As a result, the Company was often in a state of paralysis. As to competent professionals by his side, Nordin tended to purge them. The only two people who left the Company voluntarily (and very soon after being hired) were its Financial Controllers, Mr. James Walsh and Ms. Natalia Moudrina.

* * *

I'd like to end by saying that it was very hard for me to write this letter. I am not a "professional whistleblower" nor have I ever sued anyone. As a Russian-born US citizen, who spent fifteen years studying Russian political system, I care deeply about DEF's mission. I waited for a long time, hoping that Nordin's business practices would get better. Instead, they were only getting worse, and now the very existence of DEF is in danger.

Respectfully,

Matthew Maly (http://www.matthew-maly.ru/)

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