Ukroboronprom. Schemes.  Numerous journalistic investigations into corruption risks within Ukraine’s Military Industry                   State Concern “Ukroboronprom” (henceforth UOP) have exposed the existence of numerous                     systemic problems which facilitate the ineffective use, and possible misappropriation, of State                       budgetary funds particularly, the funds of State-owned enterprises (SOE) belonging to UOP. 

This paper describes six basic schemes which indicate the possible involvement of                       unscrupulous high UOP officials as well as its enterprises. Each scheme appears designed to                           promote unlawful enrichment. The mechanics of each scheme are depicted by open-source                       information. The data presented in this research has already been studied and systematized by                           analysts of the Independent Defence Anti-Corruption Committee (hereinafter “NAKO”). What is                     novel about this report is that it contains several recommendations aimed at minimizing the                           corruption potential. 

This study will be useful to UOP’s high-level management, decision-makers within the security                         and defence sector, as well as think-tanks and NGOs dedicated to reforming the security and                             defence sector in line with Euro-Atlantic standards. NAKO invites governmental and                     non-governmental organisations to cooperate in this process of change-making. 

Scheme 1. Misappropriation of Surplus Assets 

Prior to the establishment of Ukroboronprom in December 2010, the Ministry of Defence used                           to manage most of Ukraine’s defence enterprises. Those enterprises mostly carried out repairs,                         and maintenance, of military equipment for the Armed Forces of Ukraine. Accordingly, a large                           number of the MoD’s non-operational equipment, spare parts and components were stockpiled                       in the warehouses of state enterprises. 

The commencement of military activity in the East of Ukraine, necessitated the simultaneous                         overhaul, repair and delivery of a large number of armaments and military equipment by the                             MoD. At the same time, the fact that plenty of spare parts for repairs were either no longer                                   produced or were produced in Russia became a serious challenge.  

Importantly, the MoD’s warehouses and surplus assets are sources able to supply such                         Soviet-made spare parts. And this is where the state enterprises’ corrupt personnel may take                           advantage of the situation. 

For example, the National anti-corruption bureau of Ukraine has opened a criminal proceeding,                         which is added to the Unified Register of Pre-Trial Investigations by №52016000000000063                       as of 02.03.2016 .  1

The proceeding materials refer to a state-owned enterprise (SOE) Kharkiv Armored Vehicle                       Plant signing a contract with Optymumspetsdetal Ltd on 28.10.2015. It contained an                       agreement on supplying 12 of r scopes at a total cost of UAH 12 526 800. 

1 http://bit.ly/2Ye13jl (Court’s decision, Proceeding №1-кс/760/10951/18) 

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As it was repeatedly noted in journalistic investigations, Optymumspetsdetal Ltd is not a                         component parts manufacturer and the company itself has signs of fictitiousness. According to                         NABU case file, tax invoices refer to receiving 5 of such range finding scopes from                             2

Intertechnology Ltd, which got them with a help of Guard Community Ltd and Build                           Community Ltd. Separately worth noting that the last two companies are not manufacturers of                           such equipment either.  

After examining the statement on Optymumspetsdetal’s transactions, it became clear that                     money received from Kharkiv Armored Vehicle Plant had been further transferred to the other                           companies, such as Grandi Plus Ltd, Inter Technology Ltd, Build Community Ltd, TIK Enerhiia                           Ltd, ST Middle Ltd, Sheriff Comfort Ltd, Molgrant Ltd, Brom Force Ltd, Interbuild Community                           Ltd, Global Trade Company Ltd, Acrotus-system Ltd, Interbuild Community Ltd and the others                        3

. 

As for today, MoD is conducting an audit within the enterprises with such surplus assets.                             Meeting of Interim investigative commission of the Verkhovna Rada of Ukraine for                       investigating the embezzlement within the Armed Forces of Ukraine over the period 2004-2017                         took place on March 14, 2019. During that meeting the representatives of MoD have reported                             on their findings regarding lack of state’s surplus assets stockpiled in Kharkiv Armored Vehicle                           Plant at a total cost of UAH 19,5 mln . Worth noting that such a cost does not reflect the real                                       4

market value of the lost assets - only a residual book value, which, inflation-adjusted, may be                               from 10 to 100 times lower its market value. 

At this point in time, the MoD is conducting the audits regarding embezzlement of surplus                             assets not only within Kharkiv Armored Vehicle Plant, but also within all the others                           state-owned enterprises. As of March 2019, the amount of shortfall is greater than UAH 45 mln                             . 5

Overall, according to the investigative documents, the scheme of surplus assets                     misappropriation looks the next way: 

2 http://bit.ly/2Ofbf6k (NABU Civil Oversight Council, “NABU Criminal proceeding on Ukroboronprom enterprises: details of the episodes and timeline of the investigation from 2016”, 14.03.2019) 3 http://bit.ly/2Ye13jl (Court’s decision, Proceeding №1-кс/760/10951/18) 4 http://bit.ly/2YdONiI (Meeting of Interim investigative commission of the Verkhovna Rada 14.03.2019) 5 http://bit.ly/2YdONiI (Meeting of Interim investigative commission of the Verkhovna Rada 14.03.2019) 

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The investigation is underway. 

NAKO recommends to:  

1.  2. Introduce operating procedures for MoD’s surplus assets while fulfilling the State                     

Defence Order contracts. 3. Finish the process of inventory accounting of surplus assets, take a re-assessment of                         

its residual value, introduce a computerized accounting system for MoD’s surplus                     assets. 

4. Sign contracts of safe custody between MoD and the UOP’s enterprises. 5. Ensure making an annual MoD asset inventory in the future and determine the                         

responsibility in case of its failure.  6. Conduct internal investigations (within MoD and UOP’s enterprises) if an annual asset                       

inventory fails and then bring the perpetrators to justice. 

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Scheme 2. An Export and an import  

Offshore conduit companies may be used in the course of export or import operations. Such                             schemes allows to set unreasonably high ultimate price of the contract and move the profit in                               the intruder’s favor. 

As an example, according to the documents, published by Serhii Leshchenko , People’s Deputy                         6

of Ukraine, a Serbian company Sloboda decided to buy Ukrainian-made blasting caps                       (manufacturer: Public Utility Enterprise (PEU) Shostka Treasury Factory "Impuls", a part of                       Ukroboronprom) 

PEU Shostka Treasury Factory “Impuls” is not a subject of economic entity and has no right to                                 export the defence production . Therefore, it delegates executing such export operations to                       7

State Enterprise ‘Ukrinmash’ 

Ukrinmash, for its part, sells the Impuls production to a Cyprus company PH Strategic Business                             Limited for EUR 94 980,30. 

PH Strategic Business Limited resells the blasting caps to an end-user - Serbian Sloboda - at a                                 cost of EUR 689 901. 

Therefore, almost EUR 600 000 could have be moved out through such scheme. 

For the facts stated above, NABU has commenced a criminal investigation (Unified Register of                           Pre-Trial Investigations, № 52018000000000385, 17.04.2018) . 8

The investigation is underway. 

The figure below shows a possible corruption scheme: 

 

6 http://bit.ly/2Hy0DyZ (Ukrayinska Pravda. Blogs. S. Leshchenko “Military contracts corruption - in front of Poroshenko and the whole country”, July 4, 2018) 7 Order of the Cabinet of Ministers of Ukraine №1228 “On providing economic entities the right of export and import military goods and goods containing information that constitutes state secrets ” as of July 12, 1999. 8 http://bit.ly/2Tj59TD (Court’s decision, Proceeding № 1-кс/760/12796/18)

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 Additional information: this scheme may be used in a reverse order as the special exporters make an overpriced                                   

purchase not directly from manufacturers, but from intermediary companies located in offshore                       areas. Media has already reported on the details of such a deal, whereby the overpay on four SUVs                                   to the intermediary stands at more than UAH 1 mln . 9

We are aware of the fact that sometimes the corrupt foreign governments or companies may                             demand to supply products through mediators while exporting from Ukraine (in case of them                           being a beneficial owners of the scheme), yet the practices of signing the deals with offshore                               companies creates corruption risks and significantly undermines the reputation of Ukrainian                     suppliers within international arms market. 

NAKO recommends to:  

1. Improve the mechanisms of marketing and price setting on the export products in order                           to maximize the earnings of manufacturers. 

2. Іntroducing internal and external control policies over the activities of the                     spetsexporter. Import and export operations must be controlled so as to minimize the                         risk of entering into contractual obligations with corrupt or dubious offshore                     companies. 

 

9 http://bit.ly/2upFrm5 (A. Dubynsky “How to “cut” a million out of defence budget”, 18.05.2017)

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Scheme 3. The Grey mport 

The Bihus.Info investigation puts a finger on another potential corruption scheme within                       supplies of components for SOE Ukrspetsexport . The matter is a procurement of altimeters,                         10

which were smuggled from Russia through offshore company, registered in the United Arab                         Emirates. 

According to materials which were published by the investigative journalists, the altimeters                       have been procured from an unknown Russian supplier through the company called Double                         Power FZE and registered in the UAE. Later on the documents have been forged in order to                                 change the commodity classification to a civilian helicopter (probably for the purpose of                         bypassing the UAE export control system) and then re-sold to supposed shell company in                           Ukraine - AN-Service Ltd. This company has then sold the altimeters to State-owned                         "Ukrspetsexport. That said, the cost of the equipment, according to the materials published by                           journalists, increased from USD 84 000 to USD 578 000. 

Worth noting that the Register of Pre-Trial Investigations has no record of such a case. 

This corruption scheme is shown in a figure below: 

 

 

We are aware that in the context of confrontation with Russia a need for components or                               technologies from aggressor-country may occur, yet it shall not be an excuse for building up                             corruption schemes based on smuggle. 

10 http://bit.ly/2CuRZNN (Nashi Hroshi. “ARMY! FRIENDS! MONEY! p.3 “Highs and kickbacks”, 04.03.2019) 

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The international practices show that such operations may be conducted by the governments                         of different countries, with the involvement of special and intelligence state authorities. 

Intelligence services of Ukraine have rights to procure and import means of weaponry, material and technical, technology-specific and the other means, as well as firearms,                       ammunition of both local and foreign production for the means of their own needs and also in                                 case of transfer and export it out of Ukraine in the order determined by the Cabinet of                                 Ministers of Ukraine . 11

NAKO recommends to:  

1. Oblige the Ukroboronprom enterprises to verify the suppliers. 2. Oblige the Ukroboronprom enterprises to check the production background and the                     

manufacturer’s certificate. 3. The government of Ukraine to consider a possibility of using the alternative sources of                           

obtaining Soviet pieces of weaponry and military equipment (for example the countries                       of Warsaw Pact that still use Soviet models of weaponry). 

4. Improving the appropriate special services of Ukraine in caseis a need to purchase                         components from an aggressor-country in order to provide the needs of defence of                         Ukraine. 

 

Scheme 4. Contraband 

Another scheme that could be used by the intruders is an illegal trafficing of defence goods                               and components across the border of Ukraine with a further legalization and re-selling of it to                               the defence enterprises. 

In particular, case files № 758/10298/15-к point a finger at the likelihood of such a scheme.                               12

The materials refer to Promelectronic Ltd selling Russian-made electronic components during                     2014-2015. The components were smuggled and then sold to the UOP’s enterprises. A total                           contact value makes up of UAH 40 mln. The revenue earned have been presumably moved out                               via supposed shell companies.  

The corruption scheme is shown in a figure below: 

11 art.15 Law of Ukraine “On Intelligence Bodies of Ukraine”.  12 http://bit.ly/2uhugMu (Court’s decision, Case № 758/10298/15-к) 

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Also the Bihus.Info investigation points a finger on the same scheme of reselling smuggled                           13

goods (Optymumspetsdetal Ltd), but there has been no court decision so far which could point                             out the resale of illegally obtained defence goods from Russia. However, the public statements                           made by General Prosecutor of Ukraine confirm the assumptions regarding smuggling the                       14

components for military equipment to Ukraine. 

NAKO recommends to: 

1.  2. Improve the procedure of verification of products origin and certificates from the                       

manufacturer by UOP enterprises. 3. The government of Ukraine to consider a possibility of using the alternative sources of                           

obtaining Soviet pieces of weaponry and military equipment (for example the countries                       of Warsaw Pact that still use Soviet models of weaponry). 

4.  

   

13 http://bit.ly/2Hwhe6x (Nashi Hroshi, “President’s friends steal on defence sector (secret correspondence, p.1-2)”, №257-258, 2019.02.25) 14 http://bit.ly/2ukukuT (ZIK, “Defence components smuggled from Russia: Lutsenko stated the ways have been cut”, 13.03.2019) 

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Scheme 5. Collusion between participants of the procurements and                 overpricing  

The Investigation Division of Ukraine in Lviv oblast investigates the case of misappropriation                         15

within SOE Lviv State Aircraft Repair Plant at a total cost of more than UAH 15,3 mln while                                   procuring an aircraft repairment.  

As the investigation progresses, it was revealed that the staff of Avia Max Ltd has created                               numerous structures under their supervision in Kyiv and Vinnytsia (Tech-Partner Ltd, Tanhazh                       Ltd, Falcon-Avia Ltd, Spetsaviaservice Ltd, Antey-Service Ltd, ServiceAvia Ltd) and colluded                     with the staff of State-owned aircraft enterprises (Mykolaiv Repair Plant "NARP", Chuhuiiv                       Repair Plant, Odesa Aviation Factory, Lviv State Aircraft Repair Plant, Kyiv Aircraft Repair Plant                           410). Together they have organized the shipment of aviation units and the components of                           decommissioned aircrafts under the guise of 1st category production . 16

Separately worth noting that Tanhazh Ltd, Tech-Partner Ltd, AviaMax Ltd, Falcon Avia Ltd and                           Spetsaviaservice Ltd may be connected to each other. Such connection is indicated by the fact                             that they have the same IP-addresses used during tender process . In addition, all of them                             17

show signs of fictitiousness and highly likely may be the conversion centers, which has been                             identified during the course ofof the investigation (criminal proceedings №757/40538/16-к,                   761/42734/16-к, 759/12503/15-к, 759/11125/15-к, 759/15238/15-к) . 18

The figure below demonstrates the potential connections between mentioned economic                   entities: 

Also, pre-trial investigation case-files refer to a significant overprice of purchased components.                       For example, in 2015 SOE LDRAZ has purchased from Tanhazh Ltd at a total cost of UAH 113                                   333, 36. Worth noting that the same year but in May the factory had purchased the same                                 detail from Tanhazh Ltd at a cost of UAH 14 166,67, and in August 2015 the Avia Max price                                     was UAH 14 165 . 19

15 http://bit.ly/2UOj3hZ (WestNews, “Defence plundering: what schemes feature Lviv Aircraft Plant”, 07.03.2019) 16 http://bit.ly/2Tj3Cgc (Court’s decision, case №127/4733/19) 17 http://bit.ly/2CvftSE (Court’s decision, Proceeding №1- кс/760/2766/18) 18 Criminal proceeding №52017000000000448, added to URPI on: 03.07.2017, 10:00:26 19 http://bit.ly/2CvftSE (Court’s decision, Proceeding №1- кс/760/2766/18) 

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Simultaneously, the product of the above said nomenclature has been procured by SOE LDRAZ                           from Unitech Ltd (the manufacturer) at a cost of UAH 1 335,59 per one . Therefore the price,                                 20

compared with the analogous one a year before, has been raised by almost 85 (!) times.  

Signing contracts with the supposed shell companies became possible as a result of lack of civil                               oversight over the open procurements by the UOP’s enterprises.   

Most of the UOP’s enterprises are not the contractors in the understanding of the Law of                               Ukraine “On public procurements”, hence they are not obliged to use ProZorro system for their                             own procurements. 

Instead the UOP’s enterprises use electronic trading platform for commercial procurements                     “Smarttender.biz”. All the procurements made through this platform are open, although as the                         tender ends, the results are “archived”, and thereby become become unavailable for public. 

Thus, while using the open sources it is impossible to establish the winning bidder and the                               ultimate price of procurement. It essentially narrows down the potentialities of civil oversight                         and creates significant corruption risks. 

NAKO recommends to:  

1. Obliging the UOP to openly procure (if it is not a state secret) using ProZorro system. A                                 letter from NAKO containing appropriate recommendations has been sent to the UOP’s                       high management on 11.02.2019  

2. Oblige the Ukroboronprom enterprises to verify the suppliers. 3. Oblige the Ukroboronprom enterprises to check the production background and the                     

manufacturer’s certificate. 

   

20 http://bit.ly/2CvftSE (Court’s decision, Proceeding №1- кс/760/2766/18)

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Scheme 6. Exporting Arms with a Conflict of Interest   On December 28, 2010 a Decree on the               Creation of the State Concern         Ukroboronprom was signed by the         ex-President of Ukraine, Viktor Yanukovych        21

. An article on corruption risks in the export                 of Ukrainian weaponry has been published           in less than a month since the UOP's               establishment . The specified materials       22

feature the first Director-General of the           UOP, Dmytro Salamatin. Only in 2019 the             Prosecutor General of Ukraine has served a             notice of suspicion to Salamatin regarding           his participation in Yanukovych's criminal         organization, misappropriation of funds in a           particularly large amount via power abuse           and also state treason in the interests of               Russia. A total amount of losses on his               failure to sign the contracts on supplying             weaponry and military equipment to         Republic of Iraq is estimated as USD 560               mln .  23

In NAKO’s opinion, one of the root causes               for corruption risks emergence in the area of               weaponry export/import (as for the UOP's           enterprises and the ones that are not a part                 of it) is in the conflict of interest in                 decision-making regarding export of defence goods and dual-use goods. The UOP is entitled                         with the regulatory functions that the other economic entities do not have. For example,                           regarding the approval of market outlets marketing with the UOP and the regulation of prices                             on defence production and dual-use goods . 24

It is worth noting that SOE Ukrspetsexport (the head of which was Salamatin in 2010-2011 )                             25

and the UOP used to have much more influence in policy formation in the area of export                                 control. In opposite to the Law of Ukraine “On State Control for International Transfer of                             Military and Dual-Use Goods” not only the fact of export/import licensing but also the details                             of agreement (a price, for example) depend on approval of the UOP. The norms which used to                                 create such conflict of interest, have been repealed only in August, 2018 . NAKO welcomes                           26

21 http://bit.ly/2JtyLhp (Cabinet of Ministers Decree №1221 “On creation of State Concern “Ukroboronprom” as of 29.12.2010) 22 http://bit.ly/2TOwL86 (Ukrayinska Pravda, M.Nayem. “Ukrspetsexport: establishing the hierarchy”, 20.01.2011) 23 http://bit.ly/2OjNKZQ (Radio Svoboda, “GPO has given a notice of suspicion to the ex-minister of defence of Yanukovych era, 14.01.2019) 24 Point 2, Cabinet of Ministers Decree №1228 “On providing economic entities the right of export and import military goods and goods containing information that constitutes state secrets” as of July 12, 1999 25 http://bit.ly/2Wf0rYY (Wikipedia, Ukrspetsexport) 26 Cabinet of Ministers Decree №805 “On Amendments to Cabinet of Ministers’ decrees as of May 8, 1998 № 838 and as of July 12, 1999 № 1228” as of August 29, 2018.

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such move of the government, however even as for today the UOP has an opportunity to                               intrude the pricing policy of Ukrainian exporters of military and dual-use goods. 27

NAKO recommends to: 

1. Completely exclude the UOP out of the process of decision-making regarding                     import/export of defence goods. The government must provide equal environment to                     every market player (both state-owned and private). 

1. Change the procedure of appointment of the UOP’s Director General and the directors                         of the UOP enterprises. Their election should be based on the results of open                           competitions conducted according to well-defined procedures and clear selection                 criteria. 

 

 

 

 

27 Point 2, Cabinet of Ministers Decree №1228 “On providing economic entities the right of export and import military goods and goods containing information that constitutes state secrets” as of July 12, 1999 

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