By John Helmer in Moscow
In Robert Louis Stephenson’s version of the way English pirates used to issue shareholder summonses for asset distributions, the Black Spot was a ink-blot, spilled on the page of a bible, and delivered by a blind-man. You could hide from the delivery, but not from the consequences.
A second attack on the Mechel group by Prime Minister Vladimir Putin on Monday evening has increased the market perception that Igor Zyuzin, the controlling shareholder of the specialty steel and mining group, is facing a government-assisted breakup of his assets.
He may be alone in a cardiological clinic at the moment. But Mechel isn’t alone, as mid-level government officials have now been emboldened to press a campaign in favour of increasing their tax-take from ferrous and nonferrous metal exporters; and against tax optimization schemes used by the Russian non-ferrous metal exporters, such as the tolling used by United Company Rusal.
In remarks televised on a Moscow evening news broadcast, Putin added to his earlier charges against Mechel, this time referring to transfer pricing and tax evasion. Putin said: “I already mentioned at the meeting [on July 24] that one company was exporting its product at a fraction of the domestic market price. The domestic price was 4,100 rubles ($176), and they were selling it to themselves, across the border, for 1,100 rubles, and then sells the product for $323. It is a reduction in the tax basis inside the country. It’s not paying taxes, it’s creating a shortfall on the domestic market, which means an increase in the cost of metals production.”
Russian law treats a difference of 20% or more in the price of goods sold between the domestic and export branches of a company as unlawful transfer pricing. All Russian metals exporters have operated offshore trading schemes, which employ variants of the differenbtial pricing Putin described. Under pressure of their listing requirements in London or New York, the steel groups have consolidated their trading operations on to their main balance-sheets. But transfer pricing in steel, and tolling in aluminium, have continued.
Tolling is a scheme for the exchange of imported inputs to metal fabrication, such as alumina, at a fixed price, for aluminium that is exported. The smelters earn a fixed fee; the offshore trader earns the difference between the smelter fee and the market price of the metal — without paying tax in Russia. It is lawful if the importing companies are not connected to the smelter compaqnies and the exporters. But if they are all part of the same holding, the tolling scheme is at risk of tax claims by the government.
The Russian government’s tax-take from the metal exporters has been substantially below that for the oil companies, which are subject to a windfall profits tax. But as the government has decided to reduce taxes on oil companies, in order to create incentives to stimulate oilfield production, the revenue authorities propose to fill the gap on the revenue side of the budget by taxing the metals sector. Putin is therefore considering whether to implement a proposal, apparently endorsed by his Finance Ministry, to hit steel exports with an export of about 15%.
The market is also seeing a revival of proposals, long advocated by the Accounting Chamber — the government auditor headed by former prime minister Sergei Stepashin — to enforce the tax laws against tolling schemes. This week, Stepashin reportedly requested Putin’s deputy in charge of industry concessions, Igor Sechin, to consider an anti-tolling campaign. Stepashin’s small print means an attack on the owner of Rusal, Oleg Deripaska.
Stepashin’s spokesman told Mineweb that an analysis of tolling has recently been completed, and was reviewed by the Chamber presidium on July 18. The text of the Chamber’s public statement, issued yesterday, explicitly refers to Rusal as benefiting offshore through the difference between “the high price of realisation of products of processing for the foreign market and the low cost of services in the processing of the Russian enterprises [smelters] and was not subject to taxation in the Russian Federation.” The Chamber statement estimated the revenue value to Rusal at $2 billion.
The Chamber statement can be read at: http://www.ach.gov.ru/news/show/?2666 
In its IPO prospectus and F-1 registration statement, when Mechel listed in New York in October 2004, the company warned: “our independent registered public accounting firm reported material weaknesses in our internal control and we may not be able to remedy these material weaknesses or prevent future weaknesses. If we fail to maintain effective internal control, we may not be able to accurately report our financial results or prevent fraud.”
In addition, Mechel’s prospectus warned that Russian transfer pricing rules allow “wide scope for interpretation by Russian tax authorities…If such price adjustments are upheld by the Russian courts and implemented, our future financial results could be adversely affected. In addition we could face significant losses associated with the assessmented amount of prior tax under-paid and related interest and penalties.”
The Mechel filing can be read in full: http://www.mechel.com/media/for_investors/47827ACL.PDF 
At the time, in the autumn of 2004, the federal tax ministry had reported to the Prime Ministry that there was significant under-payment of taxes by Severstal, Novolipetsk, and Magnitogorosk Metallurgical Combine (MMK). No government action followed at the time. According to the Mechel prospectus, tax enforcement by the government may be “selective.”
This Monday, government officials below Putin revealed in their announcements that they were not aware of Putin’s intention to make a broad-front attack on Mechel. Arkady Dvorkovich, a government economist now working for President Dmitry Medvedev, said in a carefully scripted, if nervous presentation for the cameras: “A positive signal is that Mechel has been cooperating with the Federal Anti-Monopoly Service all these weeks, providing all the necessary information. We hope that these events will be a lesson for everybody, not just Mechel but every company, and we will act in the most civilized way.”
The head of the Federal Anti-Monopoly Service (FAS), Igor Artemyev, said in an interview for the same television broadcast that other metals companies could face price-fixing investigations. “The price situation in metals is out of control,” Artemyev said. “Mechel is not the only candidate for punishment over monopoly pricing.” The FAS — which has also been put in charge of foreign investment review of mining deals — could levy a penalty of up to 1% of annual revenue, if the charges against Mechel are sustained. For last year, Mechel has reported aggregate revenues of $6.7 billion. The mining division, including coal, iron-ore, nickel, and ferroalloys, reported revenues of $2.6 billion.
The prime minister’s spokesman, Dmitry Peskov, also tried for the second day running, to play down the market interpretation that Mechel is facing breakup. “Putin mentioned Mechel just as a flagrant example of violating the law,” Peskov said. “[His] real message for business was: We will create the most favorable environment for all of you, which you will be able to use provided that you don’t break the law. When investors understand the real meaning of Putin’s words, stock markets will cheer up.”
In fact, market speculation that the government’s tax branch is preparing a broad new attack on transfer pricing has hit the share prices and market caps of all the metals exporters, including nickel and copper giant, Norilsk Nickel. It fell 7.6% by the Moscow close on Monday. Unlisted Rusal, the country’s aluminium exporter, may also be affected, if the attack extends to tolling.
The General Prosecutor’s Investigative Committee issued confirmation of Putin’s earlier threat that it should open its files. The Committee said it is “examining Mechel’s activity in cooperation with the other law-enforcement and controlling agencies.We are now checking the situation around the company [to see] whether there are any criminally punishable actions in its work.”
After US trading overnight cut its share price by another 26%, Mechel’s market capitalization has now sunk from $24.4 billion in May to $8 billion; and this can be expected to continue falling as the Moscow market wakes up.
It is suspected that Zyuzin’s hospitalization last week, ahead of Putin’s first public attack, followed indications he understood as a takeover move, at a price he could not afford to refuse. As one Moscow broker characterized the situation at the end of Monday, “Zyuzin is now left with two choices — Siberia or London. As we understand now, the situation will not get better for the company.”
The prime candidates to benefit from Mechel’s improvement in affordability are the rival steelmakers with least coking coal of their own — Novolipetsk, with 0%, and MMK with 15%. MMK, owned by Victor Rashnikov, made a bid to merge with, and take over Mechel, in 2003. Subsequently, Mechel tried to add the state stake in MMK to its holding of 17%. With government help, Rashnikov defeated Zyuzin and Iorikh, and forced them to sell their MMK shares to himself; he also took the state stake.
In 2003, there was a violent conflict between Mechel and the Evraz group, now Russia’s largest steelmaker, over ownership of the Korshunovsky iron-ore mine. Mechel prevailed in that contest.
There is no love lost between the Russian metalmakers and miners. And so when Putin appears to be waving the Black Spot, all share in the apprehension that it will be delivered, sooner or later, to them. The pattern of foreign asset acquisition, which the major Russian metal groups have been demonstrating over the past year, especially in foreign lossmakers, may now appear, in retrospect, to be a hedge against Putin’s Black Spot in Russia.