Central Europe Review: politics, society and culture in Central and Eastern Europe
Vol 2, No 2
17 January 2000

C O R R U P T I O N:
Stealing the Eastern Slovak Steelworks
Part II

Michael J Kopanic Jr

In the mid-1990s, the Eastern Slovak Ironworks Holding Company (VSŽ - Východné slovenské železiarne) was touted as one of the greatest success stories of Slovak privatization. In this week's installment, we continue tracing the history of how - under the corrupt mismanagement Alexander Rezeš, who purchased a controlling share of VSŽ at bargain prices - the company went from steel behemoth to debt-ridden debacle.

1998: A crisis unfolds

In March 1998, VSŽ Holding announced that its profits for 1997 fell by 50 percent to 595 million Sk (USD 16.9 million). Low steel prices, high interest rates on its debts, and unfavorable exchange rates hurt it. VSŽ buys its raw materials in dollars and sells them in Deutsche Marks, so currency fluctuations did and still do impact its profitability.

By the end of the summer 1998, it was already clear that the Slovak economy was experiencing a tumble. But no one knew how serious the roll would be until after the September parliamentary elections. The Slovak Democratic Coalition (SDK) won a resounding victory over Prime Minister Mečiar's coalition partners largely on account of the deteriorating economic situation. Charges of corruption no doubt influenced some voters, but Slovak citizens were clearly feeling the effects on their pocket books.

In February 1998, a new management team had taken control of VSŽ. Since the average age of the new managers was not even thirty years old, it came to be known as the "Kindermanagement." Alexander Rezeš' son Július, who was formerly just a member of the executive board, took over Ján Smerek's job as head of the executive board of VSŽ. The company changed its official name to VSŽ Holding, and Smerek replaced Alexander Rezeš as chairman of VSŽ's supervisory board. The supervisory board was dominated by those managers who had led the change to a fully privatized company; they owned about 40 percent of the company's shares. (Financial Times, 2 March 1998).

As late as 21 August 1998, VSŽ was still flexing its financial muscles. It had announced that it intended to grab a controlling portion of the Slovak insurer, Slovenská Poistovňa, despite the fact that a law barred the insurance company from going fully private until the year 2003. The state held a 50.5 percent stake in the company, but a new stock offering worth Sk 375 million would cut the National Property Fund's stake to about 40 percent. VSŽ's direct ownership would have risen to 20 percent, and together with several other shareholders, they would control about 50 percent of the insurer (Financial Times 21 August 1998).

The purchase was seen by the opposition as another attempt to siphon off state assets at what the Financial Times termed "knockdown prices." Karol Meočík, the president of Slovenská Poistovňa, was a former HZDS member of parliament. Opposition parties initiated legal action to block the sale of new shares and convened a special session of parliament, at which they called for the resignation of then Finance Minister Miroslav Maxon as well as a number of senior officials in the National Property Fund. HZDS officials boycotted the session so that there were not enough delegates to attain quorum.

Over his first eight months at the helm, Július Rezeš managed trade so that the company was owed over Sk 4 billion in overdue payments from contract trade and dealers. Because the amount was so huge, there was suspicion that the money never made its way to Slovakia. Some conjectured that Rezeš siphoned off assets from the company and hid large amounts of cash abroad.

The seriousness and extent of VSŽ's troubles became apparent as at first it was discovered VSŽ management had fudged on the extent of its losses and then one set of losses after another was announced. The IRB disclosed that it had lost Sk 2 billion in the first nine months of 1998. Customers were continuing to withdraw their assets, which was accelerating losses. The National Bank of Slovakia injected money into the bank - so much so that it represented two-thirds of the bank's balance sheet (Pravda, 30 October 1998).

On 5 November, Július Rezeš announced at a press conference that VSŽ would lose money for the year, even though it had a Sk 683 million profit for the first three quarters. Rezeš blamed foreign exchange losses and losses from acquisitions such as the IRB. Prices dropped Sk 1,000 per ton for steel. The world economic crisis led to imports of cheap Asian and Ukrainian steel. The younger Rezeš claimed that VSŽ would resolve the situation by cutting costs and restructuring. It would stop subsidizing unprofitable operations. Some components would be merged while others would be sold or discontinued, especially those having nothing to do with the metallurgical business. Praha Sparta would be among the first to go. Financial concerns such as Slovenská Poistovňa would also be up for sale (in fact, its share had already shrunk from 20.03 to 12.7 percent on 30 October). VSŽ's Board was also considering letting go up to 2,000 employees in 1999, mainly through attrition rather than layoffs (TASR, 5 November 1998).

The extent of the crisis became public when it was revealed that on 9 November, VSŽ had defaulted on a USD 35 million loan to Merrill Lynch. Smerek even suggested that VSŽ might go bankrupt. That would be too much for the Slovak economy to handle and would devastate Košice, Slovakia's second largest city, which is heavily dependent on VSŽ. Although it employs 25,000, the ripple effects of VSŽ going under would put half of Košice out of business. One source stated that VSŽ's bankruptcy would have affected half a million people. Hence, the day after the news of the company's default, the government began talks with VSŽ's management (ČTK, 11 November 1999).

The new Dzurinda government, which had just assumed office during the last week of October 1998, offered to rescue VSŽ on the condition that its management and supervisory board resign. They refused. But faced with a possible bankruptcy, they agreed to some changes. They ousted Rezeš and brought in two American managers. One of them was Thomas Graham, nicknamed "the smiling barracuda." Graham had a history of turning around endangered steel mills. VSŽ badly needed solid leadership and an alliance with a company that could offer it both cash and an apolitical economic strategy (Financial Times, 6 January 1999). After finding out more about the extent of VSŽ's troubles and the difficulty of working with management, Graham resigned in February. The task of turning VSŽ was left to Gabriel Eichler.

Seeking a suitor

In order to bail VSŽ out of its mess, the company drafted Gabriel Eichler, a 48 year old Slovak exile who had emigrated to the United States after 1968. Originally from Bratislava, Eichler gained valuable experience as an international banker and chief economist with the Bank of America. He served as the bank's first vice-chairman for the Central European office in 1994 and later worked for two years as chief financial officer of CEZ, the Czech electrical utility.

Eichler took on the daunting task of picking up the pieces after VSŽ 's train wreck. He was elected to a six-month term as president; throughout 1999, he sold off VSŽ's non-core businesses and helped improve transparency at the firm.

When he came to the firm, he found it to be saddled with USD 450 million of debt, most of it payable "on demand," because of cross default clauses. After six months, Eichler extended his stay at VSŽ. His job was to stabilize the company and arrange a restructuring agreement with the banks VSŽ was indebted to. (Financial Times, 26 January 1999).

Both Eichler and the banks struggled to understand VSŽ's "opaque shareholding structure." Rezeš and his allies had always been able to secure majorities at shareholder meetings, because of their holdings in related companies and their ties to key people in management and the trade unions. The fact that management owned a 25 percent share of the company complicated matters; but through its control of Slovenská Spořitelna, a state-owned savings bank, the state managed to obtain a stake of over ten percent. A repurchase guarantee for unpaid loans enabled it to increase its stake through the bank and the state restitution fund.

Banks to which VSŽ was indebted pressured the firm to divest itself of non-steel related assets. The national daily Národná Obroda was sold and later the Praha Sparta soccer club. The appointment of Eichler pleased the (about 40!) banks to which VSŽ was and is indebted.

Since assuming power, the Dzurinda government has made some efforts to unearth criminal activities around privatization at VSŽ and force the perpetrators to return their ill-gotten gains to the state. The National Property Fund has to refer cases to the courts if charges are to be made. Inheriting all the ugly baggage from illicit activities, in June 1999 the NPF was looking at over 400 cases. Only nine privatization cases have resulted in charges; one of them is the fraud at VSŽ. The case is so huge that a special team was formed by the Interior Ministry to investigate the fraud - beginning 22 June (Slovak Spectator, 28 June to 4 July, 1999).

Still, investors and foreign observers are not satisfied with the slow pace of investigations. As one commentator noted: "No NPF official has said what tools they use. We are not seeing the transparency that the NPF promised last year." There has not been a clear departure from the clientelism practiced under the Mečiar government.

A Merrill Lynch analyst, Matthew Vogel, was not surprised. The problem, he said, was that "the former government may have given property away cheap, but that's not necessarily illegal. Their real chance to recover shares is very limited." (Ibid.)

An economic turnaround?

By December 1998, things looked pretty grim for VSŽ, as it tottered on the brink of bankruptcy, and raw material supplies dwindled to just a few days supply. Because VSŽ had not made its installment payments on its loans, the firm found its credit resources legally blocked. VSŽ's financial situation was considered undependable and untrustworthy. In order to stave off imminent bankruptcy, the acting directors of the company reached an agreement with bankers that tightly controlled VSŽ finances. All but the most routine expenditures required the agreement of a Bank Coordinating Commission (Cocom). Structural and organizational matters, including the purchase of necessary raw materials, their transport and the sale of finished production were handled by an exclusive contract with middlemen regulators. A total of 130 legal entities belonged to VSŽ, and of these, about 30 were in a precarious financial situation.

1999, however, was a turnaround year for VSŽ. In response to the financial stress on VSŽ, the new management had decided to consolidate the results of nine companies which it owned and although in the year's first quarter, the firm lost nearly 1.2 billion crowns, by the second quarter pre-taxable results recorded a Sk 16 million profit. Sales levels reached some of the best levels from past years. Today, while still operating in the red after taxes and currency exchange losses, VSŽ appears to be headed in the right direction. Monthly production has moved to around SK 3 billion.

A long-term solution

However, despite some improvement in its outlook, VSŽ badly needs an infusion of capital from foreign sources. It must shed it former image as a company tarnished by insider corruption and personal aggrandizement. US Steel appears to be the one company with sufficient capital that could find a solution in the mutual interest of both firms.

The outlook for an acceptable long-term solution to VSŽ's troubles appeared to improve when talks took place with US Steel in London on 7 to 8 July 1999. Those negotiations are still underway as of this writing. VSŽ President Gabriel Eichler was slated to meet with the head of US Steel, Paul Wilhelm. Just prior to the meeting, the Slovak government attempted to reach a standstill agreement, which would satisfy VSŽ's creditors and allow a deal with US Steel to proceed. A standstill agreement would mean that creditors would put off immediately demanding payment; not doing so could result in bankruptcy. The hope is that by being given more time, VSŽ could cement a deal with a foreign investor that could resolve its liquidity crisis (Slovak Spectator, 12 to 18 July, 1999)

US Steel will probably wind up being the majority shareholder in VSŽ. But the company refused to sign an agreement until it had assurances of a standstill agreement. It does not want to have to bail out VSŽ for its former mistakes.

The July talks between VSŽ and US Steel officials in London did not yield such an agreement. US Steel offered only USD 220 million for a majority interest in the firm, a figure well below what the Slovak government wanted. A better offer would come several months later.

The government involvement increased when Finance Minister Brigita Schmögnerová was given power by the cabinet to sign an agreement between the government and VSŽ's foreign creditors. This contract would precede a standstill agreement between VSŽ and its foreign creditors and was a necessary prerequisite to a capital flow into the company. The idea was to reassure foreign creditors that the Slovak state – VSŽ's biggest creditor - would not try to recover its debts ahead of time. Creditors wanted to be sure that new investment would be used to reinvest in capital improvements and not to pay off old loans.

VSŽ's fate appeared to be heading for another crisis in August, as it had still not reached a standstill agreement with its creditors. Three out of six members of VSŽ's Board of Directors resigned - including former Chairman Ladislav Drabik. The official reason for their departure was not given, but it could only help VSŽ's chances to secure time to settle its huge debts (Reuters, 12 August 1999).

When VSŽ's Gabriel Eichler expressed concern that bankruptcy proceedings might be initiated against the company, Schmögnerová assured the company of government support and stated that it was in the state's own interests to help the company overcome the financial crisis brought on by its previously "irresponsible owners." (CTK, 13 August 1999)

The company owed nearly USD 500 million to 40 banks, two-thirds of which are foreign. With a standstill agreement, the government and creditors granted VSŽ another two months before they would pursue their debt. ING of the Netherlands has the biggest stake in seeing a turnaround at VSŽ. With illegal outflows halted, exclusive contracts dissolved and world prices starting to improve, VSŽ has a chance of making a recovery.

Rezeš rides again?

Although Eichler may have thought Rezeš was out of the picture, the feisty fighter came barreling back to try to reclaim his rights to the company. After all, he still controlled a 20 to 25 percent stake in the firm.

The Slovak daily Pravda (2 September 1999) revealed that Rezeš was holding secret meetings at his Spanish villa with the intent of trying to take VSŽ out of state control. Former Prime Minister Mečiar was present, as was Jaroslav Gruber, then a member of VSŽ's Supervisory Board and head of Hutník, which owns 10 percent of VSŽ. After this meeting, on 12 August, Gruber called a special shareholders' meeting which would be held on 22 September. Gruber also convinced his fellow board members to sign a statement critical of the new leadership of the company, which was termed "un-transparent" (Slovak Spectator, 6 to 12 September 1999).

Despite their efforts, Rezeš and friends were not able to transfer power back into their own hands. Because of VSŽ's debts, the state holds about 30 percent of VSŽ's shares and foreign investors have about 25 percent. The Rezeš-Hutník alliance could not muster enough votes to unseat Eichler. At the same time, Eichler is somewhat isolated at VSŽ. Despite all the problems they caused, the Rezeš group still hold more influence among long-time managers at VSŽ.

Nonetheless at the 22 September meeting, Rezeš and his remaining allies were voted down and thrown off the board of directors. Eichler's position was secured as the company's president. Vladimir Gurtler, Rezeš's unsuccessful candidate for membership on VSŽ's supervisory board, filed a legal complaint over the September general meeting's personnel changes (Reuters, 21 December 1999). The next month, on 24 October, some thugs close to a Košice mafia boss tried to kidnap one of VSŽ's divisional directors, Štefan Sarnovský, at the Košice airport (Slovak Spectator, 8 to 14 November 1999).

It appeared that Rezeš had finally thrown in the towel – for the moment. News reached me the very morning (28 October) I was to leave for a conference on corruption in Budapest that even though trading in VSŽ shares had been suspended since November 1998, on 22 October, Rezeš managed to get a release to sell shares. He sold a significant portion - 10.75 percent - of his stock (Slovak Spectator, 20 to 26 December 1999).

Those shares belonged to Všeobecná akciová společnosť (VAS), which Rezeš and his allies closely held. Although the government had frozen VSŽ's assets because of its inability to pay its debts and blocked it from trading on the Bratislava Stock Exchange, a technical error enabled Rezeš to unload his shares. He was given permission to sell shares in a firm called Ferrimex, which he owned, and the two companies were assigned the same code number. Ferrimex held a 3.84 percent stake in VSŽ. Once he was free to trade shares, Rezeš transferred the VAS shares to Stavard Ltd, which, in turn, transferred the share to three foreign companies (Slovak Spectator, 8 to 14 November 1999).

The shares went to foreign investors for a good price, about 250 Sk per share. At the time, the name of the new owners and details of the operation were not immediately disclosed, since this was required by law only if the sale amounted to over five percent of the stock. In order to get around the five percent threshold, Rezeš sold the shares in three parts. The firms are apparently connected with firms in three different countries, later revealed to be in Cyprus, the Czech Republic and England. Since Rezeš and the trade unions held a greater share than the government, it is possible that these shares are being temporarily put on hold, waiting for the resurrection of Mr Mečiar (Sme, Pravda, 28 October 1999).

When the government got wind of the trade, Finance Minister Brigita Schmögnerová decided to dismiss Marián Sásik, the head of the Bratislava Stock Exchange, for allowing the trade to occur (Financial Times, 3 November 1999). But Rezeš and his allies still hold a slightly greater stake in VSŽ than the government (about 31 percent of the stock, or three percent more than the state), and the sale of the stock weakened the government's control of the company. The Finance Ministry considered the sale an illegal violation of a preliminary injunction issued by a regional court over a year ago. It cited a lack of communication between the court and the stock exchange as also being responsible for the unblocking of the stock. Now, the government faces the legal hurdle of trying to obtain the shares back via the courts (Slovak Spectator, 8 to 14 November 1999). Eventually, when a strategic investor such as US Steel gets involved in the brawl, a showdown will occur.

Regardless, for the moment, it appears that Rezeš is laying off any more near-term attempts to wrest control of the company. Since more than a third of the firm is in foreign hands – the identities of which do not have to be revealed since each owns less than one-third of the firm - they will try to keep Rezeš at bay. To stabilize the firm, they will have to run the company and not let VSŽ tunnel out - that is, siphon out assets - to other firms which they have no power over. The future is still up for grabs.

Future prospects

As of this date, what will happen to VSŽ is still in flux, but it seems most likely that US Steel will reach a deal. The firms have already cooperated on a joint venture over the past two years and would fit well with one another.

With Rezeš out of the way, the government has assumed primary responsibility for negotiations in London. Slovakia's Finance Minister, Brigita Schmögnerová, stated that her government would like US Steel to make a long-term commitment to the economic development of the country over the next ten years. She also confided that some other companies were interested in VSŽ but declined to give any details; Voest-Alpine of Austria has been mentioned as a possible suitor in the past (Reuters, 25 October 1999).

Yet, favoritism continues to mar privatization in Slovakia. Just this past 19 October 1999, Minister of the Economy Ľudovít Čeernák lost his post over scandals concerning privatization. The biggest revolved around Nafta Gbely, a very profitable natural gas storage company, but other examples contributed to his downfall as well (Slovak Spectator, 18 to 24 October 1999).

In addition to sacking Čeernák, on 20 October 1999, the Slovak Parliament also sacked the president of the National Property Fund, Ľudovít Kanik, and its vice president, Ladislav Sklenár. Both were accused of inappropriately handling the reacquisition of Nafta Gbely. In a paradoxical show of solidarity, both Dzurinda and the opposition parties endorsed the dismissals. The deputy chairman of the Democratic Party, Peter Zajac, accused the Prime Minister of using the opposition to depose his party's nominee, Kanik (RFE/RL Daily Report, 21 October 1999).

The sackings and connections reach across party lines and indicate that corruption is far more widespread and embedded and cannot simply be labeled a consequence of Mečiarism. It has deeper roots which stem from Communist times and even the pre-Communist period. The latter roots represent an area that requires further research; these historical origins could help lead us to a better understanding of just how entrenched such practices are within the overall course of Slovak history. A pattern of long-term corruption is much more difficult to weed out than isolated or recent cases. In the Slovak scenario, corruption, nepotism and favoritism appear to have a long history.

What can we learn from the VSŽ affair with Rezeš and company? One lesson is that countries such as Slovakia, which are making the transition from Communism to market economies, must build the legal infrastructure necessary to keep potential abuses at a minimum. Hidden means of control and ownership can be minimized by drawing on the legal experience of Western countries and the mistakes of countries such as Slovakia. By no means will this eliminate corruption if businessmen in transition countries are determined to defy the Rechtsstaat. In many respects, Communism has so infected the culture that corruption will continue to be a problem regardless of who holds the reigns of power. Media, international monitoring, time and continuing reforms will help mitigate some of the worst forms of abuse.

When an authoritarian leader such as Mečiar controls the government, there is often little that can be legally done to thwart abuse. Laws themselves are ignored. A well-developed civil society can help mitigate the harm such political leaders can connive at with their cronies. International pressure also plays a role; however, in the case of Slovakia, it did not deter Mečiar or Rezeš in their determination to create their own economic empires on their "island of Slovakia." One cannot help but be more optimistic about the future. In his endeavors to have Slovakia accepted into world and European bodies, Prime Minister Dzurinda must make a concerted effort to eradicate the most flagrant forms of corruption. A Slovakia more integrated in the European Union will be forced to throw out the dirty laundry and come clean.

Michael J Kopanic Jr, PhD, 7 January 2000

Read Part I of this series HERE.

The full version of this article was delivered at the Joint Conference on Corruption in Budapest.



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