SPEAKERS CONTENTS INSERTS
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45–764 CC
1998
UNITED STATES ENTERPRISE FUNDS IN EASTERN EUROPE AND THE STATES OF THE FORMER SOVIET UNION
HEARING
BEFORE THE
COMMITTEE ON
INTERNATIONAL RELATIONS
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTH CONGRESS
FIRST SESSION
JUNE 26, 1997
Printed for the use of the Committee on International Relations
COMMITTEE ON INTERNATIONAL RELATIONS
BENJAMIN A. GILMAN, New York, Chairman
WILLIAM GOODLING, Pennsylvania
JAMES A. LEACH, Iowa
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HENRY J. HYDE, Illinois
DOUG BEREUTER, Nebraska
CHRISTOPHER SMITH, New Jersey
DAN BURTON, Indiana
ELTON GALLEGLY, California
ILEANA ROS-LEHTINEN, Florida
CASS BALLENGER, North Carolina
DANA ROHRABACHER, California
DONALD A. MANZULLO, Illinois
EDWARD R. ROYCE, California
PETER T. KING, New York
JAY KIM, California
STEVEN J. CHABOT, Ohio
MARSHALL ''MARK'' SANFORD, South Carolina
MATT SALMON, Arizona
AMO HOUGHTON, New York
TOM CAMPBELL, California
JON FOX, Pennsylvania
JOHN McHUGH, New York
LINDSEY GRAHAM, South Carolina
ROY BLUNT, Missouri
JERRY MORAN, Kansas
KEVIN BRADY, Texas
LEE HAMILTON, Indiana
SAM GEJDENSON, Connecticut
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TOM LANTOS, California
HOWARD BERMAN, California
GARY ACKERMAN, New York
ENI F.H. FALEOMAVAEGA, American Samoa
MATTHEW G. MARTINEZ, California
DONALD M. PAYNE, New Jersey
ROBERT ANDREWS, New Jersey
ROBERT MENENDEZ, New Jersey
SHERROD BROWN, Ohio
CYNTHIA A. McKINNEY, Georgia
ALCEE L. HASTINGS, Florida
PAT DANNER, Missouri
EARL HILLIARD, Alabama
WALTER CAPPS, California
BRAD SHERMAN, California
ROBERT WEXLER, Florida
STEVE ROTHMAN, New Jersey
BOB CLEMENT, Tennessee
BILL LUTHER, Minnesota
JIM DAVIS, Florida
RICHARD J. GARON, Chief of Staff
MICHAEL H. VAN DUSEN, Democratic Chief of Staff
MARK GAGE, Professional Staff Member
ALLSION K. KIERNAN, Staff Associate
C O N T E N T S
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WITNESSES
Ambassador Richard Morningstar, Special Advisor to the President and Secretary of State on Assistance to the New Independent States and Coordinator of U.S. Assistance to the New Independent States, Department of State.
Hon. James Holmes, Coordinator for Eastern Europe Assistance, Department of State
Hon. Tom Dine, Assistant Administrator, Bureau for Europe and the New Independent States, U.S. Agency for International Development
APPENDIX
Prepared statements:
Hon. Benjamin A. Gilman, a Representative in Congress from New York, and Chairman, Committee on International Relations
Ambassador Richard Morningstar
Hon. James Holmes
Hon. Tom Dine
Additional material submitted for the record:
Responses to additional questions submitted for the record
UNITED STATES ENTERPRISE FUNDS IN EASTERN EUROPE AND THE STATES OF THE FORMER SOVIET UNION
THURSDAY, JUNE 26, 1997
House of Representatives,
Committee on International Relations,
Washington, DC.
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The committee met, pursuant to notice, at 10:07 a.m., in room 2172, Rayburn House Office Building, Washington, DC, Hon. Benjamin A. Gilman (chairman of the Committee) presiding.
Chairman GILMAN. The Committee will come to order. This morning the International Relations Committee will be taking testimony on the operations and oversight of our U.S.-funded and sponsored Enterprise Funds in Eastern Europe and the States of the former Soviet Union.
The Enterprise Funds were created under legislation reported by this committee; namely, the ''Support for Eastern European Democracy Act'' of 1989, and the ''FREEDOM Support Act'' of 1992. Regrettably, this Committee has been unsuccessful to date in convening an oversight hearing to gauge the success of these new vehicles for the delivery of the U.S. assistance to emerging democracies, or to gauge the effectiveness of the oversight of these new Funds by the State Department and the Agency for International Development.
I am pleased that we have been able to schedule this hearing this morning. I want to thank our Committee's vice chairman, Mr. Bereuter, for his interest in this issue, and for his support in organizing today's hearing.
Today, the Committee will be taking testimony from a panel of three official witnesses. First, from Ambassador Richard Morningstar, the Coordinator of U.S. Assistance to the New Independent States and Special Advisor to the President and the Secretary of State on that assistance. We welcome you, Mr. Ambassador.
Second, The Honorable James Holmes, our State Department Coordinator for U.S. Assistance for the States of Eastern Europe, and we welcome you, Mr. Holmes.
And last, but certainly not least, The Honorable Tom Dine, our Assistant Administrator for Europe and the New Independent States at the Agency for International Development.
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I would like to take a moment to congratulate you, Mr. Dine, on your appointment to head our Radio Free Europe and Radio Liberty operations. I have to say that we will miss your appearances on behalf of the Agency for International Development before our Committee, as well as your willingness to respond to inquiries from this Committee's Members and staff during such hearings and in the course of our daily work. We wish you success in your new endeavors. I am sure we will be seeing more of you as the new chairman of Radio Free Europe.
Today's hearing on this issue will be followed with a hearing featuring private witnesses as soon as that can be conveniently scheduled.
I regret that our schedule today did not allow for an immediate followup panel of private witnesses, but the Committee will do its best to make certain that the second hearing on this important issue will be held in the near future.
At this point I will be pleased to recognize any of our Members for opening comments. Mr. Bereuter.
Mr. BEREUTER. Mr. Chairman, thank you very much for scheduling this hearing. I had been looking forward to this during the last Congress and we ran out of time, so I am very pleased that we are holding it today, and we will, as you say, continue with the private panel.
I would like in particular to express my appreciation to Mark Gage for his work in preparing for the hearing, and we have had, as I understand it, very good cooperation from the agencies in preparation. Undoubtedly, it has been good background work on the minority side too.
Chairman GILMAN. Thank you, Mr. Bereuter.
If there are no other opening statements, we will now proceed with the testimony of our witnesses. As always, we will ask our witnesses to make a brief verbal statement. Your full statement may be made part of the record. Is there any objection to the insertion of the witnesses' statements in the record? Hearing none, the statements are ordered to be inserted in the record. And let us proceed with the testimony.
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Ambassador Morningstar.
STATEMENT OF RICHARD MORNINGSTAR, SPECIAL ADVISOR TO THE PRESIDENT AND STATE DEPARTMENT ON ASSISTANCE TO THE NEWLY INDEPENDENT STATES AND COORDINATOR OF U.S. ASSISTANCE IN THE NEWLY INDEPENDENT STATES
Mr. MORNINGSTAR. Mr. Chairman and Members of the Committee, thank you for inviting us here today to testify on the Enterprise Funds, and in my case, on the Enterprise Funds in the New Independent States. As you know, the NIS region currently has four such Funds in operation, and a fifth Fund is in development for the TransCaucasus region, covering Armenia, Georgia, and Azerbaijan.
The Enterprise Funds are an integral part of U.S. efforts to assist in the economic transformation of the New Independent States and pave the way for private capital. More specifically, the Enterprise Funds are expected to promote private sector development by providing capital and know-how to small and medium enterprises in regions and in industry sectors where the private sector would not yet be actively investing.
Over the last year, the Administration has taken a very hard look at the performance of the NIS Enterprise Funds. Like you, at times we have also been concerned with the seemingly slow pace of investment by the Funds. As you know, an increasingly important priority for the Administration is how to accelerate trade and investment in the NIS. With the NIS well on their way to achieving macroeconomic stabilization, their ability to attract domestic and foreign capital is critical to creating economic growth. Against this backdrop, the importance of Enterprise Funds to U.S. policy is actually growing.
In addition USAID and the Department of Defense's financial and programmatic oversight, the coordinators have an additional responsibility to deliver broader policy oversight and guidance to the Funds, and to act as the Administration's point of contact with the Funds' chairmen. We have taken several steps in the last year to strengthen our policy dialog with the Fund management, including a major meeting last November between senior Administration officials and all Enterprise Funds' CEOs and chairmen; and a followup process to review and to strengthen the performance measures that the U.S. Government uses to evaluate the Funds.
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What has been most important from my experience is to maintain regular communication with the board chairman and the CEOs of the Funds, and to participate actively in the detailed semi-annual performance reviews. We have also worked to engage the Fund management in the development of new program initiatives in the trade and investment area, particularly in the regions which we are trying to emphasize very much.
What is most important in terms of performance measures, which are now being finalized, is to evaluate each Fund against realistic expectations of what can be achieved given host country conditions, not to judge the Funds relative to each other.
Second, the targets established for performance will be different at different stages of the Funds' life. What is reasonable to expect in years one, two and three will be different from what we can expect in years four through six when most investments will be made.
Where are we today? With regard to the NIS Funds, it is too early to judge whether the Funds are successful or not. All of the Funds are just completing their third year of operation. The preliminary results are mixed as we look at early indicators, such as the pace of investments, the leverage of Fund capital to attract other U.S. and foreign investment, the geographic and industry diversity in their investments, and the implementation of active lending programs for small businesses.
It is clear that one of the biggest problems facing the Enterprise Funds is one of mandate. They are publicly funded, yet privately managed. It is difficult to reach consensus among all the stakeholders as to whether the Funds are primarily mechanisms for economic development at a very early stage, the acceleration of capital, or are early stage private venture funds. Do they exist primarily to accelerate the flow of capital or are they supposed to be profitable and self-sustaining as their primary goal?
Well, the answer, of course, is somewhere in the middle of the spectrum. Establishing, maintaining and communicating that balance is difficult for us as policymakers and for the Funds as implementers.
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We have also worked hard with USAID and the Department of Defense to manage the obligations process for the NIS Funds. We will continue to obligate additional money to the Funds based on their level of investment activity. For example, due to the Russia Fund's slow early pace, we have not obligated new monies to that Fund since Fiscal Year 1995. As we expect the pace of this investment activity to increase as these Funds enter their fourth year of operations, we will obligate new funds accordingly, but we are not wasting taxpayers' monies. They get money as they need it.
I would like briefly to address the activities of each of the NIS Enterprise Funds to date.
One, the Central Asian-American Enterprise Fund, was established in July 1994, and will be capitalized at $150 million. Despite unusually difficult circumstances stemming from the mandate to work in five different countries, the Central Asian Fund has gotten off to a very quick and promising start. It has staffed offices in all five Central Asian Republics, and has set up a very strong small business lending subsidiary.
Through May 1997, it has made direct investment commitments of almost $46 million, and disbursed $43 million. It has also made $10 million in commitments through its small loan program, with $4 million of disbursements. And this Fund's investments have the potential to provide the strong demonstration effects in the region.
Additionally, it has worked with local banks, through which it has developed a robust lending program for small businesses, helping to strengthen the financial institutions in the region.
The Western NIS Enterprise Fund was established in August 1994, and will also be capitalized at $150 million. Of all the NIS Funds, the West NIS faces the most difficult investment conditions. The environment for foreign investments in Ukraine has worsened over the last year and has resulted in numerous well publicized investment disputes with U.S. companies.
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The West NIS investment and loan numbers reflect that situation. Through May 1997, West NIS has made direct investment commitments of $40.5 million, with $18 million disbursed, and $1.64 million in their small loan program. We are hopeful that years four and five will see enough progress in the investment climate that the Fund's pace will improve. But the West NIS Fund is well positioned for the future in terms of the quality of its portfolio companies, its staff, and its pipeline of potential projects.
The U.S.-Russia Investment Fund, perhaps the most well known, was established in May, 1995 following the merger of the Fund for Large Enterprises in Russia and the Russian-American Investment Fund. TUSRIF, which is the acronym, is expected to be capitalized at $440 million.
Having dealt with serious organizational issues, the U.S.-Russia Fund is beginning to carve out a successful niche in several regions in the vast and rapidly evolving Russian market.
To date, it has made commitments of $67 million in direct investments, disbursed $63 million, and $11 million in its small loan program, of which over $7 million have been disbursed.
I have been personally involved with the CEO of that Fund to streamline their investment process, to increase the pace of getting deals done because they recognize that they have been slow in getting deals done.
The last Fund, the Defense Enterprise Fund, was established in June, 1994. Its capitalization will be $72 million. It has the unique and challenging mandate, which is to support joint venture defense conversion projects involving U.S. firms and Russia, Ukraine, Kazakhstan and Belarus.
The Defense Enterprise Fund is off to a relatively fast start. Through May 1997, the Fund has made commitments of $44 million, and disbursed $21 million. They have also been very successful in leveraging private capital. There has been something like a 7- or 8-to-1 ratio with respect to private capital.
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Finally, the TransCaucasus Fund is in the process of being set up. We are doing it in a slightly different way. There is only $25 million for this Fund. We thought that it did not make sense to have a separate board of directors and have all the expenses of an Enterprise Fund. We are establishing an OPEC Fund to handle some of the larger projects, and AID is setting up a small loan fund through a grantee for the remaining amount, which we think will end up leveraging the most investment for that relatively small amount of money. And I think there are congressional notifications that are up now with respect to that.
In conclusion, I would simply say that we have described in other hearings the Administration's future plans for assistance to the New Independent States, the Partnership For Freedom, which includes a special focus on fostering economic growth and investment in the NIS. Mobilizing capital for small business in the regions of the NIS is one of our primary objectives of the Partnership For Freedom, and the Enterprise Fund is a crucial component of the total package which will accomplish this objective.
Thank you.
[The prepared statement of Mr. Morningstar appears in the appendix.]
Chairman GILMAN. Thank you, Ambassador Morningstar.
Mr. Morningstar, just one quick question. What is the total funding for all of the Enterprise Funds?
Mr. MORNINGSTAR. The total, the actual total intended capitalization, I believe, is something over $800 million, but I have the numbers here somewhere.
Do you have the exact number right there?
Mr. HOLMES. I have the total for all of them, which is the amount of appropriations that has come from Congress to AID, then to the European part, and then to the NIS part. It is $1.3 billion——
Chairman GILMAN. Thank you.
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Mr. HOLMES [continuing]. that has been authorized.
Chairman GILMAN. Before proceeding, I am going to ask if our Ranking Minority Member has any opening comments.
Mr. Hamilton.
Mr. HAMILTON. Mr. Chairman, I think this is a very good hearing, and I commend you for it. I want to join you in the remarks you, I think, made before I got here, wishing Mr. Dine well and thanking him for his remarkable service at AID. He takes on now a very important responsibility at Radio Free Europe, and we wish you the very best.
Mr. DINE. Thank you very much.
Chairman GILMAN. Thank you, Mr. Hamilton.
And now, Mr. Holmes, our Coordinator for Eastern European Assistance in the Bureau of European and Canadian Affairs, Department of State.
You may proceed, Mr. Holmes.
STATEMENT OF JAMES HOLMES, COORDINATOR FOR EASTERN EUROPEAN ASSISTANCE, BUREAU OF EUROPEAN AND CANADIAN AFFAIRS, DEPARTMENT OF STATE
Mr. HOLMES. Thank you very much. Mr. Chairman, Members of the Committee. I appreciate this opportunity to appear before you to discuss the operation of Enterprise Funds in Central and Eastern Europe. Seven Funds currently operate in nine Central and Eastern European countries, ranging from the 7-year-old Polish/Hungarian Funds to the 2-year-old Albanian Fund.
We have one clear success, one clear failure, and several others which look promising, both in terms of carrying out their mission and closing out with assets at least equal to the original grant.
I do not come here with great wisdom on Enterprise Funds. I can tell you that in my experience there is no standard formula for Enterprise Funds' success. I do not think the U.S. Government can take much credit for the success of the Polish Fund, nor do I think it should shoulder much blame for the Czech and Slovak Fund. In both cases the boards of directors and the management which they selected should receive most of the accolades and bear most of the blame. This, I think, is what Congress intended when it created Enterprise Funds, and indicated very clearly that they were an experiment, and the government should keep the dead hand of bureaucracy off them as much as possible.
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Let me touch briefly on some of the lessons we have learned.
First and foremost, regardless of temptation the U.S. Government must stay out of the investment decisionmaking process of the Funds. We, as government bureaucrats, are trained in risk aversion, rather than risk taking. No one truly knows what will result from venture capital investments. But those with track records of success in this risky business work on Wall Street and Park Avenue, not on C Street.
Government oversight, and there is certainly a need for government oversight if we are to fulfill properly our stewardship role for the American taxpayer, must be discriminating. With USAID and State Department semi-annual reviews, annual audits by leading accounting firms, USAID's Inspector General, the GAO and special issue reviews, there is no lack of oversight provided we use the tools of oversight available and correctly.
We should insist upon clearly defined Fund goals and strategies, and we have. We should insist upon maximum transparency from the Funds, and we have. But we should not craft oversight in ways which put officialdom in the position of second-guessing the Funds' investment decisions.
On the other hand, we must keep well informed. Should boards begin to fail, should they become dysfunctional or clandestine, as was the case with the Czech and Slovak Fund, we need to act and act quickly as surrogates for the taxpayer shareholders.
Second, there is no substitute for a good professional board of directors. In my opinion, the best predictor of whether a Fund will succeed or fail is the quality of its board. In the case of the Czech and Slovak Fund, we intervened when the board of directors became dysfunctional. It was then that we learned that the problems were much greater than they had appeared, including that the Fund was not disclosing special audits and portfolio reviews that were highly critical of its management. We now require full disclosure of all independent audits and have requested that the annual audit requirements be strengthened to include the auditor's opinion of the adequacy of internal controls and processes.
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Third, privatization of the Funds is an achievable goal. With the Polish Fund's decision to begin winding up its operations early due to a success in raising private capital, we have a duplicateable exit strategy for most of the Funds.
Three of the seven Central and Eastern European Enterprise Funds have now raised some private capital, the Polish, Romania, and Hungarian Funds. If the others are expected to follow the Polish Fund model, they will separate out and privatize their investment divisions into for-profit employee-owned companies which will manage both the public and private funds. With this privatization the Funds should be able to retain most of the trained professionals and the U.S. Government should have the assurance as the close-out process proceed there will be continued investment expertise maximizing value on the sale of investments.
By almost any measure the Polish Fund has been a success. It is the premier foreign investment and lending institution in Poland. It has pioneered modern banking practice, mortgage banking and micro-lending facilities. It has raised $262 million in private capital, making the U.S. Government, in effect, a minority shareholder. The Fund estimates that it will be able to liquidate U.S. Government investment portfolio in 5 years, and end up with approximately $25 million more than the $159 million original cost.
The issues that arise from the success of the Polish-American Fund is a very pleasant one. What do we do with the reflows? The Administration has developed a proposal to answer that question, and while we are very close, it is not yet a final Administration position. With that caveat, however, let me outline for you what the current proposal would look like.
A guiding philosophical principle is that the Enterprise Fund should not return a profit to the U.S. Government from investments made in Poland. In other words, our assistance program should not be a U.S. Government moneymaker. Any profits earned should stay in the country where they were made.
Also, we need to recognize that not all of what Enterprise Funds do is profit-driven. Technical assistance and micro-lending are some of the developmental activities which Funds engage in, knowing in advance that they are unlikely to recover their costs. This is because the goal of the Funds is private sector demonstration and development; not simply profit maximization.
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The reflow proposal currently under consideration, therefore, would return to the U.S. Treasury the cost of the Fund's current investment portfolio of approximately $160 million, and would leave in a foundation in Poland the expected profits from that investment, estimated at approximately $25 million, and the proceeds from winding up the four investment subsidiaries whose cost basis is approximately $81 million.
Under this formula, the Treasury would receive a sum certain of approximately $160 million back, which we view as only fair given that the United States took the risk originally in establishing the Fund.
We will be consulting with Congress, including this Committee, once we have a final Administration position. I expect that that will be soon.
Let me also add some comments on our one clear failure, the Czech and Slovak-American Enterprise Fund. From an investment point of view it has been a disaster; losing 92 cents on the dollar of its invested capital in the Czech Republic, with a substantial loss, probably in the order of 50 to 70 percent, expected on the Slovakian investments.
From a technology transfer point of view, the Fund also failed because it did not build businesses, and, indeed, few of its investees are still in operation.
How could this happen? Here is what we know. The Czech Fund made most of its mistakes in its early years, then compounded them by gross mismanagement. In 1991, the Funds' board decided to focus on the manufacturing sector knowing that it would be one of the hardest hit by the economic transition. The Fund had a chairman who frequently acted as CEO and who hired and fired several CEOs over the course of 4 years. As a result, there was no coherence or continuity to the management.
The Fund never set up and followed internal procedures for managing its investments. In the absence of a strong manager or management system, investment decisions were made in a vacuum by inexperienced officers without proper supervision.
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In 1995, the Fund commissioned a series of portfolio reviews and special audits, which were not disclosed to the U.S. Government until late 1996, but which clearly indicated to the board the scope of the problem. I will share with you a few examples.
The Fund put money into a company that declared bankruptcy between the decision to invest and the date of disbursement. In other words, the Fund's equity investment went straight out the door to pay creditors.
In several deals the Fund put in the majority of financing, but took only a minority position in the companies, usually without a position on the board of directors.
The Fund put money into at least one deal over the objection of its local, in this case the Slovak staff, who were concerned about the honesty of the entrepreneur, and, of course, subsequently the entrepreneur absconded with the money.
The Fund failed to secure collateral before investing. In 1995, we knew none of this, but we became convinced that the board of directors itself had become dysfunctional. The U.S. Government therefore intervened. We convinced the board members to resign, and we replaced the entire Fund management. An interim board was named to begin the restructuring process, and it was during the interim board's tenure that the special audits and portfolio reviews came to light and the depth of the problems became clear.
I was particularly troubled by the fact that the Fund had received a clean bill of health in its annual audits from 1991 to 1995. I then learned that the auditors were not required to render an opinion on the adequacy of internal controls and processes; in effect, a superficial audit. We collectively have taken steps to strengthen all Fund audit requirements in this regard.
With this experience, we then looked again at all of the Central European Funds. Today, we have no reason to believe that any of the other Enterprise Funds are on track to replicate the Czech Fund disaster. It is the combination of problems which appears unique.
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In summary, and despite this glaring failure, I am comfortable with a flat declaration that this highly innovative foreign policy tool is worthy and a success. Free market investment and managerial technology is being transferred. Jobs are being created in the sector which was largely ignored under communism; small and medium-sized businesses. Capital is being preserved, profits are being produced.
By the end of this decade I am confident that we will see U.S. Government investment in the Central-Eastern European Enterprise Funds largely displaced by private capital. Little of this would have happened without congressional support for this innovative and experimental way to harass American private sector know-how, to assist in the social transformation of Central and Eastern Europe.
Thank you.
[The prepared statement of Mr. Holmes appears in the appendix.]
Chairman GILMAN. Thank you, Mr. Holmes.
Mr. Dine, you may summarize your statement or put the full statement in the record, whichever you prefer.
STATEMENT OF TOM DINE, ASSISTANT ADMINISTRATOR, BUREAU OF EUROPE AND THE NEW INDEPENDENT STATES, U.S. AGENCY FOR INTERNATIONAL DEVELOPMENT
Mr. DINE. Thank you very much, Mr. Chairman, and thank you for your and Mr. Hamilton's generous remarks earlier. I very much appreciate those words.
I welcome this opportunity to testify before this Committee on the role of Enterprise Funds in the transition of the former Communist countries of Central and Eastern Europe and the New Independent States. I emphasize the word ''transition'' because in your earlier remarks about what I am about ready to do that really is the key word. I have been involved now in our assistance program toward these 27 countries that used to be Communist countries. They are still in transition. And one thing I have learned in this job in many, many ways is that communism is defeated, the Communist system is being dismantled, but democracy is not victorious, and that is the reason I have been attracted to Radio Free Europe and Radio Liberty, and hope to be able to concentrate my energies on that particular mission.
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The Enterprise Fund program deserves careful analysis because it represents a commitment of as much as I indicated earlier, $1.3 billion of the taxpayers' money, and because the Enterprise Funds are essentially ongoing experiments. And like most experiments, they should benefit from informed evaluation and oversight.
The past 7 years has given us a base of experience from which to judge Fund performance. We know more about the life cycle of a Fund. We know more about what its operational costs are. And we know more about the need for oversight of management, as Jim Holmes just detailed in a remarkable way in terms of his forthrightness. We also have come to appreciate the influence of the country environment on what a Fund can do.
In general, we believe that properly managed Enterprise Funds tailored to country conditions and priorities can have impacts in transition economies. Where financial markets are virtually nonexistent and private foreign investors reticent, capital and technical assistance provided by the U.S. Government can act as an essential catalyst in increasing the pace of creating private enterprises and entrepreneurs.
While Funds cannot overcome the effects of poor government policy on the investment or business climate, they can be one of the tools—alongside technical assistance to the private sector and government—which can help shape that climate and they can be crucial in breathing life into a good, but untested legal and regulatory structure.
The Enterprise Fund model is not, however, a universally applicable mechanism for assisting the transition to a market economy. Where governing structures are unwilling to change macropolicy, or where organized crime makes doing honest business too risky, or where there are just too few viable investment opportunities, we have seen the unfortunate picture of Enterprise Funds all dressed up with nowhere to go. That means that the staff is hired, offices rented, and all the fixed costs of doing business accrue without very much investment activity to show for it.
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The mandate of the Funds is twofold: to seek investments that make business sense and which contribute to larger economic development goals. Their managers must look for investments that are both individually profitable and support private sector development as a whole. The need to find projects that meet both criteria limits the investment targets of the Funds, and in some countries limits them extremely.
Funds have to be flexible, and adapt their activity to the specific country circumstances. They require different strategies in different environments. For example, the Baltic Fund focuses almost exclusively on providing medium-term loans to small enterprises, while the Hungarian Fund is closer to the typical private venture capital fund, providing equity capital to somewhat larger companies. The largest Funds, that is, the Polish and Russian Funds, are alike in that they have sufficient resources to try out a broad range of approaches to developing the private sector. Yet the very different country environments in Poland and Russia heavily influence what they are able to accomplish.
Not surprisingly, therefore, the record of the Funds to date is mixed. On the one hand, there are distinct successes, and we have heard a few of them so far this morning.
The Polish Enterprise Fund has provided loans and investments to more than 7,000 enterprises, which employ over 80,000 people.
The Hungarian-American Enterprise Fund, after a controversial start, has created and sustained 9,000 jobs; invested in 150 small- and medium-sized enterprises; and 60 micro-enterprises, and has provided substantial equity investments in 36 companies. The Hungarian Fund assisted in the development of the Budapest Stock Exchange.
And, finally, in terms of successes, in less than 3 years, the Central Asian Enterprise Fund has already disbursed $35.1 million, including helping finance one of the first private local newspapers in Kazakhstan, while maintaining a reasonable expense ratio.
And, Mr. Bereuter, when I testified before your Subcommittee, I highlighted the Central Asian Enterprise Funds's activities then.
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However, there are more troubling examples which have also been mentioned earlier. Funds such as those operating in Russia and the West NIS have been unable to make investment as quickly as the Polish Fund, either due to difficult operating environments, management problems, or a combination of both. As Mr. Holmes has just elaborated, the Czech-Slovak Fund has been a failure. While it was initially able to invest funds quickly, it has been forced to write down the value of its Czech portfolio by $18 million or about 75 percent of original cost.
There are other problems as well. Operating expenses are still high as a percentage of actual investment and technical assistance expenditures. Overall, the Funds have only managed to invest about $3.00 for every $1.00 they have spent in operating expenses, although this statistic does include a number of Funds that started relatively recently.
Only three of the Funds have attracted and managed significant private money; the Polish, Hungarian, and Romania Funds. No other Funds have yet been able to attract additional capital from the private sector.
The impact of the Funds on the local economies has been relatively small, with the exception of the Polish Fund, whose numbers account for 20 percent of all direct investments, over 80 percent of all small business investments, and over 60 percent of all employment impact of all the Funds put together.
To be sure, these numbers do not do justice to the wide variation in country experience. In addition, they need to be carefully disaggregated so that we compare Funds of similar maturity to each other. However, there is room for improvement in the performance of the Funds; some Funds are better performers than others; and there is no guarantee that the younger Funds will inevitably replicate the experience of the Polish Fund without the country's specific opportunities that Poland gave that particular Fund. Still, lessons can be learned and experiences shared.
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We as U.S. Government representatives can help provide that experience; help Funds adapt to local conditions and increase the possibility that the best practices of successful Funds are followed by the newer organization. In other words, we can increase the probability of positive outcomes.
In setting up the Enterprise Funds, Mr. Chairman, Congress established a flexible non-bureaucratic framework. As originally structured, there was very limited U.S. Government oversight of the Funds. The only reporting requirement in the original grant agreements involved the publication of an annual report.
The 1991 Conference Report includes such statement as, ''AID's role is simply to write the check,'' and ''AID is not to attempt to second-guess investment decisions.'' In other words, it was the clear intent of Congress that USAID maintain a hands-off role.
However, this approach created its own problems, and in 1994, due primarily to difficulties with the Hungarian Fund, Congress increased USAID's oversight role. Nevertheless, at this time we are constrained from any direct involvement in the Funds' operations. Certainly areas such as investment decisions, remain the exclusive prerogative of the Funds. With the exception of the U.S. Government's intervention in the Czech-Slovak Enterprise Fund, corporate governance is the province of the Funds themselves.
Obviously, this type of arrangement would not fly in the private sector. The stockholders of a private sector financial institution are regularly informed about its activities and its directors serve at the pleasure of those stockholders. Transparency is required by law. In the case of the Enterprise Funds, the stockholders are the U.S. taxpayers and Congress, with the executive branch as the grant maker representing those stockholders.
We have a fiduciary responsibility to those stockholders. However, lacking structured transparency from the Funds we find ourselves hampered in fulfilling that responsibility.
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My conclusion is quite clear. More transparency is essential. We seek transparency not to control or micro-manage the activities of the Funds, especially at the level of individual investment decisions; that would be clearly against the intent of Congress. However, there clearly is a role for the U.S. Government oversight. The government should monitor the activity of the Funds, provide information and guidance with issues of general country strategy, take into consideration the totality of conditions and objectives, and then work with the boards in management of the Funds to improve performance.
The example of the Czech and Slovak Fund is a clear case where government oversight was essential in rectifying a problematic situation. The merger of the two Russian Funds, the FLER and the Russian-American Enterprise Fund, into TUSRIF is another example.
We are willing to work closely with Fund directors and managers in order to work out the least intrusive ways of exercising our oversight responsibilities.
One idea that has promise, I submit before all of you, is placing a non-voting U.S. Government representative on each of the Fund boards, as is done in the case of the South African Fund.
Another would be for Funds to develop bi-annually business strategies for discussion with U.S. Government representatives, including quantifiable performance measurement tools. The practice of best lending means not giving money away.
One could also see a role for more regular stockholders' meetings, in which both the board and management could be available to answer questions from government interlocutors.
But if we are to be effective as trustworthy custodians of the taxpayers' money, we need to change in the oversight regime so that we can work with the Funds to solve problems and improve performance.
As the U.S. Assistance Program to the Central, Eastern Europe, and New Independent State countries evolves, the role and nature of the Enterprise Funds will also necessarily change. The issues associated with this involve the impact of the existing commitments to the Funds, the mortgage, and how and when the Funds themselves will close out their activities.
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As soon as all funds currently appropriated and budgeted for Enterprise Funds are obligated, there will be an unfunded balance or mortgage of $475 million; $54 million for the European Funds and $421 million for the New Independent States' Funds, including $280 million for the Russia Fund alone. Assuming that budgets for Enterprise Funds are straight-lined, it would take approximately 2 years to pay off the European mortgage, at $27 million per year, and about 5 years to pay off the New Independent States' mortgage, at $84 million per year. The longer time period for the NIS is largely driven by the mortgage on the Russian Fund.
Given declining overall assistance levels for the NIS region, that is, technical assistance, fully funding these mortgages with the appropriated monies could easily crowd out other vital assistance programs.
So we are seeking congressional authorization to fund up to $100 million of the Russia Fund mortgage through a guarantee mechanism. It is estimated that this could cut the NIS mortgage by as much as $60 million.
None of these Funds are to go on forever. Certainly none of the assistance programs, with which each year this Committee is so deeply involved, are to go on forever. Grant agreements with the Enterprise Funds call for each Fund to begin termination and liquidation within 10 to 15 years from the date of its incorporation, except as otherwise agreed to by USAID and the Enterprise Fund. The proceeds derived from liquidation are to be distributed either to a nonprofit entity or entities for the purpose of providing assistance in the host country, or to the U.S. Treasury, or a combination of one and two. Mr. Holmes has gone into this in great detail about what we are hoping to do with the Polish Enterprise Fund, and this no longer is a hypothetical question. The Polish Fund has recently requested our approval to begin liquidating investments funded with USAID grant monies.
Mr. Chairman, our vision for the assistance program to Central and Eastern Europe and the NIS has always been based on a public/private partnership. In the macro sense, we have always seen the assistance program as a transitional set of measures that could help create an economic and political environment in these countries that would attract the infinitely larger sum of private sector investment they need.
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In the micro sense, we have always looked for opportunities to work closely with private sector actors in each of our individual activities. For instance, equity is fundamental and important to getting green field investments in the private sector going quickly.
The Enterprise Funds, almost more than any other project, exemplify this public/private partnership, and we need to continue it. It is going to take patience, but as both of the previous speakers, my colleagues, the two coordinators have said, with time we can see progress and we can see successes. We still see a role for these institutions as part of U.S. Government transition assistance, and we are proud of what we together have accomplished in the region. And we look forward to further years of collaboration with our colleagues in the Funds.
Thank you.
[The testimony of Mr. Dine appears in the appendix.]
Chairman GILMAN. Thank you, Mr. Dine.
Mr. MORNINGSTAR. Excuse me, Mr. Chairman, if I could give you a direct answer to the question you asked me.
Chairman GILMAN. Yes, Mr. Ambassador.
Mr. MORNINGSTAR. With respect to the four NIS Funds, the intended capitalization, the total is $812 million. The obligations that we expect to take place through the end of this fiscal year will be approximately $390 million, and something like $200-plus million has been drawn down by the Funds from the obligations.
Chairman GILMAN. Thank you, Mr. Ambassador.
I direct this question to any of the panelists who wish to answer. What is the formal process by which the President receives nominations for appointments to the boards of directors for the Enterprise Funds?
Mr. Holmes.
Mr. HOLMES. Mr. Chairman, it is the obligation of the coordinators to forward to the President advice as to vacancies, resignations on the boards, and to request the advice of the President for replacement for successors.
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We do that by sending to the White House Personnel Office names which have come to us from the Enterprise Funds themselves. We add to that names which have come to our attention through our own canvas, and then the White House may have some names which it adds to the pool.
Subsequently, we are advised as to the disposition of the President and his recommendation back to us and is transmitted back to the Funds.
Chairman GILMAN. Do you solicit members for the board before it goes to the President?
Mr. HOLMES. We have solicited names from the Funds. We have not solicited names for those whom we add. We do that on the basis of an informal information gathering of who may have the expertise that we are looking for for consideration.
Chairman GILMAN. Are there specific criteria that you look for?
Mr. HOLMES. It is a mix. We look for criteria in terms of professional experience as investment bankers or lenders. We look for expertise in terms of regional or language expertise. In one particular instance we were interested in bringing someone on board who had special capabilities in terms of recruitment of personnel, and we were able to get that person.
Chairman GILMAN. I see that, under the SEED Act, the board members have to have demonstrated experience and expertise in areas of private sector development in which the enterprise is involved.
Is that pretty much adhered to?
Mr. HOLMES. I believe, in the case of Central-East European States that that has been pretty faithfully adhered to.
Chairman GILMAN. And in other boards, has it been adhered to?
Mr. MORNINGSTAR. I believe so. Let me make two points with respect to the NIS.
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First of all, because the NIS Funds are younger funds, we have not yet had to put in new directors. Terms, basically, are just beginning to expire from the initial terms. I think we have made one change of one director since I have been involved in my job. But it will become more of an issue, and I think the points that Mr. Holmes made are exactly right.
With respect to the present makeup of the boards of the NIS Enterprise Funds, speaking of somebody from the private sector, I am fully satisfied with those boards from that standpoint.
Chairman GILMAN. Have they all demonstrated experience and expertise in private sector development?
Mr. MORNINGSTAR. Yes, in virtually all instances that I am aware of.
Chairman GILMAN. How many directors are there on each board?
Mr. MORNINGSTAR. I can give you approximate numbers. There are something like 11 or 12 on the U.S.-Russian Investment Fund. There are something like half a dozen on the other Funds.
And if you look at the U.S.-Russian Investment Fund, in which Mike Blumenthal is the chairman, and of course has had much private sector experience as well as public sector experience, virtually every member of that board are well renowned——
Chairman GILMAN. Are they all paid members?
Mr. MORNINGSTAR. No, none are paid members. They are all volunteers.
Chairman GILMAN. And what about the chairman of the boards?
Mr. MORNINGSTAR. The chairman is a volunteer as well. The CEO, of course, is paid.
Chairman GILMAN. How much is the CEO paid?
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Mr. MORNINGSTAR. There is a salary cap, and I think this is actually an issue if you want to get into it. There is a salary cap of $150,000 a year.
Chairman GILMAN. For each CEO?
Mr. MORNINGSTAR. For each CEO.
Chairman GILMAN. Gee-whiz, I think maybe some of the Members of Congress may be looking to become a CEO.
Mr. MORNINGSTAR. But if you are looking for good qualified investment bankers to run these Funds, they can make a lot more money in other places.
Mr. HAMILTON. Would the gentleman yield?
Chairman GILMAN. I would be pleased to yield.
Mr. HAMILTON. Is that their total compensation?
Mr. MORNINGSTAR. Excuse me, sir?
Mr. HAMILTON. Is the $150,000 their total compensation?
Mr. MORNINGSTAR. I assume that they receive some benefits such as medical.
Mr. HAMILTON. But there is no other way of them earning additional money?
Mr. MORNINGSTAR. Mr. Holmes should talk about the Polish Fund, with respect to the private part of that Fund.
As of this moment, not on any of the NIS Funds.
Chairman GILMAN. And the CEO is a full-time job?
Mr. MORNINGSTAR. Absolutely.
Chairman GILMAN. Mr. Holmes, did you want to comment?
Mr. HOLMES. Yes. Much is similar with the Central-East European Funds. None of the board members are compensated. The CEO is compensated. The qualifications, I think, have been respected for all of the members.
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As for the compensation, there is a salary cap of $150,000 for the work which is done on behalf of managing U.S. Government investment.
In the case of the Polish-American Fund, we have recently given the Polish-American Fund authority to privatize its investment team. The consequence of privatizing this investment team is that it is still capped at $150,000 as far as compensation for the management of U.S. investment is concerned. They are, however, able to earn what they can from the management of private funds which they also manage.
We did this, Mr. Chairman, because we discovered that as the Polish-American Fund was successful in raising $262 million and thereby outstripping the investment of the U.S. capital, we found that with a cap of $150,000 on their salary the U.S. Government was in effect subsidizing the management of private capital investment.
And so we asked for them to correct this. We negotiated a deal whereby the overall cost to the U.S. Government for the management of U.S. investment was dropped and capped at a total of $1.5 million, as I recall, and the $150,000 per person cap was left on. But they also picked up an obligation to pay for the management of the private capital out of their private income.
Chairman GILMAN. Then what is the total income for that CEO?
Mr. HOLMES. I cannot tell you at this point. We will have to——
Chairman GILMAN. Roughly.
Mr. HOLMES. I cannot give you a rough estimate. We will have to provide that to you, Mr. Chairman.
Chairman GILMAN. Well, if you will provide it in writing regarding the Polish Fund.
Is all of that $262 million from private sources?
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Mr. HOLMES. $262 million has been raised from private sources in two separate fund raisings since 1992, yes.
Chairman GILMAN. Is part from the European Bank?
Mr. HOLMES. Excuse me?
Chairman GILMAN. Is a portion of it from the European Bank?
Mr. HOLMES. I believe that there is a small portion.
Chairman GILMAN. Is it correct that in 1975 a consulting firm retained by AID to assess the Enterprise Funds, to assess their operations and oversight, and I think the organization was Development Alternatives, Incorporated, determined that U.S. Government monitoring and oversight of the Funds was wholly inadequate? In a 1975 report, I believe?
Mr. DINE. You mean 1995.
Chairman GILMAN. I mean 1995. Forgive me.
Mr. DINE. Yes, I have it in front of me, Mr. Chairman. The final report by the Development Alternatives, Incorporated, entitled ''Program Evaluation of the Central and Eastern Europe Enterprise Funds.''
It says, ''The Funds need to retain their independent operational status, but the U.S. Government needs a way of intervening when Funds are failing,'' and there are some other conclusions.
Chairman GILMAN. And what was done as a result of implementing that recommendation?
Mr. DINE. Well, I think that there has been more contact with many of the Funds. There is a certain resistance as well, and I think in our testimonies that that tension came out. But I would like to think that that can be creative tension.
Chairman GILMAN. Well, just saying that you think there was more conflict certainly does not implement that kind of a report.
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Was anything done formally by the——
Mr. DINE. Well, I can tell you right now, Mr. Chairman, what AID does, and there are four different ways we try to oversee these Funds.
Chairman GILMAN. Tell me what specifically they did with regard to this recommendation by Development Alternatives, Mr. Dine.
Mr. DINE. Well, first of all, that led to the opening up of the Czech-Slovak failure. That led directly to awareness of that failure.
Chairman GILMAN. What I am looking for is, what was done to implement those recommendations?
Mr. DINE. We were being stonewalled by the then chairman of the Czech-Slovak Enterprise Fund in every which way. I remembered long nights with Jim Holmes' predecessor with the chairman then.
Chairman GILMAN. You are telling us about the problem.
Mr. DINE. He would not give an inch.
Chairman GILMAN. You are telling us about the problem now, Mr. Dine.
Mr. DINE. I am sorry?
Chairman GILMAN. You are telling me about the problem.
What was done to implement?
Mr. DINE. When this official evaluation came back we were able to open up information about this Fund.
Chairman GILMAN. Well, what specifically was recommended to the Agency?
Mr. DINE. That the GAO would look into it; then our own IG went to work on it, and ultimately it led to the exposure of this particular failure. So this report was important.
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Mr. MORNINGSTAR. Let me try and answer it this way. I think there are several things that have happened since that time, including some very detailed, and I think the Funds would call overly burdensome, semi-annual reviews.
We are in the process with respect to the NIS Funds, virtually a completed process, of setting up performance measures whereby at any point in time we at least can ask questions as to why or why not certain objectives have or have not been met.
Having said that, I do not think there is any substitute for me in my job to spend the appropriate amount of time consulting and working with the CEOs of the various Funds.
Chairman GILMAN. And are you doing that now?
Mr. MORNINGSTAR. We are doing that now. I believe I am doing it now. I know Coordinator Holmes is doing it now.
Chairman GILMAN. Are the CEOs in the respective countries or are they here in Washington?
Mr. MORNINGSTAR. It depends on the CEO. The CEO of the Central Asian Fund actually lives in Almaty. The CEO of the West NIS Fund splits his time between Kiev and is spending more and more time in Kiev and the United States. The new CEO of the TUSRIF Fund is actively considering moving to Moscow, but is spending most of his time there. The Defense Enterprise Fund chairman, I think, travels back and forth.
But the point is by constantly working with the CEO there can be an accommodation and reconciliation of the various issues because the government does have a stake in these Funds from a policy standpoint. And again, not to belabor the point, I speak as somebody coming from the private sector, but the private sector believes that they are the only people that should be making decisions with respect to the Funds.
I think with this communication one can come up with the right balance as to things like pace of investment, regions where the Funds ought to be investing in, pushing the Funds in certain directions such as the small loan program, and there can be a consensus and an agreement. And at least we understand why things happen.
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When I came into my job during the first year I was very concerned about the slow pace of investment in the West NIS and the slow pace of investment in the U.S.-Russian Investment Fund. By working with the CEOs, I have realized, and also having a lot more knowledge about the region, that the West NIS problems are not problems of the Fund, but problems of the environment, and they are really doing a pretty good job. Working with the TUSRIF CEO, yes, they realize that they had some organizational issues. They are correcting those organizational issues, and they are doing a better job. I think that is the way it has gone.
Chairman GILMAN. Thank you, Mr. Ambassador
Mr. Hamilton.
Mr. HAMILTON. Thank you, Mr. Chairman.
What U.S. Government official had responsibility for the oversight of the Czech and Slovak Enterprise Fund?
Mr. HOLMES. I believe that the coordinator's office—the coordinator and USAID shared responsibility for different aspects of this. The day-to-day——
Mr. HAMILTON. Now you are talking about the coordinator of?
Mr. HOLMES. Myself, my job; my predecessor.
Mr. HAMILTON. So the coordinator for Eastern European Assistance had the responsibility to oversee the——
Mr. HOLMES. To assure——
Mr. HAMILTON [continuing]. operation of the Czech and Slovak Enterprise Fund from 1991 to 1995 or 1996?
Mr. HOLMES. That is correct. To assure that there was appropriate and adequate oversight. The day-to-day oversight was the responsibility of USAID in performance of its responsibilities under the grant agreement.
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Mr. HAMILTON. And under whose responsibility at AID was the oversight function?
Mr. DINE. That is the responsibility of myself. Until I came to this job, Mr. Hamilton, there was no assistant administrator for both Europe and the NIS. So the predecessor to me would have been the assistant administrator for just Europe. But ultimately I believe the USAID has oversight in managing the grant because it is a grant, and we are obligated by law to manage those things.
Mr. HAMILTON. Now, one of the problems may be that two people are claiming oversight responsibility; is that right?
Mr. DINE. That is correct. But both of us——
Mr. HAMILTON. How much——
Mr. HOLMES. I do not believe this is a problem. We have worked out responsibilities. We have shared the identification and allocation of those responsibilities with this Committee.
Mr. HAMILTON. Well, there is a difference between is and was. Big difference, right?
Mr. HOLMES. Correct.
Mr. HAMILTON. There was a problem, right?
Mr. HOLMES. Correct.
Mr. HAMILTON. And the oversight was not adequate, right?
Mr. HOLMES. Correct.
Mr. HAMILTON. And the oversight was not adequate in the coordinator's office for Eastern European Affairs Assistance, and the oversight was not adequate in the Assistant Administrator's Office, is that right?
Mr. HOLMES. I believe that tells part of the story. The rest of the story——
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Mr. HAMILTON. Now, who do you report to on this? I mean, who is above you in the chain of command?
Mr. HOLMES. Assistant Secretary of State for European and Canadian Affairs.
Mr. HAMILTON. Assistant Secretary of State for European Affairs?
Mr. HOLMES. Correct.
Chairman GILMAN. And, Mr. Dine, to whom do you report?
Mr. DINE. I report to the Administrator of the U.S. Agency for International Development.
Mr. HAMILTON. OK. And so we had inadequate oversight here.
How much money was lost on the part of the taxpayer?
Mr. HOLMES. Approximately $18 million.
Mr. HAMILTON. Any of it recouped?
Mr. HOLMES. A small amount of the investment. I think it is something on the order of $1.2 million of the original investment was recouped.
Mr. HAMILTON. Any criminal indictments here?
Mr. HOLMES. The issue has been referred on two previous occasions to the Inspector General's Office and to the Department of Justice. No indictments resulted.
Mr. HAMILTON. So there was no criminal conduct that we know of?
Mr. HOLMES. That is correct. Rampant mismanagement was identified as the cause by the Interim Board.
Mr. HAMILTON. Now, you have made, several of you, in the course of your observations this morning a number of recommendations.
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Do you feel that any legislative change is necessary to bring the transparency and the accountability and the power to intervene and the other things you have been talking about?
Mr. DINE. Mr. Hamilton, if I could make one suggestion. Because we are up now to the line of when we want to interfere and when we do not want to interfere. But these privately run enterprises with public funds still need to use modern measures of management.
Mr. HAMILTON. Sure.
Mr. DINE. And that is a strategic business plan, which I would like to see. I think my colleagues would like to see. Use of indicators, and use of measurement of results. That is how you want to evaluate us. But, you know, perhaps report language is all that is necessary. But we need more transparency, and we do not have it now.
Mr. HAMILTON. Do you need any legislative change?
Mr. DINE. Getting those business plans to us would be very helpful.
Mr. HAMILTON. I would like for you to reflect on the question I have asked and to let the Chairman and myself know whether or not you think any legislative change is necessary on the basis of your experience in looking back over this Czech and Slovak Enterprise Fund and maybe some of the other Funds as well. I kind of have the sense on the basis of your comments this morning that you might think some changes are necessary.
It is interesting to me in listening to you, Mr. Holmes, you put heavy emphasis on the responsibility of the board of directors, and no substitute for that, and the primary responsibility of the board of directors. Mr. Dine, in his testimony, puts a lot of emphasis on the stockholders or the U.S. taxpayers and the Congress, or the executive branch as the grant maker, as you put it. We have a fiduciary responsibility. I guess both things are true, but it does reflect to me some kind of difference, and I am afraid that the problem with the Czech and Slovak Enterprise Fund arose because of inadequacies in the oversight mechanism, and maybe inadequacies in the concepts here.
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Mr. HOLMES. If I may offer a comment. Certainly it did not arise as a result of inadequacy of oversight. It arose out of the default management structure that the board of directors put in place. The failure of the——
Mr. HAMILTON. It arose because you had some individuals who conducted themselves inappropriately.
Mr. HOLMES. Inappropriate under any sense of corporate governance.
Mr. HAMILTON. Yes.
Mr. HOLMES. The fact that we did not have the mechanism by which we could penetrate the screen which they put up in terms of the information that they provided to us was an example of inadequate oversight.
Mr. HAMILTON. Are you confident now that you have the——
Mr. HOLMES. We have rectified that.
Mr. HAMILTON. You have rectified it and you are confident now that you could not have another Czech-Slovak fiasco?
Mr. HOLMES. Having reviewed the other Enterprise Funds in Central and Eastern Europe, I believe it is not the case that there is among the other six Funds the chance of replication of that disaster.
Chairman GILMAN. Would the gentleman yield?
Mr. HAMILTON. Wait. I did not get that answer. Did you say you have put in place?
Mr. HOLMES. We have reviewed the other six Funds using the example of the Czech-Slovak, and we believe that we can offer a judgment to you that it is not likely to replicate in the other six Funds that case of disaster.
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Mr. HAMILTON. Are you satisfied with the present law? Do you see any need for a change in the law?
Mr. HOLMES. I am satisfied with the present law. I think Congress's intent was for us to be minimalist in terms of our——
Mr. HAMILTON. You have adequate powers of intervention?
Mr. HOLMES. I believe that we have adequate powers of intervention now, yes.
Chairman GILMAN. Would the gentleman yield?
Mr. HAMILTON. Yes. Sure.
Chairman GILMAN. With regard to transparency and with regard to assuring that there is proper conduct at the board level, I note that in our legislation we call for GAO audits that could be utilized. We call for annual reports. We call for independent private audits.
Now, were you receiving independent private audits?
Mr. HOLMES. Yes.
Chairman GILMAN. Were you receiving GAO audits and were you receiving reports when all of this occurred in the Czech problem?
Mr. HOLMES. The answer to that is yes, there were annual reports, there were independent private audits, but as I said in my testimony, we discovered that the independent private audit was very circumscribed because there had been a clear intent on the part of the board to direct the audits to be conducted in a way which did not result in any comment on the quality of their internal controls.
We have rectified that. They are now required to provide us with audits which also comment on the quality of internal controls.
Chairman GILMAN. And do you require GAO audits?
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Mr. HOLMES. GAO audits have been held. We have not required them. They are available to us on request, and they have been requested on occasions.
Chairman GILMAN. Just on occasion, but not on an annual basis?
Mr. HOLMES. Not on an annual basis.
Chairman GILMAN. Thank you. I thank the gentleman for yielding.
Mr. HAMILTON. Just one other question, Mr. Chairman.
If, in fact, the U.S. taxpayers and the Congress are the stockholders, as Mr. Dine says, why should there not be a government representative on these boards?
Mr. MORNINGSTAR. Let me try that one. I do not think there is any reason why there should not be a government representative on the board, at least as a nonvoting member.
You know, there was a question earlier in a discussion as to whether all of the board members had had considerable private sector experience. I do think we have to recognize that we are talking about a very strange kettle of fish when we are talking about these Enterprise Funds; that we are talking about regions in which many of the private sector board members have never had any experience. We are talking about situations where the United States has a very direct policy interest in setting up an enterprise fund in a given region, and that the Enterprise Fund has to be consistent and to be integrated with our whole foreign policy and assistance and cooperative approach in that region.
I think that there are skills which could be helpful to a board of directors that do go beyond private sector investment experience. And I think that one of the problems with the Enterprise Funds is that if you have a board that is made up 100 percent of people who have had private sector investment banking experience without at least some buffer by a member—it does not even need to be a government member—but somebody that has some kind of a policy experience or brings a different perspective. I think that that is one of the prescriptions for some of the problems that have arisen. I do not mean the Czech-Slovak problems, but more performance-related problems, and I think it is important.
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And I do think it is important that there be close coordination between the policy apparatus of the government, for lack of a better term, and the Enterprise Funds to make sure that the Funds and the government are in sync so that the objective of creating private sector ventures that are commercially profitable are met at the same time where the activities are consistent with what we want to accomplish from a foreign policy standpoint.
Mr. HOLMES. Mr. Hamilton, if I could just comment.
Mr. DINE. I think we have a conflict of nuance here. Mr. Holmes rightfully asks and calls for minimalist approach. I think what is behind my suggestions in my written and oral statement is that human nature requires something more than self-regulation. And in this case I believe that the Czech example could replicate itself. You could have a recalcitrant chairman, but it would not last long, it would not last as long as it did with the Czech-Slovak Fund example.
Mr. Birkelund, who is the chairperson of the Polish Fund, is an extraordinarily successful person in his private sector pursuits as well as in the Polish-American Fund pursuit. And he is certainly a minimalist. He claims that because the government has stayed away from the operations of that Fund it has been successful. I would say that it is because of the mixed board. Not only do you have geniuses from Wall Street like Mr. Birkelund, but also Lane Kirkland and Dr. Brezinski giving it a different flavor, a country geo-political flavor, a labor orientation that other Funds do not have.
So I stand by what I recommended in my opening statement. We need more government involvement, and I believe in a nonvoting U.S. Government member on the boards. We need more transparency. We need business plans that we can evaluate ourselves, and with these abuses we can prevent human nature overcoming us as it did on the Czech-Slovak Fund.
Chairman GILMAN. The gentleman's time has expired.
Mr. Bereuter.
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Mr. BEREUTER. Thank you, Mr. Chairman.
I would just, since we are talking about board membership, gentlemen, I would just mention it is my understanding that while the President designates the initial board members for each Fund, successor U.S. and host country board members are elected by the boards themself after receiving the advice of the President. So the board can change dramatically.
I am told that the bylaws of the Romania-American Fund, for example, permit Presidential appointees to be removed by a simple majority vote. So I bring that to your attention, and I am going to talk about conflicts of interest here that seem to me to be potentially a very serious problem.
You recall the discredit brought on by recent disclosure about a Harvard University grant in Russia. And while we have clear problems that have existed already and we want to learn from those problems, I would focus a number of comments and series of questions based upon avoiding potential conflicts of interest in the future.
Now, the Chairman got a letter from the Justice Department this month which stated its opinion that the employees of Funds authorized under the SEED Act are not subject to the Federal conflict of interest statutes.
In light of that I note that the Polish-American and Hungarian-American Enterprise Funds' efforts have underway or are planning to shift certain personnel to affiliates. Those affiliates will manage the Funds' investment activities for a fee, and they are created by the very same personnel of those Funds. Those affiliates are then to be completely privatized by purchase by those personnel, as I understand it.
It appears that the new privatization, the affiliate, will continue to manage the original Enterprise Funds' activities for a fee. So a series of questions come out of that.
Would it not ordinarily be considered a conflict of interest to have evolved in that process? How do the State Department and Agency for International Development view such efforts by Enterprise Funds personnels to create affiliates that they will ultimately own, initially using resources loaned by the Fund? What oversight do the State Department and AID enjoy over the affiliate organizations that will be created by personnel of the Enterprise Funds? If Funds' capital and/or profits go to foundations for various purposes, how do we know who will run those foundations? What will Congress's role be in approving the Funds and the personnel? How do we prevent conflicts of interest in the setting up of those foundations on the part of Fund personnel?
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I want to ask you to try to address those questions, but I want to call one related set of facts or information, at least, I hope they are factual. This is a letter sent to President Clinton I am going to read from, by a member of one of the Enterprise Funds protesting what he felt was mismanagement and inappropriate use of funds. This is a man who is an extraordinarily successful entrepreneur, had very high knowledge of Romania in the past.
I think, in fact, among the most interesting things he indicates is that a law firm, Robert C. Odel, Jr., and a law firm of Weil, Gottschall & Manges got the Romania-American Enterprise Funds business, or they became the legal advisor, that is to say, by providing Articles of Incorporation pro bono in exchange for the Romania-American Fund hiring this firm as its corporate counsel.
He then alleges that in fact this was a practice of this law firm and individual—I assume he works for the law firm—for a number of other Enterprise Funds. And that the first financial statement before a single dollar had been lent showed that for the Romania-American Fund over $273,000 was charged for professional services, very little for accounting, almost all for legal services, and that the firm was charging $450 an hour for services.
So if in fact he is right that this firm sort of has a lock on legal services for a variety of Enterprise Funds, I think it does raise a question about the appropriate use of those resources.
Now, Mr. Dine, you have in your written information here an indication that the conference report includes statements like AID's role is to simply write the check and so on. I would be interested in seeing those. I do not doubt you, but I want to look at who said those, which of my colleagues said those.
And, Mr. Holmes, you referred to a minimalist kind of approach. I certainly agree that if these Funds were to work we had to do something different so that there would be an expeditious way of handling things, and we would not be dealing with the normal kind of red tape and bureaucracy that we seem to bind AID with, for example. There is a happy medium, and somehow we need to conduct oversight—I think we certainly need to avoid conflicts of interest since apparently the conflict of interest laws of our government do not apply to the Funds.
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Now, what can you gentlemen say to set my mind at ease about this, or what do you suggest that we ought to do to avoid some of the potential conflicts of interest that will be created when we privatize the management of the resources of some of these Funds through foundations or affiliates?
Mr. HOLMES. Mr. Bereuter, if I could begin. You have asked a number of very important questions, and I certainly cannot address them all, but I will address some of them, those which I can remember, and you can refresh our memories if we fail to address those which you regard as most important.
If I could begin with one of your latter questions with respect to conflicts of interest. It is important to remember that these are privately incorporated funds, and as privately incorporated funds, I think all of them under the State of Delaware provisions, they are authorized to retain whatever legal counsel they wish, and some have chosen the firm which you identified, some have chosen some other firms as their legal counsel.
The letter to which you refer, I believe I know the author of that letter, and it is important in this regard to recall that the letter writer was himself chairman of that board for virtually the entire period of time about which he now complains. So if there was something amiss in terms of the management and the board of directors' activities with relationship to any of its undertakings, he has much to explain for himself.
In any event, taken his claim seriously. We have referred each of his letters to independent investigations, to the Office of the Inspector General in AID, and we have asked them to advise us whether or not there is any basis for a followup, either administrative or legal followup. And to date in each instance we have been advised that is not the case, not the basis for followup.
You asked whether or not the Department of State and AID had a position with respect to privatization of the investor's management team in the case of the Polish-American Enterprise Fund. And there we are in Terra incognito. We do not know precisely where we have been or where we have to go, but we do know that one of the processes through which we have to go is privatization.
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We know that what has been up until now heavily U.S. Government investment has to be arranged in a way in which it permits us to exit. And therefore we regarded favorably the proposal to privatize the investment team in a way which permits the Enterprise Fund, in this case the Polish-American Enterprise Fund, to exit and to sell off its government investments without unloading the entire operation.
Mr. BEREUTER. Mr. Holmes, if I could interject a related question.
Are you considering precluding employees of the Fund or board members of the Fund from being involved in those privatization spin offs?
Mr. HOLMES. We have precluded the investment team itself with the exception of the CEO, who is head of the investment team, we have precluded them from the board of directors which oversees this privatization structure.
So the direction which they take from a board of directors for the privatization team is independent of the team itself, with the exception of the CEO who is recused from those sorts of issues when they are discussed by the board.
Mr. BEREUTER. Mr. Holmes, on the Defense Enterprise Fund, as you move to that direction, this will be primarily your responsibility, Ambassador. In fact, your are seeding that with substantial amount of funds, U.S. Federal funds, U.S. Government funds, $15 million roughly, in that area?
Mr. MORNINGSTAR. Yes. The total capitalization, if in fact we are able to obligate it, would be $72 million, which would actually make it the—other than the TransCaucasus Fund—by far the smallest of the NIS Funds.
Mr. BEREUTER. Is it true that there will be no limitation on the compensation paid to those involved?
Mr. MORNINGSTAR. That has not been determined. And just to apprise you of the situation with respect to that, there has been a lot of consultation, much, much consultation between the Defense Enterprise Fund and various committees with respect to its future. And it is too long a history to get into at this hearing.
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One of the goals of the Defense Enterprise Fund is to set up a private fund. Before the Enterprise Fund does that or is allowed to do that, that is going to have to be cleared by all of the appropriate committees, of both the Appropriations Committees on both House and Senate, and authorizing committees.
As of 2 weeks ago, when we had our last consultation with the Senate Appropriations Committee, the Defense Enterprise Fund determined that it would not put forward its proposal for a private fund at this particular juncture, and was seeking only to have the remaining $15 million to be obligated.
As far as I am concerned, and I would have to give final approval, there is no determination yet as to how that compensation would take place.
But with respect to the U.S.-Russian Investment Fund the way it would be set up if their proposal to privatize the Fund—if they go forward with their proposal to privatize part of their Fund or to guarantee part of their Fund, no money addition to the cap could be compensated until the United States was paid back in full.
So what we need to do is to come up, with respect to these compensation issues, some kind of program where there is an incentive for the Fund people that they could ultimately make more money but not until the United States is paid back.
Mr. HOLMES. If I might add——
Chairman GILMAN. The gentleman's time has expired, and I am going to ask if you bear with us, we are on a vote and we have one more Member who would like to question.
Mr. Luther. And before doing that, oh, I am sorry. It was Mr. Davis who was here before Mr. Luther. And if you would be brief, maybe we can get Mr. Luther's question in before we finish.
And, gentlemen, we will submit some questions in writing and ask the panelists if you would be kind enough to cooperate by replying expeditiously.
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Mr. Davis.
Mr. DAVIS. Let me ask a few questions unencumbered by much knowledge as to what you all do, and if I ask you something that has already been covered just let me know and I will pick that up later.
To what extent have you all essentially polled the existing or former directors of these various Funds to ascertain their suggestions as to how to improve their ability to govern the Funds?
Mr. MORNINGSTAR. Maybe I will start on that one since I have been working, it seems like, for the last 6 or 8 months at this point on working out the appropriate performance measures with the NIS Funds, and that is a constant back and forth that has been taking place between our office, AID, and the Funds as to what is the appropriate way to look at those Funds and how should we measure it, and what should be used for informational purposes, what should be used for measurements and so on. So their input has been very great, particularly in the last several months on these types of issues.
Mr. HOLMES. For the Central-East European Funds, exactly the same. We have semi-annual reviews in which we have face to face discussions about performance. We also have, frankly, sometimes it is weekly or several times a week discussions with the CEOs and chairmen of the board about particular issues. So there is no absence of interface with them.
Mr. DINE. And you mentioned also, Mr. Congressman, former board members? Well, they call all the time because they are very curious as to what is still taking place or what is not taking place. So I can report on conversations I have had.
Mr. DAVIS. Have any of these folks identified to you tools that they need to better do their job as far as auditing?
And by auditing, I am referring to something more like a performance review, a measure of best business practices as distinguished from a fiscal or compliance audit.
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Mr. DINE. Well, what you normally hear on these phone calls is not exactly what you just suggested, although that is critical. You mainly hear comments about other human beings.
Mr. HOLMES. I recall no instance in which a member of the board has asked for a change in arrangements or authorities for them to better carry on their responsibilities. As a matter of fact, virtually all of the suggestions for change and presses for change have come in the other direction because we started out with an arrangement which had the absolute barest minimum amount of taxpayer oversight, and we have been incrementally increasing that.
Mr. MORNINGSTAR. I would agree with Mr. Holmes.
Mr. DAVIS. Last question is what is your opinion as to the merit of continuing the policy of allowing the board to reconfigure itself as far as appointments?
Mr. MORNINGSTAR. First of all, I think that that is somewhat a misnomer. That really is not what is happening, at least I can only talk with respect to the NIS. The President still has to approve any changes that are made with respect to the board. If a suggestion comes from the board for a new director, that does have to be approved by the White House, and they go through whatever vetting process they do. It does not require Senate confirmation. But we do have to have approval from the White House and the President before a new board member goes in place on the NIS Funds, and I assume the same is true with Mr. Holmes.
Mr. HOLMES. In a strictly legal sense it is probably the case, although it has never been tested, that the boards have a legal right to self-renew. They also are required, however, to gain the advice of the President. I know of no instance where any board has been prepared to challenge the issue of the advice of the President and proceed with renewal or with the selection of a board member whom it chooses in the opposition to the Administration. So in a practical sense they have not enjoyed the right of self-renewal.
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Mr. DAVIS. Thank you. I yield the balance of my time, Mr. Chairman.
Chairman GILMAN. I thank the gentleman for yielding.
Mr. Luther.
Mr. LUTHER. Thank you, Mr. Chairman. Perhaps in the interest of time if the witnesses could just respond in writing, that would certainly be agreeable.
Chairman GILMAN. I have already made the request on behalf of all the Members.
Mr. LUTHER. Thank you.
Chairman GILMAN. Go ahead, Mr. Luther.
Mr. LUTHER. Thank you, Mr. Chairman.
My interest is in whether it would make more sense in some instances to be providing assistance to change policies within the countries rather than putting as much reliance as we currently do on the Enterprise Funds. In other words, just a general discussion of whether or not this is the best way to achieve the kind of successes we are all hoping for in the countries, or whether we could be spending more of our effort on the policies. Because as I look at the success of some of the Funds compared to others, you wonder how much of it is related to the actual policies within the countries involved and whether we should then take a lesson from that and try to do more to change and reform those policies.
Chairman GILMAN. Thank you. Did you want to comment and answer?
Mr. DINE. We all have an opinion on this, Mr. Chairman.
Mr. MORNINGSTAR. First of all, let me just say——
Chairman GILMAN. Please be brief. We have about 5 minutes left to get to the floor to vote.
Mr. MORNINGSTAR. OK. On the NIS Funds we are only obligating as the Funds need investment money. The percentage of other—there still is a mortgage hanging out there. The percentage of monies that are going to Enterprise Funds compared to monies going to other assistance programs is still extremely, extremely small in the NIS.
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Mr. HOLMES. Mr. Chairman, if I could simply add to that, that Enterprise Funds are not the exceptional beneficiary of assistance, but I know of no other foreign assistance tool that has been as successful in transferring technology, stimulating private investment, training professionals in good business practices and ethics, growing jobs, illustrating marketplace economics, and interesting American entrepreneurs in the economics of the whole region, and returns money to the U.S. Treasury after it is all done, and that is what I think is a clear virtue of the Enterprise Funds.
Chairman GILMAN. Thank you very much.
The hearing stands adjourned, and I thank our panelists.
[Whereupon, at 11:40 a.m., the Committee was adjourned.]
A P P E N D I X
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