How FSB benefits from Ukraine’s botched audit of defense contractors — expert interview

Glib Kanievskyi, the head of the Kyiv-based think tank StateWatch, explained in an interview with NV Radio on Oct. 25 why Ukrainian defense enterprises are asking the government to protect them from “attacks” by state auditors and law enforcement due to an alleged mistake in a government document.

NV: You said that the inspection of the State Audit Service of Ukrainian arms and ammunition manufacturers causes concern. And secondly, in your opinion, Russia’s Federal Security Service (FSB) has hacked the Ukrainian state control and audit service. These are quite grave accusations or even assumptions. How did you arrive at these conclusions? And what’s wrong, from your point of view, with the State Audit Service?

Kanievskyi: Let’s break it down for everyone so that my statement about the FSB becomes clearer.

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First of all, the State Audit Service reviews defense contracts during martial law to determine their effectiveness or ineffectiveness. To put it simply: whether budget funds were effectively spent on secret direct contracts that were urgently concluded without procurement procedures during martial law to provide the Armed Forces of Ukraine with ammunition, missiles, weapons, etc. [This includes] both foreign suppliers and Ukrainian manufacturers.

As for Ukrainian manufacturers, unlike foreign suppliers, there is a special price agreement procedure, which is regulated by the Cabinet. That is, if we don’t have procurement procedures, but have direct contracts, we have a limited range of manufacturers. We understand that there are actually only a few manufacturers of combat drones and ammunition in Ukraine, both in the public or private sector. There can be no competition for some positions. Therefore, the price should be regulated by the Cabinet.

Accordingly, it was with the state arms and ammunition manufacturers that the problem occurred during the state audit.

At the beginning of [Russia’s] military invasion, to somehow regulate this price (there are no auctions, there are no procedures, there is a need, and there is money) so that it doesn’t go up, so that the state doesn’t suffer [economic] losses, the Cabinet issued a decree that clearly defined what should be the price of the contract under which the Defense Ministry or other security bodies have the right to purchase weapons and ammunition.

And this is where the first failure occurred in the state contract system. Because somehow it happened (for some reason no one in the Cabinet can explain this now) that it was in this price chain that they forgot to include such a component as profit. The profit of a specific arms and ammunition manufacturer, which he can count on during trade with the Defense Ministry or other authorities. Despite the fact that in all previous similar documents, for previous periods, of course, the profit was a distinct component of the contract price.

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It might seem like an obvious thing that profit must be in any contract. Because that’s how a market economy works, and it cannot work otherwise, regardless of whether it’s a public or private supplier. But here this stumbling block appeared.

The State Audit Service’s management was invited by the then-Defense Minister [Oleksii] Reznikov to check these contracts so that Reznikov could show the society and international partners, and his managers in the President’s Office that “the funds were spent efficiently.” Reznikov invited the auditors to check, and the auditors came with an inspection.

But the auditors began to literally take on this resolution, to interpret it in such a way that no producer, whether state or private, when this resolution was in force on the territory of Ukraine during martial law, has the right to make a profit from the [state] budget.

Of course, both the Defense Ministry and the Cabinet now insist that the arms and ammunition suppliers had the right to expect a profit. Do you know what would happen without profit? No one would sign a contract in March, in April 2022, i.e., at the hottest peaks of confrontation with Russia, when it was necessary to oust them from Kyiv Oblast, while international weapons had not yet arrived. We had to rely on our own capacity.

[Otherwise, if the contracts were without profit], there wouldn’t be a single contract. State auditors would simply have nothing to check.

NV: And what was left for the State Audit Service? To interpret the resolution in a different way? If it states that no profit is provided for...

Kanievskyi: It doesn’t state that it’s provided or not provided. The profit simply doesn’t go separated by commas there as a component of the contract price.

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Why do I say that our state control system is broken, and the FSB now doesn’t need to make any special efforts to get the “pick of the basket” from this problem? Because the State Audit Service, instead of trying to solve this problem at the stage when it was at least recorded, with the beginning of the first audits, raised this issue with the Cabinet that “that’s what happened, the resolution was adopted, it’s ineffective, it must be changed quickly,” they would already start conducting audits there... I emphasize the Defense Ministry and the Cabinet in this situation take the position that the audit service interprets the resolution incorrectly.

The problem of building a missile plant is really a problem, because how to build it, when we haven’t built plants to produce missiles for 30 years, we have neither specialists, nor technologies, we have nothing. This is really a problem that needs to be worked on. And here the problem is that they forgot to include the phrase in the resolution. And the government, the parliament are working on this problem, they even wrote a letter to the head of the President’s Office of Ukraine, Andriy Yermak, asking him to at least look into this problem and solve it. And no one can solve it.

NV: The manufacturers immediately understood who could decide it.

Kanievskyi: But no one has solved it yet. And look what we have. The audit service conducts its inspections. And instead of really counting the funds, whether they were effectively or ineffectively used, the auditors stick with this stumbling block, which is in fact meaningless. But at the same time, it allows state auditors to write their reports, and to write that the state has suffered billions of hryvnias in losses, because something was not specified in the [Cabinet] decree.

And it seems that the State Audit Service is working. It fulfilled its mission, checked the contracts. After that, the State Audit Service writes statements to law enforcement agencies, the State Bureau of Investigation (SBI), the police: “Open criminal proceedings, because the state has suffered billions in losses here.”

And they’re happy to open proceedings. Because it’s also a very easy matter for them. There are auditors, there are appeals from auditors, there is some amount worth billions of hryvnias, and it’s possible to issue endless press releases about the victory of investigators and prosecutors over corruption in Ukraine. Although, of course, no one will ever check whether there were any verdicts, whether there were any investigations, or whether they brought any benefit to the state.

NV: But the State Audit Service is accountable to the PM, the government, right?

Kanievskyi: Yes, to the finance minister, Mr. [Serhiy] Marchenko, and to Ukrainian Prime Minister Denys Shmyhal.

NV: There is a certain clear chain of command here. But can’t it be solved simply by a decree, an order, a phone call?

Kanievskyi: As it turns out, no. This cannot be resolved even after a parliamentary resolution. Imagine, during martial law, the entire parliament, all 400 lawmakers have to deal with this problem, heroically trying to solve it. As we know, they haven’t solved it yet.

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Because now the State Audit Service interprets... And this is also correct: everything happens within the law and in accordance with the Constitution of Ukraine. Why do I say that the FSB hacked our state control and management system? Because everything that is happening now isn’t a violation, that someone from the State Audit Service rudely violates the law, breaks the law. No, everything is done in accordance with the current laws, in accordance with the current Constitution of Ukraine.

The State Audit Service says: “Parliament passed the resolution in July 2023. Parliament, of course, well done, but everything that happened before July 2023 from March 2022, when the decree was in force, has no retroactive effect. Accordingly, from March 2022 to July 2023, this is all violations. And we’ll continue to check, determine the damage, and submit it to law enforcement agencies.”

And now look, if no joke, going back to the story with the FSB. What should the FSB do now? First of all, it should receive all the information about our relocated state and private arms and ammunition manufacturing enterprises, which are now recorded in audits.

Previously, for example, only [state defense concern] Ukroboronprom and the Defense Ministry knew about arms and ammunition manufacturers. And it’s not all thousands of officials at the Defense Ministry, but one department that works completely secretly and that is responsible for weapons and military equipment. Only this department knew what, from whom, where and how it purchases, who and what manufactures. That is, this was a limited circle of people who can really be controlled so that this information somehow doesn’t go beyond this department and beyond a specific Ukroboronprom department and officials, private manufacturers, who are responsible for preserving state secrets. So that this unique, sensitive information about our products, design studies, and the Defense Ministry’s contracts doesn’t go beyond this narrow circle of specialists and doesn’t get to the enemy.

But now this information is available to the auditors. They actively write letters to law enforcement agencies, SBI investigators, National Police investigators, and SBU [security service] investigators. The prosecutor’s office, of course, exercises procedural control over all these criminal proceedings that are opened. That is, the circle of people who get access to this sensitive information has increased significantly.

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And there is no guarantee that the SBU has already carried out systematic work among these numerous auditors, investigators, and prosecutors, identified all spies, some latent traitors who can spread this information further beyond their authority.

Moreover, I want to tell you: is it profitable for all these arms manufacturers to work with the state of Ukraine? It’s clear that the state-owned manufacturers, which are part of the Ukroboronprom’s structure, won’t go anywhere. They’ve always worked at a loss, and it’s already a traditional story for them that the Defense Ministry doesn’t allow them to set any such profits that would allow them to grow. They’re constantly poor, degrading, everyone is used to the fact that these are state-owned companies, and nothing good will ever come of them.

But private arms manufacturers that are now in the government’s spotlight will at least think twice about whether they should enter into a contract with the Defense Ministry. Because the question is not only that they’ll be subject to check, because everyone is already checking them. But the question is whether this doesn’t pose a direct threat to life, health [of workers] and production from enemy [attacks]. That’s what the problem is. The circle of people with sensitive information who can now be reached by the FSB has expanded.

NV: There are certain assumptions. Either the State Audit Service is some kind of very separate, autonomous, and all-powerful office that no one can influence, including the finance minister and the head of the government. Or simply the head of the State Audit Service isn’t in the government, but it’s influenced by some other person from some other body. How would you assess this?

Kanievskyi: There are several factors. We cannot say that there is some single factor that allows the State Audit Service and its management to take such a rigid position without consequences.

The first factor is the political distribution of offices in Ukraine. It’s not a secret for anyone that all positions are agreed in the President’s Office, not in the Cabinet of Ministers. Accordingly, officials undergoing interviews and appointments in the President’s Office enlist the support of some political groups within the structure of the President’s Office, within the structure of the ruling Servant of the People party and feel more protected by this governmental chain of command.

They understand who their real boss is, and to whom they really have to report for their results. And therefore, this is one of the factors why we have many leaders in government structures who are so autonomous from government policy and can openly get their way. They understand they have certain safeguards and protections from other state agencies.

Second. The ruling party’s personnel policy hasn’t been perfect since 2019. And now, as political scientists say, the pool of candidates for government positions isn’t really that deep.

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International partners, who have already contributed 60% of funds to Ukraine’s budget this year and are expected to cover 60% of the state budget expenses next year, are beginning to be openly annoyed by such institutional instability and weakness of the Ukrainian government.

And any such appointment-dismissals is an additional irritation for partners in Washington, in Brussels, who simply cannot understand what’s happening in our country, and why people are appointed and dismissed so often.

In our country, people are appointed to positions not based on their professional abilities, vision for the institutional system development, plans for changes, reforms, but simply because someone told someone, advised that he’s a good person, why not appoint him.

And we must remember that when most of the funds in our budget come from European and U.S. taxpayers, officials in Brussels and Washington are beginning to look more closely at how Ukrainian government structures work with their money.

This is my explanation. The government has actually distanced itself from this story. Look, no one, except for the arms manufacturers, volunteers, and the public comments on this story in public. Although it has already come to a parliamentary resolution.

NV: The head of the State Audit Service, Alla Basalaieva, said the service intends to reach an understanding with entrepreneurs and arms manufacturers. It’s not quite clear to me how they will get along.

Kanievskyi: Yes, this is a good signal. There is at least communication with the arms manufacturers. They’re trying to solve this problem with them.

In my opinion, there are two open questions here. First. Where is the guarantee that such problems won’t happen again? That is, where is the guarantee that some other resolution won’t be prepared in the Cabinet without such a mistake, which will lead to a numerous chain of mistakes?

The second problem. When law enforcement agencies, SBI, SBU open proceedings, they cannot just close the case because someone signed some memorandum. No, they’ll investigate now. They’ll conduct interrogations.

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What’s the investigators’ logic? When he [investigator] receives a specific reason to open criminal proceedings, even if he understands that this reason is very, very shaky, and probably he won’t be able to establish damages for the state and bring this case to verdicts, to charges, but every investigator, every prosecutor understands that he has a new opportunity to find some other violations of tax, customs legislation, some official violations. That is, it’s access to the economic activity of an enterprise that has money. And they can already work there and look for new criminal cases.

I have a simple question. How important is it for us now, from a strategic point of view, to make life a nightmare for our own arms manufacturers during war, given that we only have a few of them? It’s not that our market for manufacturers of missiles and artillery shells is so crowded that we can afford to look for some losers to make their life a nightmare.

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