Corruption, intimidation, robbery, violent assault, forgery, large-scale fraud. No, not the subject of the latest John Grisham novel, but sensational allegations, made public Apr. 4 by Hermitage Capital Management—until recently the largest foreign portfolio investor in Russia. In a detailed and damning report, titled Criminal Justice—Russian-Style, Hermitage alleges the fund's Russian subsidiaries have fallen victim to an elaborate con designed to defraud the fund of hundreds of millions of dollars.
The most sensational part of Hermitage's allegations is that the attempted larceny was carried out with the direct connivance of officials in the Russian police. Hermitage alleges the police seized documents and equipment that were instrumental to the attempted fraud, which involved bogus court cases based on forged documents, the aim of which was to sue Hermitage subsidiaries for hundreds of millions of dollars. "The most shocking thing is not that there are corporate raiders in Russia who attempt to steal your shares," says Jamison Firestone, managing partner of Firestone Duncan, Hermitage's law firm. "The shocking thing is that the police worked hand-in-hand with them, and actually performed the theft of the documents so that the corporate raiders could then do their work."
The unfolding scandal is sure to put pressure on Russia's President-elect, Dmitry Medvedev, to reassure the foreign investor community he's serious about fixing Russia's shaky legal environment. "The major lesson is that property rights are extremely frail in Russia," a Hermitage spokesman says. "There's such serious corruption that even [President-elect Dmitry] Medvedev has made this one of the central planks of his presidency."
It comes at a time of growing disquiet about Russia's climate for foreign investors. Hermitage's sensational allegations come just two weeks after Russian police raided the Moscow offices of British Petroleum (BP) and its Russian joint venture TNK-BP (TNBPI), and subsequently arrested a TNK-BP manager for spying (BusinessWeek.com, 3/20/08). Even in a country notorious for its shaky investment climate, the allegations are perhaps the most serious to date by a major foreign investor in Russia.
Where It All Started
Until recently, when Hermitage withdrew all its assets from the country, the fund had some $4 billion invested in Russia, making it the largest international portfolio investor. The fund's trustee and manager, British bank HSBC (HBC), is one of the world's largest financial corporations, which only recently announced plans for a major expansion in Russia.
The drama began in November, 2005, when Hermitage CEO William Browder was mysteriously denied a Russian visa, supposedly on national security grounds. Previously, Browder had become one of the best known foreign investors and shareholder activists in Russia, having spearheaded campaigns to clean up corporate governance at major Russian companies, notably Gazprom, Russia's giant national gas company. The visa incident created an international scandal (BusinessWeek.com, 3/30/06) that was widely publicized.
Despite lobbying by senior Western diplomats and executives, Browder has been denied entry to the country ever since. However, at the Davos economic summit in January last year, Browder raised the matter of his visa with Medvedev, at that time Russia's Deputy Prime Minister. Medvedev promised to submit Browder's documents to the Russian migration service, a promise he apparently kept shortly afterward.
You might think that with help from the likes of Medvedev, Browder's problems were coming to an end. But in fact they were only just beginning.
A Taxing Situation
Hermitage's report details how, on Feb. 17, 2007, Hermitage received a telephone call from a certain Lieutenant Colonel Artem Kuznetsov of the Russian Interior Ministry. According to a transcript of the call contained in the report, Kuznetsov said he had been notified of Browder's request to receive a visa, and wished to arrange a meeting to discuss the situation. Kuznetsov is reported to have said, "The sooner we meet and you provide what is necessary, the sooner your problems will disappear."
Just what Kuznetsov wanted from Hermitage isn't made exactly clear. But Hermitage next heard from Kuzentsov four months later, on June 4, 2007, when the same officer led a raid by 25 police officers on Hermitage's Moscow office. The same day, police also raided the office of Firestone Duncan, Hermitage's Moscow-based lawyer. The police claimed to be investigating tax evasion by a Hermitage client, a Russian company called Kameya, which they accused of underpaying taxes by $44 million.
During the raid on Firestone Duncan, Hermitage alleges one of the law firm's lawyers was seriously beaten by police and hospitalized for two weeks. Hermitage also claims that in the weeks immediately before and after the police raids, two lawyers employed by the fund were burglarized, while one had a briefcase containing case documents stolen from a car.
Several pages of Hermitage's report are devoted to rebutting the claims of tax evasion by Kameya. The report includes copies of documents from the Russian Finance Ministry, the Russian Federal Tax Service, and Cyprus authorities, all of which appear to support Hermitage's rebuttal. For example, according to copies of official documents stamped by the Russian Federal Tax Service, far from dodging taxes, Kameya in fact overpaid taxes by 4 million rubles ($170,000).
Agendas and Contracts
Hermitage also alleges the police investigation into Kameya violated the procedures that are laid down in Russian law for such cases. "The police got involved even though there was nothing wrong," says a Hermitage spokesman. "The tax authorities don't have any problems—they say everything was paid properly. So what's going on here? It appears there was a much more sinister agenda, which we learnt about as it unfolded over the second half of last year."
Hermitage's report details how, in the weeks following the police raid on Hermitage, Lieutenant Colonel Kuznetsov subpoenaed four Western banks—HSBC, Citibank (C), Credit Suisse (CS), and ING (ING)—demanding detailed information about a slew of Hermitage-related companies. As a result, the tax investigation "was used to justify a wide-ranging search for all of the Hermitage Fund assets," the report states.
By a strange coincidence, on July 27, nine lawsuits were issued against three Hermitage subsidiaries by an unknown company called Logos Plus. In these suits, six of which were lodged in the St. Petersburg Arbitration Court, Logos Plus claimed that the three Hermitage subsidiaries owed it $500 million for broken contracts. Logos Plus claimed that the Hermitage subsidiaries had promised to sell Logos Plus shares in Gazprom (GAZP.RTS), but revoked on the promises. As a result of the claims, the court awarded Logos Plus $376 million in damages.
According to Hermitage, the disputed contracts were in fact total forgeries. For example, a corporate seal used to validate one of the agreements was only manufactured six days after the agreement was supposedly signed. One of the lawsuits was lodged by an individual using a passport that was reported stolen in 2005.
What's more, Hermitage and HSBC were not even aware of the lawsuits until three months after they were filed.
In the meantime, Hermitage alleges, unknown lawyers claiming to represent the Hermitage subsidiaries had already conceded the case in court. These lawyers had in fact been appointed by an obscure company named Pluton, registered in the central Russian city of Kazan. Hermitage alleges this was only possible because the share registrars were fraudulently tampered with, replacing the name of the Hermitage Fund's actual trustee, HSBC, with Pluton—an entirely bogus owner.
The attempted fraud ultimately failed because, unbeknownst to the fraudsters, Hermitage had already transferred all its assets out of Russia. The claims that were lodged against the company in St. Petersburg have since been annulled by subsequent court decisions. But subsequent lawsuits have also come to light, filed in Moscow and Kazan, also worth hundreds of millions of dollars, which Hermitage is continuing to contest in court. Details of the alleged fraud have been lodged with the Russian authorities, who launched an investigation into the alleged fraud in February, after receiving six 255-page reports on the case from HSBC.
Crime Scene Investigation
The most damning allegation? Throughout the entire period of the attempted fraud, Hermitage alleges, all the tools used to accomplish it were in the possession of the Moscow branch of Russia's Interior Ministry, where they have been ever since being seized by Kuznetsov's police in June. These included the corporate seals, original copies of registration, and the original corporate charters, for each of the Hermitage subsidiaries that were targeted.
So how come Hermitage is only now going public with the story, which it has previously kept carefully under wraps? Hermitage released its dossier following another mysterious twist in the story. On Apr. 3, Russian media reported that Browder himself was under criminal investigation, in connection with the Kameya tax-evasion case.
Russia's Interior Ministry immediately issued a denial that any such investigation into Browder was under way. According to a Hermitage spokesman, the reports about the criminal investigation into Browder appear to have been planted by the same ministry officials now under investigation for large-scale fraud. "The report is being issued now, because it's a crazy injustice to be accused when we are the victims," the spokesman says.
Russia's Interior Ministry has yet to respond publicly to Hermitage's allegations. "It's being investigated. We're hoping for a positive outcome," the Hermitage spokesman says.