Russia's Watchdog Wakes

Can a new law help regulators stop stock manipulation?

On a May 12 visit to New York, top Russian securities regulator Igor V. Kostikov compared notes over croissants and coffee with fellow troubleshooter Eliot Spitzer, New York State's crusading Attorney General. At first glance, the contrast between the two breakfast partners could not be greater. While Spitzer is constantly in the limelight for pursuing high-profile cases against Wall Street firms, his Russian counterpart Kostikov has yet to wrap up any significant probes in a market that's widely viewed by traders themselves as rife with abuses. But now, after three years on the job, Russia's top securities watchdog may finally be rousing from his slumber.

A week before the morning meeting with Spitzer, Kostikov's Federal Securities Commission (FSC) quietly launched a formal investigation into alleged stock-price manipulation in a case that may define both the usefulness of an untested new Russian securities law and the ability of regulators to enforce it. The target: Brunswick UBS, a leading Moscow-based brokerage half-owned by UBS Warburg, the global investment-banking arm of Swiss banking giant UBS. The investigation centers on allegations involving possible leaks of unpublished Brunswick UBS analyst ratings of publicly traded stocks. No charges have been filed, and it's still unclear if any employees of Brunswick UBS will be implicated. The company denies wrongdoing and says it maintains close contact with Russian officials. "We are cooperating with the regulators," says Jeffrey R. Costello, Brunswick UBS's American CEO.

Whatever happens in the case, it's clear Kostikov wants to send a signal that Russia's days as an anything-goes marketplace are over. That's precisely why Russian regulators view the very launching of this investigation as a milestone. "Traders are asking us to create a transparent and fair market and to use the powers we have to protect them," says FSC Deputy Chairman Gennady Kolesnikov, a former Balkans U.N. peacekeeper who is in charge of the commission's 100-member team of investigators. "It's important to restore confidence in the markets."

Russian regulators certainly need to start regulating. Such dicey practices as insider trading and front-running have long been rampant in Moscow's bourses. "In the eight years that I have been in Russia, I have not seen anyone taken to task for insider trading," says James Fenkner, a U.S. native who's head of research at Moscow brokerage Troika Dialog. After the market meltdown following the ruble crash of 1998, fixing these abuses was not a high priority. But five years later, stock prices, although still below peak precrisis levels, are rising again, and foreign investors are returning to Russia.

Now, Kostikov, armed with a law passed last December designed to stamp out stock manipulation, is promising to crack down on corruption. FSC investigators are demanding trading records and other data from officials at Brunswick UBS and the Russian Trading System (RTS), one of the country's prime exchanges. The probe grew out of a complaint, filed on Apr. 28 by a Brunswick UBS client, that describes a pattern of spikes in the volume of shares traded in seven companies on the RTS shortly before the release of Brunswick's latest ratings for these equities (table). In some cases, the share prices of several of those stocks rose substantially after the release of the reports, which in six of the seven cases involved "buy" ratings on the stocks.

The FSC confirms that it has opened an investigation but won't provide details. "It's in a very early stage," Kostikov says. If the FSC finds Brunswick UBS has violated the market-manipulation law, sanctions could include temporary suspension of trading privileges or revocation of the brokerage's license.

Industry observers say that proving misconduct in a case like Brunswick UBS may prove very difficult for Kostikov's team. Although the new law ostensibly prohibits price manipulation, no provision on the books defines and sets penalties for insider trading. So Russian officials may lack the kind of tool that serves as a powerful disincentive to leaking sensitive information in more industrialized economies such as the U.S.

The action targeting Brunswick UBS also raises fairness questions, such as why the FSC chose to act on this tip-off. The regulators say the probe into Brunswick UBS was set into motion by the specific complaint from a reliable source -- and add that their policy is to check out grievances against any brokerage. The complaint's allegations are "serious" and seem credible, says the FSC's Kolesnikov. But brokers claim it's hard for them to know exactly what's legal and who's liable. "What we have at the moment are relatively untested regulations," says Brunswick UBS head Costello, a former U.S. securities lawyer in Washington.

The complaint against Brunswick describes a distinctive pattern of trading in the seven stocks cited. Prices of some went up sharply in the first week after the high turnover day, although in other cases, the share price declined. The dollar sums in question -- a maximum of $18.5 million in a day's trading -- aren't large by U.S. standards, but the trading-volume upticks are eye-catching and could have provided opportunities for tidy profits.

For example, according to the complaint, on Jan. 9, 2002, an obscure regional telecom, Moscow Electrosvyaz, showed trading volume of 1,200,000 shares, 23 times higher than the stock's average daily turnover on the RTS over the previous three months. That was prior to a Jan. 15 Brunswick UBS research report recommending a buy on the stock. One week after the high-turnover day, Electrosvyaz' stock price had gained 21%, with much of the gain coming before the report was published.

Brunswick UBS's Costello says the brokerage has strict Chinese walls separating its research and trading arms and further denies that the brokerage has ever tipped off clients on the contents of upcoming reports. "They are not going to find any evidence of that," he says matter-of-factly of the regulators' probe. A London spokesman for UBS Warburg echoes: "We cooperate closely with regulators and adhere to both international best practices and local regulations."

The recent complaint against Brunswick UBS is not the first. As far back as August, 2000, the FSC says it received a request from national electricity monopoly Unified Energy Systems to investigate possible manipulation of its stock price by Brunswick UBS. But the FSC says at that time it was powerless to deal with the complaint. Brunswick UBS claims the allegations were baseless. A probe by Russia's Association of National Stock Market Participants, an industry self-regulatory body, cleared the firm of any wrongdoing.

Kostikov himself has faced accusations from Russian financiers of secretly retaining ties to the St. Petersburg brokerage, AVK, he founded in the early 1990s. He has strongly denied these allegations, and a probe conducted by a U.S. law firm that advises the FSC concluded that he divested his interest in AVK in 1998. Still, the allegations show how hard it is for anyone in Russian finance to have an unsullied reputation. Even savvy players such as Brunswick UBS must prove that they don't deserve to bear a stigma for the collective sins of the industry.

By Paul Starobin in Moscow

    Before it's here, it's on the Bloomberg Terminal.