Hermitage Capital, the Russian State and the Case of Sergei Magnitsky

REP Roundtable Summary: Hermitage Capital, the Russian State, and the Case of Sergei Magnitsky
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REP Edited Transcript Hermitage Capital, theRussian State and theCase of SergeiMagnitsky William Browder Founder and CEO, Hermitage Capital15 December 2009  REP Roundtable Summary: Hermitage Capital, the Russian State, and the Case ofSergei 2 William Browder: My own experience with Russia began in 1992 when I first went to look at theprivatisation programme. At the time, the government of Russia had made avery simple decision to go from communism to capitalism, and the best waythey thought to do that was by giving everything away practically for free. Sothey created all sorts of privatisation schemes: voucher privatisation, loans-for-shares, etc., and transferred a lot of assets from public to private hands ina very short period of time. The privatisation we all know about is the oligarchpart of this programme where 22 oligarchs got to own 40 per cent of the GDPof Russia. But there were actually crumbs falling off the table that allowedpeople like me to create businesses. I created a business to invest in thestock market in Russia. I moved to Russia full-time in 1996 and with the ideato start the Hermitage Fund to invest in Russian shares.I’m trained as a financial analyst. Normally in the West when you do financialanalysis you look at balance sheets and income statements and make judgements about companies and their growth and so on. But what Idiscovered in Russia was that there was one big part of the equation, whichwas even more important than balance sheets and income statements, whichwas how much money the managers of the company were stealing.I ended up hiring Vadim Kleiner, who’s my head of research sitting here nextto me, nine months into starting my business. He and I embarked on aprogramme of analyzing of Russian companies to figure out how muchmoney they were stealing. This is not a course they teach you in businessschool; however it is one that we learned how to do quite well over a period oftime. One of the things we learnt as we were going along was that because22 people ended up with 40 per cent of the country in their hands, the other142 million were pretty angry about it. So there were a lot of people who werewilling to talk about who was stealing from who, and how much they werestealing. We found that there was a very sympathetic group of people readyto tell us everything they knew.So we ended up creating a business model where we would interview peopleto get information about companies like Gazprom, Sberbank and otherimportant Russian companies. We would then take all this information we hadgathered and share it with the Western press, the Financial Times  , the Wall Street Journal  and various other important media outlets. Interestingly, if youwent directly to a Russian newspaper to share information they weren’t allthat interested in writing about it. But if you went to the Financial Times  and  REP Roundtable Summary: Hermitage Capital, the Russian State, and the Case ofSergei 3 they wrote about it, then the Russian press would say “we must write about itas well”. When the Russian newspapers wrote about large-scale fraud atRussian companies, this would often change things in Russia politically.This might seem a little strange to people who have experience in Russia that just by publicising graft and theft would change anything, but it was roughlyaround the time that Putin came to power that things really started to change.We discovered that we had a confluence of interests with Vladimir Putin whenhe came to power. We were fighting with oligarchs, who were stealing moneyfrom the companies we had invested in, and he was fighting with oligarchswho were stealing power from the presidency. For a brief period of time, from1999-2003, every time we publicised a major fraud, the government wouldstep in and fix it. We ended up exposing the theft of huge amounts of assetsat Gazprom and the board of directors ended up firing the CEO of Gazpromand making a programme to retain all the remaining assets. We made a lot ofnoise about the asset stripping plans at the electricity company, and thegovernment cancelled the restructuring plan that had been proposed there.We filed lawsuits about the dilutive share increase at Sberbank. We didn’tstop the share issue, but we ended up getting a new law passed so no onecould do that again at any other Russian company.Our approach was working very nicely, and then something happened in2003, which changed the environment in Russia forever. That was the arrestof Mikhail Khodorkovsky, the head of Yukos. At that point they had arrestedthe richest man in Russia and it sent a very powerful message to thethirteenth, seventeenth and twenty-second richest men in Russia, which was“if we can arrest the richest guy, we can arrest you too”. I can remember howpowerful the images were of Mikhail Khodorkovsky sitting in a cage. Afterthat, if you were one of these other oligarchs, you realised that the game hadchanged, and all these oligarchs went back to the Kremlin and said “pleasetell us what needs to be done, how do we make sure we don’t become likeKhodorkovsky?” Instructions were given, and all of a sudden Putin no longerhad a problem with the oligarchs because they were no longer stealing powerfrom him, they were now part of his power structure.But we were still having problems with the oligarchs and still publicising theirmisdeeds and on November 13, 2005, as I was flying back to Russia afterliving in Moscow for ten years and running the largest foreign investment fundin the country, I was stopped at the border, told that I could no longer enter,detained for twenty four hours and then deported back to London where I’vebeen ever since. They declared me a threat to national security and despite  REP Roundtable Summary: Hermitage Capital, the Russian State, and the Case ofSergei 4 interventions by Jack Straw, who was foreign secretary at the time, TonyBlair, George Bush, the Russians refused to let me back into the country.I thought that being denied a visa was a big problem. From a businessperspective it was very detrimental because all of my clients said “why shouldwe give you money to manage in Russia if you can’t get into the country” andthey withdrew their money from the fund. But that was a very minor problemcompared to what happened next.About a year and a half later, the officers from the Moscow Tax CrimesDepartment of the Interior Ministry raided our Moscow offices and the officesof our law firm Firestone Duncan. They were particularly intent on getting holdof the statutory documents of our investment holding companies – the seals,charters, articles of association of our investment holding companies. Theyseized all of those documents even though they had nothing to do with thepretext of their search. The next thing we knew, a few months later, we get aphone call from a bailiff of the St Petersburg court looking for a couple ofhundred million dollars of judgements which had been issued against thesethree holding companies. At this point, we got very upset and very confused.We didn’t know about any lawsuits in St Petersburg and had never been tocourt. How could there have been judgements against our companies? Wesaid to ourselves, “who is the smartest lawyer in Russia who can help usfigure out what’s going on here?” We called up Sergei Magnitsky, who was a36-year-old partner at the law firm Firestone Duncan.Sergei made some initial inquiries and came back and told us that ourcompanies have been fraudulently re-registered into the name of a convictedmurderer, that the lawsuits in St Petersburg had been based on forgedbackdated contracts and all of these actions couldn’t have been possiblewithout the documents which had been taken by the police. We still didn’tunderstand why they had done this because we didn’t have any money left inRussia. At this point, we started doing more research, and Sergei sent lettersto many registry offices and tax offices around Russia. Most didn’t reply. Buthe got one reply from the tax office of Khimki, which is a suburb of Moscow.The tax office said that these stolen companies had shown up in Khimki andopened accounts at two obscure Russian banks. With this letter he started todo further research into these banks and he figured out the whole scam. Thetax police had taken our documents, the companies were then stolen usingthose documents, fake judgements against our companies were also createdfrom those seized documents, and the purpose of this was to apply for afraudulent tax refund. We had paid $230 million of taxes in 2006, and in two
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