Committee for Russian Economic Freedom

Our recent participation in the Global Macro Investing and Geopolitical Risk Forum in New York helped us focus attention on the challenges and potential rewards of investing in Russia. We are asking supporters of free markets, free ideas and free people to show support for the rule of law, transparency and secure profits by requesting a symbolic share in Russian Economic Freedom today.

By becoming a shareholder in Economic Freedom you will send a message to Russia’s leaders that direct foreign investment will increase only if they stem corruption, increase transparency and enhance corporate governance. Owning a share will cost you nothing more than the courage of your own convictions, yet it will yield tremendous social and financial rewards for asset managers and the Russian people alike. Hedge your position – short Russia’s current regime and go long Russia’s economic future.

As you know, hope for an improved investment climate in Russia surged after President Dmitry Medvedev’s tour of Silicon Valley in June and California Governor Arnold Schwarzenegger’s October visit to Skolkovo, the new business and research hub started by Medvedev to encourage high tech innovation. Despite intense words of support by the Russian political and business elite, it’s become even more apparent that incubating entrepreneurs in Russia face massive bureaucratic hurdles to success.

As part of President Medvedev’s push to diversify the economy, he has launched an anti-corruption campaign, but the results have demonstrated the systemic nature of corruption in Russian society. The Prosecutor General Yury Chaika announced that the average bribe increased 30 percent to 30,500 rubles ($1,015) from 23,100 rubles last year. At a meeting of the heads of the law enforcement agencies, Chaika exhorted his colleagues, “In 2008 and 2009, we saw a significant revival of work in this area, but the results of the activities of law enforcement agencies in the first half of this year confirm complacency and a decrease of effectiveness and quality of work.”

At the capital markets level, a disappointing performance for Russian IPOs this year reflects the lack of progress in strengthening enforceable contracts, scaling back government intervention in business and allowing greater political expression. So far, the Russian IPO market has totaled only $3 billion this year, of which $2.2 billion is made up of the Rusal IPO on the Hong Kong Stock Exchange in March. This is only a tenth of the $20 billion IPO market predicted earlier this year by sell-side analysts.

The Russian stock market is posting gains along with increases by other emerging powerhouses China and India. However, volatility reigns as valuations on the RTS Index are trading at an average multiple of seven times 2010 earnings while other emerging markets are changing hands at an average of 13 times earnings. This represents an inherent risk premium for Russian businesses as investors seek safer harbors for their assets.

Transparency International’s recently released 2010 Corruption Perceptions Index ranked Russia as the world’s most corrupt major economy, falling to 154th of 178 countries. (Russia placed 146th in the 2009 index of 180 countries.) Russians now pay bribes totaling $300 billion a year, equivalent to almost a quarter of the nation’s GDP, according to Kirill Kabanov, head of the National Anti-Corruption Committee.

Jailed Russian businessman Mikhail Khodorkovsky and Hermitage Capital’s Bill Browder know all about doing business in Russia and how successful businesses can be run aground by the capricious whims of government officials. Khodorkovsky’s second trial is approaching its end and despite the trappings of a functioning judicial system, the ultimate decision maker of his fate rests within the Kremlin.

“A guilty verdict would damage President Medvedev’s reputation and his drive for modernization,” Mark Urnov, a political scientist at the Higher School of Economics in Moscow, told Bloomberg News. “Though Medvedev has never said that he’d like Khodorkovsky to be freed, his acquittal would be seen by many as Medvedev’s achievement.”

James Beadle, a U.K.-based consultant for investors in Russia, echoed that “a negative outcome for Khodorkovsky is likely to reinforce investor skepticism toward the fairness of the Russian business climate … I don’t think that any foreign company is under any illusions that things have changed; they remain hesitant.”

Investors should also heed the fate of Sergey Magnitsky, Hermitage Capital’s attorney who refused to give in to corrupt tax officials only to pay with his life. Recently, both US houses of Congress introduced the “Justice for Sergei Magnitsky Act of 2010”, which is not only symbolic but hits his perpetrators in their pocketbooks. The bill prevents Russian officials implicated in Sergey’s murder from entering the United States and freezes their assets here.

When introducing the bill, US Senator Benjamin Cardin said,

Nearly a year after Sergei’s death, the leading figures in this scheme remain in power in Russia. It has become clear that if we expect any measure of justice in this case, we must act in the United States…At the least we can and should block these corrupt individuals from traveling and investing their ill-gotten money in our country.

Although Russia is a tempting place to invest in new business with their highly educated population and large reserves, you should be cautious about the exhortations offered by President Medvedev. He has promised much but delivered little during his term and with the 2012 presidential elections coming up, the winds are blowing against his direction and even his meager declarations of modernization, transparency and accountability may come to an end.

Email info@russianeconomicfreedom.org and become a shareholder of Russian Economic Freedom.

Pavel Khodorkovsky and Mikhail Kasyanov

On Friday, October 22, former Russian Prime Minister Mikhail Kasyanov spoke about the potential for political change in Russia at Columbia University’s Harriman Institute. Some issues he mentioned included the need for political opposition, rule of law and greater foreign investment in Russia. Kasyanov also mentioned the need for Russia to have an active political opposition, something Russia currently lacks. Over 100 people came to listen to the potential 2012 presidential candidate as he described a Russia that leads through example and cooperation, not words and intimidation.

Foreign investors are finicky and there are a lot of options. Last week, Transparency International released their latest Corruption Perception Index and Russia dropped to 154th out of 178 countries, making it the most corruption country in the G20.

President Dmitri A. Medvedev, in a Soviet-built luxury car, with Gov. Arnold Schwarzenegger.

As a counterpoint to President Dmitry Medvedev’s visit to Silicon Valley back in June, California Governor Arnold Schwartzenegger was invited to visit the Skolkovo, the new business school started by Medvedev to encourage high tech innovation with ambitious Silicon Valley aspirations. Despite intense support by the Russian political and business elite, incubating entrepreneurs in Russia face bureaucratic hurdles to success.

As part of Medvedev’s push to diversify the economy, he has launched an anti-corruption campaign but the results have demonstrated the systemic nature of corruption in Russian society. Recently, Yury Chaika the Prosecutor General has announced that the average bribe increased 30% from last year from 30,500 rubles ($1,015) to 23,100 rubles. At a meeting of the heads of the law enforcement agencies, Chaika exhorted his colleagues, “In 2008 and 2009, we saw a significant revival of work in this area, but the results of the activities of law enforcement agencies in the first half of this year confirm complacency and a decrease of effectiveness and quality of work.”

At the capital markets level, a disappointing IPO market this year reflects the lack of progress in strengthening the rule of law, scaling back government intervention in business and allowing greater political expression. So far, the Russian IPO market has totaled only $3 billion this year, of which $2.2 billion is made up of the Rusal IPO on the Hong Kong Stock Exchange in March. This is only a tenth of the $20 billion IPO market predicted earlier this year by sell-side analysts.

Although markets have been volatile, the Russian stock market has posted a 5% gain this month along with gains by other emerging markets powerhouses China and India. However valuations on the RTS Index are trading at an average multiple of 7 times 2010 earnings where other emerging markets are seeing an average of 13 times earnings. This is the inherent risk premium for businesses doing business in Russia as investors seek safer harbors for their assets.

Transparency International’s 2011 Corruption Perception Index is to be released next Monday, October 25 and it will be telling whether Russia improves or inches ever closer to the likes of Sierra Leone and Zimbabwe.

Jailed Russian businessman Mikhail Khodorkovsky and Hermitage Capital’s Bill Browder know all about doing business in Russia and how successful businesses can be run aground by the capricious whims of government officials. Khodorkovsky’s second trial is approaching its end and despite the trappings of a functioning judicial system, the ultimate decision maker of his fate rests within the Kremlin.

Investors should also heed the fate of Sergey Magnitsky, Hermitage Capital’s attorney who refused to give in to corrupt tax officials only to pay with his life. Recently, both US houses of Congress introduced the “Justice for Sergei Magnitsky Act of 2010”, which is not only symbolic but hits his perpetrators in their pocketbooks. The bill prevents Russian officials implicated in Sergey’s murder from entering the United States and freezes their assets here.

When introducing the bill, US Senator Benjamin Cardin said,

“Nearly a year after Sergei’s death, the leading figures in this scheme remain in power in Russia. It has become clear that if we expect any measure of justice in this case, we must act in the United States…At the least we can and should block these corrupt individuals from traveling and investing their ill-gotten money in our country.”

Although Russia is a tempting place to invest in new business with their highly educated population and large reserves, you should take caution to the promises offered by President Medvedev. He has promised much but delivered little during his term and with the 2012 presidential elections coming up, the winds are blowing against his direction and even his meager declarations of modernization, transparency and accountability may come to an end.

Today’s Bloomberg article details Jamison Firestone’s revelation that Russian Interior Ministry officials tried to collect $21 million in taxes using forgery and theft. The method the government officials used were similar to the expropriation in the Hermitage Capital case through taxes. In April 2009 and again in October 2009, Firestone filed complaints with the tax authorities and the General Prosecutor’s office but neither offices responded.

Russia’s issues with government, institutionalized corruption is well-known. Ranked 146th in Transparency International’s 2009 Corruption Perception Index is having a real financial effect on the Russian economy. According to data by EPFR Global,

Perceived lack of law is one reason Russia has attracted less than one-fifth the investment in China and Brazil and half of what’s invested in India, its fellow members of the so-called BRIC group of emerging nations.

Firestone supported this assertion with,

Corrupt law enforcement is the single biggest risk to business in Russia.

At last September’s Committee for Russian Economic Freedom event in New York, Firestone had this to say about the rule of law in Russia.

Transparency International released its 2009 Corruption Perception Index (CPI) and again Russia’s low ranking, 146^th out of 180 countries, demonstrates it needs to do more to reign in corruption and strengthen its legal system.

This annual survey shows that concern among business people and analysts over state corruption and legal abuse deters direct foreign investment and harms Russia’s economic health. President Medvedev himself has repeatedly stated his commitment to ending “legal nihilism” and spurring a new era of foreign investment.

Yet, Mikhail Khodorkovsky, once Russia’s most successful businessman, remains in jail on a second round of fabricated charges, further eroding business confidence. Mr. Khodorkovsky recently passed the six-year mark of his imprisonment and faces another 22 years in Siberia if convicted in this second trial. This is taking place as capital outflows totaled over $169 billion, approximately 10% of Russia’s 2008 GDP, between October 2008 and March 2009 according to U.S. State Department statistics. Multinational companies, such as IKEA and Carrefour, have announced plans to withdraw or reduce investment in Russia due to extortion and lack of judicial independence.

Pressure on business is building following the recent death while in custody of leading Russian corporate counsel Sergei Magnitsky, 37, a key witness in another absurd legal battle over alleged tax fraud between the Kremlin and Hermitage Capital, once Russia’s top investment fund. The International Bar Association and the U.K. Law Society decried Magnitsky’s death as did Firestone Duncan Managing Partner Jamison Firestone who said the government ignored calls by business and legal leaders to release his former colleague.

“There is no law in Russia at the highest level,” Firestone said. “The higher you go the less there is law. Any lawyer who tells you he can protect you in Russia is a liar.”

Risks to the financial system mount as Russian President Vladimir Putin backs energy deals with German and Italian corporations and moves for the state to take a stake in the controversial initial public offering of the embattled aluminum giant UC Rusal. As Finance Minister Aleksei L. Kudrin seeks government bond financing from London bankers, the Kremlin Deputy Chief of Staff Vladislav Surkov warns Russia risks collapsing into chaos if officials try to fix the political system by adopting liberal reforms.