Russian President Dmitry Medvedev and US Vice President Joseph Biden in Russia

The investment calculus shifted yet again in Russia as Bloomberg News reports that Prime Minister Vladimir Putin’s ruling party failed to gain a majority of the vote in several regional polls, less than a year before parliamentary and presidential elections. This comes on the heels of U.S. Vice President Joseph Biden warning the regime that only genuine change will bring “wronged or nervous” investors back in to Russia:

Americans, Europeans, and Russians themselves, are less likely to invest confidently in a country where property rights are frequently violated, where fortunes can be lost because of legal abuses, where companies can be seized on a politician’s whim, and where a lawyer like Sergei Magnitsky can be arrested after accusing the police of fraud — and then die in detention before ever being tried.

Perception is based on reality and a whistleblower came out today to implicate Prime Minister Putin at the top of an elaborate multiyear scheme to extract contributions from Russian businessmen. Sergei Kolesnikov, a business associate of Putin, has offered the most detailed description of how Putin has engaged in a combination of corruption, bribery and theft to amass his own personal wealth. Read the letter here.

In the open letter to President Medvedev, Kolesnikov reveals Putin’s secret funding network. This letter was delivered Tuesday to the Russian U.N. mission in New York. Two or three times a year Kolesnikov regularly briefed Putin on his personal wealth accumulated through contributions by businessmen. Washington Post columnist David Ignatius wrote today that “it’s one of the most detailed allegations I’ve seen of the links between Putin and Russia’s “crony capitalism.”

Additional reporting by Ellen Barry at the New York Times show how corruption and politics prevent uncovering the truth about the death of Sergei Magnitsky. Contradictory official statements and lack of oversight have prevented the truth to be known. President Medvedev established the Public Oversight Commission to look into the case but after an initial thoughtful review was hijacked by security forces.

These same Federal Security Service (FSB) forces also known as the siloviki are the subject of an article in the New York Review of Books which refers to them as the New Nobility in Russia. In the assessment the FSB runs the country with Putin at the top.

…the FSB focuses its efforts on protecting the Kremlin’s vast economic interests, suppressing legitimate political opposition, and ensuring the Kremlin’s control over the press and television through intimidation and violence.

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.

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.

This bill would bar all individuals connected to the 2009 death of Sergei Magnitsky from receiving U.S. visas and accessing U.S. financial markets.

As the US Congress tries to fight corruption from abroad, Russian authorities continue to tighten their grip on political discourse. This week Russia President Dmitry Medvedev fired Moscow mayor Yuri M. Luzhkov. In early September Luzhkov criticized Medvedev on his management of a highway between Moscow and St. Petersburg and seemed to call for Putin’s return to power. Some say this crack in Kremlin leadership left Medvedev no choice but to let Luzhkov go, but he needed affirmation by Putin, the real power in the Kremlin.

As authoritarianism calcifies in Russia, financial markets and public discourse suffers. Despite Medvedev’s grand tour of Silicon Valley and his musing on legal nihilism, the status quo in Russia remains strong.

Russian Officials Involved in Tax Fraud Against Hermitage Capital and the Death of Sergei Magnitsky

Cloudy Precipice / Tom Burgher Gallery

Despite the recent spate of international news over the past week, from the hamburger summit in DC to the G20 in Toronto to Russian spies in Suburbia USA, underlying global economics has not changed and talk of a double-dip recession has revived. Even the dreaded “d” word was uttered by NYTimes’s Paul Krugman in his assessment of the US economy. Signs of a global weakening is evidenced by the fall in world equity indices, weak US home sales and China’s manufacturing growth is weakening as its government reduces stimulus. Debate rages on the effects of deficits on the economy. While the two sides debate the merits of deficit reduction over stimulus spending, the world economy feels like it is again at a precipice.

In the most recent Reuters’ Russian analysis, three factors remain unchanges from their last report in April: oil prices, political risk and insurgency. For the 2010 budget the Kremlin used a $75 barrel estimate, but with crude oil prices falling under $73 a barrel, the Kremlin may have to return to the capital markets trough and isuue more debt to cover budget deficits.

Medvedev understands the need for Russia to diversify its economy and made a major international push last week with his visit to Silicon Valley. However, it still remains to be seen how the power struggle is resolved. The 2012 presidential election presents political risks for investors and many anaylsts predict that:

Russia is unlikely to lure the level of investment or international support it deserves as long as Putin and his ensemble remain publicly engaged.

With the tandem leadership jostling for advantage, it remains to be seen if Medvedev’s push for modernization can resist the pull of Putin. In addition to a change of guard in the Kremlin, Reuters cites the release or acquittal of Mikhail Khodorkovsky as a sign of liberalization and a “bellwether” of Russian policy.

However, current signs point to the status quo as the authorities refuse to investigate into the suspect death of Hermitage Capital’s Sergey Magnitsky in pre-trial detention.

Russian President Dmitry Medvedev visited Silicon Valley this week in hopes of wooing executives to invest in Russia. But as high-tech leaders think through the pitch, they might want to consider what could happen when their Russian investments are up and running.

I am a member of the New York Bar who’s served on the board of directors of the American Chamber of Commerce in Russia for the past six years and managed a law firm in Moscow for 17 years. My firm represented the largest foreign investor in Russia, Hermitage Fund, which once had more than $4 billion invested there.

In 2007, officials from the Moscow Interior Ministry raided my offices and my client’s offices and took all of Hermitage Fund’s statutory documents and seals. Even the Russian government now concedes in Moscow court filings that those documents and seals were then used to fraudulently re-register the companies into the name of a convicted killer. A criminal group subsequently applied for a refund of the $230 million of taxes that the Hermitage Fund paid in 2006. The payment was granted in one day, no questions asked. It was the largest tax refund in the history of Russia, a country where even the smallest refunds take months, if not years.

Hermitage hired five law firms to report the thefts and recover the stolen companies. In the two years that followed, I personally witnessed Russian officials implicated in the crimes attempting to arrest every lawyer who was involved in the investigation or reporting of the thefts. In a classic case of Kafkaesque absurdity, two of Russia’s most famous and respected lawyers were criminally prosecuted for reporting the theft. They fled the country.

third respected corporate lawyer, my partner Sergei Magnitsky, refused to flee Russia because he thought the law would protect him. He testified against the corrupt officials. One month after his testimony, he was arrested by the very officials he testified against. The next day, they tried to arrest three more lawyers, all of whom fled Russia.

Magnitsky was kept in pre-trial detention for 12 months and was tortured to get him to withdraw his testimony, but he refused. On Nov. 16, 2009, Magnitsky died as a result of torture at the age of 37, leaving a wife and two young boys.

Since then, it became public that the same group of officers and criminals had been accused of similar crimes in the past. It was also discovered that immediately after the thefts were reported, the officers’ families acquired millions of dollars in assets.

Like many people, I find Medvedev confusing. He speaks about fighting corruption, building rule of law and fostering investment, but Russia’s level of corruption continues to increase. Silicon Valley may see him as the first Russian leader to surf the Web and use e-mail, but television news still is under state control, and independent journalists, human rights activists, businessmen and now their lawyers are arrested and killed with impunity.

I would like to believe that Medvedev is sincere. But he has done nothing to bring Sergei’s killers to justice, to find the stolen government money, to help my client recover its companies or to stop the attacks on lawyers.

What happened to my client can happen to anyone doing business in Russia, and no law firm in the world can defend you in a land without law. Large companies that were sure they would have government support, like Shell, BP, Carrefour, Telenor and Ikea, were left to the wolves. In each case, the Kremlin either attacked or allowed corrupt officials to attack foreign investors that bought into the same pitch you just heard.

Caveat emptor.

JAMISON FIRESTONE is managing partner of Firestone Duncan, Moscow. He wrote this article for this newspaper.

Russian President Dmitry Medvedev looks through 3D glasses at an exhibition at the economic forum in St. Petersburg, Russia, Saturday, June 19, 2010. (AP Photo/Dmitry Lovetsky)

Just a few weeks ago Putin was front and center with his visits to Istanbul and Paris, negotiating foreign policy disputes over UN sanctions against Iran. He even made comments about his tandem leadership with Medvedev that Kremlinologist have interpreted to mean that Putin as no choice but take over the reins in 2012, lest Medvedev actually execute his modernization plans by reducing 160,000 bureaucrats and nearly 300,000 policemen. Of course not all of these government employees have profited from Putin’s rein at the helm but they benefit from the existing “old” system (“budget inefficiency and a resource-based economy” as Arkady Dvorkovich, Medvedev’s top economic advisor put it.)

What a difference a few weeks make.

This week President Medvedev is visiting Silicon Valley to drum up support for a Russian Silicon Valley in Skolkovo outside Moscow. Despite a more promising outlook for Russia’s growth this year, in order for Medvedev’s modernization to be realized, laws must be enacted and enforced.

Another hinderance to Medvedev’s efforts is widespread corruption in the country, equivalent to a third of the country’s GDP annually. The death of Sergey Magnitsky while in pre-trial detention hangs like a cloud. Today, Magnitsky’s business partner Jamison Firestone released a video documenting what the government officials who are responsible for Magnitsky’s death are doing with their ill-gotten fortunes.

Beyond the Magnitsky tragedy the Khodorkovsky trial is a symbol of the lack of property rights in Russia and is costing Russian companies a risk premium as foreign investors demand greater compensation for this political risk.

Leon Aron, director of Russian studies at the American Enterprise Institute wrote in the Los Angeles Times that:

The road to a Russian Silicon Valley starts not in California, Mr. President. It begins with unlocking the door to Mikhail Khodorkovsky’s jail cell.

This is a critical time for Russia’s development as an emerging market. It remains to be seen if Medvedev’s modernization initiatives will be allowed to proceed and allow Russia to develop in an ever crowded global economic playing field or will the presidential election of 2012 reaffirm the Kremlinologists prediction that Putin will rein in liberalizing efforts and lead Russia down the path of increased centralization in government and government oversight of business and trade.