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Caveat investor

6 March 2015 By Edward Chancellor

Since the turn of this century, the fast-growing BRICS (Brazil, Russia, India, China and South Africa) have been much hyped on Wall Street. Yet investors in these countries and many other emerging markets have been plagued by the absence of the rule of law, inadequate protection of property rights and widespread corruption.

No experience is more salutary in this respect than that of Hermitage Capital. The tale of this hedge fund which invested in Russian stocks is narrated by founder Bill Browder in “Red Notice: A True Story of High Finance, Murder, and One Man’s Fight for Justice.”

Following jobs as a consultant and investment banker, the young Browder finds his way to Moscow in the early 1990s during the privatisations under President Boris Yeltsin. An ambitious hedge fund manager, he has a family connection to the place; his grandfather once headed the American Communist Party and took a Russian wife. Yet Browder doesn’t show much interest in Russian culture. He never learns the language, appearing to prefer the trappings of hedge fund life: fancy restaurants, luxury hotels and attractive women. In short, at this stage of life Browder is pure Wall Street.

In the free-wheeling and chaotic world of Yeltsin’s Russia, where oligarchs run roughshod over the interests of other investors, Browder becomes an activist investor, appealing to the protection of the law to enhance his investments. He becomes adept at using the media, both domestic and international, to fight his battles.

After some initial success in naming and shaming oligarchic shenanigans, Browder takes on Russia’s corporate leviathans – among them Khodorkovsky’s Yukos, Gazprom and Sberbank. Hermitage’s early years are a crazy rollercoaster. The fund is up 40 percent in its first month, down 90 percent after the Russian default in 1998, and then rises 23 times over the following five years.

By the time Vladimir Putin ascends to the presidency in 2000, Browder is rich, famous and over-confident. He welcomes the arrival of the ex-KGB hard man and even publicly applauds the downfall of Khodorkovsky. The corporate battles continue, but things have subtly changed.

The oligarchs who avoid imprisonment or exile are now Putin’s hard men, the so-called siloviki. Russia’s domestic media comes under Putin’s tight control. The legal system is transformed into a tool to crush and expropriate Putin’s enemies.

Putin’s Russia was not a place where cocky Western investors, wielding legal affidavits and blathering incessantly to the press, were particularly welcome. Browder doesn’t appear to have read the signs of the times. In November 2005, he is removed from the country, officially as a “threat to national security.”

Hermitage’s downfall over the following years is grippingly narrated by Browder. The hedge fund is accused of tax fraud and its offices are turned over by Interior Ministry police. Then Hermitage becomes involved in a complex scam, involving dormant holding companies, trumped-up lawsuits, suspicious packages, the Russian security services, and a fraudulent $230 million tax rebate. As the heat is raised, Browder helps his people leave Russia. After the Moscow law firm working for Hermitage is raided by the authorities, Browder’s lawyers flee the country under cover.

The one person in Browder’s entourage who doesn’t attempt to leave is Sergei Magnitsky, a devout family man in his mid-thirties, who worked as Hermitage’s tax lawyer. Magnitsky uncovers the tax rebate scam and fingers the officials who have been hounding Hermitage.

This being Russia, these same officials are appointed to investigate his complaints. Magnitsky is arrested. He is treated roughly in prison, his health deteriorates, medical treatment is not forthcoming, and on Nov. 16, 2009, the 37-year-old Sergei Magnitsky dies in custody.

Magnitsky’s death releases in Browder a righteous desire “to create consequences for the people who killed Sergei.” The former activist now uses his well-honed media skills to campaign, both through the press and online, against Magnitsky’s tormentors.

Neither the British Foreign Office nor the U.S. State Department are helpful. Browder, however, is a consummate networker. In no time, he makes his way to the U.S. Congress, where he persuades lawmakers to pass a law banning those Russian officials allegedly involved in Magnitsky’s death from entering the United States or using the country’s banking services.

Putin’s initial response to the Magnitsky Act was to ban the adoption of Russian children by American couples, a move which Browder decries as “pure evil.” Bizarrely, Browder and the dead Magnitsky are put on trial for tax offences. Of course, they are found guilty. The Russians even seek Browder’s arrest abroad, issuing the “red notice” to Interpol from which this book takes its name.

Browder has written a genuine page-turner. “Red Notice” reads at times like a Soviet-era spy novel. It is the story of a man who, through his personal encounter with the brutality of the Russian justice system and the arbitrariness of Putin’s rule, learns that there is more to life than making lots of money.

No doubt Hollywood is awake to the commercial possibilities of this tale of redemption. Yet Browder’s fast-paced narrative skips over some important details – who exactly wanted to close down Hermitage? If what Browder writes is true, why did Putin side with Russian officials who stole a large amount of money from the Russian state? In short, is Browder being wholly candid?

Still, we can’t help but marvel at Browder’s achievement. As Karen Dawisha observed in the recently published “Putin’s Kleptocracy” (Simon & Schuster), in recent decades fortunes made in Russia, by those who exploit the absence of the rule of law, have been exported to the West where they enjoy with impunity the protection of our rule of law. The Magnitsky Act begins to redress this unsatisfactory state of affairs.

As for Western investors, Hermitage’s Russian experience calls to mind a comment made long ago by the great Victorian financial journalist Walter Bagehot: “We lend to countries,” wrote Bagehot, “whose condition we do not know, and whose want of civilization we do not consider, therefore we lose money.” When it comes to emerging markets, caveat investor.

The spelling of “siloviki” has been corrected in paragraph seven.


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