Salzburg Diary: Russia has a problem

DMITRY ASTAKHOV/AFP/Getty Images

As many of you know, I have been blogging this week from the Salzburg Global Seminar’s session on Russia: The 2020 Perspective.

Most of what I’ve written so far has been focused on U.S. policy toward Russia. But the United States can only influence Russian domestic developments on the margins. So, what does Russia itself need to do over the next 12 years?

If I were president of Russia, my absolute top priority would be to strengthen property rights, which will make it possible for Russia to diversify its economy away from oil and gas, build a real middle class, and bring in much-needed foreign investment and advanced technology. There is much work to do. Exhibit A: the case of Hermitage Capital Management Limited, which until recently was the top portfolio investment fund working in Russia.

Hermitage CEO Bill Browder, you may recall, made news in 2005 when he was suddenly barred from reentering Russia. Browder had been making too much noise about “shareholder rights,” and in doing so he apparently stepped on some powerful toes. The fund has since pulled its $4 billion worth of investments in Russia, but new details are emerging that paint a disturbing picture of the business environment in the country. Last week, Hermitage updated its investors on a campaign of “administrative harassment” in Moscow that could have ended with corrupt local officials absconding with hundreds of millions of dollars worth of the fund’s assets.

According to Hermitage, the story goes like this. In summer 2007, its offices were raided by the Moscow Interior Ministry, supposedly as part of an investigation into Kameya, a company owned by one of Hermitage’s clients. The allegation was that Kameya owed $48 million in taxes. When Kameya’s people went to clear things up with the Tax Ministry, officials there confirmed in writing that in fact, the company was eligible for a refund and owed no back taxes. Meanwhile, when one of Hermitage’s lawyers complained about the raid’s questionable relevance to Kameya, he was beaten by Interior Ministry goons, arrested, and fined 15,000 rubles for his insolence.

So, what was going on? Hermitage alleges that “a more sinister agenda” was at work. The real purpose of the Kameya raid was for Moscow Interior Ministry officials to get their hands on documents that could be used to seize the fund’s assets.

Here’s how the attempted scam worked. The Moscow Interior Ministry official in charge of the “investigation” launched what Hermitage calls a “fishing expedition” to locate the fund’s assets — demanding all records from four foreign banks that might lead him to the prize. At the same time, somebody used the captured documents to fraudulently change the ownership of three investment vehicles owned by British bank HSBC, a Hermitage trustee. From there, it gets complicated, but the bottom line is that a mysterious team of lawyers representing “their” companies then assented to a fake court ruling that would have put the three HSBC entities on the hook for $380 million. Luckily for Hermitage, the vehicles were “dormant” and held no assets, so the would-be millionaires came up empty.

“The more we learned, the more unbelieveable it became,” Hermitage says. The fund’s management passed along their findings to Russia’s finance minister in Davos, which were then put in front of President-elect Dmitry Medvedev and a pair of investigations has begun. The year before, though, Medvedev had personally assued Browder in Davos that his visa troubles would be cleared up, and he couldn’t deliver. Now, Hermitage says the officials involved in the attempted theft are making “spurious claims” and feeding misinformation about the fund to the press — so the fund is going public with the story.

This case will be a key test for Medvedev,  a lawyer by training who has vowed to tackle Russia’s property rights and corruption problems when he takes office in May. But as European Commissioner for External Relations Bentia Ferrero-Waldner put it to us in Salzburg this week, “Ultimately the world will assess Mr. Medvedev on his deeds, not just on his words.” It’s showtime, Dmitry.

Blake Hounshell is Web Editor of ForeignPolicy.com. He has been blogging this week from the Salzburg Global Seminar session on Russia: The 2020 Perspective.