Hijacking the Hermitage Fund

Hermitage Capital Management alleges that a massive fraud attempt in Russia, which even included the police, nearly made off with hundreds of millions

by Jason Bush

Corruption, intimidation, robbery, violent assault, forgery, large-scale fraud. No, not the subject of the latest John Grisham novel, but sensational allegations, made public Apr. 4 by Hermitage Capital Management—until recently the largest foreign portfolio investor in Russia. In a detailed and damning report, titled Criminal Justice—Russian-Style, Hermitage alleges the fund's Russian subsidiaries have fallen victim to an elaborate con designed to defraud the fund of hundreds of millions of dollars.

The most sensational part of Hermitage's allegations is that the attempted larceny was carried out with the direct connivance of officials in the Russian police. Hermitage alleges the police seized documents and equipment that were instrumental to the attempted fraud, which involved bogus court cases based on forged documents, the aim of which was to sue Hermitage subsidiaries for hundreds of millions of dollars. "The most shocking thing is not that there are corporate raiders in Russia who attempt to steal your shares," says Jamison Firestone, managing partner of Firestone Duncan, Hermitage's law firm. "The shocking thing is that the police worked hand-in-hand with them, and actually performed the theft of the documents so that the corporate raiders could then do their work."

The unfolding scandal is sure to put pressure on Russia's President-elect, Dmitry Medvedev, to reassure the foreign investor community he's serious about fixing Russia's shaky legal environment. "The major lesson is that property rights are extremely frail in Russia," a Hermitage spokesman says. "There's such serious corruption that even [President-elect Dmitry] Medvedev has made this one of the central planks of his presidency."

It comes at a time of growing disquiet about Russia's climate for foreign investors. Hermitage's sensational allegations come just two weeks after Russian police raided the Moscow offices of British Petroleum (BP) and its Russian joint venture TNK-BP (TNBPI), and subsequently arrested a TNK-BP manager for spying (BusinessWeek.com, 3/20/08). Even in a country notorious for its shaky investment climate, the allegations are perhaps the most serious to date by a major foreign investor in Russia.

Where It All Started

Until recently, when Hermitage withdrew all its assets from the country, the fund had some $4 billion invested in Russia, making it the largest international portfolio investor. The fund's trustee and manager, British bank HSBC (HBC), is one of the world's largest financial corporations, which only recently announced plans for a major expansion in Russia.

The drama began in November, 2005, when Hermitage CEO William Browder was mysteriously denied a Russian visa, supposedly on national security grounds. Previously, Browder had become one of the best known foreign investors and shareholder activists in Russia, having spearheaded campaigns to clean up corporate governance at major Russian companies, notably Gazprom, Russia's giant national gas company. The visa incident created an international scandal (BusinessWeek.com, 3/30/06) that was widely publicized.

Despite lobbying by senior Western diplomats and executives, Browder has been denied entry to the country ever since. However, at the Davos economic summit in January last year, Browder raised the matter of his visa with Medvedev, at that time Russia's Deputy Prime Minister. Medvedev promised to submit Browder's documents to the Russian migration service, a promise he apparently kept shortly afterward.

You might think that with help from the likes of Medvedev, Browder's problems were coming to an end. But in fact they were only just beginning.