Can Investors Mitigate Risks From Corruption in Emerging Markets: Part 1

Originally Published on September 10, 2017.

Corruption happens in every country and every industry. For example, Transparency International gave The United States a score of only 74 out of 100 with 100 indicating little to no corruption in the public sector. Emerging markets, in general, have higher rates of corruption than developed economies. For investors focused on emerging markets, rampant corruption can increase the level of risk of a portfolio and can lead to significant loss of revenue. So, how can investors mitigate corruption in emerging markets? In this article, I will demonstrate one step investors can take to protect their portfolios from corruption risks. I will use Russia as a case study.

The most important step to mitigating corruption risks is to know the major players. In countries like Russia, for example, there is a de jure political structure and a de facto political structure. Understanding how these two layers of government work together is vital to uncovering the real power players in a country. For me, it is helpful to think of the de jure political structure as the constitutionally outlined government. In the United States, we have three branches of government with different powers and are designed to check the power of the other two branches. However, just understanding the political structure of the U.S. ordained by the constitution would not give an investor an accurate picture of U.S. politics. So, the other component is the de facto political structure. I think of this layer as the shade government of a country. For example, in the United States lobbyists are influential in shaping policy and pushing agendas, but are not explicitly given any authority by the Constitution.

Russia, for example, has one style of government outlined by the Constitution, but there are players with significant influence, who have been empowered by Russian President Vladimir Putin. Russia is a semi-presidential Federation with the president designated as Chief of State and the prime minister acting as head of government. The Constitution of the Russian Federation established the parliament, which is composed of two houses. The Federal Assembly is the upper house of parliament and comprises 166 members. The State Duma is the lower house of parliament and is made up of 450 members. These houses have specific powers designated by the Constitution, such as the authority to confirm deputies and ministers appointed by the government. The president nominates all members of Russia’s three highest courts and appointed by the Federation Council. President Vladimir Putin has manipulated this de jure political system to concentrate more power in his hands. For example, Putin extended the term length of the president from four years to six years.

In Russia, the shadow government, composed of Russian Oligarchs and childhood friends of Putin, holds the real power in Russia at the pleasure of the President.

Putin and his “cronies” have consolidated control over the media through intimidation; they have silenced political opponents through violent coercion. The courts in Russia have been used to punish individuals for political reasons. Russia has a history of false charges being brought against Putin and Putin’s inner circle. Some examples include Mikhail Khodorkovsky and Sergei Magnitsky.

Understanding the players in Putin’s Russia can help investors identify the interests at play. The major players in Putin’s Russia include Igor Sechin, Gennady Timchenko, Dmitry Medvedev, Nikolai Shamalov, Kirill Shamalov, Sergei Roldugin, Vladislav Surkov, Vyacheslav Volodin, Sergey Chemezon, Yury Kovalchuk, Arkady and Boris Rotenberg. Several of these men have a connection with Putin from his time in St. Petersburg, and several men have been longtime friends of the Russian President. The majority of the men in Putin’s good graces are businessmen. Igor Sechin is the head of Rosneft, the Russia oil company. Gennady Timchencko is a long time friend of Putin, and the owner of a private investment group called the Volga Group. Dmitry Medvedev has been in both the public and private sector as chairman of Gazprom and as the current Prime Minister of Russia. The complete list of Putin’s inner circle and their connections to the President can be found here.

While monitoring the decisions of the State Duma and the Federal Assembly should not be ignored, important political decisions can be made behind closed doors in Russia at the behest of Putin and his supporters. All of the men around President Putin have interests, and they protect the interests of the President. Since the majority of Putin’s inner circle are businessmen, investors need to keep abreast of political changes in the country. Investors can begin to mitigate risks from corruption by first understanding the power players, and, consequently, knowing what industries and/or sectors (natural gas) are politically-charged. However, this is only the first step to ensuring client portfolios are not negatively affected by corrupt practices.

This article can also be found on my LinkedIn page.


Silicon Valley’s New Task: Disrupting Terrorist Networks

Originally published on January 9, 2016.

Many Silicon Valley tech firms are being asked to help the United States government disrupt the Islamic States’ communications and propaganda. Conversely, the tech firms do not seem to be responding well to this new call to action. However, this shared sentiment may have shifted following the recent shooting in San Bernardino, California.

Federal Officials and American Technology companies came together at a summit in San Jose, California, to discuss potential strategies to combat ISIS’s social media campaign. According to CNN, one area of focus is in tracking terrorists and levels of radicalization through social media. However, a push to use social media to track radicals will involve a necessary balance between protection of civil liberties and security.

The summit also focused on censoring ISIS propaganda. The U.S. government hopes tech and social media firms will block ISIS propaganda. Various tech firms such as Facebook have stated that they will help in the fight against ISIS. Melanie Ensign, the spokeswoman for Facebook, stated that “Facebook does not tolerate terrorists or terror propaganda and we work aggressively to remote it as soon as we become aware of it.”

Lastly, the US government and social media firms are working to launch a campaign to discredit ISIS. Top US officials have been setting up meetings with tech companies to find common ground on an approach to combating terrorism through the Internet. However, the government is asking media firms for a lot; specifically, allowing the government access to users information without a court order. The discussion between government officials and tech companies appears to be ongoing and evolving. We may see a final agreement within the next year.

This article can also be found here.

Detecting Securities Fraud With Whistleblower Programs

Originally Published on September 2, 2016.

After the 2007 to 2008 financial crisis and subsequent Great Recession, several federal regulations and laws have been put in place to minimize the amount and extent of securities fraud. Security fraud, also known as stock fraud and investment fraud, includes any practice that induces investors to make financial or investment decisions on the basis of false information, particularly in the stock or commodities markets. Government agencies have worked to limit the financial damaged created by fraudulent activities by implementing whistleblower programs that empower and reward individuals who come forward with information regarding securities fraud or fraudulent activities.

The United States’ Securities and Exchange Commission (SEC) has an entire office designated to whistleblowers. The Commission believes that whistleblowers can be invaluable tools, helping the Commission to identify fraudulent activities, naming those involved, and detecting these activities much earlier. A major perk of the whistleblower program is that the Commission has been able to minimize the financial damage incurred by investors due to securities fraud.

The Dodd-Frank Act created in 2010 established the Dodd-Frank Whistleblower Law in order to encourage company employees to come forward with information. The Dodd-Frank Whistleblower Law has given more power to the SEC to detect potentially financially disastrous securities fraud. According to the SEC website, the governmental department “oversees the key market participants in the securities world including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds”. Some states have followed the national government’s model by adopting individual whistleblower programs. Indiana and Utah are two examples of states that have followed the federal government’s example. Edward Siedle, a representative of a whistleblower in Indiana stated, “leveraging the power of the whistleblower is tremendously helpful, and it’s not costing the state anything.”

While the Dodd-Frank Whistleblower Law establishes that whistleblowers can and should come forward and any interference by the company in question is strictly forbidden, the law does not force companies to establish their own programs aimed at increasing company transparency. Private Investigators can lobby companies to establish whistleblower programs that will help prevent securities fraud and other illicit activities. By creating company-wide whistleblower programs, companies can save significant amounts of money for the company itself and investors.

The Securities and Exchange Commission Chairwoman Mary Jo White stated in a speech to the Ray Garrett Jr. Corporate and Securities Law Institute at Northwestern University School of Law in Chicago that she “would urge that, especially in the post-financial-crisis era, in which regulators and right minded companies are searching for new, more aggressive ways to improve corporate culture and compliance, it is past time to stop wringing our hands about whistleblowers”. According to Investment News, it has been over five years since the SEC created the whistleblower program, and as Chairman White explained the SEC has “seen enough to know that whistleblowers increase our (SEC) efficiency and conserve our scarce resources”. The Chairwoman also noted the importance of individual internal compliance programs in companies. Hiring a Private Investigator to advocate for company-wide whistleblower programs can prevent costly legal fees, poor publicity, and loss of faith in the company. The financial damage to a company because of securities fraud can be astronomical, and hiring a PI to help the company create or expand a whistleblower program can save companies millions, if not hundreds of millions of dollars.

This article can also be found here.