Criminal Trading on Russia’s Securities Markets

Posted: May 21, 2013 at 7:44 pm, Last Updated: May 28, 2013 at 6:31 pm

by Aaron Beitman

The ever increasing integration of national economies into the global economic system has meant that one country’s problems often present serious challenges for other countries.  The U.S. housing finance crisis and subsequent global economic meltdown is a recent and obvious case of this.  While national maladies can and do quickly become international headaches, certain problems a country might face appear to remain largely with national borders as global actors seek a strategy of containment.  Nelli Ponomareva, a TraCCC grantee and law student at the Saratov State Judicial Academy, outlines one such problem facing Russia today, that of criminalized trading on Russian financial markets.

Writing in Demokratizatsiya, Louise Shelley suggests that Russian organized crime has infiltrated domestic financial markets more deeply than crime groups in most other countries with strong domestic criminal organizations.  Naturally, this comes with serious implications for the development of the country’s financial system and broader economy.  In particular, Russian economist A.K. Bekryashev notes how criminalization of Russian financial markets is particularly dangerous in that it significantly contributes to the deformation of the institutional base for investing.  Other analysts, such as former Russian financial markets regulatory official Dmitry Vasiliev, suggest that with all things considered, Russia’s financial markets are not unique in the world and that like other emerging markets, participation comes with risk.  In Vasiliev’s rather optimistic view, the problems facing Russia’s financial markets can be solved by addressing larger structural issues.  Despite Vasiliev’s optimistic take, Ponomareva’s sheds light on how the criminalization of financial markets deserves greater attention from policymakers and scholars.

Ponomareva defines “criminal trading” as securities market activities which are executed illegally and bear significant damage to citizens, companies, and the state.  Noting that development of new financial institutions and instruments in Russia has been accompanied by new forms of manipulation, Ponomareva suggests that organized crime groups have sought entry access to securities markets in order to make “easy money.”  Moreover, Russian authorities have witnessed increases in money laundering and terrorist financing over the past two years.  Dmitry Pankin, the head of the Russian Federal Service for Financial Markets (FSFM), a state agency, indicates that fake financial advisory services have proliferated as well, making it difficult for some investors to gain the market access they are seeking.

In the aftermath of the global financial crisis, criminal activity on Russia’s securities markets comes with even greater risks because lower trading volumes mean that criminal manipulations have an even greater impact.  Aggregating across Russia’s seven different securities exchanges in Moscow, St. Petersburg, and Nizhni Novgorod, the Russian National Association of Securities Market Participants, estimates that the capitalization of the Russian internal market in 2010 was about 960 billion dollars.  In addition, the volume of transactions was estimated at 16.7 trillion rubles in 2010.  According the FSFM, the number of “bad” deals is about 3-4%, representing about 35,000 transactions annually. While this figure may seem small, even a relatively small percentage of registered crimes on securities markets comes with repercussions.  In particular, negative perceptions of Russian securities markets may affect national economic growth broadly and places barriers in front of legitimate Russian companies seeking listings on foreign stock exchanges.

Ponomareva provides a number of cases illustrating the problem of criminal trading, a few of which will be discussed here.  In November 2007, a client of the company “Nord Capital,” the Cyprus-based Palmaris Holding Limited, was discovered to have engaged in share price manipulation.  Palmaris apparently presented itself as both a buyer and seller of shares of RITEK, a company controlled by the Russian energy giant, Lukoil.  Shares of RITEK jumped 30%, which landed Palmaris a tidy profit.  While the FSFM served Palmaris’ stock broker a cease and desist order, no criminal sanctions against any of the actors involved have been lodged.

Misha Glenny, writing for the Financial Times, notes how the origin of Russia’s vast investment in Cyprus lies in the 1990s, a period known as “gangster capitalism.”  According most estimates, Russia’s presence in the Cypriot banking system stands about $22 billion.  This accounts for about a third of all deposits in Cypriot banks.  This is larger than Cyprus’ GDP

Financial crisis in Cyprus involves exposure of Cypriot banks to Greece, downgrading of the Cypriot economy to junk status by international rating agencies, the consequential inability to refund its state expenses from the international markets, and the reluctance of the government to restructure the troubled Cypriot banking sector.  An IMF and European bailout package totaling $30 bn is expected to be approved by Cypriot legislators in the near future.

Another case is associated with “Rich Broker Services,” (a fantastic company name) the shares of which increased 80% over the period of a month due to price manipulations by employees.  The only consequence faced by “Rich Broker Services” was a delisting of the company’s shares from the Russian Stock Exchange and the St. Petersburg Stock Exchange. Between 2008-2010, the company “Trade Finance” lost its operations license FSFM investigators proved that employees manipulated the company’s stock trading volumes.  Of the companies researched by Ponomareva, the firm “Profit-Time” (also a great company name), which had fraudulently increased the price and demand for the company’s shares, was one of the only culprits to be assessed a monetary fine, coming to about $22,000.

In Ponomareva’s view, one of the main reasons for the proliferation of criminal trading on Russia’s securities markets has to do with an insufficient legal basis for both preventing these crimes as well as bringing criminals to justice.  The absence of a strong legal architecture produces a culture of impunity on one hand and the possibility of baseless accusations against honest firms on the other hand.  Resolution of this problem will do much to improve global concerns about doing business in Russia, which will contribute to both long-term and short-term economic growth in the country.

Write to traccc at