RUSSIAN ROULETTE

Current Investment Risk in Russia

January 26, 2010

Dear World Economic Forum Attendee:

While at the World Economic Forum, keep in mind that in a cramped court room just a few
blocks from the Kremlin a drama is playing out that will have profound implications for the
future of economic and political freedom in Russia. That country’s former leading business
leader, YUKOS Chairman Mikhail Khodorkovsky, is undergoing a bizarre second trial on
fabricated charges after he criticized Vladimir Putin for failing to abide by the rule of law.
Sentenced to eight years, Khodorkovsky now faces an additional 22 years in a Siberian prison
camp.

This Kafkaesque proceeding embodies everything that stands in the way of Russia achieving
stability, growth, prosperity and Democracy for its people. GDP surges and plummets with oil
prices, inflation and unemployment each exceed 10 percent, while the average salary is about
$500 a month. Respected companies like IKEA, the Swedish home furnishings giant, have been
forced to declare a moratorium on investment in Russia, frustrated by Russian officials’
disregard for contractual obligations and fair play.

As a U.S. Senator, President Obama sponsored a bi-partisan resolution supporting Khodorkovsky

after the first prosecution, stating that the case raises “troubling questions about the impartiality
and integrity of the judicial system in Russia," and that the imprisonment represents "a violation
of the norms and practices of Russian law." Other leaders from Italy, Germany, and European
organizations joined in extending their support for Mr. Khodorkovsky. Courts from Switzerland,
the United Kingdom, the United States, Netherland, Lithuania, and Cyprus, among others, have
dismissed elements of the YUKOS affair.

The Russian government’s contempt for the Rule of Law and the simultaneous proliferation of
corruption remains a huge impediment to direct foreign investment for this key player in the
world economy. Both US and Russian officials have publicly acknowledged Russia’s weak
property rights and rampant corruption as reasons to avoid doing business in Russia.

Russian First Deputy Prime Minister Igor Shuvalov said at an international conference on
January 21, 2010, “Investment…is possible only with solid protection of private property rights.
Therefore this problem is directly linked to the course of modernization.” On January 12, 2010
US Ambassador to Russia John Beyrle stated, “Russia is still a very tough place to do business.
The combination of bureaucratic and administrative obstacles intertwined with pervasive

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corruption in Russia still constitutes a pretty significant risk premium for American investors and
American businessmen who want to enter the Russian market or grow their businesses.”

Russian attorney Sergei Magnitsky was arrested in November 2008 after defending Hermitage
Capital against expropriation by government officials. After being denied medical treatment
during his year-long incarceration, Magnitsky died in Russian custody last November. If this can
happen to Khodorkovsky and Magnitsky, what investor or corporation seeking to do business in
Russia is safe? Why invest in Russia as long as Khodorkovsky is behind bars?

According to Russian government studies and US State Department statistics, it’s estimated that
corrupt officials rob the Russia people of an estimated $300 billion annually, a sum equal to 18%
of the country’s gross domestic product. The response to the newly-adopted package of anti-
corruption legislation initiated and promoted by President Medvedev and passed by the Duma in
December 2008, has been tepid at best. Medvedev recently admitted publicly that corruption is
still endemic in Russia. The excessive role of government in the economy and business sector,
which spurs the supply side of corruption, aggravates the problem.

As 2010 begins, signs of Russia’s complacency have become larger and the world stage is
beginning to notice. The Khodorkovsky trial and continued politicization of the courts and trade
illustrate the increasingly hostile nature of the Russian business environment.

Kind regards,

Pavel Ivlev
Chairman
Committee for Russian Economic Freedom

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Contents
High Stakes ..................................................................................................................................... 4

Russian Economic and Investment Issues ...................................................................................... 4

Global Concerns over Russian Corruption ..................................................................................... 5

Selected Cases of Rule of Law Violations in Russia ...................................................................... 6

Abitare ........................................................................................................................................ 6
BP Plc ......................................................................................................................................... 6
Carrefour ..................................................................................................................................... 6
DeBeers ....................................................................................................................................... 6
Hermitage Capital ....................................................................................................................... 6
IKEA ........................................................................................................................................... 7
Motorola...................................................................................................................................... 7
Open Society Institute/George Soros .......................................................................................... 7
Peter Hambro Mining ................................................................................................................. 7
PriceWaterhouse Coopers ........................................................................................................... 7
Royal Dutch Shell ....................................................................................................................... 8
Starbucks ..................................................................................................................................... 8
YUKOS/Mikhail Khodorkovsky ................................................................................................ 8
Zoloto Resources ........................................................................................................................ 9
Who Is Mikhail Khodorkovsky? ..................................................................................................... 9

Arrest and Trial ............................................................................................................................... 9

New York Times - Ikea Plans to Halt Investment in Russia .......................................................... 10

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High Stakes
The recent initial public offering of the Russian aluminum giant Rusal is just the latest example
of how lawlessness threatens companies investing in Russia.

The $2.5 billion in proceeds from the Rusal IPO would go to repay part of its $4.5 billion loan
largely held by the Russian state-run Vnesheconombank (VEB) (controlled by Prime Minister
Vladimir Putin), also Rusal’s biggest single creditor.

Nevertheless, during the due diligence process, the Hong Kong Stock Exchange listing the shares
raised concerns and requested more information from Rusal. Goldman Sachs was dropped as a
book runner after the investment bank expressed reservations about sponsoring the deal.

More doubts surfaced when allegations emerged in offering documents that controlling
shareholder Oleg Deripaska is tied to organized crime and was refused a visa to enter the United
States on those grounds and has received millions in government money funneled through
Vnesheconombank (VEB),.

On the one hand, the Russian authorities keep Mikhail Khodorkovsky in prison, while rewarding
Mr. Deripaska for his cooperation and collaboration, stating publicly that he would transfer
Rusal back to the government at any time saying, “If the state says we need to give it up, we’ll
give it up.”

The Rusal IPO highlights the political and institutional challenges that arise when Russian
companies tap into international capital markets. Headed by someone close to the Kremlin, Rusal
benefits from regulatory and financial support in the form of advantageous loan refinancing and
investment in the IPO.

Russian Economic and Investment Issues

The Financial Times reported on January 10, 2010, that Russian companies intend to seek $90
billion over the next two years to finance debt restructuring and capital improvements and
resupply the coffers of politically connected Russian business owners, who saw their fortunes
collapse during the 2008 financial crisis.

Russia’s economic and financial outlook remains cloudy at best:

• Russia expects to see a steeper drop in economic production this year than initial
forecasts, with the country now preparing for a continuation of the economic crisis long
into 2010.
• Russia suffers from minimal domestic financial intermediation because inept state banks
dominate the financial market.
• President Medvedev announced in May wide-ranging budget cuts previously put on hold,
and conceded that Russia was far from out of the economic crisis.

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 • For the Russian government, investor perception of Russia as a high-risk country is a
very serious issue, especially as Mikhail Khodorkovsky remains behind bars. One of
President Dmitry Medvedev's key programs is to create a diverse economy and to
encourage a higher level of foreign investment. In July 2008, he urged the government to
put an end to the bureaucratic practice of creating "nightmares" for businesspeople, such
as needless inspections and various extortion schemes to force businesses to pay bribes to
bureaucrats to stay in business.
• In October 2009, Carrefour, the world’s second largest retailer withdrew from Russia,
citing an absence of growth prospects in the short- and medium-term just months after
opening its first store in June 2009.
• IKEA, in June 2009, declared a moratorium on investment in Russia after the CEO
declared that he refused to be extorted.

Global Concerns over Russian Corruption

Recently, two widely cited surveys on economic freedom, Transparency International’s
Corruption Index and the Heritage Foundation’s Index of Economic Freedom ranked Russia
close to the bottom and in the case of the Index of Economic Freedom, barely above “repressed.”

• The 2009 Corruption Perception Index from Transparency International ranked Russia
146th out of 180 countries, falling behind the likes of Libya, and Pakistan and Honduras.
By comparison, the data shows that in 2009 Georgia posted a score of 4.1 up from 3.9 in
2008, illustrating that that country’s corruption reform efforts continue to be highly
effective in earning domestic and international confidence and improving the country’s
image. Brazil, China and India, part of the BRIC emerging markets block, consistently
score higher than Russia as well.

• In the 2010 Heritage Foundation’s Index of Economic Freedom, Russia’s overall rating
in this measurement of economic openness, regulatory efficiency, the rule of law and
competitiveness, decreased to 50.3 this year, ranking it only 0.3 points away from being a
repressive economic business environment. Russia ranked 143rd out of 179 countries. Ten
different components make up the overall score and Russia’s three lowest scores are in
the Investment Freedom, Property Rights and Freedom from Corruption categories. Not
surprisingly, foreign investment in Russia continues to be challenging for investors given
the capricious nature of Russia’s investment process, rampant expropriation of property
and extensive government controls on international capital flows.

• Russia’s weak score of 25 on property rights was echoed this week by Russia’s First
Deputy Prime Minister Igor Shuvalov, who said, “Investment in high technology is
possible only with solid protection of private property rights. Therefore this problem is
directly linked to the course of modernization.” The same court system that is prosecuting
Mikhail Khodorkovsky, is so inefficient and corrupt that property rights are difficult to
enforce, a major deterrent to foreign investment.

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Russia’s future in the community of nation’s rests in the balance. During your discussions in
Davos, please consider the fate of Mr. Khodorkovsky and its impact on investment and the
Russian people’s economic future.

Selected Cases of Rule of Law Violations in Russia

Abitare
February 2005 U.S. businessman Frank Neuman, who owned a furniture chain, Abitare,
was denied entry to Russia; shortly thereafter armed gangs forcibly closed
his stores; business is re-registered to new owners upon forced "sale."
BP Plc
2004 to present BP Plc has faced numerous regulatory and legal issues in Moscow since
forming its joint venture with Russian oil company TNK, including back
tax claims, espionage allegations, immigration disputes and licensing
fights. In March 2008, armed police raided the Moscow offices of BP and
its local joint venture, TNK-BP in an attempt to persuade TNK-BP's
Russian shareholders to sell their 50% stake in the company. The Kremlin
has ratcheted up pressure on foreign energy companies in recent years as
part of its effort to consolidate control over the country's largest and most
important hydrocarbon deposits. Robert Dudley, who served as CEO of
TNK-BP after it was formed in 2003, left Russia in July 2008 citing
“sustained harassment” amid court battles and labor and tax inspections.
Carrefour
October 2009 Citing an absence of growth prospects in the short- and medium-term, the
world’s second largest retailer withdraws from Russia, just months after
opening its first store in June 2009. Among industry analysts, Russia is
known to have investment challenges, including bureaucratic
inconsistency, corruption and restrictions on lucrative sectors like energy.
Corruption weakens the rule of law and increases the fragility of property
rights.
DeBeers
January 2009 De Beers, the world’s largest diamond company, withdrew from a mining
joint venture after talks with the Federal Anti-Monopoly Service.
Hermitage Capital
2005 to present In 2007, Russia's Interior Ministry raided the corporate offices of
Hermitage Capital Management, one of the largest portfolio investors in
Russia, and stole documents that allowed them to install new executives.
The new executives forged contracts that allowed them to create nearly $1
billion in liabilities, which cleared the way for them to apply for the $230
million in fraudulent tax refunds. In July 2009, a U.S. judge ordered that

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 attorneys for Hermitage may subpoena JP Morgan Chase Bank and
Citibank NA for testimony and records relating to wire transfers that
Hermitage said will aid its four pending cases in Russia. Hermitage
contends in court documents that other Western investors in Russia had
colluded with the authorities to steal the money through the tax refunds
and then launder it through New York banks. Russian authorities had
stopped Hermitage's chief executive, William Browder, at a Moscow
airport in 2005 and deported him on national security grounds. In
November 2009, Hermitage lawyer Sergei Magnitsky died under
suspicious circumstances while in Russian custody.
IKEA
June 2009 In 2004, building licenses and construction permits were disputed by the
Moscow authorities, delaying opening of stores and increasing project
costs; IKEA's Russia head said that he feared for his life after refusing to
pay bribes to local authorities. In June 2009, IKEA declared a moratorium
on investment in Russia.
Motorola
2006 Between March and April 2006, Motorola shipped 167,500 mobile phones
to Moscow. Upon leaving customs they were immediately seized by
Moscow Interior Ministry officials as "contraband." In another incident
that year, RussGPS, a small high tech company supplying the Russian
military, persuaded the Interior Ministry to bring a claim for patent
infringements against Motorola in Russia, circumventing the normal
procedure of protecting intellectual property via courts.
Open Society Institute/George Soros
November 2003 George Soros' Open Society Institute’s Moscow office was raided at
midnight by private security forces. The cause of the raid was not clear,
but suspicion is that it was retaliation for Soros' criticism of the arrest of
Mr. Khodorkovsky.
Peter Hambro Mining
2006 Oleg Mitvol, Deputy Minister of Rosprirodnadzor asserted breaches of
license agreement against Peter Hambro Mining and threatened asset
seizure and penalties, effectively wiping £300 million from the market
capitalization of the company.
PriceWaterhouse Coopers
2007 Russia’s Interior Ministry raided the firm’s offices allegedly in connection
with the YUKOS affair; the Interior Ministry opened a tax evasion case
against PwC, widely seen as a deliberate effort to discourage PwC from
supporting the defense of the new charges brought against Mikhail
Khodorkovsky. Ultimately in June 2007, PwC announced the withdrawal
of its YUKOS audited financial statements. Two days after PwC
announced its withdrawal of the YUKOS audited financial statements, the

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 General Procurator’s Office advised PwC that it found no evidence of
wrongdoing by PwC in its audits of YUKOS. Less than two weeks later,
an appellate court overturned a lower court’s judgment against PwC for
tax evasion and returned the matter to the lower court for reconsideration
on nearly the entire assessment.
Royal Dutch Shell
2006 Gazprom, the Russian energy monopoly, seized control of the world's
largest combined oil and natural gas development after a highly publicized
campaign of pressure on its foreign operator, Royal Dutch Shell. Before
the seizure, Shell came under pressure for alleged cost overruns, delays
and environmental violations at its Sakhalin-2 project. Shell was forced to
sell half its stake in the Sakhalin-2 project to Gazprom for $7.45 billion,
far below its value and the Shell investment. Relations between Shell and
the Russian government have thawed, with Putin welcoming Shell to
participate in two upcoming natural gas projects in Russia in June 2009.
Shell partnered with Russian gas giant OAO Gazprom to launch Russia's
first liquefied natural-gas plant in February 2009.
Starbucks
2002 to 2005 Starbucks trademark was appropriated by Russian squatter, delaying
market entry by three years and after extensive legal fights. Starbucks
prevailed in Russian court; the victory was seen as a sign that Moscow
may realize that defending intellectual property rights must be recognized.
Starbucks opened its first store in Russia in September 2007.
YUKOS/Mikhail Khodorkovsky
2003 to present A circle of businessmen and politicians initiated legal proceedings against
the oil mogul Mikhail Khodorkovsky and his partner Platon Lebedev
based upon alleged illegality in connection with Group Menatep Limited’s
acquisition of assets during privatization and the subsequent alleged abuse
of these entities and tax evasion. Lebedev and Khodorkovsky were
arrested and convicted in a show trial. YUKOS was systematically
dismantled through, first, a sham tax auction wherein its largest asset was
auctioned off at a fraction of its market value to an ad-hoc shell company
which promptly transferred its assets to state-owned Rosneft. Second,
there was a contrived bankruptcy wherein YUKOS’s remaining assets
were sold at deflated prices to, among others, Rosneft and state-dominated
Gazprom. Since then, YUKOS former shareholders have filed claims for
damages worth more than $30 billion as a result of the Russian
government's expropriation of their investments. Meanwhile, U.S.
shareholders have lost from $4 billion to $6 billion as a result of the
Russian government's attack on YUKOS and Khodorkovsky. Today,
Khodorkovsky and Lebedev are now on trial on criminal charges, inter
alia, of embezzling all of the oil produced by the YUKOS production
subsidiaries and money laundering that widely regarded as baseless.

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Zoloto Resources
2008 Zoloto Resources, a Canadian gold exploration company stopped
investing in Russia after the strategic deposit legislation designed to
protect domestic producers became law.

Who Is Mikhail Khodorkovsky?

Prior to his arrest, Mikhail Khodorkovsky was known throughout the world as Russia's most
successful businessman and leading philanthropist. He actively promoted civil society, fought
corruption, encouraged foreign investment, and sought to integrate Russia into the world
community. Mikhail Khodorkovsky is a patriot whose continued imprisonment is a scar on the
Russian political and economic landscape.

Mikhail Khodorkovsky built YUKOS into one of the most successful businesses in Russia by
combining the best talent and best practices known in the oil industry. He, along with Platon
Lebedev, introduced modern technology and management skills into what had been a nearly
bankrupt Soviet-style energy producer. Wishing to share his success with his country,
Khodorkovsky became a leading philanthropist, contributing millions of his own for civil society
foundations, education programs, and student scholarships.

Mikhail Khodorkovsky was born on June 26, 1963, in Moscow. His parents, Boris and Marina,
worked as chemical engineers, earning modest salaries. Deciding to follow in his parents'
footsteps, Khodorkovsky chose to study chemical engineering and graduated in 1986 from
Moscow's Mendeleev Institute of Chemical Technologies. Khodorkovsky has also studied at the
Plekhanov Institute of Economy - Russia's top economic management school - as well as at the
Institute of Law.

In 1987, at the age of 24, he founded the Youth Center for Scientific and Technical Development
to conduct market research for large manufacturers and introduce them to new technologies. In
1989, Khodorkovsky together with his business partners founded one of the first commercial
banks in Russia - later known as Bank MENATEP. In 1994, Bank MENATEP's board of
directors decided to expand its business model to form a diversified industrial group called
ROSPROM, which managed the transition of more than 100 large manufacturers from the Soviet
economic model to free enterprise. In 1997, Group MENATEP Limited was established as a
holding company, which later acquired majority interest in YUKOS.

At the end of 2001, Mikhail Khodorkovsky established the Open Russia Foundation, a non-
governmental organization dedicated to the principles of freedom and democracy.

Arrest and Trial

The arrest of Khodorkovsky's key associate, Platon Lebedev in July 2003 was widely interpreted
as a warning sign aimed at the YUKOS chief. Against the advice of many, Khodorkovsky chose
not to leave Russia because he was determined to refute the charges against him. He also
considered leaving Russia a betrayal of Lebedev, his employees, and his homeland.

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On October 25, 2003 Khodorkovsky was arrested at gunpoint in the city of Novosibirsk.
After an unfair trial on trumped-up charges believed by many to be politically motivated,
Khodorkovsky was sentenced on May 16, 2005, to nine years in prison. This sentence was
reduced by the Moscow City Court to eight years.

New York Times - Ikea Plans to Halt Investment in Russia

June 24, 2009

By Andrew E. Kramer

MOSCOW — Ikea said Tuesday that it was suspending further investment in Russia, apparently
because of pervasive corruption and demands for bribes.

The announcement came after a rare statement by Ikea’s 83-year-old founder in a radio interview
that Ikea had decided not to solve problems by slipping money under the table.

Russian President Dmitri A. Medvedev has acknowledged that corruption is a national problem,
and curbing official corruption is one of the goals of his tenure.

Mr. Medvedev has signed a law prohibiting surprise inspections from fire and health authorities
of the type often used to extort companies, and has required bureaucrats to disclose not only their
own income and assets but their spouses’, a once common conduit for bribes. Beyond
embarrassing Mr. Medvedev’s administration, the Swedish retailer’s public stance could mark an
economic turning point if it leads to more Western businesses speaking out against corruption
here.

The decision is particularly damning for Russia because Ikea runs outlets in dozens of countries
around the world and is hardly thin-skinned when it comes to dealing with bureaucracies.

“We all support the anticorruption policies of President Medvedev,” Elena A. Panfilova, Russia
director of Transparency International, the anticorruption group, said in a telephone interview.
“But people need to see real results. And if companies like Ikea don’t see results in their daily
business practices, it’s sad news for Russia.”

In a statement, Ikea’s Russia director cited the “unpredictability of administrative processes” in

Russia as the basis of the decision. Outside experts said that was the company’s way of
describing a pattern of bribe-taking and shakedowns by Russian officials that had become
intolerable.

“Ikea as a major shopping center developer wishes to invest in Russia to serve our customers and
bring jobs and growth,” the director, Per Kaufmann, said in the statement. “Yet, as long as the
principal issues being crucial for Ikea development in Russia remain pending, we have to put all
new investment plans on hold.”

Ikea’s announcement came after a series of public complaints, including from the company’s
founder, the secretive billionaire Ingvar Kamprad, who went on Swedish radio to complain that

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the company had been cheated out of millions of dollars by overcharging for electricity. Mr.
Kamprad linked the problems to Ikea’s decision not to pay bribes in Russia.

Western business executives have complained privately for decades that bribery is an integral
part of Russian business culture, often tolerated or silently rebuffed. In fact, foreign companies
retain legions of lawyers so they can adhere scrupulously to regulations in hopes of avoiding
providing an opening for bribe-seeking officials.

Russia has fared badly on the group’s corruption perception index, tying with Bangladesh,
Kenya and Syria for 147th place, out of 180 countries.

The traffic police routinely take cash bribes, and in popular lore, their large motorcycle gloves
are especially designed to store wads of bills.

However, it is the next level of official venality, so-called administrative corruption, that is most
harmful to business as fire, sanitary, tax, customs and other authorities with the power to halt
business activity demand bribes.

“It becomes a choice of businesses either to pay or get involved in years and years of paperwork
exchange,” Ms. Panfilova said.

Ikea operates both as a furniture retailer and a developer of malls in Russia, with its stores as
anchor clients. Since the first store opened in 2000, the company said it had become the target
for corrupt officials in Moscow and the provincial towns where it operated.
In a recent interview, Mr. Kaufmann, the Russia director, told The Associated Press that the
inspectoral assault sometimes gave him the feeling that “someone somewhere does not like us.”

The company had been growing more vocal about its troubles this spring. Mr. Kaufmann went
public with a threat to halt investment throughout Russia — the decision taken Tuesday —
unless authorities allowed a store in the southern Russian city of Samara completed some months
ago to open. Inspectors had said that the building was not sturdy enough to withstand hurricane-
force winds; Ikea pointed to historical records showing that such winds have never occurred in
central Russia.
Regional officials in Samara have said they were ensuring the safety of the store, and that Ikea’s
public statements were attempts to pressure inspectors.

This dispute at the Samara store fits a pattern. Authorities have consistently blocked openings at
the last moment, when a company is most vulnerable to delays because of the capital it has
already invested.

Days before the first opening of an Ikea store on the outskirts of Moscow, authorities declined to
connect the electricity; Ikea resorted to renting generators, and since then has made a practice of
having them on hand.

In 2004, officials halted an opening ceremony at a separate Moscow store minutes before it was
to begin, saying the parking lot was too close to a natural gas pipeline.

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An outlet in Nizhny Novgorod was closed for its opening holiday season in 2006 on the grounds
of fire-code violations; the opening of an outlet in Novosibirsk was postponed over demands to
rebuild a road.

In his statement, Mr. Kaufmann said Ikea would complete stores already under construction in
Omsk, Ufa and the Moscow region but suspend future investment.
The central government in Moscow has made no comment.

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