Czech investment funds

Worrying trend

Mar 27th 1997 | PRAGUE
From The Economist print edition

EVERY month, it seems, brings another stain on the Czech Republic’s reputation as a financial centre. Last year, eight banks went down thanks to incompetence or fraud. Now investment funds are being tainted. In recent weeks more than 75,000 shareholders in two investment-fund groups, Trend and CS Fondy, have been fleeced of assets worth nearly 2.3 billion koruna ($79m). “If this sort of thing continues,” says Kamil Goca, an analyst at Wood & Co, a Prague broking firm, “the market will close down.”

In the past year foreign investors have pulled about $500m out of the Czech stockmarket, thanks in part to lax regulation. This withdrawal is one reason why the market has fallen by 3.8% in dollar terms this year, while bourses in neighbouring Hungary and Poland have been rising. Much more could follow, says Howard Golden, president of the New York-based Central European Privatisation Fund, unless the government “fights the perception that the Prague stock exchange is just a vehicle for select insiders to enrich themselves at the expense of the ordinary shareholder.”

The latest scandals are the worse for happening under officials’ noses. Shareholders in CS Fondy were let down by their custodian, a small bank called Plzenska, which allowed the transfer of 1.4 billion koruna out of the fund. Because the money left the country, the transfer had to be approved by the finance ministry. Although some officials tried to block the transfer, it was approved. Some shareholders have started legal action against the deputy finance minister, Vladimir Rudlovcak. And on March 25th the Czech central bank said that it and the finance ministry would carry out an investigation of Plzenska’s custodianship of CS Fondy’s assets. Shareholders in Trend were just as unlucky: at least 270m koruna of their assets were stolen while Trend was being run by government-appointed administrators.

“The state could be liable for damages,” says John Moffitt, a director of Trend who represents the Czech Value Fund (CVF), part of Hong Kong’s Regent Pacific group. Last summer CVF bought 37% of Trend for about $10m. Trend’s portfolio, then worth 1.2 billion koruna, has since been drained of nearly 1 billion koruna-worth of assets, including a big stake in Prague’s biggest department store, Kotva.

In October 1996 Trend was put into administration at CVF’s request, after it realised that some of the fund’s directors were stealing its assets. Early this month five men, including senior directors of Trend and Kotva, were arrested, charged with fraud and detained—but not before a final block of shares in Kotva was sent, in breach of a court injunction, to a Cypriot company, Formister Enterprises. There is no guarantee that those shares will ever be returned to Trend. Mr Moffitt is livid: “This country’s laws”, he seethes, “have been flagrantly violated, proceeds of the fraud are still held unencumbered, and so far public institutions have responded ineffectually at best and negligently at worst.”

The scandals at Trend and CS Fondy are merely the latest in a lengthening list. Last year investors in the Harvard investment fund group, run from the Bahamas by its founder, Viktor Kozeny, were relieved of $30m in the form of management fees, advertising expenses and dubious share transactions, according to the Czech finance ministry. Harvard was fined by the ministry and asked to repay $6.8m. Another 11 local investment funds, including some managed by state-owned banks, were also fined last year.

Now Mr Kozeny is the subject of more allegations. The financier, who has swapped his Czech citizenship for Irish, failed to appear in a court in Plzen, a provincial city, on March 17th to testify in the retrial of a former secret-service agent, Vaclav Wallis. Mr Wallis claims that in 1992 Harvard paid him for information about the government’s privatisation programme.

The arrests, investigations and the fines may give the impression that the government is tough on fraud. But the latest thefts, at institutions supposedly in official care, and the sheer frequency of deceit, suggest that regulation of the market is far too slack. Mr Golden, whose fund has sunk $32m into Czech equity, has teamed up with local banks, including state-owned CSOB, and local broking firms to form the Foundation for Capital Market Development. This group is lobbying for tougher securities laws and the setting-up of a regulatory body independent of the finance ministry and modelled on America’s Securities and Exchange Commission.

Is the government listening? It seems not. Vaclav Klaus, the prime minister, has so far resisted calls for greater shareholder protection. He says that “there is only one investor who is complaining all the time”—meaning Mr Golden. But troublesome foreigners are not the only losers. Thousands of ordinary Czechs are equally unhappy to have been robbed.