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Freedom Holding: The Red Flag Factory in Belize

Freedom Holding Corp. has some explain­ing to do.

The finan­cial ser­vices firm has quite improb­a­bly become one of the fastest grow­ing com­pa­nies on the plan­et. It lists its shares on the Nasdaq, is incor­po­rat­ed in Las Vegas, but for all intents and pur­pos­es runs its oper­a­tions most­ly in Kazakhstan.

As a December inves­ti­ga­tion by the Foundation for Financial Journalism showed, Freedom Holding’s bal­loon­ing prof­its have result­ed from baf­fling and opaque busi­ness prac­tices that its man­age­ment is not keen to discuss.

Among the arrange­ments is Freedom Holding’s close con­nec­tion to FFIN Brokerage Services, a Belize-based secu­ri­ties trad­ing firm owned by Timur Turlov. He also is Freedom Holding’s bil­lion­aire founder and major­i­ty shareholder.

Even the most sea­soned investor has prob­a­bly not wit­nessed relat­ed-par­ty trans­ac­tions of the scope of FFIN’s deal­ings with Freedom Holding.

Last year more than 56 per­cent of Freedom Holding’s rev­enue came from FFIN com­mis­sion pay­ments, and in 2019 they rep­re­sent­ed over 65 per­cent. What Freedom Holding does to earn the com­mis­sions is not read­i­ly appar­ent, how­ev­er. Yet the two com­pa­nies are so inter­twined – Freedom Holding’s senior man­agers use FFIN email accounts – it’s not clear the two com­pa­nies are sep­a­rate in any real sense.

In June, Freedom Holding for the first time dis­closed in its annu­al report its rela­tion­ship with FFIN, cat­e­go­riz­ing this as a risk fac­tor for investors to weigh before buy­ing shares. Highlighted as a mat­ter of par­tic­u­lar inter­est: the por­tion of rev­enue that Freedom Holding received from Turlov’s com­pa­ny. In the annu­al report, Freedom Holding’s audi­tor, Salt Lake City’s WSRP LLC, acknowl­edged the FFIN con­nec­tion as part of sev­er­al “crit­i­cal audit mat­ters.” (Engaged by Freedom Holding to assess the accu­ra­cy of its account­ing, WSRP did not weigh in on the pro­pri­ety of Freedom Holding’s FFIN relationship.)

But FFIN’s own annu­al report, also released in June, ought to give Freedom Holding investors pause: In just a year, FFIN’s assets grew almost 1,100 per­cent, to more than $2.5 bil­lion. That’s sig­nif­i­cant­ly larg­er than Freedom Holding’s $2 bil­lion in assets.

Were FFIN ever to hit dire finan­cial straits, Freedom Holding could be in real trouble.

And FFIN’s prof­its have put sub­stan­tial cash in Turlov’s pock­ets: $12.8 mil­lion in 2019 and more than $30 mil­lion last year. (Although FFIN record­ed a $16 mil­lion loss last year, Freedom Holding’s out­side legal advi­sor Ron Poulton of Salt Lake City explained that no actu­al loss occurred. The $46.53 mil­lion in impaired trade receiv­ables record­ed by FFIN were not loss­es result­ing from clients fail­ing to pay but an “account­ing con­ven­tion” to doc­u­ment a charge like a non­cash expense such as depre­ci­a­tion, he said.)

Keeping terms of a relationship under wraps

While the specifics of FFIN and Freedom Holding’s arrange­ment have not been pub­licly dis­closed, the basic con­tours are clear: FFIN acts as a bro­ker for Freedom Holding, pri­mar­i­ly exe­cut­ing trades in pop­u­lar U.S. exchange-list­ed equi­ties and ini­tial pub­lic offerings.

Peddling IPOs is Freedom Holding’s most aggres­sive­ly pro­mot­ed line of busi­ness, and FFIN han­dles the firm’s IPO-relat­ed cus­tomer ser­vice issues. For its part, FFIN has a dis­tinc­tive busi­ness prac­tice: requir­ing clients to observe a 93-day lock­up peri­od for any IPO shares they pur­chase. Customers can­not sell or even trans­fer to an out­side account the new­ly pur­chased shares for that three month period.

This is stark­ly at odds with the typ­i­cal U.S. and European bro­ker­age prac­tice, where­by clients are free to trade their shares imme­di­ate­ly after receiv­ing an allo­ca­tion. Any oth­er bro­ker­age that tried to impose this con­straint would like­ly be assured of an imme­di­ate cus­tomer exo­dus and a wave of litigation.

The Foundation for Financial Journalism asked Poulton sev­er­al ques­tions about the par­tic­u­lars of the Freedom Holding-FFIN rela­tion­ship. (Poulton addressed one group of ques­tions but refused to answer a sec­ond, more spe­cif­ic set.) He would speak only gen­er­al­ly about FFIN, say­ing, “The func­tion­al pur­pose of FFIN Brokerage Services to its clients are diverse and pri­vate to them.”

Poulton also cit­ed changes in Russian and Kazakh laws that might reduce Freedom Holding’s reliance on FFIN. Turlov set up FFIN in 2014 to offer Russian and Kazakh res­i­dents access to U.S. dol­lar-denom­i­nat­ed invest­ments, Poulton said. At the time, Russian reg­u­la­tors frowned on indi­vid­u­als own­ing British pound- and U.S. dol­lar-denom­i­nat­ed invest­ments. In 2018, how­ev­er, the two coun­tries start­ed to ease such regulations.

The Foundation for Financial Journalism posed the same ques­tions to Adam Cook, Freedom Holding’s cor­po­rate sec­re­tary; Askar Tashtitov, Freedom Holding’s pres­i­dent; and Turlov but did not receive a reply.

Generating huge profits via a small Cyprus unit

Notwithstanding the steady sky­ward march of Freedom Holding’s share price, its finan­cial state­ments are sure­ly cat­nip for short sell­ers and finan­cial skeptics.

Embedded in the fil­ings is the promi­nent role Freedom Holding’s Cyprus unit plays in the company’s growth. That sub­sidiary, which used to be the prime com­po­nent of Freedom Finance Europe Limited, has been for­mal­ly renamed Freedom Finance Europe Limitedthe unit opened in 2017 and its main task is oper­at­ing Freedom 24, an elec­tron­ic trad­ing system.

As described in the December arti­cle, the Cyprus subsidiary’s defin­ing fea­ture is achiev­ing astro­nom­i­cal prof­it growth, unri­valed on Wall Street. Although in 2017 the Cyprus unit report­ed a $30,000 loss, by 2019 it had $33.8 mil­lion in earn­ings. In 2020, the subsidiary’s income rose to $80.4 million.

Freedom Holding’s earn­ings growth sto­ry is entire­ly a func­tion of its Cyprus sub­sidiary. One way to track this is to com­pare the pub­lished finan­cial results for both Freedom Holding and its Cyprus sub­sidiary from Jan. 1, 2020, through Dec. 31, 2020. (The Cyprus unit files a risk dis­clo­sure state­ment once a year that includes its annu­al net income, but cor­po­rate par­ent Freedom Holding releas­es its income quar­ter­ly and its fis­cal year ends on March 31.)

For the nine months that end­ed Dec. 31, 2020, Freedom Holding report­ed $90.1 mil­lion in net income, with $80.4 mil­lion of this derived from the Cyprus subsidiary.

Thus, for nine months of Freedom Holding’s most recent fis­cal year, the Cyprus unit con­tributed at least 56 per­cent of the par­ent company’s $142.9 mil­lion in net income.

And accord­ing to a recent reg­u­la­to­ry fil­ing, the Cyprus sub­sidiary achieved those results with min­i­mal resources. Making that sum of mon­ey took only 13 employ­ees and $6.3 mil­lion in capital.

Taken at face val­ue, the Cyprus unit’s gaudy per­for­mance like­ly cat­a­pults it to the top of the list of the most prof­itable trad­ing desks in his­to­ry. (The dis­tant sec­ond: Michael Milken’s high-yield trad­ing oper­a­tion at Drexel Burnham Lambert, which in 1987 gen­er­at­ed a pur­port­ed $2 bil­lion in rev­enue, with Milken pock­et­ing an esti­mat­ed $550 million.)

To an out­side observ­er, the fact that the Cyprus unit could gen­er­ate prof­its at this scale is baf­fling. After all, it is a no-frills online trad­ing oper­a­tion that facil­i­tates indi­vid­ual investors’ stock trades. It def­i­nite­ly is not an elite pro­pri­etary trad­ing divi­sion; com­pen­sa­tion for its 13 employ­ees last year totaled less than $1.3 million.

Carrying out trades in a circuitous fashion

Freedom Holding employs a remark­ably cir­cuitous order exe­cu­tion process for its customer’s trades. It is labyrinth to a degree that sug­gests that obtain­ing the best pos­si­ble price for the client is a sec­ondary concern.

A trans­ac­tion might look some­thing like this, accord­ing to con­ver­sa­tions with cur­rent and for­mer Freedom Holding clients, as well as a for­mer com­pa­ny exec­u­tive: A client of Freedom Holding who attempts to buy shares online is prompt­ly direct­ed out­side its plat­form to FFIN, which then routes the order to Freedom Finance Europe in Cyprus. But final exe­cu­tion of the client’s order appears to require anoth­er hand­off, either to a Freedom Holding sub­sidiary in Moscow or (fre­quent­ly) to a firm with a trou­bling reg­u­la­to­ry his­to­ry, Lek Securities U.K. Limited in London.

One pos­si­ble rea­son for this com­plex­i­ty? Fee lay­er­ing, the prac­tice of charg­ing a client mul­ti­ple fees on a sin­gle transaction.

Layering is a legal, albeit con­tro­ver­sial, prac­tice that has fall­en out of favor in the U.S. mon­ey man­age­ment indus­try, giv­en the rise of low­er-cost index and exchange-trad­ed fund invest­ing. But for Turlov and his col­leagues, elon­gat­ing a trade’s life cycle in order to col­lect two or three sets of fees might be tempt­ing since their large­ly Russian and Kazakh client base might have scant expe­ri­ence with Wall Street prac­tices or robust con­sumer advocacy.

A fur­ther puz­zle: The Cyprus unit’s 2020 risk dis­clo­sure state­ment not­ed that last year FFIN exe­cut­ed 24 per­cent of the trades made by the unit, up from 9 per­cent in 2019. This is odd since nei­ther FFIN nor the Cyprus sub­sidiary hold any U.S. bro­ker­age licenses.

Doing business with companies of questionable repute

One of the nicer things about man­ag­ing an expand­ing and prof­itable com­pa­ny is hav­ing options. For exam­ple, if a cus­tomer pos­es a rep­u­ta­tion risk or is too demand­ing rel­a­tive to his or her eco­nom­ic val­ue, end­ing the rela­tion­ship is gen­er­al­ly a low-risk proposition.

Timur Turlov and his man­agers do not seem to hold this view, how­ev­er, because they have reg­u­lar­ly done busi­ness with peo­ple and com­pa­nies whose exten­sive legal prob­lems would cause most U.S.-based man­agers to stop in their tracks.

Consider FFIN’s busi­ness rela­tion­ship with two Moscow-based com­pa­nies: asset man­ag­er QBF LLC and net­work mar­keter CityLife.

Both QBF and CityLife have attract­ed the scruti­ny of the Russian gov­ern­ment: The Ministry of Internal Affairs raid­ed QBF on May 31 and arrest­ed two of its prin­ci­pals for pur­port­ed­ly con­duct­ing a Ponzi scheme. And on June 1, the Central Bank of Russia’s Unfair Trade Practices unit added CityLife to a list of com­pa­nies with iden­ti­fied signs of ille­gal activ­i­ty for alleged­ly show­ing signs of run­ning a pyra­mid scheme.

How does FFIN fit into all this? According to a trans­la­tion of a Russian lan­guage press account of the Interior Ministry’s QBF raid, FFIN was one of sev­er­al banks and bro­ker­ages the asset manager­­­’s exec­u­tives were said to have used to move investor cash out of Russia. (Neither Turlov nor Freedom Holding were named in the article.)

While using a Russian lan­guage search engine, the Foundation for Financial Journalism found a CityLife co-founder’s FFIN wire instruc­tions des­ig­nat­ing 16 sep­a­rate bank accounts that were to receive funds. It is not clear who post­ed such a sen­si­tive doc­u­ment online, but the root link is from a CityLife web­site. One of the banks list­ed on the form is Freedom Holding’s Bank Freedom Finance LLC.

Questioned about FFIN’s rela­tion­ship with QBF and CityLife, Poulton con­firmed that the two firms “at one time did have stan­dard client bro­ker­age accounts with FFIN Brokerage Services.” He said that FFIN closed the QBF account “in the fall of 2018” but did not pro­vide a reason.

Poulton added that the CityLife account was opened in ear­ly 2021 and “con­duct­ed mod­est trad­ing” and when the Central Bank of Russia added it to its list of com­pa­nies with iden­ti­fied signs of ille­gal activ­i­ty, FFIN closed the account.

Update: This sto­ry was updat­ed on Aug. 8, 2021, to  clar­i­fy the rela­tion­ship of the Cyprus unit to Freedom Holding’s Freedom Finance Europe; it used to be referred to as its sub­sidiary but now is sim­ply called Freedom Finance Europe.

Original source of arti­cle:

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