Kremlin Has Forgotten the Lessons of the Past

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Fiasco is probably not a strong enough word to characterize the way the government and President Vladimir Putin have handled the Yukos affair. Yukos was an easy target. Once oil prices hit $30 per barrel, its CEO, Mikhail Khodorkovsky, became a born-again advocate of transparent corporate behavior. Before then, however, Khodorkovsky's own record and that of his company were typical of the personal and corporate misbehavior that marked the "piratization of Russia." If not the prototype of the Russian oligarch-pirate, Khodorkovsky came a pretty close second.

The official court charges against him and his team range from tax evasion to fraud, embezzlement, theft of state property, murder and attempted murder. Undoubtedly some of the accusations are exaggerated, but it is hard to ignore some of the circumstantial evidence, including the bodies of some who ran afoul of Yukos in one way or another. I personally have knowledge of or know individuals who saw an investment of $2 billion disappear after Khodorkovsky separated them from their investment, and others who were threatened physically by Yukos officials. Even I was warned that I would be sued for libel if I included negative material about Khodorkovsky and Yukos in my most recent book.

But even if Yukos officials are innocent of the charges against them, a case could be and is being made that the privatization process itself was flawed and that some re-examination of it is warranted. The fact that privatization allowed Khodorkovsky to gain control of Yukos in the 1995 loans-for-shares initiative for only $309 million was politically and morally untenable. Through no effort on Khodorkovsky's part, Yukos in short order registered a market value of approximately $15 billion. At its peak, when oil prices hit $30 to $40 per barrel, Yukos had a capitalized value close to $40 billion.

The Audit Chamber examined a whole range of such situations. When the chamber published its report in late November, we learned of other companies whose owners could be forced to share their sudden and usually unearned wealth with the public. This might take the form of supplemental payments to the state so the original price paid plus the supplement will come to approximate a more realistic market value. In any case the state is likely to insist on the payment of back taxes, a shortcoming not unique to Yukos.

Neither Khodorkovsky nor Yukos was beyond reproach. The fact that Khodorkovsky led the way in hiring Western auditing firms, appointed competent and honest senior Western executives to the higher ranks of the company and recruited three experienced Western businessmen and women as outside directors of Yukos is to be applauded and should be considered by any judge in assessing penalties. But it is not enough to exclude Khodorkovsky from prosecution.

Putin's mistake was that he was not content to prosecute Khodorkovsky and Yukos under the law. The viciousness of the attack, and arrest of not just senior Yukos executives but subordinate and low-ranking staff, lend credibility to the charges that as much as anything this was also a political vendetta against Khodorkovsky. How dare he sponsor rival political parties or buy up (lobby?) State Duma deputies in his effort to defeat a tax increase on Yukos and other oil companies?

The raids on the offices and homes of Yukos officials and their lawyers, not to mention jailing them and Khodorkovsky without bail for over a year, and freezing Yukos assets so it could not pay its back taxes, dramatize how obsessed the siloviki around Putin are with regaining control of Yukos' assets. In a February 2003 conversation, a high-ranking government official warned a Western investment adviser that Yukos would be destroyed within a year. He could not mask his resentment that control of Russia's most valuable natural resources was in the hands of these "outsiders" and not the siloviki.

Such recourse to the rule of "laws" and accommodating judges has validated those who warned that Russia was still a long way from embracing the market and the results of privatization. But putting such "terrorist" tactics aside, sooner or later there had to be a political reconsideration of the process.

The Yukos case also makes one wonder just who is in charge. Putin has insisted several times that he does not want Yukos to go bankrupt. He told me in September that if I gave him the names of any government official who was seeking to bankrupt Yukos, he would fire that official immediately. Putin also said the officials who kept upping Yukos' tax bill were just doing their jobs, of course. Every company should and will pay the taxes it owes.

The siloviki did not realize that as they became more and more unreasonable in their demands, they not only would lose whatever support they might have had in the outside world, but that they would all but invite international intervention. They are now learning that globalization is a two-way street. They can profit from sales of petroleum to the outside world, but when oil profits attract Western investors, those investors are likely to pursue legal remedies in non-Russian courts if they feel cheated. Just as General Electric, a U.S. company, discovered that the European Union could block its acquisition of Honeywell, another U.S. company, so Russian officials now must deal with a U.S. federal judge in Houston. Baikal Finance Group may feel it can ignore a U.S. judge and bid to take over ownership of Yuganskneftegaz. But Gazprom -- which will probably end up with Yugansk -- and the banks that planned to finance its bid realized that acquiring the company openly would have exposed them to the risk of lawsuits and legal penalties. In this globalized world, this could result in a suit filed in a U.S. court against a German bank over a Russian company.

For that matter there is every reason to believe that Baikal and/or Gazprom will be vulnerable with or without loans from Western banks. Back in 1993, I advised Noga, the Swiss trading company, that if it wanted to collect on what it considered to be the refusal of the Russian government to pay its bills, it should seize Russian-owned assets in the West. This led to a claim placed on the Russian-owned East West United Bank in Luxembourg, as well as on a Russian ship and other properties. As the supplier of 40 percent of Germany's natural gas, Gazprom and those who deal with it will find their assets outside of Russia similarly vulnerable. Once it tries to export Yukos petroleum to the outside world, Baikal, as mysterious as it is, will also be vulnerable.

Had Putin and those around him pursued a temperate case against Yukos, there is a strong possibility that the state would have recouped significant unpaid taxes and restored its control over much of Russia's energy resources. All of this could have been done without jeopardizing Russia's and Putin's credibility in the world business and political communities. Now Putin seems to be reinstituting Soviet-era controls across a whole spectrum of institutions. In the economic sphere, capital flight is back. Western businessmen are wondering whether they might one day join Yukos' top executives in jail. How easy it is to forget the lessons of the past.

Marshall I. Goldman is Kathryn W. Davis Professor of Russian Economics, Emeritus, at Wellesley College and the associate director of the Davis Center for Russian and Eurasian Studies at Harvard University. He contributed this comment to The Moscow Times.