Crime and punishment, Putin-style

A government attack on Russia's premier businessman threatens to derail years of economic progress.

By Kim Iskyan

Published September 3, 2003 7:30PM (EDT)

Russia's past is coming back to haunt it. Not the torture of seven decades of repression and economic disaster wrought by Soviet-style communism -- but, more immediately, the legacies of Russia's post-Soviet experiments with capitalism.

In the dark ages -- that is, the mid-1990s -- of Russia's transition to its present perverted free-market economy, a small group of well-connected corporate and political insiders bought handfuls of Mother Russia's choice crown jewels for kopeks on the ruble, through a series of rigged privatization auctions. Thanks to strong prices for natural resources, and (occasional) good management, these insiders -- Russia's oligarchs -- amassed tremendous fortunes and wound up controlling huge swaths of the Russian economy.

A few months ago, forces linked to President Vladimir Putin began to play with the lock on the Pandora's box of privatizations past. In the Byzantine politics of the Kremlin, the "siloviki," a faction made up of former KGB men, is orchestrating a power play, based in part on its close relationship with Putin -- who himself is a former KGB colonel. Putin, mindful of the political hay that he can harvest from kicking Russia's despised oligarchs in the head -- particularly in the run-up to December's parliamentary elections -- hasn't discouraged his henchmen. But as a result, many of the foundations of the new Russia no longer seem quite so sturdy: the sanctity of private property; the social contract that has kept the peace between big business and big government; the significant achievements of the Putin government's reform program of the past few years; the government's cornerstone economic goal of doubling Russia's GDP by 2010; and, most broadly, the country's economic system.

Mikhail Khodorkovsky, Russia's richest man (with a personal fortune of some $8 billion) and the CEO and largest shareholder of Yukos Oil Co., the country's biggest oil producer, is the primary object of current siloviki ire. Until recently, the 40-year-old Khodorkovsky was widely regarded as an ascending star and the international ambassador of Russian business, a status underscored by Yukos' announced takeover in April of fellow Russian oil giant Sibneft, which vaulted Khodorkovsky into the global leagues as head of the world's fourth-largest oil producer. A darling of international investors, with a ranking on Fortune magazine's list of the most powerful business leaders outside the United States, and a dining buddy of the likes of Condoleezza Rice, Khodorkovsky was widely rumored to be pondering a run for the presidency in 2008, when the all-but-certain second term of Putin will end.

Then the borscht went bad. On July 2, Khodorkovsky's top associate was tossed into one of the country's most notorious prisons, charged with fraud related to the 1994 privatization of Apatit, a curiously named fertilizer company. Over the next several weeks Khodorkovsky and employees of his company were hit with charges of bribery, tax fraud, corruption and murder -- charges issued by the prosecutor general's office, apparently acting on orders from the siloviki. Khodorkovsky himself was hauled in for questioning, and prosecutors -- accompanied by masked armed men -- stormed Yukos offices to rifle through the company's files. Within a few weeks, $7 billion in market capitalization vanished as Yukos shares dropped nearly 30 percent, and the Russian equity market as a whole fell as much as 18 percent. Share prices have subsequently recovered thanks to the oceans of liquidity in the Russian banking sector and capital markets, but the underlying questions posed by the crisis are no closer to resolution.

Pretty much every big businessman in Russia who got his start in the pistol-to-the-head days of the early 1990s, or who finagled a fortune through the privatization process, has a truckload of bodies in the backyard to show for it. The question is if and when the authorities -- goaded, threatened or bribed by a particular faction -- will decide to blow the dust off some old files and go after one oligarch or another in an attempt to squeeze him for cash, to score cheap populist brownie points for the boss, or just to show who's really in charge.

So whether Khodorkovsky's buddy cut a few corners back in 1994 isn't really the point: Khodorkovsky is a marked man. His real crime, in the eyes of the powers that be, is that he violated the terms of a gentlemen's agreement between the government and the oligarchs, whereby Putin promised to let the oligarchs keep their ill-gotten assets -- as long as they didn't meddle in politics and focused on their businesses. In an effort to set the stage for his career in politics, and perhaps also to throw a legislative monkey wrench into the Kremlin's plans to hike taxes on oil producers, Khodorkovsky began earlier this year to finance a range of candidates for the December parliamentary elections.

As if to flaunt his waxing political clout, Khodorkovsky also held a hard line in negotiations with the finance ministry over taxation rates for natural resources. As part of his efforts to burnish his international profile -- besides hobnobbing with international business leaders and politicians and giving generously to a range of foreign charities -- Khodorkovsky publicly criticized Russia's Iraq policy, favoring a more pro-U.S. stance.

Meanwhile, the remarkable growth of Yukos into a bona fide competitor on the global business stage threatened to make the company, and its powerful chairman, all but untouchable. The siloviki, and Putin, were threatened by the success of Khodorkovsky's attempts to create an aura of legitimacy independent of that permitted by the state, and they were jealous of the enormous wealth he had created -- which had not been anticipated in the original gentlemen's agreement. The exhumation of Khodorkovsky's skeletons is intended to send a message to other oligarchs who might be inclined to develop an interest in politics -- while cutting down to size the most aggressive and ambitious of the lot.

What's at stake is more than just the future of a preening billionaire who fancies himself a politician, or whether so many lemminglike institutional investors will again find themselves at the short end of the risk-reward equation. Suddenly up for debate are the terms of the next compromise between Russia's oligarchs and the government -- part and parcel of which is the future of property rights and, by extension, Russia's position in the global political economy.

The greatest fear -- for which at this point evidence remains weak -- is that the campaign against Yukos may represent a baby step toward a wholesale reexamination of the privatization process. From digging about in the privatization of a long-forgotten fertilizer producer, it's only a short leap to seriously questioning the mechanisms through which Yukos, and many other of Russia's largest and most powerful companies, were acquired. And in the tense world of Russian big business, a small threat is a very big deal: Just a hint of the possibility of the expropriation and renationalization of large chunks of the Russian economy would be enough to significantly shift its tectonic plates, by triggering a sharp decline in investment and a reallocation of investment and assets to destinations outside Russia. A full-scale reassessment, and unraveling, of the privatization process that currently defines the economic infrastructure of post-Soviet Russia would be, in the words of one top minister, "suicidal"; one top Putin economics advisor warned that revisiting privatization could lead to civil war. Pursuing Yukos, wrote defense analyst Pavel Felgenhauer in the Moscow Times in mid-July, "would send the wrong signal to potential foreign investors, lead to increased capital flight and destroy President Putin's stated strategic aim of building a 'competitive' market economy."

Indeed, the present uncertainty threatens to derail the Putin government's oft-repeated aim to double the GDP by 2010. Investment will vanish faster than a puddle in the Sahara at the first whiff of renationalization (or, critically, the lack of a credible renunciation of it), and capital flight -- only recently reversed -- has shown signs of picking up again. (Roman Abramovich, one of Khodorkovsky's oligarch colleagues, has in recent weeks accelerated his efforts to sell off portions of his vast industrial holdings in Russia, diversifying into, among other investments, the British Premier League soccer team Chelsea.) Putin may be calculating that sacrificing investment and reform -- the only path toward pulling Russia out of a permanent Third World stupor -- on the altar of control, while getting rid of a pesky up-and-comer, is a good deal. It took investors only a few years to forget the betrayal of Russia's August 1998 debt default and currency crisis. How long could it take for them to forget that even Russia's wealthiest and best-connected man was unable to protect his assets?

Khodorkovsky's comeuppance was long overdue -- in karmic terms, if nothing else. The billionaire won control over Yukos in 1995 for the low price of $309 million, through a privatization auction that was held by a bank controlled by Khodorkovsky himself. He subsequently took advantage of naive international investors, and a toothless stock market regulatory regime, to indulge in an orgy of financial legerdemain. The share dilutions, asset stripping, cash flow diversion, and highly questionable accounting practices that Khodorkovsky oversaw were bold enough to make even the most brazen Enron bankers blush. In one of its most infamous schemes, Yukos sold controlling stakes in three of its subsidiaries (which together had oil reserves roughly two-thirds the size of BP's) via a series of repurchase agreements to a string of offshore companies, some of which -- surprise, surprise -- were linked to a Yukos-controlled bank. Yukos, and Khodorkovsky, became synonymous among investors in Russia with aggressively poor corporate governance, and contributed to Russia's reputation as a market as risky as pogo-jumping on a minefield. Investors fled as if on fire, and the share price of Yukos plummeted by more than 95 percent, underperforming even the death spiral that was the Russian stock exchange during the economy's devastating financial crisis in 1998-99.

Somewhere around the end of 1998, though, Khodorkovsky found stock market religion. Investors (particularly in small, illiquid markets like Russia's) reward a company's honesty and transparency by buying its shares, propelling the share price upward, thereby making the controlling shareholder far wealthier than he could ever become through asset stripping and defrauding investors. Khodorkovsky grew to understand that Yukos would at some point need investment to help fund the company's considerable capital expenditure program -- and that he could become wealthier through making the right corporate governance noises, than through stealing money from his own company. So he orchestrated a dramatic shift in the company's attitude toward investors, by releasing financial statements audited to international standards that showed both impressive profitability and full accounting for all cash flows, and bringing in foreign oil-industry veterans to fill key management positions. Khodorkovsky's compensation for being a P.R. quick study -- and for learning that a slick veneer applied to a polished surface can inspire selective amnesia in wishful-thinking investors -- was a 1,000-fold increase in the Yukos share price within roughly six years.

Khodorkovsky hasn't become a wallflower in the face of the Putin and Co. onslaught, although over the past several weeks he's softened his rhetoric. Early in the dispute, Khodorkovsky threatened to cut off oil provided by Yukos to some regions. He hasn't followed through, though, perhaps aware that depriving citizens of light and heat wouldn't facilitate a possible political career. Khodorkovsky has rejected the charges against him and his company at every turn, warning that the attack on Yukos is symptomatic of Putin's tendencies toward totalitarianism. On Aug. 11, the Financial Times reported that Khodorkovsky was planning to increase his support for some political parties, a step that may exacerbate tensions.

Khodorkovsky hasn't received much support on any front. Prime Minister Mikhail Kasyanov was soundly cracked on the knuckles for labeling the arrest that kicked off the crisis "excessive," and other members of the Putin government not affiliated with the siloviki have carefully avoided outright criticism of the attack on Yukos. Other oligarchs, terrified of being next on Putin's list, quietly counseled Khodorkovsky to stop throwing sand in the president's eyes, while publicly offering up bland comments about the potential impact of the Yukos investigation on Russia's investment climate. Subsequently, Russia's quaking-in-their-Guccis industrial titans -- in a chapter straight out of "Ripley's Believe It Or Not" -- volunteered to pay more taxes, and to increase contributions to the government's charitable efforts (that is, pro-Kremlin political parties).

"Putin and the siloviki want to scare the oligarchs and strengthen their control over them ... They're trying to make sure that everyone follows the rules they establish," says Alexander Bim, a political analyst at the Russian political science consultancy Image-Contact.

Khodorkovsky's friends abroad have similarly proved themselves to be of the fair-weather variety, wary of taking sides in what is perceived as a domestic dispute. In early July the U.S. embassy in Moscow asked for "clarification" of the situation, but a subsequent visit to Washington by Khodorkovsky to meet with what a Yukos spokesman characterized as "a wide range of high-ranking people" didn't help anything. Khodorkovsky's energetic networking at a high-profile annual summer confab of billionaire businessmen in Sun Valley, Idaho, appears to have yielded little more than a few shots of Khodorkovsky posing with Bill Gates and Warren Buffet for the Yukos Web site.

Putin, the only person who might have the power to override the siloviki, has offered only a few vanilla comments about the importance of the rule of law ("Methods and means of work should be suited to your tasks and should strengthen the economy," he told a deputy minister in a blink-and-you'll-miss-it reference to the issue at hand) and has otherwise allowed the fiasco to spiral into the gravest crisis of his presidency.

What is the way out? Neither the Kremlin nor Khodorkovsky can back down without a huge loss of face, and cosmetic appearances notwithstanding, the underlying issues raised by the crisis won't just slip into deep freeze as the winter approaches. Yukos denied rumors in early August that ChevronTexaco might acquire a 25 percent stake, a transaction that would allow Khodorkovsky to cash out and improve his company's chances of survival, although at the personal price of exile. But the dark cloud hanging over Yukos will dissuade potential white knights, who in any case would be loath to take a minority stake. And the Kremlin would want to prevent a national treasure from falling into foreign hands, particularly if that would mean Khodorkovsky would slip through its own.

Khodorkovsky has made no indication that he's going to follow (at least publicly) the example of fellow oligarch Vladimir Potanin, who -- showing suspiciously good timing --publicly prostrated himself on June 28 before the Putin government to plead forgiveness for relieving the state of its stake in Norilsk Nickel, which produces 20 percent of the world's nickel and platinum, and 60 percent of palladium, for a small fraction of its true value, in another privatization sweetheart deal. By the standards of the Russian political environment, Potanin's mea culpa, in the words of intelligence provider, was "the equivalent of rolling on your back and asking the president to rub your tummy."

Despite the costs, Putin will probably stand firm. The oligarchs will be encouraged to give generously to good causes, like pro-Kremlin political parties, as long as they fear that they might be targeted next. The Kremlin won't shy away from earning cheap political points with voters at the expense of the deeply despised oligarchs, particularly with the approach of December's parliamentary elections. A recent poll in Russia found that 77 percent of respondents think that the outcome of privatization should be assessed, and 88 percent believe that Russia's wealthiest citizens made their fortunes unlawfully. Putin's already-nosebleed-high approval ratings increased from 70 percent in May to 78 percent in July, a jump at least in part attributable to the Yukos investigation.

Khodorkovsky isn't the first oligarch to suffer for violating the oligarchs' pact with Putin. Boris Berezovsky -- insider enough to be the subject of a book titled "Godfather of the Kremlin" -- was chased out of Russia by the Putin government and now lives in self-imposed exile in London. During the early months of the Putin government in 2000, media baron Vladimir Gusinsky lost a struggle to maintain control over a wide range of media outlets -- including one of Russia's most popular television stations -- that presented a point of view different from that of state-controlled media. In late August, Gusinsky was detained in Athens at the request of the Russian government, which hopes to have him extradited to face accusations of fraud. If Putin succeeds, his hand will be strengthened at the expense of the oligarchs -- who will be served notice that mere exile won't be enough to satisfy Putin and Co.

The most immediate problem is for Russia to put its privatization problem behind it, to ensure that the progress of recent years isn't suspended as investment narrows to a trickle. The next generation of the social contract between the oligarchs and Putin will need to be developed -- or else such an informal mechanism of keeping the peace will need to be discarded in favor of something more permanent. The English-language Moscow Times suggests an amnesty on the privatization deals of the 1990s, combined with a "windfall tax" on those who acquired assets during privatization. This mechanism would bring about a transfer from the haves of privatization to the rest of Russia. Christof Ruhl of the World Bank in Moscow suggests a mechanism vaguely analogous to South Africa's Truth and Reconciliation Commission, which would be a more inclusive way of definitively writing the final chapter to Russia's painful privatization period.

"I think they should just line up all the oligarchs and shoot them," says Vadim Shenderov, a salesman in a suburb of Moscow, reflecting the deep loathing many Russians feel. "They're all dirty criminals."

But the Yukos scandal and, more broadly, the gentlemen's agreement holding together the economic structure of Russia, raise a number of unsettling questions about the soundness of Russia's political institutions and structures. The tackling of Yukos highlights that "property rights, personal freedom, the law, the judiciary, parliament and electoral processes ... are all still viewed as instruments of the state, rather than defining its limits," writes Roland Nash of the Moscow investment bank Renaissance Capital. Also unsettling is the specter of the siloviki -- or some other self-interested gang running wild within the walls of the Kremlin -- deciding to extend their reach to hijack, for example, foreign policy.

The biggest question will be whether any new regime or gentlemen's agreement will enjoy even a thimbleful of credibility. As the Yukos crisis underscores, Russian politics and policy are a function of individuals rather than of institutions. Until the cult of personal power dissipates, Russia will remain an uncertain place.

Kim Iskyan

Kim Iskyan is a freelance writer living in Armenia.

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