The tycoon and the president: the Khodorkovsky case

What Mikhail Khodorkovsky’s downfall says about Russia’s recent past, and its future

The Economist | May 19th 2005

MISHA, as Marina Khodorkovsky refers to her son Mikhail, was always, she says, a fiercely determined little boy, whether he was learning to swim or looking for a holiday job. His childhood nickname was “Toy soldier”.

Her son’s ruthless determination brought him a stunning career, one that exemplifies Russia’s post-Soviet history: the opportunities, corruption and chaos of the Boris Yeltsin years; the disappointments and revanchism of Vladimir Putin’s presidency; and the uncertainty of the future. Mikhail Khodorkovsky made more money more quickly than almost anyone in history. Then—somehow—he incurred Mr Putin’s wrath. This week saw the culmination of his trial in a Moscow court for fraud, tax evasion, embezzlement and running a criminal organisation.

Russia’s “oligarchs”—the small group of men who became ultra-rich in the years after communism collapsed—like to say that they are hated in their own country because, prejudiced by communist propaganda and Orthodox Christian asceticism, Russians do not yet understand the virtues of entrepreneurialism or the legitimacy of personal wealth. That is too kind an analysis of their unpopularity.

Like many who have prospered in post-Soviet Russia, though he came from a humble family Mr Khodorkovsky began with two advantages. He had a scientific background (and was thus less exposed than others to Soviet indoctrination); and, as an official in the communist youth league, he had powerful friends. As rules were bent and blind eyes turned in the Gorbachev era, legend has it that Mr Khodorkovsky found a way to convert hypothetical Soviet accounting units into cash, the cash into hard currency, and that into lucrative imports. He waded into the initial “voucher” privatisations of the early 1990s, which in theory were supposed to distribute the state’s wealth fairly, and (in 1988) started a bank, which began to manage government money.

The bank also ran the rigged auction that led to Mr Khodorkovsky and his associates acquiring a majority stake in Yukos, which until recently was Russia’s premier oil company. They got it in the gigantic scam known as “loans-for-shares”, in which great slabs of the Russian industrial base were sold to a small cabal of businessmen for a song. The motives for this crooked giveaway were mixed: an urge on the part of Mr Yeltsin’s economic reformers to get state assets into private hands; the government’s need for funds to see off the communist challenge in the 1996 elections; and sheer greed.

Loans-for-shares was perhaps not technically illegal; but as Andrei Illarionov, Mr Putin’s maverick economic adviser, says, adapting Talleyrand, “worse than a crime, it was a mistake”. (He adds, though, that renationalisation of the ripped-off assets would be an even worse mistake.) The huge enrichment of a few insiders while most people struggled with poverty helps to explain why, for many Russians, democracy and the free market are still synonymous with corruption and inequality. If Mr Khodorkovsky and the other loans-for-shares participants helped to make a return to communism impossible, they are responsible also for the warped nature of Russian capitalism, and their country’s disillusionment with reform.

Foreign investors with short memories are now bemoaning the demise of Russia’s most “westernised” oligarch, which is what, when it suited him, Mr Khodorkovsky became. But that was only after he used every means at his disposal to take full control of Yukos. Especially after Russia’s default-and-devaluation crash of 1998, some of the means were outrageous: squeezing out minority shareholders; moving important meetings at the last moment; hiding shares in offshore vehicles. There were rumours of worse.

Then, as his supporters now prefer to remember, Mr Khodorkovsky was the first of the Yeltsin-era tycoons to see that there was even more money to be made by going straight. Yukos started to keep western-style accounts and courted foreign partners. Oil prices rose; shares in Yukos, which was pumping 2% of global oil output, rocketed (see chart). Still in his 30s, Mr Khodorkovsky became, reputedly, the richest man in Russia. His career—from nothing to billions and then to prison—has the pure arc of a classical tragedy. This was its peak.

The over-reacher

Mr Putin’s installation as president in 2000 was probably the real beginning of Mr Khodorkovsky’s fall, though the new president was so opaque that his attitude to the uppity tycoons he inherited from his predecessor was not immediately clear. The downturn in Mr Khodorkovsky’s fortunes became obvious in July 2003, when Platon Lebedev, his partner and now co-defendant, was arrested. Three months later, Mr Khodorkovsky himself was nabbed on a Siberian runway.

Almost immediately afterwards, Moscow discovered a new favourite parlour game: who’s next? The game was hard to play, however, because nobody knew exactly what Mr Khodorkovsky had done wrong. The most popular theory was and is that he had violated a (possibly apocryphal) pact that Mr Putin struck with the oligarchs in 2000: they could keep what they had got in the 1990s if they paid their taxes and stayed out of politics. Mr Khodorkovsky and his associates funded several political parties, attempting what one Moscow banker describes as an “aggressive takeover of the Duma”, the lower house of Russia’s parliament. There were whispers of a Khodorkovsky run for the presidency or other high office. In this analysis, a concerted effort to sway policy over energy taxes in June 2003 was the final straw.

But there are other plausible explanations. Given the oligarchs’ unpopularity, it was politically expedient for Mr Putin to swing one from a lamp-post. As the very richest, swinging Mr Khodorkovsky would be especially symbolic. Or it may have been his plans to build a private oil pipeline to China that grated most. Or the Kremlin may have been alarmed by talk of a deal between Yukos and a big American oil company, after the planned (now cancelled) merger of Yukos with Sibneft, another oil firm controlled by Roman Abramovich, the owner of London’s Chelsea Football Club. Mr Khodorkovsky also clashed publicly with Mr Putin over government corruption in February 2003.

Probably there was no single motive for destroying Mr Khodorkovsky. One that seems to have emerged along the way is the renationalisation of Yukos—and thus the strengthening of the government’s control over the country’s energy sector.

After Mr Khodorkovsky’s arrest, many western fund-managers in Moscow told anyone who would listen that the problem was merely a private contretemps between the tycoon and the president, from which Yukos would emerge unscathed. They were wrong. A parallel campaign against the company soon began, in the form of vast claims and penalties for allegedly unpaid taxes, eventually amounting to around $28 billion; for one year, Yukos is said to owe more than it took in revenues. The basis for the claims was the purportedly illegal exploitation of regional tax-incentive schemes.

Mr Putin said repeatedly that there would be no renationalisation of privatised firms on his watch. But by freezing the company’s bank accounts and setting impossible deadlines, the tax authorities and courts ensured that Yukos’s tax bills were unpayable. Last December, in a transaction surreal even by Russian standards, Yuganskneftegaz, Yukos’s main production arm, was forcibly sold in another rigged auction, to a front company registered at a provincial grocery shop.

The Russian government apparently came up with this ruse—”the swindle of the year”, as the loose-lipped Mr Illarionov called it—after Yukos tried to protect its assets by filing for bankruptcy in America. The origin of the $9.35 billion paid for the subsidiary is still a mystery, but the firm ended up in the hands of Rosneft, a state-owned oil firm. If Yukos’s remaining assets go the same way (as looks likely), there will be nothing left of the company for the other shareholders who believed in Mr Khodorkovsky’s transformation and bought in.

Rosneft’s acquisition of Yuganskneftegaz, meanwhile, has derailed plans to merge the oil firm with Gazprom, the state-controlled gas giant (finally and farcically cancelled this week, though the government came up with another plan that would remove restrictions on foreign ownership of Gazprom shares, a move designed to alleviate some of the pain caused by the Yukos fiasco). The wrangling over the terms of the merger—and over which group of Kremlin henchmen ultimately gets control of Yugansk—vindicates those, including Mr Khodorkovsky, who maintain that the real explanation for the Yukos affair was always the simplest and most obvious one: graft.

The debacle of the auction confirmed the first big lesson of the long, meandering campaign against Mr Khodorkovsky and his company: that Mr Putin’s regime is worryingly tactical, changing its methods and even its aims as obstacles that it ought to have anticipated present themselves. This amateurism has infected economic policy, over which the cabal of siloviki (roughly, “power people”) around Mr Putin, himself a former KGB officer, has come to exert a destructive influence.

The result has been queasiness among investors, falling stock prices and rising capital flight. Whatever the moral case for revisiting the privatisations—and it was a strong one—this was not the way to go about it. After Yukos, conciliatory government noises, such as Mr Putin’s recent public instruction to the tax authorities to stop “terrorising” business, are automatically disregarded by Russian businessmen.

Will anyone be “next”? The Kremlin probably underestimated the economic impact of its grudge against the tycoons, and may now consider it has done enough pour encourager les autres. But, as capricious tax bills levied by freelancing officials have attested, the forces unleashed by the Yukos affair may be beyond Mr Putin’s control. Whether oligarchs or smaller fry, businessmen sense that the old KGB adage—”Give us the man and we will find you the crime”—now characterises their dealings with the state.

The Trial

The charges in Mr Khodorkovsky’s 11-month trial do not centre on the “loans-for-shares” rip-off that made him a multi-billionaire. They focus on the allegedly fraudulent part-privatisation in 1994 of Apatit, a fertiliser company, and of another firm, plus personal tax evasion, embezzlement of Apatit’s profits through a transfer-pricing scheme, and his leading of an “organised criminal group”.

Mr Khodorkovsky’s defence has been that he was not personally responsible for the alleged crimes, or that the actions involved were not in fact illegal. He and his partners say that they turned Apatit from a failing company into a going concern, and that the problems over its acquisition have already been addressed in a civil suit. (Yukos’s defence against the tax claims is essentially that “everyone was doing it”; indeed Sibneft, Mr Abramovich’s firm, exploited the tax loopholes even more efficiently than did Yukos.)

But most people who visited the stuffy little room in the Meshchansky district courthouse, where the trial was held, emerged with the sense that the precise charges were beside the point. It was a bizarre scene: the accused’s families and a clutch of journalists crammed on to a few benches, while Mr Khodorkovsky listened from the defendants’ cage and, beside him, Mr Lebedev scornfully filled out Japanese crosswords. The three judges who came up with the verdicts—only a minority of Russian trials as yet involve juries—did not always seem to be concentrating.

This air of predestination was not unusual: almost all Russian criminal trials result in guilty verdicts. A report prepared for the parliamentary assembly of the Council of Europe last year catalogued the improprieties in the Yukos cases: restrictions on the defendants’ access to their lawyers; capricious denial of bail; harassment of witnesses; and the unnecessary secrecy of the trial of Alexei Pichugin, a former Yukos security official sentenced to 20 years for murder in a trial that ended in March.

This is the second important lesson of the Khodorkovsky saga: that in Russia, power still matters more than the law. Property is held at the discretion of the president-cum-tsar. Invisible rules and relationships and grievances matter more than rules that are written down. (It is said in Moscow that when the Yukos bankruptcy case was dismissed by a court in Texas, which happened soon after the Russian and American presidents met in Slovakia, Mr Putin took it as proof that things worked just the same way in America.)

Perhaps this was Mr Khodorkovsky’s biggest mistake: to think that Russia had changed more than it has. “We lived our lives in the Soviet period,” says his mother, “and we warned him that you cannot trust power in our country.” But, says Mrs Khodorkovsky, her son told her that the country had changed forever. Another view is that Mr Khodorkovsky came to believe that he was invincible, and that his real failing was a classic tragic flaw: hubris.

It is the government’s behaviour, as much as Mr Khodorkovsky’s own, that has made him an unlikely icon of dissent for Russia’s band of put-upon liberals. “His case is a symbol of the authoritarian state, of the unclear rules of the game, of autocracy,” says Vladimir Ryzhkov, an independent Duma deputy. Russians revere suffering, and many have relatives who once spent time in prison on spurious grounds. In Russia, says Igor Shaitanov, a literature professor, “to be unfairly treated is a big step towards becoming a hero.”

It helps that Mr Khodorkovsky led a relatively unflamboyant life, buying no yachts or football clubs, and preferring camping holidays to orgies in the south of France. It also helps that he and his associates spent some of their money on good causes: an orphanage, a university (Mr Shaitanov’s), think-tanks, and so on.

But the biggest contribution Mr Khodorkovsky has made to the transformation of his own image, in some quarters at least, from robber-baron to anti-authoritarian dissident, was simply that he stayed in Russia. Boris Berezovsky and Vladimir Gusinsky, two of the other original oligarchs who fell out with Mr Putin, gave up some of their assets and fled abroad, as have several of Mr Khodorkovsky’s former associates. Mr Gusinsky left after a brief spell in prison persuaded him to cut a deal.

Mr Khodorkovsky, too, may have been supposed to crack and run. But, according to his mother, “To escape abroad means to admit one’s guilt, and Misha does not accept any guilt.” Outside the court, as a few hundred supporters waved his portrait and yelled “Freedom”, Yevgeny Yasin, guru of Russia’s liberal economists, said that by choosing to be a political prisoner rather than a political émigré, Mr Khodorkovsky had proved he was “a real man”. The Khodorkovsky fans were subsequently kept away from the court by riot police.

The last laugh?

Behind bars, Mr Khodorkovsky has also striven to re-engineer his reputation by issuing prison manifestos, which, like show trials, are a venerable Russian tradition. In the letters from his cell, Mr Khodorkovsky has criticised the inequities of the reforms that made him rich, assailed the liberal reformers for neglecting the plight of the common man, and abjured what he now calls “the tyranny of wealth”. In his last address to the Meshchansky court, he compared himself to the Decembrists, idealistic military officers who plotted unsuccessfully against the tsar in 1825.

The judges were still reading their verdicts as The Economist went to press, having repeatedly adjourned the hearing early. Though the final sentences had not yet been handed down, the judgment was said more or less to reiterate the prosecution’s case (which called for ten-year jail terms). The two men will also face money-laundering charges, which will keep them in prison even if the sentences are light or suspended. Even a brief spell in a Russian jail, where tuberculosis is rife and “accidents” not uncommon, is perilous.

If he survives, what might Mr Khodorkovsky do? For all the mistakes and misfortunes of the last year—the Beslan calamity; the ill-conceived meddling in Ukraine; the botched introduction of social reforms—Mr Putin still enjoys strong public support, according to the polls, and he has nobbled the media to help him keep it. But his power-base in the elite, amounting to some siloviki and allies from his days in St Petersburg, is small. His enemies, meanwhile, are numerous. Mr Berezovsky and Mr Gusinsky, still rich men, have not given up hope of revenge. The other oligarchs have not generally spoken up for Mr Khodorkovsky, partly out of self-interest, partly because of old business grudges, partly because they worry that his obstinacy has jeopardised their own status. But none of them is fond of Mr Putin either.

He himself has denied rumours that he intends to change Russia’s constitution and stand for a third presidential term in 2008. Many people are unpersuaded, and even he has not ruled out returning for another spell in the Kremlin in 2012, which the constitution would permit. By then, Mr Khodorkovsky—a ruthless man sunk by an even greater ruthlessness than his own—could be out of prison. The story of Putin and the oligarchs may not be over yet.

Category: Russia