Follow the Money, if You Can

Follow the Money, if You Can

By Timothy L. O'Brien, The New York Times, Sept. 5, 1999 published: “One way that Yukos's assets might be disappearing is through the use of offshore shell companies”. “Financial documents show that Yukos has established offshore entities in Cyprus, Switzerland, the Caribbean and elsewhere”.

“RELAXING in a plush Manhattan hotel room recently, Mikhail Khodorkovsky, one of Russia's wealthiest and most influential businessmen, chatted about theft.

Rampant stealing, Mr. Khodorkovsky conceded, was certainly bad for Russia. ''If what we're talking about is sucking the lifeblood out of industry into some personal holdings so that this money will no longer be plowed back into the company, if we word it that way, then yes, it's a huge problem,'' he said.

But, Mr. Khodorkovsky quickly added, that is not his game -- it is the game of politicians, who, he believes, are responsible for the lion's share of corruption in Russia.

As chairman of Rosprom, the holding company for Yukos Oil, Russia's second-biggest oil company, Mr. Khodorkovsky, 35, said he was determined to build an industrial empire as competitive as any Western enterprise. At times, he allowed, that has meant trying to move control of his companies to places outside Russia -- but only to keep the companies out of the hands of corrupt politicians or nettlesome investors, and always with the goal of rebuilding the Russian economy.

Still, Mr. Khodorkovsky, his oil company and another Rosprom business -- Bank Menatep, which is now insolvent -- have been drawn repeatedly into investigations of possible wrongdoing. Russian securities regulators are examining whether Yukos used offshore entities to illegally evade the scrutiny of Russian authorities. Some of his shareholders, including prominent American financiers, have similarly complained in legal filings in Russia that he has spirited away oil profits from Yukos subsidiaries.

Now, the money-laundering investigation of the Bank of New York by United States authorities is examining whether Mr. Khodorkovsky's companies moved funds illegally through the New York bank, authorities say. The Bank of New York examination -- involving at least $4.2 billion and possibly as much as $10 billion -- is the biggest money-laundering investigation in American history and has become a lightning rod for criticism of how the West has carried out foreign policy and conducted business in Russia.

There is no question that the Bank of New York handled banking transactions for Mr. Khodorkovsky's companies, a relationship that he said in a recent interview was legitimate. And no one has charged Mr. Khodorkovsky or his companies with breaking any laws.

His business empire, however, is being scrutinized by investigators looking at the activities of Natasha Gurfinkel Kagalovsky, a senior vice president at the Bank of New York who oversaw the bank's dealings in Russia. Ms. Kagalovsky is married to Konstantin Kagalovsky, a former Russian Government official who is now a vice chairman of Yukos and was a vice chairman of Menatep, Mr. Khodorkovsky's bank.

The intersection of Mr. Khodorkovsky's empire with the Bank of New York investigation has drawn attention to the vulnerability of Western institutions that chase lucrative deals while willingly or unwittingly ignoring the freewheeling business practices in many pockets of the global economy.

Graft, of course, is no novelty in Russia. It is as old as the czars and was a hallmark of the old Soviet bureaucracy. But the oceans of Western cash that have washed through Russia in recent years, combined with scandal-plagued efforts to privatize state-owned companies, have created an unprecedented ability for the country's business and political elite to enrich themselves.

At their disposal are secretive offshore concerns, dizzying arrays of subsidiaries and holding companies, bogus bankruptcy procedures and other forms of financial sleight of hand designed to hide money and assets from Russian tax authorities, law enforcement officials and investors.

This financial arsenal allows criminals, politicians and businesses to siphon vast sums of money out of the country. Some of these operations are legal -- but not, many Russians say, in the best interest of their country. Others are of dubious legality. And some are clearly criminal enterprises.

The amount of money siphoned out of Russia illegally in recent years is difficult to quantify, because the Government does not track it closely and because much legitimate cash is sent abroad in search of stable banks. Russia's Interior Ministry estimates that anywhere from $50 billion to $250 billion was transferred out of the country illegally from 1994 to 1998. In a recent report, the credit rating agency Fitch IBCA said $136 billion left the country from 1993 to 1998.

''Russians don't recognize that by cheating someone today, they are hurting themselves in the long run,'' said Stephen Kotkin, director of the Russian studies program at Princeton University.

Left behind by the plundering are average Russians whose livelihoods and futures are diminished by the ingrained corruption. And the corruption in Russia threatens any Western institution that does business there, including private companies like the Bank of New York and publicly financed lenders like the International Monetary Fund and the World Bank -- especially when such institutions are so focused on raking in easy profits or achieving policy goals that obvious problems are sometimes ignored.

For Russia, the money-laundering investigation at the Bank of New York has further laid bare the real dynamic that has driven events in the country in the last few years.

''The whole political struggle in Russia between 1992 and 1998 was between different groups trying to take control of state assets,'' said Nodari A. Simonia, deputy director of the Institute of World Economy and International Relations, a Moscow research organization. ''It was not about democracy or market reform.''

Trying to Connect the Dots

Last March, a phalanx of private guards dressed in paramilitary uniforms and toting machine guns were hired by Yukos Oil to block access to a shareholders meeting in Moscow. In response, and fearing that Yukos's managers would use the meeting to tighten their grip on the company and loot it, some investors enlisted the help of the local police. And the police, arriving in an armored vehicle and wearing bulletproof gear, succeeded in postponing the meeting.

The showdown bore little resemblance to the lofty visions of a market economy embraced by reformers who sent Russia on its pell-mell sprint from Communism to capitalism in the early 1990's -- a sprint unencumbered by an adequate regulatory and legal system.

Yukos, a major force in an industry that employs hundreds of thousands of people and that is vital to the Russian economy, is swamped in allegations of wrongdoing. Russian securities regulators have begun a criminal investigation of possible theft, stock manipulation and tax scams at the company.

A Yukos spokesman said the criminal investigation was ''prejudiced and groundless.''

State-owned until 1995, Yukos reported a loss of $79 million last year on revenue of about $4 billion. Mr. Khodorkovsky, who once held a top post in Russia's energy ministry, won control of the company for about $310 million in a privatization auction marred by rigged, low-ball bids.

Much of the criticism of Yukos has been leveled directly at Mr. Khodorkovsky, who vigorously defended his record in a series of lengthy interviews with The New York Times that began late last spring and culminated in a telephone interview from Moscow nine days ago.

''Five years from today, I expect that Yukos's operating efficiency should be no less than any Western company,'' Mr. Khodorkovsky said through an interpreter. ''We've told our shareholders that we are acting in their interests, even if they think we are not.''

At once congenial and hard-nosed, Mr. Khodorkovsky bears a long scar on his left forearm from a knife fight on the streets of Moscow, a teen-age memento offset by the expensive suits and Ermenegildo Zegna ties he favors.

The only child of factory workers, Mr. Khodorkovsky was a gifted chemistry and mathematics student who parlayed academic prowess, entrepreneurial zeal and valuable Communist Party connections into a personal-computer business in the late 1980's. The venture, sponsored by the Soviet Government, was so profitable that it helped start Mr. Khodorkovsky on his career as a banker, when he founded Menatep in 1988.

Menatep blossomed after the fall of Communism. But like most large Russian banks, it made questionable loans to related companies or gambled large sums on risky securities. It collapsed last year as Russia's flimsy financial structure came unglued.

Menatep's name has resurfaced in the money-laundering investigation involving the Bank of New York. Money laundering is a catch phrase for the criminal practice of taking ill-gotten gains and moving them through a sequence of bank accounts so they ultimately look like legitimate profits from legal businesses. The money is then withdrawn and used for further criminal activity.

Federal investigators are examining whether Menatep moved funds through the Bank of New York, authorities say, a suspicion fueled by the Kagalovskys' jobs and relationship. Neither of the Kagalovskys has been charged with wrongdoing, and their lawyer, Stanley Arkin, said they never engaged in money laundering.

Mr. Khodorkovsky, in the phone interview late last month, said Menatep has never been found guilty of money laundering, despite repeated investigations in Russia.

''Menatep in its history has never done any money laundering,'' he said. ''Tying Mr. Kagalovsky into this scandal that is raging in the United States seems strange to me.''

In a recent statement, Menatep said it ''valued the Bank of New York for the high level of service that came with the extraordinary commitment that bank consistently demonstrated to the Russian market.''

Indeed, Mr. Khodorkovsky has nothing but praise for Ms. Kagalovsky, whom he considers representative of the new Russians leading their country to a better future.

''Ms. Gurfinkel became very well known in Russia before she married Mr. Kagalovsky,'' Mr. Khodorkovsky noted. ''She was a native Russian who had emigrated to the States and became a U.S. citizen and returned to Russia bringing banks with her.''

The Bank of New York, which said it is cooperating with the money-laundering investigation, has not been charged with any wrongdoing. It has declined to comment further on the matter.

Business as Usual?

But many banks that avidly pursued business ties with Russia are now scurrying to explain how they actually conducted business there. And Russian regulators and Western investors say Mr. Khodorkovsky is, at a minimum, turning a blind eye to misconduct within his own business empire. Some of the harshest critics say that Yukos may be looting parts of its sprawling operations.

One of the angriest critics is Kenneth B. Dart, the wealthy and reclusive heir to a foam-cup fortune, who gave up his United States citizenship years ago for residence in tax-free havens like Belize. His Russian investment vehicle, Dart Management, has stakes in Yukos subsidiaries and has sued Yukos in Russia, accusing the company and Mr. Khodorkovsky of illegally diverting money, oil and other assets out of Yukos subsidiaries.

Dart Management and other investors in Yukos subsidiaries contend that Mr. Khodorkovsky has shifted billions of dollars from the subsidiaries by selling their oil at artificially low prices to the parent company -- a contention substantiated by evidence of the practice in footnotes to Yukos's own financial statements. The oil is then resold by Yukos at much higher prices to buyers on the open market. Investors say that these windfall profits accrue to Yukos alone -- not to the subsidiaries -- and may even be channeled away from Yukos and into offshore accounts.

''Yukos has failed to make reasonable disclosure of its financial dealings,'' said Michael Hunter, president of Dart Management, which is based in Summit, N.J. ''It is therefore difficult to gather conclusive evidence of where this cash goes.

''Mr. Khodorkovsky surely knows the answer,'' Mr. Hunter added, ''and presumably has his own reasons for his unwillingness to share the answer.''

Mr. Khodorkovsky says he has not pilfered money from Yukos or improperly managed its finances. He says oil is transferred at rock-bottom prices between Yukos and its subsidiaries to minimize taxes, a strategy that he said all Russian oil companies use. The Darts' contentions are baseless, he said, part of a campaign by their lawyers to wrest control of Yukos from him. But Mr. Khodorkovsky, who enthusiastically told of a job he once held guarding payrolls armed only with an ax, said he likes a good fight.

''We have teeth, and we know how to bite back,'' he said.

Offshore, and Under Inquiry

To be sure, Dart Management, like most Western investors in Russia, is hardly naive when it comes to the hardball tactics and unsavory realities of doing business there, and the firm has been tough-minded about getting its own way in deals that straddle the globe. But investors are not the only ones complaining about Yukos.

Residents of Tomsk, a Siberian city that is home to Tomskneft, one of Yukos's biggest oil subsidiaries, are also upset. They say Tomskneft, the city's main employer, has been purposefully mismanaged, resulting in the layoffs of tens of thousands of oil workers.

''Tomskneft was one of the few companies in Russia that was profitable, took care of its workers and had very efficient output,'' said Alexander Yakovlevich, a local director of the Russian Federal Securities Commission, who has lived in Tomsk for all his 51 years.

Mr. Yakovlevich also complains that even as Mr. Khodorkovsky has enriched himself while running Yukos, he explains the layoffs by saying the company's cupboards are bare. ''The explanation Khodorkovsky gives for all of this is that there's no money,'' he said. ''But how is that possible?''

One way that Yukos's assets might be disappearing is through the use of offshore shell companies.

Financial documents show that Yukos has established offshore entities in Cyprus, Switzerland, the Caribbean and elsewhere. And, according to corporate documents, arrangements have been made for these entities to receive controlling stakes in Yukos's subsidiaries, a move that investors like the Darts think will solidify Mr. Khodorkovsky's control and allow him too much leeway in managing his oil riches.

Among the offshore entities is Valmet, an investment vehicle located on the Isle of Man, in the Irish Sea. Mr. Khodorkovsky's bank, Menatep, bought a big stake in Valmet a few years ago from the Riggs National Corporation, a Washington bank. Valmet subsequently played a central role in a possible fraud that the Russian Government is now investigating. The Government moved in April to take over a Russian titanium company, Avisma, in which Menatep once had a large stake, saying the metal company's profits were siphoned by Menatep and stashed in Valmet's accounts.

Riggs and Valmet declined to comment, citing client confidentiality.

Mr. Khodorkovsky says the Government's allegations of theft at Avisma are meritless, but he acknowledges that Valmet has been the recipient of some Yukos assets. He says, however, that he does not use companies like Valmet to facilitate theft. On the contrary, he says, he uses his stable of offshore companies to protect his holdings from interlopers like Dart Management or from expropriation by corrupt Government officials in Russia.

Dart, which also once held a stake in Avisma, has also been pulled into the problems surrounding the titanium company. Avisma recently sued Dart and other Western investors in Federal court in Newark, accusing them of diverting profits from the company. Dart representatives say the charges are meritless.

The lawsuit has attracted the attention of Federal investigators examining the Bank of New York.

Bruce S. Marks, a Philadelphia lawyer representing Avisma, said he was contacted recently by Justice Department officials seeking information related to the Bank of New York investigation. While declining to offer details about the agency's query, Mr. Marks said he planned to subpoena the Bank of New York for records pertaining to Valmet. ''We believe Bank of New York was in the loop because Menatep was in the loop, and Menatep transacted through Valmet, Mr. Marks said.

Others are interested in Valmet as well. A Swiss Government prosecutor said last week that he is examining Valmet's ties to the Bank of New York.

A Daunting Troika

All the interest from law enforcement officials in the dealings of Russian businessmen rankles Mr. Khodorkovsky. In the telephone interview late last month, he suggested that Russian politicians controlled a large portion of the funds being examined for money laundering at the Bank of New York, asserting that the officials sent their money abroad before Russia's financial collapse last year. It is a theory that many Russians, including Boris Y. Nemtsov, a former First Deputy Prime Minister, -- say is extremely credible.

The theory, while perhaps Mr. Khodorkovsky's opening salvo against politicians anxious to investigate his dealings, also points out some difficulties of tackling corruption in Russia.

While wrongdoing in the Russian worlds of politics, business and organized crime is often discussed separately, denizens of these groups typically rub shoulders in their dealings, and this powerful troika presents a tremendous hurdle to meaningful reform. As long as that is the case, few observers of Russia are optimistic about the country's future.

''The problem with Russia is that the Government, business and organized crime are so closely involved with one another that it is very hard to find clean institutions to work with,'' said R. James Woolsey, a former director of the Central Intelligence Agency and now a lawyer in Washington. ''Right now, I don't think you can put any real money into Russia without its getting stolen.'' - notes The New York Times in the article “Follow the Money, if You Can

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