The Russia Conundrum

CHAPTER 10

THE TRIAL

For a thousand years, Russia has vacillated between two distinct models of society and governance. Geographically split between Europe and Asia, the Russian mentality has been torn between East and West, between the European template of liberal, market-oriented openness and the ‘Eastern’ model of coercive autocracy, which places the wielders of power above the law, allowing them to rule by divine right or ‘by the dictatorship of the people’, but almost always by brute force. Educated Russians – the intelligentsia – have traditionally looked to the West, but the forms of governance that the nation imbibed in the early years of her history, what Russians refer to as the silnaya ruka, the iron fist of centralised power, have remained a powerful presence.

The intelligentsia of the nineteenth century were repelled by the authoritarian nature of tsarist autocracy. The writer Pyotr Chaadayev attributed Russia’s failure to emulate Western democratic principles to the baleful legacy of the Mongol occupation, which lasted from 1237 to 1480. Chaadayev’s arguments for a decisive turn towards Western values of law and social justice coalesced into a powerful school of so-called Westernisers. But an equally vigorous movement emerged, in stark disagreement with Chaadayev’s solution and proposing instead a return to the supreme ‘Russian values’ of Orthodoxy, collectivism and nationalism. These were the so-called Slavophiles, nationalist conservatives who supported tsarism and autocracy.

The Slavophiles saw Russia’s strength in its unique historical mission and communal institutions that gave Russia an advantage over the decadent, individualistic West. Dostoyevsky summed it up in the 1870s: ‘Our land may be destitute and chaotic … but it stands as one man. All eighty million of its inhabitants share a spiritual unity which does not, and cannot, exist anywhere in Europe.’ The Slavophiles were anti-Western in the sense that they rejected European social values and lamented Peter the Great’s attempts to introduce them. They believed in the old social model of an autocratic, Orthodox society in which everyone knew their place and did not challenge the power of autocracy. The Slavophiles proclaimed Russia’s moral superiority and need to avoid contamination by the West, reviving the old myths of ‘Holy Rus’ and Russia’s divine mission to save the world. The crusading conviction that Russia’s destiny was to teach the rest of humanity how to live would characterise Slavophile teachings in the nineteenth century and surface again in the messianic communism of the twentieth.

In 2003, we clearly saw the pendulum swing precipitously from one historic model to the other, an epochal political pivot from the Westerniser ideal of openness, participatory government and social guarantees to the Slavophile glorification of Russian nationalism, isolationism and quasi-feudal authoritarianism. The Yukos managers who took control after my resignation came up with a jolt against the new despotism that had taken hold in Putin’s Kremlin. Despite knowing that the demands for tax arrears against the company were bogus, they engaged with the authorities and made constructive offers to resolve the standoff, spending months trying to negotiate with the Kremlin. But the charges of tax evasion, which had begun at $1 billion, mysteriously escalated to $3.5 billion and then, ludicrously, to $5 billion or even $20 billion. When Yukos agreed to pay $1 billion, then $2 billion, then $20 billion and more, the prosecutor simply thought of a higher number. It was clear that Putin had no intention of resolving the dispute.

The Tax Ministry, directed by the Kremlin, justified all the additional taxes and fines by inventing entirely new legal concepts, which were applied only to Yukos, and by misapplying Russian tax law, notably by retroactively assigning profits made by Yukos’s trading subsidiaries to the parent company at a higher tax rate. Yukos’s alleged back-tax bill for 2000 to 2004 ended up exceeding $30 billion. According to an analysis by the Parliamentary Assembly of the Council of Europe, published in January 2005, ‘the total tax burden for Yukos, including the retroactive reassessments, is indeed about triple that of its Russian competitors’ and ‘the tax burden for 2002 exceeds Yukos’s whole turnover for that year’.

In April 2004, Yukos was given just two days to pay all the ‘reassessed’ additional tax for 2000. But the tax authorities did not even bother to wait: they froze all the company’s assets, making it impossible for Yukos to pay even while simultaneously challenging the legitimacy of the reassessment. The spurious back-tax claims, asset- freezing orders and absurdly unrealistic payment deadlines ultimately led to the seizure of one of Yukos’s crown-jewel production assets, Yuganskneftegaz (YNG), in June 2004. In November 2004, the Russian authorities announced that an auction of YNG would take place the following month. This contravened Russian law, which requires the sale of non-core assets before core assets for the settlement of tax claims. Yukos had proposed to the tax authorities that the company would sell its shares in Sibneft, which would have allowed it to pay off most of the tax liability without affecting its core operations, but the tax authorities ignored the proposal.

At the time of its seizure, YNG was responsible for over 60 per cent of Yukos’s total output. It had been valued by management at between $16.1 billion and $22.1 billion, and by the Russian state- appointed evaluators Dresdner Kleinwort Wasserstein at between $14.7 billion and $17.3 billion. Nonetheless, the Russian Ministry of Justice announced that the value of YNG for the purposes of the auction would be no more than $10.4 billion.

In an effort to block the sale of YNG, Yukos filed for bankruptcy protection in December 2004, in the United States Bankruptcy Court for the Southern District of Texas. The Texas court agreed to issue a temporary restraining order, according to which, ‘the weight of the evidence supports a finding that it is substantially likely that the tax assessments of Yukos and the manner of enforcement regarding taxes were not conducted in accordance with Russian law’. The court also found that ‘the evidence supports a finding of the likelihood that the Plaintiff’s shares of YNG will be sold for approximately half the value estimated by two different investment bankers’.

In spite of the court order, the auction went ahead on 19 December 2004. The only bidder was a mysterious company called Baikal Finance Group, which was completely unknown in the industry and appeared to have been founded just two weeks earlier. Its total share capital was declared at $300 and its registered company address turned out to be a liquor store in the city of Tver. President Putin nevertheless gave Baikal Finance his enthusiastic endorsement, stating that its shareholders were ‘individuals who have been in the energy business for many years … and who intend to build relations with Russia’s other energy companies interested in this asset’. Despite its lack of capital, Baikal Finance Group was somehow able to put up the $1 billion deposit needed to participate in the auction and then another $8.8 billion to make good on its successful, uncontested bid to purchase YNG. The mystery was explained two weeks later, when it was announced that Baikal Finance Group was itself being purchased by the state- controlled Rosneft, chaired by Igor Sechin, for an undisclosed sum.

The chief Kremlin economic adviser, Andrei Illarionov, who was still in his post at the time, described the unlawful expropriation of YNG as the ‘scam of the year’, stating that there was ‘no free economic space remaining anywhere in Russia’ and that Russia now qualified as ‘a politically unfree country’. When he resigned 12 months later, he amplified his remarks. ‘Russia has become a different country,’ he said. ‘It is no longer a democratic country. It is no longer a free country.’ Illarionov confirmed that his resignation was in protest against the embezzlement of billions of dollars out of Rosneft’s profits by Putin’s inner circle. Russia, he said, was now run by an authoritarian, corrupt elite. ‘It is one thing to work in a country that is partly free. It is another thing when the political system has changed, and the country has stopped being free and democratic.’

In June 2006, the Kremlin appointed a bankruptcy receiver for the remaining Yukos divisions and a creditors’ meeting was called. At the meeting, a restructuring plan was presented by Yukos that would have allowed the company to settle its liabilities and continue operating in light of rising oil prices. The plan was rejected by the Kremlin, as the Russian authorities again demonstrated that they were not interested in settling with Yukos. In August 2006, a Russian court declared Yukos insolvent. The rejection of Yukos’s restructuring plan forced a fire sale of the company’s remaining assets, which included the production facilities Tomskneftegaz (including the Angarsk and Achinsk refineries) and Samaraneftegaz (with a further three refineries). The majority of the assets were acquired at well below market value by Rosneft. Rosneft then included its stake in YNG in its IPO for flotation on the London Stock Exchange. As the Financial Times pointed out, the state-controlled company’s expropriation of all of Yukos’s production units and refineries transformed Rosneft from Russia’s number-eight oil major, worth just $6 billion, into the country’s biggest producer, with a market capitalisation of $90 billion. Rosneft itself described the purchase of YNG as ‘the most monumental bargain in Russia’s modern history’.

Yukos investors received no benefit from any of the auctions, as Yukos’s liabilities were artificially calculated to match exactly the fire sale prices of its assets, leaving no balance to be distributed to the shareholders. American investors in particular lost nearly $7 billion. In November 2007, Yukos’s liquidation was complete and the company was removed from the Russian register of enterprises.

I was put on trial, together with my friend and business partner, Platon Lebedev, at the start of summer in 2004. There was a widespread acceptance in Russia and abroad that the charges against us were a legal farce, and that this was a politically motivated show trial. The Parliamentary Assembly of the Council of Europe, which oversees the European Court of Human Rights, had appointed a commission to investigate the legality of the case. Its chairman, the former German Justice Minister Sabine Leutheusser-Schnarrenberger, was outspoken in her assessment:

There are many circumstances which lead us to believe there must be a political motivation in this case. Khodorkovsky is the only oligarch who sits in prison since October last year. There are massive claims for back taxes directed against him. And this is not happening to any other large company in Russia. These are all circumstances where one can say there is politics involved, not the rule of law. There are significant accusations that human rights have been violated around the arrest and also in prison, especially concerning the medical treatment of some of the Yukos detainees. That a businessman manager is held in pre-trial detention for nine months although he is highly unlikely to flee abroad, that he is held like an animal in a cage during court hearings, all this is alarming.

The commission highlighted the wider threat to democracy posed by the Yukos case:

I am very concerned about the developments as far as the rule of law is concerned, democracy in general and the strengthening of civil society. In summary, I believe we are really faced with a very dangerous development here, a move away from democracy and the rule of law.

I believe we must tell Putin: If you are going to continue like this, with the cloak of justice but with political reasons in the background, then we won’t be able to continue business relations in this way.

Leutheusser-Schnarrenberger issued a formal report documenting Russia’s ‘gross infringements’ of the European Human Rights Convention and concluded that the Yukos executives had been ‘arbitrarily singled out … in order to weaken an outspoken political opponent, intimidate other wealthy individuals and regain control of economic assets’. I had been arrested because I was perceived to be a figurehead for the democratic, Western-friendly, internationalist future that many of us wanted for our country, while Putin and his ex-KGB colleagues were plotting a return to authoritarian rule.

Behind bars in the courtroom, surrounded by the press and media

At our televised clash in the Kremlin in February 2003, Putin had responded to my exposé of the huge scale of government corruption by implying that I myself had improperly benefited from the privatisation of Yukos. Yet nowhere in any of the charges against me was there any mention of the Yukos privatisation. Instead, there was a grab bag of indictments relating to long-forgotten business deals that Group Menatep had completed in the 1990s, including the privatisation of the Apatit mineral fertiliser company; the sales of Apatit production; the privatisation of the Research Institute for Fertilisers and Insecto-Fungicides; the use of a specially legislated zone for reducing Yukos’s tax burden; the tax implications of registration as private entrepreneurs; and the investment of Yukos funds in Media Most Corporation.

The prosecution’s case was conspicuously light on facts and figures, relying instead on misrepresentation and misinterpretation of the law, demanding a conviction based on untenable declarations and ominous insinuations rather than relevant evidence or cogent analysis. None of which mattered in the slightest, of course, because the judges were never going to decide the case on the facts; their role was simply to play the part of an independent judiciary, while waiting by the telephone for the Kremlin to ring and dictate their verdict. The prosecution knew before the trial began that it would be triumphant, yet even with all the advantages it enjoyed, it still managed to demonstrate its professional incompetence and woeful lack of understanding of the fundamental concepts of business law. The judges showed themselves to be equally clueless, making unsubstantiated pronouncements that simply parroted the prosecution’s lines, ignoring obvious violations of Russian law and refusing to consider even the most irrefutably well-founded arguments from the defence. Extensive defence evidence was simply discarded, while the judges copied vast tracts from the text of the prosecution’s indictment directly into their verdict.

Independent observers from European institutions catalogued the court’s violations of due process. Sabine Leutheusser-Schnarrenberger wrote:

The sheer number and seriousness of procedural violations in my view exceeds a mere accumulation of mistakes that could be explained by a lack of experience or professionalism. During my mandate, I have been confronted with a number of examples of the serious problems from which the Russian judiciary suffers in general, including its notorious openness to corruption, lack of respect for the rights of the defence, and, in particular, the overwhelming influence of the procuracy, which in turn is a tool in the hands of the executive.

The list of due process violations reported by observers at the trial was extensive:

The court did not treat the prosecutors and the defence equally.

The defence was not provided sufficient time to present its case and the overwhelming majority of defence motions and requests were denied.

The prosecution was allowed to introduce impermissible evidence, including unauthenticated documents and materials obtained illegally.

The defence was denied the opportunity to introduce exculpatory evidence, including key expert reports.

The scope of direct questions to defence witnesses and of defence cross-examination of prosecution witnesses was restricted.

The defence was denied cross-examination of prosecution expert witnesses.

The defence was denied requests to subpoena prosecution expert witnesses.

Witnesses were harassed and improperly influenced, including through continued investigation and interrogation; threats of searches, arrests and prosecution; and improper questioning during trial.

The court made motions on behalf of the prosecution.

The court questioned witnesses on behalf of the prosecution.

The defendants were denied effective assistance of counsel, including through interference with access; interference with confidential communications; and harassment of counsel.

The prosecution failed to disclose exculpatory evidence.

Further legal abuses included the selective and retrospective application of laws – selective because such sanctions were never invoked against any entity other than Yukos, and retrospective because the law in question did not exist at the time of the alleged offence. For instance, the prosecution charged that Yukos had used a specially legislated low-tax zone to reduce its tax burden, a fact we never hid, and a scheme of which other Russian oil companies also took advantage. Indeed, the Kremlin itself had encouraged the creation of low-tax zones in order to boost economic activity in areas that were suffering through the post-Soviet transition. The Russian tax authorities had explicitly approved Yukos’s use of such mechanisms for reducing the company’s overall tax burden. Yet, the prosecution now sought to class this usage as a crime. The tax authorities reopened Yukos’s tax returns from previous years that had already been signed off and accepted. They ruled that the use of regional tax shelters was illegal – despite the Russian Audit Chamber having declared them legal just a few months earlier. A representative of the tax authorities specifically confirmed that, at the time of the supposed infringements, the tax reduction methods in question were widely used and considered legal, while the legislation was only changed thereafter, with new rules entering into force shortly before my trial began. Other oil companies operating in Russia used the same methods to reduce their overall tax burden, but only Yukos was subjected to a tax reassessment and prosecution. The Organisation for Economic Co-operation and Development (OECD) concluded that the proceedings against Yukos were therefore ‘a case of highly selective law enforcement’ which demonstrated how ‘Russia’s courts are subservient to the executive … and its prosecutors highly politicised’.

We knew full well that the court would find Lebedev and myself guilty on all counts, so the nine-year prison sentences we were handed in May 2005 came as no surprise. We appealed, because there was no reason not to appeal, but we didn’t hold out great hope. In September 2005, in a one-day hearing, the court rejected the arguments put forward in our application, while reducing our sentences from nine to eight years in a show of simulated magnanimity. The fact that the judges could review hundreds of bound volumes of evidence from a case that had lasted a year in the space of just a few hours might have surprised outside observers; but it was entirely understandable to Russians. The appeal was rushed through, ensuring a conviction in time to prevent me filing papers to register as a candidate in the forthcoming parliamentary elections, which would have placed me firmly in the public eye during the campaign. When I politely pointed out to the appeal judge that I was by law permitted to address the court and to be represented by my own lawyer, I saw the panic in his eyes, before he denied my requests with a witty legal quip, ‘You’re not in Strasbourg here!’

Counting the prison time we had served since our arrests in 2003, Platon and I were scheduled for release in 2011 – but this evidently did not suit Vladimir Putin. In 2009 he ordered us to go on trial again. This time, we were accused of embezzling the entire oil production of Yukos over a period of six years leading up to 2003, around 350 million metric tons of oil worth over $25.4 billion, and of laundering all the proceeds from the sale of this oil to the tune of over $21.4 billion. We were found guilty once more and ordered to remain in prison until 2016. We appealed to the European Court of Human Rights and won favourable rulings that had no effect whatsoever on the Russian authorities.

I had assumed at the outset that I would spend two to four years in jail. It’s not that I was looking forward to it, but I was ready to do that. It turned out to be more than ten. I suppose my assessment of how far the justice system could be perverted was naive. But, even after losing a decade of my life, I continue to believe that freedom, democracy and civil rights cannot be contained by even the harshest of jailors.