The Oligarchs (78 page)

At the time, Khodorkovsky was also nose to nose in an increasingly tense confrontation with Dart, the minority shareholder in the Yukos extraction subsidiaries. For more than a year, Dart, a reclusive billionaire, seethed as Khodorkovsky drained away the value of his investments. Now Khodorkovsky was ready for war. He didn't need to coddle investors any longer because Russia had the world's worst credit rating as a country, and the Western lenders would not be back for a while. Khodorkovsky struck against both his Western creditors and his minority shareholders by hijacking the oil company away from them. Even more audaciously, he tried to take it out of Russia altogether.

In the early turbulent years of his banking career, Khodorkovsky built an offshore financial network. Menatep branched out to offshore havens in Switzerland, Gibraltar, the Caribbean, and other secretive locations where hundreds of millions of dollars could easily be hidden. When he obtained Yukos, Khodorkovsky moved his money into this offshore financial network. This was a common practice in the oil industry; oil was one of the most surefire methods to move wealth out of Russia. Whenever Yukos oil left Russia for abroad, it was sold through offshore trading companies that Khodorkovsky controlled. The oil wealth then accumulated outside Russia, avoiding taxes and other risks inside the country. The offshore network was an ever rotating menu of odd names and places. One key component, for a while, was Jurby Lake Ltd. on the Isle of Man, a well-known offshore tax
haven in the United Kingdom. Jurby Lake was a group of oil trading companies that handled the Yukos exports and then deposited the earnings to other select companies controlled by Khodorkovsky and his partners, according to documents describing the structure and a former Menatep official who spoke to me about it. Menatep Bank had its own web of offshore links, such as Menatep Ltd. Gibraltar and Menatep Finance SA of Switzerland. Moreover, Khodorkovsky in 1994 purchased 20 percent of Valmet Group, a Geneva-based global investment management company with offices in Gibraltar, Cyprus, the Isle of Man, and other financial centers catering to clients who wanted to avoid taxes and detection.
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Khodorkovsky's far-reaching offshore network was typical for Russian big business. All the other oligarchs—indeed, thousands of Russian businessmen—did the same thing, although many on a scale less grand. Every month, by very rough calculations, up to $2 billion slipped out of Russia in wire transfers, phony import-export documents, oil shipments, and other means. The leakage was known as capital flight, and it became one of Russia's most debilitating sicknesses in the 1990s. Over the decade, perhaps $100 to $150 billion flowed out of Russia, money that was needed for investment at home, to rebuild factories and start businesses. Instead, Russian capital found its way to overseas bank accounts, real estate, luxury resorts, and offshore tax havens. The money was on the run for many reasons: to hide it from taxes, shareholders, investors, and creditors; to conceal the pillage of natural resources or stripped factory assets; or just to skirt political and economic upheaval.

Sadly, capital flight was a sickness that no one in the Russian elite was willing to cure. A midlevel banker once told me that getting capital out of the country was so easy because no one wanted to stop it. Although Russia had some Central Bank rules against exporting capital, they were widely ignored and almost never enforced. Too many people benefited by the leakage—politicians, tycoons, and even small-time factory directors who stashed their rake-off abroad.
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Stopping capital flight really meant changing the entire operating system of the country, creating a stable, rule-of-law state, and that task was too big for Yeltsin and his generation in the first decade of post-Soviet Russia. Occasionally the Russian government machine would rouse itself to attempt halfhearted police state methods to stanch the leakage. Departing airport passengers were asked by Customs Service officers
to open their wallets to show how much cash they were carrying out of Russia. I saw this happen many times at Sheremetyevo Airport as I waited impatiently in line. It was a pathetic and silly exercise, when everyone knew that $1 billion could fly out by wire transfers, undetected. Capital flight did not have a departure gate.

Stunning evidence of the full extent of the phenomenon of capital flight came in the aftermath of the ruble crash when it was disclosed that the Russian Central Bank had sent billions of dollars out of the country through a tiny offshore company, the Financial Management Company in Jersey, a favorite tax haven in the United Kingdom. The full story of this obscure company, FIMACO, was never disclosed, but the obvious message was that even the government was taking advantage of offshore havens. If the Central Bank, paragon of stability, guardian of Russia's treasure, could divert its currency reserves to a tiny offshore company, then there was no telling what others might dare.
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To wrest Yukos out of the grip of its creditors and minority shareholders, Khodorkovsky created an elaborate plan to move the oil company offshore. A complex transfer of shares would scatter Yukos and its daughter companies to the winds, making it impossible for others to find where he was hiding them. The plan was even more audacious than moving oil profits abroad. Khodorkovsky was taking the whole company offshore. The plan was to leave the minority shareholders and the Western creditors with an empty shell, while he took the company's shares to small, remote islands in the Atlantic and Pacific Oceans.

Khodorkovsky began with a scheme to issue millions of new shares in the subsidiaries. The new shares would dilute the value of those held by Dart. Dart's shares in the subsidiaries were relatively small—12.85 percent of Yuganskneftegaz, 12.3 percent of Samaraneftegaz, and 13 percent of Tomskneft, which gave him little leverage in how the companies were run. Even so, Khodorkovsky resorted to battleship tactics against Dart, just to make sure there was no question about victory. For example, at the time there were 40 million shares of Yuganskneftegaz outstanding. Khodorkovsky laid plans to issue 77.8 million new shares. This meant that Dart's share of the overall company would drop from 12.85 percent to less than 5 percent. The story was the same with the other subsidiaries. For Samaraneftegaz, Khodorkovsky planned to add 67.4 million shares to the existing 37.6 million. At Tomskneft, he planned to add 135 million
shares to the existing 45 million. In short, Dart's holdings were becoming the incredible shrinking oil company. This onerous tactic was the same as the transfer pricing that had originally drawn Dart's anger in 1998. Hundreds of millions of dollars were at stake.
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For his next sleight of hand, Khodorkovsky decided to sell all these millions of new shares in the oil extraction subsidiaries to obscure, distant offshore companies. For example, Yuganskneftegaz shares would be sold to Asbury International Inc. of the Bahamas, Rennington International Associates Ltd. of Ireland, Thornton Services Ltd. of the Isle of Man, and Brahma Ltd. of the Isle of Man. Who were these mysterious new buyers? Khodorkovsky-affiliated shell companies, most probably. Khodorkovsky could not admit that he controlled these offshore companies, since the whole gambit would be illegal under Russian law, but he was surely not selling his oil company to strangers.
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In yet another brazen twist, Khodorkovsky proposed that the additional millions of shares would be purchased not with cash but with
veksels
, or promissory notes, issued by the other Yukos extraction subsidiaries. How the mysterious buyers would obtain the
veksels
in the first place is just one of the many mysteries about Khodorkovsky's plan that I could never fathom. The whole transaction was a circular, deceptive paper chase: one company issues millions of new shares, sells them to distant offshore companies, and collects a promissory note for the shares. The loser was going to be Dart.

To ratify the share dilution gambit, three emergency shareholder meetings, one for each oil extraction subsidiary, were called on March 16, 23, and 30, 1999. The meetings were held at a palatial prerevolutionary castle in the center of Moscow at 5 Kolpachny Lane, once a Komsomol building and later Menatep headquarters. Outside the gate, shareholders of Yuganskneftegaz presented their papers to a clerk for admittance. Some were allowed to enter, but one of Dart's representatives, John J. Papesh, was not. He asked for a pass but was refused. He was presented with a court order signed by a provincial judge just a few days earlier. The order froze Dart's shares on a technicality. Papesh was left out in the cold. Inside the meeting, the 77 million new shares were quickly issued, dramatically shrinking Dart's holding. “This is the Russian version of theft in the executive suite,” Papesh fumed afterward. “It is red-collar crime.” The huge share emissions were approved at the other two meetings as well. An even more bizarre dodge
occurred in June at a subsequent scheduled meeting of Tomskneft shareholders. When the minority shareholders arrived at 5 Kolpachny Lane, they saw a sign saying the meeting had been moved to a small town south of Moscow, and it would start in two hours. They jumped in their car and raced off; the address turned out to be an old building under reconstruction. Inside, up a makeshift stairway without handrails, they found a room with seven chairs, a table, and two copies of the meeting agenda. The construction workers said the “meeting” had concluded twenty minutes earlier. They were out of luck.

Yet the battle was not over. When it came to business in offshore zones, Dart was no neophyte, being heir to a $3 billion fortune created when his father and grandfather invented a way to mass-produce foam cups. Dart renounced his U.S. citizenship to become a citizen of Belize, a tiny country known as an offshore tax haven. He was a hard-nosed player in global investments, once facing down the government of Brazil over a bond issue, and he was prepared for tough battles with Khodorkovsky. In the early 1990s, Dart sunk hundreds of millions of dollars into Russia during mass privatization, buying up stakes in many of the oil extraction companies and other properties. Like many other foreign investors, he was a speculator, buying low and hoping to sell high.
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While Dart sought profit, Khodorkovsky, who bought Yukos cheaply in loans for shares, did not want Dart's profit to come out of his own pocket. He wanted Dart to go away. A collision was inevitable.

The two magnates had been thrown together in a shotgun wedding: Dart as minority shareholder in the extraction subsidiaries and Khodorkovsky as the winner of the Yukos holding company. It was always expected that, sooner or later, they would have to settle. But first they were making war. Each side threw lawyers, public relations companies, and private detectives into the battle. Yukos issued statements calling Dart a “green mailer” (someone who practices pressure tactics in hopes of reaping a fat profit) and a “vulture.” Dart said Khodorkovsky was “looting” the subsidiaries.

When Dart got wind of Khodorkovsky's offshore gambit with the Yukos subsidiaries, he began to chase the shares around the globe. Dart's lawyers filed suit in such offshore jurisdictions as the Marshall Islands, the British Virgin Islands, and the Isle of Man to try and stop Khodorkovsky. In a remarkable piece of detective work, Dart lawyers and private investigators compiled a dense, complex flow chart,
showing what they believed to be Khodorkovsky's far-flung corporate structure. The chart was a jungle of arrows and boxes illustrating shell companies, ownership ties, and share transfers stretching from Cyprus in the Mediterranean to Nuie in the Pacific Ocean. Across the bottom it included, in small boxes marked with a star, the names and locations of offshore zones that Khodorkovsky intended to use as the new “home” base for his oil subsidiaries. The chart, while impressive in its detail, was still not complete; in fact, Khodorkovsky's offshore empire stretched even further than the document suggested. For example, the chart did not mention the Jurby Lake structure of oilexporting companies.

While fighting Dart with one hand, Khodorkovsky tried to shake off Western creditors with the other. The three banks that had loaned Khodorkovsky's Bank Menatep $236 million could, under terms of the deal, claim a total of about 30 percent of Yukos when Menatep defaulted on the loan. The 30 percent was a sizable chunk of the oil company. If Khodorkovsky relinquished it, he could, at some point in the future, be vulnerable to losing control of Yukos. This he did not want to do, at any cost.

Khodorkovsky's game with the banks was partly psychological warfare. If he made a strong enough case that he was not going to pay back the money, he calculated, maybe the Westerners would eventually give up and just write off the debt as a loss at the end of the fiscal year. This was not an unreasonable expectation: the big Western banks and investment funds knew there were huge risks in emerging markets like Russia. They had reaped fortunes in the last few years as the Russian stock market skyrocketed. So what if they had a bad year? They might try and squeeze the debtor a little, but they knew they had little leverage inside Russia because the courts were weak. The Western banks had both a limited attention span and a diffuse chain of command. The managers were not making decisions with their own money; it was other people's money. They would not suffer just because of some bad loans in Russia. But Khodorkovsky, by contrast, had everything at stake. He was playing for his own survival. He used ruthless tactics to make sure his foes got the point. He took the Yukos-owned shares in the oil-extraction subsidiaries and sent them offshore along with the new, diluted shares. (This action only came to light when one of the small minority shareholders looked at the register, the book in which share ownership is recorded.) The bottom line
was that the banks were being left with 30 percent of an empty shell. Daiwa Europe Ltd., which held about 13 percent of Yukos, issued a statement expressing concern that its assets would be “irretrievably lost.”
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That was putting it mildly.