TCS Daily

The Law West of Yukos

By Constantin Gurdgiev - June 29, 2005 12:00 AM


According to the majority of foreign observers, concerns over the overtly political nature of the trial and conviction of Yukos oil-company founder and CEO Mikhail Khodorkovsky for alleged tax evasion and fraud have kept many would be investors from Russia.

In reality, though, foreign direct investment has nearly doubled over the last six years, while a massive capital flight out of Russia - a trademark of the Yeltsin years - was reduced threefold by Vladimir Putin's reforms. Foreign capital inflows went from around $23.5 billion in 2002 to $60 billion in 2004, while capital outflows averaging $20 billion per annum in 1998-2001 decreased to $6.6 billion per annum in 2002-2004. Foreign direct investment increased from $8 billion in 2003 to the forecasted $13 billion in 2005.

Although Yukos was a singular case of the state reversing a previous privatization result, this reversal was incomplete, Instead of merging the purchaser of Yukos' assets, Rosneft, with the state-controlled Gasprom monopoly, Kremlin left Rosneft to compete with the gas monopoly. By the end of the year Rosneft will be floated at the stock exchange, and both, Rosneft and Gasprom will see lifting of restrictions on foreign ownership of their shares.

The Yukos affair also tightened tax compliance among the major oil producers - something that international lenders, such as the IMF and EBRD, were calling a necessary condition for Russia's development. Year on year, effective corporate tax rates paid by Russia's five oil majors increased from 8.4 percent in 2003 to 33 percent in 2004.

Throughout the duration of the Yukos trial, both Russian and Western media largely focused on the presence of a small, highly visible group of supporters of the defendants. Yet, according to the independent opinion polls, the majority of Russians did not side with Khodorkovsky and his business partner Platon Lebedev in the case. Following Khodorkovsky's arrest in October 2003, 33 percent of Russians expressed their approval of the action, 19 percent were surprised by the arrest, while only 10 percent stated that they were concerned by the turn of events. Some 69 percent of Russians who identified themselves as being informed about the case agreed with the position taken by the prosecution; 81 percent agreed that the large tax evasion accusations warranted pre-trial detention without a bail. Consequently, 82 percent of those informed sided with the state in the Yukos affair. Only one bloc of opposition parties supports Khodorkovsky and Lebedev. Ironically, the bloc received less than 5 percent of the popular vote in the latest elections for Russia's Duma, or parliament.

Not surprisingly, when asked "Which events and developments in recent years are the cause for your concern?" only 3 percent of Russian voters identified judicial prosecution of big business owners as a threat to Russia's democracy (see chart below).

Public Concern with the Future, November 2004 poll.

A Harsh Sentence?

In the end, Yukos' spokesperson summed up Khodorkovsky's nine-year sentence as "...a tragic example of the authorities turning a legal system against an individual for political ends." Recalling that Khodorkovsky and Lebedev built their defense on the argument that everyone committed fraud in conducting business in early-1990s Russia, this begs a question: Was the sentence unjustly harsh relative to the magnitude of the fraud involved?

Khodorkovsky is commonly credited with making Yukos an example of good corporate governance. Yet, the defendants were accused of defrauding the state of tens of billions of dollars. Up to date, their company was charged with some $28 billion in back taxes claims. Far from being a case of corporate righteousness, Yukos is facing additional charges for $10.5 billion from its former subsidiary. Other executives of the company were separately convicted for five contract killings and one attempted murder. Outside the narrow circle of the previously disgraced oligarchs, their supporters and foreign press correspondents, hardly anyone in Russia thinks that the defendants suffered an undeserved hardship.

Given the prospects for serving the sentences in a medium-security prison camp, Khodorkovsky and Lebedev can look forward to a rather comfortable existence within a prison system that is based on corruption. Russian prison camps are run by those who pay, not the state. One example is the ex-mayor of Nijniy Novgorod (Russia's third largest city), Andrey Klimentiev. Convicted on bribery charges, the mayor, who served just two days in office, spent his six-year sentence in a resettlement camp. He was free to meet the press and enjoyed substantial privileges. In one of his interviews from the camp, Klimentiev claimed that he was able to summon his private helicopter at any time.

Nor is the Khodorkovsky-Lebedev case unique in international practice. In the United States, junk-bond king Michael Milken got 10 years in jail for insider trading and defrauding investors of a fraction of the funds misappropriated by the Yukos duo. Japanese executive Yoshiaki Tsutsumi is facing an eight-year sentence for crimes similar to those of Milken. Kenneth Lay (Enron) and Bernard Ebbers (WorldCom) can get 175 and 85 years, respectively, for minor (by the Yukos standards) fraud. Mou Quizhong, convicted for defrauding Chinese state and stealing state funds to the tune of $75 million (an amount that Yukos executives were clearing almost weekly), got a life sentence. In all of these cases, the Western press sided with the prosecutors well before the actual trials, yet no one accuses the American, Japanese or Chinese justice systems for trying the defendants before the courts had their say. Why is the Russian legal system being singled out as the one where the defendants' rights were circumvented by the politics of the case?

The moral of the Yukos story is simple: Khodorkovsky and Lebedev broke the law. They were caught and convicted. Not a single report concerning the case found any real evidence to support the assertion of a Kremlin-led witch-hunt. The sentences passed are lenient relative to the magnitude of the crime. The story should be closed and the country should move on, focusing on much needed reforms.

Constantin Gurdgiev is Lecturer in Economics, Trinity College, Dublin, and a director of the Open Republic Institute, Dublin.


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