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Dropping the Hammer

But gone were the days when Soviet dictators merely shipped their enemies to a hellhole in Siberia. Putin was determined to maintain his public image as a democratic leader by acting within the letter of the law.

He bided his time. He went quiet after the TV spat and Khodorkovsky's announcement of the Yukos/Sibneft merger, leaving many to believe that Putin had lost control, especially when he also withdrew the government's opposition to private oil pipeline projects that would further enrich Russia's tycoons. Many analysts were duped into thinking that the president was yielding to his adversaries and that the country's oil sector would belong to the oligarchs and be dominated by Yukos.

Putin was far craftier than that, though. His retreat, in fact, was strategic. He knew that a rich opportunity had presented itself, one that in a single stroke could eliminate the Yukos threat, further domination by Rosneft, his own favored company, and warn off anyone who might stand in his way. But everything had to be done carefully.

As noted earlier, if you wanted to find something damaging to a veteran of Russia's 1990s business world, you didn't have to look too closely at his books before it smacked you in the face.

The Putin forces did their homework and then made their first move in July 2003. Moscow police arrested Platon Lebedev, a principal shareholder and director of Bank Menatep and member of the executive committee of Yukos. Armed with a warrant from the Russian prosecutor general, they dragged Lebedev from a Moscow hospital bed and charged him with embezzling state assets. Additional charges followed: tax evasion, abuse of trust, and so on.

Three months later, masked FSB agents stormed Khodorkovsky's airplane and arrested him. He was charged with tax evasion, embezzlement, fraud, and forgery.

The Russian government also froze the assets of the two men, including a large block of shares in Yukos, which made it impossible to sell the company to Chevron or any other buyer. Without its two largest shareholders and lacking a financial white knight with the courage to enter the battle, Yukos was helpless.

Ironically, as Russia inched its way toward greater respect for law and transparency, Putin was attacking the company that had taken the longest strides in that direction. Had he merely been looking to make an example of a tax evader, he had plenty of better targets. But he wasn't. Putin was looking for an opening to prevent the Yukos/Sibneft merger, to shake down Khodorkovsky, and to reverse the privatization of the energy sector—and to do so without having to renationalize any company outright.

Despite having approved Yukos's tax standing in July 2003, the Russian Tax Ministry began a series of audits of the company's tax accounts in December of the same year, about two months after Khodorkovsky was arrested. The Tax Ministry adopted novel legal theories invented solely for attacking Yukos, and twisted Russian tax law to retroactively assign subsidiaries' profits to Yukos.

Ultimately, Yukos was handed a $30 billion bill for back taxes for the years 2000 to 2004. The company was given exactly two days to pay the tab for 2000; but its assets were frozen, so the two-day meter ran out.

Although tax claims in Russia are supposed to be settled by first selling off the taxpayer's nonessential assets, the Russian government went straight for the heart. In June 2004, it seized Yuganskneftegaz (YNG)— Yukos's largest enterprise, which was responsible for 60 percent of its oil production—for an auction later that year. At the time, YNG was valued at $15 billion to $22 billion. However, prior to the December auction, the Russian Ministry of Justice announced that YNG was worth a mere $10.4 billion. To drive the price down even further, the government assessed new taxes against the company.

Yukos tried to block the sale through the Russian courts. It also sought relief in the European Court of Human Rights and even filed for Chapter 11 bankruptcy in the United States. Although Yukos was unable to prevent the sale of YNG, the Russian bankruptcy court did issue a temporary restraining order preventing third parties—including Gazprom and banks under the court's jurisdiction—from participating in the auction.

With Gazprom excluded, the only bidder left was Baikal Finance Group. Baikal acquired YNG at the bargain basement price of $9.35 billion, which it paid out of a loan from state-controlled (i.e., Putin-controlled) Rosneft. This was quite a leap for a shell company with net capital of just $300 (yes, three hundred dollars). Three days later, Rosneft swallowed up Baikal.

That tripled Rosneft's production overnight, from barely 5 percent of Russia's output to 15 percent. Its reserves grew almost fivefold. Rosneft had become the third-largest oil producer in Russia.

In the meantime, the Yukos/Sibneft merger was unwound in the wake of Khodorkovsky's arrest, restoring Sibneft to essentially the condition it had been in prior to the deal. The prospects of survival for what remained of Yukos, however, looked dim.

Rosneft purchased Yukos's remaining debts in 2007, making the Russian government indirectly the company's main creditor. After the company's proposed restructuring plan was rejected, a Russian court declared the company insolvent. A bankruptcy sale followed, at which Rosneft purchased most of Yukos's remaining assets for about one-third of their value.

Khodorkovsky and Lebedev were put through a show trial. The court allowed gross procedural violations and accepted all of the prosecution's claims at face value. It questioned witnesses on the prosecution's behalf, whereas the two defendants weren't allowed to introduce evidence of their innocence. The court routinely denied defense motions and requests, and restricted Khodorkovsky's and Lebedev's contact with their attorneys.

The trial ended in May 2005, with Khodorkovsky and Lebedev each being sentenced to prison for nine years. On appeal to the Moscow City Court, the sentences were reduced to eight years. Yet eight years later, neither prisoner would be free.

After serving half of their respective sentences, both men became eligible for parole. In order to secure Putin an extended vacation from his nemeses and to prevent Khodorkovsky's return to Russia's economic and political landscape, the two were charged with additional crimes: embezzlement and money laundering.

In 2009, the two political prisoners were tried and once again convicted. Each of their sentences was extended to 2016. Later, Natalia Vasilyeva, the assistant to the presiding judge throughout the trial, stated that the judge's verdict was foisted on him by higher authority. No one had to ask who that authority might be.

Khodorkovsky left prison in December 2013, and Lebedev followed in January 2014.

What Putin accomplished with the Khodorkovsky affair is remarkable. In one move, he crippled a troublesome political critic and asserted state (and, by extension, personal) control over a huge element of Russia's natural resources industry.

In Putin's view, that control benefited the nation. But it may also have resulted in a financial windfall for Putin himself because of the large increase in the value of the shares he is believed to own in the companies involved. His actual net worth is a secret, because if he does own those shares (he denies it), it would be through nominees and shell companies. Unsubstantiated estimates that he might be worth upwards of $70 billion, which would make him the richest man on the planet, could be just so much hot air. Or not.

Putin accomplished it all within the formalities of the law and without alienating the public. In the latter, he was supported by the public's perception of the oligarchs as thieves who deserved whatever they got. Widespread dislike of Jews was also a help.

Putin would likely do anything to keep the respect of his people, but he cares little about outsiders' opinions of him. He ignored foreign criticism of the show trials of Khodorkovsky and Lebedev. It has been of no consequence to him that international nongovernmental organizations (NGOs) such as Human Rights Watch and Amnesty International criticized the trials as political, with the latter organization labeling the two men prisoners of conscience.

The Parliamentary Assembly of the Council of Europe Committee on Legal Affairs and Human Rights found the first trial riddled with violations of due process. In 2007, the European Court of Human Rights found that Lebedev had been illegally detained and that the Russian courts had conducted hearings without Lebedev or his attorneys present. None of those findings mattered.

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