On October 25, 2003, Khodorkovsky was arrested at gunpoint on a Siberian airport runway by the Russian prosecutor general's office, on charges of tax evasion. Shortly thereafter, on October 31, the government further took the unprecedented step of freezing shares of Yukos. The action against Khodorkovsky and Yukos appears to be a dramatic move on the part of the Kremlin to wrestle power back from the oligarchs, who made huge fortunes from the 1990s privatizations and now control an estimated 60% of the Russian economy. It may also show emergence of new business groups aimed at re-distributing Russian property again, this time strictly following the law and using law-enforcement agencies as a tool.
Khodorkovsky grew up in a typical, tough Soviet environment in Moscow in a grim two-room communal apartment. The young Khodorkovsky worked hard, received excellent grades and was deputy head of Komsomol (the Communist Youth League) at his university, the Mendeleev Institute of Chemical Technology.
With partners from Komsomol, and technically operating under its authority, Khodorkovsky in 1986 opened his first business, a private café, an enterprise made possible by Soviet leader Mikhail Gorbachev's programme of perestroika and glasnost. Successful, they also imported computers, other technology, brandy and a wide range of goods to sell at a profit.
He proved himself a capable entrepreneur building an import-export business with a turnover by 1988 of 80 million rubles a year or US$10 million.
Armed with cash from his business operations, Khodorkovsky and his partners bought a banking licence to create Bank Menatep in 1989. As one of Russia's first privately owned banks, Menatep expanded quickly, by using most of the deposits raised to finance Khodorkovsky's successful import-export operations.
Bank Menatap also got government business, awarded the right to manage funds allocated for the victims of the Chernobyl nuclear accident. By 1990, critics suggest the bank was active in facilitating the large-scale theft of Soviet Treasury funds that went on at the time prior to and following the collapse of the USSR in 1991.
Boris Yeltsin's elevation to power in 1991 meant an acceleration of the market reforms under Gorbachev and created a dynamic business environment in Russia for entrepreneurs like Khodorkovsky. By then Bank Menatep was by Russian standards a well-developed financial institution and became the first Russian business to issue stock to the public since the Russian Revolution in 1917.
The bank grew quickly, winning more and more valuable Government clients such as the Ministry of Finance, the State Taxation Service, the Moscow municipal government and the Russian arms export agency, all of whom deposited their funds with Menatep, which Khodorkovsky mostly used to expand his burgeoning trading empire.
Bank Menatep provided the foundation for Khodorkovsky's bidding for Yukos in 1995. Yukos says that approximately US$1.5 billion has been spent purchasing the assets that now make up Yukos, with a market capitalisation of US$31 billion.
In 1995, the Yeltsin Government decided to privatise sclerotic state industries, including the state owned oil company Yukos. They appointed Khodorkovsky's bank Menatep to conduct a public auction process.
A higher bid from a group of rivals was ruled out of the process by Menatep on a technicality. Menatep paid US$350 million for 78% of the company, which inferred a value of $450 million. When the company was listed two years later, it was valued at $9 billion. That transaction—and dozens like it—has fed the envy and suspicion of many Russians, some of whom believe the oligarchs like Khodorkovsky have stolen their fortunes from the state.
Amoco—later taken over by British Petroleum—was an early partner with Yukos in a highly prospective Siberian oil field. Amoco spent $300 million developing the oil field before being completely squeezed out by Khodorkovsky, using methods that would be unlawful in most of the developed world. That oil field now produces 90 million barrels per day.
When the Russian ruble collapsed in 1998, Bank Menatep collapsed with it as many of it had borrowed money in foreign currencies. It lost its banking licence. Three banks, the Standard Bank of South Africa, Japanese Daiwa Bank and German West LB Bank, had lent $266 million to Menatep secured by Yukos shares. Khodorkovsky offered oil instead. They refused and took possession of the shares. They dumped the shares very quickly, collecting less than half of their loan, prompted in a panic sale by Khodorkovsky's public threats of massively diluting their stake with new shares. While lawful in Russia at the time, it would not have been so in most of the developed world. Yukos also sold shares in its main production subsidiaries to offshore shelf companies believed to be linked to Khodorkovsky. Daiwa and West LB, suspecting they would end up with nothing if they persisted, sold out to Standard Bank in mid-1999, which in turn exited Yukos at the end of 2000.
The two deals gave Khodorkovsky, Menatep and Yukos terrible notoriety in Western financial circles. Only in 2003 did it feel sufficiently confident to return to Western banks with loan proposals.
Khodorkovsky is considered one of the first of the oligarchs to realise that in order to build a global business, one needed foreign investment. In order to attract foreign investment, investors would be motivated by both greed and fear. Khodorkovsky's tough treatment of some of the West's largest and most powerful businesses created a large amount of fear in most investors. His fellow oligarchs had acted similarly, if not more outrageously at times. Coupled with the collapse in the ruble in 1998, very few investors, oil companies or banks were interested in doing business with Russia.
Khodorkovsky introduced unprecedented transparency at Yukos. Having once denied owning any shares in Menatep and Yukos, he confessed his controlling stake. Yukos revealed the identity of its shareholders for the first time, published accounts following international standards GAAP, and started paying taxes and issuing large dividends. Khodorkovsky hired many executives from large Western oil companies, placing them in senior roles and appointed respected non-executive directors to the board of directors of Yukos.
Bank Menatep - by this stage rebuilt around its St Petersburg subsidiary which remained solvent—even started lending money to non-Khodorkovsky businesses. The Bank now claims only 15% of its loans are advanced to Khodorkovsky group businesses.
As his foreign executives and consultants had predicted the effect of the new corporate governance principles was a soaring share price as foreign investors forgave past atrocities and bought into Yukos, which continues to be heavily discounted for sovereign risk.
When rival Alfa Bank was successful in attracting BP to invest billions in its oil subsidiary in 2003 many regarded this as a turning point in Western confidence in investing in Russia. President Putin and Prime Minister Blair both attended the signing ceremony, signalling the growing respectability of business in Russia.
Khodorkovsky also became a philanthropist, whose efforts include the provision of internet-training centres for teachers, a forum for the discussion by journalists of reform and democracy, and the establishment of foundations which finance archaeological digs, cultural exchanges and summer camps for children. Khodorkovsky's critics saw this as political posturing, in light of his funding of several political parties ahead of the elections for the Duma to be held in late 2003.
He is openly critical of what he refers to as 'managed democracy' within Russia. Careful normally not to criticise the elected leadership, he says the military and security services exercise too much authority. He told The Times:
In April 2003, Khodorkovsky announced that Yukos would merge with Sibneft, creating an oil company with reserves equal to those of Western petroleum multinationals. Khodorkovsky has been reported to be negotiating with ExxonMobil and ChevronTexaco about them taking a large stake in Yukos. Sibneft was created in 1995, at the suggestion of Boris Berezovsky, comprising some of the most valuable assets of a state-owned oil company. In a controversial auction process, Berezovsky acquired 50% of the company at what most agree was a very low price.
When Berezovsky had a confrontation with Putin, and felt compelled to leave Russia for London (where he was granted asylum) he assigned his shares in Sibneft to Roman Abramovich. Abramovich subsequently agreed to the merger.
With 19.4 billion barrels of oil and gas, the merged entity owns the second-largest oil and gas reserves in the world after ExxonMobil. YukosSibneft will be the fourth largest in the world in terms of production, pumping 2.3 million barrels of crude a day.
Russian president Vladimir Putin had made a tacit agreement with the oligarchs soon after he was elected in 2000 that he would not touch the huge wealth they had gained in crony dealings with state officials in the 1990s. In return, they were told to pay taxes and keep out of politics.
Most of the oligarchs have chosen to keep low profiles — but not Khodorkovsky.
The arrest in early July 2003 of Platon Lebedev, a Khodorkovsky partner and second largest shareholder in Yukos, on suspicion of illegally acquiring a stake in a state-owned fertiliser firm in 1994, was considered by observers a shot across the bows.
The arrest was followed by investigations into taxation returns filed by Yukos, and a delay to the antitrust commission's approval for its merger with Sibneft.
The warning was not heeded, as Khodorkovsky continued his involvement in the political process in the lead-up to the presidential elections scheduled for 2004. Khodorkovsky has spoken out in favour of closer ties with the United States, was in favour of the US toppling of Iraqi dictator Saddam Hussein and — paradoxically for an oil man — advocated lower but stable oil prices as being good for Yukos and the world economy. He cultivated close ties with government and business figures in the US.
Finally, Khodorkovsky was himself arrested in October, 2003, charged with fraud and tax evasion.
The Russian Prosecutor General's Office claims Khodorkovsky and his associates cost the state more than $1 billion in lost revenues.
Khodorkovsky's supporters say the arrest is politically-motivated and will have a devastating effect on Russia's nascent financial markets.
The spectacular and heavy-handed method of Khodorkovsky's arrest attracted as much attention as the fact he was charged with serious crimes. Many saw it as a sign that President Putin was favouring a very tough approach with prominent business leaders, regardless of how it was perceived by foreign investors. The received wisdom of Russian political circles is that tough, decisive leadership wins votes, particular if exercised against unpopular figures like the oligarchs.
Around 5 A.M. on October 23, 2003, Khodorkovsky's private jet landed in the remote Siberian Tolmachevo airport near Novosibirsk in transit to an even more remote Yukos refinery production centre in Angarsk, East Siberia. He had been making a series of visits to Yukos and Sibneft properties, which are in some of Russia's most remote territories.
Forewarned to his arrival, FSB (the domestic successor of the KGB) agents lay in wait. The plane needed refuelling and had some minor technical problems.
Then two vans with heavily tinted windows drove across the airport. Fifteen masked operatives wearing FSB issued black combat fatigues leapt out of the vans and stormed the plane. Several dozen more agents armed with assault rifles and pistols surrounded the jet.
Khodorkovsky was in passenger compartment with several staff members and security guards, who were unarmed, as they were required to hand their weapons to the pilots while on board. He was arrested and immediately flown to Moscow and presented before the Basmanny Court, which ordered his detention pending further investigation and trial.
Initially news of Khodorkovsky's arrest had a significant effect on the share price of Yukos. The Moscow stock market was closed for the first time ever for an hour in order to assure stable trading as prices collapsed. Russia's currency, the ruble, was also hit as some foreign investors questioned the stability of the Russian market. Media reaction in Moscow was almost universally negative in blanket coverage, some of the more enthusiastic pro-business press discussed the end of capitalism, while even the Government owned press criticised the "absurd" method of Khodorkovsky's arrest.
Yukos moved quickly to replace Khodorkovsky, replacing him as CEO of Yukos with Russian born US citizen Simon Kukes, an experienced oil executive.
The US State Department said the arrest was likely to be very damaging to foreign investment in Russia, as it appeared there were "selective" prosecutions occurring against Yukos officials but not against others.
A week after the arrest, the Prosecutor-General froze Khodorkovsky's shares in Yukos to prevent Khodorkovsky from selling his shares although he retains all his rights to vote the shares and to receive dividends.
The move alarmed foreign investors.
One very influential Washington figure with close ties to the White House, Richard Perle told Kommersant that Russia ought to be expelled from the G-8 over the arrest of Khodorkovsky, and described the campaign against Yukos as "arbitrary, capricious and vindictive."
Khodorkovsky's supporters point to the Russian Prosecutor-General's summoning of the Khodorkovsky's lawyer on the lawyer's activities as evidence that Russian authorities are over-zealous, if not corrupt. President Putin denied that he had played an active role in the prosecution, saying that the prosecutors' move showed that no one was above the law. Some also question the impartiality of the Basmanny Court and one of its judges who approved Khodorkovsky's arrest, Andrei Rasnovsky who is a former employee of the Prosecutor-General's office. The Basmanny Court is in the same district as the investigative division of the Prosecutor-General's office, which is the official reason why it is generally the forum for hearing its cases. Some say it is because many of the judges in that court are former employees of the Prosecutor's office and remain loyal to it. One of Yukos' lawyers say there is not even an attempt to conceal their bias, with judges seen in private discussions with prosecutors prior to hearings.
President Putin's powerful chief of staff Alexander Voloshin, regarded as close to former President Yeltsin and to some of the oligarchs, disagreed that Putin had no role in the prosecution and tendered his resignation in protest at Khodorkovsky's arrest. The resignation of the pro-business Chief of Staff augurs a new era of the domination of military and security services figures within the Kremlin say some.
Khodorkovsky is not taking the arrest or the prosecution lying down, threatening to bring defamation lawsuits against the Prosecutor-General and his officials, which is not likely to be heard in the Basmanny Court. Those proceedings will display the resources Khodorkovsky is able to bring to bear to challenge the activities of the prosecution team. The Prosecutor-General is an influential factor throughout the Russian legal system but does not enjoy the same dominance in other courts as he does in the Basmanny Court.
There is an obvious contradiction about Khodorkovsky protesting alleged process law violation by the prosecutors, and his own treatment of law during privatisation. In a broader sense, there is a dilemma facing Russian businesspeople who have made their fortunes during the 90s. On one hand today they support rule of law and protection of private property rights. On the other hand many of them are against enforcing this same law when applied to suspected cases of corruption and fraud in a very recent past.
As long as this contradiction remains, Russian business elite is vulnerable not only to government pressure, but to legal attacks from newcomers to the market. Khodorkovsky's case has little to do with his political views and a lot with some people's desire to re-distribute Russian property again, this time acting strictly within the law and using official law enforcement agencies as a tool.
Prosecutors say they operate independently of the elected government. The Prosecutor-General Vladimir Ustinov was appointed by former President Yeltsin and is not seen as being particularly close to Putin who once tried to remove him. However, he is politically ambitious and prosecuting Russia's most prominent and successful oligarch is perceived as a boost to his political career and intended candidacy for the Duma.
The formal charges against Khodorkovsky read as follows:
In addition, prosecutors are believed to be conducting extensive investigations into Yukos for offences that go beyond the financial and tax-related charges currently filed. They say there are three cases of murder and one of attempted murder that they believe are linked to Yukos, if not Khodorkovsky.
One area of interest to the Prosecutor-General includes the 1998 assassination of the mayor of Nefteyugansk in the Tyumen region, Vladimir Petukhov. Nefteyugansk was the main centre of oil production within the Yukos empire. Suspicions arose in Nefteyugansk because Petukhov had publicly and frequently campaigned about Yukos' non-payment of local taxes.
President Putin himself commented on this aspect of the investigation while questioned about the investigation into Yukos in September 2003. President Putin said:
One wholly unintended consequence of the prosecutors' aggressive move on Khodorkovsky (allegedly initiated by Kremlin), some supporters say, is that it might build his popularity. One political leader, Irina Khakamada, of the main right of centre party claimed that Khodorkovsky's imprisonment was making the once hated oil billionaire into a political hero. She asserted:
Budding entrepreneur in Soviet Union
A fortune built on privatization
Foreign business partners complain
A new era of transparency
Political ambitions
The merger
The Kremlin strikes back
The effect of Khodorkovsky's arrest
What Khodorkovsky's supporters say
What Khodorkovsky's critics say
Formal charges
He is charged with acting illegally in the privatisation process of the former state-owned mining and fertiliser company Apatit. It is alleged that the CEO of Bank Menatep and large shareholder in Yukos Platon Lebedev assisted Khodorkovsky. Lebedev was arrested and charged in July 2003.A martyr
Others pointed to his unpopularity and his Jewish background as insurmountable obstacles to his election in a country with a deep loathing of the oligarchs and a shameful record of anti-Semitism.