Banking Lessons for Future Oligarchs

Editor's Note: This is the second in a three-part series on the rise and fall of Mikhail Khodorkovsky and his financial empire.

It was 1997 and the heyday of Russia's boom transition to capitalism. Christian Michel and Christopher Samuelson could not help but quietly gasp as they climbed the girl-lined, sweeping staircase of one of Moscow's most lavish hotels, the Metropol.

In the hall below, where rich young Russians clinked glasses to celebrate the fifth anniversary of Rossiisky Kredit Bank, were many of the victors of the asset grab that marked the collapse of the Soviet Union.

With their global trust business, Valmet, acting as a key link to the outside world for at least three rapidly growing empires -- Mikhail Khodorkovsky's Group Menatep, Boris Berezovsky's Logovaz and Vitaly Malkin's Rossiisky Kredit Bank -- Samuelson and Michel had helped make most of them.

In those days, it looked like they had good reason to congratulate each other. They had given these upcoming business barons a crash course in the rudiments of Western banking practices. They had facilitated the transfer of cash made in lucrative export deals from an inflation-ravaged economy to safer havens in the West -- and helped point out prime oil assets along the way.

They had nurtured their young proteges' transformation from driven and ambitious, young, jean-wearing, black marketeers of the Soviet late 1980s into the slick flag bearers of Russia's new order mulling in the ornate Metropol. Together, these new Russian businessmen controlled a large chunk of GDP and wielded a growing political clout.

Today, the brand of capitalism Samuelson and Michel helped cultivate has been torn down. Just as he was about to cash in with the sale of part of his Yukos oil company to a Western major, the arch-capitalist they helped climb to power, Khodorkovsky, was arrested in October 2003 on charges of large-scale fraud and tax evasion. He and his partner Platon Lebedev, who was tried with him, await a court ruling this week, while most of the rest of the group have fled to Israel with warrants out for their arrest.

It has been a battle for empire as well as wealth, according to Samuelson, a well-connected financier. "[President Vladimir] Putin appears to be trying to rebuild the Russian empire. That's where the danger is because it will inevitably lead to clashes with the U.S.," Samuelson said during more than seven hours of interviews in the lounge bar of the well-appointed Goring Hotel, locked in a wedge of prime London real estate between Victoria Station and Buckingham Palace.

Under Putin, the Kremlin has turned the tide against these Yeltsin-era business barons toward increasing state dominance. Not content with tightening political control, he has also moved his top aides into key positions at state-owned energy companies and is bidding for the creation of a new state-controlled energy behemoth to boost the Russian government's influence over global oil supply. Instead of being snapped up by a Western group, Khodorkovsky's oil major has been partially swallowed by state-owned Rosneft.

In part, this clampdown on laissez faire capitalism is also a backlash against the tactics of little known, inside players like Samuelson and Michel. They had joined hands with upcoming oligarchs like Khodorkovsky to help build schemes to minimize taxes, which drained the federal budget and weakened the Kremlin to such an extent that eventually Khodorkovsky could seek to eclipse Putin's hold on power.

Their role was significant. "They taught us a great deal," Menatep shareholder Mikhail Brudno said by telephone from Tel-Aviv. "They taught us about the principles of organizing business: from both the financial and the business side. We didn't know anything. Until we met, we couldn't even imagine how these business processes were built."

In Michel's eyes, his teachings helped boost the Russian economy, freeing business from an overly powerful state.

It was also an initiation, of sorts.

Samuelson and Michel's Valmet Group was part of an extensive network that spread from Russia to the secretive financial system of Dubai, then on to Africa, London and the United States. Wrapped up in the network was not only Khodorkovsky's Menatep, but the founders of Rossiisky Kredit and Stephen Curtis, a former Dubai-based lawyer who via Samuelson became a consultant to Berezovsky and Khodorkovsky, setting up a legal framework for their offshore transactions. Michel sold off his stake in Valmet in 2000 and was followed a year later by Samuelson. The company's reputation was in tatters following a series of scandals in the late 1990s in which it was alleged to have been part of an extensive money-laundering network involving the Bank of New York and Menatep. Samuelson and Michel deny any wrongdoing.

Curtis, the man with the keys to much of this network, continued in his role. But a few months after he was appointed managing director of Menatep to replace the jailed Lebedev, he died in a helicopter crash. More than a year after the March 2004 accident, the inquest is yet to be held.

The Early Days

The young Khodorkovsky's linkup with Valmet back in the early days of 1989 was fortuitous. It marked the beginning of instruction in capitalist business practices, from standard banking procedures to offshore shell games and acquisitions, all an initiation that proved key in crafting the course of their business for much of the 1990s.

Khodorkovsky had already moved fast to seize new opportunities. He had leapt from importing computer parts from the West to founding one of the first private banks to be granted a license for commercial banking as the Soviet Union was collapsing. He needed immediately, however, a skilled Western counterpart.

After a seemingly random visit in late 1988 to their office in Paris by a Russian emigre living in France, Samuelson and Michel's contact with Menatep was made.

The emigre, who spoke French with a thick Russian accent, had arrived in their office unannounced with a strange proposal that Valmet finance a tour of the Moscow circus, Michel said. "I asked him, 'Is this a joke?'" he said. He asked, were we not a finance company. "I said, 'Yes, but we don't do this type of finance.' I started to tell him what we do."

A couple of months later, Michel said he got a call from Moscow. It was the emigre, whose name Michel said he did not want published. "He told me, 'There's a group of young people who have started a bank. They're looking for a foreign partner'"

Valmet, which stood for Valeur et Metaux or Assets and Metals, had been transformed with the help of Samuelson into a pioneering global trust business with branches in Gibraltar and the Isle of Man from a Swiss-based family business that managed the wealth of the South American mining dynasty Michel had married into.

With the help of British government connections, Valmet had already built up a wealthy clientele that included the ruling family of Dubai.

Samuelson and Michel were experts in the art of creating shell companies and moving money into tax havens. But for Khodorkovsky and his team, the first lessons they gave were in basic Western banking practices and even in basic personal finance.

"I taught them what a credit card was, and how to use a checkbook," Michel said. When they first came to Geneva to Valmet's offices, they stayed in Michel's apartment. "Initially their budget was so tight they could not afford even to stay in a hotel," he said.

"Khodorkovsky and Nevzlin came several times. Every trip they made they traded up. First, it was my Geneva flat, then it was a low-cost hotel and eventually it was a suite at the five-star Hotel des Bergues."

Then came the lessons in Western business practices, which began with banking and later expanded even to advice on future possibilities in the oil industry.

"I spent two weeks training the entire staff in Budapest ... running through in basic detail how a bank works," Michel said. "I taught them how to read a balance sheet, how to conduct an audit, how to put internal control mechanisms in place, and how to provide credit facilities. It was a crash course in banking 101.

"They were fast learners," he said.

Soon their clients, Bank Menatep and others, were moving on to more complicated transactions and testing the Western system to the limit. "These newly formed corporations had no idea of Western business practices and who the players were. One of the very first transactions ... was something completely crazy. It was not that it wasn't legitimate. It was just that you couldn't do that," Michel said.

"We told them that Arthur Andersen, who were my auditors, would not allow it, and we got a letter back from them saying 'Could you tell Mr. Arthur Andersen ...' ... They didn't have a clue."

Both Michel and Samuelson declined to say what the transaction involved or which of their Russian clients it involved. They declined to elaborate on any of the transactions they were conducting for their Russian clients at a time when the Soviet Union was heading for bankruptcy as it rapidly hemorrhaged cash.

While the Soviet Union teetered toward collapse and its hegemony over a vast swathe of territory from East Germany to Turkmenistan began to fracture, Bank Menatep was growing fast.

The Family

Itar-Tass The country's most powerful businessmen and bankers, including Khodorkovsky, center, meeting with President Boris Yeltsin and Prime Minister Sergei Kiriyenko in the Kremlin on June 2, 1998, two months ahead of the devaluation and default.

By the time Boris Yeltsin took the stand during the 1991 coup that was to make him the country's leader, Khodorkovsky was building close ties with the future regime. As Yeltsin stood on a tank and rallied the crowds in front of the White House, Khodorkovsky, by then an adviser to the Russian government, was inside with Yeltsin's press secretary, who was steeling himself for a storm and standing guard with a gun, Khodorkovsky said in an interview with the U.S. television network PBS.

Shortly after Yeltsin moved into the Kremlin, Khodorkovsky worked a brief stint in the Oil and Gas Ministry. Future allies such as Konstantin Kagalovsky, who became a Menatep vice president, also received posts from Yeltsin, while Menatep corporate lawyers worked for Alexander Mamut, a Kremlin financier, and for Yeltsin's son-in-law Leonid Dyachenko.

The bank was growing rapidly not just because it courted ties in high places, but also because it was embarking on an image campaign of its own. Menatep advertised for shareholders on television while making sure to cultivate an image of wealth. The bank opened up a representative office in Paris on the fashionable Rue de la Paix. Tucked alongside Cartier shops, the two-room rep office made an immediate impression.

"All the Russians that came through Paris went to visit their office and left favorably impressed," Michel said. "This was part of [Leonid] Nevzlin's brilliant PR strategy. He reasoned that if you outwardly appear successful then this will be rapidly backed up by genuine success."

They had been joined in late 1989 by Lebedev, the only card-carrying member of the Communist Party to enter the group and former head of planning and economics at Zarubezhgeologiya. They formed a formidable team.

"Lebedev was the organizational genius. He liked things to run like a well oiled machine," Michel said. Nevzlin, meanwhile, was the artist, he said, in charge of government communications. "Nevzlin was all charm and smiles. He would embrace you and bring you into the fold. The team was impressive in that they all complemented each other perfectly."

They also rarely let one another out of their sight.

Nevzlin, Lebedev, Khodorkovsky, Vladimir Dubov and Brudno all lived together throughout. "Over the years, they migrated like one nomadic clan through a series of compounds. One of the early ones was a group of apartment blocks, surrounded by high walls and barbed wire. The only thing lacking was a watchtower. It was extraordinary. They lived there like a commune. They worked together at the office, they were together after office hours. Their children played together, their wives spent much of their time in each other's company. None of them could receive a visitor without the others' knowledge," Michel said. "They reproduced the only lifestyle they knew befitting leaders of a powerful organization, that of Soviet government ministers."

It was also a vicious climate of little trust.

Worse still for the banking industry, there was no such thing as credit history. Clients were closely watched by security agents. "A typical credit committee of a Russian bank in 1989, 1990 would have to be entirely based on personal confidence in the entrepreneur. There was no balance sheet, no asset, no record to collateralize a loan," Michel said.

"When the payback time came, they would send someone to collect the loan. It went a little like this: They'd say 'we're here for the money and if you don't pay we'll nail your kneecaps to the floor,' so to speak," Michel said. "All the security people at the banks were debt collectors, I suspect."

It was a tough climate that continues to haunt all involved in the scramble to the top, including Valmet. Khodorkovsky's second in command, Nevzlin, now faces charges he ordered a double murder and the attempted murders of three other executives in a series of attacks in the late 1990s. Nevzlin denies the charges, which he says were motivated by the political onslaught against Menatep, but as one former senior Yukos executive puts it: It was a battle for empire. "Western countries also had colonial wars. But they do not carry any responsibility for those who got killed," said the official, Alexei Kondaurov, a former KGB general who headed Menatep's analytical department.

The risks indeed got higher as Menatep began to expand its empire out of banking and into industry. Most of the nation's biggest enterprises were sold off via voucher auctions. Meant to be distributed to the population, the vouchers were soon bought up by the rich few banking groups like Menatep as ordinary people, their savings ravaged by hyperinflation, sold them off for just enough to cover the cost of staple goods.

The Real Prize

For Samuelson and Michel, it was also a turning point and one they watched closely over. Used to dealing with the riches of Arab leaders, they found Menatep, by comparison still relatively small fry. By 1994, however, Menatep had started moving into all kinds of industries, from chemicals to textiles to metallurgy. But for Valmet, which by that time had already partnered up with one of the oldest banks in the United States, Riggs Bank, and for Menatep, the real prize was oil.

The West had long had its eyes on Russia's vast oil reserves. Exxon had hired a former high-ranking Soviet-era geologist, George Mirkin, who had left Russia for the United States before the perestroika era, in order to gain an inside view on where the biggest treasures were, according to Samuelson, who also had founded companies for Western investors to take stakes in smaller Russian oil ventures, such as via the Anglo-Siberian Oil Co. In one meeting between Exxon officials and Russian ministers, Exxon asked if they could run Siberia, Samuelson cited Mirkin as telling him. "The answer was: 'No way: We know what you did to Saudi Arabia.'"

Knowing it was going to be politically impossible for the new Russian government to sell its oil riches directly into the hands of big Western oil majors, even if it could have gotten world prices for the fields, Samuelson stayed on the inside track with the up and coming Russian business barons who could win them.

Samuelson said that he sat down with a couple of them with a Fortune 500 listing of the largest companies in the world, and after going through the first 30 or so, the message was delivered: The biggest fortunes had been made in oil.

As the government prepared to sell off part of its oil industry in the controversial loans for shares auctions of 1995, Samuelson and Michel were already getting a bird's-eye view of the choicest assets. Via a consulting arm of Valmet, GT Valmet, they won a contract in 1995 from the World Bank to make sure that $1.6 billion it had extended in loans was being spent properly by production units such as Yuganskneftegaz and Purneftegaz. Yuganskneftegaz, which was visited by Valmet consultants, formed the backbone of the soon-to-be privatized oil company Yukos. Purneftegaz, meanwhile, was part of the same Soviet-era network of production units as Sibneft.

By that time, Valmet was also acting as a consultant to Berezovsky, the Kremlin intriguer who won close ties with the Yeltsin family. Both Khodorkovsky and Berezovsky ended up big winners in the auctions of Yukos and Sibneft, gaining controlling stakes for just over $300 million and just over $100 million, respectively.

As Samuelson and Michel see it, there was no other way for the Russian government, which was being urged to privatize its assets by the Western world.

"The solution chosen was absolutely the right one for the country. Give the companies away! Give them to entrepreneurs who have demonstrated their ability to run a business," Michel said.