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MOSCOW – It used to be said about a fraudster in Australia that he was too crooked to lie straight in bed. Until now, however crooked the Russian oligarchs – the handful of men who seized control of Russia’s oil and mineral wealth a decade ago – may have seemed, the lure of their money has overwhelmed the inhibitions of investors, bankers, non-executive directors and managers from jumping into the same bed. Until now, they had reason to believe that they could get in and out swiftly, and make a clean getaway.

A class-action lawsuit, filed last week in a federal court in New York, changes these calculations.

According to a 26-page statement of claim by lawyers for Rothwell Holdings Ltd, a Caribbean-registered investor fund, for nine months of last year, the controlling shareholders of oil company Yukos; the company’s chief financial officer; Yukos’ authorized representatives in the United Kingdom and the US; and the company auditor, PricewaterhouseCoopers (PwC), connived to lie, cheat and swindle investors who purchased Yukos’ Russian shares, or its American Depositary Shares (ADS), each of which represents four units of the common stock. Among others named individually in the lawsuit are shareholders Mikhail Khodorkovsky, Platon Lebedev and Valery Shakhnovsky, and chief financial officer Bruce Misamore.

At the heart of the US claim against them is the massive tax evasion for which Yukos has already been held liable in a Moscow court, and which Yukos has conceded in a letter to Prime Minister Mikhail Fradkov. The jurisdiction of the New York court was granted by Yukos when it registered its ADS issue for market purchase, and submitted thereby to US securities regulations. It was not safe to commit fiscal crimes in its homeland if by so doing, and by subsequent concealment and misreporting, Yukos took investors’ cash on the territory of the United States, violating their rights under US law.

“In order to overstate its earnings and to understate its tax liability for the period,” the US complaint alleges that “Yukos engaged in an illegal tax evasion scheme by creating fake organizations in the oil and after-product movement chain and further by registering these fake organizations in territories with preferential tax treatment. Defendants’ scheme was designed to avoid payment of the following types of taxes: profit tax, value-added tax, motorway user tax, tax on the sales of petroleum, and oils and lubricants and housing stock and social amenities maintenance tax on the amount of receipts from oil and after-product sales.”

The shareholders and managers, aided and abetted by auditors at PwC, then “materially misled the investing public, thereby inflating the price of Yukos securities by publicly issuing false and misleading statements and omitting to disclose material facts necessary to make defendants’ statements, as set forth herein, not false and misleading. Said statements and omissions were materially false and misleading in that they failed to disclose material adverse information and misrepresented the truth about the company, its business and operations, as alleged herein.”

Since the arrests in Moscow last July and October of Lebedev and Khodorkovsky, the details of the crimes alleged against them have been well known. That Shakhnovsky has already pleaded guilty to the charges against him in Moscow is also documented. But the international financial newspapers, which have touted for the oligarchs and benefited from their largesse, have editorialized against the charges against the Yukos group, calling them a politically motivated frameup, and intimating their wrongdoing was minor compared to the human rights violations alleged against Russian President Vladimir Putin and his prosecutors.

More woes for Yukos
Yukos’ troubles were compounded at the end of last week when international creditors declared it in default on a US$1 billion loan. The firm confirmed this on Monday, but the lenders have not demanded payment yet so technically it has not defaulted.

The move on the part of the lenders is presumably aimed at protecting their interests as the Russian government is forcing the giant oil firm to begin paying the first half of nearly $7 billion in back taxes.

Yukos accounts for a fifth of foreign petroleum sales by Russia, the world’s second-largest oil exporter. Yukos produces about 1.7 million barrels a day, ahead of all other Russian oil companies. With its bank accounts frozen by the government, the company has warned that it may have to start shutting down production soon. On Monday, it said it would be able to continue production until the end of the month.

The loan default notice was sent on Friday by a group of banks led by Societe Generale just days after a Moscow court upheld the first of the two tax bills to be paid. The notice asserted the lenders’ right to call the loan immediately, but the banks did not demand instant payment and said they wanted to help Yukos find a way to avoid bankruptcy.

The Yukos crisis has contributed to a rise in world oil prices, which broke above $39 on Tuesday morning. Other contributing factors were Iraqi crude exports being halved by sabotage and threats of disruptions to Nigerian supplies by union action.

The latest attacks in Iraq came a little over a week after that country’s exports recovered from earlier sabotage strikes, which halted shipments for about 10 days in the middle of June. Iraqi exports were running at 984,000 barrels per day (bpd) on Monday, down from close to 2 million bpd before attackers bombed a feeder pipeline running to two southern oil terminals and another pipeline linking oilfields in the north and south. Officials said repairs would take up to four days before exports would recover.

Yukos has tried to calm markets by saying that it planned no export cuts this month and had prepaid pumping deals with pipeline monopoly Transneft until the end of July.

On the trail of the oligarchs
What is more than novel about the new lawsuit filed against Yukos in the United States is that it threatens to put an end to all attempts by the Russian oligarchs to cash out their vulnerable Russian assets into UK- or US-registered securities, and launder the proceeds of their Russian deeds into ostensibly clean Western bank accounts, real estate, and other forms of wealth. The massive tax evasion that was practiced at Yukos is suspected to have been the standard operating procedure for the building of all the Russian oil, mineral, metal and mining fortunes that have been amassed by the likes of Roman Abramovich, Oleg Deripaska, Vladimir Potanin, Victor Vekselberg, and Mikhail Fridman, head of the Alfa banking group.

Thus, if the Yukos investors win their claim in a US federal court, lenders, investors and even employees and contractors of the other oligarchs risk facing parallel claims for fraud, based on what they have concealed (or had a duty to disclose) about the real operations of their companies. Indeed, Rothwell Holdings and US investors in Yukos do not even have to win a court ruling to detonate a bomb of due diligence and liability under the plans of the other oligarchs, whether or not they are prosecuted in Moscow, pay tax reparations, or negotiate an amnesty with the Kremlin.

For now, the threat of this litigation casts an immediate shadow over every transaction by Abramovich in spending cash derived from his oil company Sibneft and other Russian companies that are subject already to, or may soon be facing, charges of tax evasion. Tax investigations of Sibneft have already begun. They include a scheme of tax preferences issued by Abramovich in his capacity as governor of the Chukotka region to companies in which he had a financial interest. More than once, Abramovich has declared himself innocent of the charges against him, and Russian prosecutors have been hesitant to lay the type of indictment against him and Sibneft, which has been prosecuted against the Yukos group. Nonetheless, if Abramovich obtains funds from investors or lenders on the basis of artificially inflating the value of his Russian assets, and of illegally shielding his cashflow from legitimate Russian taxation, then the potential legal liabilities of doing business with him become serious.

A similar shadow also falls over the year-long negotiations by Oleg Deripaska’s Russian Aluminum (Rusal) to borrow $800 million from a syndicate of international banks; over Vladimir Potanin’s attempt to acquire shares in the South African mining company Gold Fields Ltd through borrowings from Citibank; and over Victor Vekselberg’s plan to float his SUAL International corporation under the leadership of Brian Gilbertson, and trade its shares with those of another Johannesburg or London-listed company. The most heavily indebted of the oligarch companies – Deripaska’s Rusal is estimated to owe at least $2.5 billion at the moment – are the most vulnerable to the new standard of disclosure and liability set by the New York court claim. The declared ambitions of these companies to retire their bank debt with unsecured Eurobonds, or issue initial public offerings in London or New York, face protracted delays.

Non-Russians who have been engaged to manage these companies, sit on their boards of directors, direct their legal and accounting departments, negotiate their borrowings, plan their mergers and acquisitions, or persuade investors to buy their shares and bonds, should no longer feel financially secure. What Western executive would risk his reputation and personal fortune in taking a position in these enterprises that would expose them to the type of liability claim now filed against Yukos’ Misamore? What insurance company would write a policy to protect them, in the event of a comparable lawsuit in the future?

According to the New York court documents, Misamore is alleged to be one of several defendants who “participated in the drafting, preparation, and/or approval of the various public and shareholder and investor reports and other communications complained of herein and were aware of, or recklessly disregarded, the misstatements contained therein and omissions therefrom, and were aware of their materially false and misleading nature. Because of their board membership and/or executive and managerial positions with Yukos, each of the individual defendants had access to the adverse undisclosed information about Yukos’ business prospects and financial condition and performance as particularized herein and knew (or recklessly disregarded) that these adverse facts rendered the positive representations made by or about Yukos and its business issued or adopted by the company materially false and misleading.”

Misamore will have his day in court to explain what he knew, what he didn’t know, and what he could have been expected to know about the flow of Yukos funds. For the time being, Yukos is officially not commenting on the allegations. Misamore is on the list of defendants, say lawyers involved in the case, because he provides a means of compelling discovery, according to the US rules of evidence (and perjury); and because his insurance coverage provides a means of recovery, in the event that Yukos itself goes into bankruptcy.

The naming of PwC, and the charges against the audit company for its role in misrepresenting the true state of Yukos’ accounts, mark the first time an international auditor has been charged with liability in a case of Russian corporate malfeasance. They have not been able to make a clean getaway in the best-known cases of US corporate fraud, but they have not been charged by Russian prosecutors to date. For as long as it takes to resolve Rothwell’s claim against PwC, this case opens up the possibility of litigation against accountancy firms, as well as law firms, by investors or lenders in many other cases.

“PwC’s responsibility as Yukos’ independent auditor,” assert the New York plaintiffs, included determining “sufficient competent evidential matter… to afford a reasonable basis for an opinion regarding the financial statements under audit” as to “the fairness with which they present, in all material respects, financial position, results of operations, and its cash flows in conformity with generally accepted accounting principles”.

By attacking PwC for failing this duty, the US claimants have punched a hole in the bubble of corporate transparency that has protected and promoted the oligarchs since the Russian financial crisis of 1998. For as long as the corporate assets of the oligarchs cannot be valued without taking into account their hidden and uncertain tax liabilities, and auditors such as PwC cannot warrant their balance sheets as a fair and accurate presentation of their financial position, it will be impossible for the oligarchs to cash out their assets on the international market. And without that cash as their lifeline, the oligarchs are likely to wither away.

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