Virtues of Yukos Re-Nationalization from Russian Perspective

To summarize the point of this posting in a few words, partial renationalization of Yukos today is done to help strengthen governmental regulatory control over publicly traded Russian issuers, by (i) shielding core Russian assets from powerful private corporations like Yukos plundering ruthlessly at Russian wealth (oil reserves) without necessary controls in Russia like those operating in this country through the Federal Securities and Exchange Commission and Office of the Attorney’s General (think Spitzer in NY); (ii) using the revenue derived from partly renationalized assets to create the necessary controls by hiring, retaining, and training qualified personnel to regulate the markets (something lacking right now); (iii) achieving stable and predictable governmental controls so as to boost reliance from international investors in the future. This is not an easy task—we in the US really have a very small idea how bad structurally things are in Russia today, and taking steps in the direction of remedy, for a change, is a Hurculean task. We have to see if it will bear fruit that is edible, and hope for the best. This perspective gives hope that President Putin is not an egocentric maniac--but a concerned leader trying to put Russian economy on its tracks, and the means are desperate, but may be the only ones available under the circumstances.

Final note to our readers—we would appreciate if you could contribute your thoughts as to which alternative methods Pres. Putin could utilize to achieve the results he set out to achieve.

Russia’s emerging governmental regulatory agencies are slowly emerging but still very weak to truly work properly. They are overrun by corruption and fail to attract smart aspiring people to work for them. In addition, government does not have enough funds to expand its personnel to carry out laws it implements. Russia has failed to meet these basic needs to sustain its economy after privatization. Once privatization has happened, government lacked funds and resources to regulate and became a puppet of a massive and powerful private sector, which now benefited from the core Russian assets—oil and gas. Corrupt government branches failed to shield the rest of the population from powerful oligarchs. Thus, neither minority shareholders nor foreign investors of oil companies have any recourse. And, power of new ruling class—the oligarchs effectively prevented any development of the law, since it would effectively prevent them from stealing. To strengthen its government apparatus partial re-nationalization of oil reserves will achieve revenue from which government can build necessary infrastructure to insure true protection of investors.

In any country, making sure that private economy yields positive results (i.e. does not defraud the shareholders and supports society by paying taxes to the government), it needs to have a strong government agencies regulating and overseeing the process. Just think of all the recent scandals we had: Enron, Tyco, etc, etc. in the recent years. They all happened because regulators were asleep at the switch at the time of the wrongdoings. But the prosecutions did happen, so the regulators finally woke up. In Russia, on the contrary, there are no regulators to either sleep or wake up, since the regulatory system at present is so week as to be completely run down by corruption, which means those in the private sector can do whatever they please just so long as they pay, threaten, or commit exemplary murders of those officials in Russia who were not quick enough to catch up the real rules of the game.

To solve its corruption problem Russia has to increase pay to governmental officials. For example, judges get about $600 per month in Moscow where prices are at the world standard and even higher. Most basic things like food costs as much or even higher than it does in NY. To meet the basic needs of their families judges are forced to take bribes. To allow governmental officials to look beyond basic needs of being able to bring bread to the table at the end of their day, like caring about their integrity and their career objectives beyond making a buck, they have to get pay that will cover the essentials. And they don’t in today’s Russia.

To develop its regulatory structure further, like strengthening its Securities and Exchange Commission, Russia has to attract better-qualified personnel and hire more people. It would only be able to do that with increases in its budget. Lacking revenue sources such as from tax revenues, since Russia lacks efficient tax regime, does not have the sources to enforce the scheme since their regulatory agencies are weak and prone to corruption, and is up against corporations that through their present ownership of country’s oil and gas reserves have gotten tremendous power and incentives to avoid the laws and prevent and circumvent any future development of them.
The privatization that took place in the early 90’s was done in a way, which resulted in extremely uneven distribution of wealth to a few favored individuals who got the funds in the first place as government loans that were never repaid. In essence, privatization, sad to say, was larceny on a grandiose scale. But it was more then larceny, which could be later, prosecuted. Russian problems stem from a much more basic fact, that is very hard to grasp, this scale of larceny was so grand, that it created a redistribution of resources in the whole country--the crooks had the country by the gills, and while they were stealing funds into offshore accounts they were also preventing any further developments in the regulatory sector, since those developments would have prevented them from stealing. The result is that the country was slowly moving in the direction of complete anarchy. I say, "was" because fortunately Russia got Putin as its president, who as opposed to Russia’s prior president is actually trying to build something.Below are some historical examples for implications stemming from regulatory impotency described in “Russian Privatization and Corporate Governance: What Went Wrong?” Published in Stanford Law Review, in July, 2000

Bank Menatep (formed and controlled by Mikhail Khodorkovski) acquired Yukos, a major Russian oil holding company, in 1995. For 1996, Yukos' financial statements show revenue of $8.60 per barrel of oil-- about $4 per barrel less than it should have been. [This assumes that Yukos exported roughly 25% of its production, at world prices of around $18/barrel, and sold the balance at domestic prices of around $10.50/barrel. Yukos' revenue is based on translated Yukos financial statements provided to us by Graham Houston of National Economic Research Associates. Houston's numbers are also reported in Jeanne Whalen, Shareholders Rights: Round 2, Moscow Times, Feb. 17, 1998 Mr. Khodorkovski skimmed over 30 cents per dollar of revenue while stiffing his workers on wages, defaulting on tax payments, destroying the value of minority shares in Yukos and its production subsidiaries, and not reinvesting in Yukos' oil fields. It's doubtful that running Yukos honestly could have earned Khodorkovski a fraction of what he earned by skimming revenue, let alone offshore and tax-free. He made a rational, privately value-maximizing choice. Even if running Yukos honestly was the best long-run strategy, Khodorkovski might have preferred present profit to future uncertainty. Besides, skimming was a business that he knew, while oil production was a tough business that he might fail in.

After Yukos defaulted on its loans from western banks when the Russian ruble collapsed in mid-1998, Yukos proposed for shareholder approval the following package of proposals, with minor variations: (i) A massive new share issuance to obscure offshore companies, at prices that valued the companies at 1% or less of their true value, and perhaps 10% of their depressed trading prices. Even that modest amount would be paid not in cash but in promissory notes issued by other Yukos subsidiaries, of dubious legality and even more dubious value. Enough shares were to be issued (between 194% and 243% of the previously outstanding shares) to transfer control from Yukos to the offshore companies. (ii) A multiyear agreement obligating the subsidiary to sell its output to the offshore companies at the laughable price of 250 rubles per ton (around $1.30 per barrel at mid-1999 exchange rates, and headed lower as the ruble depreciates against the dollar). (iii) Shareholder approval of large asset transfers to still other obscure companies, including both past and unidentified future transactions.

Shareholders who opposed these proposals were given the opportunity to sell their shares back to the company at prices that valued the three companies, with proven oil and gas reserves of around 13 billion barrels of oil equivalent, at a total of $33 million-$.0025 per barrel of proven reserves. No, this is not a misprint. (Check materials presented by Michael Hunter, President of Dart Management Inc., a major investor in the Yukos subsidiaries, at the OECD Conference on Corporate Governance in Russia (Moscow, 1999)); Alan S. Cullison, Russian Firm Bars Minor Holders, Passes Contentious Share Increase, Wall St. J., Mar. 24, 1999, at A21; David Hoffman, Out of Step With Russia? Outsider's Battle over Stake in Oil Giant Offers a Glimpse of Nation's Uncertain Capitalist Ways, Wash. Post, Apr. 18, 1999, at H1; Alan S. Cullison, Yukos Transfers Two Oil Units to Offshore Firms, Wall St. J., June 4, 1999, at A12; Alan S. Cullison, Vanishing Act: How Oil Giant Yukos Came to Resemble an Empty Cupboard, Wall St. J. Eur., July 15, 1999, at 1; Alan S. Cullison, Russian Share Shuffle Maddens Investors, Wall St. J., July 23, 1999, at A12.

Yukos eventually settled with Kenneth Dart, reportedly buying his shares for over $100 million--far above market value, but still far below their true value. See Jeanne Whalen, Russia's Yukos to Buy Dart Stock, Ending Long Feud, Wall St. J., Dec. 21, 1999, at A16. Bernard Black was an advisor to the Dart Group in connection with the Yukos transactions described in the text).
The impotency and corruption of governmental agencies is evidenced in that Mr. Khodorkovski's behavior didn't trouble senior Russian officials. In the middle of the scandal, he accompanied then Prime Minister Yevgeni Primakov on a trip to meet President Clinton. And while it did trouble the Securities Commission, which launched an investigation, it wasn’t able to get too far, since the Chairman failed to get the cooperation he needed from other government agencies to bring a court action, and resigned in disgust, while the remaining members approved the share issuances.

Aside from regulatory violations and plain stealing of billions in cash, some even worse developments have occurred. For example, after the mayor of Nefteyugansk publicly demanded that Yukos subsidiary Yuganskneftegaz pay its local taxes and back wages 1998 he was murdered shortly after. In March 1999, Yevgeni Rubin, the head of a company, which had won a lawsuit against Yukos, had his car blown up near his home, with armed attackers waiting to finish off anyone who survived the bomb. By chance, he wasn't inside, but his bodyguards were less fortunate.

In view of above examples it appears that partial renationalization of at least such core assets, as oil is an important undertaking to build the necessary framework for future economic success in Russian developing markets.

What Yukos CFO told TX Judge under oath

AFFIDAVIT OF BRUCE K. MISAMORE
I accepted the company’s offer of employment and joined Yukos in February, 2001, relocating
myself and my wife to Moscow, Russian Federation ("Russia") shortly thereafter. The facts
set forth herein are within my personal knowledge and are, in all things, true and correct.
OUR AIM OF BUILDING YUKOS INTO A TRANSNATIONAL ENTERPRISE
3. Before joining Yukos, I researched the company thoroughly and knew from what
I had read about the company’s history that I would be joining a leading emerging
multinational oil and gas company. Yukos was created by the Russian Government in 1993
as a state-owned entity through the consolidation of a number of other state-owned oil
entities. Through a privatization process in 1995 and 1996, Yukos basically became Russia’s
first fully privatized oil company. Despite the involvement of private investors though, the
company was still suffering from the effects of mismanagement during state ownership and
was facing the bankruptcy of its main oil production subsidiary, Yuganskneftegas ("YNG").
It even still owed the Russian Government more than US$ 3.5 billion. However, through the
implementation of a deliberate and focused strategic plan, the company’s fortunes were all
being turned around by the time I became the company’s CFO in 2001.
4. In May 1996, Mikhail Khordokovsky, the man who later brought me to Yukos,
had stepped in as CEO of Yukos, bringing a dynamic, experienced and professional
management team with him. The task assigned to the new management was clear: transform
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Yukos into a multinational enterprise, managed in accordance with the highest international
standards of operational efficiency, transparency, and corporate governance. This same
objective was also spelled out to me when I joined in 2001. My role, as CFO, was to build
on the work that had already been accomplished by the management team by taking it to the
next level, with a particular emphasis on globalizing the company.
5. Before I had joined the company, Yukos had completely repaid all the debts it
owed to the Russian authorities and had increased its production capacity by reinvesting its
profits in its Russian operations. While we have been able to pay substantial dividends to our
investors, reinvesting a significant amount of our profits back into the company’s Russian
operations was a fundamental cornerstone to our success and continued until the Russian
Government began taking the funds which otherwise would have been reinvested.
6. Internationalization of Yukos was pivotal to the turnaround of the company’s
fortunes. The company’s corporate culture had to be developed into one that would attract
international investors. For this purpose, Yukos undertook a number of steps, many of which
were firsts for any Russian company. A Corporate Governance Charter was adopted in 2000,
setting policy standards to guide the company towards becoming a fully transparent,
multinational corporation. An independent Board of Directors was also set up with nearly
half of the Board consisting of professionals from outside Russia with significant
international business experience. In 1999, we became the first Russian oil company to
switch to international accounting standards. Since that time, the company has published its
annual financial statements in U.S. GAAP format back to 1997, and until the Russian
Government attacks started in 2004, had issued regular quarterly U.S. GAAP reports since
2001. In June 2002, I was involved in the decision to disclose the company’s management
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and ownership structure to the public, including recommending that the names and holdings
of its core shareholders also be disclosed. This was important for international investors who
prefer companies that have full transparency of ownership and management. Again, in
taking this step, we became the first large Russian company to make such a disclosure. The
company also has had all of its annual reports audited by an international auditing firm,
PriceWaterhouseCoopers, the results of which we also publically disclosed.
7. In 2001, the year I joined Yukos, the company’s annual oil production output
increased by 17 percent, and then by 19 percent in 2002. By 2002, we accounted for over 18
percent of Russia’s total oil production, pumping an average of 1.4 million barrels a day.
Today, Yukos and its subsidiaries are the largest producers of crude oil in Russia and the
largest exporters of crude oil from Russia. Together we produce nearly 20% of all the crude
oil produced in Russia, and refine and market slightly less than 20% of the refined products
in Russia. This makes us one of the largest oil-and-gas companies in the world. In 2003, for
example, Yukos’ production was 80.8 million metric tons (591 million barrels) of crude oil
and gas condensate, which is a production capacity exceeding that of some household name
international oil companies, and even some of the OPEC countries.
8. In December 2002, Standard & Poor’s rated Yukos "BB with stable outlook," and
in January 2003, Moody’s Investor Service assigned the company a rating of "Ba2." This
was very important for us as a reflection of the quality of the company because, at the time,
these were the highest long-term and foreign currency issuer ratings for any private Russian
company, and in the case of Moody’s, Yukos was rated higher than the Russian Federation.
Mikhail Khodorkovsky deservedly won the 2002 "Entrepreneur of the Year" prize, awarded
annually by Russia's leading business newspaper, Vedomosti, which is published jointly by
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the Financial Times and the Wall Street Journal. That same year, the Russian government
named Yukos the "Best Company for Compensation and Social Payments Programs," as well
as for the "Implementation of Social Programs at Enterprises and Organizations" in
recognition of our work with social programs for our employees and local communities. We
also won a number of awards for our charitible and philanthropic work in Russia and abroad,
and for corporate governnance, investor relations and risk management.
9. On the professional side, I was also heavily involved in Yukos’ negotiation and
execution of joint venture investment and strategic alliance agreements with major
international companies. From 2001 through 2003, we were engaged in discussions with a
number of other major United States based oil companies about their purchasing equity in
our subsidiaries. Yukos’ principal shareholders also had discussions about selling substantial
amounts of their shares to various of these companies.
10. Even though it started as a completely Russian company, the multinationalization
of Yukos has meant that today it has significant foreign ownership. Approximately 53% of
Yukos’ shares are owned by a Cypriot company through Isle of Man and Gibraltar parents.
Approximately 24% of the common stock of Yukos is owned by entities, many of which are
United States residents, who purchased their stock through public market sources.
Approximately 15% to 19% of Yukos’ common stock is, or has been, owned by large
institutional investors, many of which are, again, in the United States. In addition, we have
international subsidiaries in a dozen locations or so, including in the USA, Switzerland and
the United Kingdom.
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YUKOS’ TIES TO THE UNITED STATES
11. In seeking foreign investment into the company, we specifically set our sights on
seeking investment from the United States and Europe. We engaged in substantial investor
relations and speaking engagements throughout the United States and Europe to attract and
solicit investors and lenders, including meetings in Houston, the center of the energy
industry. In 2002, for example, Mikhail Khodorkovsky was a keynote speaker at the Baker
Institute in Houston, talking about the need for investment in Russian companies such as
Yukos. He was also a regular keynote speaker at the CERA (Cambridge Energy Research
Associates) Week conference in Houston, sponsored by Cambridge Energy Research
Associates, the largest oil and gas conference in the world, held annually. Also, as part of his
worldwide philanthropy, he gave generously to a number of foundations and charitable
institutions in the U.S. I also spoke at industry events throughout the United States and
Europe and at non-industry meetings such as the International Chamber of Commerce.
12. Our Manager of Investor Relations and I were regular participants and speakers at
oil, gas and emerging markets investor conferences in the United States and Europe on behalf
of the company. He and I also met regularly in the United States and Europe with the
investment management arms of major investment banking firms, large asset management
firms, major institutional investors and other organizations including the U.S. Government.
In 2003 and 2004, Yukos won the IR Magazine award for best investor relations for an
emerging market company in the London market, and in 2004, I was named the best
CEO/CFO in Russia for investor relations by the magazine.
13. The company has links to Houston and the United States in general. Some of
Yukos’ top expatriate executives have been educated in Texas schools or have come from the
United States oil and gas industry based here in Houston. Steven Theede, Yukos’ current
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CEO, for example, was formerly a senior officer of Conoco based here in Houston. I was a
former officer of PennzEnergy Company, Pennzoil Company and Marathon Oil Company,
all based here in Houston.
14. Yukos also has historic ties with Houston and Texas. In 1994, Yukos had a
business development function in Texas. As recently as September 2004, one of the
company’s subsidiaries had an employee in Houston who conducted business activities in
Houston on behalf of Yukos. On the commercial side, Yukos, through its subsidiary
Petroval, has shipped oil to the Houston, Texas area and has purchased equipment and
services from providers based in the city. Members of Yukos’ management team make
regular trips to Houston for business activities.
15. On the back of this success, both in attracting investment and in increasing
productivity by reinvestment, the value of Yukos’ shares increased exponentially after 1998.
The company’s shares trade on stock exchanges in Moscow. Currently, substantial amounts
of Yukos’ American Depository Receipts ("ADRs") are traded in the U.S. on the over-thecounter
market pursuant to a Level 1 ADR program we instituted in March 2001. In this
regard, we registered with the Securities and Exchange Commission under the Securities and
Exchange Act of 1933 and appointed an agent for service of process here in the United
States. Yukos was actively working to upgrade its ADR facility to Level II under the U.S.
Securities so that ultimately its ADRs would be traded directly on the New York Stock
Exchange. Today, our ADRs are traded over-the-counter in the U.S., directly on the
Stuttgart, Berlin, Frankfurt and Munich stock exchanges, and through the London Stock
Exchange International Order Book.
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16. All in all, Yukos was the success story of the new Russian Federation. I believed
that Yukos had major potential to become such an international player when I first joined the
company, and this was a principal factor in drawing me out of temporary retirement. By
October 2003, the estimated market capitalization of Yukos’ stock had been over $40 billion.
After some downward movements, the stock recovered and in April 2004; the company’s
market capitalization was again over $40 billion. Little did we know what was to come.
Within only eight months, between April and December 2004, this company which we spent
years building into a highly transparent, respected multinational corporation, worth over US$
40 billion in market capitalization, was subjected to a series of malicious politically
motivated attacks, improper taxes, seizures, confiscation, investigations and intimidation by
the Russian Government in apparent retribution – at least initially – for Mikhail
Khodorkovsky’s political activities and complaints about governmental corruption. Despite
our best efforts to protect the company, the Russian Government has so far succeeded, and
has left us with no choice but to seek bankruptcy in Houston.
THE GOVERNMENT ATTACKS YUKOS
17. Attacks on Mikhail Khodorkovsky began with strikes against two of his business
partners. Platon Lebedev, Chairman of Group Menatep Limited, Yukos’ largest shareholder,
was arrested in July 2003 on charges of fraud and tax evasion relating to the privatization of
a fertilizer company, and Vasily Shakhnovsky, a member of Yukos’ Management Board, was
charged with tax evasion. In July 2003, the Government raided our offices – in an incredible
scene full of armed, masked officers – during which they trawled through our computer
records for approximately 17 hours. On October 25, 2003, Mikhail Khodorkovsky himself
was arrested at gunpoint in Siberia by Government agents in a theatrical display of power
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and was jailed on what are universally held to be clearly false charges of tax evasion, theft of
state property, and fraud.
18. Yukos, as a company, was very careful not to get involved in politics other than
the normal general corporate lobbying efforts of any company. Mikhail Khodorkovsky’s
contributions to opposition parties, for example, were not made from any of our corporate
accounts. While everyone at the company was, of course, concerned about Mikhail, we
never seriously thought that Yukos itself would be in danger. After all, we were the success
story of the new Russian Federation. The world was watching us and we could not imagine
that the Government would take action against us without a legitimate reason to do so. We
were wrong. The Government apparently decided – having learned from actions it had
previously taken against other so-called "oligarchs" – that the best way to attack
Khodorkovsky would be to eradicate his wealth; and his wealth was predominantly in one
company: Yukos. Following his arrest, in December 2003, the Russian Ministry of Taxation
conducted a perfunctory two-week special audit of our company’s books. There were no
problems of which we were aware which should have triggered such an audit. Yukos’ books
were prepared according to U.S. GAAP and Russian accounting standards, audited by PWC,
and made transparent as part of the company’s overriding corporate philosophy. As one of
Russia’s largest taxpayers, Yukos’ tax management team were in constant communication
with the national and regional Russian tax authorities, who had consistently approved all of
our previous filings and had confirmed their correctness through audits.
19. To everyone’s surprise, after just a two-week audit, the Government sent us an
audit report claiming an incredible US$ 3.4 billion for the year 2000. I was astonished that in
light of the audits of the taxing authorities in confirming that our books and tax payments
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were correct each and every year, they suddenly "discovered" that we had allegedly failed to
pay an amount as large as US$ 3.4 billion.
20. That was just the start. Since then, the improper tax assessments have not stopped
being levied, in the billions, on a persistent basis – nearly every week. Today, they total over
US$ 27 billion on Yukos and its subsidiaries. The assessments involve absurd claims that
contractual arrangements entered into by various legal entities were instead attributable to
Yukos, that Yukos misused tax abatement incentives granted under Russian law, improperly
claimed VAT refunds from the Government and made unlawful transfers between Yukos’
affiliated companies. What the Government has chosen to ignore though is that every action
we took which they now say is against the law (a) was either expressly authorized by or not
prohibited under Russian tax law, (b) was used by many Russian companies that have not
received tax assessments anything similar to those against Yukos, and (c) concern some tax
years for which Russian federal authorities had expressly indicated to us that no additional
taxes were due.
21. What the Government is essentially doing is making a selective and retroactive
reinterpretation of the tax law that we could never have anticipated when the transactions
were undertaken. The actual taxes though are only the beginning. In addition to the amount
of the taxes, we have been slapped with huge default interest, penalties, and fines. The cash
which the Government is collecting from Yukos’ bank accounts to pay the improper tax
claims has jeopardized our ability to conduct business. The most striking part about these
taxes is when they are compared to the company’s gross revenue for 2001 and 2002, the
assessments have been in excess of 100% of our annual consolidated gross revenue, and in
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excess of 80% of our 2003 consolidated gross annual revenue. That is as much as four times
the industry average taxes and, to my mind, clearly confiscatory.
22. We have tried our best to defend ourselves against these taxes before the Russian
courts. We hired Sergei Pepeliaev, a respected tax lawyer who helped author many of the
Russian tax laws and who is generally considered the leading tax lawyer in all of Russia.
Nevertheless, beginning in May 2004, the company has not won any of its tax cases. With
little or no separation of powers in Russia, the Russian administration exerts near total
control over its judiciary. There have been plenty of examples showing how the judiciary
has consistently ruled in favor of the Government: in one case, the Tax Ministry was allowed
to present its case for three days, while we were only given three hours; in another, the court
gave us just a few hours to review a full 342 volumes of documents; in another case, the
court refused to even open 255 volumes of documents submitted in our defense before
passing judgment against Yukos; and in yet another case, certain evidence presented by the
Tax Ministry and used by the court to make a finding was not even provided to Yukos.
23. Concluding that we would never find justice within the Russian judicial system,
we have also tried – in vain – to settle this matter outside of the court apparatus in an effort to
save the company, preserve whatever shareholder value we could, and get on with rebuilding
Yukos. I know that we have sent over 70 letters to various Russian authorities, trying to
reach a settlement for these assessments. We have offered a host of reasonable solutions:
cash settlement, periodic payments according to an agreed schedule, and Mikhail
Khodorkovsky even offered to give the Government his equity in the company. All our
letters and pleas have been substantively ignored.
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24. In fact, instead of seeking to resolve the disputes, the Government has continued
to seek to destroy our company, utilizing the full apparatus of its court system. In October
2003, days after Khodorkovsky’s arrest, it froze Group Menatep Limited’s shares in Yukos.
In July 2004, it obtained a court order freezing our bank accounts and forbidding the sale of
any assets of Yukos, YNG, and Yukos’ other directly-owned subsidiaries, including
Samaraneftegas ("SNG") and Tomskneft ("TN"). As a result, the Company has not been
able to sell assets or access this cash to reinvest in our operations, operate our businesses,
disburse company expenses, ensure salaries to our employees, satisfy any amounts levied by
these tax assessments, and most importantly of all, pay current taxes. The Government has
also obtained a collection order from its courts permitting it to seize money directly from
Yukos’ bank accounts. Yukos has paid to the Government over US$ 4 billion since just July
both voluntarily and through these collections. We have told the Government many times
that much of the money in these bank accounts does not belong to Yukos – it is received by
Yukos as agent for subsidiaries not involved in the tax dispute, and for third parties in joint
ventures with Yukos, but they have not listened. By forcing Yukos to operate without
sufficient cash, the Russian Government has purposely driven the Company to bankruptcy
and, in the interim, is forcing it to risk losing some operating licenses, one of Yukos’ most
valuable assets.
25. Recently, the Government has put into place a plan to accelerate the Company’s
demise. The Government has persuaded its courts to allow it to attach Yukos’ shares of the
common stock of YNG, our principal oil and gas producing subsidiary, and of our other
major oil and gas producers, SNG and TN. In contravention of Russian law, and despite
many appeals regarding tax matters pending before the Russian judiciary, the Government
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has announced that it will conduct an auction of YNG’s shares, the result of which is
scheduled to be announced on December 19, 2004, supposedly to raise money to pay a
portion of Yukos’ $27.5 billion tax bill. I understand that, under Russian law, bailiffs are
only allowed to attach assets pursuant to court order in a mandatory order of preference: (i)
cash, (ii) non-operating assets, (iii) operating assets, and (iv) assets of private shareholders
and directors, if appropriate. Clearly, this law was designed to protect against the
Government picking and choosing which of a debtor’s assets it takes. In Yukos’ case
though, in the face of the clear language under the law, bailiffs immediately seized YNG’s
shares. YNG is the oil producing heart of this company. Of course, we immediately
appealed the Government’s actions but, not surprisingly, the Russian court approved of this
attachment of our core operating assets.
26. It has been reported that Gazprom, another oil and gas company, has been
instructed by the Russian Government, its principal shareholder, to bid for the shares in YNG
at the auction. I have also read that two other entities have reportedly filed with the relevant
authorities to bid at the auction: OAO First Venture Company and ZAO Intercom. I have
been in the oil and gas industry for over 27 years, including in Russia for almost 4 years, but
I have never even heard of these companies and would be surprised if they could assemble
the capital they would need to be legitimate contenders in the auction. These other
companies may just be nominal, as under Russian law, at least two companies have to bid in
order for the auction to be "legitimate." According to what I have read in the newspapers,
Gazprom is raising financing for its bid at the auction from a consortium of international
banks. Not surprisingly, no international company has acknowledged that it will bid for the
shares of YNG. That is because it is likely that there can only be one real winner in this
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auction: Gazprom. It is no coincidence that Gazprom is set to become a majority stateowned
oil company early next year when it is scheduled to merge with Rosneft, the Russian
state-controlled oil company.
27. The price for the sale of YNG’s shares has been set by the Russian Government at
well below fair market value. By forcing down the value of the sale of YNG shares in the
auction, the set-off which the Government says that it will make against Yukos’ tax bill will
still leave a substantial claimed tax liability. Using this as an excuse to sell more of Yukos’
assets, the Government will likely conduct similar auctions for other principal subsidiaries.
By forcing the auction of our major oil producing subsidiaries, the Russian Government will
utterly strip Yukos of virtually all of its value, damaging thousands of international investors.
28. At the Government’s request, Dresdner Kleinwort Wasserstein valued the shares
of YNG in preparation for the auction. It came back with a valuation of between
approximately US$ 15-18 billion, after considering potential liabilities. In making its
valuation, Dresdner: (i) reduced its valuation significantly for the alleged taxes owed by
YNG; and (ii) reduced its valuation for YNG alone for guarantees owed collectively by a
number of Yukos subsidiaries for loans taken out by Yukos. Nevertheless, despite
independent bank appraisals reporting an asset value of about US$ 20 billion, the
Government has decided to set the auction to start at significantly under US$ 9 billion, less
than half the valued amount. With the price of crude oil today, and the identified recoverable
resources which we believe are in YNG’s portfolio, a fair auction could value YNG well in
excess of US$ 20 billon. I agree with the reports in the press that this auction is being
organized by the Government so that it can sell our crown jewel to a Government-owned
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entity for an artificially low price. If the auction is consummated, Yukos will be severely and
irreparably damaged.
MOVING YUKOS’ COMMAND TO HOUSTON
29. To date, there has been no evidence that the Russian Government has changed
course in its desire to destroy Yukos. In fact, criminal prosecution with no basis whatsoever
against people related to Yukos has accelerated. Attacks have proceeded far down the ranks,
including arrests of Yukos’ managers, intimidation of its employees thorough illegal searches
of their homes and confiscation of personal property of the company and its managers.
Within the past week, for example, Svetlana Bakhmina, a young Deputy General Counsel of
Yukos and the mother of two young children, was arrested at night at her home in Moscow
on yet further meritless criminal charges. It has been reported to me that she is currently in a
semi-conscious state unable to recognize colleagues shown to her. This is just a solitary yet
eminently repugnant example of a series of such recent malicious arrests of Yukos
employees and outside service providers. Diplomats and other high level emissaries have
sought to intervene with the Russian Government on these matters, but to no avail.
30. As the Russian Government has continued on its path against Yukos and its
personnel, we have increased our business presence in the United States and Houston
specifically. Two weeks ago, I was on my way back to Russia after a business trip when I
received an informed message advising me not to return for my own safety. I immediately
called my wife, who was waiting for me at our home in Moscow. I told her to pack all our
possessions and belongings at once. My wife and I returned to our home in Houston, Texas
on December 4, 2004. Since then the role of Chief Financial Officer for Yukos has been
conducted out of my home office in Houston, Texas.
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31. Since December 5, 2004, the company has been forced to hire a western law firm
to deal with the company’s insolvency and related arbitration issues. As a result, a
substantial retainer was paid to Fulbright & Jaworski L.L.P., which is property of Yukos Oil
Company, and is being held here in Houston, Texas at Wells Fargo Bank. This money was
transferred from a non-Russian subsidiary for the benefit of Yukos. Additionally, earlier this
year when shareholders sued Yukos in the United States under the U.S. securities laws
relating to the precipitous decline in Yukos’ stock, we placed a substantial retainer with
Debevoise & Plimpton LLP in the United States to defend those U.S. securities fraud
lawsuits.
32. Since I returned to Houston, an additional approximate half a million dollars in
cash was transferred from a non-Russian subsidiary for the benefit of Yukos and is on
deposit in Houston, to ensure that Yukos has sufficient additional assets available: (1) for me
to continue operating the CFO function of Yukos from Houston; and (2) to pay
administrative expenses of the company’s bankruptcy case pursuant to any Court orders.
This property of Yukos is in an account in Houston at Southwest Bank of Texas, in the name
of Yukos USA, Inc., a subsidiary of Yukos, organized under the laws of Texas, for the
beneficial ownership of Yukos. This money at Southwest Bank of Texas is property of
Yukos Oil Company.
33. Our Management Board made the decision that we had to file bankruptcy in
Houston because our company is being rendered insolvent by unlawful Russian Government
actions which have greatly damaged the Company and destroyed billions of dollars of value
for investors. Our Management Board concluded that there is absolutely no chance of our
obtaining justice in the Russian court system or from the Russian Government.