The Death of Paul Klebnikov and Russia’s Tragedy

Russian society suffered another serious blow, when Forbes editor Paul Klebnikov was brutally murdered in Moscow.

Paul was a friend, not an old friend, but one whom I valued a great deal. When I first met him, we spoke about “War and Peace”, a book much discussed in his family, and he asked which of the two male protagonists I respected more: Prince Andrei Bolkonsky, the principled, analytical man devoted to his country; or Count Pierre Bezuhov, who led a life of moral and spiritual questioning. I answered that I respected both, and later could not help thinking that Paul embodied what was noble in each; Bolkonsky’s principles and strength, and Bezuhov’s non-conformity and insatiable need to seek the truth. He was one of those rare spirits who held passionate convictions about what is right and wrong, and would stop at nothing to serve what is right.

Since his death, much has been written about Paul’s love for Russia, his belief in Russia’s inherent greatness and his ardent desire to see this realized. His passion drove him to seek the truth about the darker elements of Russian society and expose them in the hope that forcing Russia to confront its ills would help find cures. He also wanted to help Russia rebuild. When I last saw him in June, he was very positive about Russia’s future and optimistic about his own ability to make a difference.

We were lucky to see him that evening. He was based temporarily in Moscow where he was building the Forbes presence; when in New York, he preferred to spend all his time with his wife, Musa, and his three children, whom he adored. At the time, he was conceiving an article that would draw on the wisdom of New York educators for perspective on educating young Russians in a transitional society to ensure that they develop the right system of human values.

Paul represented the Russia that could be –the one he believed in - and his death is a grim reminder of the Russia that is today. Russia has no idea what it lost.

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When we assess investment opportunities in emerging economies, we evaluate political risk, and a key determinant of political risk is the presence or absence of the rule of law. The rule of law means that the law is supreme, bigger than any individual, and that the law is applied fairly and consistently, rather than selectively, by an independent judiciary. In economics and business, the rule of law ensures that property owners have recourse in the event of unfair treatment. In society, the rule of law provides a forum for reasoned conflict resolution and a mechanism for punishing immoral behavior, and thus reinforces a culture of honesty and stability. The rule of law is a fundamental underpinning of any functioning pluralistic political system.

At Tocqueville, the rule of law is an essential element of our decision to invest in a country. This is so not only because, as fiduciaries, we need to know that we have some kind of dependable remedy in the event that our clients’ assets are misappropriated, but also because the culture of corruption and violence that thrives in the absence of the rule of law represents a huge tax on an economy.

We have made investments in many emerging countries, from Brazil to Indonesia and Burkina Faso. This shows that we do not follow a naively dogmatic approach to assessing political risk. A country does not need to match American or European standards of democracy and governance to deserve our attention as investors. But we want to be satisfied that, from whatever level of unruliness it started, it is making clear and steady progress toward the establishment of a rule of law. In fact, if such an improving trend is evident, we believe it judicious and moral, as well as profitable, for foreign investors to encourage it through investment activity, even if the rule of law does not yet prevail fully.

It is therefore significant that we have yet to make a substantial investment in Russia. And this in spite of Russia’s size and importance, the closer relations that have been forged between the Kremlin and the current U.S. Administration, and the country’s enormous natural resources. Why not?

The absence of rule of law in Russia is manifest in two important aspects of daily life. One is the persistence of strong and violent networks of organized crime who operate outside the law and are not prosecuted. The other is the ongoing tug-of-war between the government and some one hundred “oligarchs”, who control a significant portion of the economy and can wield enormous political power. This creates an environment where the rule of law is at best mercurial, at worst evanescent. Paul Klebnikov’s murder is symptomatic of a society where violent crime goes unpunished. The Yukos Oil Company saga has become the most publicized example of the tug-of-war between the government and the “oligarchs”, and the most notorious example of selective prosecution, anathema to the rule of law.

We took our first serious look at Yukos as a potential investment several years ago. The company had enormous reserves of oil and gas assets, a good production profile, efficient operations, and a clear-headed management team that had a reasonable strategy for building shareholder value. Moreover, it was leading the movement to improve corporate governance and transparency in Russia. On a cash flow basis, the company was very cheap relative to its global peers. Had the oil and gas reserves been located outside of Russia, the company would have been extremely undervalued. However, we could not get comfortable with Russian political risk and we did not invest.

Last October, when Yukos’ now famous Chairman Khodorkovsky was jailed on charges of fraud and tax evasion, Yukos’ stock dropped over 30% in a few days and we revisited the investment idea. From the point of view of asset value and cash flow, Yukos was even more attractive. The price of oil was up and in our judgment would stay high for some period. The global majors, having difficulty replacing their reserves with the drill bit, were circling around Russia’s asset rich companies. There was no way, we thought, that whatever gripe they might have against Mr. Khodorkovsky, the Russian government would do anything to diminish the value of Russia’s best oil producer, particularly since its shareholder base included several of the largest U.S. and European institutional investors. Fortunately, we were counseled by a friend, former head of an oil service company with extensive contacts in Russia, to wait until the political dynamics became clearer. Since then, the government has repeatedly increased the assessment of back taxes owed by Yukos in an apparent attempt to bankrupt the company.

We have no illusion that the oligarchs are paragons of virtue. In fact, most of them initially acquired their properties through questionable means – though not uncommon ones at the time. Some, it is alleged, have links with organized crime. Nevertheless, as a group, they have contributed significantly to the emergence of a dynamic private sector in Russia, and some have since strived to acquire a new respectability.

In the case of Khodorkovsky, it has become clear that he was singled out because he was using his wealth and influence to foment political debate and cultivate opposition to Mr. Putin’s government. Subsequently, several reports have highlighted the selective nature of the Yukos prosecution by alleging, as David Satter did in the Wall Street Journal, that fellow oligarch, Roman Abramovich, who controls Sibneft, has an even larger tax evasion issue, but has been protected due to his relationship with the Kremlin.

Last October, the Carnegie Moscow Center stated “everyone in Russia is certain that the case against Khodorkovsky is politically motivated and because of this the rule of law is undermined. The realization that law enforcers as well as the courts are manipulated by the state further deepens the mistrust between the Russian state and society”. Since Khodorkovsky’s arrest, Yukos stock has declined by 50%, the public trust in Russian institutions has deteriorated and investor interest in Russia has waned. Needless to say, this last point is damaging to Russia’s economic prospects.

We at Tocqueville continue to take a dim view of political risk in Russia and will require signs of substantial improvement in the rule of law before we make a significant investment there. The Russian economy will suffer by virtue of the lawlessness exhibited in the Yukos affair.

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Freedom of expression normally goes hand in hand with the rule of law in civilized societies. The ability for the individual to express himself, for a society to criticize itself and to assimilate a variety of opinions, is a pre-condition to pluralism and, as Paul Klebnikov believed, critical to a society’s health. And freedom of expression needs to be protected by the law. To this point, as Serge Schmemann notes in the International Herald Tribune, a variety of Russian radio and TV shows have been shut down in recent years, most recently the political weekly Svoboda Slova. According to Mosnews, Russian journalist Gleb Pavlosky recently was fined $1 million for suggesting the existence of a St. Petersburg group of new oligarchs with links to the Kremlin. Fifteen journalists have been killed in Russia in just the last four years with no one being brought to justice for their murders. Surely, this does not help business or government transparency. As for Paul’s case, the TASS news agency says that there is “much extensive work in the U.S. journalist murder case”. We will see.

Paul is receiving apt recognition for his exceptional work as journalist, writer, and warrior for the truth. I have been heartened that his death has stirred so much outrage and provoked calls for a serious investigation held up to public scrutiny. I hope that part of Paul’s legacy will be to provoke the Russian government to recognize that it is not acceptable to allow gangsters to kill with impunity and that it is in Russia’s best long-term interest to enforce the rule of law and guard freedom of expression.

Paul was right. Russia has the potential for greatness. Russia has productive soil and is rich in natural resources. Russia has produced Tolstoy, Shostakovich, the Bolshoi and Gregiev, Kasparov, extraordinary scientists and the first successful voyage to space. In the last decade, there has been some economic progress, evidenced by high foreign reserves and an improving credit rating. Without the rule of law and freedom of expression, however, Russia remains far from greatness.

Today family and friends are mourning the death of Paul Klebnikov.  Russia should be mourning too. 

James Hunt

July 22, 2004
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