The Tick-Tock

Should Harvard University president Lawrence Summers travel this week to the World Economic Forum in Davos, Switzerland, as he usually does, he’ll find that the hottest item in the snowy little Alpine village is the international edition of Institutional Investor — the one with the cover story, “How Harvard Lost Russia: The inside story of what happened when the enormous power and resources of the United States government were put in the wrong hands.”

Those hands, of course, were those of Summers’ close friend and former student, Harvard University economist Andrei Shleifer, whose misbehavior cost Harvard something like $25 million in damages, plus another $10 million or $15 million in legal fees.

Author David McClintick presents in the magazine what reporters sometimes call a tick-tock — a highly-detailed narrative account — of what transpired in the 1990s, when the US Agency for International Development hired Harvard to advise the Russian government on how to create a legal and institutional framework for its capital markets — only to see the project collapse in scandal after four years, thereby turning “Harvard” into a Russian codeword for “hypocritical American greed.”

McClintick’s article is a complicated tick-tock. The one-time Wall Street Journal investigative reporter waded through thousands of pages of depositions and courtroom transcripts. He interviewed many participants. The story takes 25,000 words to tell, and even then, McClintick is forced to leave out important parts of the story — its political dimension, for example.

You can read it for yourself online at for the price of watching a fifteen-second advertisement — all but the 21 photos, that is, and some of the quote boxes and sidebars. Once an opulent American fanzine for money managers, Institutional Investor was purchased a few years by London-based Euromoney. It is in greatly reduced circumstances now, but the old taste for quality remains, everywhere but the Website.  The article itself is superb.

Not only is McClintick a best-selling author (Indecent Exposure, Swordfish). He is a graduate of Harvard College and a member of the advisory board of the university’s alumni magazine.  

At last the outlines of the story are clear. (The story a journalist tells is very different from the case lawyer makes.) Much of what McClinttick offers is new, even to close students of the affair. The picture that emerges is not pretty.

“The best and brightest of America’s premier university came to Moscow in the 1990s to teach Russians how to be capitalists,” writes McClintick. “This is the inside story of how their efforts led to scandal and disgrace.”

The Russians in question were two bright economists from St. Petersburg, 36-year-old Anatoly Chubais, and 29-year-old Dimitri Vasiliev, who in 1991 began working on privatization for Yegor Gaidar, minister of economics and finance. Boris Yeltsin recently had elbowed aside Mikhail Gorbachev, and the goldrush was on.

The Americans included Harvard University professor Summers, 36; his arch-rival and fellow professor Jeffrey Sachs, also 36; and Summers’ friend and former student, 29-year-old Andrei Shleifer. An ŽmigrŽ from the Soviet Union at 14, Shleifer had gone to college at Harvard, graduate school at MIT, and recently been recalled to Harvard from the University of Chicago and dispatched to Russia by Summers, who by then was chief economist for the World Bank. Sachs, who had advised the government of Poland on the “shock therapy” by which they had converted their economy to market principles, had been invited to Russia by Gaidar.

Then Bill Clinton was elected and Summers moved to the Treasury Department. In Moscow, Shleifer quickly elbowed aside Sachs, as Chubais and Vasiliev discovered that Shleifer was one of their own. Shleifer soon signed on as director of an ambitious USAID project, and hired a favorite student, Rhodes Scholar and lawyer Jonathan Hay, 30, as his deputy. Shleifer’s wife, Nancy Zimmerman, had quit her job at Goldman Sachs and started a hedge fund specializing in Russian investments.  At the Treasury Department, Summers was beginning a spectacular rise.

Yet within 18 months of beginning their work for the US government, Shleifer and Zimmerman and Hay began investing in Russia, in direct violation of Shleifer’s contracts with USAID and Harvard — some oil stocks, a fund with equity in a group of companies whose privatization they were overseeing, nothing big, just enough to demonstrate a certain canniness in circumventing detection (Channel Island bank accounts, the use of Zimmerman’s banker father as a straw).

To be sure, McClintick notes, Moscow in the aftermath of communism resembled the old American West at its wildest. Greed was rampant. Violence was common. Breathtaking corruption was rife.  But then that’s precisely why the Harvard team was there.

“In running Harvard’s Russia project, Andrei Shleifer and Jonathan Hay had an opportunity to preach the importance of integrity, transparency and fairness in shaping a business culture, and to work to enshrine those values in the country’s legal and financial infrastructure,” McClintick writes.

“Instead, their personal dealings sent a very different message.”

The centerpiece of McClintick’s article is a painstaking a reconstruction of the events of spring and summer of 1996, when Boris Yeltsin was running for re-election against an old-line nationalist named Gennady Zyuganov, campaigning on, among other things, a promise to quickly create a nation of individual investors, the better to soak up the ubiquitous “mattress money” that made fiscal and monetary policy hard to conduct.

Against that backdrop, Shleifer’s wife and Hay’s new girl friend, Elizabeth Hebert, quietly formed a company they called Pallada (after Pallas Athena, the ancient Greek goddess of wisdom and truth) and began a drive to become the first licensed mutual fun in Russia. To run their back office (known as a “specialized depository”), they contracted with John Keffer, a Portland, Maine, businessmen whose firm, Forum Financial,  had experience working with mutual funds companies in Poland.

Would-be investors in Pallada, including Farralon Capital Management, the San Francisco hedge-fund for which Zimmerman worked at the time, and Boston’s Peter Aldrich, a real estate magnate with close connections to the Harvard economics department, were told that Zimmerman and Hebert expected to turn their close relationship with “the regulator” (meaning Shleifer and Hay’s advisee Vasilev) into a powerful “first-mover advantage” — and thereafter into gold mine. At the World Economic Forum meeting, in Davos, in January, 1996, several wealthy Russian oligarchs had recruited Chubais to run Yeltsin’s re-election campaign.

McClintick is at his best re-creating the pell-mell scramble that ensued that May, when the Russians regulators tried to install one of Hay’s employees, Julia Zagachin, as chief of Pallada’s back-office unit, and to limit Keffer to a 49 percent share of the business. Harvard’s Hay promptly backed the Russians up, and for a time, the deal went forward, though tensions between Keffer and Zagachin slowly escalated. Yeltsin was re-elected in July; a September 2 deadline was established for the first mutual fund. His regulators were threatened with jail if it wasn’t met.

In August, Vasiliev licensed Pallada’s specialized depository and registered two of its mutual funds. Seeing several other global securities firms brushed aside, the Western financial establishment in Moscow was agog.

With show time at hand, Keffer dug in his heels and refused to name Zagachin to the top job. She quit and attempted to shift $400,000 he had deposited for the specialized depository into a bank account to which she had access.

Hebert and Hay, Shleifer and Zimmerman, then began a frantic search for  $400,000 with which to take Keffer out of the deal — a quiet solution to which he had agreed at the urging of a Harvard-hired lawyer named Michael Butler. They were ultimately successful when Hebert phoned Hay’s father in Idaho (who already had begun investing in Russian securities on his son’s behalf) and persuaded him to wire $200,000 of his own money ands another $200,000 of his son’s to Zagachin, permitting her to become the depository’s sole owner.

And all the while, Shleifer and Zimmerman and their son vacationed with Summers and his family in Truro, on Cape Cod, as was their annual custom. The year before, Summers had been named to the number-two post at the Treasury, with oversight responsibility for US economic aid to Russia.

But during a long walk up the beach with his protégé, he could remember under oath years later giving only relatively general advice and eliciting almost no information. “You’ve got to be careful,” Summers recalled telling his friend. “There’s a lot of corruption in Russia.”

“It wasn’t my habit to do U.S. Government business on beaches,” he told the assistant US attorney who was taking his deposition.

McClintick found the only forthright explanation of what the principals were thinking at the time (or at least saying) in a lengthy quotation that culled from the sworn testimony of Louis O’Neill, a Harvard Law School graduate who also worked for Hay for a while.

Julia was Beth’s friend. Beth was Jonathan’s girlfriend. And Beth Hebert had formed Pallada.  Pallada was to be the first share investment fund in the Russian economy. … What I observed directly was that Pallada received the first license from the Russian SEC, that Dimitri Vasiliev headed. And yet I knew, and the press certainly later screamed,  that Credit Suisse First Boston… was way ahead of it in the sort of paper game, get your paperwork in, get your stamps done, get everything approved….

…I went to Jon [Hay] and said, “This is kind of strange. Why this and not CSFB?…. He said something to me that made sense…. He said, “Well, this is a very serious pilot project.  It will be… basically, the first mutual fund in Russia.  We want to have someone as the leader, as the first person, who we are friendly with and who we can monitor very closely for transparency, fairness, proper procedures, proper accounting…” I remember the phrase he used because it made sense. “We’ll run water through the pipes on this one, see where the leaks are, fix them, and then we’ll open it up to the larger market.” That to me was convincing.

…I then began to notice Beth Hebert in the office using our facilities, our phones, our faxes, our people, or drivers; Julia Zagachin doing the same; their whole staff, both women’s staff, doing the same. … It seems strange to me that Jonathan was running the project, responsible for all the donor money, and his girlfriend was in the office running a private company….

…I’d gone there sort of out of law school, excited, eager, bright-eyed, maybe to do some good, and it all ended on a kind of a sour note. So I just felt kind of bad about it, kind of wished it would all go away at the time.

Pallada continued to get preferential treatment from the Russian government and Harvard for a time.  In December, Hay and Vasiliev recommended to the US Treasury Department that it be included in its official Capital Markets Forum. In February, 1997, Shleifer wired $200,000 from his and Zimmerman’s joint bank account, labeling it as a loan but not documenting it.

Shortly after that, the situation in Moscow boiled over. In his article, McClintick carefully traces the channels by which various complaints flowed to Cambridge, where they were ignored, and to Washington, where in April 1997, after a few weeks’ behind-the-scenes investigation, USAID abruptly shut down the Harvard project.

The US attorney in Boston began its investigation a few months later.  In September 2000, the government sued Harvard, Shleifer, Hay and their wives (Hay and Hebert having married by then), seeking treble damages under the False Claims Act — as much as $120 million in the case of Harvard. The university vigorously defended its team throughout.

The subsequent trial provided much of McClintick’s documentation. Harvard paid only $26.5 million for breach of contract in the end, Shleifer $2 million for fraud, and Hay whatever he could afford over the next ten years. Zimmerman’s firm separately had agreed to pay $1.5 million for inappropriate use of taxpayer resources. Keffer sued Harvard in Maine and eventually settled for an undisclosed sum — but not before putting enough material in the record in the Portland courthouse to insure that the story later could be unraveled blow-by-blow.

When Summers returns to Cambridge from Davos, it will be to a university more determined than ever to understand the history of its failed Russia project. McClintick’s article will circulate hand to hand. The frustration among the faculty that McClintick  details will only grow. Some fellow economist may yet come forward to defend Shleifer publicly (instead of grousing anonymously that he has been treated unfairly), but that hasn’t happened yet.

It is Harvard’s governing corporation which will continue to oversee the matter. The seven member board perhaps will pay special attention to the collapse of a determined mediation effort by US District Court Judge David Mazzone. It broke down two weeks after Summers was elected president, in March 2001, and before he recused himself in the matter, apparently at the Corporation’s request.

This was the point at which the bad outcome in court was sealed. It’s not that Harvard’s many decisions under President Neil Rudenstine and two of his provosts, Albert Carnesale and Harvey Fineberg, don’t deserve scrutiny. Their team leaders had been caught cheating, but Shleifer denied his guilt. So Harvard defended him to the hilt.

By 2001, however, the outlines of the situation were clear. The men and women who hired Larry Summers could have hoped that he would settle the matter advantageously as possible for the university, on the terms outlined by the judge.

Inexplicably, he did not.

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