Since being named president of Harvard University in
2001, former U.S. Treasury secretary Lawrence Summers has
sparked a series of controversies that have grabbed headlines.
Summers incurred the wrath of African-Americans when he
belittled the work of controversial religion professor Cornel
West (who left for Princeton University); last year he
infuriated faculty and students alike when he seemed to
disparage the innate scientific abilities of women at a
Massachusetts economic conference, igniting a national uproar
that nearly cost him his job; last fall brought the departure
of Jack Meyer, the head of Harvard Management Co., which
oversees the school's endowment but had inflamed some in the
community because of the multimillion-dollar salaries it pays
some of its managers.
Then, in quiet contrast, there is the case of economics
professor Andrei Shleifer, who in the mid-1990s led a Harvard
advisory program in Russia that collapsed in disgrace. In
August, after years of litigation, Harvard, Shleifer and others
agreed to pay at least $31 million to settle a lawsuit brought
by the U.S. government. Harvard had been charged with breach of
contract, Shleifer and an associate, Jonathan Hay, with
conspiracy to defraud the U.S. government.
Shleifer remains a faculty member in good standing.
Colleagues say that is because he is a close longtime friend
and collaborator of Summers.
In the following pages investigative journalist David
McClintick, a Harvard alumnus, chronicles Shleifer's role in
the university's Russia Project and how his friendship with
Summers has protected him from the consequences of that debacle
inside America's premier academic institution.
Off duty and in swimsuits, the mentor and his
protégé strolled the beach at Truro. For years,
with their families, they had summered together along this
stretch of Massachusetts' famed Cape Cod. Close personally and
professionally, the two friends confided in each other the most
private matters of family and finance. The topic of the day was
the former Soviet Union.
"You've got to be careful," the mentor, Lawrence Summers,
warned his protégé, Andrei Shleifer. "There's a
lot of corruption in Russia."
It was late August 1996, and Summers, 42, was deputy
secretary of the U.S. Treasury. Shleifer, 35, was a rising star
in the Harvard University economics department, just as Summers
had been 15 years earlier when he had first taken Shleifer
under his wing.
Summers' warning rose out of their pivotal roles in a
revolution of global consequence -- the attempt to bring the
Russian economy out from the ruins of communism into the
promise of Western-style capitalism. Summers, as Treasury's
second-in-command, was the architect of U.S. efforts to help
Russia. Shleifer's involvement was more intimate. Traveling
frequently to Moscow, he was directing key elements of the
reform effort under the banner of the renowned Harvard
Institute for International Development.
Working on contract for the U.S., HIID advised the Russian
government on privatizing its economy and creating capital
markets and the laws and institutions to regulate them.
Shleifer did not report formally to Summers but rather to the
State Department's Agency for International Development, or
AID, the spearhead of the U.S.'s foreign aid program.
Personal affection as much as official concern prompted
Summers' admonition. He had come to know that Shleifer and his
wife, Nancy Zimmerman, a noted hedge fund manager, had been
investing in Russia. Though he didn't know specifics, he
understood just enough to worry that the couple might run afoul
of myriad conflict-of-interest regulations that barred American
advisers from investing in the countries they were
Summers did not restrict his warnings to Shleifer.
"There might be a scandal, and you could become embroiled,"
Summers told Zimmerman. "You should make sure you're clear with
everybody. People might want to make Andrei a problem some day.
The world's a shitty place."
Summers' warnings proved at once prophetic and ineffectual.
Even as Shleifer and his wife strove to reassure their friend,
they were maneuvering to make an investment in Russia's first
authorized mutual fund company. Within eight months their
private Russian dealings, together with those of close
associates and relatives, would explode in scandal -- bringing
dishonor to them, Harvard University and the U.S. government.
The Department of Justice would deploy the Federal Bureau of
Investigation and the U.S. Attorney's Office in Boston to
launch a criminal investigation that would uncover evidence of
fraud and money laundering, as well as the cavalier use of U.S.
government funds to support everything from tennis lessons to
vacation boondoggles for Harvard employees and their spouses,
girlfriends and Russian pals. It would, in the end, be an
extraordinary display of an overweening "best and brightest"
arrogance toward the laws and rules that the Harvard people
were supposed to live by.
Says one banker who was a frequent visitor to Russia in that
era, "The Harvard crowd hurt themselves, they hurt Harvard, and
they hurt the U.S. government."
Mostly, they hurt Russia and its hopes of establishing a
lasting framework for a stable Western-style capitalism, as
Summers himself acknowledged when he testified under oath in
the U.S. lawsuit in Cambridge in 2002. "The project was of
enormous value," said Summers, who by then had been installed
as the president of Harvard. "Its cessation was damaging to
Russian economic reform and to the U.S.-Russian
Reinventing Russia was never going to be easy, but Harvard
botched a historic opportunity. The failure to reform Russia's
legal system, one of the aid program's chief goals, left a
vacuum that has yet to be filled and impedes the country's
ability to confront economic and financial challenges today
(see box, page 77).
Harvard vigorously defended its work in Russia, but in 2004,
after protracted legal wranglings, a judge in federal district
court in Boston ruled that the university had breached its
contract with the U.S. government and that Shleifer and an
associate were liable for conspiracy to defraud the U.S. Last
August, nine years after Summers and his protégé
took their stroll along that Truro beach, Harvard, Shleifer and
associates agreed to pay the government $31 million-plus to
settle the case. Shleifer and Zimmerman were forced to mortgage
their house to secure their part of the settlement.
Russia's struggles today certainly don't result entirely
from Harvard's misdeeds or Shleifer's misconduct. There is
plenty of blame to share. It is difficult to overstate the
challenge of transforming the economic and legal culture, not
to mention the ancient pathologies, of a huge, enigmatic nation
that once spanned one sixth of the earth's land surface, 150
ethnicities and 11 time zones. The Marshall Plan, by
comparison, was simple.
Summers wasn't president of Harvard when Shleifer's mission
to Moscow was coming apart. But as a Harvard economics
professor in the 1980s, a World Bank and Treasury official in
the 1990s and Harvard's president since 2001, Summers was
positioned uniquely to influence Shleifer's career path, to
shape U.S. aid to Russia and Shleifer's role in it and even to
shield Shleifer after the scandal broke. Though Summers, as
Harvard president, recused himself from the school's handling
of this case, he made a point of taking aside Jeremy Knowles,
then the dean of the faculty of arts and sciences, and asking
him to protect Shleifer.
Months after Harvard was forced to pay the biggest
settlement in its history, largely because of his misdeeds,
Shleifer remains on the faculty. No public action has been
taken against him, nor is there any sign as this magazine goes
to press in late December that any is contemplated.
Throughout the otherwise voluble university community, there
has been an odd silence about the entire affair. Discussions
mostly have taken place sotto voce in deans' offices or in
local Cambridge haunts, such as the one where a well-connected
Harvard personage expressed deep concern, telling II:
"Larry's handling of the Shleifer matter raises very basic
questions about the way he governs Harvard. This is fraught
with significance. It couldn't be more fraught."
The silence is now beginning to break, thanks to the
leadership of academic worthies like former Harvard College
dean Harry Lewis, who is finishing a book about the university
to be published in the spring by Perseus Public Affairs. Lewis
agreed to show II the manuscript, in which he asserts,
"The relativism with which Harvard has dealt with the Shleifer
case undermines Harvard's moral authority over its
Whether this new questioning will erupt into yet another
crisis engulfing Summers and the university remains unclear.
What is certain, though, is that the story of Harvard and its
representatives' malfeasance, told in full for the first time
over the following pages, shows how much damage can be done
when the considerable power and resources of the U.S.
government are placed in the wrong hands.
THE SEEDS OF RUSSIAN REFORM WERE planted in the late 1980s
-- when Russia was the Soviet Union and Harvard hadn't yet
arrived. The U.S.S.R.'s seven-decade experiment with
Marxist-Leninist totalitarianism lay in shambles. By 1989, even
as the Berlin Wall fell in Germany, the Soviet Union and its
economy were imploding.
Reform-minded Mikhail Gorbachev, the last general secretary
of the Communist Party, strove to introduce limited economic
and political change. The first competitive elections for the
Congress of People's Deputies were held in March 1989. In May
1990, Gorbachev's populist rival, the maverick Boris Yeltsin,
was elected chairman of the Russian Republic's Parliament. A
month later Russia declared itself independent of the Soviet
That summer Gorbachev and Yeltsin ordered two economists to
draw up a "500 Days" plan for converting the Soviet Union to a
market economy based on private property. Gorbachev also sought
advice from the West. In October 1990 the then-chairman of the
New York Stock Exchange, John Phelan Jr., led a group of U.S.
securities lawyers and academics to Moscow to begin showing the
Soviets how to form capital markets. The meeting was organized
by the Big Board's Russian-speaking legal counsel, Richard
Bernard, then 40.
Bernard's collaborator in organizing the meeting was a
leading Soviet attorney, Peter Barenboim. Together they formed
the Soviet-American Securities Law Working Group, or SASLAW,
which began drafting securities laws for the U.S.S.R.
On October 15, 1990, two days after the Americans returned
to New York, Gorbachev was awarded the Nobel Peace Prize. The
next day, under pressure from the KGB and Kremlin hard-liners,
Gorbachev withdrew his support for the 500 Days plan. But it
was too late to reverse the tide of change. In December,
Yeltsin, from his leadership post in Parliament, pushed through
legislation that would allow limited private land ownership in
Russia for the first time since the 1917 revolution. In June
1991, Yeltsin was elected president, the first leader of Russia
to be popularly elected. Then, in August, after a failed coup
attempt by Communist revanchists, Gorbachev resigned as general
secretary of the Communist Party, dissolved its central
committee and effectively ceded power to Yeltsin.
The new leader treated his victory as a window of
opportunity -- one that would slam shut if he didn't show
results promptly. Transforming the economy was his first
priority. He set a young economist named Yegor Gaidar and a
group of planners to work in a dacha outside Moscow in
September and October. Gaidar had grown up in the Moscow
intelligentsia and had a Ph.D. in economics from Moscow State
University. He had been convinced for years that the Soviet
Union needed to transform itself into a free-market economy
based on Western models.
The Gaidar group formulated a set of principles that they
believed must guide the reform. First, all Russian citizens
should have the right to own private property. Second,
ownership of property, as well as other components of a free
economy, such as stock and bond trading, should be governed by
codes of law.
On November 1, 1991, Yeltsin named Gaidar deputy prime
minister and minister of Economics and Finance. Gaidar summoned
St. Petersburgbased economist Anatoly Chubais, then 36,
who sped to Moscow. Chubais in turn telephoned an even younger
St. Petersburg economist, 29-year-old Dmitri Vasiliev. Could
Vasiliev write a two-page program for mass privatization of all
of the property and assets in Russia? And could he write it
fast? Vasiliev could, and did, and rushed the memorandum to
Only a few years earlier, Chubais, a tall strawberry blond
who liked fast cars, and Vasiliev, a diminutive, politically
savvy, bespectacled intellectual who resembled Woody Allen, had
been plotting the privatization of the Soviet economy as part
of a group of young dissident economists at the universities of
Leningrad and Moscow, hiding their activities out of fear of
the KGB. During the final days of Gorbachev, they had advised
the government of Leningrad, soon to regain its original name,
St. Petersburg, on economic reforms.
In the Moscow of November 1991, the team faced a different
fear -- of the dire consequences of failure. "Russia was facing
the largest and most complex privatization process in the
history of humankind . . . and the absence of any legal base
for its development," Gaidar would later write in Days of
Defeat and Victory. He dubbed his group "the kamikaze
The team did have some models. Though discarded, the 500
Days plan remained a focus of public discourse. And there was
the example of Poland, which had been experimenting with
capitalism since the late 1980s.
The man who had guided Poland's economic reform, Jeffrey
Sachs, an economics professor at Harvard University, was a
boyish-looking 35-year-old with explosive energy and little
patience. An economic wunderkind, Sachs had passed the general
examinations for his Ph.D. and was invited to join the rarefied
Harvard Society of Fellows while he was still a Harvard
undergraduate. He won tenure in the department of economics at
Sachs had begun advising the Polish Solidarity Movement
before it took control of the government in August 1989. He
invited another Harvard-trained economist, David Lipton, to
work with him. Lipton, who had been Sachs' student, had spent
most of the 1980s at the International Monetary Fund. On
January 1, 1990, following Sachs' and Lipton's advice, the
Polish government introduced what came to be known as "shock
therapy" -- the rapid conversion of all property and assets
from public to private ownership. After initial shortages and
inflation, goods and services soon were flowing through the
economy in unprecedented varieties and quantities; prices
Though envious of Poland's success, Russian reformers knew
their task would be much more difficult. "When socialism
collapsed in Poland, an entire generation of people still
remembered what markets, market institutions and private
ownership were," Gaidar wrote in State and Evolution:
Russia's Search for a Free Market, published in 2003. "In
Russia there was no such experience to be had. In 1991 the vast
majority of Russian citizens had never seen a normal retail
Still, the Polish experiment was getting worldwide
publicity, and it wasn't long before Moscow reached out to
Sachs, who began formally advising the Russians in late 1991,
simultaneously with the official dissolution of the Soviet
Union. In November, Gaidar invited Sachs and Lipton to work
with the new economic team.
Moscow by then was crowded with foreigners eager to help
Russia and get in on the ground floor of a great social and
economic change. Entrepreneurs, consultants, lawyers, bankers
and academics with foundation grants, as well as fast-buck
artists and swindlers from all over the world, swarmed across
Russia looking for a piece of the action. The atmosphere was
charged with possibility and fraught with danger. Financial
transactions were mostly conducted in cash; cities were awash
in rubles. Kidnappings were common, as was gunfire and even
bombings. Organized crime darkened the already grim
Russia's leaders felt a near-apocalyptic sense of urgency.
They understood that to prevent chaos they had to quickly lay
the foundation for a Russian-style capitalism or face a return
to authoritarianism couched as a restoration of law and order.
Even as Yeltsin's reformers got to work, they faced strong
opposition from reactionary former Communists who protested the
speed and cost of change.
Sachs wasn't the only Harvard professor in Moscow in the
summer and fall of 1991. No fewer than four university
affiliates -- the John F. Kennedy School of Government, the
Russian Research Center, HIID and the economics department --
were represented. Graham Allison, the founding dean of the
Kennedy School, was pushing an updated version of the 500 Days
plan with its co-author, liberal economist Grigory Yavlinsky.
Marshall Goldman, the director of Harvard's venerable Russian
Research Center and a frequent visitor to the Soviet Union for
decades, was providing counsel to various parties. Sachs,
thanks to his experience in Poland, emerged as the leading
figure among these notables. In Moscow he encountered yet
another Harvard colleague, Andrei Shleifer. Shleifer had been
sent to Moscow by the World Bank, where Summers, on leave from
Harvard, was serving as chief economist. Shleifer possessed a
distinct advantage over other Westerners: He was a native of
Russia and fluent in the language, having been born there in
1961. His parents were engineers, a profession the state chose
for them. Shleifer revealed at an early age that he was
ambitious; in a photograph taken when he was six, he is dressed
as a Soviet Army general. When a friend transferred to one of
the best schools in Moscow, Shleifer bicycled there and didn't
leave until he had persuaded the principal to admit him as
The Shleifers left Russia in 1976 with the help of the
Hebrew Immigrant Aid Society and moved to Rochester, New York.
Andrei later claimed he learned most of his English by watching
the popular television show Charlie's Angels. He
excelled in mathematics and was admitted to Harvard College. In
his sophomore year he went to see Summers and pointed out
errors in a paper the young assistant professor had written.
Summers, the nephew of two Nobel laureates in economics, soon
took Shleifer under his wing. Like Sachs, Summers was one of
the youngest economists ever granted tenure by Harvard -- they
had made it the same year. Summers guided Shleifer onto a
similar path, and the friends maintained their close
relationship after Summers went to the World Bank in 1991.
There was no love lost between Sachs and Summers, who had
been rivals as newly tenured prodigies. Each had to be the
smartest man in the room; their presence at faculty meetings
ensured lively debate tinged with animosity. Shleifer had a
similar personality, and when the confident upstart encountered
Sachs in Moscow, he didn't get along any better with Sachs than
his mentor did.
Nonetheless, Sachs introduced Shleifer around the Russian
government. It was decided that Shleifer would work with
Chubais and Vasiliev on privatization while Sachs advised
Gaidar on macroeconomic issues.
Gaidar appointed Chubais to head a new government agency,
the State Committee on the Management of State Property. Known
by its Russia acronym, GKI, it had no office or charter, except
the vague commission to "privatize" the economy and Vasiliev's
two-page outline recommending Polish-style shock therapy.
The daunting task was further complicated by the fact that a
portion of the economy -- nobody knew how much -- had already
been privatized in a de facto sense: In the confusion of
perestroika, Gorbachev's mid-1980s effort to restructure the
economy to make communism more efficient, a number of senior
government bureaucrats, managers of state-owned factories and
farms, had been allowed to quietly transfer public assets to
themselves and their families. Some of these transfers verged
on "theft and embezzlement," Gaidar acknowledged in State
and Evolution, but it was too late to reverse them, and
the real problem, he allowed, "has been the system itself;
complete ambiguity around property rights, absolute lack of
accountability." This would have to be changed with new legal
Left to be privatized at the end of 1991 were approximately
225,000 state companies spread across Russia. Gaidar and
Chubais, advised by Shleifer, decided that these enterprises
could not be privatized one at a time. That would take "well
into the 22nd century," Gaidar figured. Rather, they had to
devise a form of the shock therapy that had been used in Poland
-- near-simultaneous privatization.
So in 1992 the Russian government began issuing certificates
with a face value of 10,000 rubles each to all of the 148
million citizens of the country. The certificates were liquid;
they could be traded or used to purchase property. By the end
of 1992, 46,000 small enterprises out of the 225,000 were in
private hands. Chubais, Vasiliev and Shleifer had privatization
off to a good start, and Shleifer was forging strong personal
relationships with his Russian advisees.
While helping draft securities laws, Richard Bernard, who
moved to Moscow in 1992, fired off letters to thenU.S.
secretary of State Lawrence Eagleburger urging that the U.S.
government support one of the pivotal movements of history --
the transformation of the Russian economy from communism to
capitalism. Though Bernard never heard from Eagleburger, there
was action in Washington.
In October 1992, just a few weeks before losing the
presidency to Bill Clinton, president George H.W. Bush signed
the Freedom for Russia and the Emerging Eurasian Democracies
and Open-Market Support Act. It authorized up to $350 million
in aid to Russia, to be provided and managed by AID, which
already had an advance team working informally in Russia at the
In short order, AID, learning that Sachs and Shleifer were
in Moscow, contracted with Harvard to direct and manage the
reform program. The agency initially gave $2.1 million to
Harvard, which would run the operation out of its Harvard
Institute for International Development, a 30-year-old entity
located on Eliot Street in Cambridge. With financial support
from foundations, international aid agencies, development banks
and host governments, HIID operated economic reform programs
around the world, concentrating on assisting nations that were
changing from government-run to market-driven economic systems.
In Indonesia, for example, HIID helped revise the tax system
and liberalize financial markets. It also had been active in
Colombia, Kenya, Pakistan and Zambia.
The Russia Project would be HIID's largest and most
important program by far. The institute had been run since 1980
by Harvard political economy professor Dwight Perkins, who
reported directly to Albert Carnesale, Harvard's provost and
second-in-command. With Sachs advising Gaidar, the HIID project
would be directed by Shleifer, who would retain his
professorship in the economics department. Shleifer was charged
with hiring staff, setting budgets and priorities and creating
and supervising the project from Cambridge and on frequent
trips to Russia.
Shleifer's first need was to find someone who could
supervise the day-to-day operations of the Russia Project. For
this critical post he chose Jonathan Hay, 30, an Idaho native,
Rhodes Scholar and newly minted graduate of Harvard Law
Fluent in Russian, Hay had moved to Moscow hoping to get in
on the excitement of social transformation. Brilliant and
intense, with unruly hair, oversize horn-rim glasses and an
ethereal academic mien, he dazzled everyone he encountered. Hay
had negligible practical experience, but soon, with Shleifer's
blessing, he was setting up Harvard's Moscow operations at
Chubais's GKI in a drafty government building near Red Square.
"We had no heat, no Xerox, no fax, no food," Hay recalled later
to the Washington Post's David Hoffman, author of
The Oligarchs: Wealth and Power in the New Russia.
"The first time I came there, I saw just Dmitri Vasiliev and 30
people sitting in a huge hall, just this small man in big
glasses, and they were all around him, in a heated discussion,
talking about small-scale privatization."
AID gave the Harvard people wide independence and
discretion. HIID relied heavily on Shleifer and Hay, who
savored the challenge. The young lawyer had a high tolerance
for chaos, which came in handy at the end of 1992. "Don't
worry! Be happy!" is the way lawyer Barenboim characterized
Hay's approach to reforming Russia.
The country's banking system was barely functional. ATMs
were unheard of. There were a few rudimentary stock exchanges
spread across the nation, but trading was chaotic. Few laws,
regulations or formal procedures had yet taken effect.
Meanwhile, much of the Russian Parliament believed Yeltsin
was moving too fast, too soon. The fall of 1993 was marked by
turmoil as the president and his opponents struggled for
supremacy. When Yeltsin's rivals in Parliament refused to leave
the legislative building known as the White House, the
president cut off its television service, telephones,
electricity and water. Tanks rolled, bullets flew, scores of
people died -- and Yeltsin prevailed, with more freedom to
proceed with economic reform.
A mile from the Kremlin, however, the people in charge of
the Russia Project were becoming seriously distracted. Under
their contract with the U.S. government, Shleifer, Hay and
their staff were required to submit regular written progress
reports, but they were falling behind. "We have reviewed the
delinquent . . . reports and found them to be sorely lacking in
substance," an AID staffer in Moscow informed Washington.
One reason for Shleifer and Hay's distraction may have been
a growing interest in their own opportunities. As advisers on
fundamental reform of the Russian economy, HIID staffers were
privy to the most-private details of the vast nation's
financial future. They were swimming in inside information.
They were hemmed in, however, by strict prohibitions against
using their positions for personal financial gain. The U.S.
government and Harvard -- as well as the contract that Harvard
and AID signed in December 1992 -- barred everyone assigned to
the project, their families and people acting on their behalf
from any investment of their personal funds in Russia and any
personal involvement in Russian businesses or financial
transactions. Even savings accounts in Russian banks were
"We had this test -- how is this going to look on the front
page of the New York Times?" Louisa French, HIID's
human resources officer, said under oath in the government's
lawsuit. "It was our mantra to say, 'If you have to ask, you're
too close to the line.'"
As the people running the project, Shleifer and Hay were
obliged not only to obey the rules themselves but also to
enforce them on their staffs. But by December 1993, less than a
year after the Russia Project had ramped up, Alberto Neri, a
Moscow-based HIID financial officer, wrote four memorandums
warning the institute's deputy director in Cambridge, Rosanne
Kumins, that he believed Harvard was complicit in financial
irregularities and tax evasion and was condoning dissemination
of false data, irregularities in employment contracts and
misrepresentation of expenditures, all so that income to the
Russian staff could be hidden from the tax authorities.
"I fail to see why Harvard should assume the huge
responsibility of abetting tax evasion (which is a criminal
offense in Russia -- as it is in the USA . . .)," Neri wrote in
one memo. The memos were entered into evidence and cited by the
U.S. government in court papers in its lawsuit.
Those memos, Kumins says today, "were received with concern.
We never condoned tax evasion. As a result, we changed the way
local hires were paid."
In July 1994, Shleifer and Nancy Zimmerman began investing
in Russia in direct violation of his contract and the
restrictions imposed by AID and Harvard.
Though she called her husband "Boss," Zimmerman, 31, was a
hard-charging financial wizard in her own right. She had left a
lucrative career at Goldman, Sachs & Co. in New York to
start a hedge fund in Cambridge, Farallon Fixed Income
Associates, in a joint venture with Farallon Capital
Management, a prominent fund group based in San Francisco.
Zimmerman earned far more trading bonds than Shleifer did
teaching economics: $1.06 million to his $191,000 in 1994.
Their combined income supported a comfortable lifestyle,
including a spacious home in the affluent Boston suburb of
In 1994, Shleifer and Zimmerman, with the help and advice of
Leonard Blavatnik, a New Yorkbased Russian emigrant and a
member of the Forbes 400, placed $200,000 in a
Blavatnik vehicle called Renova-Invest, which invested in a
group of Russian corporations that were being privatized under
Shleifer's guidance. The companies included telephone operator
Rostelecom; oil and natural-gas behemoth Gazprom; aluminum
smelters in the cities of Irkutsk, Sayansk and Bratsk; Vladimir
Tractor; and oil producer Chernogorneft. The U.S. government
alleged in its complaint against Harvard, Shleifer and Hay that
these companies benefited financially not only from Shleifer's
advice on privatization but also from AID-funded assistance,
including free legal services. When Blavatnik was merging
several aluminum companies in which Shleifer and Zimmerman had
invested, Hay and other AID-funded lawyers worked on the merger
documents at no cost to Blavatnik or the companies. According
to a U.S. statement of "undisputed material facts" submitted
with the lawsuit, Hay was aware of some of the private
investments of Shleifer and his wife, which were violations of
the bars against private investment in Russia.
Also in the summer and fall of 1994, the Shleifers partnered
with Farallon Capital Management to invest in Russian oil
stocks. "Investing in Russia at that stage was like the Wild
West, and we were petrified about getting involved," Farallon
partner David Cohen later told a federal grand jury. (Farallon
would, in fact, lose money on these oil stock investments.)
Cohen, who had been a Rhodes Scholar at Oxford University
with Hay, said: "There was incredible crookery. . . . We wanted
to get as much protection as we could . . . and we thought
Andrei provided some of those things. People might have been
more hesitant to hurt Andrei Shleifer than to hurt Farallon. .
. . His relationship to Chubais was definitely one of the
Shleifer began the investment process on August 11, 1994, by
wiring $165,000 to a Channel Islands bank account for the
purchase of 30,000 shares of Russian oil company Purneftegas.
By November 4 a total of more than $4 million was invested, 90
percent by Farallon, 10 percent by Shleifer and Zimmerman. The
Shleifers concealed their investment by registering the shares
in the name of Zimmerman's father, Howard Zimmerman, a Chicago
investor in real estate and racehorses and a director and
shareholder of a small institution called Central Illinois
Shleifer suggested that Hay join his Rhodes Scholar friend
Cohen among the investors. Hay chipped in $66,000, but only
after directing an AID-funded Harvard staffer in Moscow to
research the price and trading activity of Russian oil stocks.
Louis O'Neill, a first-year student at Harvard Law School who
was working in Moscow for the summer, found that the
information -- a mix of pricing and liquidity data on a
less-than- transparent market -- was harder to obtain than in
Western securities markets. Fluent in Russian, O'Neill posed as
the "Russian representative of a foreign investor who was keen
to enter the Russian securities market," he stated in a sworn
affidavit filed later in the U.S. lawsuit.
"I remember [Hay] telling me to look at oil and gas because
they were sort of in the forefront of privatization," O'Neill
testified. "He said, 'Get me some answers on what's happening
in the market.' [Oil and gas] would be the most valuable assets
in the economy, so of course they would be the most desirable
Once the stock was purchased, Hay turned to Julia Zagachin,
26, who had been born in Russia and moved to the U.S. when she
was 11. After graduating from George Washington University in
Washington, D.C., with a degree in international politics,
Zagachin had gotten a job with Deloitte & Touche. She would
become one of Jonathan Hay's first hires at HIID. In 1994, Hay
appointed her to run another AID-funded enterprise, the
Depository Clearing Co., which was intended to become Russia's
central clearinghouse for securities transactions. After the
Shleifer-Farallon stock purchases, Hay instructed Zagachin to
make sure the securities were properly registered, because the
owner, Hay said, was an "old Oxford friend" (David Cohen of
Farallon) who should receive "the best service."
Less than a year later, while still holding oil shares,
Shleifer wrote a memorandum to Russian officials advocating the
inclusion of oil stocks in a program to distribute Russia's
energy assets to rich entrepreneurs in exchange for loans to
The ironies abound. Russia, where secrecy and corruption
were ubiquitous, was looking to the U.S. and Harvard as beacons
of honesty and transparency in financial affairs. Gaidar,
Yeltsin's sometime economic adviser and erstwhile deputy prime
minister (he left the government for the second time in early
1994), even invoked Thomas Jefferson and the Declaration of
Independence as inspiration for an open and free economic
system "fitting for Russia." Gaidar wrote his words in the
summer of 1994, at precisely the time that some of America's
representatives, while giving lip service to those principles,
appeared to be using inside connections to enrich themselves
from investments in a Russia still mired in corruption.
JEFFREY SACHS, MEANWHILE, WAS SPENDING less time in Russia
and more in Cambridge, where he would eventually become
director of HIID. His appointment was not good news to
Shleifer, who feared that Sachs would encroach on the Russia
Project's turf and who instructed Hay not to speak to Sachs at
all. Shleifer needn't have worried. Sachs knew nothing of
Shleifer's investments. However, he did warn Shleifer about
corruption in Russia, telling him to carefully vet the
institute's Russian employees.
Shleifer and his wife could be surprisingly unguarded about
their dealings. In October 1994, at a cocktail party at the
home of Dale Jorgenson, then-chairman of Harvard's economics
department, Shleifer and Zimmerman chatted casually about their
Russian investments. The gathering was brimming with economics
stars. In 1971, Jorgenson had won the John Bates Clark Medal,
which the American Economic Association awards every other year
to the person under 40 making the greatest contribution to
economics. Another prominent Bates Clark medalist, Harvard
economist Martin Feldstein, who had been chairman of the White
House Council of Economic Advisers under Ronald Reagan, was
also present. Feldstein was intrigued to hear of the Shleifers'
investments and phoned Andrei later for a referral to
Blavatnik. He ultimately decided against investing in
Indeed, the chaos had made it clear to the Russian
government and its advisers that tighter organization and focus
were needed at the Harvard project. In November 1994, Yeltsin
issued a decree creating a centralized authority responsible
for developing the Russian securities market. Though officially
named the Russian Federation Commission on Securities and the
Capital Market, the agency was commonly called the Russian
Securities and Exchange Commission. This was appropriate: The
American SEC was not only the model but was lending technical
assistance funded by AID. Charged with running the RSEC were
Chubais and Vasiliev, who had launched privatization three
years earlier and were ready for a new challenge. Keeping close
tabs on the agency were Albert Sokin, a tough lawyer from the
St. Petersburg reformers, and Ruslan Orekhov, Yeltsin's chief
legal counselor, whose responsibilities included reform of the
Through HIID, AID funded the Resource Secretariat, a think
tank created in late 1994 that coordinated aid flowing to the
new Russian securities commission for the creation of stock
exchanges, broker-dealer networks, back-office functions and,
most fundamentally, codes of law -- securities law, corporate
law, tax law and bankruptcy law -- governing the vast new
economic activity set in motion by privatization. The crafting
of law was based in an entity called the Legal Reform Project,
which later created the Institute for Law-Based Economy. The
ILBE was staffed by American-guided Russian lawyers.
To run the Resource Secretariat, Shleifer and Hay reached
out to Richard Bernard, who had been active in Moscow as a
partner for New Yorkbased law firm Milbank, Tweed, Hadley
& McCloy since 1990 and a full-time resident since 1992.
Shleifer offered Bernard the position of executive director
with a two-year contract. Bernard assumed his responsibilities
on January 1, 1995, and promptly hired a second-in-command,
Holly Nielsen, a Moscow-based, Russian-speaking partner with
the Houston law firm of Baker & Botts.
The RSEC was headquartered on the ninth floor of a high-rise
Soviet-era office building on Leninski Prospect. Vasiliev had
an office there and another, where he spent most of his time,
near Bernard and Nielsen at the Resource Secretariat on Gazetni
Street, close to the Kremlin. Hay was at the Legal Reform
Project, whose offices were about a mile away on Gasheka
Bernard and Nielsen's first months at the Resource
Secretariat were frantic. At first, conditions were primitive
-- there were few desks and no photocopiers. Hay, Vasiliev and
Sokin were desperate for knowledge and insight. Bernard and
Nielsen helped them as best they could while supervising a
sprawl of people, activities and contractors that included
Arthur Andersen, Price Waterhouse and KPMG, which were advising
the government on various securities functions. The Resource
Secretariat also worked with a growing community of foreign
financial institutions, such as Chase Manhattan Bank and Credit
Suisse First Boston, that were eager to gain footholds in what
promised to be a burgeoning new market.
Coordinating all of this activity wasn't easy. The top
management of the Resource Secretariat and the RSEC, while
sharing common purposes, comprised diverse and strong
Vasiliev, Sokin and Hay had been working together for two
years and had bonded. Vasiliev, who declined to be interviewed
for this article, was a short, garrulous intellectual who loved
political intrigue. He was "knowledgeable, committed and not
overwhelmingly mature," Larry Summers would say later. Sokin,
the crude, rotund, chain-smoking lawyer with many girlfriends,
had been dubbed the "pig in the polyester suit" by one American
lawyer. Then there was Hay, the brain-on-overdrive academic
with a piercing stare, limited business experience and no time
for haircuts. The three were joined at the hip, in Bernard's
phrase, spending countless hours together, day and night,
sometimes behaving like frat boys. "You're as worthless as a
dick on a stump," Sokin liked to banter in Russian to Hay, who
found the expression endlessly amusing.
They also recognized each other's strengths: Vasiliev and
the more politically savvy Sokin had the ears of Chubais and
Orekhov, and, through them, Yeltsin. Hay was their direct
pipeline to the millions in U.S. government money that the 1992
Freedom Act had earmarked for Russian reform.
The trio's relationship to Bernard proved problematic. After
16 years counseling the New York Stock Exchange and five years
helping craft a Russian securities code, he was "one of the
best resources Russia ever had, a brilliant lawyer," says Bruce
Lawrence, then one of Credit Suisse First Boston's top men in
Moscow. Hay, less than three years out of law school, was very
green, yet he was Bernard's titular boss and looked for ways to
assert his authority. Bernard tried to be diplomatic, always
ready with a smile and a quip, at least to Hay's face. Behind
their backs he called Hay and Shleifer "the kids from
Hay had gone Russian: He was not only Vasiliev's closest
adviser; he socialized, drank and vacationed with Vasiliev and
Sokin. Hay "wanted to be buried in the Kremlin Wall," Bernard
said in a deposition.
"Jonathan was my boss, at least in the HIID hierarchy,"
Bernard recalled. "[But] I was his vast superior in substantive
knowledge of the business we were in -- much more experienced
in business, in management, in leadership. Jonathan struggled
Bernard had an easier time with Vasiliev, who valued his
superior knowledge of the markets. Bernard, for his part,
appreciated Vasiliev's insight into the Russian politics that
had to be navigated en route to the desired reforms. Bernard's
coaching helped Vasiliev assert himself as head of the RSEC,
which he needed to do in waging a critical political struggle,
a war with the Russian Central Bank for control of securities
On one level it resulted from a policy dispute: Should the
Russian securities industry develop along U.S. lines, where
broker-dealers and investment bankers were the main players in
the market, or along German lines, where commercial banks
dominated securities trading? Vasiliev and the RSEC, under the
influence of American advisers, favored the former approach,
while the Central Bank, particularly deputy chairman Andre
Kozlov, preferred the latter. A deep personal animosity between
Vasiliev and Kozlov fueled the dispute. The RSEC attacked the
bank for concealing trading information on and limiting
participation in the government securities market. Kozlov told
the Wall Street Journal in September 1995 that "Mr.
Vasiliev wants to control everybody and anything in the market,
and he is angry because he cannot do this totally in the
government securities market."
Meantime, Bernard discovered irregularities at the Russia
Project. He was tipped off that Russian staffers had created
no-show jobs for their relatives and friends in the Institute
for Law-Based Economy and that employees were using
AID-financed cars and drivers to run personal errands around
Moscow. For instance, one top aide to Hay took off three to
four hours in the middle of each day to play tennis and used
ILBE drivers to convey her. Sokin, too, used office
transportation to squire his girlfriends around. Hay had hired
one of the girlfriends to make a short documentary about the
initial public offering of the Red October candy company, the
first IPO in the history of Russia. Bernard also learned that
an RSEC contractor was paying reporters at Moscow newspapers to
write favorable articles about the commission.
Bernard conveyed his concerns to Hay over coffee at the
Starlite Diner, an American-style burger-and-shake joint that
had just opened off of Garden Ring Road, a mile from the
Kremlin. He told Hay that Sokin was corrupt. Hay scoffed at
Bernard's concerns, warning him that he wasn't "with the
Subsequently, Hay began to reduce Bernard's
responsibilities. Vasiliev told his press attaché,
Andrea Rutherford, that Bernard was "too Western and
In the summer of 1995, just months into his tenure, in a
move orchestrated by Hay, Bernard was called in by Yeltsin's
chief legal adviser, Orekhov, and told that he would not be
retained in his job. The rationale: A Russian would have more
credibility. Shleifer sealed Bernard's firing by phone,
breaking his promise of at least a two-year tenure.
Bernard, who returned to the U.S. as executive vice
president and general counsel of the NYSE, was succeeded on
January 1, 1996, by Dmitri Subbotin, a young, Oxford-educated
back-office specialist. Subbotin, though able, smart and
hardworking, was inexperienced and later acknowledged that he
wasn't qualified to succeed Bernard.
In 1995, Shleifer published Privatizing Russia, in
which he and his co-authors, Maxim Boycko, a Russian reformer
and chief executive of the Russian Privatization Center, and
Robert Vishny, a finance professor at the University of
Chicago, claimed credit for the success of economic reform to
that point. Summers supplied a blurb for the book, noting that
"the authors did remarkable things in Russia."
The problems at Harvard's Russia program, however, were
mounting. The number of no-show jobs rose as some of Sokin's
girlfriends were put on the payroll, and Sokin himself was
given a large AID-funded salary increase and housing allowance,
with the funds deposited in a foreign bank account so Sokin
could avoid Russian taxes. "[Sokin] is really double-dipping,"
HIID deputy director Kumins warned Shleifer in a memorandum. "I
can't imagine that you will do anything about this, but I
believe it is not right all around and does not show good faith
on anyone's part." Shleifer ignored the warning.
The Harvard crowd was soon to become embroiled in a bigger
IN THE SUMMER OF 1995, YELTSIN DECREED THAT the RSEC would
start licensing and registering mutual funds to attract the
estimated $40 billion in "mattress money" that skeptical
Russians had stashed away. Alarmed by Communist parliamentary
gains spurred by persistent financial fraud, Yeltsin made safe
investments a major campaign theme as he looked toward the 1996
presidential election. He ordered Sokin and Vasiliev to make
mutual funds the highest priority of the RSEC.
In anticipation of the decree, several global securities and
investment banking firms -- Credit Suisse First Boston, Robert
Fleming & Co., Franklin Templeton Investments and Pioneer
Group among them -- had deployed people and resources to
Moscow. As the RSEC's chief Harvard adviser, Hay strove to
build relationships with the potential mutual fund operators.
Fleming's Moscow representative, Elizabeth Hebert, 33, was a
tall Ohio native with flowing dark hair. She held master's
degrees from Columbia University in business and international
affairs. Fluent in Russian, she aspired to start her own
company to launch funds specializing in Russian securities. Hay
encouraged Hebert and promised to help her. Soon they were
On November 15, 1995, Shleifer and Zimmerman gave a dinner
party at their home in Newton honoring one of Yeltsin's top
economic advisers, Alexander Livshits, a prominent Moscow
academic. Hay and Hebert flew in for the event, which was
attended by a number of Shleifer's Harvard colleagues.
Feldstein and his wife, Kate, were there, as was Boston
philanthropist Peter Aldrich, then 51, the founder and a
principal of one of the oldest and largest real estate
investment advisory firms in the U.S., AEW Capital Management.
A graduate of Harvard College and Harvard Business School,
Aldrich had been active in university affairs for decades,
donating a lot of money and counting the Feldsteins, Shleifer
and Zimmerman and other professors and their families as
friends. Aldrich's interest in business had strong intellectual
dimensions. He regularly assembled Harvard professors to
discuss economic and political ideas with the chief investment
officers of endowment and pension funds. He was especially
interested in Russia. Beginning in the early 1990s, Aldrich and
his company had made several modest investments in Russia and
neighboring countries, converting an apartment house in St.
Petersburg into a modern office building, for example, and
turning a Moscow warehouse into a Gold's Gym.
By the end of the evening, Shleifer, Zimmerman and Hay had
prevailed upon Aldrich to meet the following day with Hebert to
learn about her plans for a mutual fund company.
Aldrich received Hebert as a favor to his friends. Despite
his interest in Russia, he wasn't impressed and barely
remembered the meeting later. "How many times do you remember
you swatted the fly?" he said when pressed during his sworn
deposition in the U.S. government lawsuit. Ever the polite,
patrician Brahmin, however, Aldrich did not rebuff Hebert, and
she returned to Moscow optimistic that he might invest in her
To launch her company, Hebert knew she would need
back-office expertise. She turned to Julia Zagachin, the
Russian-born, U.S.-educated clearing and settlement specialist
who had helped Hay make sure the 1994 oil stock deal was
properly registered. High-strung and intense, Zagachin had been
forced out of her job heading the Depository Clearing Co.,
having been told, like Bernard, that a Russian was needed.
Zagachin had retorted that the real reason was that she was
"young, female, American and Jewish." Over Thanksgiving drinks
at the Slavyanskaya Hotel, she and Hebert agreed to work
together. Zagachin declined to be interviewed for this
Hay, meantime, continued to facilitate the relationship
between Hebert and the reformers in Yeltsin's circle. That
Christmas the Idaho native hosted a weeklong party in his home
state to which he invited Hebert; Vasiliev and his wife,
Tatiyana; and Sokin and one of his girlfriends. AID funds paid
for the festivities, which included snowmobiling and hikes in
the woods. Hebert used the time to talk up her mutual fund
plans with Sokin and Vasiliev.
A few days later Hay and Hebert flew east to spend New
Year's Eve at Shleifer and Zimmerman's home in Newton. Hebert
continued to discuss her plans, expanding on her ideas while
strolling around Harvard Square with Shleifer on January 1. She
then flew to New York and pitched her fund to an array of
potential financial backers.
By the early months of 1996, Hay and Hebert's budding
romance was a hot gossip item among both the expat community of
Moscow and their Russian colleagues, many of whom marveled at
the attraction of opposites. Hebert was the kind of person who
would arrive at a meeting promptly, wearing a trim suit,
carrying a leather portfolio of meticulous notes. Hay would
blow in late, hair flying, clothes askew, without a pen.
Hay and Hebert's relationship blurred the line between
personal and professional. He let her use his AID-financed car
and driver and sank $20,000 into the Fleming Russia Securities
Fund, which she managed. As she became friendly with Vasiliev
and Sokin, Hebert let the Moscow business community know that
she had a close relationship with the people who would be
registering and regulating her Russian mutual fund.
IN JANUARY 1996, SHLEIFER AND ZIMMERMAN began to expand
their questionable activities. According to the U.S.
government's complaint, Zimmerman set up a Russian company,
Novyi Mir, or New World Capital. Zimmerman turned to Central
Illinois Bank, to arrange a $5 million loan to Novyi Mir. The
loan was secured by a certificate of deposit purchased from the
bank, the U.S. government said. Zimmerman invested the money in
Russian government debt instruments, or GKOs. The U.S.
government alleged that profits from the GKO investments were
sent to the bank as loan repayments, thus avoiding Russian
taxes that would have been due had the funds been declared as
profits. The money was then forwarded to Zimmerman's company in
In February, Zimmerman flew to Moscow to confer with Hebert
about investing in her mutual fund company -- an investment
that was barred by the U.S. government's and Harvard's
conflict-of-interest rules, which applied to employees' family
members. Hebert and her new partner, Zagachin, gave a full
presentation to Hay, Sokin and Zimmerman. Hebert asserted that
she had the backing of prominent Russians, including former
Finance minister and senior Parliament member Boris Fyodorov
and cellist Mstislav Rostropovich. She said she needed to raise
upwards of $1 million. Zimmerman tentatively agreed to invest
$200,000 and to take the lead in helping her raise the rest of
The Yeltsin decree establishing the rules for a mutual fund
industry required that each such company provide for strict
back-office controls, such as registration of shares and
shareholders, custody of securities, financial recordkeeping
and regulatory compliance. It wasn't enough for the fund
management company to establish such controls internally. The
decree required the company to contract them out. In late
February 1996, Hebert contacted Forum Financial Group, a
Portland, Mainebased company that specialized in such
functions and was already working with mutual fund companies in
Poland. Forum's CEO, John Keffer, flew to Moscow, met with Hay,
Vasiliev, Hebert and Zagachin and devised a plan for his
company to become Hebert's strategic partner. That would be
about the only thing that Keffer and the others would later
FROM THE BEGINNING THE HARVARD RUSSIA Project had failed to
make complete, timely reports to AID. By March 1996 these
lapses had come to the attention of the House International
Relations Committee, which directed the U.S. General Accounting
Office to audit the program.
Shleifer and Hay immediately assigned a lawyer to coordinate
Harvard's response to the audit: Washington attorney Michael
Butler, whom they had used as a troubleshooter in recent months
and who became known in HIID circles as "Mr. Fix-it."
In early April, as the audit was beginning, Hay, Hebert and
Zagachin flew to Boston. Hebert had been cultivating a
relationship with AEW's Aldrich and had scheduled a meeting
with him and two of his aides. Aldrich was more receptive than
he had been in November. One meeting turned into six spread
over two days.
Hebert told the group that she expected to receive one of
the first -- if not the first -- registrations to operate a
mutual fund company in Russia. "I'm at the head of the queue,"
she said, noting that she expected Zimmerman and Farallon Fixed
Income Associates, as well as Farallon Capital Management in
San Francisco, to back her financially.
"Beth said she had a trusting relationship with the Russian
SEC," Aldrich recalled later.
On the second day Hay spoke to the AEW group, explaining how
strongly RSEC head Vasiliev supported Hebert's venture and how
important Yeltsin considered mutual funds to his
Though Aldrich's people liked Hebert's plan, Hay gave them
pause. "Jonathan struck me as someone who was very academically
inclined," aide Jeffrey Hammer said later. "I was somewhat
bemused that Peter Aldrich introduced him to us. Jonathan did
not seem to have, quite frankly, business acumen."
Still, it was clear that Hay had influence with the Russian
officials who would award the first mutual fund registration
and that he was committed to helping Hebert and Zagachin raise
money. He assured Aldrich that nothing he was doing posed a
conflict between his public responsibilities and his personal
At the end of the second day of meetings, Hay, Hebert and
Zagachin returned to the Charles Hotel off Harvard Square,
where HIID put up visitors. Now that it appeared likely that
the mutual fund enterprise would go forward, Hay told Zagachin
that she would have to decide whether to work for HIID or for
"You need to choose one way or the other which seat you want
to sit in," Hay told Zagachin outside the hotel. "They're a
different set of interests." Zagachin chose Hebert but did not
resign from HIID for another four weeks.
Although Hebert had approached Aldrich for a single
investment, her nascent business had evolved into two companies
-- a mutual fund management operation, which would be called
Pallada Asset Management, and a separate entity to provide
back-office services. Hay, Hebert and Zagachin, as well as
Zimmerman, believed that money could be made from both.
Zimmerman, as the potential lead investor, had solicited an
investment in the management company from Farallon Capital's
founder and senior partner, Tom Steyer. She also asked Hay and
Hebert to fax Steyer a memorandum about the back-office
company, known as a "specialized depository."
"Our advantage comes from the fact that the regulator wants
us to be first . . . ," said the memo, dated May 16. "Our
project will be established with the active involvement of the
Russian legal team that the [RSEC] entrusted with the drafting
of the original mutual fund regulation." The memo emphasized
that the Russian legal team was managed by Hay himself. The
same memo was faxed to Zimmerman and Shleifer. With the Russian
presidential election only two months away, the Yeltsin
administration was putting heavy pressure on Sokin and Vasiliev
to implement the previous summer's decree promoting regulated
"You're a failure!" Yeltsin's prime minister, Viktor
Chernomyrdin, told Vasiliev. If mutual funds weren't registered
soon, Sokin said, Vasiliev could be thrown in prison. The RSEC
chief was "incredibly nervous," an aide said. He was "basically
hysterical," said another.
Sokin and Vasiliev in turn assailed Hay, Hebert and Zagachin
for moving too slowly. "If we don't get this thing up and
running, I'm going to end up in jail," Zagachin told
colleagues. She would explain later that the Russian officials
had made it clear to her that failure would carry "very serious
Earlier in May the RSEC had awarded Forum Financial Group
$2.5 million in World Bank funds to help create a back-office
entity to be called First Russian Specialized Depository. Forum
Financial CEO Keffer had been glad to get the $2.5 million, but
he had been surprised by two pieces of unwelcome news. First,
Forum could own a maximum of 49 percent of the FRSD -- the RSEC
wanted the majority owned by Russians. Second, the RSEC wanted
the FRSD to be run not by a real Russian but by the
Russian-born, American-bred Zagachin. The matter-of-fact Keffer
and the voluble Zagachin clashed over how to structure the
company. Over the summer the animosity between them flared into
Hay, spurred by Hebert, demanded that Keffer agree to
Zagachin's controlling the depository.
In the meantime, the U.S. government audit of HIID
proceeded; in correspondence the General Accounting Office
protested that the institute was withholding information.
Washington attorney Butler, who had gone to Moscow to oversee
the audit for HIID, sometimes spoke twice a day with Shleifer
in Cambridge. Shleifer and Zimmerman were concerned about the
Pallada and FRSD projects. Zimmerman had learned that
Farallon's Steyer was lukewarm about investing. And Shleifer
was nervous about possible conflicts of interest associated
with his wife's involvement.
"The bottom line is, we continue having serious concerns,"
Shleifer informed Hay on June 9 in a fax marked "strictly
The Shleifers met with Aldrich at Zimmerman's office two
days later to discuss the investment in Hebert's Pallada.
Shleifer, who showed up late, appeared "very uncomfortable" and
said "he really wasn't supposed to be expressing opinions on
the subject," Aldrich recalled later in his deposition in the
U.S. case. Zimmerman was frustrated.
"What am I supposed to do -- have a Chinese wall between me
and my husband through our bedroom?" she had recently ranted to
a young aide.
The secrets of the Shleifer-Zimmerman bedroom in Newton were
not a trivial issue. It wasn't unusual for Zimmerman, a
recognized expert on global fixed-income securities markets, to
receive late-night phone calls from top Treasury officials
seeking her counsel, including Summers, now deputy secretary,
and David Lipton, Sachs' old Russia colleague, who was now
assistant Treasury secretary for international affairs. "Our
little world," Summers called the small cluster of government
officials and private sector players who were in frequent
touch. And it wasn't unusual for Shleifer to get calls at the
same hour from Hay and others in Moscow, where it was early
morning, wanting to confer about the most sensitive aspects of
aid to Russia as well as their personal investments.
Yet as frustrated as they were with Russia, Shleifer and
Zimmerman also had another subject to discuss with Aldrich: the
education of their four-year-old son. The couple had visited
the Shady Hill School, an elite, private elementary school in
Cambridge. They were "tremendously impressed" and "desperately
wanted" their son to be admitted, Aldrich recalled later, but
had been dismayed to learn that "there were very few spaces."
Could Aldrich use his contacts to help? He promised to try.
Zimmerman's meeting with Aldrich was a success: An Aldrich
aide agreed in principle that AEW would invest $50,000 in
Hebert's fund management company against an eventual total of
at least $200,000. He prepared a draft deal memo which stated
that his firm would invest on the condition that "Nancy
Zimmerman and Andrei Shleifer would be invited to participate
on favorable terms with the invitation coordinated through AEW
Hebert, assured that the RSEC would register her company
soon, ahead of more-qualified competitors such as CSFB and
Pioneer Group, resigned from Fleming at the end of June.
Meantime, Hay and his father, Dr. Robert Hay, decided to
invest some of their money in Russia. From Idaho the elder Hay
put $150,000, including $50,000 of Jonathan's personal funds,
into GKOs. The Hays made the investment through Novyi Mir.
Jonathan made sure to inform Shleifer of this latest
THE STAKES FOR HARVARD IN Russia escalated after Boris
Yeltsin's reelection on July 3. The Harvard project commanded
the attention of top officials of both governments. U.S. vice
president Al Gore and Russian prime minister Chernomyrdin held
a mid-July summit on economic reform in Moscow attended by
Summers and Shleifer. Gore and Chernomyrdin decided to launch a
Capital Markets Forum, which twice a year would bring together
experts from both nations to foster the growth of the Russian
securities markets and financial services industry. The first
U.S. delegation would be led by Treasury secretary Robert Rubin
and SEC chairman Arthur Levitt Jr., who would choose industry
practitioners to counsel their Russian counterparts on subjects
like enforcement and transparency. Invitations to serve on the
forum panels would be coveted.
Although the Russian government had imposed a September 2
deadline for First Russian Specialized Depository to be funded,
the feud between Keffer and Zagachin made that date look
impossible. Keffer, who kept notes on his daily activities,
wrote of Zagachin: "undercutting, unhelpful, distrusting,
incompetent, saboteur of the effort." Zagachin said similarly
unflattering things about Keffer.
Hay and Vasiliev tried to mediate, without success. Finally,
an angry Sokin took Keffer aside. "Julia is a grain of sand,"
he told the American, with Hay translating. "You should ignore
her as an irritant. We will eliminate her in the future, but
you must take her into your company now."
Reassured, Keffer agreed to hire Zagachin for an
as-yet-unspecified job. He signed a consulting agreement with
the RSEC and deposited $400,000 in a cash custody account at
Citibank Moscow as seed capital for FRSD.
Meanwhile, there were tensions at the Harvard project. Hay
was getting fed up with Zimmerman, who treated him and his U.S.
taxpayerfinanced Moscow colleagues as if they were her
employees. "We were frankly trying to get rid of Zimmerman as a
client because she was very demanding," Hay testified
In August 1996, Hebert got what she had been waiting for:
The RSEC granted a license to First Russian Specialized
Depository and registered the prospectuses of two of Hebert's
mutual funds, a bond fund and a corporate equities fund,
allowing Pallada to be the first to open its doors to the
The news stunned Moscow's financial community. "It seemed to
confirm my fear and concern that special favors were being
given," Timothy Frost, Pioneer Group's top man in Moscow, said
in later testimony.
Holly Nielsen, the deputy director of the Resource
Secretariat, had just returned to Moscow from a four-month
maternity leave in the U.S. when she began getting urgent phone
calls from colleagues. A savvy, steely lawyer, Nielsen was not
naive, especially about the Moscow of 1996. But the activities
of Hay and Hebert shocked her.
Nielsen testified under oath in a deposition that her
reaction was one of "complete surprise, and also some
disbelief, that this would have occurred."
The buzz in Moscow did not faze Hay. In fact, after the
registration award, Hay gave Hebert and Pallada free rein to
operate out of HIID's offices and to use its computers, phones
and faxes, according to the grand jury testimony of David
Weiler, who was the Legal Reform Project's chief financial
officer in Moscow. Pallada was the only mutual fund company
invited to exhibit its marketing material at the Collective
Investment Center, a new public facility in the Baumanski
district of downtown Moscow where consumers could learn about
investment products, said Frost, Nielsen and Rutherford. The
mutual fund company was also granted, without a tender, the
exclusive and lucrative right to manage millions of dollars of
assets for a government fund set up to bail out defrauded
Before Hebert could actually sell mutual fund shares, First
Russian Specialized Depository had to be up and running. The
RSEC had granted FRSD a license, but the organization was still
plagued by intramural rancor. Keffer had offered Zagachin a
midlevel management job, far below the position she wanted;
when she refused it, he fired her.
On Monday, August 19, before flying back to Washington,
Butler spent five hours with Keffer in a conference room at the
Tverskaya Hotel. Butler convinced Keffer to find a buyer and
recoup his $400,000 deposit. The same day, Zagachin strode into
Citibank Moscow, next door to the ILBE, and tried to shift the
$400,000 that Keffer had deposited into an FRSD account to
which she had access. Only the intervention of an alert
Citibank staffer thwarted her maneuver. The staffer informed
Keffer, who confronted Hay with the "attempted theft," Keffer
said in his deposition. At this point, Keffer testified, he
informed Hay about "the fraud that we felt was going on and the
misdirection of U.S. funds and the misdirection of the capital
markets program in Russia." He threatened to withdraw his
$400,000 outright. That would delay the launch of Russia's
mutual fund industry for months, unless a buyer for his stake
in FRSD could be found quickly. The government's September 2
deadline for the depository to be funded stood fast.
SHLEIFER AND ZIMMERMAN FLEW INTO Moscow that Monday
afternoon and found themselves in the midst of the crisis. Over
dinner at the ornate National Hotel, Hebert and Hay, flanked by
Zagachin and Sokin, briefed the Shleifers on Keffer's
Panic gripped the group. Sokin implored Shleifer to devote
himself personally to resolving the problem before the
September deadline. Then all heads turned to Zimmerman. Was she
still hesitant to invest with Hebert? If not Pallada, would she
consider helping with the FRSD? Conflicted, Zimmerman asked a
lot of questions. Could it be a loan instead of an equity
investment? What would secure the loan? By the end of the
dinner, Zimmerman was weighing the notion that she might become
the lead investor in FRSD.
The group held a series of urgent conferences -- at Hay's
dacha, at the HIID offices, at restaurants around Moscow -- but
the issue was still unresolved when Shleifer and Zimmerman left
Russia three days later. Zimmerman returned to Boston, and
Shleifer flew to Istanbul, where he gave the globally renowned
Joseph Schumpeter Lecture at a meeting of the European Economic
Association. Shleifer argued in this lecture, "Government in
Transition," that Russia's evolution to a market economy was
being retarded by a slow and uneven political shift away from a
communist dictatorship to a freer form of government.
One week later Shleifer and Zimmerman were back at their
vacation house on Cape Cod -- and catching up with Larry
Summers. In the lazy days easing toward Labor Day at Truro, the
friends had an opportunity to kick back.
As the trio strolled the beach and lounged around their
houses, they talked about Russia. Shleifer and Zimmerman were
under a lot of stress because of the crisis in Moscow: If
Keffer weren't bought out of his investment by the following
Monday, the launch of Russia's mutual fund industry would be
substantially delayed and might even collapse. They didn't
mention any of this to Summers, who asked some general
questions about privatization and the like.
Summers also had some questions of a more personal nature:
He knew the couple were investing in Russia. He didn't know the
specifics, but he understood enough to ask about Zimmerman's
GKO investments. She said she had done well. Shleifer and
Zimmerman said they were "bullish on Russia." Though he was
unaware of Zimmerman's tax-avoidance scheme and the use of her
father to conceal the Shleifers' oil investments, Summers had
heard enough to caution the couple.
He said that it would be "a good idea for Andrei to make
sure he was operating within the rules of whatever legal
arrangements he had with Harvard" and that Shleifer should
check what his personal contract said. Zimmerman, Summers said,
"should just think hard" about what she was doing.
When Zimmerman later consulted with her husband about
Summers' advice, Shleifer said, "We can use Michael Butler if
we're concerned about specific things."
ZIMMERMAN WAS NOT TO BE DETERRED. FROM Truro, on Thursday,
August 29, amid the friendly chats with Summers, she agreed in
an e-mail to loan Zagachin $200,000 and to sink an additional
$200,000 into an equity investment so that Zagachin could get
control of FRSD. But arrangements couldn't be concluded by the
deadline -- September 2, Labor Day -- only four days away.
Desperate to avoid missing her big opportunity, Hebert
telephoned Hay's father in Idaho and confided her anguish.
"Keffer has created a panic -- he's blackmailing us," she
said. "You could help me come up with some bridge financing for
Julia. It would be very short term, until we can find someone
to make a long-term investment in the project. I'll make sure
that it's 100 percent secure."
Dr. Hay immediately withdrew $200,000 of his own funds and
$200,000 of Jonathan's and wired the money to Zagachin's bank
account in Delaware the same day. Zagachin was the new owner of
That evening Hebert and Hay reflected that Dr. Hay's
generosity and quick action might have saved the Russian mutual
fund industry and his son's career, and kept Vasiliev in
The younger Hay e-mailed Zimmerman in Truro: "Everything
sounds fine. Call me on the mobile or at Beth's."
While Pallada was setting up shop, other financial
institutions were struggling with the Russian bureaucracy. On
September 13, 1996, Credit Suisse First Boston submitted an
application to the RSEC for authorization to start a
depository, requisite for a mutual fund company. The RSEC
employees who opened the application found two small travel
alarm clocks. The clocks were inexpensive tokens akin to
ballpoint pens or key chains. But Vasiliev summoned CSFB's
Moscow representative, Bruce Lawrence, a respected back-office
specialist, accused him of criminal conduct and returned the
clocks. Vasiliev sent a strongly worded letter to the CEO of
Credit Suisse in Zurich. He then called in Hay and Butler and
suggested that the episode be reported to the Moscow police
fraud squad. Though no call was made, Credit Suisse's
application was stalled, and word made its way to Washington.
"I was aware," said Summers years later, "that there were
concerns of impropriety surrounding Credit Suisse . . . "
Separately, Butler counseled Hay to inform Vasiliev of his
relationship with Hebert, which he did later in a formal
letter. Butler also advised Hay to "work out some arrangement
that you won't be involved with matters that affect her
A few days later Hay told Butler, "I've worked it out with
Butler also demanded that Hay impose order on the disorderly
Institute for Law-Based Economy. Not for the first time, Butler
took Hay to task for paying employees in cash and for "the
out-of-control use of drivers for personal purposes." In a
stern memo he wrote: "This system does not have to be perfect,
or even very good. But it does need to be good enough to get
What Butler didn't know was that Hay's headquarters in
Moscow had become a virtual branch office of Zimmerman's firm,
as evidenced by e-mails cited by the U.S. in its lawsuit. On
September 23, for example, Zimmerman e-mailed Hay from
Cambridge to say: "zagachin loan ready to go" and "we will make
u a 400k loan -- u will pay back 200k asap, and the balance
when it is appropriate."
Zimmerman was indicating that she might be ready, either
through her firm or personally, to take Hay and his father out
of the emergency $400,000 loan they had made to Zagachin at the
end of August. But she continued to waver.
In other communications Zimmerman asked Hay to execute
certain investment actions.
"please buy some oct 23 gkos and we will take care of
everything when the current ones roll off," she e-mailed on
Less than two hours later: "did u get my last message?"
Less than two hours after that: "Did u do anything in
It took Hay another five hours to reply that he had bought
the October 23 bonds.
THE ACTIVITIES OF THE HARVARD PROJect were causing alarm
among other Americans in Moscow. Holly Nielsen, deputy director
of the Resource Secretariat, began to worry about a possible
scandal that could embarrass Harvard and the U.S. government.
In late October she met with Vasiliev to discuss the awarding
of the first mutual fund registration to Hay's girlfriend
rather than to a proven global securities firm like CSFB or
Pioneer, Nielsen said in her deposition. Vasiliev's aide Andrea
"What would your superiors and the Russian government think
of these conflicts?" Nielsen asked, according to her
"My superiors wouldn't care." Vasiliev seemed perplexed.
"People within the industry have certainly voiced concern,"
Nielsen replied. "It's becoming an increasingly difficult issue
to try to defend."
Nielsen decided to confront Shleifer. Because she hardly
knew him, she asked Rutherford to introduce her to someone who
did, Joseph Blasi, a professor at the Rutgers School of
Management and Labor Relations who was working for HIID,
advising on employee ownership of businesses, a key aspect of
privatization. Nielsen took Blasi to breakfast at the Aerostar
Hotel off of Garden Ring Road on Sunday, November 3, just hours
before he was to fly to New York.
Talking fast, she poured out the story of the mutual fund
registration while Blasi scribbled notes on a napkin. She asked
him to arrange for her to see Shleifer in Cambridge. She also
asked that the communication be kept confidential: Blasi should
use a code when referring to the meeting in a fax or e-mail:
"The appointment with your pediatrician is confirmed."
The morning after Blasi arrived in the U.S., he called
"If what Holly Nielsen told me is true," Blasi declared,
"Jonathan Hay should be fired immediately." Shleifer agreed to
see Nielsen, although they would not meet for more than a
Vasiliev and Rutherford flew to New York in mid-November to
represent the RSEC at the listing of mobile phone operator
VimpelCom Corp. on the New York Stock Exchange, the first Big
Board listing of a Russian company. They took the occasion to
call on exchange attorney Richard Bernard, who warned them
that, based on what he had heard since leaving Moscow, Shleifer
and Hay as well as Sokin would eventually bring public
embarrassment to Vasiliev.
"Your reputation has already been damaged by the mutual fund
talk," Bernard said. "The reputation you have with the SEC and
with people here at the exchange is being damaged."
Vasiliev listened but didn't say much. In the town car
headed uptown, he asked Rutherford's opinion. She told him she
agreed with Bernard.
"I essentially agree with Rich," she said, speaking in
Russian. "You've been very successful in building a reputation
in the West, not just for competence but honesty, and my
impression is that reputation is being damaged by the talk, the
rumors, the gossip about how you've treated Pallada, how you've
treated Pioneer, how you've treated Credit Suisse."
"We've had too much scandal. Too many people have lost too
much money," Vasiliev replied. "The reason we're handling
Pallada as we are is that it is very important that there are
no scandals or problems connected with the first mutual funds
in Russia. The only way we can do that is to ensure tight
control over these first new funds -- with somebody we know
well, somebody close to us we can trust running Pallada."
RELEASED IN NOVEMBER 1996, the final report of the U.S.
General Accounting Office could have been far worse for
Harvard. Butler had done an excellent job of containing the
auditors. The report's most severe criticism was that AID's
management of HIID was "lax." "In particular," the report read,
"USAID did not . . . set measurable goals and was not aware of
decisions HIID was making that could have resulted in costs to
the U.S. government or that could significantly affect U.S.
The HIID group was relieved. Shleifer arranged for the
then-president of Harvard, Neil Rudenstine, to send a
handwritten thank you note to Butler.
In Moscow the firms whose mutual fund applications were
being thwarted were not taking the obstruction lightly.
Pioneer's Frost demanded and got an audience with Hay. They met
on Saturday, November 30, at the Starlite Diner but moved to a
nearby French pastry shop for privacy.
Frost began by praising Hay for all the good he had done for
Russia. It would be tragic, he said, if that record were
tainted by scandal.
"There really is a problem here," Frost said. "If it isn't a
real conflict of interest, there is a strong perception, an
odor of conflict of interest. You need to make sure you are
leaning over backwards to guard against this."
Frost later testified in the U.S. government lawsuit that
Hay responded with threats, implying that he could make sure
that Vasiliev and the RSEC further thwarted Pioneer's entry
into the Russian mutual fund business: The application process
could drag out and might not be approved. All of Pioneer's
financial initiatives in Russia could be delayed.
"Is it fair to say you took Jonathan Hay's comments on
November 30, 1996, as a threat?" Frost was asked under oath in
"In your view, would any reasonable person in your position
sitting at that meeting come away feeling that they had been
"Yes. I think they would have felt threatened in terms of
business, our ability to conduct business, yes."
Pallada continued to get special treatment from the Russian
government and the Harvard project. In December, Hay and
Vasiliev recommended to the U.S. Treasury that Pallada, along
with such global powers as Citicorp and Salomon Brothers, be
included in the coveted Capital Markets Forum. Hebert would sit
on two panels alongside people far more prominent than she,
including Citi CEO John Reed and Salomon CEO Deryck
Despite her interest in committing $400,000 to Pallada and
FRSD, Zimmerman still had invested nothing in Hebert's
ventures. Then, as the end of the year neared, Butler gave her,
Shleifer and Hay advice that made them squirm. He had decided a
case could be made that her investment in Pallada was
legitimate, but he said investing in the FRSD was
"inadvisable." He recommended that the Shleifers disclose their
plans to Vasiliev, to the Harvard general counsel's office and
to Gregory Poppe, one of Harvard's attorneys.
According to exhibits entered in the lawsuit by the U.S.,
Zimmerman e-mailed Hay on December 2: "[Butler] would like us
to tell Greg Poppe and just do it above board. He thinks . . .
it should be done in an upfront way. I talked to Boss about
this plan; he seemed less sure. . . ."
Hay replied: "I am just worried about what we do when Greg
Poppe says no. I think that the issue must be prepared very
carefully to minimize the risk that this happens. I also think
we have to have a fallback if Poppe says no."
They decided to tell Poppe nothing.
Nielsen met with Shleifer in Cambridge on December 9. They
lunched at the Harvard Faculty Club, speaking first about a
range of issues and problems at HIID in Moscow. It wasn't until
the next morning in Shleifer's office in the Littauer Center
that Nielsen raised the concerns that had brought her to
"Jonathan and Beth are being stupid and arrogant about the
registration issue," she said, according to her deposition in
the lawsuit. "If they had quietly gone about getting
[registration] No. 3 or 4, no one would even have noticed. But
the fact that they felt they had to get No. 1 caused a huge
"I can't control who Jonathan sleeps with," Shleifer
Nielsen was stunned, but continued. "I believe that
Jonathan's direction of public funds to benefit a commercial
private organization in which Hebert has an interest is a
conflict of interest and an improper use of public funds."
Shleifer was unmoved. As Nielsen was leaving, he said, "I'm
naming Jonathan executive director of the Resource
Secretariat." Hay would be taking over from Bernard's
replacement, Dmitri Subbotin, who was being pushed out because
he had objected to the RSEC's registration of Pallada. The
change would also make Hay Nielsen's direct boss.
Nearly a year after Hay and Hebert had begun seeing each
other and three months after Butler had advised Hay to disclose
the relationship to Vasiliev, Hay sent Vasiliev a letter,
drafted by Butler, recusing himself from any oversight role
concerning Pallada Asset Management. The letter was a formality
-- Vasiliev had known of the relationship from the start. Hay's
treatment of Pallada didn't change. He did finally move into
Hebert's apartment, however, the plumbing at his own flat
having long since failed.
When Hay and Hebert flew to Idaho for Christmas with Dr.
Hay, they finally got around to documenting the emergency loan
he had made to Zagachin in August. Zagachin would repay Hebert,
who would repay Dr. Hay. In a promissory note Hebert pledged
her personal assets, including a bank account in the Channel
Islands and a 1991 blue Volvo 740.
In February, Shleifer wired $200,000 from his and
Zimmerman's joint bank account to Pallada. He was implementing
a cash advance from his wife to Hebert. The parties labeled the
advance a loan, but it was not documented for the time being,
leaving the option of structuring it as either debt or
Meanwhile, Zimmerman sent First Russian Specialized
Depository's latest business plan to AEW, which had indicated
it would invest $50,000 in Pallada against an eventual total of
$200,000 and would consider investing in FRSD as well.
AID had been stung by the General Accounting Office's
finding that it had been lax in supervising Harvard's Russian
Project, but did not take action for several months. In late
February, Olga Stankova, a senior Moscow staffer of AID,
privately informed Janet Ballantyne, the agency's mission
director, that Hay's girlfriend "had been given unfair
advantage in the registering of the first mutual fund program,"
according to Ballantyne's deposition in the lawsuit.
Ballantyne, a 20-year AID veteran, was a smart bureaucrat, but
she had only been in Moscow for three months and was still
catching up with the agency's work in Russia, where 150
employees administered 80 to 90 programs. Though she had met
with Hay on half a dozen occasions, she spent no more than 5
percent of her time on the Harvard program.
Upon hearing of the potential problem, Ballantyne summoned
her top legal officer, Mark Ward, and then telephoned the
agency's inspector general in Washington. The IG is independent
of AID, appointed by the president of the U.S. and reporting
directly to Congress. The IG immediately dispatched two special
agents to Moscow to investigate. Ballantyne briefed the charge
d'affaires and the Treasury attaché at the U.S. embassy
in Moscow, who alerted ambassador Thomas Pickering.
The two agents conducted a quiet preliminary investigation
over six weeks. On April 10, Ballantyne and Ward telephoned
Jeffrey Sachs at Harvard; he had become HIID director two years
earlier, but he had not been in Moscow since 1994, having been
preoccupied with other projects around the world.
"Don't say anything," Ballantyne said. "We have a
She informed him that AID's inspector general was
investigating possible improprieties in the Harvard program in
Moscow and that the agency was asking his cooperation in
interviewing the staff. A stunned Sachs said he would get back
Sachs called the Harvard general counsel's office, then
notified the university's second-in-command, provost Albert
Carnesale, who had been running Harvard with unusual authority
for two years, since illness had sapped president Rudenstine's
capacity. Then he called his old rival.
According to Sachs' testimony, Shleifer tried to portray the
investigation as a "vendetta" orchestrated by "enemies" of
Harvard, competing universities that had bid for the Russia job
Sachs was furious, later telling a federal grand jury his
opinion of Shleifer's illicit investments: "Mr. Shleifer would
be doing a disservice and would be entering a conflict of
interest to make an investment like this. . . . I would find
such investments to be highly inappropriate. . . . It would be
damaging to HIID to engage in this kind of behavior while
serving as an HIID consultant or employee to Russia."
WHEN HAY LEARNED OF THE investigation, he immediately called
Butler. "Something funny is going on," he said. "You may need
to get involved." Together they called Poppe at the Harvard
general counsel's office. Poppe, who had just been notified of
the investigation by Sachs, asked that Butler represent
Harvard, HIID, Shleifer and Hay in any contacts with AID
Hay, Hebert and Zagachin scrambled. There was the matter of
the loan that Hebert had arranged for Hay's father to make to
Zagachin the previous August. Zagachin telephoned one of
Aldrich's aides at AEW and asked if the funds earmarked for
FRSD could be transferred immediately -- and if the amount
could be doubled, to $400,000, in exchange for a larger piece
of the company and better terms. Aldrich authorized the
transfer of the funds to Zagachin. She instantly wired the
money to Hebert, who passed it on to Dr. Hay in Idaho. A few
days later AEW proceeded with its Pallada investment, paying
$50,000 for 2 percent of the company.
With his university's reputation at stake, Carnesale
demanded that the U.S. government put its charges in writing.
On April 17, AID faxed a letter to Sachs stating that a senior
HIID official in Moscow had a close relationship with the
manager of a Russian mutual fund company and "may have used his
or her position to seek preferential treatment for this mutual
fund and the fund's specialized depository." The letter also
alleged that "some USAID funding may have been used for the
personal gain of one or more HIID employees" and insisted that
Harvard people submit to interrogation by U.S. agents.
Hay fired back from Moscow. He drafted an angry letter for
Vasiliev to send to AID mission director Ballantyne, denouncing
the investigation as "deeply insulting," "crude" and "a
violation of elementary norms of courtesy." The letter stated
that Hay had no financial interest in either Pallada or
Vasiliev dispatched another outraged, Hay-written letter to
Richard Morningstar, who, as a special ambassador, advised the
White House and the State Department on U.S. aid to the states
of the former Soviet Union. The letter asserted that FRSD "has
received private financing from a well-known trustee for
pension funds," meaning Aldrich in Boston. He did not say that
the financing had been in place for only a week. He did,
however, warn of possible dire consequences to Russian-American
relations as a result of the AID investigation.
From Cambridge, Sachs asked all HIID employees in Moscow to
cooperate fully with the investigation.
On April 30 special agents Philip Rodonkanakis and Mary
O'Mara interrogated Hay for three hours and 20 minutes in the
mission director's conference room at the AID offices in
Moscow, with Butler at his side.
Over the next few days, Shleifer called around Moscow trying
to find out what the HIID staff was telling the investigators.
A few people believed the Resource Secretariat's Holly Nielsen
had been responsible for sparking the investigation. Shleifer
ordered that she be fired. Nielsen informed Sachs, who
countermanded the order. Shleifer reinstated it. "I'm running
this project, and you'll do what I say," he told Rachel
Glennerster, the Cambridge-based administrator in charge of
contracts. She informed Sachs, who again reinstated
Nielsen couldn't be fired, but she could be restrained.
Vasiliev ordered the security guards to bar her from the
offices of the Resource Secretariat.
On May 9, Sachs asked Carnesale to fire Hay and to suspend
Shleifer from the Russia Project. Not knowing this, a
distraught Shleifer that same day let loose an extraordinary
nine-page diatribe to the provost, calling the U.S.
investigation "zealous," "outrageous" and "vicious," with the
objective of "getting" him, Hay and Harvard.
Shleifer asserted that there was "no evidence of wrongdoing
by myself and Hay." He oddly and grandiosely insisted that
Carnesale cancel the entire Russia program: "It is a great time
for Harvard to send [AID] straight to hell."
On May 19, Anatoly Chubais, who had become first deputy
prime minister of Russia, dispatched a letter to AID
administrator J. Brian Atwood in Washington demanding that he
terminate HIID programs in Russia. The next day AID summarily
killed the Russia Project, initiated five years earlier with
such hope and intellectual heft. HIID had spent upward of $40
million of U.S. government funds and controlled the spending of
an additional $350 million by other contractors.
The official letter, which the agency faxed to Sachs from
Moscow, contained strong language unusual for a federal agency.
Shleifer and Hay, AID charged, "have abused the trust of the
United States Government by using personal relationships . . .
for private gain. . . . USAID has been trying to explain to key
Russian Government counterparts the value of open and
transparent processes, and the importance of avoiding conflicts
of interest, as ways to increase investor confidence in the
Russian capital markets. . . . The private activities of [Hay
and Shleifer], supported by staff and equipment paid for with
U.S. Government funds, conveys exactly the wrong message to the
Russians." On May 21 the Committee of Fellows of the Harvard
Institute for International Development met twice in emergency
session and crafted a letter to university president Rudenstine
"expressing our dismay and concern," castigating Shleifer and
Hay and urging that they be suspended. "Nothing less than
HIID's integrity and ability to function effectively in the
future is at stake," the letter stated.
In lower Manhattan that morning, Richard Bernard sent a
memorandum to his boss, New York Stock Exchange CEO Richard
Grasso, commenting on the coverage of Harvard's problems that
day in the Wall Street Journal. "On a personal level,"
Bernard wrote, "it is hard not to rejoice in seeing Shleifer
and Hay get their comeuppance. However, I am concerned about
the possible ramification of the scandal for the good work that
we did manage to accomplish."
Harvard fired Shleifer and Hay from their HIID positions the
next day. Shleifer, however, retained his tenured professorship
in the department of economics.
THE REVELATIONS FROM MOSCOW shocked no one more than
Peter Aldrich, who invited Shleifer to dine at their usual
haunt, Henrietta's Table in the Charles Hotel. Shleifer tried
to shift the blame. "I've been hung out to dry," he railed. "I
was just a consultant. It was Jeffrey's [Sachs] program, and he
Aldrich later telephoned Vasiliev in Moscow, who defended
Hay. "Jonathan has been a tremendously valued adviser,"
Vasiliev said. "He's the only good money the U.S. government
has spent. This is a political vendetta by the Central Bank
against me and especially Chubais. The bank wants control of
the securities market."
Hay visited Boston in late May in an effort to defend
himself. He met with Sachs and Dwight Perkins, the senior
professor who had run HIID for 15 years and had approved the
hiring of Hay in 1992.
He also met with Aldrich, who called Hay to his office and
directed him to a chair so they could face each other.
"Jonathan, I absolutely need to know the truth," Aldrich
said, according to his deposition in the U.S. lawsuit.
Hay proclaimed his innocence, furious that he had been
"summarily dismissed . . . and . . . prejudicially judged."
"Jonathan, did you or did you not invest in Russian
"No." Hay looked uncomfortable.
"Is that your truthful answer?"
"Well, I invested for my father. It wasn't much."
"What are we talking about here? How much money was it?"
"There's nothing else that these people can catch you on,
hang you on?"
Aldrich wasn't convinced. "Jonathan, this is really
important to me. I'm a fiduciary here. I've got money I'm
responsible for. Is there anything else that you did that is
wrong? Is there something else I should know about?"
"No, no, that's it."
"You're telling me that your father's investment of $50,000
was something that you were perfectly within your rights to
"Yes. I didn't do anything wrong."
On May 30, Chubais and Vasiliev complained directly to
Summers at Treasury "with considerable vigor and bitterness,"
Summers later recalled in his deposition. "They felt the U.S.
government's refusal to fund the HIID project . . . constituted
a significant interference with their objective of bringing
about market and democratic institutions in Russia and seemed
to them to be a kind of unconstructive and hostile act by the
United States government."
Several days later Zimmerman received a call at home from
Leonard Blavatnik, the Forbes 400 billionaire who had
arranged the Shleifers' first investment in Russian stocks,
back in 1994. Blavatnik was concerned about the public
controversy surrounding the Harvard Russia Project.
"It's a witch hunt," Zimmerman said. "A political
Blavatnik promptly prepared a backdated document changing
the beneficial ownership of the stock purchased in 1994 from
Shleifer to Zimmerman. The Shleifers' $200,000 investment
through the Blavatnik vehicle Renova at one time had tripled in
value -- the Gazprom component had been up fivefold.
The collapse of the Harvard project had an immediate and
negative consequence for the Russian reformers with which it
was connected. On Friday, May 30, 1997, barely more than a week
after first deputy prime minister Chubais pulled the plug on
the Harvard project, he summoned Vasiliev to the Kremlin and
resolved his conflict with the Central Bank. The Central Bank
would be given the right to license commercial banks to trade
in the equity market -- in effect opening the door to the
German model of heavy bank investment in the stock market,
which Vasiliev had opposed so bitterly for so long. Vasiliev
resigned in October 1999, citing personal reasons.
By then Harvard had put HIID out of its misery, replacing it
with the Center for International Development. Sachs, who
stayed around for the launch of the CID, eventually left
Harvard for Columbia.
Also by that time, Pallada had been bought by State Street
Global Advisors and Farallon Capital had decided to dissolve
its joint venture with Zimmerman. In late 1998, according to
sources at Farallon, the San Francisco firm gave back to her
its passive minority stake on the condition that she change the
name of her firm from Farallon Fixed Income Associates; she
renamed it Bracebridge Capital. Public records show that in
2001 she also began to use the acronym FFIA for her business;
she continued to do so into 2004, when Farallon discovered its
use and protested.
WHEN AN AGENCY OF THE U.S. government determines that crimes
have been committed, it prepares a "criminal referral" to the
Department of Justice, which evaluates the case and decides
whether to prosecute. AID made its referral in June 1997. The
Justice Department approved the case and assigned it to the
U.S. Attorney's Office in Boston and the FBI. On July 10 a
meeting of FBI agents and federal prosecutors was convened at
the Boston federal courthouse by Assistant U.S. Attorneys Sara
Miron Bloom and Stephen Huggard.
Bloom and Huggard gathered evidence for a year and presented
witnesses and documents to a federal grand jury for two
additional years. Though they wanted a criminal prosecution,
the government, in the end, filed civil charges only.
On September 26, 2000, the U.S. government sued Harvard
University, Andrei Shleifer, Jonathan Hay, Nancy Zimmerman and
Elizabeth Hebert on 11 counts, including fraud, breach of
contract and making false claims to the federal government. The
suit estimated that the government had been defrauded of at
least $40 million and asked treble damages under the False
One month later Forum Financial Group and John Keffer sued
Harvard, Shleifer and Hay for fraudulent misrepresentation and
other alleged infractions and asked unquantified actual and
punitive damages. The defendants denied the alleged wrongdoing
in both suits.
On November 12, 2001, U.S. District Court Judge Douglas
Woodlock dismissed the charges against Zimmerman and Hebert on
the grounds that the government essentially had failed to
allege a sufficient number of relevant facts against them.
However, he left open the possibility that the government could
refile the charges under certain circumstances.
After extensive discovery, including about 60 depositions
and the collection of more than 1,000 documentary exhibits, the
government and the defendants all moved for summary judgment in
their favor. Shleifer insisted he was a "consultant" rather
than an employee, was never "assigned" to Russia and was
therefore exempt from conflict-of-interest regulations. A key
question for the judge was whether Shleifer or Hay had violated
the "regulations governing employees."
On June 28, 2004, Judge Woodlock ruled against Shleifer and
Hay. He wrote, "I find that the Cooperative Agreements were
valid contracts between Harvard and USAID, that they created an
obligation to remain free of conflicts of interest, and that
actions by Hay and Shleifer breached that duty.
"Shleifer was in charge of the entire Russian Project, and
classifying him as a consultant would result in the anomalous
circumstance that the head of the project was exempt from the
conflicts of interest regulations. . . . I find no genuine
dispute of material fact as to Shleifer's status as an employee
The judge determined that Shleifer and Hay were subject to
the conflict-of-interest rules and had tried to circumvent
them; that Shleifer engaged in apparent self-dealing; that Hay
attempted to "launder" $400,000 through his father and
girlfriend; that Hay knew the claims he caused to be submitted
to AID were false; and that Shleifer and Hay conspired to
defraud the U.S. government by submitting false claims.
On July 30, 2004, the government announced that Zimmerman
had settled with the U.S. Even though the charges against her
personally had been dismissed, the U.S. said that her firm had
"improperly diverted U.S. taxpayer resources for its own
purposes and profit" in AID's Russia program between 1992 and
1997. Zimmerman's firm had to pay $1.5 million to the U.S.
That December, Judge Woodlock conducted a jury trial to
settle the factual question of whether Shleifer was "assigned
to" Russia and thus obliged to obey the relevant
conflict-of-interest regulations. The jury concluded that he
On August 3, 2005, the parties announced a settlement under
which Harvard was required to pay $26.5 million to the U.S.
government, Shleifer $2 million and Hay between $1 million and
$2 million, depending on his earnings over the next decade.
Shleifer was barred from participating in any AID project for
two years and Hay for five years. Shleifer and Zimmerman were
required by terms of the settlement to take out a $2 million
mortgage on their Newton house. None of the defendants
acknowledged any liability under the settlement. (Forum
Financial also settled its lawsuit against Harvard, Shleifer
and Hay under undisclosed terms.)
As the U.S. government's litigation proceeded with
deliberate speed, Shleifer was distinguishing himself in the
world of economics. He was earning a growing reputation as a
theorist in the emerging field of behavioral finance even as he
published a series of books and articles analyzing the changes
in Russia. (In 1994 the industrious Shleifer had formed with
fellow academics -- and behavioral finance specialists -- Josef
Lakonishok and Robert Vishny a Chicago-based money management
firm known as LSV Asset Management. Today it manages about $50
billion in quantitative value equity portfolios, though,
according to the firm's Web site, Shleifer no longer has an
In 1999, Shleifer cemented his place in the firmament of
American economists when he won the John Bates Clark Medal, a
ticket to the most-exalted circles of global academic
economists. Paul Samuelson, who won it in 1947, and Milton
Friedman, who won in 1951, subsequently received Nobel prizes.
Summers was awarded the medal in 1993.
Shleifer remained close to his friend and mentor Summers;
they talked to and saw each other frequently and continued
vacationing together in the summer on the Cape. Then it became
known in early 2001 that Summers was on the short list of
candidates to succeed Neil Rudenstine as the president of
Harvard University. Shleifer and Zimmerman began campaigning
for Summers to get the Harvard post, giving meet-and-greet
parties for him at their home. Summers stayed with them when he
In March 2001, Summers was named president of Harvard.
Shleifer, who had been courted by New York University's Stern
School of Business, decided to stay put.
Having his close friend as his boss would turn out to be
quite helpful to Shleifer. Summers asserted in his deposition
that he recused himself from any involvement in the
university's handling of the Shleifer matter, but the new
president stayed involved anyway. Early in his presidency he
told the dean of the faculty of arts and sciences, Jeremy
Knowles, to keep Shleifer at Harvard.
"I expressed to Dean Knowles," Summers testified in a
deposition in 2002, ". . . that I was concerned to make sure
that Professor Shleifer remained at Harvard because I felt that
he made a great contribution to the economics department . . .
and expressed the hope that Dean Knowles would be attentive to
that. . . . I think he recognized and shared the concern."
Summers hinted in the deposition that although he didn't
know all the facts and wasn't a lawyer, he felt his friend
Shleifer might have been unfairly accused -- that there was
nothing necessarily wrong with "providing advice on a financial
issue in which one had an interest."
Summers said conflict-of-interest "issues," in his
Washington experience, were "left to the lawyers." He said he
was sensitive to "ethics rules," but testified that "in
Washington I wasn't ever smart enough to predict them . . .
things that seemed very ethical to me were thought of as
problematic and things that seemed quite problematic to me were
thought of as perfectly fine. . . ."
Knowles, at least in principle, took a different view. He
testified to the federal grand jury investigating Shleifer that
he expected faculty to know the regulations prohibiting
conflicts and to "understand the spirit, not just try to
squeeze past the letter. . . ."
Harvard has disciplinary procedures for dealing with errant
professors. The Committee on Professional Conduct, composed of
a rotating group of senior faculty, provides guidance on
conflict-of-interest questions to professors who seek it in
advance of making an investment. It isn't unusual to solicit
such counsel. Had Shleifer and his wife approached Knowles
before making their investments, Knowles told the grand jury,
he probably would have referred them to the committee. They had
not come to him.
The committee also gathers facts on alleged misconduct and
reports its findings to the dean, who then must decide whether
to discipline or sanction the alleged offender. Penalties range
from light to severe. Dismissing or forcing the resignation of
a tenured professor at Harvard is very rare, but it can be done
under the so-called Statutes of Harvard University, the
school's venerable governing tenets, originating in 1650, 14
years after Harvard's founding. The Third Statute provides for
dismissal for ". . . grave misconduct or neglect of duty . . ."
The procedure, which is called "invoking the Third Statute," is
so rare that few at Harvard have even heard of it.
When the Shleifer scandal broke, Knowles did not mobilize
the committee. As allegations against Shleifer hadn't yet been
litigated, Knowles took the position -- and so testified to the
grand jury -- that Shleifer was innocent until proven
Knowles tells Institutional Investor that he does
not remember Summers' approaching him about Shleifer. "I don't
recall this particular conversation, but the president and I
shared the goal of recruiting and retaining the best faculty,
so it would have been perfectly natural for us to mention to
each other the names of people that we certainly wouldn't want
to lose." However, not long after Summers says he intervened on
the professor's behalf, Knowles promoted Shleifer from
professor of economics to a named chair, the Whipple V.N. Jones
Knowles left the deanship in 2002 and is currently the Amory
Houghton professor of chemistry and biochemistry and a
distinguished service professor at Harvard. His successor as
dean of the faculty of arts and sciences was William Kirby, a
former chairman of the history department and a noted China
scholar, who was appointed dean by Summers effective July 1,
Shleifer's legal position changed on June 28, 2004, when
Judge Woodlock ruled that he and Hay had conspired to defraud
the U.S. government and had violated conflict-of-interest
regulations. Still, there was no indication that the Summers
administration had initiated disciplinary proceedings. To the
contrary, efforts were seemingly made to divert attention from
the growing scandal. The message from the top at Harvard was,
"No problem -- Andrei Shleifer is a star," says one senior
The Summers-Shleifer friendship flourished. They spoke on
the phone more than once a day, on average. Two months after
the court ruling against Shleifer, he hosted Summers at a
break-the-fast dinner on Yom Kippur.
David Cutler, another Summers protégé and
professor of economics, whom the Harvard president had elevated
to dean of social sciences, hosted a "Social Sciences
Colloquium" lecture series in 2004 and designated Shleifer as
one of the first speakers. Shleifer spoke on Russia, about
which he had penned an article for the March/April 2004 issue
of Foreign Affairs; the article, "A Normal Country,"
grew into a book of that name published in 2005. Later in the
year Cutler invited Shleifer to a gathering of prominent
Harvard scholars to discuss what the university should be doing
to advance research and scholarly work in Russia.
The continuing efforts on Shleifer's behalf, particularly
after the court adjudged him liable for conspiracy to defraud
the government, offended a number of professors, some of whom
quietly approached the chairman of the Committee on
Professional Conduct, professor Jeffrey Frieden of the
government department. In departments of the university that
depend heavily on grants from the U.S. government,
conflict-of-interest rules are ubiquitous and strictly
observed; some of the professors warned that the university's
credibility with federal agencies could be compromised if no
action were taken against Shleifer.
Committee chairman Frieden told those who inquired that the
committee's function was limited to fact-finding and that as
the federal court had already established the facts in the
Shleifer case, the matter was more appropriately before Dean
Kirby than before the committee. More than one professor felt
that Frieden seemed intimidated by Summers.
"I have a vague recollection of having mentioned to a
colleague some years ago . . . that whatever the CPC might or
might not do, it could not act so long as the case was in the
courts," Frieden told II in an e-mail comment. "When
there is a prior court decision, the CPC . . . would not
normally need to carry out much in the way of fact-finding
because presumably the courts would have done this."
With no action forthcoming by the committee after the
court's ruling, it's understood that members of the faculty of
arts and sciences have taken up the Shleifer case with Dean
Kirby on at least half a dozen occasions of varying formality
over the past 16 months.
One instance was a meeting early in the academic year that
began in September 2004, less than two months after the federal
court formally adjudicated Shleifer's liability for conspiring
to defraud the U.S. government. A faculty member asked Kirby
why Harvard should defend a professor who had been found liable
for conspiring to commit fraud. The second confrontation came
early in the current academic year when another professor asked
Kirby why Harvard should pay a settlement of $26.5 million and
legal fees estimated at between $10 million and $15 million for
legal violations by a single professor and his employee, about
which it was unaware. On both occasions Kirby is said to have
turned red in the face and angrily cut off discussion.
On at least one other occasion, Summers himself told members
of the faculty of arts and sciences that the millions of
dollars that Harvard paid in damages did not come from the
budget of the faculty of arts and sciences, but didn't say
where the money came from. Those listening inferred he meant
that the matter shouldn't be of concern to the faculty and that
they shouldn't raise it, a curious notion, given that Shleifer
was one of their own.
A spokesman for Summers said he was "unable to schedule" an
interview with Summers for II in December, when this
article was being prepared. As the lawsuit was against the
university, not just the faculty of arts and sciences, the
settlement came from "university funds available for these
purposes," the spokesman added.
A spokesman for the faculty of arts and sciences told
II, "Consistent with its practices the FAS is not in a
position to comment on any internal personnel matter involving
a member of its faculty." The spokesman added that Dean Kirby
"would never flare with anger."
Publicly, Harvard has made only one statement about the
affair since the settlement in August. "We welcome having this
matter behind us," vice president and general counsel Robert
For the most part, the Harvard community -- students,
faculty and alumni -- have been silent about the Shleifer case.
This stands in clear contrast to the other imbroglios of
Summers' tenure, over religion professor Cornel West and women
in science. When it came to Shleifer, many professors, though
upset, have preferred to stay in the shadows, wary of the close
friendship he has with Summers.
Nonetheless, a few of Harvard's most senior professors are
beginning to break the silence. One such is Harry Lewis, who
has taught mathematics and computer science at Harvard for 32
years. He taught Bill Gates as an undergraduate in the 1970s
and was dean of Harvard College from 1995 until 2003, when he
was dismissed in a restructuring of the college administration
and returned to teaching full-time.
"The University is losing its moral authority over
undergraduates . . . by failing to respond to faculty
malfeasances with the same high-mindedness with which it treats
undergraduates," Lewis writes in his forthcoming Excellence
Without a Soul: How a Great University Forgot
Lewis contrasts the Shleifer case with the way Harvard
approaches student misconduct, demanding "openness and honesty"
of the student, investigating the alleged infraction promptly
and imposing sanctions, including expulsion where appropriate.
Lewis also invokes recent cases of academic misfeasance by two
prominent law professors -- Charles Ogletree and Lawrence
Tribe. Both were accused of "misusing the words of others" in
books they had written. When the "errors" were discovered, they
apologized. The episodes were investigated by panels of Harvard
eminences, including former president Derek Bok, now a
university professor, who determined that the infractions were
"inadvertent." In the case of Tribe, Summers and law school
dean Ellen Kagan announced last April that his error was a
"significant lapse in proper academic practice." The Summers
administration announced no action against Tribe, however, and
the Harvard Crimson, the undergraduate daily newspaper
started in 1873, took strong exception. "The evident double
standard," it editorialized, "sets a poor example for the
student body and for the wider community. A student caught
committing a similar crime might face the termination of his
Lewis, in his new book, draws a stark contrast between the
Tribe and Ogletree cases, on the one hand, and the Shleifer
scandal on the other.
"The Shleifer matter is strikingly different," Lewis writes.
Shleifer has never acknowledged doing anything wrong. Summers
has said nothing. And so far as is known, there has been no
internal investigation or sanction. "An observer trying to make
sense of the University's position on Shleifer, Ogletree and
Tribe is driven to an unhappy conclusion. Defiance seems to be
a better way to escape institutional opprobrium than confession
and apology. . . . And most of all being a close personal
friend of the president probably does one no harm."
Greek and Latin professor Richard Thomas, the chairman of
the classics department and a member of three key committees of
the faculty of arts and sciences, agrees with Lewis's last
point at least: "If I had been found liable for conspiracy to
defraud the U.S. government, with the result that Harvard had
to pay a substantial settlement, I can't imagine there would
have been no consequences for me," Thomas tells
Although Lewis does not declare Summers unfit to be
president of Harvard, he comes close. The faculty vote of no
confidence in Summers last spring indicates they believe he
does not "meet the Harvard standard," Lewis writes. Summers
doesn't offer "leadership they could respect. The Harvard
faculty would rather mind its own business than vote down the
president; they did not do so for sport." Summers, the computer
scientist says, has "failed to bring honor to the
For the record
This article broadly reflects facts as determined by Judge
Douglas Woodlock of the U.S. District Court in Boston in his
Memorandum and Order of June 28, 2004, in the case of United
States of America v. The President and Fellows of Harvard
College, Andrei Shleifer, Jonathan Hay, et al. After reviewing
the parties' court papers as well as nearly 60 depositions and
more than 1,000 documentary exhibits in the lawsuit, Judge
Woodlock found that, while running the Harvard Institute for
International Development's advisory program in Russia in the
early 1990s, Harvard economics professor Shleifer and attorney
Hay had conspired to defraud the U.S. government, engaged in
self-dealing and violated conflict-of-interest regulations. The
judge earlier dismissed the case against Shleifer's wife, Nancy
Zimmerman, a hedge fund manager, and Hay's wife, Elizabeth
Hebert, a mutual fund company executive, because, he found, the
government essentially had failed to state sufficient relevant
facts upon which to base a judgment.
However, later in 2004 the government announced that
Zimmerman's firm had agreed to pay $1.5 million in a
settlement. A year later Harvard agreed to pay the largest
amount in its history to settle a lawsuit -- $26.5 million.
Shleifer agreed to pay $2 million, Hay between $1 million and
$2 million. All four of the original individual defendants
testified extensively under oath, defending their roles in the
Russian aid program. None acknowledged liability. In his
settlement Hay said he disputes "certain of the contentions"
against him. In a statement at the time, Shleifer said: "An
individual can fight the unlimited resources of the government
for only so long. After eight long years, I have decided to end
this now -- without any admission of liability on my part. I
strongly believe I would have prevailed in the end, but my
lawyers told me my legal fees would exceed the amount that I
will be paying the government."
Shleifer and Zimmerman declined through their lawyer to be
interviewed directly. The magazine was unable to reach Hay.
Hebert, responding in an e-mail, asked that the author not
contact her in the future.
The reformers' report card
How much did the scandal involving the Harvard Institute for
International Development harm Russia?
It's easy to exaggerate the extent of U.S. influence. A
glance at Iraq underscores how difficult it is for Washington
to effect fundamental change in other countries: One can make
the case that reforming Russia was more critical to the world
-- and more challenging. Sowing the seeds of shareholder
capitalism in a country with an authoritarian history and no
experience of free markets for seven decades was going to be an
uphill task even for the elite of the premier U.S. academic
Notwithstanding those constraints, however, Harvard
University was in a unique position to exert a powerful
influence. Post-Soviet Russia turned to the West for help in
rebuilding its economy and filling the vacuum left by
communism's fall. 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. Instead, their
personal dealings sent a very different message.
"The defendants' actions undercut the fundamental purpose of
the United States' program in Russia -- the creation of trust
and confidence in the emerging Russian financial markets and
the promotion of openness, transparency, the rule of law, and
fair play in the development of the Russian economy and laws,"
the Justice Department asserted in its initial complaint in
U.S. v. Harvard, Shleifer, Hay, et al. on September 26,
Janet Ballantyne, a veteran officer for the U.S. Agency for
International Development, who headed AID's Moscow office when
the scandal broke, echoed that view in her testimony in the
lawsuit brought by the U.S government.
The Harvard advisers "had access to the highest levels of
government," she said. "What should have happened . . . as
Russians become acquainted with the way American institutions
work, [was] that they [would] learn the transparency and the
conflict of interest values that we also expect of our own
officials. I think that the damage to the United States'
relations with Russia was very great."
The collapse of the Harvard project arrested work on a
number of vital reform projects. At the Institute for Law-Based
Economy, some planned legislation was never finished. The
Resource Secretariat's effort to design a central clearinghouse
was halted, and Russia to this day lacks a fully realized
central clearing facility capable of handling both securities
and cash, a gap that has hampered the development of the
domestic securities market.
"This scandal hobbled the development of the Russian capital
market infrastructure for a substantial period of time," says
Bruce Lawrence, a Credit Suisse First Boston executive in
Moscow at the time. In A Normal Country: Russia after
Communism, his 2005 book on Russia, even Shleifer acknowledged
that "[i]nvestor protection and corporate governance in Russia
The Harvard scandal also undermined Dmitri Vasiliev and the
fledgling Russian Securities and Exchange Commission that he
headed. The commission was one of the few executive agencies
fully controlled by free-market reformers, and Vasiliev waged a
lonely battle against communist-era factory managers known as
"Red directors," budding oligarchs and conservative government
bureaucrats in trying to establish rules for a modern financial
market. The scandal tarnished Vasiliev's reputation, weakening
him politically. Eventually, the RSEC was demoted from an
independent agency to a department of the prime minister's
"It was the start of what we call the dark times," says Igor
Moryakov, president of the Depository Clearing Co. "People who
really understood . . . how to operate the market were
dismissed. New people, without any experience, without any
understanding of how markets work, came to power. It was an
absolutely huge disappointment."
Vasiliev had been virtually the only senior official to
oppose the Yeltsin government's overreliance on the domestic
bond market, calling it effectively a pyramid scheme. Russia
defaulted on more than $40 billion worth of domestic debt in
August 1998, triggering a financial tremor felt around the
"The scandal caused an extreme decline in the Russian SEC's
influence as a regulator," says economist Alexander Abramov,
head of development at the Moscow-based Russian Trading System,
the country's principal stock exchange, and the author of a new
book on Russia's securities markets. "It made the financial
crisis of 1998 more likely. And I think it destroyed the trust
and relationships between Russian authorities and American
The Harvard program can claim some successes. HIID advisers
did help create Russia's main stock exchange, the RTS, and
worked with the RSEC to establish a Web site and public
information service, the first of its kind set up by a Russian
agency. -- D.McC.
Where are they now?
Richard Bernard is the executive vice
president and general counsel of the New York Stock
Anatoly Chubais is CEO of UES of Russia,
the country's biggest power company. He survived an
assassination attempt on the streets of Moscow in April
Yegor Gaidar runs the Institute for the
Economy in Transition, a prominent Moscow think tank;
Jonathan Hay married Elizabeth Hebert
following the end of the Harvard Russia Project; he is an
associate in the London office of Cleary Gottlieb Steen &
Hamilton and is currently on leave;
Elizabeth Hebert left Pallada Asset
Management in the fall of 2005. The firm was sold to State
Street Global Advisors in 1998; in 2005, according to Russian
media reports, State Street sold Pallada to a Moscow entity
called Russian Funds Investment Group;
Holly Nielsen is international counsel and
co-head of the Russian practice at Debevoise & Plimpton in
Andrea Rutherford lives in Massachusetts,
where she moved in 2004 after five years as a managing director
at Brunswick UBS in Moscow;
Jeffrey Sachs directs the Earth Institute
at Columbia University and is a special adviser to United
Nations Secretary General Kofi Annan;
Andrei Shleifer teaches economics as a
tenured professor at Harvard. He is on leave for the current
academic year. He travels the world, publishes voluminously and
is widely cited as an expert in a variety of economic
Dmitri Vasiliev is first deputy general
director for strategy and corporate policy at the Russian power
Julia Zagachin runs the First Specialized
Depository (formerly the First Russian Specialized Depository)
in Moscow. She was a cooperating witness in the case of U.S. v.
Harvard, Shleifer, Hay, et al, having invoked the Fifth
Amendment and been granted immunity from prosecution before her
grand jury testimony;
Nancy Zimmerman runs Bracebridge Capital,
in Cambridge, across Massachusetts Avenue from Harvard Yard. --