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July 7, 2002
David Warsh, Proprietor


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The Thing’s a Mess

With the breakdown of negotiations for a settlement last month, the Justice Department’s complaint against Harvard University in connection with its 1990s mission to Moscow has taken a new and ominous turn.

The Boston Globe reported last month that prosecutors had filed a motion for summary judgment, asserting that in a thousand pages of exhibits and depositions, they had proved their case. (To read Thanassis Cambanis’ two excellent stories, however, you’ll have to search the Globe yourself and pay.)

Before long, we’re going to find out what the judge thinks of the government’s case that Professor Andrei Shleifer and Jonathan Hay illegally speculated in Russian stocks and bonds, even as they directed a US-funded, Harvard-backed project to help the Russian government set up honest and transparent capital markets — a project whose rules expressly forbid them to invest in the host country.

It’s hard to imagine that it’s going to end happily for Harvard.

The question is, how big a black eye?

The verdict, when it comes, could cost Harvard as much as $102 million — a substantial sum even for the world’s richest university. The US is seeking treble damages under the False Claims Act.

But in some ways, that’s the least of it.

Then again, if the judge finds for Harvard, it’s always possible the case simply could go away. Someone at university headquarters in Massachusetts Hall apparently thinks he will — otherwise, why not settle now?

But even if Harvard wins, you can expect aftershocks to continue for years to come.

There is no better introduction to the background of the case than a new book, The Oligarchs: Wealth and Power in the New Russia, by David Hoffman. Hoffman was chief of the Moscow bureau of The Washington Post from 1995 until 2001. His book is a tour de force, focusing on the intertwined lives of six powerful men to demonstrate how a relative handful of highly adaptable buccaneers took control of the Russian economy in the 1990s. It was the greatest seizures of power since the Russian Revolution, and a good deal less widely understood.

The reformers around Boris Yeltsin at the beginning of the decade believed they had little time to dismantle state communism, Hoffman writes. So they deliberately “set out to wreck the old system at any cost.” They freed prices and property rights first and established rules only later. “Russian capitalism was born in an airless space, a vacuum without effective laws and a state so badly weakened it could not enforce laws that were on the books.”

“Time and again, questions arose about the deals made by these six men,” he writes. “Were they legal? Were they criminal? But the questions were not easily answered because the players moved about in a world lacking the legal constraints or the moral compass of a mature Western society. …Lying, cheating, stealing were a part of daily business…”

Given the situation in Russia, the basic facts of the government’s case against Harvard are these. Once a last-ditch coup by the old guard failed in 1991 and it became clear that Russia would remain on a liberalizing path, the Bush administration decided to send it a measure of technical help.

The US State Department twice hired Harvard’s Institute for International Development to advise the Russian government, first under the Bush administration in 1992 and then again under the Clinton administration in 1995. HIID gave the required assurances to the government that its employees would make no investments. It required no less of them itself. Then it named Shleifer project director and designated Jonathan Hay, a Rhodes scholar and graduate of Harvard Law School, head of its Moscow office.

Under Shleifer, Harvard’s Russia Project quickly became the flagship of US aid to Moscow, offering advice on all manner of financial reforms and overseeing the grants of other contractors as well. After all, the project director wasn’t just another out-of-town theorist armed with a quick course from Berlitz.

In fact, Shleifer had grown up in what was then the Soviet Union, the child of successful but frustrated engineers. He was 15 when his family was allowed to emigrate, first to Italy, then to the US, with the help of the Hebrew Immigrant Aid Society. During a couple of years in high school in Rochester, N.Y., he showed exceptional promise, before being recruited to Harvard College. There he met a rapidly rising assistant professor of economics named Lawrence Summers, who promptly took him under his wing.

A wry and gregarious man, Shleifer turned out to possess terrific economic intuition. His English, on the other hand, he would tell friends, all came from watching “Charlie’s Angels.” After an MIT Ph.D. and a year at Princeton and three more at the University of Chicago, he returned to Harvard as a full professor, under Summers’ sponsorship. Within a decade, he had won the John Bates Clark Award given every other year to the most promising economist under 40, for his work in finance, corporate governance and transition economics, securing his reputation as one of the most influential contributors to economics of his generation.

And for a time, in the mid-90s, Shleifer cut a dashing figure on his frequent trips to Moscow, a once-despised local boy who returned as Harvard’s pointman on the US economic mission — a Kissinger for the next century. He befriended the leadership of a generation of technocratic Russian reformers, including deputy prime minister Anatoly Chubais and Dimitri Vasiliev, chairman of the Securities Commission. He basked in the fact that his old mentor Larry Summers now was second-in-command at the Treasury Department, with broad responsibility for monitoring aid to the Russian economy. (Eventually Summers would succeed to the top Treasury job.)

But almost immediately, according to the government, Shleifer and Hay had begun investing in Russian projects, each in connection with his spouse or girlfriend. It wasn’t a matter of their engaging in insider trading, the lawsuit asserts; any investment at all would be a stark violation of the terms of service.

In 1994, the government says, Shleifer put $200,000 into a company called Renova Invest. Apparently the money came from his well-to-do wife, Nancy Zimmerman. Not long before she had left Goldman Sachs in order to start a hedge fund; soon she would be investing in Russian securities.

The same year, he and Hay bought $264,000 of Russian oil stocks through a Channel Islands account registered in the name of Zimmerman’s father. Hay made a quick $3,000 profit speculating in short-term Russian government bonds.

The pair then traded on their reputations to launch Russia’s first licensed mutual fund depository, operated by a former Harvard employee and Hay’s girlfriend. They helped plan its drive to market, then invested in it themselves. The gains were potentially enormous.

None of this is in dispute.

At that point, any number of whistles sounded — commercial competitors, subordinates, rival advisors. Harvard investigated and fired Hay. USAID investigated and fired Harvard. Miffed that their friends had been sacked, the Russians in turn fired USAID. Harvard dissolved HIID. Assistant US Attorney in Boston Sara M. Bloom investigated and, in due course, sued Harvard, charging that its failure to supervise its project ultimately destroyed its credibility and thus constituted fraud.

The particulars of the case seem well-established. The government last month filed a compendium of 249 “undisputed material facts,” some of them e-mails describing in excruciating detail various investments and the pains taken — or not taken — to disguise them. Harvard’s defense apparently rests on its contention that Shleifer and Hay never disclosed to the university that they were investing. Shleifer apparently contends that he was a consultant rather than an employee under the contract and therefore not covered by conflict of interest provisions. Hay, having long ago been fired by Harvard, is working as a consultant in Moscow. His rejoinder, like that of the other defendants, will come later.

There is no point in arguing about it in advance. US District Judge Douglas P. Woodlock will decide the case soon enough. So incendiary are the issues that it wants the closest possible determination. That’s what legal proceedings are all about. A civil case against Harvard, brought by competitors for mutual fund licenses who lost out to the Harvard-backed firm, is slowly making its way as well.

But there are two other constituencies here besides the courts. One is Harvard itself — not just the Harvard that is actively managed from Massachusetts Hall, but the larger community that is loosely cared for by faculty and alumni who are concerned for its sensibility and reputation over time. For this constituency the role of Harvard Management Co. is another issue. The highly sophisticated money management firm, which oversees Harvard’s $18 billion endowment, apparently invested directly in the Russian economy throughout the ’90s.

The other expert community is the economics profession. No matter what happens next, lingering questions will remain in both quarters.

Perhaps the chief surprise so far has been the position of former Treasury Secretary Larry Summers. In 1996 he cautioned both Shleifer and his wife about the potential for scandal if she tried to invest in Russia; neither had disclosed to him their personal investments. The assumption had been that he would distance himself after the government case was filed.

But Summers is understood to have regularly stayed at the Shleifers’ home in Newton while interviewing for the presidency. And in his deposition last March, he came as close as anyone yet has to defending his friend. “Post this thing coming to light,” Summers allowed in his testimony, “there probably were conversations that the thing’s a mess; it’s a mess.”

But, he noted, “I had enough knowledge of Russian mores and Russian practices and Russian views… to be confident that the set of issues contained in the allegations were not issues that were consequential for them; and indeed, that they would have, in part, valued advisers more extensively if they were more involved in actual private sector activities.”

In other words, it’s easier when everybody at the table is an oligarch — a reasonable enough argument, though not one that shows up in Shleifer’s 1999 book (with Daniel Treisman) on political tactics and economic reform in Russia, Without a Map. Indeed, such considerations are ordinarily depicted only in thrillers, when the border-crossing government op flirts with mob ways in order to prove his bona fides. He then turns his targets — or is turned himself.

To which Assistant US Attorney Bloom responds in the government brief, “This is not a case where the defendants did not know the rules — it is one where they did not care…. Harvard and its employees, no matter how brilliant, are still subject to the laws of the United States.” Every bit as much as Shleifer, Bloom is a central figure in the story — a resourceful and implacable investigator who for five years has withstood enormous pressure to drop the case.

Summers has recused himself from Harvard’s decisions about its defense against the government lawsuit — though not before telling outgoing faculty dean Jeremy Knowles how important he thinks it is that Shleifer should remain at Harvard. Who quarterbacks a case as difficult as this one when the university president is involved — and when the issues are not only narrowly legal but moral? The short answer is the Harvard Corporation.

“The Corporation” is the oldest self-perpetuating body in North America. It governs Harvard, quietly and gently, but firmly. The newest of its seven members is Citigroup banker Robert Rubin, who was Summers’ boss at the Treasury Department. Rubin recently replaced Herbert “Pug” Winokur, CEO of Capricon Holdings and chairman of the finance committee at Enron Corp, who resigned from the corporation only after some months of backstage maneuvering. Others include Summers himself, ex officio; Harvard treasurer D. Ronald Daniel; Hanna Holborn Gray, president emerita of the University of Chicago; Conrad K. Harper, partner, Simpson Thacher & Bartlett; James R. Houghton, Chairman of the Board Emeritus, Corning Inc.; and Robert G. Stone Jr., chairman emeritus of Kirby Corp.

No less than in the ’50s, when in a variety of subtle ways Harvard faced the choice of whether and how to throw its weight against the anti-communist hysteria, the university is once against poised on a razor’s edge. This time the dilemma is between financial realpolitik and some updated version of semi-insulated disinterestedness. The same choices regularly recur all along a lengthy spectrum extending from the research frontiers of the medical school to the consideration given major donors to the seemingly mundane philosophy of undergraduate admissions and athletics. The Shleifer case is only momentary the leading edge.

As for the economics profession, rivalries among departments surely play a role. Shleifer has no more avid defenders within Harvard than his immediate colleagues, who, as Summers told his interrogators in March, view Shleifer as having been somehow “screwed.” The Harvard economists have worked hard over the past 35 years to rebuild their department from the also-ran shambles that it was in the early ’60s. They don’t want to see one of their strongest drawing cards (remember, the best new students from each year’s crop of entrants are the life’s blood of any university) defect to MIT — or the University of Chicago.

Meanwhile, the elders of the economics profession have expressed solidarity with the embattled professor by appointing Shleifer editor of the “Journal of Economic Perspectives.” Since the quarterly is intended by the American Economic Association to represent technical economics to the general public, the job is a position of enormous influence. The fact that former World Bank chief economist Joseph Stiglitz doesn’t mention the government’s case against Harvard in his otherwise incendiary Globalization and Its Discontents suggests just how far professional courtesy extends. For that matter, the Shleifer story doesn’t come up in The Oligarchs, either.

Whatever ventilation the issues will receive thus lies ahead. A hearing before the judge is slated for September — September 11, to be precise.

* * *

This column has been corrected since its first posting. Joseph Stiglitz, the former chief economist of the World Bank, was originally misidentified as the former chief economist of the International Monetary Fund.

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