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July 4, 2004
David Warsh, Proprietor


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Judge Finds Against Shleifer, Hay and Harvard

The US government’s long-running wrangle with economist Andrei Shleifer and Harvard University over Harvard’s ill-fated Russia Project in the 1990s was resolved last week, in the government’s favor.

A Federal judge ruled that, by quietly investing on their own accounts while advising the Russian government, Harvard professor Shleifer and his Moscow-based assistant Jonathan Hay had conspired to defraud the US Agency for International Development (USAID), which had been paying their salary.

Hay was faulted for violating three counts of the False Claims Act, Shleifer for one, with two other counts against him pending a possible jury trial on what it means to have been “assigned” to Russia under the contract’s terms. (Shleifer asserts that the conflict-of-interest rules didn’t apply to him since, though directing the project, he had continued to reside outside of Russia, in Newton, Mass.)

The decision by US District Court Judge Douglas P. Woodlock, based on motions by all sides for that he decide the case as a matter of law on the facts presented, left both Shleifer and Hay liable for treble damages — as much as $120 million apiece, in the worst case.

At the same time, Judge Woodlock cleared Harvard University of the government’s most serious accusation, namely that its administrators knew or should have known that their team leaders were investing personally in concert with their wives.

He ruled out treble damages under the False Claims Act, thereby confirming Harvard’s view of itself as the victim of a couple of rogue employees.

Harvard couldn’t be faulted for failing to investigate “rumor-like allegations” that trickled back to Cambridge, the judge wrote, for the “red flags” identified by the government never quite reached the level of a piercing whistle; they had more to do with gossip about the provision of various goods and services to Russian officials and their families.

The fact that the Project flew the chairman of the Russian SEC and his wife to Idaho for a part-work, part-vacation trip, and that Shleifer paid for training the chairman’s wife at his own personal expense “may be ethically dubious,” he observed, but they don’t demonstrate a clear conflict of interest. Nor could the university be blamed for inadequate supervision.

“A more careful employer might have, for instance, distributed a short memorandum explaining the conflicts provision, and perhaps even required Project staff (whether ‘employees’ or ‘consultants’) to fill out a disclosure form,” wrote the judge.

“If the applicable legal standard in this case were negligent supervision,” he continued, “the government would have a better case against Harvard.” Instead, he noted, the fraud law required proof of actual knowledge or reckless disregard.

Paul Ware, the university’s outside counsel, said last week, “Harvard is very encouraged that the court has unequivocally ruled that the university neither engaged in nor knew of any fraudulent conduct. Even the breach of contract claim, according to the court, is not established as a result of any institutional wrongdoing by the university.”

In finding that Harvard had breached its contract to deliver the impartial advice it promised, Judge Woodlock’s decision left Harvard liable for damages. Previously Harvard has defended the outcome of its project as, on balance, a great success. The university can be expected to argue that there should be a considerable offset to whatever damages are assessed in recognition of the benefits gained by Russia.

It was in 1992, after Congress passed the Freedom for Russia and the Emerging Eurasian Democracies and Open Market Support Act, that USAID hired Harvard to provide consultants to the Russian government to help design institutions favorable to democratic government and a market economy.

Shleifer in due course became the project director, Hay his deputy.

Allegations of conflict of interest boiled over among US aid workers in Moscow in 1997, and USAID began an internal investigation. The agency suspended the project in May. An angry Russian government, staffed by friends of Shleifer and Hay, shelved the relationship the same day. Harvard then fired Hay and relieved Shleifer, a tenured professor, of his project duties. USAID then cancelled the contract.

And in September, 2000, the US Attorney in Boston filed an 11-count civil claim against Harvard University, Shleifer, Hay, Nancy Zimmerman (Shleifer’s wife and a partner in a hedge fund with investments in Russia) and Elizabeth Hebert (Hay’s then-girlfriend, now his wife).

US Attorney Donald Stern said at the time that his office had contemplated criminal charges but filed none.

Judge Woodlock quickly dismissed the charges against Zimmerman and Hebert, on grounds that neither worked for Harvard or the government and were not parties to the contract.

As previously reported, Harvard at one point offered to settle its part of the case for as much as  $24 million, or two-thirds the value of its contract, in the course of an unsuccessful mediation by Judge David Mazzone, according to attorneys familiar with the case. Now that the government’s claim to treble damages has failed, the offer, whatever it was, will have long-since disappeared from the table.

Shleifer, who left Russia with his parents when he was 15, only to return as a senior adviser to its government (and a distinguished economist) at the age of 30, remains a Harvard professor.

Until last year, he was a principal of LSV Asset Management, a money management firm for institutional investors that, with fellow economist Robert Vishny and Josef Lakonishok, he co-founded in 1991.

His attorney, Earl Nemser, told Marcella Bombardieri of The Boston Globe, “We’re pleased now that most of the claims in the case, and against Andrei Shleifer, have been dismissed. We expect the remaining claims will be disposed of favorably to him.”

Jonathan Hay, who became a student of Shleifer’s while at Harvard Law School, joined the London office of the Cleary Gottlieb law firm as an associate in 2002.

An initial hearing on the damages phase of the trial may be held as early as July 19.  Extensive arguments about the ultimate success or failure of Harvard’s Russia Project eventually can be expected from all sides.

Judge Woodlock’s finding, reported in a clearly-written 100-page memorandum and order, came nearly 18 months after both sides asked him to decide the legal issues as a matter of summary judgment.

It was, perhaps, an unusually long deliberation, even for a judge with a reputation for taking his time. On the other hand, his findings were delivered a little in the manner of an O. Henry story, with a sudden twist at the end.

The nub of the case turned out to be the Pallada Asset Management Company.  Though evidence was adduced to show that Shleifer had been inviting his former student-turned deputy to invest with him in Russian oil stocks as early as the summer of 1994 — and though he and Hay made several other kinds of personal investments in the next couple of years — it was a scheme to win a license from the Russian SEC for Hay’s then girlfriend, Elizabeth Hebert, as the first authorized vendor of Russian mutual funds, that led to Woodlock’s decision to find both men guilty of the False Claims conspiracy charge.

The meaning of “assigned to Russia” might be so ambiguous that a jury would be required to decide two counts of the complaint that Shleifer committed fraud by investing in Russia while regularly visiting Moscow from Newton, Mass., Judge Woodlock wrote.

But on the third count, wrote the judge, there could be no such doubt. The available evidence clearly showed that a working understanding existed among Shleifer and Hay to inappropriately finance and assist in the launch of Pallada, in hopes of turning it into a Russian version of market-dominating Fidelity Investments.

Hay’s father lent Hebert $200,000 to buy a related business. Shleifer loaned her a similar amount a few months later to advance her plans.  The smoking gun here was something called “the Steyer memo,” a business plan written by Hebert, reviewed by Hay (and perhaps designed to be signed by him), and addressed to Thomas Steyer, a business associate of Shleifer’s wife, in hopes of attracting a further round of investment from him and others.

“We are likely to get a license before anyone else which will give us a significant first mover advantage… Given this project’s relationship with the Commission, any other attempts by definition will be in a catchup mode… In the short to medium term, our advantage comes from the fact the regulator wants us to be first…”

Shleifer was advisor to the Securities Commission.  Hay was drafting the securities law.  At one point, Shleifer consulted a Harvard lawyer to ask if his wife could invest in Pallada. It just wouldn’t look right, replied attorney Michael Butler.

“Tellingly” wrote the judge, “Shleifer did not ask Butler whether he could invest in Russia.”   And so it was, by making the loans and thereby financing the Pallada scheme, that the two men caused the submission of a false claim. 

Coming on page 92 of a 100-page opinion, the finding was a something of a surprise. It turned out that the meaning of “assigned to Russia” probably doesn’t matter in Shleifer’s case. One count of fraud is as defeating as three. The decision seemed to render moot any need to resort to a jury trial, and freed the court to move on to the question of who owes what and to whom.

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