Khodorkovsky & Lebedev Communications Center

Morning Session.

Mr. Khodorkovsky resumed cross-examining Mr. Zubkov. Mr. Khodorkovsky continued working with YUKOS' consolidated financial statements, asking Mr. Zubkov to confirm, or deny, information found there or in other related documents. Mr. Zubkov testified that approximately $15 billion USD in profits from 1999 through 2003 matched with his recollections. So did dividend payments of over $2 billion USD during the same period. Mr. Zubkov remembered that YUKOS was increasing its share capital in various subsidiaries, but explained that he would need to look at additional documents to testify with more specificity. Mr. Zubkov testified that YUKOS provided documents detailing ownership of various securities. He added that, on balance, YUKOS was purchasing more assets than it was selling.

Mr. Khodorkovsky asked about some of the matters discussed within PwC concerning the draft of YUKOS audit for 2003. Mr. Zubkov explained that one of the matters concerned Sibneft shares. YUKOS had on its balance sheet 92% of all outstanding Sibneft shares, but did not have operational control of that company. The question that PwC was working on was how to reflect that in consolidated statements.

Mr. Khodorkovsky asked Mr. Zubkov whether YUKOS management provided PwC with information about bank accounts where its subsidiary traders and investment companies maintained substantial deposits or other valuable assets. Mr. Zubkov testified that PwC received information as a letter signed by Messrs. Khodorkovsky and Misamore. [Later Mr. Khodorkovsky would ask about Mr. Zubkov's knowledge of Management Discussions and Analysis which accompanied YUKOS consolidated statements. -Eds.] While the information was not specifically broken down by individual companies' bank accounts, YUKOS management indicated full disclosure.

Mr. Zubkov testified that he and his colleagues knew that YUKOS consolidated its statements according to US GAAP. Mr. Zubkov explained that he during audit he worked with YUKOS domestic traders, testing certain transactions to make sure the information received from YUKOS was what it was. Other members of the YUKOS audit group tested the treasury group of companies.

Mr. Khodorkovsky asked what Mr. Zubkov knew about Management Discussions and Analysis that came with YUKOS financial statements. Mr. Zubkov explained that this document contained key financial information about the company, as well as management's commentary on key matters. He added that the auditor was responsible for making sure that information in that document matched with what was in the financial statements themselves.

After a short break, Mr. Khodorkovsky asked Mr. Zubkov, if the later knew, if PwC was aware that YUKOS production companies sold crude oil to YUKOS trading companies at prices different from those in Rotterdam. Mr. Zubkov confirmed that it was a well known fact that prices in crude oil production regions were considerably lower than those in Rotterdam. Mr. Khodorkovsky asked why PwC would not have considered this fact to be a material risk or, at least, something that was unusual. Mr. Zubkov, explaining that he wasn't the one to sign on the auditor's report, explained that PwC disregarded these sales as sales within a group of consolidated companies. According to Mr. Zubkov, an auditor was to provide a neutral opinion on the company, and nothing about the lower prices in production regions was likely considered unusual. Mr. Zubkov testified that based on what he remembered being written in media sources at the time, the public was aware that prices on the Russian market were lower than those on international markets.

Mr. Khodorkovsky asked Mr. Zubkov to examine a letter Mr. Shakhnovsky, President of YUKOS-Moscow, sent to PwC. In the letter, Mr. Shakhnovsky explained the substance of the exchange of VNK subsidiaries' shares, as well as that the exchange was temporary. Furthermore, Mr. Shakhnovsky assured PwC that those shares were under YUKOS control and YUKOS continued to consolidate Tomskneft's results. Mr. Zubkov, who did not audit these transactions, testified that, while he did not remember when the reverse exchange and the merger of VNK into YUKOS occurred, Tomskneft was consolidated in 2000, 2001 and 2002. Furthermore, he remembered that, in 2001, remaining Tomskneft minority shareholders sold their shares to YUKOS.

Turning to foreign crude oil traders, Mr. Khodorkovsky explained to Mr. Zubkov that the indictment had two groups: one with Behles Petroleum, Baltic Petroleum and South Petroleum, the other with Petroval, Pronet Holdings and Routhenhold Holdings. Mr. Zubkov testified that YUKOS consolidated the second group, while the first group was not consolidated.

Mr. Khodorkovsky asked Mr. Zubkov to examine an internal PwC memorandum, which discussed Baltic Petroleum and Behles Petroleum as being a related party to YUKOS. The memorandum, despite the aforementioned conclusion, also concluded that it wasn't necessary to include these companies in YUKOS consolidation perimeter and, furthermore, did not consider the issue to be material. Mr. Zubkov explained that a company could be related, but not consolidated, because it did not meet certain conditions, which he discussed last week. Mr. Zubkov did not want to speculate why PwC personnel decided that the issue of Behles and Baltic was not material to the financial statements.

Afternoon Session.

Mr. Khodorkovsky asked Mr. Zubkov to examine the letter PwC sent to Mr. Rebgun, where it informed him that all YUKOS auditor's reports were being recalled. Mr. Khodorkovsky went through each of the stated reasons, while asking Mr. Zubkov questions. Mr. Zubkov testified that he was not aware of any facts that would suggest that Messrs. Muravlenko, Ivanenko, Kazakov and others were not granted beneficiary interest in YUKOS shares for their services in developing YUKOS. Mr. Zubkov confirmed that, aside from those facts showing affiliation, he was not aware of any additional facts which would have shown control over domestic traders that YUKOS was consolidating. Finally, Mr. Zubkov was not aware that YUKOS ever purchased or paid for third party obligations before Bank MENATEP. Instead, Mr. Zubkov reiterated what he testified about last week - YUKOS purchased Bank MENATEP collection rights for approximately $191 million USD. Despite being unable, without looking at additional documents, to describe gains or losses on resulting transactions, Mr. Zubkov remembered that one of the outcomes was YUKOS receiving approximately 90 million of its shares.

Mr. Lebedev took over. Mr. Zubkov testified that in addition to informing PwC what companies were consolidated, YUKOS provided information from companies' registries and evidence of purchase of additional shares, as it did for Yuganskneftegaz. Mr. Zubkov testified that he participated in testing management's inclusion of Russia-based crude oil traders. According to Mr. Zubkov, PwC Moscow office maintained all documents that, put together, made-up the audit dossier, but he did not know the names of specific employees in charge of the dossier.

Mr. Lebedev, apologizing in advance for the type of question he was about to ask, inquired if Yuganskneftegaz profit was consolidated in YUKOS financial statements during the time that Mr. Zubkov worked on the YUKOS audit team. Mr. Zubkov testified that it was.

Mr. Lebedev asked Mr. Zubkov to examine consolidated income figures from the 2002 financial statements. He asked whether YUKOS, because its financial statements showed consolidated revenue and all of its subsidiaries were under its control, had to pay taxes on that income, as well. Mr. Zubkov told the court that he wasn't a tax specialist, but understood that tax authorities successfully convinced the courts that YUKOS had to pay taxes instead of companies like Fargoil. Mr. Lebedev asked whether during the audit each company was a registered tax payer, or was YUKOS the only one registered to pay taxes. Mr. Zubkov testified that during audits every subsidiary was registered as an individual tax payer.

Mr. Lebedev asked Mr. Zubkov to look at some of Fargoil's tax statements. After examining the documents before him, Mr. Zubkov testified that when Fargoil paid out dividends to its parent company, it paid taxes to the federal budget, as well. According to Mr. Zubkov, taxes paid by Fargoil and other traders were accounted for in YUKOS consolidated financial statements. Mr. Zubkov confirmed the same information for Ratibor, another crude oil trader. Mr. Lebedev asked whether, after tax authorities began reclassifying crude oil trader activities in the tax audits, PwC made an attempt to reconcile the new tax demands with traders' previous tax payments. Mr. Zubkov did not know.

Mr. Lebedev returned to South Petroleum and Baltic Petroleum. In quick succession, while examining financial statements for each company, Mr. Zubkov testified that none of the companies listed as shareholders or final beneficial owners were ever consolidated with YUKOS, because there was no information to support their affiliation with the company. Examining a list of South Petroleum's executive directors, Mr. Zubkov recognized Peter Bond's name, but only remembered it as appearing on some of the documents he may have come across while being a member of the YUKOS audit team.

Mr. Lebedev asked Mr. Zubkov about the latter's familiarity with a Clifford Chance memorandum explaining YUKOS privatization. Mr. Zubkov, after examining the document, confirmed that this was probably the memorandum he saw while still working at PwC. Mr. Zubkov testified that he did some work on project "Voyage," but seemed surprised when he admitted that he was unaware that all documents related to privatization of YUKOS, including copies of contracts and statements by government agencies, were uploaded into data-room, to which PwC had access along with other parties involved in the proposed YUKOS listing on the NYSE.

Mr. Lebedev asked a series of questions about Brittany Assets Limited and Project "Victor." Mr. Zubkov seemed surprised when Mr. Lebedev told him that Mr. Misamore was Brittany's director. Mr. Zubkov testified that he did not know the origin of the project and wasn't aware why the project was never completed. Mr. Zubkov confirmed that Brittany was one of the companies that YUKOS consolidated. Mr. Zubkov confirmed that Brill Management was Brittany's subsidiary. Mr. Zubkov testified that some of PwC employees collected information on ownership structure of various companies, with other employees using it in their projects. Mr. Lebedev asked where that information was now or if it was seized by investigators. Mr. Zubkov testified that he thought the information was in electronic form, but because he was not present during any search and seizures, he could not testify as to what happened to it.

Mr. Khodorkovsky, who took over for Mr. Lebedev, asked a series of questions about Abacus Ltd., a Cyprus-based professional services firm which provided accounting services to YUKOS subsidiaries who operated in Cyprus. Mr. Zubkov explained that Abacus provided accounting services to YUKOS subsidiaries and he contacted it on numerous occasions while working on YUKOS audits. Mr. Zubkov did not know, except for what he told the court, if and how Abacus was connected with PwC or YUKOS.

Mr. Khodorkovsky's final round of questions was about Brittany Assets. Mr. Khodorkovsky prefaced by explaining that the question may seem difficult. Mr. Khodorkovsky asked the witness to note that, based on a table Mr. Zubkov earlier in the hearing, YUKOS had approximately $15.6 billion USD in consolidated profit [from 1999 through 2003]. During that time period YUKOS spent funds on merger with Sibneft, acquiring other assets, paying dividends and so on. That comes up to approximately $15 billion USD. At the same time, it looks like there's $8 billion USD on Brittany. Mr. Khodorkovsky asked if Mr. Zubkov was able to explain anything about this to the court. Mr. Zubkov was reticent, so Mr. Khodorkovsky asked whether the $8 billion was in cash or liquid securities, meaning [could this sum be spent]. Mr. Zubkov explained that the same balance sheet contained entries for over $2 billion USD in loans made by Brittany but, in any event, the company did not have an available cash balance of $6 billion USD. Mr. Zubkov posited that if Brittany was consolidated, all intra-company promissory notes would have been eliminated.

After a short brake, Ms. Kovalihina asked to re-direct. Answering Ms. Kovalihina's questions, Mr. Zubkov testified that domestic crude oil traders within YUKOS consolidation perimeter paid dividends to their shareholders, who were companies based in foreign jurisdiction. According to Mr. Zubkov, domestic traders purchased crude oil from production subsidiary companies at intra-company prices. Using YUKOS or YUKOS Export Trade as commission agents, domestic trading companies sold crude oil to Routhenhold at prices that could be several times higher than what the crude oil was purchased for. That price was based on the current exchange quotes. Routhenhold sold to third parties, using Petroval as an agent, but the margin resulting from sales to third-parties was insignificant when compared to consolidated profit of YUKOS.

Ms. Kovalihina asked about consulting services that YUKOS paid for. Mr. Zubkov testified that YUKOS hired various consultants, some to market crude oil, for example. These may have totaled $70 to $100 million USD, but Mr. Zubkov could not be more specific. Ms. Kovalihina asked if Mr. Zubkov remembered any company names. Mr. Zubkov told the court that "Yauza" came to mind, but he could not be more specific.

Ms. Kovalihina asked if YUKOS faced any risks due to its use of intra-company pricing. Mr. Zubkov testified that these risks were considered to be insignificant, with no reserves or disclosures being made in consolidated financial statements.

Ms. Kovalihina asked whether US GAAP required the client to provide truthful information only. Mr. Zubkov told the court that, although it may not be stated specifically, it was implied. Ms. Kovalihina asked whether under US GAAP an auditor could discover embezzlement if the client provided false information. Mr. Zubkov explained that in his understanding the purpose of an audit was not to uncover embezzlement. The purpose was to express an opinion about the financial statements of a company. However, if an auditor uncovered embezzlement or any other criminal activity, there were procedures which directed the auditor on how to react.

Mr. Lebedev asked the court to re-cross Mr. Zubkov. Discussing Mr. Zubkov's answer about use of intra-company pricing, Mr. Lebedev asked to clarify whether sales to Routhenhold weren't also intra-company. Mr. Zubkov testified that sales from domestic traders to Routhenhold were intra-company, as well. Furthermore, Mr. Zubkov clarified that the price crude oil was sold for was based on a formula, which included deductions for various expenses. Mr. Lebedev whether Mr. Zubkov was aware that crude oil purchase price at which domestic traders purchased from producers was also based on a formula. Mr. Zubkov was not, explaining that he did not see all the documents that were part of domestic crude oil purchases. However, Mr. Zubkov testified that domestic crude oil trader assumed all expenses once they obtained ownership right over crude oil.

Mr. Lebedev asked why Mr. Zubkov thought to compare Routhenhold's margin to YUKOS consolidated profit, calling the former insignificant. Mr. Zubkov was unable to provide a clear answer, telling the court that it was a comparison between profits. Mr. Lebedev asked whether Mr. Zubkov meant to compare Routhenhold's margin with that of Fargoil or YUKOS-M, meaning that the latter had more profit than the former. Mr. Zubkov answered that that was the case. Mr. Lebedev asked whether Mr. Zubkov realized that domestic trader's profitability was not based on margin on the trade, but on the tax incentives and tax breaks those companies received, and that crude oil pricing did not play a role. Mr. Zubkov admitted that Fargoil and YUKOS-M had an advantage due to tax breaks on the income tax, meaning that the tax breaks had an impact on those companies' bottom line.

About consulting services, Mr. Zubkov admitted that financial statements did not contain a line totaling consulting expenses. Mr. Zubkov explained that he thought Ms. Kovalihina and he were discussing where consulting expenses would be entered in consolidated statements, but that to find specific details one needed to look at statements for specific companies.

Mr. Lebedev asked whether tax authorities, prior to Mr. Lebedev's arrest in July 2003, won any court cases where the issue litigated was intra-company pricing. Furthermore, Mr. Zubkov testified he wasn't aware that as late as November 2003 the Tax Ministry was informing YUKOS that it had no outstanding tax liabilities before the federal budget. Mr. Zubkov testified that from whet he remembered, until December 2003 levy of 90 billion Rubles YUKOS was never presented with these kinds of amounts.

Mr. Lebedev asked if Mr. Zubkov was aware what the VAT rate was for crude oil export sales. Mr. Zubkov, smiling, told the court that he did not know the exact legal term, but the VAT rate was zero. Mr. Lebedev asked if Mr. Zubkov knew why YUKOS was the only company to be assesses VAT of 20% for export sales in 2000-2003 and 18% in 2004. Judge Danilkin struck the question. Mr. Lebedev asked whether PwC ever recommended to YUKOS management creation of reserves to plan for a possibility that YUKOS will be the only Russian company to be assessed VAT on export sales, that a risk of about $15 billion USD existed. Mr. Zubkov explained that he never audited tax transactions. He testified that based on his knowledge of financial statements he did not remember that reserves for payment of VAT ever existed.

Mr. Lebedev asked whether Fargoil or YUKOS-M underwent audits by tax authorities that YUKOS underwent for 2000-2004. Mr. Zubkov did not know, but Mr. Lebedev pointed out that not one of YUKOS domestic traders was audited by tax authorities.

The clock was approaching 19:30. Mr. Lebedev did not have anymore questions and Mr. Zubkov was free to leave.

The trial will resume on Wednesday, March 10, 10:30 Moscow Time.