Khodorkovsky & Lebedev Communications Center

Morning Session.

The trial resumed with Ms. Ibragimova reading the written version of the "operative information" she presented verbally on last Friday. According to well informed sources at the Investigative Committee at the General Prosecutor's Office, based on the information received from the PwC Moscow Office, Mr. Kubena no longer worked for ZAO PricewaterhouseCoopers Audit. Mr. Lebedev asked the court to note that according to the just offered information, Mr. Kubena did not work at the Moscow Office, which did not exclude the possibility that he worked for PwC at one of their other offices.

The court asked the defense to continue with presentation of evidence. Mr. Klyuvgant told the court that defense would like to call Mr. Mikhail Kasyanov, who was in the courthouse, to the witness stand. Judge Danilkin inquired what questions defense sought to ask Mr. Kasyanov. Mr. Klyuvgant was succinct and told the court that all questions will be about the witness' knowledge of activities conducted by YUKOS. Mr. Lakhtin demanded to know how any of the potential testimony would be connected with the indictment - including specific pages that he wanted the defense to cite to. Having heard both sides, Judge Danilkin told Mr. Klyuvgant to continue.

After having answered the preliminary questions posed by the court, including providing a description of his previous employment history - Minister of Finance of the Russian Federation, Deputy Prime Minister of the Russian Federation and, from May 2000 through February 2004, Prime Minister of the Russian Federation - Mr. Kasyanov began answering Mr. Klyuvgant's questions.

Mr. Kasyanov testified that he knew Mr. Khodorkovsky, but never met Mr. Lebedev. According to Mr. Kasyanov, as Prime Minister he met regularly with representatives of the nine biggest crude oil companies, who were the biggest tax payers in the Russian Federation. During the very first such meeting, held sometime in early 2001, he met Mr. Khodorkovsky.

Mr. Klyuvgant told Mr. Kasyanov that the next few questions were standard to discover whether the witness may have a particular predisposition to testifying favorable about the defendants - a kind of reverse of the question that was asked by the court about personal animosity towards defendants. Mr. Kasyanov testified that he met Mr. Khodorkovsky's parents on several occasions. He told the court that he was not offered any payment and was not threatened in any way in order to secure his testimony. He did not feel obligated to testify at the trial for any other reason.

Mr. Klyuvgant turned to questions about YUKOS. Mr. Kasyanov testified that amongst the nine largest crude oil companies which produced over 90% of Russia's crude oil output, YUKOS and LUKOIL were the two largest both in terms of crude oil production and payments made into the federal budget. During the time period he was asked about - 1998 through 2003 - Mr. Kasyanov characterized all crude oil companies as having three common characteristics: being vertically integrated, practice of using transfer pricing and permitted by law use of zones with preferential tax treatment. Mr. Kasyanov added that this description applied to the aforementioned nine companies because he regularly met with those companies' CEOs.

Mr. Kasyanov testified that no new crude oil complexes were built since the Soviet times, which meant that existing crude oil complexes were widely dispersed within the Russian Federation. According to Mr. Kasyanov, this allowed the maintenance of the vertical integration as it existed in the Soviet Union; meaning that in any geographical region a crude oil refinery had, at most, two production companies which could provide the crude oil for refining. In practical terms, it meant that there was no competition. Mr. Kasyanov explained that the technological chain of crude oil production included crude oil production companies, refineries, traders and servicing companies.

Mr. Kasyanov described transfer pricing as normal price-forming mechanism within a vertically integrated holding, in the crude oil and other industries. He explained that this mechanism allows establishing an adequate price for delivery of crude oil for refining, with the final goal of having reasonable prices for the final product on the open market. According to Mr. Kasyanov, transfer pricing mechanism allowed to show the entire revenue volume and to provide the government with accurate information about the company's tax base for subsequent taxation. Mr. Kasyanov testified that the government received regular reports on the total amount of payments and comparison on payments between the companies within the crude oil industry. YUKOS tax payments per ton of crude oil produced were consistently in the middle or upper half of those amongst the largest crude oil companies.

Mr. Kasyanov testified that when he was the Prime Minister and to this day, there was no wholesale crude oil market within the Russian Federation. The crude oil companies and their divisions are located where they were during the Soviet times and the transfer pricing exists to this day, due to the way the industry is organized.

Mr. Kasyanov told the court that at the time he became the Prime Minister, the tax system which existed was based on a common consensus amongst the member of the Russian Duma, which passed laws allowing formation of zones with preferential tax treatment. He explained that he began an effort to convince the legislators that a system where certain regions were being supported by tax collection from crude oil companies based there had to be changed to a centralized federal system. Towards the end of 2003 his cabinet presented a package of laws aimed at changing the system, laws which were passed and exist to this day. Regardless of the existence of the new tax system, the vertical integration continues to exist and the transfer pricing continues to exist, as well.

Asked about the government's oversight of the crude oil industry, particularly the tax and the export controls, Mr. Kasyanov explained that there exist tax inspection services, including at that time a division for the largest tax payers, which, together with the Ministry of Finance, regularly reported on the funds the government received. Mr. Kasyanov testified that the federal budget was based in large part on these expected funds, which resulted in his practically weekly reviews of the funds flowing into the government accounts. He added that in 2001 and 2002 he met regularly with the heads of the crude oil companies to ensure that the government and the business arrived at a consensus on the extent of the proposed tax legislation.

Mr. Kasyanov testified that the government played an active role in controlling crude oil exports. According to Mr. Kasyanov, during the early 2000s crude oil prices hovered around $20 per barrel, which made budgeting a difficult task. In order to ensure that excessive crude oil exports did not tank the market, the government had a tight control over crude oil exports. He explained that then, as now, there were "indicative prices" around which export pricing was based. Mr. Kasyanov testified that he did not remember an instance where one of the crude oil companied deviated substantially from the average export prices.

Mr. Kasyanov testified that he wasn't aware of any special oversight of the crude oil companies by the law enforcement or security agencies, but he was certain that he would have been informed if something outside of regular norms was occurring. As it was, no one reported any problems about YUKOS or other crude oil companies. Mr. Kasyanov could not confirm or deny that oversight of crude oil companies by the law enforcement and security agencies existed, but added that the crude oil industry was overseen by the Economy Ministry, Fuel and Energy Ministry, Tax Ministry, Environment Ministry and others, with all compiling reports and statistics.

Mr. Kasyanov testified that YUKOS, aside from being the second largest then the largest crude oil producer, was not any different from any of its industry peers. According to Mr. Kasyanov, while he did not remember the exact numbers, YUKOS was always in the middle or top half of all taxpayers within the group and at the top for crude oil production. [Later in the hearing Mr. Kasyanov would clarify that this remark was about taxes per ton of crude oil produced. In total YUKOS was one of the largest tax payers, period. -Eds.]

Mr. Kasyanov testified that he knew then, as he knows now, that prices at which crude oil is sold in the regions are substantially lower than those on the European exchanges. According to Mr. Kasyanov, this information was available publically. Mr. Kasyanov told the court that this price difference was a "fact of life" and it was difficult to imagine crude oil being sold in Omsk for the same price it was sold in Rotterdam. According to Mr. Kasyanov, the gasoline prices would have shot up higher than those in Europe. The situation remained the same to this day.

Mr. Kasyanov testified that it would have been unrealistic for crude oil companies, YUKOS included, to deliver crude oil to refineries at prices mirroring those in Europe. In fact, though these requests were never made through official channels, the government asked the crude oil companies to not raise crude oil and petroleum prices during the planting season, so that the farmers could afford to run their equipment. The companies heard the government's concerns and did not index prices with inflation and other factors. In addition, crude oil companied delivered crude oil and petroleum products to ministries and other government agencies, adjusting their prices for the Ministry of Defense, for example. Mr. Kasyanov testified that, in fact, a certain price control by the crude oil companies was part of political calculation and was encouraged by the government.

Mr. Kasyanov testified that Mr. Khodorkovsky was the CEO of YUKOS and represented the company in its interactions with the government. He confirmed that he never received any information about Mr. Khodorkovsky trying to hide his affiliation with YUKOS, including his position at the company. Mr. Kasyanov testified that when it came to the crude oil industry Mr. Khodorkovsky was by far the most active CEO and actually represented the industry during the negotiations about the new tax legislation. According to Mr. Kasyanov, he found Mr. Khodorkovsky to be the most astute CEO amongst the nine biggest crude oil companies, who acted as the leader of that team.

Mr. Kasyanov testified that until 2003 he did not notice any substantial disagreements between the government, its representatives and Mr. Khodorkovsky. But in 2003 there was a moment when he began to realize that there existed tension. He remembered participating in a February 2003 meeting between President Putin and a group of business leaders, when a fight against corruption was part of the discussion. Mr. Khodorkovsky presented a report, describing a deal by Rosneft to purchase Severnaya Neft as having characteristics of a corrupt transaction. Mr. Kasyanov told the court that he was surprised by President Putin's reaction, who, in a very sharp tone, told Mr. Khodorkovsky that there were issues with privatization of "his" company. Mr. Kasyanov told the court that from that moment on he began to feel that there was pressure being exerted on business and that around that time he began to have disagreements with Mr. Putin.

Mr. Kasyanov testified that he was never made aware of instances when YUKOS management and Mr. Khodorkovsky specifically, attempted to hide any information about the company. In fact, he remembered YUKOS being one of the first if not the first companies to publically disclose its financial information, which later became the norm for many large companies. He remembered that Mr. Khodorkovsky made numerous public appearances inside and outside of Russia, discussing transparency and other business initiatives. Mr. Kasyanov testified that Mr. Khodorkovsky was making these appearances as the CEO of YUKOS.

Mr. Klyuvgant asked Mr. Kasyanov if he knew Mr. Khodorkovsky in any other capacity than the CEO of YUKOS. Mr. Kasyanov did not. Mr. Klyuvgant explained that Messrs. Khodorkovsky and Lebedev were accused of leading an organized group of persons who stole 350 million tons of crude oil from YUKOS production subsidiaries during 6 years from 1998 to 2003 and asked whether a crime of this magnitude could have gone unnoticed by the government. Mr. Lakhtin objected, arguing that the question lacked specifics and was of leading nature. Mr. Kasyanov told the court that the volume alleged to have been stolen was probably the entire volume of the crude oil YUKOS produced and YUKOS, which was one of the largest tax payers and whose production was closely tracked, sold crude oil and petroleum products domestically and internationally. "To talk about embezzlement of this magnitude?! My answer is - absolutely not! That's not possible!" Mr. Kasyanov replied.

Mr. Klyuvgant asked why YUKOS, if its activity wasn't different from any other crude oil company, became the subject of tax prosecutions while its management became the subject of criminal investigations. Mr. Kasyanov testified that he had only one understanding of the situation. When the tension between Messrs. Putin and Khodorkovsky became apparent after February 2003 and Mr. Lebedev was arrested in July of that year, Mr. Kasyanov attempted to get an explanation from Mr. Putin, as these events were having an adverse effect on the business community and foreign investments into Russia. Mr. Putin refused twice to discuss this issue, but finally told him that YUKOS was financing political parties - not only SPS and Yabloko, which Mr. Putin approved, but the KPRF, which Mr. Putin did not approve. Mr. Kasyanov explained that he declined to pursue the conversation any further - first, because he was surprised to find out that a perfectly legal activity of financing political parties required a secret approval from the President and, second, because the answer was given about a question on why Mr. Lebedev was arrested. Mr. Kasyanov testified that after this conversation he formed an opinion that Mr. Lebedev's arrest was politically motivated.

Mr. Kasyanov testified that after Mr. Khodorkovsky was arrested he approached Mr. Putin once more, but this time was told to talk to the Office of the General Prosecutor, who knew what they were doing. He was able to get a briefing from Deputy General Prosecutor Birukov, who explained that the case against YUKOS and its management was being built on the practice of using companies in regions with preferential tax treatment to minimize taxes. Mr. Kasyanov explained that until December 2003 using companies in those regions was in compliance with the law, which further cemented his certainty that the process was politically motivated. Mr. Kasyanov testified that he publically announced his unhappiness with Messrs. Khodorkovsky and Lebedev's arrest, which was one of the reasons for the growing tension between Mr. Putin and him, finally leading to his dismissal as the Prime Minister.

Mr. Kasyanov testified that issues of export tariffs paid by crude oil companies and the stabilization fund which was formed from these payments were followed by two Deputy Prime Ministers in his government - Messrs. Kudrin and Khristenko. General analysis was performed by customs and tax authorities.

The defense had no more questions.

Mr. Smirnov cross-examined Mr. Kasyanov. Mr. Kasyanov testified that he did not know anything about the VNK subsidiaries shares exchange and he did not follow specific crude oil sales transactions that occurred within YUKOS. He explained that he knew the general principle that YUKOS, like all other crude oil companies, utilized transfer pricing within the holding. Mr. Smirnov asked why YUKOS was the leader in crude oil production and sales while being only in the middle of the pack when it came to payment of taxes. Mr. Kasyanov explained that the tax payment being made was not that different between the companies - it was affected by the production environment and production costs. [Pursuant to Mr. Khodorkovsky's follow-up question, Mr. Kasyanov clarified that he was comparing taxes paid per ton of crude oil produced, where YUKOS was in the middle or in the top half of the nine largest crude oil companies. As far as total tax payments, YUKOS was consistently one of the largest tax payers in the country. -Eds.]

Mr. Smirnov asked why a system of tax incentives in the regions remained in place until the end of 2003. Mr. Kasyanov explained that it took a while to change the minds of regional governors and members of the Duma about the way taxes should be collected. Mr. Smirnov asked whether the real reason for changing the law was the fact that big companies registered in regions with preferential tax treatment and were evading taxes. Mr. Lebedev objected to Mr. Smirnov's formulation, but Mr. Kasyanov was already telling the prosecutor that his version was simply not true. The tax legislation as it existed at the time allowed the regions to lower tax rates and to provide other incentives to crude oil companies, amongst others. According to Mr. Kasyanov, the practice fully complied with the laws as they were at the time. The government thought that it was inappropriate for the regions to finance themselves through this type of arrangement and made a decision to change the system.

Mr. Smirnov asked about transfer pricing within a vertically integrated holding and whether there was any difference based on whether crude oil was going to be utilized on the domestic and foreign market. Mr. Kasyanov told the court that economic advantages of vertical integration did not depend on where the crude oil or petroleum products were going to be sold. Mr. Smirnov's last question was about a standard of difference between domestic and international prices. Mr. Kasyanov told the court that in practice the price inside and outside Russia was very different - one had only to go to Europe to see that the gasoline is at least twice as expensive as it is in Russia.

After Mr. Khodorkovsky asked Mr. Kasyanov to clarify his comments that YUKOS was one of the largest tax payers while at the same time was in the middle or top half of the nine largest crude oil companies, Mr. Kasyanov explained that he was discussing the tax paid per ton of crude oil produced, because that was how he was briefed at the time.

The parties did not have anymore questions and Mr. Kasyanov was free to leave.

As the hearing resumed after a short break, the defense continued to present documentary evidence. Mr. Klyuvgant turned to the General Agreements concluded by YUKOS with Yuganskneftegaz, Samaraneftegaz and Tomskneft. He explained that the defense was going to highlight certain additional details which were omitted by the prosecution when they selectively read these documents into evidence. Mr. Khodorkovsky referred to those details in his testimony.

Reading the YUKOS/Yuganskneftegaz agreement, Mr. Klyuvgant asked the court to note that the agreement was signed by duly authorized persons, acting according to the by-laws of their respective companies - Mr. Muravlenko for YUKOS and Mr. Parasyuk for Yuganskneftegaz. Mr. Klyuvgant noted that Paragraph 2 of the agreements "Guarantees and Disclosures of the Parties" showed that a year an a half prior to the time period of the charges the parties made mutual guarantees and disclosures, which showed that Yuganskneftegaz did not enter into this agreement due to being misled.

Mr. Klyuvgant noted that the third and fourth paragraphs clearly established who was authorized to sign the subsequent crude oil purchase contracts on behalf of the parties and what attributes were required to comply with the General Agreement. In the fifth paragraph, establishing terms for transfer of crude oil, crude oil ownership rights and the assumption of risk, Mr. Klyuvgant pointed out that the paragraph described documents necessary to evidence the transfer. He pointed out that the indictment made other assertions, which were contradicted by Mr. Khodorkovsky's testimony and were supported by the agreement.

Mr. Klyuvgant noted that the sixth paragraph clearly established payment requirements for the property being transferred, which contradicted the government's assertions that crude oil was transferred free of payment.

Mr. Klyuvgant noted that Paragraph 11 Section 2 allowed the purchaser to assign his rights and obligations under the agreement, including assigning the crude oil ownership right obtained according to terms of the agreement.

Finally, Mr. Klyuvgant added that the government asserted that the general agreement established price terms which were disadvantageous to the production company. The court could see for itself that the agreement made no mention of the price, negotiation of which was relegated to the subsequent crude oil purchase contracts.

Mr. Klyuvgant read the YUKOS/Samaraneftegaz General Agreement, commenting on provisions analogous to those in the YUKOS/Yuganskneftegaz General Agreement.

Before the trial was adjourned for lunch, Mr. Klyuvgant entered into evidence a request for document production which Khamovnicheskiy Court sent to the Arbitrage Court of the West Siberian Circuit, asking the court to provide copies of arbitrage court decisions from Khanty Mansiysk, where the YUKOS/Yuganskneftegaz General Agreement was analyzed during litigation and, subsequently, served to support YUKOS contention that crude oil produced by Yuganskneftegaz could not be arrested by its creditors because the ownership rights were transferred to YUKOS. Mr. Klyuvgant noted that after the lunch break the defense planned to enter into evidence the court decisions which were received pursuant to the document production request.

Afternoon Session.

After the trial resumed, Mr. Klyuvgant went over the YUKOS/Tomskneft General Agreement. Mr. Klyuvgant noted that, as Mr. Khodorkovsky testified, the agreement contained described in detail when crude oil is transferred and when crude oil ownership rights are transferred. Furthermore, the parties never contemplated transfer of anything without payment. Once again, Mr. Klyuvgant noted that unlike what the government asserted in the indictment the parties did not establish any prices, as those were left to be determined for each subsequent crude oil purchase contract.

Next, Mr. Klyuvgant read two blocks of Arbitrage Court decisions. Each block ended with a final cassation review by the Federal Arbitrage Court of the West Siberian Circuit. The first three decisions involved the Arbitrage Courts' ruling on the validity of the YUKOS/Yuganskneftegaz General Agreement, with the Prosecutor's Office for Khanty Mansiysk arguing violations of the Russian Civil Code. The court of first instance found that only one provision in the entire General Agreement was invalid - the transfer of crude oil ownership rights at the well head. The court saw in this provision an attempt to prevent Yuganskneftegaz's creditors from arresting Yuganskneftegaz's property to satisfy outstanding obligations. [Mr. Khodorkovsky testified about the common practice used by the local criminal element, involving arrest of crude oil to satisfy claims based on criminally induced transactions. -Eds.] The decision of the court of first instance was overturned on appeal, with the appellate court ruling that the court of first instance was incorrect in voiding the provision on transfer of crude oil ownership rights. The court ruled that the fact that Yuganskneftegaz retained possession of the crude oil for processing after crude oil ownership rights were transferred did not make the ownership rights transfer fictitious, designed to prevent arrest of Yuganskneftegaz's property. The cassation decision affirmed the lower court, finding that the entire General Agreement was valid.

Mr. Klyuvgant asked the court to note that a final decision of the Federal Arbitrage Court, which entered into force, found existence of transactions with payment for crude oil, validity of the YUKOS/Yuganskneftegaz General Agreement and no violations of any third parties' rights.

The next block of decision examined an arrest of over 428 thousand tons of crude oil, which was effectuated by the Khanty Mansiysk bailiffs at the prompting of over twenty Yuganskneftegaz creditors. YUKOS, filing a petition to lift arrest, argued that no arrest could be placed on as yet non-existent property. However, when Yuganskneftegaz will extract crude oil, the ownership right will be transferred to YUKOS at the well head, pursuant to the General Agreement. Therefore, the arrest that was placed by the bailiffs violated the law by preventing the rightful owner from exercising ownership rights. The court of the first instance actually wrote that there couldn't be anything to arrest as Yuganskneftegaz did not have the capacity to store this kind of volume of crude oil, and the crude oil was transferred to Transneft. The appellate and cassation decisions affirmed the lower court's decision lifting the arrest.

Mr. Klyuvgant asked the court to note that the cassation decision, which entered into force, unambiguously recognized YUKOS's rights as the owner of the crude oil, rights that were transferred pursuant to the YUKOS/Yuganskneftegaz General Agreement. Mr. Klyuvgant, reminding the court about Mr. Khodorkovsky's testimony, noted the twenty entities which gathered together to seek arrest of the crude oil.

Mr. Klyuvgant told the court that the defense had a big block of documents to enter into evidence and asked for adjournment. His request was granted.

The trial will resume on Tuesday, May 25, 10:30 Moscow Time.