Son Seeking Father's Estate Traces Trusts Benefiting Officers of Energy Giant From Siberia to Isle of Man

By GLENN R. SIMPSON
December 6, 2006

ON THE last day of August in 1997, a Russian oil tycoon named Vitaly Schmidt sat down to lunch at his Moscow apartment with his woman friend and his sister. The 48-year-old engineer downed a large helping of boiled-meat dumplings and a couple of shots of vodka. Three hours later, he was dead.

Mr. Schmidt was a multimillionaire with luxury residences in four countries. Much of his fortune came from a group of small offshore energy companies he oversaw on behalf of himself and a few fellow executives of a big Russian oil company, OAO Lukoil.

His sudden death touched off a struggle for control of his patrimony, hidden in tax havens from the Isle of Man to Panama. It has led his son, 19 when Mr. Schmidt died, to accuse Lukoil executives of raiding his father's estate, allegations they deny.

The eight-year courtroom fight over Mr. Schmidt's estate has helped expose the tangled inner workings of Lukoil, a powerful player on the world energy stage with a history of opaque business deals between the company and its own executives. Allied with President Vladimir Putin's Kremlin, Lukoil is at the forefront of Russia's push for economic might. At 16 billion barrels, its oil reserves are the greatest of any publicly traded company. Lukoil, 19-percent-owned by ConocoPhillips of Houston, has also been raising its profile in the West, with thousands of Lukoil gas stations in the U.S. and Europe and a stock that trades in London.

Among the fallout of the fight over Mr. Schmidt's estate is the exposure of some secrets he knew: the methods by which Lukoil executives, over the years, engaged in lucrative business deals with their own company, via secret trusts and ostensibly independent oil-service firms.

Lukoil acknowledges having unusual corporate structures. "In the rapidly developing business environment in the Russian Federation, companies and individuals have frequently used nominees and other forms of intermediary companies in transactions," Lukoil's latest annual report said. It said management "has appropriate procedures in place to identify and properly disclose transactions with related parties" and has disclosed all that are significant.

Yet as recently as two years ago, top Lukoil executives engaged in transactions with their own company, and with only limited disclosure. Around 2004, a previously unknown firm began to manage Lukoil's pension fund, bought a bank from Lukoil and became Lukoil's main insurer. The firm turned out to be majority-owned by Lukoil's president, Vagit Alekperov, and his top lieutenant, Leonid Fedun -- ownership that wasn't disclosed until this year.

Mr. Fedun said in an interview that the two men kept their ownership on a need-to-know basis to protect themselves from political attack in Russia, where the ultra-rich are unpopular. "Those who should know about it do know," he said. Mr. Alekperov, whose 13.4 percent stake in Lukoil is worth some $9.5 billion, said in an interview there was no impropriety.

He rejected allegations made by Mr. Schmidt's son, Vadim, that Lukoil executives sometimes took control of company profits Mr. Schmidt had secreted in the Isle of Man. Vadim made the allegations in an Isle of Man court and in the high U.K. appellate court known as the Privy Council. "Unfortunately, the son didn't take after his father," said Mr. Alekperov. "He's looking for his father's supposed money."

As for ConocoPhillips, it said it had "no knowledge of the allegations. Our experience with Lukoil has been positive."

Lukoil arose in the dying days of the Soviet Union in 1991, set up by a small group of Soviet oil bureaucrats. Their leader was Mr. Alekperov, a former drilling engineer from Azerbaijan who had become deputy oil minister. Another member of the group was his close friend Mr. Schmidt, a petroleum engineer. The group forged strong bonds working in a remote drilling camp in the Siberian swamp town of Kogalym, meaning "the lake where a man died."

Mr. Schmidt became head of drilling in Kogalym when Mr. Alekperov moved to the oil ministry in Moscow. There, Mr. Alekperov helped form Lukoil as a state company with control of Kogalym and extensive natural-gas assets. A minority slice of Lukoil's shares started trading publicly in Russia in 1993, after which the state's interest gradually shrank to zero. Mr. Schmidt, meanwhile, crisscrossed Europe lining up foreign buyers for Lukoil's oil.

A frequent stop was the Isle of Man, in the Irish Sea. There he set up a series of trusts, working with a financial-services firm called Lorne House, based in a mansion next to a medieval castle. Lorne House also set up various small energy companies whose names often were variations on the word Lukoil, such as Lukoil International Ltd.

Soon, the newly formed companies were receiving contracts and oil allotments from Lukoil and entering into joint ventures with it. But the existence of numerous similarly named entities in different national jurisdictions made it difficult to track the sources and destinations of funds flowing through them.

Mr. Fedun said Lukoil had to use such structures because "15 years ago, there was no business infrastructure" in Russia. "Numerous institutions were created not with state funds -- although at that point Lukoil was a state company -- but with the managers' money," he said. He added that "all the money earned by the servicing companies ended up in Lukoil."

Bank statements and accounting records indicate otherwise. They show that dozens of these companies, in numerous transactions during the 1990s, sent money to the Isle of Man, where it ended up in the trusts Mr. Schmidt had set up.

And the beneficiaries of these trusts were Lukoil executives, according to records disclosed in an Isle of Man and a U.K. court. A trust called the Angora Discretionary Trust, for instance, directly benefited "Mr. Schmidt and other senior Lukoil executives," said a 2003 ruling by the Privy Council.

Lukoil said in a statement that it "never participated in the management of the trusts" and knows nothing "about the possible participation of any of its former employees." The company added that Mr. Alekperov never had any financial interest in Isle of Man entities.

Mr. Schmidt managed the flow of funds into and out of the trusts and the newly established oil companies, faxing handwritten notes to a director of Lorne House, Janek Basnet. As an example, one note in December 1995 said: "Janek! Would you please arrange urgently the loan of $6.5 million from Angora trust to Lukoil International." The note said to take the money out of certain other private entities within the trust and to wire it to a numbered Swiss bank account.

Mr. Basnet wasn't available for comment, said a lawyer for Lorne House, where he's no longer a director. Several years ago, in a response to an Isle of Man lawsuit, Mr. Basnet said there had been no "dubious activity" in relation to Mr. Schmidt's affairs.

Several of the companies that sent money to the trusts were cited in a 1993 lawsuit by a U.S. oil-service firm called Frankenburg Inc. It alleged in U.S. district court in Houston that Lukoil executives had pushed Frankenburg out of a Siberian contract in favor of one of the newly set up companies -- one that Frankenburg said was part-owned by Messrs. Alekperov and Schmidt. In court filings, the executives denied such ownership. Lukoil, without admitting wrongdoing, settled the suit the next year with a payment that a Frankenburg lawyer described as "large."

The episode was barely a hiccup for Lukoil. It was growing rapidly, along with the circle of small companies, such as one named MD Seis. That company sold seismic data to Lukoil.

This wasn't MD Seis's only activity, however. Bank records show that a Panamanian unit of MD Seis held a Viennese bank account that funded 16 Visa cards in the names of Lukoil executives and their family members. Lukoil says that no company funds were diverted for the benefit of its executives.

Mr. Schmidt, whose title was senior vice president for international operations, grew rich. He had "personal assets somewhere in the region of several hundred million U.S. dollars," said a filing in an Isle of Man court by his son, Vadim.

At the end of August in 1997, Mr. Schmidt returned from a trip to Europe, where he was working on an overhaul of Lukoil's chaotic international structure to meet shareholder pressure for greater transparency. He was supposed to have lunch with another Lukoil executive and old friend from the Siberian oilfields, Ralif Safin, but Mr. Safin begged off, leaving Mr. Schmidt to dine with his woman friend and his sister, according to an official account by Moscow prosecutors of Mr. Schmidt's last hours. It said he had Russian dumplings called pelmeni and two or three shots of vodka.

Mr. Schmidt, who had a heart condition, then fell ill. His woman friend summoned an ambulance and Mr. Safin. Mr. Alekperov went to the home too, he said. Mr. Schmidt died before they got there, of what the official report three years later said was a heart attack.

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