How Harvard lost Russia

Since being named president of Harvard University in 2001, former U.S. Treasury secretary Lawrence Summers has sparked a series of controversies that have grabbed headlines. Summers incurred the wrath of African-Americans when he belittled the work of controversial religion professor Cornel West (who left for Princeton University); last year he infuriated faculty and students alike when he seemed to disparage the innate scientific abilities of women at a Massachusetts economic conference, igniting a national uproar that nearly cost him his job; last fall brought the departure of Jack Meyer, the head of Harvard Management Co., which oversees the school's endowment but had inflamed some in the community because of the multimillion-dollar salaries it pays some of its managers.

Then, in quiet contrast, there is the case of economics professor Andrei Shleifer, who in the mid-1990s led a Harvard advisory program in Russia that collapsed in disgrace. In August, after years of litigation, Harvard, Shleifer and others agreed to pay at least $31 million to settle a lawsuit brought by the U.S. government. Harvard had been charged with breach of contract, Shleifer and an associate, Jonathan Hay, with conspiracy to defraud the U.S. government.

Shleifer remains a faculty member in good standing. Colleagues say that is because he is a close longtime friend and collaborator of Summers.

In the following pages investigative journalist David McClintick, a Harvard alumnus, chronicles Shleifer's role in the university's Russia Project and how his friendship with Summers has protected him from the consequences of that debacle inside America's premier academic institution.

ff duty and in swimsuits, the mentor and his protégé strolled the beach at Truro. For years, with their families, they had summered together along this stretch of Massachusetts' famed Cape Cod. Close personally and professionally, the two friends confided in each other the most private matters of family and finance. The topic of the day was the former Soviet Union.

"You've got to be careful," the mentor, Lawrence Summers, warned his protégé, Andrei Shleifer. "There's a lot of corruption in Russia."

It was late August 1996, and Summers, 42, was deputy secretary of the U.S. Treasury. Shleifer, 35, was a rising star in the Harvard University economics department, just as Summers had been 15 years earlier when he had first taken Shleifer under his wing.

Summers' warning rose out of their pivotal roles in a revolution of global consequence -- the attempt to bring the Russian economy out from the ruins of communism into the promise of Western-style capitalism. Summers, as Treasury's second-in-command, was the architect of U.S. efforts to help Russia. Shleifer's involvement was more intimate. Traveling frequently to Moscow, he was directing key elements of the reform effort under the banner of the renowned Harvard Institute for International Development.

Working on contract for the U.S., HIID advised the Russian government on privatizing its economy and creating capital markets and the laws and institutions to regulate them. Shleifer did not report formally to Summers but rather to the State Department's Agency for International Development, or AID, the spearhead of the U.S.'s foreign aid program.

Personal affection as much as official concern prompted Summers' admonition. He had come to know that Shleifer and his wife, Nancy Zimmerman, a noted hedge fund manager, had been investing in Russia. Though he didn't know specifics, he understood just enough to worry that the couple might run afoul of myriad conflict-of-interest regulations that barred American advisers from investing in the countries they were assisting.

Summers did not restrict his warnings to Shleifer.

"There might be a scandal, and you could become embroiled," Summers told Zimmerman. "You should make sure you're clear with everybody. People might want to make Andrei a problem some day. The world's a shitty place."

Summers' warnings proved at once prophetic and ineffectual. Even as Shleifer and his wife strove to reassure their friend, they were maneuvering to make an investment in Russia's first authorized mutual fund company. Within eight months their private Russian dealings, together with those of close associates and relatives, would explode in scandal -- bringing dishonor to them, Harvard University and the U.S. government. The Department of Justice would deploy the Federal Bureau of Investigation and the U.S. Attorney's Office in Boston to launch a criminal investigation that would uncover evidence of fraud and money laundering, as well as the cavalier use of U.S. government funds to support everything from tennis lessons to vacation boondoggles for Harvard employees and their spouses, girlfriends and Russian pals. It would, in the end, be an extraordinary display of an overweening "best and brightest" arrogance toward the laws and rules that the Harvard people were supposed to live by.

Says one banker who was a frequent visitor to Russia in that era, "The Harvard crowd hurt themselves, they hurt Harvard, and they hurt the U.S. government."

Mostly, they hurt Russia and its hopes of establishing a lasting framework for a stable Western-style capitalism, as Summers himself acknowledged when he testified under oath in the U.S. lawsuit in Cambridge in 2002. "The project was of enormous value," said Summers, who by then had been installed as the president of Harvard. "Its cessation was damaging to Russian economic reform and to the U.S.-Russian relationship."

Reinventing Russia was never going to be easy, but Harvard botched a historic opportunity. The failure to reform Russia's legal system, one of the aid program's chief goals, left a vacuum that has yet to be filled and impedes the country's ability to confront economic and financial challenges today (see box, page 77).

Harvard vigorously defended its work in Russia, but in 2004, after protracted legal wranglings, a judge in federal district court in Boston ruled that the university had breached its contract with the U.S. government and that Shleifer and an associate were liable for conspiracy to defraud the U.S. Last August, nine years after Summers and his protégé took their stroll along that Truro beach, Harvard, Shleifer and associates agreed to pay the government $31 million-plus to settle the case. Shleifer and Zimmerman were forced to mortgage their house to secure their part of the settlement.

Russia's struggles today certainly don't result entirely from Harvard's misdeeds or Shleifer's misconduct. There is plenty of blame to share. It is difficult to overstate the challenge of transforming the economic and legal culture, not to mention the ancient pathologies, of a huge, enigmatic nation that once spanned one sixth of the earth's land surface, 150 ethnicities and 11 time zones. The Marshall Plan, by comparison, was simple.

Summers wasn't president of Harvard when Shleifer's mission to Moscow was coming apart. But as a Harvard economics professor in the 1980s, a World Bank and Treasury official in the 1990s and Harvard's president since 2001, Summers was positioned uniquely to influence Shleifer's career path, to shape U.S. aid to Russia and Shleifer's role in it and even to shield Shleifer after the scandal broke. Though Summers, as Harvard president, recused himself from the school's handling of this case, he made a point of taking aside Jeremy Knowles, then the dean of the faculty of arts and sciences, and asking him to protect Shleifer.

Months after Harvard was forced to pay the biggest settlement in its history, largely because of his misdeeds, Shleifer remains on the faculty. No public action has been taken against him, nor is there any sign as this magazine goes to press in late December that any is contemplated.

Throughout the otherwise voluble university community, there has been an odd silence about the entire affair. Discussions mostly have taken place sotto voce in deans' offices or in local Cambridge haunts, such as the one where a well-connected Harvard personage expressed deep concern, telling II: "Larry's handling of the Shleifer matter raises very basic questions about the way he governs Harvard. This is fraught with significance. It couldn't be more fraught."

The silence is now beginning to break, thanks to the leadership of academic worthies like former Harvard College dean Harry Lewis, who is finishing a book about the university to be published in the spring by Perseus Public Affairs. Lewis agreed to show II the manuscript, in which he asserts, "The relativism with which Harvard has dealt with the Shleifer case undermines Harvard's moral authority over its students."

Whether this new questioning will erupt into yet another crisis engulfing Summers and the university remains unclear. What is certain, though, is that the story of Harvard and its representatives' malfeasance, told in full for the first time over the following pages, shows how much damage can be done when the considerable power and resources of the U.S. government are placed in the wrong hands.

THE SEEDS OF RUSSIAN REFORM WERE planted in the late 1980s -- when Russia was the Soviet Union and Harvard hadn't yet arrived. The U.S.S.R.'s seven-decade experiment with Marxist-Leninist totalitarianism lay in shambles. By 1989, even as the Berlin Wall fell in Germany, the Soviet Union and its economy were imploding.

Reform-minded Mikhail Gorbachev, the last general secretary of the Communist Party, strove to introduce limited economic and political change. The first competitive elections for the Congress of People's Deputies were held in March 1989. In May 1990, Gorbachev's populist rival, the maverick Boris Yeltsin, was elected chairman of the Russian Republic's Parliament. A month later Russia declared itself independent of the Soviet Union.

That summer Gorbachev and Yeltsin ordered two economists to draw up a "500 Days" plan for converting the Soviet Union to a market economy based on private property. Gorbachev also sought advice from the West. In October 1990 the then-chairman of the New York Stock Exchange, John Phelan Jr., led a group of U.S. securities lawyers and academics to Moscow to begin showing the Soviets how to form capital markets. The meeting was organized by the Big Board's Russian-speaking legal counsel, Richard Bernard, then 40.

Bernard's collaborator in organizing the meeting was a leading Soviet attorney, Peter Barenboim. Together they formed the Soviet-American Securities Law Working Group, or SASLAW, which began drafting securities laws for the U.S.S.R.

On October 15, 1990, two days after the Americans returned to New York, Gorbachev was awarded the Nobel Peace Prize. The next day, under pressure from the KGB and Kremlin hard-liners, Gorbachev withdrew his support for the 500 Days plan. But it was too late to reverse the tide of change. In December, Yeltsin, from his leadership post in Parliament, pushed through legislation that would allow limited private land ownership in Russia for the first time since the 1917 revolution. In June 1991, Yeltsin was elected president, the first leader of Russia to be popularly elected. Then, in August, after a failed coup attempt by Communist revanchists, Gorbachev resigned as general secretary of the Communist Party, dissolved its central committee and effectively ceded power to Yeltsin.

The new leader treated his victory as a window of opportunity -- one that would slam shut if he didn't show results promptly. Transforming the economy was his first priority. He set a young economist named Yegor Gaidar and a group of planners to work in a dacha outside Moscow in September and October. Gaidar had grown up in the Moscow intelligentsia and had a Ph.D. in economics from Moscow State University. He had been convinced for years that the Soviet Union needed to transform itself into a free-market economy based on Western models.

The Gaidar group formulated a set of principles that they believed must guide the reform. First, all Russian citizens should have the right to own private property. Second, ownership of property, as well as other components of a free economy, such as stock and bond trading, should be governed by codes of law.

On November 1, 1991, Yeltsin named Gaidar deputy prime minister and minister of Economics and Finance. Gaidar summoned St. Petersburg­based economist Anatoly Chubais, then 36, who sped to Moscow. Chubais in turn telephoned an even younger St. Petersburg economist, 29-year-old Dmitri Vasiliev. Could Vasiliev write a two-page program for mass privatization of all of the property and assets in Russia? And could he write it fast? Vasiliev could, and did, and rushed the memorandum to Moscow.

Only a few years earlier, Chubais, a tall strawberry blond who liked fast cars, and Vasiliev, a diminutive, politically savvy, bespectacled intellectual who resembled Woody Allen, had been plotting the privatization of the Soviet economy as part of a group of young dissident economists at the universities of Leningrad and Moscow, hiding their activities out of fear of the KGB. During the final days of Gorbachev, they had advised the government of Leningrad, soon to regain its original name, St. Petersburg, on economic reforms.

In the Moscow of November 1991, the team faced a different fear -- of the dire consequences of failure. "Russia was facing the largest and most complex privatization process in the history of humankind . . . and the absence of any legal base for its development," Gaidar would later write in Days of Defeat and Victory. He dubbed his group "the kamikaze team."

The team did have some models. Though discarded, the 500 Days plan remained a focus of public discourse. And there was the example of Poland, which had been experimenting with capitalism since the late 1980s.

The man who had guided Poland's economic reform, Jeffrey Sachs, an economics professor at Harvard University, was a boyish-looking 35-year-old with explosive energy and little patience. An economic wunderkind, Sachs had passed the general examinations for his Ph.D. and was invited to join the rarefied Harvard Society of Fellows while he was still a Harvard undergraduate. He won tenure in the department of economics at age 29.

Sachs had begun advising the Polish Solidarity Movement before it took control of the government in August 1989. He invited another Harvard-trained economist, David Lipton, to work with him. Lipton, who had been Sachs' student, had spent most of the 1980s at the International Monetary Fund. On January 1, 1990, following Sachs' and Lipton's advice, the Polish government introduced what came to be known as "shock therapy" -- the rapid conversion of all property and assets from public to private ownership. After initial shortages and inflation, goods and services soon were flowing through the economy in unprecedented varieties and quantities; prices stabilized.

Though envious of Poland's success, Russian reformers knew their task would be much more difficult. "When socialism collapsed in Poland, an entire generation of people still remembered what markets, market institutions and private ownership were," Gaidar wrote in State and Evolution: Russia's Search for a Free Market, published in 2003. "In Russia there was no such experience to be had. In 1991 the vast majority of Russian citizens had never seen a normal retail shop."

Still, the Polish experiment was getting worldwide publicity, and it wasn't long before Moscow reached out to Sachs, who began formally advising the Russians in late 1991, simultaneously with the official dissolution of the Soviet Union. In November, Gaidar invited Sachs and Lipton to work with the new economic team.

Moscow by then was crowded with foreigners eager to help Russia and get in on the ground floor of a great social and economic change. Entrepreneurs, consultants, lawyers, bankers and academics with foundation grants, as well as fast-buck artists and swindlers from all over the world, swarmed across Russia looking for a piece of the action. The atmosphere was charged with possibility and fraught with danger. Financial transactions were mostly conducted in cash; cities were awash in rubles. Kidnappings were common, as was gunfire and even bombings. Organized crime darkened the already grim picture.

Russia's leaders felt a near-apocalyptic sense of urgency. They understood that to prevent chaos they had to quickly lay the foundation for a Russian-style capitalism or face a return to authoritarianism couched as a restoration of law and order. Even as Yeltsin's reformers got to work, they faced strong opposition from reactionary former Communists who protested the speed and cost of change.

Sachs wasn't the only Harvard professor in Moscow in the summer and fall of 1991. No fewer than four university affiliates -- the John F. Kennedy School of Government, the Russian Research Center, HIID and the economics department -- were represented. Graham Allison, the founding dean of the Kennedy School, was pushing an updated version of the 500 Days plan with its co-author, liberal economist Grigory Yavlinsky. Marshall Goldman, the director of Harvard's venerable Russian Research Center and a frequent visitor to the Soviet Union for decades, was providing counsel to various parties. Sachs, thanks to his experience in Poland, emerged as the leading figure among these notables. In Moscow he encountered yet another Harvard colleague, Andrei Shleifer. Shleifer had been sent to Moscow by the World Bank, where Summers, on leave from Harvard, was serving as chief economist. Shleifer possessed a distinct advantage over other Westerners: He was a native of Russia and fluent in the language, having been born there in 1961. His parents were engineers, a profession the state chose for them. Shleifer revealed at an early age that he was ambitious; in a photograph taken when he was six, he is dressed as a Soviet Army general. When a friend transferred to one of the best schools in Moscow, Shleifer bicycled there and didn't leave until he had persuaded the principal to admit him as well.

The Shleifers left Russia in 1976 with the help of the Hebrew Immigrant Aid Society and moved to Rochester, New York. Andrei later claimed he learned most of his English by watching the popular television show Charlie's Angels. He excelled in mathematics and was admitted to Harvard College. In his sophomore year he went to see Summers and pointed out errors in a paper the young assistant professor had written. Summers, the nephew of two Nobel laureates in economics, soon took Shleifer under his wing. Like Sachs, Summers was one of the youngest economists ever granted tenure by Harvard -- they had made it the same year. Summers guided Shleifer onto a similar path, and the friends maintained their close relationship after Summers went to the World Bank in 1991.

There was no love lost between Sachs and Summers, who had been rivals as newly tenured prodigies. Each had to be the smartest man in the room; their presence at faculty meetings ensured lively debate tinged with animosity. Shleifer had a similar personality, and when the confident upstart encountered Sachs in Moscow, he didn't get along any better with Sachs than his mentor did.

Nonetheless, Sachs introduced Shleifer around the Russian government. It was decided that Shleifer would work with Chubais and Vasiliev on privatization while Sachs advised Gaidar on macroeconomic issues.

Gaidar appointed Chubais to head a new government agency, the State Committee on the Management of State Property. Known by its Russia acronym, GKI, it had no office or charter, except the vague commission to "privatize" the economy and Vasiliev's two-page outline recommending Polish-style shock therapy.

The daunting task was further complicated by the fact that a portion of the economy -- nobody knew how much -- had already been privatized in a de facto sense: In the confusion of perestroika, Gorbachev's mid-1980s effort to restructure the economy to make communism more efficient, a number of senior government bureaucrats, managers of state-owned factories and farms, had been allowed to quietly transfer public assets to themselves and their families. Some of these transfers verged on "theft and embezzlement," Gaidar acknowledged in State and Evolution, but it was too late to reverse them, and the real problem, he allowed, "has been the system itself; complete ambiguity around property rights, absolute lack of accountability." This would have to be changed with new legal codes.

Left to be privatized at the end of 1991 were approximately 225,000 state companies spread across Russia. Gaidar and Chubais, advised by Shleifer, decided that these enterprises could not be privatized one at a time. That would take "well into the 22nd century," Gaidar figured. Rather, they had to devise a form of the shock therapy that had been used in Poland -- near-simultaneous privatization.

So in 1992 the Russian government began issuing certificates with a face value of 10,000 rubles each to all of the 148 million citizens of the country. The certificates were liquid; they could be traded or used to purchase property. By the end of 1992, 46,000 small enterprises out of the 225,000 were in private hands. Chubais, Vasiliev and Shleifer had privatization off to a good start, and Shleifer was forging strong personal relationships with his Russian advisees.

While helping draft securities laws, Richard Bernard, who moved to Moscow in 1992, fired off letters to then­U.S. secretary of State Lawrence Eagleburger urging that the U.S. government support one of the pivotal movements of history -- the transformation of the Russian economy from communism to capitalism. Though Bernard never heard from Eagleburger, there was action in Washington.

In October 1992, just a few weeks before losing the presidency to Bill Clinton, president George H.W. Bush signed the Freedom for Russia and the Emerging Eurasian Democracies and Open-Market Support Act. It authorized up to $350 million in aid to Russia, to be provided and managed by AID, which already had an advance team working informally in Russia at the government's invitation.

In short order, AID, learning that Sachs and Shleifer were in Moscow, contracted with Harvard to direct and manage the reform program. The agency initially gave $2.1 million to Harvard, which would run the operation out of its Harvard Institute for International Development, a 30-year-old entity located on Eliot Street in Cambridge. With financial support from foundations, international aid agencies, development banks and host governments, HIID operated economic reform programs around the world, concentrating on assisting nations that were changing from government-run to market-driven economic systems. In Indonesia, for example, HIID helped revise the tax system and liberalize financial markets. It also had been active in Colombia, Kenya, Pakistan and Zambia.

The Russia Project would be HIID's largest and most important program by far. The institute had been run since 1980 by Harvard political economy professor Dwight Perkins, who reported directly to Albert Carnesale, Harvard's provost and second-in-command. With Sachs advising Gaidar, the HIID project would be directed by Shleifer, who would retain his professorship in the economics department. Shleifer was charged with hiring staff, setting budgets and priorities and creating and supervising the project from Cambridge and on frequent trips to Russia.

Shleifer's first need was to find someone who could supervise the day-to-day operations of the Russia Project. For this critical post he chose Jonathan Hay, 30, an Idaho native, Rhodes Scholar and newly minted graduate of Harvard Law School.

Fluent in Russian, Hay had moved to Moscow hoping to get in on the excitement of social transformation. Brilliant and intense, with unruly hair, oversize horn-rim glasses and an ethereal academic mien, he dazzled everyone he encountered. Hay had negligible practical experience, but soon, with Shleifer's blessing, he was setting up Harvard's Moscow operations at Chubais's GKI in a drafty government building near Red Square. "We had no heat, no Xerox, no fax, no food," Hay recalled later to the Washington Post's David Hoffman, author of The Oligarchs: Wealth and Power in the New Russia. "The first time I came there, I saw just Dmitri Vasiliev and 30 people sitting in a huge hall, just this small man in big glasses, and they were all around him, in a heated discussion, talking about small-scale privatization."

AID gave the Harvard people wide independence and discretion. HIID relied heavily on Shleifer and Hay, who savored the challenge. The young lawyer had a high tolerance for chaos, which came in handy at the end of 1992. "Don't worry! Be happy!" is the way lawyer Barenboim characterized Hay's approach to reforming Russia.

The country's banking system was barely functional. ATMs were unheard of. There were a few rudimentary stock exchanges spread across the nation, but trading was chaotic. Few laws, regulations or formal procedures had yet taken effect.

Meanwhile, much of the Russian Parliament believed Yeltsin was moving too fast, too soon. The fall of 1993 was marked by turmoil as the president and his opponents struggled for supremacy. When Yeltsin's rivals in Parliament refused to leave the legislative building known as the White House, the president cut off its television service, telephones, electricity and water. Tanks rolled, bullets flew, scores of people died -- and Yeltsin prevailed, with more freedom to proceed with economic reform.

A mile from the Kremlin, however, the people in charge of the Russia Project were becoming seriously distracted. Under their contract with the U.S. government, Shleifer, Hay and their staff were required to submit regular written progress reports, but they were falling behind. "We have reviewed the delinquent . . . reports and found them to be sorely lacking in substance," an AID staffer in Moscow informed Washington.

One reason for Shleifer and Hay's distraction may have been a growing interest in their own opportunities. As advisers on fundamental reform of the Russian economy, HIID staffers were privy to the most-private details of the vast nation's financial future. They were swimming in inside information. They were hemmed in, however, by strict prohibitions against using their positions for personal financial gain. The U.S. government and Harvard -- as well as the contract that Harvard and AID signed in December 1992 -- barred everyone assigned to the project, their families and people acting on their behalf from any investment of their personal funds in Russia and any personal involvement in Russian businesses or financial transactions. Even savings accounts in Russian banks were prohibited.

"We had this test -- how is this going to look on the front page of the New York Times?" Louisa French, HIID's human resources officer, said under oath in the government's lawsuit. "It was our mantra to say, 'If you have to ask, you're too close to the line.'"

As the people running the project, Shleifer and Hay were obliged not only to obey the rules themselves but also to enforce them on their staffs. But by December 1993, less than a year after the Russia Project had ramped up, Alberto Neri, a Moscow-based HIID financial officer, wrote four memorandums warning the institute's deputy director in Cambridge, Rosanne Kumins, that he believed Harvard was complicit in financial irregularities and tax evasion and was condoning dissemination of false data, irregularities in employment contracts and misrepresentation of expenditures, all so that income to the Russian staff could be hidden from the tax authorities.

"I fail to see why Harvard should assume the huge responsibility of abetting tax evasion (which is a criminal offense in Russia -- as it is in the USA . . .)," Neri wrote in one memo. The memos were entered into evidence and cited by the U.S. government in court papers in its lawsuit.

Those memos, Kumins says today, "were received with concern. We never condoned tax evasion. As a result, we changed the way local hires were paid."

In July 1994, Shleifer and Nancy Zimmerman began investing in Russia in direct violation of his contract and the restrictions imposed by AID and Harvard.

Though she called her husband "Boss," Zimmerman, 31, was a hard-charging financial wizard in her own right. She had left a lucrative career at Goldman, Sachs & Co. in New York to start a hedge fund in Cambridge, Farallon Fixed Income Associates, in a joint venture with Farallon Capital Management, a prominent fund group based in San Francisco. Zimmerman earned far more trading bonds than Shleifer did teaching economics: $1.06 million to his $191,000 in 1994. Their combined income supported a comfortable lifestyle, including a spacious home in the affluent Boston suburb of Newton.

In 1994, Shleifer and Zimmerman, with the help and advice of Leonard Blavatnik, a New York­based Russian emigrant and a member of the Forbes 400, placed $200,000 in a Blavatnik vehicle called Renova-Invest, which invested in a group of Russian corporations that were being privatized under Shleifer's guidance. The companies included telephone operator Rostelecom; oil and natural-gas behemoth Gazprom; aluminum smelters in the cities of Irkutsk, Sayansk and Bratsk; Vladimir Tractor; and oil producer Chernogorneft. The U.S. government alleged in its complaint against Harvard, Shleifer and Hay that these companies benefited financially not only from Shleifer's advice on privatization but also from AID-funded assistance, including free legal services. When Blavatnik was merging several aluminum companies in which Shleifer and Zimmerman had invested, Hay and other AID-funded lawyers worked on the merger documents at no cost to Blavatnik or the companies. According to a U.S. statement of "undisputed material facts" submitted with the lawsuit, Hay was aware of some of the private investments of Shleifer and his wife, which were violations of the bars against private investment in Russia.

Also in the summer and fall of 1994, the Shleifers partnered with Farallon Capital Management to invest in Russian oil stocks. "Investing in Russia at that stage was like the Wild West, and we were petrified about getting involved," Farallon partner David Cohen later told a federal grand jury. (Farallon would, in fact, lose money on these oil stock investments.)

Cohen, who had been a Rhodes Scholar at Oxford University with Hay, said: "There was incredible crookery. . . . We wanted to get as much protection as we could . . . and we thought Andrei provided some of those things. People might have been more hesitant to hurt Andrei Shleifer than to hurt Farallon. . . . His relationship to Chubais was definitely one of the factors."

Shleifer began the investment process on August 11, 1994, by wiring $165,000 to a Channel Islands bank account for the purchase of 30,000 shares of Russian oil company Purneftegas. By November 4 a total of more than $4 million was invested, 90 percent by Farallon, 10 percent by Shleifer and Zimmerman. The Shleifers concealed their investment by registering the shares in the name of Zimmerman's father, Howard Zimmerman, a Chicago investor in real estate and racehorses and a director and shareholder of a small institution called Central Illinois Bank.

Shleifer suggested that Hay join his Rhodes Scholar friend Cohen among the investors. Hay chipped in $66,000, but only after directing an AID-funded Harvard staffer in Moscow to research the price and trading activity of Russian oil stocks. Louis O'Neill, a first-year student at Harvard Law School who was working in Moscow for the summer, found that the information -- a mix of pricing and liquidity data on a less-than- transparent market -- was harder to obtain than in Western securities markets. Fluent in Russian, O'Neill posed as the "Russian representative of a foreign investor who was keen to enter the Russian securities market," he stated in a sworn affidavit filed later in the U.S. lawsuit.

"I remember [Hay] telling me to look at oil and gas because they were sort of in the forefront of privatization," O'Neill testified. "He said, 'Get me some answers on what's happening in the market.' [Oil and gas] would be the most valuable assets in the economy, so of course they would be the most desirable things."

Once the stock was purchased, Hay turned to Julia Zagachin, 26, who had been born in Russia and moved to the U.S. when she was 11. After graduating from George Washington University in Washington, D.C., with a degree in international politics, Zagachin had gotten a job with Deloitte & Touche. She would become one of Jonathan Hay's first hires at HIID. In 1994, Hay appointed her to run another AID-funded enterprise, the Depository Clearing Co., which was intended to become Russia's central clearinghouse for securities transactions. After the Shleifer-Farallon stock purchases, Hay instructed Zagachin to make sure the securities were properly registered, because the owner, Hay said, was an "old Oxford friend" (David Cohen of Farallon) who should receive "the best service."

Less than a year later, while still holding oil shares, Shleifer wrote a memorandum to Russian officials advocating the inclusion of oil stocks in a program to distribute Russia's energy assets to rich entrepreneurs in exchange for loans to the government.

The ironies abound. Russia, where secrecy and corruption were ubiquitous, was looking to the U.S. and Harvard as beacons of honesty and transparency in financial affairs. Gaidar, Yeltsin's sometime economic adviser and erstwhile deputy prime minister (he left the government for the second time in early 1994), even invoked Thomas Jefferson and the Declaration of Independence as inspiration for an open and free economic system "fitting for Russia." Gaidar wrote his words in the summer of 1994, at precisely the time that some of America's representatives, while giving lip service to those principles, appeared to be using inside connections to enrich themselves from investments in a Russia still mired in corruption.

JEFFREY SACHS, MEANWHILE, WAS SPENDING less time in Russia and more in Cambridge, where he would eventually become director of HIID. His appointment was not good news to Shleifer, who feared that Sachs would encroach on the Russia Project's turf and who instructed Hay not to speak to Sachs at all. Shleifer needn't have worried. Sachs knew nothing of Shleifer's investments. However, he did warn Shleifer about corruption in Russia, telling him to carefully vet the institute's Russian employees.

Shleifer and his wife could be surprisingly unguarded about their dealings. In October 1994, at a cocktail party at the home of Dale Jorgenson, then-chairman of Harvard's economics department, Shleifer and Zimmerman chatted casually about their Russian investments. The gathering was brimming with economics stars. In 1971, Jorgenson had won the John Bates Clark Medal, which the American Economic Association awards every other year to the person under 40 making the greatest contribution to economics. Another prominent Bates Clark medalist, Harvard economist Martin Feldstein, who had been chairman of the White House Council of Economic Advisers under Ronald Reagan, was also present. Feldstein was intrigued to hear of the Shleifers' investments and phoned Andrei later for a referral to Blavatnik. He ultimately decided against investing in Russia.

Indeed, the chaos had made it clear to the Russian government and its advisers that tighter organization and focus were needed at the Harvard project. In November 1994, Yeltsin issued a decree creating a centralized authority responsible for developing the Russian securities market. Though officially named the Russian Federation Commission on Securities and the Capital Market, the agency was commonly called the Russian Securities and Exchange Commission. This was appropriate: The American SEC was not only the model but was lending technical assistance funded by AID. Charged with running the RSEC were Chubais and Vasiliev, who had launched privatization three years earlier and were ready for a new challenge. Keeping close tabs on the agency were Albert Sokin, a tough lawyer from the St. Petersburg reformers, and Ruslan Orekhov, Yeltsin's chief legal counselor, whose responsibilities included reform of the legal system.

Through HIID, AID funded the Resource Secretariat, a think tank created in late 1994 that coordinated aid flowing to the new Russian securities commission for the creation of stock exchanges, broker-dealer networks, back-office functions and, most fundamentally, codes of law -- securities law, corporate law, tax law and bankruptcy law -- governing the vast new economic activity set in motion by privatization. The crafting of law was based in an entity called the Legal Reform Project, which later created the Institute for Law-Based Economy. The ILBE was staffed by American-guided Russian lawyers.

To run the Resource Secretariat, Shleifer and Hay reached out to Richard Bernard, who had been active in Moscow as a partner for New York­based law firm Milbank, Tweed, Hadley & McCloy since 1990 and a full-time resident since 1992. Shleifer offered Bernard the position of executive director with a two-year contract. Bernard assumed his responsibilities on January 1, 1995, and promptly hired a second-in-command, Holly Nielsen, a Moscow-based, Russian-speaking partner with the Houston law firm of Baker & Botts.

The RSEC was headquartered on the ninth floor of a high-rise Soviet-era office building on Leninski Prospect. Vasiliev had an office there and another, where he spent most of his time, near Bernard and Nielsen at the Resource Secretariat on Gazetni Street, close to the Kremlin. Hay was at the Legal Reform Project, whose offices were about a mile away on Gasheka Street.

Bernard and Nielsen's first months at the Resource Secretariat were frantic. At first, conditions were primitive -- there were few desks and no photocopiers. Hay, Vasiliev and Sokin were desperate for knowledge and insight. Bernard and Nielsen helped them as best they could while supervising a sprawl of people, activities and contractors that included Arthur Andersen, Price Waterhouse and KPMG, which were advising the government on various securities functions. The Resource Secretariat also worked with a growing community of foreign financial institutions, such as Chase Manhattan Bank and Credit Suisse First Boston, that were eager to gain footholds in what promised to be a burgeoning new market.

Coordinating all of this activity wasn't easy. The top management of the Resource Secretariat and the RSEC, while sharing common purposes, comprised diverse and strong personalities.

Vasiliev, Sokin and Hay had been working together for two years and had bonded. Vasiliev, who declined to be interviewed for this article, was a short, garrulous intellectual who loved political intrigue. He was "knowledgeable, committed and not overwhelmingly mature," Larry Summers would say later. Sokin, the crude, rotund, chain-smoking lawyer with many girlfriends, had been dubbed the "pig in the polyester suit" by one American lawyer. Then there was Hay, the brain-on-overdrive academic with a piercing stare, limited business experience and no time for haircuts. The three were joined at the hip, in Bernard's phrase, spending countless hours together, day and night, sometimes behaving like frat boys. "You're as worthless as a dick on a stump," Sokin liked to banter in Russian to Hay, who found the expression endlessly amusing.

They also recognized each other's strengths: Vasiliev and the more politically savvy Sokin had the ears of Chubais and Orekhov, and, through them, Yeltsin. Hay was their direct pipeline to the millions in U.S. government money that the 1992 Freedom Act had earmarked for Russian reform.

The trio's relationship to Bernard proved problematic. After 16 years counseling the New York Stock Exchange and five years helping craft a Russian securities code, he was "one of the best resources Russia ever had, a brilliant lawyer," says Bruce Lawrence, then one of Credit Suisse First Boston's top men in Moscow. Hay, less than three years out of law school, was very green, yet he was Bernard's titular boss and looked for ways to assert his authority. Bernard tried to be diplomatic, always ready with a smile and a quip, at least to Hay's face. Behind their backs he called Hay and Shleifer "the kids from Harvard."

Hay had gone Russian: He was not only Vasiliev's closest adviser; he socialized, drank and vacationed with Vasiliev and Sokin. Hay "wanted to be buried in the Kremlin Wall," Bernard said in a deposition.

"Jonathan was my boss, at least in the HIID hierarchy," Bernard recalled. "[But] I was his vast superior in substantive knowledge of the business we were in -- much more experienced in business, in management, in leadership. Jonathan struggled with that."

Bernard had an easier time with Vasiliev, who valued his superior knowledge of the markets. Bernard, for his part, appreciated Vasiliev's insight into the Russian politics that had to be navigated en route to the desired reforms. Bernard's coaching helped Vasiliev assert himself as head of the RSEC, which he needed to do in waging a critical political struggle, a war with the Russian Central Bank for control of securities trading.

On one level it resulted from a policy dispute: Should the Russian securities industry develop along U.S. lines, where broker-dealers and investment bankers were the main players in the market, or along German lines, where commercial banks dominated securities trading? Vasiliev and the RSEC, under the influence of American advisers, favored the former approach, while the Central Bank, particularly deputy chairman Andre Kozlov, preferred the latter. A deep personal animosity between Vasiliev and Kozlov fueled the dispute. The RSEC attacked the bank for concealing trading information on and limiting participation in the government securities market. Kozlov told the Wall Street Journal in September 1995 that "Mr. Vasiliev wants to control everybody and anything in the market, and he is angry because he cannot do this totally in the government securities market."

Meantime, Bernard discovered irregularities at the Russia Project. He was tipped off that Russian staffers had created no-show jobs for their relatives and friends in the Institute for Law-Based Economy and that employees were using AID-financed cars and drivers to run personal errands around Moscow. For instance, one top aide to Hay took off three to four hours in the middle of each day to play tennis and used ILBE drivers to convey her. Sokin, too, used office transportation to squire his girlfriends around. Hay had hired one of the girlfriends to make a short documentary about the initial public offering of the Red October candy company, the first IPO in the history of Russia. Bernard also learned that an RSEC contractor was paying reporters at Moscow newspapers to write favorable articles about the commission.

Bernard conveyed his concerns to Hay over coffee at the Starlite Diner, an American-style burger-and-shake joint that had just opened off of Garden Ring Road, a mile from the Kremlin. He told Hay that Sokin was corrupt. Hay scoffed at Bernard's concerns, warning him that he wasn't "with the program."

Subsequently, Hay began to reduce Bernard's responsibilities. Vasiliev told his press attaché, Andrea Rutherford, that Bernard was "too Western and inflexible."

In the summer of 1995, just months into his tenure, in a move orchestrated by Hay, Bernard was called in by Yeltsin's chief legal adviser, Orekhov, and told that he would not be retained in his job. The rationale: A Russian would have more credibility. Shleifer sealed Bernard's firing by phone, breaking his promise of at least a two-year tenure.

Bernard, who returned to the U.S. as executive vice president and general counsel of the NYSE, was succeeded on January 1, 1996, by Dmitri Subbotin, a young, Oxford-educated back-office specialist. Subbotin, though able, smart and hardworking, was inexperienced and later acknowledged that he wasn't qualified to succeed Bernard.

In 1995, Shleifer published Privatizing Russia, in which he and his co-authors, Maxim Boycko, a Russian reformer and chief executive of the Russian Privatization Center, and Robert Vishny, a finance professor at the University of Chicago, claimed credit for the success of economic reform to that point. Summers supplied a blurb for the book, noting that "the authors did remarkable things in Russia."

The problems at Harvard's Russia program, however, were mounting. The number of no-show jobs rose as some of Sokin's girlfriends were put on the payroll, and Sokin himself was given a large AID-funded salary increase and housing allowance, with the funds deposited in a foreign bank account so Sokin could avoid Russian taxes. "[Sokin] is really double-dipping," HIID deputy director Kumins warned Shleifer in a memorandum. "I can't imagine that you will do anything about this, but I believe it is not right all around and does not show good faith on anyone's part." Shleifer ignored the warning.

The Harvard crowd was soon to become embroiled in a bigger mess.

IN THE SUMMER OF 1995, YELTSIN DECREED THAT the RSEC would start licensing and registering mutual funds to attract the estimated $40 billion in "mattress money" that skeptical Russians had stashed away. Alarmed by Communist parliamentary gains spurred by persistent financial fraud, Yeltsin made safe investments a major campaign theme as he looked toward the 1996 presidential election. He ordered Sokin and Vasiliev to make mutual funds the highest priority of the RSEC.

In anticipation of the decree, several global securities and investment banking firms -- Credit Suisse First Boston, Robert Fleming & Co., Franklin Templeton Investments and Pioneer Group among them -- had deployed people and resources to Moscow. As the RSEC's chief Harvard adviser, Hay strove to build relationships with the potential mutual fund operators. Fleming's Moscow representative, Elizabeth Hebert, 33, was a tall Ohio native with flowing dark hair. She held master's degrees from Columbia University in business and international affairs. Fluent in Russian, she aspired to start her own company to launch funds specializing in Russian securities. Hay encouraged Hebert and promised to help her. Soon they were close friends.

On November 15, 1995, Shleifer and Zimmerman gave a dinner party at their home in Newton honoring one of Yeltsin's top economic advisers, Alexander Livshits, a prominent Moscow academic. Hay and Hebert flew in for the event, which was attended by a number of Shleifer's Harvard colleagues. Feldstein and his wife, Kate, were there, as was Boston philanthropist Peter Aldrich, then 51, the founder and a principal of one of the oldest and largest real estate investment advisory firms in the U.S., AEW Capital Management. A graduate of Harvard College and Harvard Business School, Aldrich had been active in university affairs for decades, donating a lot of money and counting the Feldsteins, Shleifer and Zimmerman and other professors and their families as friends. Aldrich's interest in business had strong intellectual dimensions. He regularly assembled Harvard professors to discuss economic and political ideas with the chief investment officers of endowment and pension funds. He was especially interested in Russia. Beginning in the early 1990s, Aldrich and his company had made several modest investments in Russia and neighboring countries, converting an apartment house in St. Petersburg into a modern office building, for example, and turning a Moscow warehouse into a Gold's Gym.

By the end of the evening, Shleifer, Zimmerman and Hay had prevailed upon Aldrich to meet the following day with Hebert to learn about her plans for a mutual fund company.

Aldrich received Hebert as a favor to his friends. Despite his interest in Russia, he wasn't impressed and barely remembered the meeting later. "How many times do you remember you swatted the fly?" he said when pressed during his sworn deposition in the U.S. government lawsuit. Ever the polite, patrician Brahmin, however, Aldrich did not rebuff Hebert, and she returned to Moscow optimistic that he might invest in her venture.

To launch her company, Hebert knew she would need back-office expertise. She turned to Julia Zagachin, the Russian-born, U.S.-educated clearing and settlement specialist who had helped Hay make sure the 1994 oil stock deal was properly registered. High-strung and intense, Zagachin had been forced out of her job heading the Depository Clearing Co., having been told, like Bernard, that a Russian was needed. Zagachin had retorted that the real reason was that she was "young, female, American and Jewish." Over Thanksgiving drinks at the Slavyanskaya Hotel, she and Hebert agreed to work together. Zagachin declined to be interviewed for this article.

Hay, meantime, continued to facilitate the relationship between Hebert and the reformers in Yeltsin's circle. That Christmas the Idaho native hosted a weeklong party in his home state to which he invited Hebert; Vasiliev and his wife, Tatiyana; and Sokin and one of his girlfriends. AID funds paid for the festivities, which included snowmobiling and hikes in the woods. Hebert used the time to talk up her mutual fund plans with Sokin and Vasiliev.

A few days later Hay and Hebert flew east to spend New Year's Eve at Shleifer and Zimmerman's home in Newton. Hebert continued to discuss her plans, expanding on her ideas while strolling around Harvard Square with Shleifer on January 1. She then flew to New York and pitched her fund to an array of potential financial backers.

By the early months of 1996, Hay and Hebert's budding romance was a hot gossip item among both the expat community of Moscow and their Russian colleagues, many of whom marveled at the attraction of opposites. Hebert was the kind of person who would arrive at a meeting promptly, wearing a trim suit, carrying a leather portfolio of meticulous notes. Hay would blow in late, hair flying, clothes askew, without a pen.

Hay and Hebert's relationship blurred the line between personal and professional. He let her use his AID-financed car and driver and sank $20,000 into the Fleming Russia Securities Fund, which she managed. As she became friendly with Vasiliev and Sokin, Hebert let the Moscow business community know that she had a close relationship with the people who would be registering and regulating her Russian mutual fund.

IN JANUARY 1996, SHLEIFER AND ZIMMERMAN began to expand their questionable activities. According to the U.S. government's complaint, Zimmerman set up a Russian company, Novyi Mir, or New World Capital. Zimmerman turned to Central Illinois Bank, to arrange a $5 million loan to Novyi Mir. The loan was secured by a certificate of deposit purchased from the bank, the U.S. government said. Zimmerman invested the money in Russian government debt instruments, or GKOs. The U.S. government alleged that profits from the GKO investments were sent to the bank as loan repayments, thus avoiding Russian taxes that would have been due had the funds been declared as profits. The money was then forwarded to Zimmerman's company in Cambridge.

In February, Zimmerman flew to Moscow to confer with Hebert about investing in her mutual fund company -- an investment that was barred by the U.S. government's and Harvard's conflict-of-interest rules, which applied to employees' family members. Hebert and her new partner, Zagachin, gave a full presentation to Hay, Sokin and Zimmerman. Hebert asserted that she had the backing of prominent Russians, including former Finance minister and senior Parliament member Boris Fyodorov and cellist Mstislav Rostropovich. She said she needed to raise upwards of $1 million. Zimmerman tentatively agreed to invest $200,000 and to take the lead in helping her raise the rest of the money.

The Yeltsin decree establishing the rules for a mutual fund industry required that each such company provide for strict back-office controls, such as registration of shares and shareholders, custody of securities, financial recordkeeping and regulatory compliance. It wasn't enough for the fund management company to establish such controls internally. The decree required the company to contract them out. In late February 1996, Hebert contacted Forum Financial Group, a Portland, Maine­based company that specialized in such functions and was already working with mutual fund companies in Poland. Forum's CEO, John Keffer, flew to Moscow, met with Hay, Vasiliev, Hebert and Zagachin and devised a plan for his company to become Hebert's strategic partner. That would be about the only thing that Keffer and the others would later agree on.

FROM THE BEGINNING THE HARVARD RUSSIA Project had failed to make complete, timely reports to AID. By March 1996 these lapses had come to the attention of the House International Relations Committee, which directed the U.S. General Accounting Office to audit the program.

Shleifer and Hay immediately assigned a lawyer to coordinate Harvard's response to the audit: Washington attorney Michael Butler, whom they had used as a troubleshooter in recent months and who became known in HIID circles as "Mr. Fix-it."

In early April, as the audit was beginning, Hay, Hebert and Zagachin flew to Boston. Hebert had been cultivating a relationship with AEW's Aldrich and had scheduled a meeting with him and two of his aides. Aldrich was more receptive than he had been in November. One meeting turned into six spread over two days.

Hebert told the group that she expected to receive one of the first -- if not the first -- registrations to operate a mutual fund company in Russia. "I'm at the head of the queue," she said, noting that she expected Zimmerman and Farallon Fixed Income Associates, as well as Farallon Capital Management in San Francisco, to back her financially.

"Beth said she had a trusting relationship with the Russian SEC," Aldrich recalled later.

On the second day Hay spoke to the AEW group, explaining how strongly RSEC head Vasiliev supported Hebert's venture and how important Yeltsin considered mutual funds to his reelection.

Though Aldrich's people liked Hebert's plan, Hay gave them pause. "Jonathan struck me as someone who was very academically inclined," aide Jeffrey Hammer said later. "I was somewhat bemused that Peter Aldrich introduced him to us. Jonathan did not seem to have, quite frankly, business acumen."

Still, it was clear that Hay had influence with the Russian officials who would award the first mutual fund registration and that he was committed to helping Hebert and Zagachin raise money. He assured Aldrich that nothing he was doing posed a conflict between his public responsibilities and his personal financial interests.

At the end of the second day of meetings, Hay, Hebert and Zagachin returned to the Charles Hotel off Harvard Square, where HIID put up visitors. Now that it appeared likely that the mutual fund enterprise would go forward, Hay told Zagachin that she would have to decide whether to work for HIID or for Hebert.

"You need to choose one way or the other which seat you want to sit in," Hay told Zagachin outside the hotel. "They're a different set of interests." Zagachin chose Hebert but did not resign from HIID for another four weeks.

Although Hebert had approached Aldrich for a single investment, her nascent business had evolved into two companies -- a mutual fund management operation, which would be called Pallada Asset Management, and a separate entity to provide back-office services. Hay, Hebert and Zagachin, as well as Zimmerman, believed that money could be made from both.

Zimmerman, as the potential lead investor, had solicited an investment in the management company from Farallon Capital's founder and senior partner, Tom Steyer. She also asked Hay and Hebert to fax Steyer a memorandum about the back-office company, known as a "specialized depository."

"Our advantage comes from the fact that the regulator wants us to be first . . . ," said the memo, dated May 16. "Our project will be established with the active involvement of the Russian legal team that the [RSEC] entrusted with the drafting of the original mutual fund regulation." The memo emphasized that the Russian legal team was managed by Hay himself. The same memo was faxed to Zimmerman and Shleifer. With the Russian presidential election only two months away, the Yeltsin administration was putting heavy pressure on Sokin and Vasiliev to implement the previous summer's decree promoting regulated mutual funds.

"You're a failure!" Yeltsin's prime minister, Viktor Chernomyrdin, told Vasiliev. If mutual funds weren't registered soon, Sokin said, Vasiliev could be thrown in prison. The RSEC chief was "incredibly nervous," an aide said. He was "basically hysterical," said another.

Sokin and Vasiliev in turn assailed Hay, Hebert and Zagachin for moving too slowly. "If we don't get this thing up and running, I'm going to end up in jail," Zagachin told colleagues. She would explain later that the Russian officials had made it clear to her that failure would carry "very serious repercussions."

Earlier in May the RSEC had awarded Forum Financial Group $2.5 million in World Bank funds to help create a back-office entity to be called First Russian Specialized Depository. Forum Financial CEO Keffer had been glad to get the $2.5 million, but he had been surprised by two pieces of unwelcome news. First, Forum could own a maximum of 49 percent of the FRSD -- the RSEC wanted the majority owned by Russians. Second, the RSEC wanted the FRSD to be run not by a real Russian but by the Russian-born, American-bred Zagachin. The matter-of-fact Keffer and the voluble Zagachin clashed over how to structure the company. Over the summer the animosity between them flared into a feud.

Hay, spurred by Hebert, demanded that Keffer agree to Zagachin's controlling the depository.

In the meantime, the U.S. government audit of HIID proceeded; in correspondence the General Accounting Office protested that the institute was withholding information. Washington attorney Butler, who had gone to Moscow to oversee the audit for HIID, sometimes spoke twice a day with Shleifer in Cambridge. Shleifer and Zimmerman were concerned about the Pallada and FRSD projects. Zimmerman had learned that Farallon's Steyer was lukewarm about investing. And Shleifer was nervous about possible conflicts of interest associated with his wife's involvement.

"The bottom line is, we continue having serious concerns," Shleifer informed Hay on June 9 in a fax marked "strictly confidential."

The Shleifers met with Aldrich at Zimmerman's office two days later to discuss the investment in Hebert's Pallada. Shleifer, who showed up late, appeared "very uncomfortable" and said "he really wasn't supposed to be expressing opinions on the subject," Aldrich recalled later in his deposition in the U.S. case. Zimmerman was frustrated.

"What am I supposed to do -- have a Chinese wall between me and my husband through our bedroom?" she had recently ranted to a young aide.

The secrets of the Shleifer-Zimmerman bedroom in Newton were not a trivial issue. It wasn't unusual for Zimmerman, a recognized expert on global fixed-income securities markets, to receive late-night phone calls from top Treasury officials seeking her counsel, including Summers, now deputy secretary, and David Lipton, Sachs' old Russia colleague, who was now assistant Treasury secretary for international affairs. "Our little world," Summers called the small cluster of government officials and private sector players who were in frequent touch. And it wasn't unusual for Shleifer to get calls at the same hour from Hay and others in Moscow, where it was early morning, wanting to confer about the most sensitive aspects of aid to Russia as well as their personal investments.

Yet as frustrated as they were with Russia, Shleifer and Zimmerman also had another subject to discuss with Aldrich: the education of their four-year-old son. The couple had visited the Shady Hill School, an elite, private elementary school in Cambridge. They were "tremendously impressed" and "desperately wanted" their son to be admitted, Aldrich recalled later, but had been dismayed to learn that "there were very few spaces." Could Aldrich use his contacts to help? He promised to try.

Zimmerman's meeting with Aldrich was a success: An Aldrich aide agreed in principle that AEW would invest $50,000 in Hebert's fund management company against an eventual total of at least $200,000. He prepared a draft deal memo which stated that his firm would invest on the condition that "Nancy Zimmerman and Andrei Shleifer would be invited to participate on favorable terms with the invitation coordinated through AEW Boston."

Hebert, assured that the RSEC would register her company soon, ahead of more-qualified competitors such as CSFB and Pioneer Group, resigned from Fleming at the end of June.

Meantime, Hay and his father, Dr. Robert Hay, decided to invest some of their money in Russia. From Idaho the elder Hay put $150,000, including $50,000 of Jonathan's personal funds, into GKOs. The Hays made the investment through Novyi Mir. Jonathan made sure to inform Shleifer of this latest investment.

THE STAKES FOR HARVARD IN Russia escalated after Boris Yeltsin's reelection on July 3. The Harvard project commanded the attention of top officials of both governments. U.S. vice president Al Gore and Russian prime minister Chernomyrdin held a mid-July summit on economic reform in Moscow attended by Summers and Shleifer. Gore and Chernomyrdin decided to launch a Capital Markets Forum, which twice a year would bring together experts from both nations to foster the growth of the Russian securities markets and financial services industry. The first U.S. delegation would be led by Treasury secretary Robert Rubin and SEC chairman Arthur Levitt Jr., who would choose industry practitioners to counsel their Russian counterparts on subjects like enforcement and transparency. Invitations to serve on the forum panels would be coveted.

Although the Russian government had imposed a September 2 deadline for First Russian Specialized Depository to be funded, the feud between Keffer and Zagachin made that date look impossible. Keffer, who kept notes on his daily activities, wrote of Zagachin: "undercutting, unhelpful, distrusting, incompetent, saboteur of the effort." Zagachin said similarly unflattering things about Keffer.

Hay and Vasiliev tried to mediate, without success. Finally, an angry Sokin took Keffer aside. "Julia is a grain of sand," he told the American, with Hay translating. "You should ignore her as an irritant. We will eliminate her in the future, but you must take her into your company now."

Reassured, Keffer agreed to hire Zagachin for an as-yet-unspecified job. He signed a consulting agreement with the RSEC and deposited $400,000 in a cash custody account at Citibank Moscow as seed capital for FRSD.

Meanwhile, there were tensions at the Harvard project. Hay was getting fed up with Zimmerman, who treated him and his U.S. taxpayer­financed Moscow colleagues as if they were her employees. "We were frankly trying to get rid of Zimmerman as a client because she was very demanding," Hay testified later.

In August 1996, Hebert got what she had been waiting for: The RSEC granted a license to First Russian Specialized Depository and registered the prospectuses of two of Hebert's mutual funds, a bond fund and a corporate equities fund, allowing Pallada to be the first to open its doors to the public.

The news stunned Moscow's financial community. "It seemed to confirm my fear and concern that special favors were being given," Timothy Frost, Pioneer Group's top man in Moscow, said in later testimony.

Holly Nielsen, the deputy director of the Resource Secretariat, had just returned to Moscow from a four-month maternity leave in the U.S. when she began getting urgent phone calls from colleagues. A savvy, steely lawyer, Nielsen was not naive, especially about the Moscow of 1996. But the activities of Hay and Hebert shocked her.

Nielsen testified under oath in a deposition that her reaction was one of "complete surprise, and also some disbelief, that this would have occurred."

The buzz in Moscow did not faze Hay. In fact, after the registration award, Hay gave Hebert and Pallada free rein to operate out of HIID's offices and to use its computers, phones and faxes, according to the grand jury testimony of David Weiler, who was the Legal Reform Project's chief financial officer in Moscow. Pallada was the only mutual fund company invited to exhibit its marketing material at the Collective Investment Center, a new public facility in the Baumanski district of downtown Moscow where consumers could learn about investment products, said Frost, Nielsen and Rutherford. The mutual fund company was also granted, without a tender, the exclusive and lucrative right to manage millions of dollars of assets for a government fund set up to bail out defrauded investors.

Before Hebert could actually sell mutual fund shares, First Russian Specialized Depository had to be up and running. The RSEC had granted FRSD a license, but the organization was still plagued by intramural rancor. Keffer had offered Zagachin a midlevel management job, far below the position she wanted; when she refused it, he fired her.

On Monday, August 19, before flying back to Washington, Butler spent five hours with Keffer in a conference room at the Tverskaya Hotel. Butler convinced Keffer to find a buyer and recoup his $400,000 deposit. The same day, Zagachin strode into Citibank Moscow, next door to the ILBE, and tried to shift the $400,000 that Keffer had deposited into an FRSD account to which she had access. Only the intervention of an alert Citibank staffer thwarted her maneuver. The staffer informed Keffer, who confronted Hay with the "attempted theft," Keffer said in his deposition. At this point, Keffer testified, he informed Hay about "the fraud that we felt was going on and the misdirection of U.S. funds and the misdirection of the capital markets program in Russia." He threatened to withdraw his $400,000 outright. That would delay the launch of Russia's mutual fund industry for months, unless a buyer for his stake in FRSD could be found quickly. The government's September 2 deadline for the depository to be funded stood fast.

SHLEIFER AND ZIMMERMAN FLEW INTO Moscow that Monday afternoon and found themselves in the midst of the crisis. Over dinner at the ornate National Hotel, Hebert and Hay, flanked by Zagachin and Sokin, briefed the Shleifers on Keffer's "blackmail."

Panic gripped the group. Sokin implored Shleifer to devote himself personally to resolving the problem before the September deadline. Then all heads turned to Zimmerman. Was she still hesitant to invest with Hebert? If not Pallada, would she consider helping with the FRSD? Conflicted, Zimmerman asked a lot of questions. Could it be a loan instead of an equity investment? What would secure the loan? By the end of the dinner, Zimmerman was weighing the notion that she might become the lead investor in FRSD.

The group held a series of urgent conferences -- at Hay's dacha, at the HIID offices, at restaurants around Moscow -- but the issue was still unresolved when Shleifer and Zimmerman left Russia three days later. Zimmerman returned to Boston, and Shleifer flew to Istanbul, where he gave the globally renowned Joseph Schumpeter Lecture at a meeting of the European Economic Association. Shleifer argued in this lecture, "Government in Transition," that Russia's evolution to a market economy was being retarded by a slow and uneven political shift away from a communist dictatorship to a freer form of government.

One week later Shleifer and Zimmerman were back at their vacation house on Cape Cod -- and catching up with Larry Summers. In the lazy days easing toward Labor Day at Truro, the friends had an opportunity to kick back.

As the trio strolled the beach and lounged around their houses, they talked about Russia. Shleifer and Zimmerman were under a lot of stress because of the crisis in Moscow: If Keffer weren't bought out of his investment by the following Monday, the launch of Russia's mutual fund industry would be substantially delayed and might even collapse. They didn't mention any of this to Summers, who asked some general questions about privatization and the like.

Summers also had some questions of a more personal nature: He knew the couple were investing in Russia. He didn't know the specifics, but he understood enough to ask about Zimmerman's GKO investments. She said she had done well. Shleifer and Zimmerman said they were "bullish on Russia." Though he was unaware of Zimmerman's tax-avoidance scheme and the use of her father to conceal the Shleifers' oil investments, Summers had heard enough to caution the couple.

He said that it would be "a good idea for Andrei to make sure he was operating within the rules of whatever legal arrangements he had with Harvard" and that Shleifer should check what his personal contract said. Zimmerman, Summers said, "should just think hard" about what she was doing.

When Zimmerman later consulted with her husband about Summers' advice, Shleifer said, "We can use Michael Butler if we're concerned about specific things."

ZIMMERMAN WAS NOT TO BE DETERRED. FROM Truro, on Thursday, August 29, amid the friendly chats with Summers, she agreed in an e-mail to loan Zagachin $200,000 and to sink an additional $200,000 into an equity investment so that Zagachin could get control of FRSD. But arrangements couldn't be concluded by the deadline -- September 2, Labor Day -- only four days away.

Desperate to avoid missing her big opportunity, Hebert telephoned Hay's father in Idaho and confided her anguish.

"Keffer has created a panic -- he's blackmailing us," she said. "You could help me come up with some bridge financing for Julia. It would be very short term, until we can find someone to make a long-term investment in the project. I'll make sure that it's 100 percent secure."

Dr. Hay immediately withdrew $200,000 of his own funds and $200,000 of Jonathan's and wired the money to Zagachin's bank account in Delaware the same day. Zagachin was the new owner of FRSD.

That evening Hebert and Hay reflected that Dr. Hay's generosity and quick action might have saved the Russian mutual fund industry and his son's career, and kept Vasiliev in office.

The younger Hay e-mailed Zimmerman in Truro: "Everything sounds fine. Call me on the mobile or at Beth's."

While Pallada was setting up shop, other financial institutions were struggling with the Russian bureaucracy. On September 13, 1996, Credit Suisse First Boston submitted an application to the RSEC for authorization to start a depository, requisite for a mutual fund company. The RSEC employees who opened the application found two small travel alarm clocks. The clocks were inexpensive tokens akin to ballpoint pens or key chains. But Vasiliev summoned CSFB's Moscow representative, Bruce Lawrence, a respected back-office specialist, accused him of criminal conduct and returned the clocks. Vasiliev sent a strongly worded letter to the CEO of Credit Suisse in Zurich. He then called in Hay and Butler and suggested that the episode be reported to the Moscow police fraud squad. Though no call was made, Credit Suisse's application was stalled, and word made its way to Washington. "I was aware," said Summers years later, "that there were concerns of impropriety surrounding Credit Suisse . . . "

Separately, Butler counseled Hay to inform Vasiliev of his relationship with Hebert, which he did later in a formal letter. Butler also advised Hay to "work out some arrangement that you won't be involved with matters that affect her company."

A few days later Hay told Butler, "I've worked it out with Vasiliev."

He hadn't.

Butler also demanded that Hay impose order on the disorderly Institute for Law-Based Economy. Not for the first time, Butler took Hay to task for paying employees in cash and for "the out-of-control use of drivers for personal purposes." In a stern memo he wrote: "This system does not have to be perfect, or even very good. But it does need to be good enough to get USAID's approval."

What Butler didn't know was that Hay's headquarters in Moscow had become a virtual branch office of Zimmerman's firm, as evidenced by e-mails cited by the U.S. in its lawsuit. On September 23, for example, Zimmerman e-mailed Hay from Cambridge to say: "zagachin loan ready to go" and "we will make u a 400k loan -- u will pay back 200k asap, and the balance when it is appropriate."

Zimmerman was indicating that she might be ready, either through her firm or personally, to take Hay and his father out of the emergency $400,000 loan they had made to Zagachin at the end of August. But she continued to waver.

In other communications Zimmerman asked Hay to execute certain investment actions.

"please buy some oct 23 gkos and we will take care of everything when the current ones roll off," she e-mailed on October 10.

Less than two hours later: "did u get my last message?"

Less than two hours after that: "Did u do anything in GKO?"

It took Hay another five hours to reply that he had bought the October 23 bonds.

THE ACTIVITIES OF THE HARVARD PROJect were causing alarm among other Americans in Moscow. Holly Nielsen, deputy director of the Resource Secretariat, began to worry about a possible scandal that could embarrass Harvard and the U.S. government. In late October she met with Vasiliev to discuss the awarding of the first mutual fund registration to Hay's girlfriend rather than to a proven global securities firm like CSFB or Pioneer, Nielsen said in her deposition. Vasiliev's aide Andrea Rutherford translated.

"What would your superiors and the Russian government think of these conflicts?" Nielsen asked, according to her deposition.

"My superiors wouldn't care." Vasiliev seemed perplexed.

"People within the industry have certainly voiced concern," Nielsen replied. "It's becoming an increasingly difficult issue to try to defend."

Nielsen decided to confront Shleifer. Because she hardly knew him, she asked Rutherford to introduce her to someone who did, Joseph Blasi, a professor at the Rutgers School of Management and Labor Relations who was working for HIID, advising on employee ownership of businesses, a key aspect of privatization. Nielsen took Blasi to breakfast at the Aerostar Hotel off of Garden Ring Road on Sunday, November 3, just hours before he was to fly to New York.

Talking fast, she poured out the story of the mutual fund registration while Blasi scribbled notes on a napkin. She asked him to arrange for her to see Shleifer in Cambridge. She also asked that the communication be kept confidential: Blasi should use a code when referring to the meeting in a fax or e-mail: "The appointment with your pediatrician is confirmed."

The morning after Blasi arrived in the U.S., he called Shleifer.

"If what Holly Nielsen told me is true," Blasi declared, "Jonathan Hay should be fired immediately." Shleifer agreed to see Nielsen, although they would not meet for more than a month.

Vasiliev and Rutherford flew to New York in mid-November to represent the RSEC at the listing of mobile phone operator VimpelCom Corp. on the New York Stock Exchange, the first Big Board listing of a Russian company. They took the occasion to call on exchange attorney Richard Bernard, who warned them that, based on what he had heard since leaving Moscow, Shleifer and Hay as well as Sokin would eventually bring public embarrassment to Vasiliev.

"Your reputation has already been damaged by the mutual fund talk," Bernard said. "The reputation you have with the SEC and with people here at the exchange is being damaged."

Vasiliev listened but didn't say much. In the town car headed uptown, he asked Rutherford's opinion. She told him she agreed with Bernard.

"I essentially agree with Rich," she said, speaking in Russian. "You've been very successful in building a reputation in the West, not just for competence but honesty, and my impression is that reputation is being damaged by the talk, the rumors, the gossip about how you've treated Pallada, how you've treated Pioneer, how you've treated Credit Suisse."

"We've had too much scandal. Too many people have lost too much money," Vasiliev replied. "The reason we're handling Pallada as we are is that it is very important that there are no scandals or problems connected with the first mutual funds in Russia. The only way we can do that is to ensure tight control over these first new funds -- with somebody we know well, somebody close to us we can trust running Pallada."

RELEASED IN NOVEMBER 1996, the final report of the U.S. General Accounting Office could have been far worse for Harvard. Butler had done an excellent job of containing the auditors. The report's most severe criticism was that AID's management of HIID was "lax." "In particular," the report read, "USAID did not . . . set measurable goals and was not aware of decisions HIID was making that could have resulted in costs to the U.S. government or that could significantly affect U.S. strategy."

The HIID group was relieved. Shleifer arranged for the then-president of Harvard, Neil Rudenstine, to send a handwritten thank you note to Butler.

In Moscow the firms whose mutual fund applications were being thwarted were not taking the obstruction lightly. Pioneer's Frost demanded and got an audience with Hay. They met on Saturday, November 30, at the Starlite Diner but moved to a nearby French pastry shop for privacy.

Frost began by praising Hay for all the good he had done for Russia. It would be tragic, he said, if that record were tainted by scandal.

"There really is a problem here," Frost said. "If it isn't a real conflict of interest, there is a strong perception, an odor of conflict of interest. You need to make sure you are leaning over backwards to guard against this."

Frost later testified in the U.S. government lawsuit that Hay responded with threats, implying that he could make sure that Vasiliev and the RSEC further thwarted Pioneer's entry into the Russian mutual fund business: The application process could drag out and might not be approved. All of Pioneer's financial initiatives in Russia could be delayed.

"Is it fair to say you took Jonathan Hay's comments on November 30, 1996, as a threat?" Frost was asked under oath in his deposition.

"Yes."

"In your view, would any reasonable person in your position sitting at that meeting come away feeling that they had been threatened?"

"Yes. I think they would have felt threatened in terms of business, our ability to conduct business, yes."

Pallada continued to get special treatment from the Russian government and the Harvard project. In December, Hay and Vasiliev recommended to the U.S. Treasury that Pallada, along with such global powers as Citicorp and Salomon Brothers, be included in the coveted Capital Markets Forum. Hebert would sit on two panels alongside people far more prominent than she, including Citi CEO John Reed and Salomon CEO Deryck Maughan.

Despite her interest in committing $400,000 to Pallada and FRSD, Zimmerman still had invested nothing in Hebert's ventures. Then, as the end of the year neared, Butler gave her, Shleifer and Hay advice that made them squirm. He had decided a case could be made that her investment in Pallada was legitimate, but he said investing in the FRSD was "inadvisable." He recommended that the Shleifers disclose their plans to Vasiliev, to the Harvard general counsel's office and to Gregory Poppe, one of Harvard's attorneys.

According to exhibits entered in the lawsuit by the U.S., Zimmerman e-mailed Hay on December 2: "[Butler] would like us to tell Greg Poppe and just do it above board. He thinks . . . it should be done in an upfront way. I talked to Boss about this plan; he seemed less sure. . . ."

Hay replied: "I am just worried about what we do when Greg Poppe says no. I think that the issue must be prepared very carefully to minimize the risk that this happens. I also think we have to have a fallback if Poppe says no."

They decided to tell Poppe nothing.

Nielsen met with Shleifer in Cambridge on December 9. They lunched at the Harvard Faculty Club, speaking first about a range of issues and problems at HIID in Moscow. It wasn't until the next morning in Shleifer's office in the Littauer Center that Nielsen raised the concerns that had brought her to Boston.

"Jonathan and Beth are being stupid and arrogant about the registration issue," she said, according to her deposition in the lawsuit. "If they had quietly gone about getting [registration] No. 3 or 4, no one would even have noticed. But the fact that they felt they had to get No. 1 caused a huge sensation."

"I can't control who Jonathan sleeps with," Shleifer replied.

Nielsen was stunned, but continued. "I believe that Jonathan's direction of public funds to benefit a commercial private organization in which Hebert has an interest is a conflict of interest and an improper use of public funds."

Shleifer was unmoved. As Nielsen was leaving, he said, "I'm naming Jonathan executive director of the Resource Secretariat." Hay would be taking over from Bernard's replacement, Dmitri Subbotin, who was being pushed out because he had objected to the RSEC's registration of Pallada. The change would also make Hay Nielsen's direct boss.

Nearly a year after Hay and Hebert had begun seeing each other and three months after Butler had advised Hay to disclose the relationship to Vasiliev, Hay sent Vasiliev a letter, drafted by Butler, recusing himself from any oversight role concerning Pallada Asset Management. The letter was a formality -- Vasiliev had known of the relationship from the start. Hay's treatment of Pallada didn't change. He did finally move into Hebert's apartment, however, the plumbing at his own flat having long since failed.

When Hay and Hebert flew to Idaho for Christmas with Dr. Hay, they finally got around to documenting the emergency loan he had made to Zagachin in August. Zagachin would repay Hebert, who would repay Dr. Hay. In a promissory note Hebert pledged her personal assets, including a bank account in the Channel Islands and a 1991 blue Volvo 740.

In February, Shleifer wired $200,000 from his and Zimmerman's joint bank account to Pallada. He was implementing a cash advance from his wife to Hebert. The parties labeled the advance a loan, but it was not documented for the time being, leaving the option of structuring it as either debt or equity.

Meanwhile, Zimmerman sent First Russian Specialized Depository's latest business plan to AEW, which had indicated it would invest $50,000 in Pallada against an eventual total of $200,000 and would consider investing in FRSD as well.

AID had been stung by the General Accounting Office's finding that it had been lax in supervising Harvard's Russian Project, but did not take action for several months. In late February, Olga Stankova, a senior Moscow staffer of AID, privately informed Janet Ballantyne, the agency's mission director, that Hay's girlfriend "had been given unfair advantage in the registering of the first mutual fund program," according to Ballantyne's deposition in the lawsuit. Ballantyne, a 20-year AID veteran, was a smart bureaucrat, but she had only been in Moscow for three months and was still catching up with the agency's work in Russia, where 150 employees administered 80 to 90 programs. Though she had met with Hay on half a dozen occasions, she spent no more than 5 percent of her time on the Harvard program.

Upon hearing of the potential problem, Ballantyne summoned her top legal officer, Mark Ward, and then telephoned the agency's inspector general in Washington. The IG is independent of AID, appointed by the president of the U.S. and reporting directly to Congress. The IG immediately dispatched two special agents to Moscow to investigate. Ballantyne briefed the charge d'affaires and the Treasury attaché at the U.S. embassy in Moscow, who alerted ambassador Thomas Pickering.

The two agents conducted a quiet preliminary investigation over six weeks. On April 10, Ballantyne and Ward telephoned Jeffrey Sachs at Harvard; he had become HIID director two years earlier, but he had not been in Moscow since 1994, having been preoccupied with other projects around the world.

"Don't say anything," Ballantyne said. "We have a statement."

She informed him that AID's inspector general was investigating possible improprieties in the Harvard program in Moscow and that the agency was asking his cooperation in interviewing the staff. A stunned Sachs said he would get back to them.

Sachs called the Harvard general counsel's office, then notified the university's second-in-command, provost Albert Carnesale, who had been running Harvard with unusual authority for two years, since illness had sapped president Rudenstine's capacity. Then he called his old rival.

According to Sachs' testimony, Shleifer tried to portray the investigation as a "vendetta" orchestrated by "enemies" of Harvard, competing universities that had bid for the Russia job and lost.

Sachs was furious, later telling a federal grand jury his opinion of Shleifer's illicit investments: "Mr. Shleifer would be doing a disservice and would be entering a conflict of interest to make an investment like this. . . . I would find such investments to be highly inappropriate. . . . It would be damaging to HIID to engage in this kind of behavior while serving as an HIID consultant or employee to Russia."

WHEN HAY LEARNED OF THE investigation, he immediately called Butler. "Something funny is going on," he said. "You may need to get involved." Together they called Poppe at the Harvard general counsel's office. Poppe, who had just been notified of the investigation by Sachs, asked that Butler represent Harvard, HIID, Shleifer and Hay in any contacts with AID investigators.

Hay, Hebert and Zagachin scrambled. There was the matter of the loan that Hebert had arranged for Hay's father to make to Zagachin the previous August. Zagachin telephoned one of Aldrich's aides at AEW and asked if the funds earmarked for FRSD could be transferred immediately -- and if the amount could be doubled, to $400,000, in exchange for a larger piece of the company and better terms. Aldrich authorized the transfer of the funds to Zagachin. She instantly wired the money to Hebert, who passed it on to Dr. Hay in Idaho. A few days later AEW proceeded with its Pallada investment, paying $50,000 for 2 percent of the company.

With his university's reputation at stake, Carnesale demanded that the U.S. government put its charges in writing. On April 17, AID faxed a letter to Sachs stating that a senior HIID official in Moscow had a close relationship with the manager of a Russian mutual fund company and "may have used his or her position to seek preferential treatment for this mutual fund and the fund's specialized depository." The letter also alleged that "some USAID funding may have been used for the personal gain of one or more HIID employees" and insisted that Harvard people submit to interrogation by U.S. agents.

Hay fired back from Moscow. He drafted an angry letter for Vasiliev to send to AID mission director Ballantyne, denouncing the investigation as "deeply insulting," "crude" and "a violation of elementary norms of courtesy." The letter stated that Hay had no financial interest in either Pallada or FRSD.

Vasiliev dispatched another outraged, Hay-written letter to Richard Morningstar, who, as a special ambassador, advised the White House and the State Department on U.S. aid to the states of the former Soviet Union. The letter asserted that FRSD "has received private financing from a well-known trustee for pension funds," meaning Aldrich in Boston. He did not say that the financing had been in place for only a week. He did, however, warn of possible dire consequences to Russian-American relations as a result of the AID investigation.

From Cambridge, Sachs asked all HIID employees in Moscow to cooperate fully with the investigation.

On April 30 special agents Philip Rodonkanakis and Mary O'Mara interrogated Hay for three hours and 20 minutes in the mission director's conference room at the AID offices in Moscow, with Butler at his side.

Over the next few days, Shleifer called around Moscow trying to find out what the HIID staff was telling the investigators. A few people believed the Resource Secretariat's Holly Nielsen had been responsible for sparking the investigation. Shleifer ordered that she be fired. Nielsen informed Sachs, who countermanded the order. Shleifer reinstated it. "I'm running this project, and you'll do what I say," he told Rachel Glennerster, the Cambridge-based administrator in charge of contracts. She informed Sachs, who again reinstated Nielsen.

Nielsen couldn't be fired, but she could be restrained. Vasiliev ordered the security guards to bar her from the offices of the Resource Secretariat.

On May 9, Sachs asked Carnesale to fire Hay and to suspend Shleifer from the Russia Project. Not knowing this, a distraught Shleifer that same day let loose an extraordinary nine-page diatribe to the provost, calling the U.S. investigation "zealous," "outrageous" and "vicious," with the objective of "getting" him, Hay and Harvard.

Shleifer asserted that there was "no evidence of wrongdoing by myself and Hay." He oddly and grandiosely insisted that Carnesale cancel the entire Russia program: "It is a great time for Harvard to send [AID] straight to hell."

On May 19, Anatoly Chubais, who had become first deputy prime minister of Russia, dispatched a letter to AID administrator J. Brian Atwood in Washington demanding that he terminate HIID programs in Russia. The next day AID summarily killed the Russia Project, initiated five years earlier with such hope and intellectual heft. HIID had spent upward of $40 million of U.S. government funds and controlled the spending of an additional $350 million by other contractors.

The official letter, which the agency faxed to Sachs from Moscow, contained strong language unusual for a federal agency. Shleifer and Hay, AID charged, "have abused the trust of the United States Government by using personal relationships . . . for private gain. . . . USAID has been trying to explain to key Russian Government counterparts the value of open and transparent processes, and the importance of avoiding conflicts of interest, as ways to increase investor confidence in the Russian capital markets. . . . The private activities of [Hay and Shleifer], supported by staff and equipment paid for with U.S. Government funds, conveys exactly the wrong message to the Russians." On May 21 the Committee of Fellows of the Harvard Institute for International Development met twice in emergency session and crafted a letter to university president Rudenstine "expressing our dismay and concern," castigating Shleifer and Hay and urging that they be suspended. "Nothing less than HIID's integrity and ability to function effectively in the future is at stake," the letter stated.

In lower Manhattan that morning, Richard Bernard sent a memorandum to his boss, New York Stock Exchange CEO Richard Grasso, commenting on the coverage of Harvard's problems that day in the Wall Street Journal. "On a personal level," Bernard wrote, "it is hard not to rejoice in seeing Shleifer and Hay get their comeuppance. However, I am concerned about the possible ramification of the scandal for the good work that we did manage to accomplish."

Harvard fired Shleifer and Hay from their HIID positions the next day. Shleifer, however, retained his tenured professorship in the department of economics.

THE REVELATIONS FROM MOSCOW shocked no one more than Peter Aldrich, who invited Shleifer to dine at their usual haunt, Henrietta's Table in the Charles Hotel. Shleifer tried to shift the blame. "I've been hung out to dry," he railed. "I was just a consultant. It was Jeffrey's [Sachs] program, and he ran it."

Aldrich later telephoned Vasiliev in Moscow, who defended Hay. "Jonathan has been a tremendously valued adviser," Vasiliev said. "He's the only good money the U.S. government has spent. This is a political vendetta by the Central Bank against me and especially Chubais. The bank wants control of the securities market."

Hay visited Boston in late May in an effort to defend himself. He met with Sachs and Dwight Perkins, the senior professor who had run HIID for 15 years and had approved the hiring of Hay in 1992.

He also met with Aldrich, who called Hay to his office and directed him to a chair so they could face each other.

"Jonathan, I absolutely need to know the truth," Aldrich said, according to his deposition in the U.S. lawsuit.

Hay proclaimed his innocence, furious that he had been "summarily dismissed . . . and . . . prejudicially judged."

"Jonathan, did you or did you not invest in Russian securities?"

"No." Hay looked uncomfortable.

"Is that your truthful answer?"

"Well, I invested for my father. It wasn't much."

"What are we talking about here? How much money was it?"

"Well, $50,000."

"There's nothing else that these people can catch you on, hang you on?"

"Nothing else."

Aldrich wasn't convinced. "Jonathan, this is really important to me. I'm a fiduciary here. I've got money I'm responsible for. Is there anything else that you did that is wrong? Is there something else I should know about?"

"No, no, that's it."

"You're telling me that your father's investment of $50,000 was something that you were perfectly within your rights to do?"

"Yes. I didn't do anything wrong."

On May 30, Chubais and Vasiliev complained directly to Summers at Treasury "with considerable vigor and bitterness," Summers later recalled in his deposition. "They felt the U.S. government's refusal to fund the HIID project . . . constituted a significant interference with their objective of bringing about market and democratic institutions in Russia and seemed to them to be a kind of unconstructive and hostile act by the United States government."

Several days later Zimmerman received a call at home from Leonard Blavatnik, the Forbes 400 billionaire who had arranged the Shleifers' first investment in Russian stocks, back in 1994. Blavatnik was concerned about the public controversy surrounding the Harvard Russia Project.

"It's a witch hunt," Zimmerman said. "A political vendetta."

Blavatnik promptly prepared a backdated document changing the beneficial ownership of the stock purchased in 1994 from Shleifer to Zimmerman. The Shleifers' $200,000 investment through the Blavatnik vehicle Renova at one time had tripled in value -- the Gazprom component had been up fivefold.

The collapse of the Harvard project had an immediate and negative consequence for the Russian reformers with which it was connected. On Friday, May 30, 1997, barely more than a week after first deputy prime minister Chubais pulled the plug on the Harvard project, he summoned Vasiliev to the Kremlin and resolved his conflict with the Central Bank. The Central Bank would be given the right to license commercial banks to trade in the equity market -- in effect opening the door to the German model of heavy bank investment in the stock market, which Vasiliev had opposed so bitterly for so long. Vasiliev resigned in October 1999, citing personal reasons.

By then Harvard had put HIID out of its misery, replacing it with the Center for International Development. Sachs, who stayed around for the launch of the CID, eventually left Harvard for Columbia.

Also by that time, Pallada had been bought by State Street Global Advisors and Farallon Capital had decided to dissolve its joint venture with Zimmerman. In late 1998, according to sources at Farallon, the San Francisco firm gave back to her its passive minority stake on the condition that she change the name of her firm from Farallon Fixed Income Associates; she renamed it Bracebridge Capital. Public records show that in 2001 she also began to use the acronym FFIA for her business; she continued to do so into 2004, when Farallon discovered its use and protested.

WHEN AN AGENCY OF THE U.S. government determines that crimes have been committed, it prepares a "criminal referral" to the Department of Justice, which evaluates the case and decides whether to prosecute. AID made its referral in June 1997. The Justice Department approved the case and assigned it to the U.S. Attorney's Office in Boston and the FBI. On July 10 a meeting of FBI agents and federal prosecutors was convened at the Boston federal courthouse by Assistant U.S. Attorneys Sara Miron Bloom and Stephen Huggard.

Bloom and Huggard gathered evidence for a year and presented witnesses and documents to a federal grand jury for two additional years. Though they wanted a criminal prosecution, the government, in the end, filed civil charges only.

On September 26, 2000, the U.S. government sued Harvard University, Andrei Shleifer, Jonathan Hay, Nancy Zimmerman and Elizabeth Hebert on 11 counts, including fraud, breach of contract and making false claims to the federal government. The suit estimated that the government had been defrauded of at least $40 million and asked treble damages under the False Claims Act.

One month later Forum Financial Group and John Keffer sued Harvard, Shleifer and Hay for fraudulent misrepresentation and other alleged infractions and asked unquantified actual and punitive damages. The defendants denied the alleged wrongdoing in both suits.

On November 12, 2001, U.S. District Court Judge Douglas Woodlock dismissed the charges against Zimmerman and Hebert on the grounds that the government essentially had failed to allege a sufficient number of relevant facts against them. However, he left open the possibility that the government could refile the charges under certain circumstances.

After extensive discovery, including about 60 depositions and the collection of more than 1,000 documentary exhibits, the government and the defendants all moved for summary judgment in their favor. Shleifer insisted he was a "consultant" rather than an employee, was never "assigned" to Russia and was therefore exempt from conflict-of-interest regulations. A key question for the judge was whether Shleifer or Hay had violated the "regulations governing employees."

On June 28, 2004, Judge Woodlock ruled against Shleifer and Hay. He wrote, "I find that the Cooperative Agreements were valid contracts between Harvard and USAID, that they created an obligation to remain free of conflicts of interest, and that actions by Hay and Shleifer breached that duty.

"Shleifer was in charge of the entire Russian Project, and classifying him as a consultant would result in the anomalous circumstance that the head of the project was exempt from the conflicts of interest regulations. . . . I find no genuine dispute of material fact as to Shleifer's status as an employee of HIID."

The judge determined that Shleifer and Hay were subject to the conflict-of-interest rules and had tried to circumvent them; that Shleifer engaged in apparent self-dealing; that Hay attempted to "launder" $400,000 through his father and girlfriend; that Hay knew the claims he caused to be submitted to AID were false; and that Shleifer and Hay conspired to defraud the U.S. government by submitting false claims.

On July 30, 2004, the government announced that Zimmerman had settled with the U.S. Even though the charges against her personally had been dismissed, the U.S. said that her firm had "improperly diverted U.S. taxpayer resources for its own purposes and profit" in AID's Russia program between 1992 and 1997. Zimmerman's firm had to pay $1.5 million to the U.S. government.

That December, Judge Woodlock conducted a jury trial to settle the factual question of whether Shleifer was "assigned to" Russia and thus obliged to obey the relevant conflict-of-interest regulations. The jury concluded that he was.

On August 3, 2005, the parties announced a settlement under which Harvard was required to pay $26.5 million to the U.S. government, Shleifer $2 million and Hay between $1 million and $2 million, depending on his earnings over the next decade. Shleifer was barred from participating in any AID project for two years and Hay for five years. Shleifer and Zimmerman were required by terms of the settlement to take out a $2 million mortgage on their Newton house. None of the defendants acknowledged any liability under the settlement. (Forum Financial also settled its lawsuit against Harvard, Shleifer and Hay under undisclosed terms.)

As the U.S. government's litigation proceeded with deliberate speed, Shleifer was distinguishing himself in the world of economics. He was earning a growing reputation as a theorist in the emerging field of behavioral finance even as he published a series of books and articles analyzing the changes in Russia. (In 1994 the industrious Shleifer had formed with fellow academics -- and behavioral finance specialists -- Josef Lakonishok and Robert Vishny a Chicago-based money management firm known as LSV Asset Management. Today it manages about $50 billion in quantitative value equity portfolios, though, according to the firm's Web site, Shleifer no longer has an ownership stake.)

In 1999, Shleifer cemented his place in the firmament of American economists when he won the John Bates Clark Medal, a ticket to the most-exalted circles of global academic economists. Paul Samuelson, who won it in 1947, and Milton Friedman, who won in 1951, subsequently received Nobel prizes. Summers was awarded the medal in 1993.

Shleifer remained close to his friend and mentor Summers; they talked to and saw each other frequently and continued vacationing together in the summer on the Cape. Then it became known in early 2001 that Summers was on the short list of candidates to succeed Neil Rudenstine as the president of Harvard University. Shleifer and Zimmerman began campaigning for Summers to get the Harvard post, giving meet-and-greet parties for him at their home. Summers stayed with them when he visited Harvard.

In March 2001, Summers was named president of Harvard. Shleifer, who had been courted by New York University's Stern School of Business, decided to stay put.

Having his close friend as his boss would turn out to be quite helpful to Shleifer. Summers asserted in his deposition that he recused himself from any involvement in the university's handling of the Shleifer matter, but the new president stayed involved anyway. Early in his presidency he told the dean of the faculty of arts and sciences, Jeremy Knowles, to keep Shleifer at Harvard.

"I expressed to Dean Knowles," Summers testified in a deposition in 2002, ". . . that I was concerned to make sure that Professor Shleifer remained at Harvard because I felt that he made a great contribution to the economics department . . . and expressed the hope that Dean Knowles would be attentive to that. . . . I think he recognized and shared the concern."

Summers hinted in the deposition that although he didn't know all the facts and wasn't a lawyer, he felt his friend Shleifer might have been unfairly accused -- that there was nothing necessarily wrong with "providing advice on a financial issue in which one had an interest."

Summers said conflict-of-interest "issues," in his Washington experience, were "left to the lawyers." He said he was sensitive to "ethics rules," but testified that "in Washington I wasn't ever smart enough to predict them . . . things that seemed very ethical to me were thought of as problematic and things that seemed quite problematic to me were thought of as perfectly fine. . . ."

Knowles, at least in principle, took a different view. He testified to the federal grand jury investigating Shleifer that he expected faculty to know the regulations prohibiting conflicts and to "understand the spirit, not just try to squeeze past the letter. . . ."

Harvard has disciplinary procedures for dealing with errant professors. The Committee on Professional Conduct, composed of a rotating group of senior faculty, provides guidance on conflict-of-interest questions to professors who seek it in advance of making an investment. It isn't unusual to solicit such counsel. Had Shleifer and his wife approached Knowles before making their investments, Knowles told the grand jury, he probably would have referred them to the committee. They had not come to him.

The committee also gathers facts on alleged misconduct and reports its findings to the dean, who then must decide whether to discipline or sanction the alleged offender. Penalties range from light to severe. Dismissing or forcing the resignation of a tenured professor at Harvard is very rare, but it can be done under the so-called Statutes of Harvard University, the school's venerable governing tenets, originating in 1650, 14 years after Harvard's founding. The Third Statute provides for dismissal for ". . . grave misconduct or neglect of duty . . ." The procedure, which is called "invoking the Third Statute," is so rare that few at Harvard have even heard of it.

When the Shleifer scandal broke, Knowles did not mobilize the committee. As allegations against Shleifer hadn't yet been litigated, Knowles took the position -- and so testified to the grand jury -- that Shleifer was innocent until proven guilty.

Knowles tells Institutional Investor that he does not remember Summers' approaching him about Shleifer. "I don't recall this particular conversation, but the president and I shared the goal of recruiting and retaining the best faculty, so it would have been perfectly natural for us to mention to each other the names of people that we certainly wouldn't want to lose." However, not long after Summers says he intervened on the professor's behalf, Knowles promoted Shleifer from professor of economics to a named chair, the Whipple V.N. Jones professorship.

Knowles left the deanship in 2002 and is currently the Amory Houghton professor of chemistry and biochemistry and a distinguished service professor at Harvard. His successor as dean of the faculty of arts and sciences was William Kirby, a former chairman of the history department and a noted China scholar, who was appointed dean by Summers effective July 1, 2002.

Shleifer's legal position changed on June 28, 2004, when Judge Woodlock ruled that he and Hay had conspired to defraud the U.S. government and had violated conflict-of-interest regulations. Still, there was no indication that the Summers administration had initiated disciplinary proceedings. To the contrary, efforts were seemingly made to divert attention from the growing scandal. The message from the top at Harvard was, "No problem -- Andrei Shleifer is a star," says one senior Harvard figure.

The Summers-Shleifer friendship flourished. They spoke on the phone more than once a day, on average. Two months after the court ruling against Shleifer, he hosted Summers at a break-the-fast dinner on Yom Kippur.

David Cutler, another Summers protégé and professor of economics, whom the Harvard president had elevated to dean of social sciences, hosted a "Social Sciences Colloquium" lecture series in 2004 and designated Shleifer as one of the first speakers. Shleifer spoke on Russia, about which he had penned an article for the March/April 2004 issue of Foreign Affairs; the article, "A Normal Country," grew into a book of that name published in 2005. Later in the year Cutler invited Shleifer to a gathering of prominent Harvard scholars to discuss what the university should be doing to advance research and scholarly work in Russia.

The continuing efforts on Shleifer's behalf, particularly after the court adjudged him liable for conspiracy to defraud the government, offended a number of professors, some of whom quietly approached the chairman of the Committee on Professional Conduct, professor Jeffrey Frieden of the government department. In departments of the university that depend heavily on grants from the U.S. government, conflict-of-interest rules are ubiquitous and strictly observed; some of the professors warned that the university's credibility with federal agencies could be compromised if no action were taken against Shleifer.

Committee chairman Frieden told those who inquired that the committee's function was limited to fact-finding and that as the federal court had already established the facts in the Shleifer case, the matter was more appropriately before Dean Kirby than before the committee. More than one professor felt that Frieden seemed intimidated by Summers.

"I have a vague recollection of having mentioned to a colleague some years ago . . . that whatever the CPC might or might not do, it could not act so long as the case was in the courts," Frieden told II in an e-mail comment. "When there is a prior court decision, the CPC . . . would not normally need to carry out much in the way of fact-finding because presumably the courts would have done this."

With no action forthcoming by the committee after the court's ruling, it's understood that members of the faculty of arts and sciences have taken up the Shleifer case with Dean Kirby on at least half a dozen occasions of varying formality over the past 16 months.

One instance was a meeting early in the academic year that began in September 2004, less than two months after the federal court formally adjudicated Shleifer's liability for conspiring to defraud the U.S. government. A faculty member asked Kirby why Harvard should defend a professor who had been found liable for conspiring to commit fraud. The second confrontation came early in the current academic year when another professor asked Kirby why Harvard should pay a settlement of $26.5 million and legal fees estimated at between $10 million and $15 million for legal violations by a single professor and his employee, about which it was unaware. On both occasions Kirby is said to have turned red in the face and angrily cut off discussion.

On at least one other occasion, Summers himself told members of the faculty of arts and sciences that the millions of dollars that Harvard paid in damages did not come from the budget of the faculty of arts and sciences, but didn't say where the money came from. Those listening inferred he meant that the matter shouldn't be of concern to the faculty and that they shouldn't raise it, a curious notion, given that Shleifer was one of their own.

A spokesman for Summers said he was "unable to schedule" an interview with Summers for II in December, when this article was being prepared. As the lawsuit was against the university, not just the faculty of arts and sciences, the settlement came from "university funds available for these purposes," the spokesman added.

A spokesman for the faculty of arts and sciences told II, "Consistent with its practices the FAS is not in a position to comment on any internal personnel matter involving a member of its faculty." The spokesman added that Dean Kirby "would never flare with anger."

Publicly, Harvard has made only one statement about the affair since the settlement in August. "We welcome having this matter behind us," vice president and general counsel Robert Iuliano declared.

For the most part, the Harvard community -- students, faculty and alumni -- have been silent about the Shleifer case. This stands in clear contrast to the other imbroglios of Summers' tenure, over religion professor Cornel West and women in science. When it came to Shleifer, many professors, though upset, have preferred to stay in the shadows, wary of the close friendship he has with Summers.

Nonetheless, a few of Harvard's most senior professors are beginning to break the silence. One such is Harry Lewis, who has taught mathematics and computer science at Harvard for 32 years. He taught Bill Gates as an undergraduate in the 1970s and was dean of Harvard College from 1995 until 2003, when he was dismissed in a restructuring of the college administration and returned to teaching full-time.

"The University is losing its moral authority over undergraduates . . . by failing to respond to faculty malfeasances with the same high-mindedness with which it treats undergraduates," Lewis writes in his forthcoming Excellence Without a Soul: How a Great University Forgot Education.

Lewis contrasts the Shleifer case with the way Harvard approaches student misconduct, demanding "openness and honesty" of the student, investigating the alleged infraction promptly and imposing sanctions, including expulsion where appropriate. Lewis also invokes recent cases of academic misfeasance by two prominent law professors -- Charles Ogletree and Lawrence Tribe. Both were accused of "misusing the words of others" in books they had written. When the "errors" were discovered, they apologized. The episodes were investigated by panels of Harvard eminences, including former president Derek Bok, now a university professor, who determined that the infractions were "inadvertent." In the case of Tribe, Summers and law school dean Ellen Kagan announced last April that his error was a "significant lapse in proper academic practice." The Summers administration announced no action against Tribe, however, and the Harvard Crimson, the undergraduate daily newspaper started in 1873, took strong exception. "The evident double standard," it editorialized, "sets a poor example for the student body and for the wider community. A student caught committing a similar crime might face the termination of his academic career."

Lewis, in his new book, draws a stark contrast between the Tribe and Ogletree cases, on the one hand, and the Shleifer scandal on the other.

"The Shleifer matter is strikingly different," Lewis writes. Shleifer has never acknowledged doing anything wrong. Summers has said nothing. And so far as is known, there has been no internal investigation or sanction. "An observer trying to make sense of the University's position on Shleifer, Ogletree and Tribe is driven to an unhappy conclusion. Defiance seems to be a better way to escape institutional opprobrium than confession and apology. . . . And most of all being a close personal friend of the president probably does one no harm."

Greek and Latin professor Richard Thomas, the chairman of the classics department and a member of three key committees of the faculty of arts and sciences, agrees with Lewis's last point at least: "If I had been found liable for conspiracy to defraud the U.S. government, with the result that Harvard had to pay a substantial settlement, I can't imagine there would have been no consequences for me," Thomas tells II.

Although Lewis does not declare Summers unfit to be president of Harvard, he comes close. The faculty vote of no confidence in Summers last spring indicates they believe he does not "meet the Harvard standard," Lewis writes. Summers doesn't offer "leadership they could respect. The Harvard faculty would rather mind its own business than vote down the president; they did not do so for sport." Summers, the computer scientist says, has "failed to bring honor to the institution."

For the record

This article broadly reflects facts as determined by Judge Douglas Woodlock of the U.S. District Court in Boston in his Memorandum and Order of June 28, 2004, in the case of United States of America v. The President and Fellows of Harvard College, Andrei Shleifer, Jonathan Hay, et al. After reviewing the parties' court papers as well as nearly 60 depositions and more than 1,000 documentary exhibits in the lawsuit, Judge Woodlock found that, while running the Harvard Institute for International Development's advisory program in Russia in the early 1990s, Harvard economics professor Shleifer and attorney Hay had conspired to defraud the U.S. government, engaged in self-dealing and violated conflict-of-interest regulations. The judge earlier dismissed the case against Shleifer's wife, Nancy Zimmerman, a hedge fund manager, and Hay's wife, Elizabeth Hebert, a mutual fund company executive, because, he found, the government essentially had failed to state sufficient relevant facts upon which to base a judgment.

However, later in 2004 the government announced that Zimmerman's firm had agreed to pay $1.5 million in a settlement. A year later Harvard agreed to pay the largest amount in its history to settle a lawsuit -- $26.5 million. Shleifer agreed to pay $2 million, Hay between $1 million and $2 million. All four of the original individual defendants testified extensively under oath, defending their roles in the Russian aid program. None acknowledged liability. In his settlement Hay said he disputes "certain of the contentions" against him. In a statement at the time, Shleifer said: "An individual can fight the unlimited resources of the government for only so long. After eight long years, I have decided to end this now -- without any admission of liability on my part. I strongly believe I would have prevailed in the end, but my lawyers told me my legal fees would exceed the amount that I will be paying the government."

Shleifer and Zimmerman declined through their lawyer to be interviewed directly. The magazine was unable to reach Hay. Hebert, responding in an e-mail, asked that the author not contact her in the future.

The reformers' report card

How much did the scandal involving the Harvard Institute for International Development harm Russia?

It's easy to exaggerate the extent of U.S. influence. A glance at Iraq underscores how difficult it is for Washington to effect fundamental change in other countries: One can make the case that reforming Russia was more critical to the world -- and more challenging. Sowing the seeds of shareholder capitalism in a country with an authoritarian history and no experience of free markets for seven decades was going to be an uphill task even for the elite of the premier U.S. academic institution.

Notwithstanding those constraints, however, Harvard University was in a unique position to exert a powerful influence. Post-Soviet Russia turned to the West for help in rebuilding its economy and filling the vacuum left by communism's fall. In running Harvard's Russia Project, Andrei Shleifer and Jonathan Hay had an opportunity to preach the importance of integrity, transparency and fairness in shaping a business culture, and to work to enshrine those values in the country's legal and financial infrastructure. Instead, their personal dealings sent a very different message.

"The defendants' actions undercut the fundamental purpose of the United States' program in Russia -- the creation of trust and confidence in the emerging Russian financial markets and the promotion of openness, transparency, the rule of law, and fair play in the development of the Russian economy and laws," the Justice Department asserted in its initial complaint in U.S. v. Harvard, Shleifer, Hay, et al. on September 26, 2000.

Janet Ballantyne, a veteran officer for the U.S. Agency for International Development, who headed AID's Moscow office when the scandal broke, echoed that view in her testimony in the lawsuit brought by the U.S government.

The Harvard advisers "had access to the highest levels of government," she said. "What should have happened . . . as Russians become acquainted with the way American institutions work, [was] that they [would] learn the transparency and the conflict of interest values that we also expect of our own officials. I think that the damage to the United States' relations with Russia was very great."

The collapse of the Harvard project arrested work on a number of vital reform projects. At the Institute for Law-Based Economy, some planned legislation was never finished. The Resource Secretariat's effort to design a central clearinghouse was halted, and Russia to this day lacks a fully realized central clearing facility capable of handling both securities and cash, a gap that has hampered the development of the domestic securities market.

"This scandal hobbled the development of the Russian capital market infrastructure for a substantial period of time," says Bruce Lawrence, a Credit Suisse First Boston executive in Moscow at the time. In A Normal Country: Russia after Communism, his 2005 book on Russia, even Shleifer acknowledged that "[i]nvestor protection and corporate governance in Russia remain weak."

The Harvard scandal also undermined Dmitri Vasiliev and the fledgling Russian Securities and Exchange Commission that he headed. The commission was one of the few executive agencies fully controlled by free-market reformers, and Vasiliev waged a lonely battle against communist-era factory managers known as "Red directors," budding oligarchs and conservative government bureaucrats in trying to establish rules for a modern financial market. The scandal tarnished Vasiliev's reputation, weakening him politically. Eventually, the RSEC was demoted from an independent agency to a department of the prime minister's office.

"It was the start of what we call the dark times," says Igor Moryakov, president of the Depository Clearing Co. "People who really understood . . . how to operate the market were dismissed. New people, without any experience, without any understanding of how markets work, came to power. It was an absolutely huge disappointment."

Vasiliev had been virtually the only senior official to oppose the Yeltsin government's overreliance on the domestic bond market, calling it effectively a pyramid scheme. Russia defaulted on more than $40 billion worth of domestic debt in August 1998, triggering a financial tremor felt around the globe.

"The scandal caused an extreme decline in the Russian SEC's influence as a regulator," says economist Alexander Abramov, head of development at the Moscow-based Russian Trading System, the country's principal stock exchange, and the author of a new book on Russia's securities markets. "It made the financial crisis of 1998 more likely. And I think it destroyed the trust and relationships between Russian authorities and American advisers."

The Harvard program can claim some successes. HIID advisers did help create Russia's main stock exchange, the RTS, and worked with the RSEC to establish a Web site and public information service, the first of its kind set up by a Russian agency. -- D.McC.

Where are they now?

Richard Bernard is the executive vice president and general counsel of the New York Stock Exchange;

Anatoly Chubais is CEO of UES of Russia, the country's biggest power company. He survived an assassination attempt on the streets of Moscow in April 2005;

Yegor Gaidar runs the Institute for the Economy in Transition, a prominent Moscow think tank;

Jonathan Hay married Elizabeth Hebert following the end of the Harvard Russia Project; he is an associate in the London office of Cleary Gottlieb Steen & Hamilton and is currently on leave;

Elizabeth Hebert left Pallada Asset Management in the fall of 2005. The firm was sold to State Street Global Advisors in 1998; in 2005, according to Russian media reports, State Street sold Pallada to a Moscow entity called Russian Funds Investment Group;

Holly Nielsen is international counsel and co-head of the Russian practice at Debevoise & Plimpton in Moscow;

Andrea Rutherford lives in Massachusetts, where she moved in 2004 after five years as a managing director at Brunswick UBS in Moscow;

Jeffrey Sachs directs the Earth Institute at Columbia University and is a special adviser to United Nations Secretary General Kofi Annan;

Andrei Shleifer teaches economics as a tenured professor at Harvard. He is on leave for the current academic year. He travels the world, publishes voluminously and is widely cited as an expert in a variety of economic specialties;

Dmitri Vasiliev is first deputy general director for strategy and corporate policy at the Russian power conglomerate Mosenergo;

Julia Zagachin runs the First Specialized Depository (formerly the First Russian Specialized Depository) in Moscow. She was a cooperating witness in the case of U.S. v. Harvard, Shleifer, Hay, et al, having invoked the Fifth Amendment and been granted immunity from prosecution before her grand jury testimony;

Nancy Zimmerman runs Bracebridge Capital, in Cambridge, across Massachusetts Avenue from Harvard Yard. -- D.McC.