The Gangster State

It began as a spore of suspicion --a tip that British investigators picked up in some boxes of corporate documents last summer. That led them to Canada, and then, along with the FBI, to several accounts at a respectable, midsize New York bank. Nothing very startling--until authorities realized that billions and billions of dollars were getting "laundered" through the Bank of New York accounts, apparently shunted through a maze of companies traced to Russia. Today the case has become a scandal that threatens to unravel the whole threadbare structure of relations between Russia and the West.

The facts of the case, first reported by The New York Times on Aug. 19, remain murky. A senior FBI official familiar with the investigation cautioned it is still at an early stage, and along with other officials he expressed concern the story may have been prematurely overblown by some media. "All we know is that lots of money was going in and out of these accounts. Whether it's nefarious or not we really don't know," the FBI official said. "Basically we don't know if this is legitimate money or illegitimate." Investigators say at least $4.2 billion and as much as $10 bil- lion may have been laundered--funneled through legitimate accounts so it appears clean--from as early as October 1997 to March of this year. This was done through Bank of New York accounts largely in the name of Benex Worldwide Ltd., a firm that authorities say is controlled by Semyon Mogilevich, allegedly a vicious mafioso known as the "brainy don." The accounts flowed through a department managed by Natasha Kagalovsky, a bank executive who has since been suspended. Her husband is Konstantin Kagalovsky, an admired economic reformer who was, as recently as 1995, Russia's chief delegate to the International Monetary Fund. Neither she nor her husband has been charged with any wrongdoing.

The biggest mystery is where all these billions came from. It's too much cash, most investigators agreed, to have flowed only from "traditional" Russian mob pursuits like prostitution, drugs or even arms sales. More likely, authorities believe, the money was looted from IMF loans (The IMF has asked for a new audit of Russian central-bank transactions, NEWSWEEK has learned) or represents revenues from state assets like oil or aluminum. It might even be legitimate capital fleeing Russia. Whatever the source of the money, it probably originated with some of Russia's leading political and business figures, many of them engaged in what seems to be an unholy alliance with Mogilevich.

How do two men like Mogilevich and Kagalovsky--seemingly from opposite poles of Russian society--get linked to the same scandal? Investigators say it's the main problem in Russia today. Virtually no one, from the nation's business elite to Presi- dent Boris Yeltsin to his major political opponents in next year's presidential election, seems untainted any longer by corruption. Here the connection may amount only to innuendo. But if it turns out that massive laundering is involved, "this [case] is a dagger aimed at the heart of the Russian elite we have built up in the post-communist era," says a U.S. official with knowledge of the investigation.

Authorities are fairly convinced that Mogilevich is a kind of lodestone drawing in a vast network of official Russian corruption. One U.S. official familiar with the probe says Mogilevich and other principals in the case have corporate links with both of Russia's main power centers: Boris Berezovsky, the industrialist and media baron who is Yeltsin's main financier; and Systema, a group of companies supporting Yeltsin's main political rival, Moscow Mayor Yuri Luzhkov. Indeed, by last weekend both the Yeltsin and Luzhkov camps were hurling charges of corruption at each other based on the case. U.S. intelligence sources tell NEWSWEEK that the CIA, which has long watched Mogilevich, believes he also had business interactions with other members of the political elite, especially former prime minister Viktor Chernomyrdin and former economic czar Anatoly Chubais (both of whom deny wrongdoing). Russia's political and business elite sought out Mogilevich, officials say, because of his money-laundering savvy. Mogilevich has also denied criminal activity, and the FBI official cautioned that, contrary to some reports, there is as yet no direct criminal evidence linking the Bank of New York case to President Yeltsin or his powerful daughter, Tatyana, or to so-called oligarchs like Berezovsky (who like Luzhkov has also said he is guilty of nothing criminal).

Whatever the details, the case is really about the unmaking of a myth. Throughout the 1990s the Clinton administration has unstintingly promoted the idea that in Russia, liberal democracy was slowly replacing communism. That may still happen, but for now Russia seems mired in a transition stage that no one anticipated: the gangster state. "We probably have been deluding ourselves that reform has taken hold," says Brent Scowcroft, national-security adviser to President Bush. Many investigators and Russia experts now say that the so-called Russian mafia is so tied in with the Russian state that the two are no longer distinguishable.

Ironically, it may be Al Gore who pays for the sins of the Russian elite. Last week GOP presidential candidates criticized the vice president, the leading Democratic contender, for his deep involvement in the Clinton administration's Russia policy. Some Clinton critics suggested that key Russia policymakers in Washington--especially Deputy Secretary of State Strobe Talbott and Secretary of the Treasury Larry Summers--basically facilitated the fleecing of Russia by looking the other way at corruption.

But the Clinton administration is not admitting defeat, yet. "Calm down, world," Talbott said in an interview with NEWSWEEK. "We have been aware from the beginning that crime and corruption are a huge problem in Russia and a huge obstacle to Russian reform." Talbott insisted: "Russian reform is not over." But "it's going to take decades [and] the problem will only get worse if you isolate Russia." Others note that some reform, like the banishment of central planning, has taken hold.

In the end, the Bank of New York case may rank as one of the great swindles of the 20th century--or it may just be another case of vast capital flight from the wreckage of the Russian economy. The bank, which also denies wrongdoing, on Friday fired another Russian-born executive, Lucy Edwards, reportedly for gross negligence and falsification of bank records, among other reasons. But the real mystery was Kagalovsky and her husband, Konstantin. After leaving his IMF post he plunged into Russia's financial world, working as VP at Menatep Bank. The now bankrupt Menatep was known to have been deeply connected to the Russian central bank--the recipient of IMF money--through its purchase of Russian treasuries. Through their New York attorney, Stanley Arkin, the couple said they "have never been involved in money laundering in any way, shape or form." The point was well taken: is it even possible to "launder" from a country where the theft of state assets is not against the law? That's one of many questions that investigators may spend years pondering.