In 2004, the European Bank for Reconstruction and Development conducted a Corporate Governance Sector Assessment, under which corporate governance related "laws on the books" were assessed. In this assessment, the Russian Federation was rated as having achieved "high compliance", when compared to the Organization for Economic Cooperation and Development Principles of Corporate Governance. The main legislation concerning corporate governance in Russia is the Law on Joint Stock Companies, most recently amended in February 2006. Further, in 2002 the FCSM, Russia's former securities market regulator, issued a voluntary Corporate Governance Code, which required joint stock companies to report compliance on a comply-or-explain basis. While most of the laws and regulations concerning corporate governance are on the books in Russia, the general consensus of available assessments for Russia is that implementation and enforcement is severely lacking. Improvement in the quality of legislation has not yet been matched by improvements in the quality of institutions that implement the laws or those that resolve legal disputes and enforce the laws. Without effective, impartial third-party enforcement of the law, property rights are likely to be insecure and arm's-length contracting will involve much higher transaction costs. Regarding the roots of the weak enforcement culture in Russia, the Institute of International Finance cites the combination of large-scale direct state involvement in the economy and persistent state corruption as a major obstacle to improving corporate governance.

General Overview

In July 2006 the European Bank for Reconstruction and Development (EBRD) published its latest country strategy for the Russian Federation. The strategy paper referred to the 2004 results of the EBRD's Corporate Governance Sector Assessment, under which corporate governance related "laws on the books" were assessed. In this assessment, the Russian Federation was rated as having achieved "high compliance", when compared to the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. (EBRD 2006a, p. 50)

In 2002 the FCSM, Russia's former securities market regulator, issued a Corporate Governance Code, developed with the technical assistance of the EBRD and the financial support of the government of Japan. The Code, although being voluntary by nature, provides important guidelines on board composition (for example, there should be at least three independent directors and the audit committee should be composed of such directors) and transparency. The Code is voluntary and JSCs are only required to report compliance with the Code's principles and explain deviations from these principles. In December 2004 a new regulation issued by the FSFM made some of the principles included in the Code enforceable starting from 1 July 2005 - then extended until 1 January 2006 - with respect to those companies that have listed equity and/or debt. In addition, the regulation introduced a requirement to publish audited IFRS or US GAAP annual. (EBRD 2006a, p. 49)

The main legislation concerning corporate governance in Russia is the Law on Joint Stock Companies (the JSC Law), which came into force in January 1996 with amendments in subsequent years, the most recent being in February 2006. The latest amendment to the JSC Law, which entered into force on 1 July 2006, substantially changed the requirements for the acquisition of major shareholdings in open joint stock companies. In summary, each acquisition of more than 30, 50 or 75 % of the voting shares in an open joint stock company triggers an obligation to launch a public offer to buy the remaining shares. The same amendment introduces minority shareholders squeeze out provisions, according to which a dominant shareholder holding more than 95 % of an open joint stock company's voting shares as a result of a public offer can force the minority shareholders to sell their shares. EBRD 2006a, p. 49)

The other main laws and regulations addressing corporate governance in Russia are: (1) Civil Code (part I) in force on January 1, 1995; (2) Federal Law on Securities Market No. 39-FZ of April 22, 1996, in force on April 22, 1996; (3) Federal Law on Protection of Rights of Investors in the Securities Market No. 46-FZ of March 5, 1999; (4) Law on Competition and Limitation of Monopolist Activity in the Commodity Markets No. 948-1 of March 22, 1991; (5) Federal Law on Insolvency (Bankruptcy) No. 127-FZ of October 26, 2002; (6) FCSM Regulations. (EBRD 2004, p. 2)

There are numerous institutions that make-up the institutional framework for corporate governance in Russia. The following institutions have at least one core activity focusing on corporate governance: (1) Supreme Arbitration Court; (2) public sector institutions, such as Federal Financial Markets Service (FFMS); Ministry of Economic Development and Trade and State Duma; (3) private sector institutions and market participants (MICEX, RTS; Standard & Poor's and Troika Dialog); (4) international organizations (Global Corporate Governance Forum, International Finance Corporation, Organization for Economic Cooperation and Development and the World Bank); and (5) numerous non-governmental organizations (NGOs). (IFC & U.S. DoC 2004, Ch. 1 p. 25)

The OECD Russia Roundtable has provided the framework for all co-operation between Russia and the OECD on corporate governance issues since 1999. In 2004, the Ministry of Economy set up a corporate governance experts group to formulate priorities for corporate governance reform, using the OECD White Paper as a basis. In early 2005, the FSFM is creating its own corporate governance experts group which will consider as its priority a review of the Roundtable task force paper on "Improving Transparency of Related Party Transactions". The Duma formed a Working Group on Improving Corporate Governance in Russia, led by the Duma Committee on Property, encouraging synergies with the Roundtable's work. These efforts now also include the Supreme Arbitrazh Court. (OECD 2005b, pp. 1, 2)

While most of laws and regulations concerning corporate governance are in the books in Russia, the general consensus of available assessments for Russia is that implementation and enforcement are severely lacking. A 2004 assessment of Standard and Poor's regarding the progress of Russia in implementing the 2002 OECD White Paper recommendations came to the conclusion that only moderate progress has been made in the past couple of years, and these improvements are mostly due to positive initiatives by internationally oriented companies. The legal and regulatory environment has not changed substantially and remains a major obstacle to the improvement of corporate governance standards in Russia. This has been particularly aggravated by the recent Yukos affair that has severely undermined the stability of ownership rights and the nascent trust that had been developing between businesses and the state. (Standards and Poor's 2004, p. 2)

A 2005 background paper for an OECD-Russia liaison meeting stated that enforcement of corporate governance rules is undoubtedly a central challenge in Russia. Improvement in the quality of legislation has not yet been matched by improvements in the quality of institutions that implement the law or those that resolve legal disputes and enforce the law. Without effective, impartial third-party enforcement of the law, property rights are likely to be insecure and arm's-length contracting will involve much high transaction costs. The Federal Service for Financial Markets (FSFM) is keen to address institutional issues concerning investigative power and sanctions as well as capacity issues. This is also timely as the FSFM seeks to increase its status to a "Mega-regulator" with stronger enforcement powers. The stock exchanges and self-regulatory organizations of market participants are weak in monitoring or enforcing corporate governance standards. At the same time, any improvements in regulatory enforcement need to go hand-in-hand with reform in the judiciary. The Supreme Aribtrazh Court has agreed to work with the OECD to bring more transparency to the decision-making process on commercial cases and examine criminal and civil enforcement as well as the infrastructure. (OECD 2005b, p. 3)

Furthermore, the 2006 EBRD strategy paper asserts that a general reform priority for Russia is to improve effective implementation and enforcement of existing legislation. The effectiveness (how the law works in practice) of corporate governance legislation was assessed by the EBRD in 2005. A case study dealing with related-party transactions was designed. The case study investigated the position of a minority shareholder seeking to access corporate information in order to understand if a related-party transaction was indeed entered into by the company and on how it was possible to obtain compensation in case damage was suffered. Effectiveness of legislation was then measured according to four principal variables: complexity, speed, enforceability and institutional environment. The survey revealed a variety of actions available to minority shareholders to obtain disclosure and redress but procedures are generally considered quite complex while it is reported to be easy for the defendant to further delay the proceedings. When considering enforceability, because of deficiencies in the Russian court system, such as case overload and the scarcity of judges, the procedure to enforce actions can be difficult and take more than several months. Finally, when considering the institutional environment, the survey evidenced the difficulty to find reliable corporate information and independent statutory auditors. Courts and the market regulator are deemed generally competent and experienced in corporate law cases, but courts can be biased - especially in favor of powerful defendants - while the market regulator's position was deemed unpredictable. (EBRD 2006a, p. 50)

Finally, in 2004, the Institute of International Finance (IIF) issued an update of its original 2002 report on corporate governance in Russia. The report pointed out that lack of compliance by Russian firms with the voluntary Corporate Governance Code (CG Code) has been disappointing to investors. Enforcement of rules and regulations remains weak with the Federal Service for Financial Markets (FSFM) likely to bear much of the burden of carrying out this crucial function. (IIF 2004, p. 2)

Regarding the roots of the weak enforcement culture in Russia, the IIF cites the combination of large-scale direct state involvement in the economy and persistent state corruption as a major obstacle to improving corporate governance. In many large companies the government continues to have a significant equity stake that allows it to control the profitability of those companies through contracts, leases, and licensing agreements, often to the detriment of minority shareholders. This situation is compounded by a dysfunctional judicial system in which courts are unable to resolve minority shareholder disputes efficiently, due to, inter alia, heavy case loads and unskilled judges. (IIF 2004, p. 3)

Nevertheless, according to the IIF, progress has bee made in the separation of ownership from the oversight and management functions of private sector companies. More companies have brought in independent, professional board members, including independent board members and sometimes minority shareholder representation. Majority owners in some of the largest companies have decided to reduce their hands-on role in company management and have hired professional management teams. (IIF 2004, p. 3)

However, despite some progress that has been made in improving the infrastructure of corporate governance, Russia still has a relatively weak equity culture that tends to undervalue minority shareholders' rights. Part of the reason for this is that there has been little time for an equity culture to develop since the end of communism and the mass privatizations of the early 1990s. Ownership concentration remains high, with many of Russia's oligarchs still exercising firm control over boards. Moreover, since many of Russia's larger companies are natural resource companies and benefit from substantial retained earnings, they are not as dependent on equity markets for financing. As a result, market capitalization, free float, and share turnover, all remain small relative to the size of the economy. (IIF 2004, p. 3)

Merrit Fox, in a 2006 paper for the eJournal "Corporate Governance in Russia Today", pointed to the difficulties in knowing who are the beneficial owners of a firm's shares and how the shares have been voted as close to being the root of all evil in Russian corporate governance. Whether is was asset stripping, tunneling, and the squeezing out of minority shareholders for little or no compensation by various means such as dilution or sham bankruptcy, all of these unfortunate events have involved "interested transactions." Interested transactions are ones in which a benefit is derived by an insider, i.e., a director, a high-level manager, or a shareholder who has enough power, alone or in conjunction with a group of other shareholders, to influence corporate action. If, as is often the case, the terms of the transaction are less favorable to the corporation than would be the terms of a comparable arms-length transaction, the benefit received by the interested insider will come at the expense of the rest of the corporation's shareholders. The 1996 corporate law appeared to have had a means for dealing with interested transactions. The draftsmen understood that Russia would for some time have a weak judicial system and that its judges would be inexperienced in matters of business and capital. (Fox 2006, p. 1)

According to Fox, a number of the legal reforms adopted since the 1996 legislation are aimed at preventing one kind of bad transaction or other, such as dilutions arising from low-priced share offerings made only to insiders. In large measure, these reforms represent patchwork solutions, however. They may be helpful, but they are not a complete cure. As long as there is no credible way of knowing who are the beneficial owners of Russian company shares, there is no effective way of stopping any type of interested transaction that is not specifically banned. When any one type of interested transaction is banned, ingenious insiders simply develop new ways of advantaging themselves at the expense of the other shareholders. (Fox 2006, p. 2)

Market infrastructure in Russia consists of the following exchanges. The Moscow Interbank Currency Exchange (MICEX) is the largest financial exchange operating in the Russian Federation. Trading in non-government securities was launched in March 1997. Later that year, following the example of the MICEX, regional currency and stock exchanges in Samara, Rostov-on-Don, St. Petersburg, Nizhniy Novgorod and Yekaterinburg also launched trading in bonds and stocks. The financial crisis of 1998 had a disastrous effect on the Russian stock market and the MICEX Summary Stock Index (the MICEX SSI) dropped to its historically lowest level of 20.92 units. Since then the market has continued to grow and at the end of 2004, the MICEX Index1 reached 552.22 points with 413 securities of 267 issuers traded in the MICEX. (EBRD 2006b, p. 6)

Growth in stock trade volumes was not accompanied by an expansion of the list of high-liquidity papers. As before, the lion's share of operations was conducted with highly liquid stocks of several issuers and in the final analysis this determined the low liquidity risk on these instruments. At the same time, the very fact that the investment portfolio contained a limited number of instruments made the aggregate result of stock investments increasingly dependent on the price dynamics of individual instruments. In the structure of secondary stock trade on MICEX, including negotiation deals, eight issuers accounted for 95% of aggregated turnover (97% in 2004), in which the Unified Energy Systems accounted for 37% (49% in 2004). In the Russian Trading System Stock Exchange (RTS), 10 issuers accounted for 87% of aggregate turnover (89% in 2004), in which the Unified Energy Systems and LUKoil accounted for 50% (47% in 2004). Energy and oil sector companies accounted for 75% of the aggregate secondary stock trade turnover on MICEX (83% in 2004) and 70% in the RTS (73% in 2004). Most of the second- and third-tier shares on the organized market remained barely liquid and their price dynamics were highly volatile. (CBR 2006, pp. 31-32)

The Principles

Principle I: Ensuring the Basis for an Effective Corporate Governance Framework

EN

In July 2006 the European Bank for Reconstruction and Development (EBRD) published its latest country strategy for the Russian Federation. The strategy paper referred to the 2004 results of the EBRD's Corporate Governance Sector Assessment, under which corporate governance related "laws on the books" were assessed. In this assessment, the Russian Federation was rated as having achieved "high compliance", when compared to the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. (EBRD 2006a, p. 50)

According to the 2004 Institute of International Finance (IIF) assessment on corporate governance in Russia, the foundation of corporate governance in Russia rests primarily on the Law on Joint Stock Companies (JSC Law), which is supported by parts of the Securities Market Law, the Criminal Code, the Civil Code Laws on Privatization and the Administrative Code. Also of key importance is the non-binding CG Code, which applies to all listed companies on a comply or explain basis. The Russian authorities have done a thorough job at codifying key elements of corporate governance within the Company Law and especially the CG Code. Although many of the guidelines in these two documents may conform to the IIF Code, in some instances other rules and regulations exist that create ambiguities or contradictions. This can leave minority shareholders vulnerable and with limited recourse. (IIF 2004, p. 9)

The latest amendment to the JSC Law, which entered into force on 1 July 2006, substantially changed the requirements for the acquisition of major shareholdings in open joint stock companies. In summary, each acquisition of more than 30, 50 or 75 % of the voting shares in an open joint stock company triggers an obligation to launch a public offer to buy the remaining shares. The same amendment introduces minority shareholders squeeze out provisions, according to which a dominant shareholder holding more than 95 % of an open joint stock company's voting shares as a result of a public offer can force the minority shareholders to sell their shares. (EBRD 2006a, p. 49)

The International Finance Corporation and the U.S. Department of Commerce, in 2004 issued the "Russia Corporate Governance Manual". It states that Russia's legal and regulatory framework for corporate governance has improved dramatically but remains nascent. All commercial enterprises, regardless of their legal form, are subject to a comprehensive set of laws, regulations, and governmental decrees. In addition to the general legal and regulatory framework, there are legal acts that deal in more detail with specific corporate forms in Russia such as joint stock or limited liability companies. For example, Civil Code and Company Law apply to all joint stock companies in Russia. In addition to this general rule, companies in the banking, investment and insurance industries, as well as agribusinesses and state- or municipally-owned companies need to comply with specific legislation. Law on the Securities Market and regulations by the Federal Commission for the Securities Market (FCSM). now the Federal Financial Markets Service (FSFM) also apply to publicly traded companies. Russian companies are also subject to other laws including, among others, laws on taxation, the registration of legal entities, bankruptcy, accounting, and auditing. (IFC & U.S. DoC 2004, Ch. 1 p. 21)

The IIF notes that with its establishment in May 2004, the FSFM received broader regulatory writ and greater independence from the government than its predecessor. It has, at least on paper, the necessary powers to regulate financial markets including: rulemaking, licensing, supervision, and investigation, as well as the power to issue cease and desist orders and fines for breach of laws and regulations. A good working relationship has been established between the FSFM and the corporate and broker-dealer community. (IIF 2004, p. 7)

The FSFM has primary oversight, regulatory, and enforcement responsibilities for governance issues. While the Chairman of the FSFM is praised for his integrity and professionalism, the agency is significantly understaffed and needs additional resources to improve enforcement. The MICEX and the RTS have the authority to suspend the trading of securities or cancel a trading license for violation of any mandatory rule, but they have only limited resources for investigation and enforcement. The FSFM is empowered to investigate, judge, issue cease and desist orders, and punish through the application of fines and suspension of licenses any irregularity due to an infraction of mandatory rules, as well as that might occur in the securities market. In the event of any suspicious activities, the FSFM may initiate an administrative inquiry to collect information, formal statements, and material evidence aiming at the identification of responsibility. Appeals of decisions lie with the arbitration court. (IIF 2004, p. 14)

Dialogue between governmental bodies and the private sector in respect to the need of improving corporate governance in Russia is active. The governmental bodies are involved in the process either by direct participation (like the FCSM) or by indirect support in organizing research, discussions, conferences and other relevant events. The major Russian companies and their associations have been actively involved in the process. Several of them have adopted their own codes of corporate governance on the basis of the Code, proposed by the FCSM. (EBRD 2004, p. 1)

However, the IIF notes that an equity culture cannot flourish if there are significant doubts about the integrity of the basic system of property and contract rights. In the case of Yukos, prosecutors, tax officials, and the courts must now work to bring closure through due process, free of political influence. In addition, the government needs to reassure investors that in the future the justice system will uphold the law and recognize corporate governance principles in a transparent manner. (IIF 2004, p. 6)

A primary reason for the infringement of shareholders rights, as well as for other corporate governance problems, is that there have been little, if any, direct costs to the perpetrators of these actions. Effective enforcement is still lacking, whether through the regulator or through the courts. At the heart of the problem are the under-funded arbitration court system, a lack of adequately trained personnel, and the widely alleged use of bribery and intimidation to thwart justice. On a number of occasions the Task Force was told of how the judicial process had been used as a tool to deny basic investor rights, or even as a tool to harass minority investor activists. Moreover, investors have found it difficult to access information even if it is publicly available. (IIF 2004, p. 8)

Some efforts are being made to rectify these problems including increased budget allocations for the judiciary to improve court and administrative procedures, some proposed changes in the Criminal and Arbitration Codes, and the sponsorship of training programs for legal personnel. However, in general there has been little progress since the 2002 Task Force visit. Some progress has been made in creating private dispute adjudication mechanisms. Arbitration is now available through the Russian Union of Industrialists and Entrepreneurs and the Charter of Corporate and Business Ethics. However, until the judicial system is reformed it is unlikely that there will be a significant improvement in enforcement of minority investor protections. (IIF 2004, p. 8)

Principle II: The Rights of Shareholders and Key Ownership Function

EN

In July 2006 the European Bank for Reconstruction and Development (EBRD) published its latest country strategy for the Russian Federation. The strategy paper referred to the 2004 results of the EBRD's Corporate Governance Sector Assessment, under which corporate governance related "laws on the books" were assessed. In this assessment, the Russian Federation was rated as having achieved "high compliance", when compared to the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. (EBRD 2006a, p. 50)

According to the 2002 OECD White Paper, significant progress has been made in creating a modern legal framework for shareholder protection. In 1995, Russia adopted the Federal Law On Joint-Stock Companies (JSC Law, Company Law) that set out the principles for the protection of shareholders' rights. The duty to provide information to shareholders was considerably expanded through the Federal Law On the Securities Market adopted in 1996 (Securities Law). In 1999, the Law On the Protection of Rights and Legal Interests of Investors on the Securities Market (Investor Protection Law) increased the powers of the Federal Commission for Securities Markets (FCSM) (currently the Federal Financial Markets Service) by providing a mechanism to fine companies for violation of disclosure rules. (OECD 2002, p. 11)

Shareholders can participate in the decision-making of the company through their right to vote during the General Meetings of Shareholders (GMS). The right to vote can be exercised personally or by a power of attorney. A shareholder has the right to appeal decisions of the GMS in court. A shareholder (or a group of shareholders) holding at least 1% of common shares has the right to file a claim with the court on behalf of the company to recover losses caused by certain circumstances. Shareholders are residual claimants when a company is being liquidated, i.e. they will receive a portion of the assets remaining after creditor claims are satisfied. (IFC & U.S. DoC 2004, Ch. 3 pp. 8-9, 19)

The Company Law provides general requirements for shareholder meetings, while the Corporate Governance (CG) Code outlines in detail a number of procedures for conducting a meeting. It recognizes the importance of giving timely notice of a meeting, and the recommended 30-day notice before each meeting is an improvement over the 20-day notice mandated by law. The CG Code includes a precise formulation of meeting agenda items, which are aimed at preventing multiple interpretations. (IIF 2004, p. 9)

The Company Law provides shareholders with the right to receive information about the company based on the percentage of shares held. Distinctions are made between any shareholder and a shareholder (or a group of shareholders) owning at least 25% of voting shares. Any shareholder has the right to receive information about the activities of a company. The company must give registered shareholders holding at least 1% of voting shares the opportunity to inspect the shareholder list within three days of a request. (IFC & U.S. DoC 2004, Ch. 3 p. 13)

The Company Law requires that a majority of shareholders approve reorganization (mergers, divisions, spinoffs) and provides for the right of minority shareholders to sell shares at appraised value in the event of corporate reorganizations. The CG Code stipulates that anti-takeover actions that are inconsistent with shareholder interests should not be taken, which is consistent with the IIF guidelines. (IIF 2004, p. 9)

According to the 2004 assessment by the Institute of International Finance (IIF), to address the problem of asset stripping in Russia, special rules have been adopted for shareholder approval of transactions that do not rise to the level of corporate reorganizations. The sale of more than 25 percent of a company's assets requires either unanimous Board approval or consent of 75 percent of shareholders, and for the sale of more than 50 percent, a vote of 75 percent of shareholders is needed. Some companies set the threshold at an even lower level. In particular, Svyazinvest and its subsidiaries have internal corporate standards that require large transaction procedures for all operations with assets exceeding 0.5 percent of total asset value. (IIF 2004, p. 10)

In addition, shareholders must now approve any "interested party deal" such as a loan or surety that involves 2 percent or more of the total assets of the company. While asset stripping has abated, the diversion of company revenues (sometimes called "income channeling") is still a problem in some companies, particularly those that involve the sale of natural resources or other commodities. For example, in April 2004, Vostok Nafta Investments filed a complaint against Slavneft and its holders that it had engaged in related party transactions by income channeling profits into its subsidiary, Megionneftegaz, by selling oil at below market prices. (IIF 2004, p. 10)

The CG Code requires board members to disclose related party transactions, but this provision is often ignored. This is one key area where fraud on minority investors can only be prevented by a statutory requirement. Insider trading remains a problem. Unfortunately, a law proposed by the FSFM was recently defeated in the Duma. A revised draft will be resubmitted and investors hope that it will be enacted next year. (IIF 2004, p. 10)

Under Russian law shareholders must disclose acquisition of 30 percent or more of outstanding shares of a company, as well as each incremental transaction of 5 percent. The CG Code recommends starting disclosure with shareholdings of 5 percent. The Company Law provides that when a 30 percent ownership threshold is reached a tender offer is required for the remaining shares (the FSFM has recently proposed extending the rule to the acquisition of a 25 percent stake). However, this requirement can be waived by the company. (IIF 2004, p. 13)

Amendments to the Company Law adopted in the Spring of 2004 have created a number of key improvements relative to the 2002 IIF Task Force report. A new requirement is that all companies have a minimum of 5 directors, that companies with 1,000 or more shareholders have a minimum of 7, and that companies with 10,000 shareholders or more must have a minimum of 9. All directors must be elected through cumulative voting. This combination has made it far easier for minority investors to elect representatives to boards of listed companies. In several high-profile cases these directors have played an important role in protecting minority shareholder rights, including by monitoring related party transactions and overseeing auditors. (IIF 2004, p. 11)

According to an Article in the International Financial Law review, one of the unusual features of Russian company law is that the general director or sole executive body does not have to be a physical person. Indeed, if the foundation documents so allow, it is possible to appoint a corporate to the position of sole executive body (or general director), meaning that the company will be managed by a management company, which will exercise all the powers of a general director and hold all the corresponding responsibilities. This form of corporate governance is now frequently used, in Russia, by the large privately held groups, because it is viewed as ultimately increasing shareholder control over the general director. In practice, when a management company is appointed as sole executive body, the work is executed by individuals who are employees of the management company and individually appointed to represent the management company when performing its duties. Such employees can be replaced or removed with greater ease than a physical person officially holding the position of general director (and sometimes even named in the charter of the company). In short, many shareholders view a management company as a more pliant tool than a physical person in the same position. (IFLR 2006)

Principle III: The Equitable Treatment of Shareholders

EN

In July 2006 the European Bank for Reconstruction and Development (EBRD) published its latest country strategy for the Russian Federation. The strategy paper referred to the 2004 results of the EBRD's Corporate Governance Sector Assessment, under which corporate governance related "laws on the books" were assessed. In this assessment, the Russian Federation was rated as having achieved "high compliance", when compared to the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. (EBRD 2006a, p. 50)

However, according to a 2004 assessment by the Institute of International Finance (IIF), Russia has a history of a weak equity culture that tends to undervalue minority shareholders' rights. One of the reasons for this is that there has been little time for an equity culture to develop during the relatively short time period which elapsed between the end of communism and the mass privatizations of the early 1990s. Another key reason for the lack of an equity culture relates to the continuing high level of ownership concentration. According to a 2003 report by Standard & Poors, only 6 of the 42 largest Russian companies were widely held, while 25 were controlled directly through a majority stake. In many if not most of these companies, control is exercised by a small number of so-called oligarchs who acquired state assets in the shares-for-loans privatizations of the 1990s. (IIF 2004, p. 5)

According to Russian rules and regulations, minority shareholders have the legal right to vote on all matters of importance including mergers and the sale of substantial assets. Shareholders may vote/attend meetings both personally and by proxy. A cumulative voting procedure is mandatory in all joint-stock companies. Under company practices and policies of the IIF guidelines, cumulative voting should be permitted. There have been reports, however, that proxy voting is sometimes challenged successfully on unsubstantiated grounds. Also, shareholders holding more than 2 percent of votes are entitled to nominate a candidate to the board. (IIF 2004, p. 9)

Company Law requires that within any class of shareholders all shareholders have the same voting rights. Federal Law on Securities Market (Securities Law) requires that all investors have access to information about the voting rights attached to all classes of shares before they purchase. There are no any laws in Russia which impose special restrictions on certain classes of shareholders of the company regarding the voting rights and/or procedures at a shareholders meetings. In addition, Securities Law requires the company to disclose company information which is likely to affect stock exchange prices. There are provisions which prevent or punish the trading of shares where the seller or purchase is using important information which has not been provided to the public. (EBRD 2004, pp. 9-10)

The effectiveness (how the law works in practice) of corporate governance legislation was assessed by the EBRD in 2005. A case study dealing with related-party transactions was designed. The case study investigated the position of a minority shareholder seeking to access corporate information in order to understand if a related-party transaction was indeed entered into by the company and on how it was possible to obtain compensation in case damage was suffered. Effectiveness of legislation was then measured according to four principal variables: complexity, speed, enforceability and institutional environment. The survey revealed a variety of actions available to minority shareholders to obtain disclosure and redress but procedures are generally considered quite complex while it is reported to be easy for the defendant to further delay the proceedings. When considering enforceability, because of deficiencies in the Russian court system, such as case overload and the scarcity of judges, the procedure to enforce actions can be difficult and take more than several months. Finally, when considering the institutional environment, the survey evidenced the difficulty to find reliable corporate information and independent statutory auditors. Courts and the market regulator are deemed generally competent and experienced in corporate law cases, but courts can be biased - especially in favor of powerful defendants - while the market regulator's position was deemed unpredictable. (EBRD 2006a, p. 50)

Principle IV: The Role of Stakeholders in Corporate Governance

EN

In July 2006 the European Bank for Reconstruction and Development (EBRD) published its latest country strategy for the Russian Federation. The strategy paper referred to the 2004 results of the EBRD's Corporate Governance Sector Assessment, under which corporate governance related "laws on the books" were assessed. In this assessment, the Russian Federation was rated as having achieved "high compliance", when compared to the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. (EBRD 2006a, p. 50)

Civil Code contains provisions for protecting the rights of employees, suppliers and creditors as stakeholders. The Labor Code of December 30, 2001 amended in 2002 and 2003 protects rights of employees and permits participation in company's decisions by employees' representation on boards. Federal Law on Insolvency and Law on Joint Stock Companies relate to protection of the rights of creditors and permits creditor's involvement in the decision-making process in the context of insolvency proceedings. All laws incorporate remedies for violation of stakeholders' rights. (EBRD 2004, p. 11)

Principle V: Disclosure and Transparency

EN

In July 2006 the European Bank for Reconstruction and Development (EBRD) published its latest country strategy for the Russian Federation. The strategy paper referred to the 2004 results of the EBRD's Corporate Governance Sector Assessment, under which corporate governance related "laws on the books" were assessed. In this assessment, the Russian Federation was rated as having achieved "high compliance", when compared to the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. (EBRD 2006a, p. 50)

According to the 2002 OECD White Paper, there was a good legal and regulatory basis in Russia for obtaining basic information about a publicly listed company. The Russian Joint Stock Company Law contains a list of documents that a joint-stock company is required to make available. The Securities Law and numerous regulations by the Ministry of Finance and the Federal Commission for Securities Markets (FCSM) (currently the Federal Financial Markets Service) require additional disclosure. (OECD 2002, p. 22)

The list of information subject to mandatory public disclosure by a joint stock company, as well as subject to disclosure upon shareholders' request, is set forth in the Federal Law No.39-FZ on the Securities Market of April 1996, as well as in the Federal Law Law No.208-FZ on Joint Stock Companies of December 1995. (ICLG website)

All companies listed on the Russian Stock Exchange should submit quarterly financial reports (balance sheet, profit and loss statement and required disclosures) and additional information to the Federal Service for Financial Markets (FSFM) within 30 days after the close of the quarter. As of 2006, such companies were permitted to file their International Financial Reporting Standards (IFRSs) or US GAAP based financial statements in lieu of statutory accounts. In the future, however, they will need to make their existing IFRSs or US GAAP based financials available to the general public. (Ernst & Young 2006, p. 40)

The company's charter is an important source of information for shareholders and potential investors. The original charter document must be kept at the offices of the executive bodies. Shareholders, the External Auditor, and other interested parties have the right to inspect the original charter at the company's headquarters within seven days after filing a request. Copies of the latest registered charter and amendments must be provided to shareholders on request. (IFC & U.S. DoC 2004, Ch. 1 p. 52)

The International Finance Corporation and the U.S. Department of Commerce, in 2004, issued the "Russia Corporate Governance Manual". Financial and operating results appear in the prospectus, and annual and quarterly reports. The Law on the Securities Market requires that the following information on the last five operating years and the last reporting period be disclosed in these documents: major areas of company activity; results of the financial and business activity, as well as any major factors affecting revenues; financial and economic ratios of the company; market capitalization, liquidity, and its obligations; capital structure, including working capital; composition, structure, and value of fixed assets; total amount of export; and inventory of the company's property. (IFC & U.S. DoC 2004, Ch. 4 p. 18)

Legislation requires that company objectives (such as the issuance of securities, acquisition plans, replacement and sales of assets, or research and development) be disclosed in the prospectus. In addition, quarterly reports must contain forward-looking information including sources of revenue, plans for new production procedures, expansion or reduction of production, new product development, substitution of old products, modernization or repair of fixed assets, and modification of the types of company activities. In addition, the annual report must outline the company position in the industry, priority areas of activity, and development trends. (IFC & U.S. DoC 2004, Ch. 4 pp. 19-20)

The 2004 assessment by the Institute of International Finance (IIF) notes that the Corporate Governance (CG) Code requires board members to disclose related party transactions, but this provision is often ignored. This is one key area where fraud on minority investors can only be prevented by a statutory requirement. Insider trading remains a problem. Unfortunately, a law proposed by the FSFM was recently defeated in the Duma. A revised draft will be resubmitted and investors hope that it will be enacted next year. (IIF 2004, p. 10)

Under Russian law shareholders must disclose acquisition of 30 percent or more of outstanding shares of a company, as well as each incremental transaction of 5 percent. The CG Code recommends starting disclosure with shareholdings of 5 percent. The Company Law provides that when a 30 percent ownership threshold is reached a tender offer is required for the remaining shares (the FSFM has recently proposed extending the rule to the acquisition of a 25 percent stake). However, this requirement can be waived by the company. (IIF 2004, p. 13)

Russia's two leading stock exchanges, the Russian Trading System (RTS) and Moscow Interbank Currency Exchange (MICEX) have specific listing rules. For example, companies listed on Tier-A, Level 1 on any of these exchanges must provide documents confirming their full compliance with the FCSM Code (or, if listed on MICEX, with their internal company-level code of corporate governance that is based on the FCSM Code). Companies listed on RTS' Tier-A, Level 1 are further required to disclose their financial statements according to both Russian and International Financial Reporting Standards. On the other hand, companies listed on Tier-A, Level 2 must simply provide documents confirming their compliance with Chapter 7 of the FCSM Code on information disclosure. RTS requires that companies additionally report on specific material events, for example, on issuing, splitting, consolidating, or retiring securities; on transferring the register to another External Registrar; on the date of the General Meeting of Shareholders (GMS); on the record date; and on the total number of shareholders. (IFC & U.S. DoC 2004, Ch. 4 p. 9)

Principle VI: The Responsibilities of the Board

II

In July 2006 the European Bank for Reconstruction and Development (EBRD) published its latest country strategy for the Russian Federation. The strategy paper referred to the 2004 results of the EBRD's Corporate Governance Sector Assessment, under which corporate governance related "laws on the books" were assessed. In this assessment, the Russian Federation was rated as having achieved "high compliance", when compared to the Organization for Economic Cooperation and Development (OECD) Principles of Corporate Governance. Some minor shortcomings were noted in the "Responsibilities of the board" section, where under the law, the responsibilities of the board do not include functions such as reviewing key executive and board remuneration, ensuring a formal and transparent nomination process for board members, ensuring the integrity of the corporation's accounting and financial reporting systems and overseeing the process of disclosure and communications. (EBRD 2006a, p. 50) However, the source does not address Russia's compliance with this particular principle.

The 2002 OECD White Paper on corporate governance in Russia noted that the structure, composition and functioning of the board are regulated in the Russian Joint Stock Companies Law (Company Law) and in the Civil Code. While certain provisions are mandatory, others are dispositive and allow some characteristics of the board to be defined in the charters of the individual corporations. The law stipulates that all companies with 50 or more voting shareholders are required to have a board of directors. All companies must have at least a single-person executive body (manager or general manager). On a voluntary basis, joint stock companies may further establish a management board. (OECD 2002, p. 28)

The 2004 assessment by the Institute of International Finance (IIF) notes that under the Company Law, executives should not form the majority on the board of directors. Moreover, under the Company Law, a company's CEO cannot be chairman of the board. A survey of companies conducted by the Russian Institute of Directors showed that more than two-thirds of the members of boards of directors were non-executive. The CG Code states that the number of independent directors should be three or at least one-fourth of the board. While this provision has not yet been widely followed (only about a third of listed companies now have independent directors, and most of those only have one), many of the largest companies now have three, and the trend has been towards increasing numbers of independent directors. (IIF 2004, p. 11)

International Financial Law Review (IFLR), in a 2006 note on corporate governance in Russia notes that the main executive body in a Russian company (joint stock company inclusive) is referred to as its sole executive body. Most frequently (but not exclusively), this is the general director. The sole executive body is normally elected by the shareholders' meeting, although the foundation documents of the company may provide for election by the board of directors or supervisory board (which is unusual in practice). In accordance with the JSC Law, the main duty of the sole executive body is to "conduct the current activities of the company". (IFLR 2006)

The powers of the sole executive body, including a general director, are determined by the foundation documents of the company and also, importantly, in the employment agreement that must be concluded between the company and the general director (Article 69.3 of the JSC Law). Under the JSC Law certain minimum authorities are conferred on the general director, which cannot be constrained (the exclusive competence). (IFLR 2006)

The International Finance Corporation and the U.S. Department of Commerce, in 2004, issued the "Russia Corporate Governance Manual". The Company Law defines the Supervisory Board's authority. The Supervisory Board is responsible for setting the company's strategy and business priorities, as well as guiding and controlling managerial performance, and for making decisions on matters that do not fall under the GMS authority. In essence, the role of the Supervisory Board is to direct and not to manage. In some cases, the charter may delegate certain GMS powers to the Supervisory Board. The charter can assign additional powers to the Supervisory Board as well. The Supervisory Board has the authority to make decisions in the following areas: (1) strategic oversight and control over management, as well as the election (when provided by the charter) and oversight of the General Director and Executive Board; (2) organization of the GMS; (3) charter capital and assets of the company; (4) disclosure and transparency; and (5) other areas determined by the Company Law and charter. (IFC & U.S. DoC 2004, Ch. 2 pp. 11-12 )

In the area of the company's strategic oversight and control Supervisory Board has the following authorities: setting company priorities and strategic direction; establishing the executive bodies; terminating the executive bodies' powers; suspending the executive bodies' powers; appointing interim executive bodies; supervising the executive bodies' operations; preliminarily approving the annual report. (IFC & U.S. DoC 2004, Ch. 2 pp. 12-19)

According to IFLR note, the Russian law on director liability is set out in statute, mainly in Article 71 of the JSC Law. There are few (if any) precedents of judicial enforcement, before the courts, of this form of civil liability (as opposed to administrative or criminal liability of directors, of which there are examples). Under the JSC Law, all directors (including the general director) must act reasonably, in good faith and in the best interests of the company (this is also repeated in Article 53 of the Civil Code). The JSC Law further indicates that directors are liable towards the company (not the shareholders) for any damages that their actions (or failure to act) cause the company, provided that these actions (or this failure to act) are constitutive of a fault. After the January 2006 changes, directors are now also liable towards the shareholders, as well as the company, for losses incurred by them in the specific case of breach of new tender offer rules on acquisition of large shareholdings (in excess of 30%) in open joint-stock companies. (IFLR 2006)

The general principle is that directors are liable to the company in the event of fault in the performance of their duties. The existence and measure of liability must be determined in light of customs of commerce and other circumstances. Customs of commerce is generally defined in the Civil Code (Article 5) as rules of conduct that have taken form and are widely applied, but are not provided for in any specific legislation. This can of course be viewed as a fairly open-ended, race to the bottom clause, especially if the usual standards of conduct of business are not high. According to some commentators, the actions or inactions of directors constitute a fault that would lead to liability only if the actions or inactions were specifically performed with a view to causing damage. Poor business judgment in itself is not, by the same analysis, normally constitutive of fault. Directors are only liable if they voted for a certain resolution. Voting against (or failure to vote, for example, in the case of absence) will normally exonerate them from potential liability. (IFLR 2006)

In a Joint Stock Company (JSC), general liability suits can be brought against directors either by the company or by shareholders owning more than 1% of ordinary shares (derivative lawsuit). For the specific case of breach of the new tender offer rules for open joint-stock companies, the January 2006 changes now allow any shareholder to file suit (regardless of percentage of shares owned). It has been pointed out that, in a JSC, shareholders need to own 25% or more voting shares to access copies of board resolutions. Beneath this threshold, therefore, minority shareholders (including those owning 1% or more) might simply not be in a position to access enough materials to enable them to consider a potential liability claim. (IFLR 2006)