HERMITAGE CAPITAL MANAGEMENT
OECD: the 4th meeting of the Russian Corporate
Governance Roundtable
The Role of the Board of Directors in
Promoting Corporate Governance
by William F. Browder
Managing Director,
Hermitage Capital Management
June 19-20, 2001
Overview of Presentation
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
In Theory, the Board of Directors has many powers to
protect shareholders;

In practice, there are many ways for corporate
governance abusers to get around the power of the
Board of Directors;

Hermitage Capital suggestions of legal reform to
improve corporate governance and effectiveness of
Board of Directors.
Power of the Board of Directors
is Impressive in Theory
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Rules to protect shareholders against interested party
transactions;
 Rules (in some companies) to require unanimous
decisions on certain issues;
 Rules to restrict the ability of management to do certain
things without Board of Directors approval;
 Rules to allow Board of Directors to investigate and
gather information on any aspect of the business.

Interested Party Transactions
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According to Article 81 of JSC Law, any person or entity that is in the position to
influence the decisions of the Company and also stands to benefit from the
transaction is an interested party and the transaction is then by definition an
interested-party transaction.
LIST A
LIST B
Persons in the position to
influence the decision of the
Company
Participants in the transaction
1 Members of the Board of Directors (or their
close relatives or affiliates)
2 Officers of the Company (or their close
relatives or affiliates)
3 Entities (persons) which jointly with affiliates
If any person
meets any criteria
on List A and any
criteria on List B,
then the
transaction is by
definition an
interested party
transaction.
possess more than 20% of voting stock of the
Company (or their close relatives or affiliates)
(Source: Russian Company Law. Basic Legislation. Third Edition. Landwell CIS Law Firm, 2000)
1 Participants or intermediaries in the
transaction
2 Persons (entities) who possess with affiliates
more than 20% of participant or intermediary
in the transaction
3 Officers of participant or intermediary in the
transaction
Interested Party Transactions
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Example: Volzhanka Conflict - Baring Vostok vs. minority shareholders
Minority
shareholders
49.7%
United Confectioneries BV (Slad&Co)
50.3%
86.6%
Volzhanka
Konfi
85%
Zarya
Interested Party Transactions
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Example: Volzhanka Conflict - Baring Vostok vs. minority shareholders
Purchasing
Old Structure
New Structure
Volzhanka
Volzhanka
$
$ supplies
Suppliers
Condensed Milk;
Dry Milk;
Sugar;
Corn Syrop, etc.
supplies
Yurprovider
$
affiliated
company
supplies
Suppliers
Condensed Milk;
Dry Milk;
Sugar;
Corn Syrop, etc.
Slad&Co
Higher prices of inputs
Special fees
New structure is $1.3 mln more expensive than old structure*
* HCML estimate
Interested Party Transactions
HERMITAGE CAPITAL MANAGEMENT
Example: Volzhanka Conflict - Baring Vostok vs. minority shareholders
Old Board of Directors
(before May 31, 2001)
Valerian Khubulava
Andrei Terekhov
Alexei Leonov
Julia Baunova
Alla Dos Santos
Vadim Kleiner
Kurt Butenhoff
Interested
Parties
Independent
Parties
New Board of Directors
(after May 31, 2001)
Valerian Khubulava
Andrei Terekhov
Dmitri Panov
Inna Lebedeva
Nadya Brezhneva
Vadim Kleiner
Kurt Butenhoff
Interested
Parties
Maybe independent
Maybe not
Independent
Parties
Voted to
approve
Interested Party
Transactions
Unanimity of the Board of
Directors
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Theory at Sberbank:
“The decision to issue new shares of bank should be approved by
the Board of Directors unanimously if this right is granted to it by
the shareholders meeting or the Charter of the Bank”
Source: Instruction No.8 of the Central Bank of Russia
Unanimity of the Board of
Directors
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Example: Sberbank - new share issue
Number of shares, million
20
19,000,000
36% capital
increase
26.3%
to be sold
15
14,002,000
10
Central Bank
61.8%
Central Bank
45.5%
Others 4.9%
Others 3.6%
5
Investment
companies 21.4%
Source: Sberbank prospectus.
226,000
individuals 11.9%
Before new issue
Investment
companies 15.8%
226,000
individuals 8.8%
After new issue
4,998,000
New shares
were sold
for approx.
$173 mln
Unanimity of the Board of
Directors
HERMITAGE CAPITAL MANAGEMENT
Example: Sberbank - new share issue
120
$110 / share
USD per share
100
31.5%
of Book
Value
80
For each new dollar
raised, that will only
realize $0.32 of new
market value
60
$34.65/share
40
20
0
Book Value per share as of 1 Dec 2000
Source: Central Bank web-site.
Proposed Issue price
Unanimity of the Board of
Directors
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Example: Sberbank - new share issue
100%
90%
Sberbank's Supervisory board
80%
70%
Central Bank
62%
60%
50%
40%
30%
Other legal entities
21%
20%
Individuals 7%
10%
15 investors 10%
0%
Source: Sberbank quarter reports.
Elected with
the support of
investors
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
Victor Geraschenko
Vladimir Goruynov
Arnold Voilukov
Vladimir Kolbaev
Georgi Luntovski
Victor Melnikov
Vyacheslav Solovov
Alexei Kudrin
Sergei Kolotukhin
Bella Zlatkis
Sergei Ignatiev
Andrei Kazmin
Alla Aleshkina
Alexander Soloviev
Mikhail Zhivilo
Boris Fedorov
Ilya Sherbovich
Central Bank
Central Bank
Central Bank
Central Bank
Central Bank
Central Bank
Central Bank
Ministry of Finance
Ministry of Finance
Ministry of Finance
Ministry of Finance
Sberbank
Sberbank
Sberbank
MIKOM
UFG
UFG
Voted together
with management
• received special
permission from
Central Bank for
offshore
registration of
Sberbank shares;
• received special
allocation in new
share issue.
Restrictions on Sales of Assets
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Theory:
“A decision in relation to conclusion of a large-scale (major)
transaction, the subject of which is property whose value
comprises from 25% up to 50% of the balance sheet value of the
assets of the Company,.. shall be adopted unanimously”
Joint Stock Company Law, article 79.
Restrictions on Sales of Assets
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Example: Gazprom
Worth
Gas contracts to
ITERA
$1,800-$2,200 mln
Tarkosaleneftegas
$112-$896 mln
Sibneftegas
$78-$627 mln
Rospan
$104-$345 mln
Zapsibgazprom
$43-$327 mln
Gazprom shares
$191-$846 mln
38%
Gazprom
24%
51%
14%
4.83%
Total Value*: $2,328-$5,241 mln
* Based on HCML estimates of comparable market value.
Restrictions on Sales of Assets
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Example: Gazprom
“On October 27, 2000, the Board of Directors of Gazprom
required all asset transactions, including waiving rights to
participate in capital increases, had to be approved by the Board of
Directors.”
Source: Reuters.
Restrictions on Sales of Assets
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Example: Gazprom
Gazprom
Gazprominvest
holding
June 15, 2001
Undisclosed sum
21% of
Yugraneft
Sibur Energy
Did this violate the Board resolution? - No.
Did this violate the spirit of the Board resolution? - Yes.
Information on Transactions
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Theory:
Board of Directors’ regulations insure proper access of Board to all
information about the companies activity.
Information on Transactions
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Example: UES purchase of REN-TV
Unknown date of purchase of REN-TV
UES
? daughter
company
Sometime in year 2000
Undisclosed sum
X% of
REN-TV
? Seller of
REN-TV
Information on Transactions
HERMITAGE CAPITAL MANAGEMENT
Example: UES purchase of REN-TV
Unknown date of purchase of REN-TV
In October 2000, Boris Fedorov, member of UES Board of
Directors, officially requested information on acquisition:
- price paid;
- method of financing;
- date of purchase;
- transaction counterparties.
So far, there has been no information available to the Board on this
transaction.
What needs to be done to improve
corporate governance?
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• All public companies should be required by law to have a certain
portion of truly independent directors;
• There should be serious civil and criminal liabilities for management
board members who are involved in self dealing and hiding their
interests in transactions.
• Board of Directors members should be allowed direct access to all
information in the Company without making requests of Management;
• Anti-monopoly definitions of relationships should apply to all rules
about asset transactions to prevent loopholes.
• A Company should be treated as a Holding, which includes all its
daughter’s and grand-daughter’s assets. Board of Directors’ authorities
should be extended to influence the most crucial decisions to be taken
on daughter/ grand-daughter levels.
• Definition of “major transaction” (Article 79 of JSCL) should be
amended to decrease the overall value and close a loophole of splitting
major transactions into small related ones.
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Disclaimer
This material is for information purposes only and is not an invitation to subscribe for units or shares in the Hermitage Fund.
Subscriptions will only be received and units or shares issued on the basis of the current prospectus for the Fund, and prospective
investors should carefully consider the risk warnings and disclosures for the Fund set out therein. Investors should also consider any
other factors that may be relevant to their circumstances, including tax considerations, before making an investment.
The information is based on data obtained from publicly available sources, which have not been verified by Hermitage Capital
Management Limited, or any of its respective associates or affiliates. As a result of the difficulty in obtaining reliable data in Russia, we
do not represent this information to be accurate and complete and we do not accept any responsibility for the reasonableness of any
conclusions based upon such information.
Past performance is not necessarily indicative of the likely future performance of an investment. The price of units or shares can go
down as well as up and may be affected by changes in rates of exchange.
The Hermitage Fund has been authorised by the Guernsey Financial Services Commission as a Class B Collective Investment Scheme
under the Protection of Investors (Bailiwick of Guernsey) Law 1987 and the Collective Investment Schemes (Class B) Rules 1990. It
must be understood that in giving this authorisation the Commission does not vouch for the financial soundness or correctness of any of
the statements made or opinions expressed with regard to The Hermitage Fund. Investors in The Hermitage Fund are not eligible for the
payment of any compensation under the Collective Investment Schemes (Compensation of Investors) Rules 1998 made under the Law.