«Vostok Nafta Investments Ltd.»
Corporate presentation
1
The costs/benefits of
disclosing beneficial
ownership
OECD, Russian corporate
governance roundtable
meeting
11th-12th November 2004
All financial and other information contained in this presentation has
been obtained from and prepared on the basis of publicly available data
which has not been verified by Vostok Nafta Investment Ltd. for its
completeness or accuracy; Vostok Nafta Investment Limited does not
make any representation or warranty (whether express or implied), nor
does it assume any liability, as regards completeness or accuracy of
financial or other information which has been obtained from such
publicly available sources.
«Vostok Nafta Investments Ltd.»
Corporate presentation
2
– The need for disclosure of
beneficial ownership.
– Examples of how Sibneft and
TNK hide true ownership.
– Related parties masquerading as
independent shareholders.
– The UK regulatory environment.
– Other problems related to the
enforcement of Corporate Law
and Securities Market laws in
Russia.
Contents
«Vostok Nafta Investments Ltd.»
Corporate presentation
3
– The Russian equity market has a
number of unique features which are
relevant to framing policy. The single
most important factor is that many
shareholdings have been created as a
direct, or indirect result of voucher
privatisation, as opposed to
entrepreneurs looking to access equity
capital. This fact has two critical
implications;
1.Having completed voucher
privatisation, the Government
should protect the interests of
shareholders as an extension of its
privatisation policy.
Policy framework
2.
•
The negative consequences
of poor corporate governance
– a low share price and/or a
lack of access to equity
funding is an entirely counterproductive disincentive. In
many companies a dominant
shareholder whose is
extracting cash flows is
actually interested in lowering
the share price in order to
deter minority investors.
In summary, market mechanisms
on their own are not an adequate
disincentive to stop bad corporate
governance in Russia – legislation
and penalties to stop self-dealing
are also vitally important.
«Vostok Nafta Investments Ltd.»
Corporate presentation
4
– Vostok Nafta is involved in a
major legal challenge to the way
in which a Russian oil company
(OAO “Slavneft-Megionneftegaz”)
is run. Part of that challenge
involves uncovering the beneficial
ownership of a multitude of
Russian, Cypriot and BVI
companies.
The case for shareholder activism
– We believe that this work is
important not only because it
helps secure our assets, but also
helps in the wider context of
improving property rights and
frustrating the pernicious practice
of transfer pricing.
«Vostok Nafta Investments Ltd.»
Corporate presentation
5
Beneficial ownership
– why is it important?
– The key concern for minority
shareholders is to understand the
nature and extent of any related
party transactions – that can only
be determined if a company’s
ownership structure is clear.
– An understanding of who owns
what generates a number of
related benefits in the areas of;
– This issue is particularly relevant
in Russia where financial
industrial groups tend to own
numerous companies in various
sectors which trade with each
other – thereby creating
conditions for transfer pricing.
– These latter areas are not the
concern of minority shareholders
– but we briefly touch on them.
– Competition policy;
– Takeover code;
– Fighting corruption and fraud.
Ownership structures in
Russia
«Vostok Nafta Investments Ltd.»
Corporate presentation
6
–Financial Industrial Groups control multiple enterprises,
accordingly the potential for related party transactions are
infinitely greater than in the UK where companies are 70%
owned by financial institutions.
Estimated control of Russian Industry (by sales) 2003
Ownership of UK companies listed on the London
Stock Exchange 1998
Big business
(oligarch
groups)
35.0%
Other owners
34.7%
Others
1.4%
Charaties
1.9%
Individuals
16.5%
Foreign share
5.3%
Government
(Regional)
4.9%
Source: World Bank, Country Economic Memorandum, April 2004.
Government
(Federal)
20.1%
Overseas
institutions
24.0%
Source: Analysis and data of share ownership and control in UK, Dr Geof Stapledon.
Domestic
institutions
(Insurance
companies,
Pension Funds and
Unit Trusts)
56.2%
«Vostok Nafta Investments Ltd.»
Corporate presentation
7
– Ownership disclosure in Russia is
improving, however it still focuses
on the owner of record rather
than the ultimate beneficial
owner.
Existing disclosure of beneficial
ownership and related parties
– The existing Russian disclosure
can be combined with GAAP
accounts, international company
searches and press statements to
build up a fairly accurate picture
of ultimate ownership. However
this exercise requires time,
money and effort. This data
should be voluntarily disclosed,
there is no valid reason to hide
such data.
– By combing different data
sources it is possible to work out
what has not been disclosed.
«Vostok Nafta Investments Ltd.»
Corporate presentation
8
Risks arising from nondisclosure of beneficial
ownership
– The key risk relating to non-disclosure is that related party transactions
will be carried out between entities under common ownership or control
without shareholders being aware of any relationship. In addition to
this obvious threat, we identified two related risks;
Majority
shareholders
masquerade as
minorities
In the case of Megionneftegaz three Cypriot companies
(Edie, Select and Hassla) voted “for” all related party
transactions – our investigation showed that these entities
were ultimately owned and controlled by majority
shareholders. By participating in voting they rendered article
83 of Corporate Law nugatory.
Majority
shareholders
influence
professional
advisors/market
participants
Any securities market requires strong and independent
professional participants – notably; auditors, valuers and
registrars. In the case of Megion, we believe that the
registrar (OAO Registrar R.O.S.T.) was not independent and
that it failed to execute its responsibilities with adequate
care.
«Vostok Nafta Investments Ltd.»
Corporate presentation
9
– Based on the results of various
extraordinary shareholder meetings,
we understood that three Cypriot
entities (Edie, Select and Hassla
Holdings) consistently voted “for”
related party transactions.
– By voting on those issues, the
Cypriot entities were representing
themselves as being independent
(within the meaning of Russian law).
Further the registrar (OAO
Registrator R.O.S.T.) was similarly
certifying that the Cypriot entities
were allowed to vote by including
them in the quorum.
Beneficial ownership – the
majority masquerades as a
minority
– We spent many months uncovering
the ownership of those entities in
order to determine that three Cypriot
individuals apparently owned the three
Cypriot entities, implying that those
individuals owned some USD 480
million worth of Megionneftegaz
ordinary shares.
– Further one of the “independent”
companies nominated 3 members of
TNK’s management to the Board of
Megionneftegaz in March 2002*.
– Our investigation showed that the
Cyprus companies were ultimately
owned (via a trust agreement) by OAO
Sibneft and OAO TNK (acting jointly).
«Vostok Nafta Investments Ltd.»
Corporate presentation
10
Related party voting patterns
– Megionneftegaz failed to even ask shareholder approval for most of its related party
transactions and sold oil to related parties in contravention of the requirements of article
83 of corporate law.
– For those transactions where the Board did actually bother to invite allegedly
independent shareholders to vote, 27.5% of “independent” shareholders consistently
voted in favour of related party transactions.
Mechanisms used to hide
TNK/Sibneft ownership in
Megionneftegaz
«Vostok Nafta Investments Ltd.»
Corporate presentation
11
BP Plc
Alfa Group
Access Renova
50% (AAR)
50%
TNK-BP
Unidentified
core shareholders
Sibneft
BVI
50%
Sibneft and TNK
acting jointly
Stanberg Investments
100%
Limited
Invest -Oil
implied minority
50%
CDSV Trust
shareholders in NGK Slavneft
NOT beneficially owned by
5.47%
TNK/Sibneft
10.83%
1.05%
Joint venture
(winner of Dec 02
Yianna Georgiou
Nitsa Charalambous
Sophia Iosif
Individual - Cyprus
Individual - Cyprus
Individual - Cyprus
auction)
100%
74.95%
100%
Dorling Holdings Limited
Fteriki Holdings Ltd.
Yianna Georgiou (Sole Director)
Nitsa Charalambous (Sole Director)
Sophia Iosif (Sole Director)
Cyprus
Cyprus
Cyprus
100%
AO NGK Slavneft
100%
Novabest Holdings Ltd
100%
100%
7.70%
Select Holdings Limited
Edie Holdings Limited
Hassla Holdings (Overseas) Limited
Yianna Georgiou (Sole Director)
Nitsa Charalambous (Sole Director)
Cyrprus
Cyprus
Cyprus
9.74%
9.88%
60.66%
7.88%
OAO Slavneft Megionneftegaz
* CDSV shareholdings in NGK Slavneft estimated based on 98.95% joint ownership of NGK Slavneft by TNK/Sibneft less identified holdings of Invest Oil, Stranberg Investments and Select Holdings.
Source: Company searches, TNK and Sibneft GAAP accounts, NGK Slavneft and Megionneftegaz Federal Securities Market filings.
Related parties – what is not
disclosed is often the most
relevant
«Vostok Nafta Investments Ltd.»
Corporate presentation
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TNK International
Miller Technolgies S.A.
BVI
50%
AO Sibneft
50%
BVI
Russia
500 Class C shares
Jones Resources Ltd.
1,500 C shares
BVI
TOC Investments
1,500 T shares
BVI
500 Class T shares
Thriftiness Investments
CDSV Trust
Limited
Cyprus
Sibneft and TNK
acting jointly
Stanberg Investments
100%
Limited
Implied minority
shareholders in NGK Slavneft
NOT beneficially owned by
TNK/Sibneft
1.05%
Invest -Oil
13.10%
Joint venture
10.83%
(winner of Dec 02
100% (prior to 30th June 2003)
auction)
74.95%
AO NGK Slavneft
OOO Triftiness Investments
Kalmikiya
Russia
60.66%
Oil trading
27.50%
OAO Slavneft Megionneftegaz
Russia
The “independent”
shareholder registrar ROST
«Vostok Nafta Investments Ltd.»
Corporate presentation
13
BP Plc
Alfa Group
Access Renova
50% (AAR)
50%
TNK-BP
Core shareholders
management
contract
Sibneft
BVI
Millhouse Capital (UK)
Limited
management contract
50%
50%
50%
Invest -Oil
50%
Sibneft and TNK
Joint venture
(winner of Dec 02
auction)
CDSV Trust
acting jointly
management
Stanberg Investments
contract
Limited
74.95%
10.83%
Various Cyprus holding
companies, trusts and
individuals
ROST
7.70%
shareholders
AO NGK Slavneft
Board member
Board of Directors
Mr. Bondarenko - Millhouse
Mr. Davidovich - Millhouse and former Member of Board NGK Slavneft
Mr. Ivanov - Millhouse
60.66%
Ms. Burlakova
Mr. Zhiznenko
27.50%
OAO Slavneft Megionneftegaz
Registrar ROST
Source: Website ROST (www.rrost.ru), Federal Securities Market filings NGK Slavneft and Megionneftegaz.
«Vostok Nafta Investments Ltd.»
Corporate presentation
14
How independent is ROST?
– 4 out of 5 members of the Board
– “Independent” shareholders who
work for Millhouse Capital – the
are ultimately owned by
manager of a majority stake in
TNK/Sibneft appear to have no
Sibneft. One of those Board
trouble in receiving and returning
members was also a Board member
voting papers for the 29th January
of NGK Slavneft.
2004.
– Via its management of a dominant
stake in AO Siberian Oil Company,
Millhouse Capital can indirectly
control an estimated 27% in Megion
plus a further 12.6% through
various trust arrangements,
Millhouse apparently manages a
significant stake in ROST.
Source: website ROST (www.rrost.ru), information on
Board of Directors of NGK Slavneft from FSC quarterly
filings. Rost ownership data from website Bankpress.ru
«Vostok Nafta Investments Ltd.»
Corporate presentation
15
– The following events took place
whilst ROST acted as registrar for
Megionneftegaz;
– Austro (Cyprus) Limited’s voting
papers for Megionneftegaz’s
EGM held 29th January 2004
were sent by post to Austro
(Cyprus) Limited using ZAO
Brunswick UBS Nominees postal
address. The combination of a
foreign recipient with a Russian
entity’s postal address rendered
the envelope undeliverable.
ROST’s role as
Megionneftegaz’s registrar
– Related parties (Edie, Select and
Hassla) are inappropriately
included in the quorum for voting
on related party transactions,
thus rendering the safeguards in
article 83 of Corporate Law
useless.
«Vostok Nafta Investments Ltd.»
Corporate presentation
16
– Vostok Nafta identified and
received confirmation that some
40 individuals received voting
papers for Megionneftegaz’s
annual general shareholders
meeting (25th June 2004) on or
after the deadline for the return of
voting bulletins to
Megionneftegaz (22nd June
2004).
ROST’s role as
Megionneftegaz’s registrar
– The explanations provided to
date such as “problems with the
post”, mistakes by the nominees
and inaction on the part of the
issuer simply lack credibility.
«Vostok Nafta Investments Ltd.»
Corporate presentation
17
– The costs of disclosure are
essentially zero – the costs of
non-disclosure are extremely
high. The complex web of
trusts/offshore ownership
companies utilised by
TNK/Sibneft to hide their
ownership in Megionneftegaz are
both expensive to set up and
costly to maintain.
The costs/benefits of
disclosure
– In terms of benefits of disclosure
– the obvious benefits are;
– To allow minority shareholders to
understand and quantify the risks
of related party transactions;
– To build up a factual case to
pursue corporate malpractice
suits via the court system;
– To understand whether key
market participants such as the
auditor, valuer and/or registrar
are really independent.
«Vostok Nafta Investments Ltd.»
Corporate presentation
18
– There are other benefits of
disclosure, not strictly relevant to
minority shareholders, but none
the less useful such as making it
harder for politicians to hide
ownership of substantial assets.
The costs/benefits of
disclosure
«Vostok Nafta Investments Ltd.»
Corporate presentation
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– The UK recognises (as does
Russia) that it is important to
disclose information on significant
shareholders.
– The UK regulatory regime is
robust and sets out very clear
responsibilities and mechanisms
for disclosure, the UK regime;
– Clearly defines ownership
arrangements and specifies in
detail what type of ownership
does and does not need
disclosure;
Ownership disclosure
– UK experience
– Clearly defines the various
thresholds for ownership
disclosure (both increases and
decreases);
– Clearly defines responsibilities for
disclosure (and information
dissemination);
– Clearly defines penalties for nondisclosure, or inaccurate
disclosure.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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– UK disclosure requirements are
worded in such a way that it is
impossible to evade the spirit of
the law. The regulatory regime
includes disclosure requirements
related to a number of key
concepts; including;
Ownership concepts
– direct or indirect ownership;
– Interest or right conferred under
an agreement;
– The nature of pooled
investments;
– An obligation to disclose the
steps taken to ensure
independence between an entity
and its largest shareholder;
– The use of negative
representations.
Summary of UK regulatory
regime on ownership
notifications
«Vostok Nafta Investments Ltd.»
Corporate presentation
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Companies Act 1985 (as amended)
Listing requirements
UK Listing Authority (Financial
Services Authority)
Continuing Obligations
UK Listing Authority (Financial
Services Authority)
Takeover code & Substantial
Acquisition Rules
Panel on takeovers and mergers
Disclosure of information on controlling shareholder (30% or
more) or who controls majority of Board.
A statement explaining how the issuer is able to carry out
business independently of the controlling shareholder and that
any transactions with the controlling shareholder will be on an
arm’s length basis.
Shareholder disclosure of all interest above 3% (and
subsequent increases of 1%);
Company discloses all information received from major
shareholders within 1 day of the receipt of such
information.
Shareholders acquiring more than 15% of a company’s
capital are required to inform a regulatory information
service.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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– In the event that a company
requests a shareholder to
disclose ownership (pursuant to
212) and that shareholder fails to
do so and/or makes a materially
misleading statement the person
is “liable to imprisonment or a
fine, or both”. Further a company
can request a court to freeze the
non-disclosing person’s shares.
Summary of penalties relating
to failure to disclosure
– Directors (without exception) are
responsible for ensuring that all
necessary information included in
listing particulars. Directors of a
company (individually and
collectively) are responsible for a
company’s compliance with listing
rules.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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Closing words
on enforcement
«Vostok Nafta Investments Ltd.»
Corporate presentation
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– The OECD is right to focus on
enforcement issues (Chapter 5 of
the White Paper). We have
distributed a separate paper
which details key issues of policy
enforcement – in summary these
are;
– Excessively literal interpretation
of legislation which allows
Russian courts to ignore and/or
contradict the clear intention of
legislation in order to achieve the
“required” outcome;
Main enforcement issues
– A total lack of realistic penalties to
deter corporate wrong doers.
– A total lack of interest and activity
on the part of the market
regulator – the Federal Service
for the Financial Markets.
– These factors mean that even
well intentioned legislation can be
usurped and that confidence in
the Russian legal system and
securities market remains low.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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– We have posted a number of
lower court decisions on our
website (described in our paper)
which highlight the ways in which
legislation is deliberately
misinterpreted, here we
summarise the following
important decisions;
Specific examples of poor
enforcement
– The Federal Service for the
Financial Market letter from 17th
July 2004;
– The Tyumen court of cassation
decision on the disclosure of
information.
– Court decisions on declaring
related party transactions invalid.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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The FSFM decision on related
party transactions
– “it can be confirmed that the
– In response to various complaints
(most of which remain unanswered to transactions with them [the related
parties] are executed in the ordinary
this day), the FSFM sent us a letter
course of business and in accordance
(04-BC-04-1/2912). This particular
with point 5 of article 83 of the Law [on
complaint centred around the fact
joint stock companies] do not require
that numerous related party
approval prior to their execution, and
transactions had never been
information on such transactions does
approved (or even voted upon in
not require disclosure in accordance
general meeting), the FSFR
with the Decision on information
concluded;
disclosure..”.
– This conclusions effectively even
denies the existence of article 83 of
corporate law, which clearly sets out
that related party transactions should
be approved.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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– The lower court refused to force
Megionneftegaz to disclosure
information pursuant to the Federal
Law on the Securities Market, Russian
accounting legislation and Instructions
of FSFM (No.32, superseded by 0335/ps). The reasoning includes the
following statement1:
– Only a 25% shareholder can have
access to accounting records;
– The data being requested is
confidential;
Russian court decisions on
disclosure of information
concerning related party
transactions
–The court of appeal maintained this
position, the court of cassation in
Tyumen2 further added that;
–The data subject to disclosure in
accordance with the ongoing
disclosure requirements (Article
30 of the Federal Law on the
Securities Market) is not actually
ongoing disclosure – but
disclosure required at the time of
listing. This decision seeks to
deny the need for ongoing
disclosure.
1 - A75-1738-Г/04 decision 26th May 2005. 2 – Tyumen Court of cassation, 12th October 2004.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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Court decisions relating to
declaring related party
transactions invalid
– In none of the cases we brought
– The reasoning includes the
did the court ever declare a
following concepts;
related party transaction to be
– In the absence of the actual
void – even though the fact that
related party contracts (which the
courts refused to request and the
the transaction took place was
defendants refused to provide)
finally acknowledged, the fact that
the claimant cannot particularise
the parties were related was
its case1;
acknowledged and the fact that
– Even if such documents were
the shareholders never approved
available a shareholders primary
the transactions was also
right is to have a representative
on the Board of a company and
acknowledged.
that right is not affected by the
conclusion of related party
transactions2.
1 – case A75-1598-Г/04. 2– case A75-1936-Г/04 – Judge Oparina’s decision dated 2nd September 2004.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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Court decisions relating to
declaring related party
transactions invalid
– Even if the related party
transactions reduced the
company’s profit there is no direct
link between profits and dividends
and therefore no impact on a
shareholders financial interests3.
– This reasoning can only be
described as bizarre, the net
effect is to make it impossible to
prevent below market related
party transactions – thereby
rendering section 83 of Corporate
Law meaningless.
3 – case A75-1936-Г/04 – Judge Oparina’s decision dated 2nd September 2004.
«Vostok Nafta Investments Ltd.»
Corporate presentation
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A final word on enforcement
– The OECD correctly identifies a lack of meaningful sanctions as further
reason why corporate law is not adhered to. The table highlights the
laughable nature of many Russian sanctions;
Nature of violation
Liability under Russian
law
Closest equivalent
liability under
English law
Serious breaches of
accounting legislation in
preparation and
presentation of accounts.
From USD 69 up to USD 104 (20 to 30
Minimum Wages) payable by the
responsible corporate officers (Article
15.11 of the Administrative Code)
Unlimited fine on
directors.
Issuer’s failure to disclose
information or disclosure
of misleading information
in response to a
shareholders query
From USD 690 to USD 1,035 (200 to
300 Minimum Wages) payable by the
company (Article 15.19(1) of the
Administrative Code)
Unlimited fine on
directors.
Failure to present
evidence upon a court
order
Up to USD 175 (up to 50 Minimum
Wages) payable by the responsible
corporate officers and up to USD 3,500
(up to 1,000 Minimum Wages) payable
by the company (Articles 66, 119 of the
Arbitration Procedure Code)
Contempt of court
leading to sanctions
ranging from
sequestration of
assets to
imprisonment.
«Vostok Nafta Investments Ltd.»
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Further information
Most of the court decisions referred to in this presentation have been
posted on Vostok Nafta’s website (www.vostoknafta.com). Further
questions on legal issues should be addressed to;
Questions on Russian law should be
addressed to:
Mr. Yuri E Monastrsky
Managing Partner
Novinsky Boulevard, Moscow 121099,
Russia
Telephone: +7 095 231 4222
Fax: +7 095 231 4223
Tel: +7 095 231 4222
www.mzs.ru
Questions on international law and
applying Russian law in foreign courts
should be addressed to:
Mr. Richard Gwynne
Partner
Litigation Department
Stephenson Harwood
One, St.Paul’s Churchyard
London
EC4M 8SH
Tel: +44 (0) 20 7329 4422
www.shlegal.com