Crisis Reactions Rile Minority Shareholders

When equity markets were climbing, credit was flowing freely and the economy was prospering, many satisfied minority shareholders with stakes in profitable Russian companies did not concern themselves with issues of corporate governance and shareholder rights.

But Russian equity markets have fallen about 70 percent since their all-time high in May and cash-strapped oligarchs have been driven to take desperate measures to avoid margin calls and hang onto their assets.

Now, broaching the topic with some distressed investors is likely to evoke a stream of expletives. After one such bout, Ian Hague, the director of Firebird Management, sighed heavily and apologized.

"Sorry, but that's the way I'm talking these days," said Hague, whose company invests heavily in Russian equities.

Investors like Hague are no longer "shutting their mouths" about unfair treatment, says minority-shareholder rights activist Alexei Navalny.

"When the market was going up, nobody cared about how much shareholder capital managers were siphoning off for personal use. Now the crisis has pushed the minority to begin talking about their rights. They are demanding responsible corporate expenditures."

Recent actions by Russian corporations testify to the precarious state of corporate governance in Russia.

On Dec. 3, Sibir Energy's stock took a 57 percent nosedive after the company announced that it would buy $340 million worth of distressed real estate assets from one of the firm's majority shareholders, Shalva Chigirinsky, who owns a 47 percent stake in the company along with his partner Igor Kesayev.

"The Russian government could have stepped in and repaid their accounts, instead [Chigirinsky] chose to wreck the value of Sibir by injecting his worthless real estate into it," Hague said.

Sibir's board defended the investor bailout, claiming that the company's success hinges on its majority Russian ownership structure.

According to Navalny, Chigirinsky's sale and the board's approval of the asset purchase perfectly characterize the treatment of minority shareholders in Russia.

"For [the majority shareholders] the minority are kinds of invisible, abstract, stupid people who give them money," said Navalny. "Because the minority shareholders are not people to them, they can't be taken into consideration when there is a big decision to be made."

Billionaire Vladimir Potanin carried out a similar asset shuffle in mid-October when he sold $600 million in assets, including a stake in Rusia Petroleum and his 35 percent stake in the U.S. fuel cell maker Plug Power, to Norilsk Nickel's power company OGK-3. Potanin is the mining giant's dominant shareholder.

Some are more sanguine on the issue, however, arguing that minority shareholders in Russia aren't any worse off than other investors.

"There is natural tendency to be a bit paranoid about minority rights based on a perception with historical problems with minority problems," said Frank Mosier, head of Kazimir Partners, which manages Russia-focused equity funds.

"But the situation globally and in Russia doesn't have to do with majority or minority. It has to do with the global banking system, and I don't think minority investors are being treated any differently than they have always been in Russia."

Although other investors agree that there have always been risks related to corporate governance and minority rights in Russia, they say now — in a time of crisis — investors who used to overlook these issues are starting to pay attention.

"When the going was good and money was cheap, people glossed over the issue. But now it's very much back on the agenda," said Robert Procope, a Russia fund manager at Charlemagne Capital.

"And we are definitely concerned. Minority shareholders have been treated with contempt in recent high profile instances."

In one recent high-profile case, billionaire Mikhail Prokhorov, owner of about half of power utility TGK-4, backed out of a 15 billion ruble buyout offer to minority shareholders, citing a government decision to place the company on a list of natural monopolies because it owns a gas pipeline in the Ryazan region.

Onexim was obliged to make the offer in June after acquiring a majority stake in the company but canceled it just before the payments came due, when TGK-4's share price was down 50 percent from the time of the offer and the purchase at the higher June levels was no longer attractive.

Onexim maintained it could not acquire more shares without state approval because the utility was part of a strategic sector, which Onexim, as a Cyprus-registered company, would be disqualified from purchasing.

Prosperity Capital Management, along with other minority shareholders, took a large blow when Onexim reneged on the deal — worth close to $1 billion.

"It is completely frivolous. TGK-4 has a small pipeline that serves 10 clients and makes $10,000 per year. It is a minute part of the company and that somehow qualifies it to become a natural monopoly," said Mattias Westman, Prosperity's founding partner.

"[Prokhorov] is abusing the law on strategic investment, and if it is allowed to be applied in a arbitrary way like that, then strategic investors will think twice about investing back into Russia," Westman said.

As the pressure to find cash to repay debt mounts, some oligarchs are returning to "ruthless" 1990s maneuvers toward minority shareholders, he said.

"If this is allowed to proceed and the government and the courts do nothing about it, you risk to losing the investment case for Russia for years going forward."

And minority shareholders might not be the only victims, Westman said. The country's banking system might lose out by such behavior as well.

Rosbank, which issued a bank guarantee on Onexim's buyout, received a court injunction banning it from making payments to the minority shareholders. The injunction stemmed from a lawsuit filed by Onexim Group, registered in the British Virgin Island's against Onexim Holdings, based in Cyprus.

"Banking guarantees are supposed to be irrevocable," said Westman.

"This puts the entire Russian banking system into question. Most likely we will win in the end, but lots of major financial institutions know about this and they will not forget, they will not trust banking guarantees from Russia. Maybe the government doesn't realize how serious this really is."

An increase in the number of moves against minority shareholders shows that corporate governance during the current financial crisis is "easily" worse than it was in the 1990s, said Hague of Firebird.

"In the nineties, people didn't know what proper corporate governance was. Now they do and they are knowingly backing out of their obligation to act in the interest of all shareholders," he said.

Not everyone has such a pessimistic outlook, however.

"Companies all over, and in Russia in particular, are incentivized to abide by good corporate governance," said Mosier of Kazimir Partners.

"Their access to the global capital markets depends on that. When it is hard to find a loan, when loans are expensive, you have to be better than the other and if you are known to be transparent, known to be open, known to be a good guy, your cost of capital is lower and that is good for your business."

But the current capital markets in Russia may not have an incentive structure that rewards good behavior.

"Right now it is easier for companies to get loans from the Russian government and for that you don't need to behave well, you actually need to be the opposite: corrupt and nontransparent," Navalny said.

"Banks that care about corporate governance and transparency are not lending."

The print version of this article incorrectly stated that Sibir bought distressed assets from Igor Kesayev.