. Last Updated: 07/27/2016

The Great Boardroom Revolution

When Boris Jordan and fellow investors turned up in the small mining town of Lipetsk one day this spring, they were prepared for a fight. The event was the annual shareholders' meeting of Novolipetsk Ferrous Metal, Russia's second largest steel maker. The mission: to secure seats on the company's board of directors proportionate to the consortium's roughly 40 percent holding.

But the plant's management, siding with another strategic investor, had other ideas. Despite their 44 percent stake, Jordan and his team got zero representation on the board.

Days after the April 26 meeting, Jordan's Russian visa was unexpectedly revoked for two months. In an interview with The Moscow Times a week after his July 5 return, Jordan said he had no evidence to connect the byzantine intrigue over his visa with the showdown at the metal factory: "We have had problems ... at the shareholders' meeting," he said laconically.

As the 1996 season of annual general meetings, or AGMs, draws to a close, the opposing teams have squared off for boardroom battles similar to Jordan's, and the balance of forces is more or less clear.

On one side, brokers, fund managers and other investors are consolidating the stakes they swallowed up during Russia's rapid privatization program and are demanding the right to protect and manage those holdings in an effort to restructure enterprises. They are lining up for board seats, monitoring voting procedures and cracking open company books.

Jordan is a classic case. "The first wave of direct investment is just happening now and if we are unsuccessful and if we cannot enforce our rights and if we can't push, then the real big money -- billions of dollars -- will never come here," he said.

Eyeing Jordan and his allies warily are entrenched company directors, many of whom enjoy virtually unchecked command of the production lines they've presided over for decades. Outside investors allege these "Red Directors" are used to running enterprises according to Soviet tenets: overpricing supplies, underpricing output and pocketing the rest.

But if they see outside shareholders trying to get hold of their company, these managers often shout down their proposals at meetings, intimidate employees who side with them and hold tight to the board -- which is still often considered a Soviet-era workers' council.The result is a battle now being played out in scores of boardrooms and annual general meetings. Dmitry Vasiliyev, chairman of the Russian Securities Commission, which has the responsibility of regulating the brawl, said that often directors realize they either "must leave, or adapt. They don't want to do that, therefore they try to resist all means and methods [of relinquishing control]."

A sweeping new study due for publication this week, "Corporate Ownership and Corporate Governance in the Russian Federation," reveals a number of telling details in who owns these blocks of shares. The numbers are based on the last quarter of 1995 and draw from a sample of 185 medium- and large-sized companies in 30 regions.

Commissioned by the Securities Commission and prepared by Professor Joseph Blasi of Rutgers and Princeton Universities and Professor Andrei Shleifer of Harvard University, the report found that insiders -- employees and management -- own an average of 59 percent of the stock of Russian companies, while outside shareholders hold 31 percent and the government has 9 percent (the figures don't add up to 100 because of rounding).

This may make it seem like the red directors and their worker's collectives have the upper hand but in fact, outside investors have already made up of a lot of ground. Professor Blasi said that immediately after voucher privatization, which ended in 1994, more than 90 percent of companies were majority-owned by employees.

But experts agree that the movement in ownership is toward equal parts insider and outsider, with state holdings lumped in the outsider category.

"The tendency is that we're moving closer and closer to a 50-50 relationship," Vasiliyev said. "The battle for control is intensifying."

But at the same time there is evidence that managers are willing to relinquish control. Vasiliyev said as many as 30 percent of directors are ready to sell a majority block of shares, while the study showed that 12 percent of managers have been changed in the last 12 months.

There is, of course, still much opposition in Russia to private ownership and fierce nationalists have protested loudly that foreign imperialists are raping the country and stealing its abundant wealth. Even factory directors will use that argument to keep outsiders away.

Surprisingly, though, the report showed that foreigners hold on average a tiny portion of Russian companies. Among outside shareholders in the companies surveyed, foreign corporations accounted for a mere 3 percent.

But again, the figure is misleading. The study revealed that foreigners tend to concentrate their holdings in a small number of companies, as do Russian financial industrial-groups, or FIGs, and Russian bank holding groups, which hold much higher average stakes than foreign firms. Foreign commercial firms own more than 34 percent of 1 percent of Russian companies.

Blasi ascribed foreigners' concentration in key enterprises to cherry picking. "We would expect that foreigners would have bought into companies selectively," he said. "Obviously foreign investors tried to find what they felt were good investments."

The list of management disputes confronting outside investors today is long and the battles frustrating. It affects such well-known companies as Norilsk Nickel, Bratsk Aluminum and oil giant SIDANCO.

But these examples are tame compared with the bombshells of 1994 and 1995, when international headlines screamed of negligent registrars and secret dilutive share issues, decrying the Wild East nature of Russia's fledgling capital markets.

One notorious incident involved Krasnoyarsk Aluminum, which deleted from its share register -- the only legal proof of ownership -- a 20 percent stake held by the British Trans World Group, effectively wiping out its holding.

Oil concern Komineft instilled a similar wave of fear in international investor circles when it issued two fresh batches of shares without bothering to inform its shareholders, who learned of the issue nine months later. Primorsky Shipping and the Far East Shipping Company, or FESCO, also watered down existing shares by introducing new ones.

The Securities Commission leaned hard on these companies, and one fund manager said pressure lay behind Komineft's decision to nullify the issue. Since then, new laws are in place to help guard against these types of violations and shareholders in general have put some mechanical problems like control of registers behind them.

They have already shifted their focus to more substantive issues of corporate governance. Outside shareholders are mainly concerned with influencing decision-making commensurate with the size of their stakes and generally cooperating with management in restructuring efforts. This often boils down to basic issues of corporate governance, such as strictly following protocol at AGMs.

"One of the highest concerns on the issue list is probably at the level of governance," said Austin Beutner, president and chief executive of the $100 million U.S.-Russia Investment Fund, which holds stakes in 24 different companies.

One key protection is the sweeping Law on Joint-Stock Companies, effective from Jan. 1. It marks Russia's first federal law to outline detailed rules of corporate governance, from how to inform shareholders about AGMs to the method for counting ballots. For instance, it includes a clause allowing shareholders holding at least 2 percent to propose agenda items and one which stipulates that if new shares are issued they must be at the market price.

But many fund managers and analysts named cumulative voting as one of the most significant and welcome provisions in the law.

Cumulative voting -- which companies with more than 1,000 shareholders are required under the law to use in electing directors -- is a way of allowing small shareholders to gain representation on the board. That means that if a shareholder holds 10 percent of a company's stock and there are 10 seats on the board, the shareholders is guaranteed at least one representative.

"That's what's most important about the new law," said Andrei Volgin, president of Adamant Financial Corporation and chairman of the Moscow Shareholders' Rights Committee.

While the joint-stock company law marks a giant step forward for shareholders' rights, it is not enough on its own. To repeat a familiar refrain among the foreign business community: Having a law in place is one thing, enforcing it another.

"Still most things are not decided by legal means but by personal relationships and other sorts of influence," said Mike Calvey, managing director of SovLink, the investment advisor to the $160 million to $200 million First NIS Regional Fund.

Rules on cumulative voting and holding secret ballots are still violated at AGMs.

Vasiliyev admitted that despite a recent restructuring which requires the commission to report directly to the president, its powers remain limited under Russian law. "It must be understood that our commission will always have less authority than the American one because of the tradition of Russian legislation," he said.

The U.S. Securities and Exchange Commission, or SEC, maintains the right to settle shareholder disputes and in general polices the activities of market participants.

But Vasiliyev said the commission drafted and sent to the State Duma, or lower house of parliament, amendments to the Civil Code which would force a criminal investigation of shareholder rights violations. He also said he and his team are currently examining with Western experts various shareholder rights regimes in Europe and America, deciding which method would work best here.

Resistance to outside control is hardly unique to Russia. As Professor Blasi pointed out, protest against proper corporate governance is a major issue in the United States right now.

"The difference is that in most developed market economies managers may not like to have a lot of corporate governance but they realize it's a necessity," he said.

Another difference is that sometimes Russia's corporate disputes have turned from boardroom battles to gunfights. "The company says, 'If you don't leave us alone, we'll send the boys around,' and the Russian company says, 'We have boys too,'" said Andrew Fox, chairman of Tiger Securities in Vladivostok. "We [foreign investors] don't have conversations like that. We're soft and fluffy."

In fact, sometimes "red" directors have a legitimate concern about strangers coming round to shake things up. Not all outside shareholders have the company's best interests at heart.

Aluminum company Trans CIS Commodities, for example, which is at the center of the battle for Krasnoyarsk Aluminum and indirectly related to the battle for Novolipetsk Steel, is headed by the infamous brothers Lev and Mikhail Chornoye, and has been surrounded in corruption allegations involving former first deputy prime minister Oleg Soskovets. A number of businessmen linked with the aluminum industry have been killed in recent years.

But despite the roughness of the game, shareholders are developing tactics to enforce their rights, trying to make sure the law is implemented. Some are even winning seats of boards of companies.

Tiger Securities' Fox sits on FESCO's board as a representative of a consortium of foreign investors who account for 33 percent of the shipping concern's shares.

Fox, the first foreigner to win a seat on the Vladivostok Stock Exchange, said the blue chip company's management itself actually suggested putting a foreigner on the board -- though one representative on a nine-member board isn't commensurate with the foreigners' 33 percent stake.

But Fox, who also sits on about a dozen other boards of companies in Russia's Far East, said Tiger Securities' approach is gentle, and having one seat was better than having none. Fox said that in the circumstances it was "Better to say, 'One is great, thanks very much.'"

Fox said he nonetheless had significant input at the board's first meeting, a few days after FESCO's AGM. He suggested a certain remuneration package related to company performance for the general director which other board members supported and passed.

Another development that will help change attitudes and reduce resistance of management is for investors to start fighting violations of their rights through the courts, an approach Vasiliyev has long pushed for.

One example is the case with Illingworth Morris, which has received a great deal of local and international press. The British textile company is fighting managers at the Bolshevichka textile plant in Moscow for control of the company and has twice taken the matter to court.

"We believe that this case and others are setting important precedents and examples that are being closely watched by other investors and potential investors," a company statement said.

Most employee shareholders, on the other hand, are still passive and exert little influence over corporate governance because they are underrepresented on company boards, the study found.

But there are signs of life for small shareholders. Anecdotal evidence suggests they are going to AGMs and asking lots of questions.

When asked at a recent news conference about Norilsk Nickel's June 27 AGM, the metal giant's chairman Vsevelod Generalov remarked: "We joke that 70 percent of the questions were asked by one guy who has 5 shares."

At the LUKoil AGM last month, one shareholder who collected 200 shares by gathering vouchers said he came to the meeting to watch for the planned share swap announcement with LUKoil Holding and five daughter companies.

"If they use the numbers I've heard mentioned, I'm going to lose big," said Anatoly, 46, during a break in the action at the Federation Council building. He said he also planned to attend the Gazprom shareholders' meeting, to watch over his 300 shares.

Volgin, in his role as protector of shareholders, has been doing his part to get the word out. The Moscow Shareholders' Rights Committee has -- along with lobbying for and drafting federal legislation -- published more than 150 articles in popular newspapers, appeared on more than 100 television programs and fielded hundreds of thousands of calls from average Russian shareholders via a committee hotline.

"We see that the level of understanding has improved incredibly," Volgin said. "When I see a low-level worker at a company meeting asking why Article 5 in the charter doesn't conform with Article 27 in the law, I really feel that the process is coming along."

The most convincing force driving open the door for shareholder's rights is that factory managers are starting to accept they need capital to survive."They are beginning to realize they have to adapt to the market economy and the market way of allocating capital, and capital will go to those managers who are receptive to good ideas," said Beutner of the U.S.-Russia investment fund.

Perhaps most important is for investor-shy directors to witness how outside capital has produced growth in other companies.

"We take managers, trade union leaders, other employee leaders to a company where assets have increased and say, 'That's what you may have,'" Volgin said. "'No serious cuts in the labor force, regular salary payments, not a single delay, the company's improving, production is growing,' ... and it works."

But he said Russia is far from having this "critical mass" of success stories necessary to affect real change. "People who live around our [rubber] company in Yaroslavl, they see the success story. People who live five, 10 kilometers out, they don't see it."

Volgin's Adamant took a controlling interest in Yaroslavl Rubber in November 1994, and immediately changed six of seven directors. A year and a half later, the company's share price has shot up to about $6 from 50 cents, production climbed by 50 percent last year and 100 shiny new computers sit where scraps of paper and abacuses were before.

Another success story is the Bolshevik Biscuit Factory, Russia's biggest pastry maker and the first state enterprise to be privatized, in December 1992. Investment company Alfa-Kapital -- at that time a major voucher privatization fund -- bought up shares with vouchers and then bought heavily on the secondary market.

Then, Alfa-Kapital wanted to bring in a strategic investor, and eventually Danone of France was chosen. After some initial skepticism from Danone, they found that when they came in, they had a normal working partner in the management of Bolshevik.

And even though Danone initially had cold feet and management was still wary of bringing in a strategic investor, eventually directors, who were typically conservative, realized the benefits of bringing Danone on board.

Stephen Jennings, who led the deal at CS First Boston and how heads up Renaissance Capital's merchant banking department, remembers being impressed by a key player in the deal, a 62 year-old economist for the factory.

"She had been in the [Soviet] system all her life, this was the first semi-hostile takeover ... and she really thought through the consequences ... she was really intelligent about it."