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. Last Updated: 07/27/2016

Independent Directors Find Seat on the Board

VedomostiEmerging-market guru Mark Mobius
Pearls of wisdom handed down in a Harvard Business School speech more than half a century ago are at last resonating in Russian boardrooms.

Then Sidney J. Weinberg, the chairman of Goldman Sachs and one of America's corporate governance pioneers, set out his vision of what it takes to be an effective member of the board.

"The director has obligations to all stockholders," Weinberg said in a 1949 address to the school's Alumni Society. "Beyond his legal duties, he must recognize the broad social responsibilities he has to the general public and to the country. ... I consider being a director a semi-public service, and directors should look at it that way, or not serve."

Fifty-four years later, in a country where the concept of the boardroom has existed for little over a decade and serves predominantly as a battleground between a company's owners and its minority shareholders, some corporate governance experts are suggesting Weinberg's advice from Harvard may be taking root in Russia.

"The practice of nominating and electing independent directors has changed in 2003," said Alexander Filatov of the National Association of Independent Directors, a self-regulatory body established in conjunction with Ernst & Young to promote the appointment of independent directors.

"Today it's not just minority shareholders that are interested in putting forward independent representatives, but the companies themselves, their controlling and strategic shareholders," he said. "The companies feel real returns from the inclusion of independent members on the board, which make them more attractive to investors and raise their capitalization."

After all, Filatov said, the presence of independent directors on the board was cited as the No. 1 factor affecting investment attractiveness in a survey of corporate governance in Russia released last year by Ernst & Young. In second place came the ability of management to speak English.

Up until 2000, there were only two types of company directors, said Mark Jarvis, a partner at Ernst & Young and head of the Transaction Advisory team: "One representing the major shareholder and the other representing the minority investor. And the minority investor reps were there to stop their assets from being stripped."

Today Yukos, where independent directors predominate on the board, is the corporate darling that most springs to mind with analysts. The reformed oil major invariably tops a list that includes LUKoil, Wimm-Bill-Dann, Norilsk Nickel, Sibneft, United Heavy Machineries and Vimpelcom.

According to Filatov, of his association's 94 independent directors in 2003, 21 were appointed as independents in a total of 29 companies, while a further eight were selected to represent minority shareholders' interests on the boards of 15 companies.

"One of the pharmaceuticals distribution companies with Western capital approached our association," Filatov said. "It's a rapidly developing company; they said they needed fresh blood for their strategy and development."

While the number of independents appointed by the association in 2003 is down from previous years, Filatov said this is explained chiefly by consolidation in the telecommunications sector.

A new report from the association on directors' salaries, out later this month, is likely to show the growing importance of directors, compared with a few years ago, when salaries were often insignificant. "If you need the best people in terms of reputation and qualification, you have to pay," Filatov said.

The corporate governance code produced last April by the Russian Union of Industrialists and Entrepreneurs, or RSPP, has done its bit to raise standards in boardrooms over the past year, Ernst & Young's Jarvis said.

"I'm a firm believer that good corporate governance development board practices are growing through the market, pushing people who have a desire to run the companies better, rather than being legislative," he said. "People can find a way round the law. Far better to incentivize them through added market value, or cheaper debt. ... The fact that we have a corporate governance code is a huge step."

Still, analysts concede that improvements are limited to a top tier of around 20 to 30 companies. Typically those about to issue eurobonds, IPOs or keen to make themselves attractive for a foreign investor are most interested.

For others, the arrival of an independent director with all the attendant transparency that entails is often the last thing they want.

"Many companies don't particularly like having an independent director on their board," said William Browder, the chief executive of Hermitage Capital Management. "It means a person will be asking tough questions and not necessarily be content with the status quo."

"We're still at the beginning of the road," said Filatov. "The wars for control of companies have not finished and the redistribution of property is not over. The companies that are generating cash and expanding rapidly are afraid to disclose information because of the hostile takeovers that could be possible."

Corporate governance experts believe the solution, as ever, is to improve legislation and combat a corrupt judicial system that allows abusive takeovers to flourish.

According to Yelena Krasnitskaya, corporate governance analyst at Troika Dialog, a code is not enough. What Russia still lacks is a legal definition of what an independent director is and the will to enforce it. Until the Duma passes affiliated parties legislation it has been sitting on for three years, she says, and amendments are made to the joint stock company law, only a handful of directors can be considered truly independent. "What we are really talking about when we say 'independent' is outside directors," she said.

"If we were in the West it would probably be enough to say, 'Yes, he or she is an independent, because they're not associated with the core shareholders or the management.' But in Russia that will not necessarily mean they have the full degree of independence. These will be outside directors elected with the votes of core shareholders: independent, but loyal or convenient directors."

The exceptions, according to Krasnitskaya, are the Mark Mobiuses of the Russian business world, directors whose reputations are the best guarantee of their independence.

"In the West there is significant liability for board members, which means that directors have a real incentive to operate in the shareholders' best interests," said Browder. "In Russia, the legal system is so weak that there are no consequences for bad or corrupt decisions by directors."

Compared with the United States, where such definitions were first laid down in the Securities and Exchange Legislation of 1934 and more recently in the Sarbanes-Oxley Act of 2002, Article 83 of Russia's law on joint stock companies is sadly lacking.

The only definition provided falls within the context of voting on related party transactions. "Outside of that context, say on any other issues considered by the board, I don't know what an independent director is," Krasnitskaya said.

But bad practices are by no means the preserve of marauding entrepreneurs. "The problem is particularly bad in companies with significant government ownership," said Browder. "In most cases, the government representatives on the board do not behave like owners, and end up allowing all sorts of inefficiency and corruption to occur under their watch."

Browder speaks from experience. In June, Vadim Kleiner, an independent director representing Hermitage Capital Management on the board of state savings bank Sberbank, was sued for defamation when he went public with a critical report on the bank's business practices.

Pavel Oliyanchuk, deputy director of the Russian Institute of Directors, the administrative arm of the National Council for Corporate Governance, said the difference is often in the role directors are expected to perform.

And while a handful of businesses may behave like true public companies, it could be some years yet before Weinberg's philosophy of civic responsibility finds broader application in the country.

"[In the West] members of the board of directors are perceived not as hired executives but as creative participants in the process. It is still too early to draw such conclusions in Russia," Oliyanchuk said.