HERMITAGE CAPITAL MANAGEMENT The Role of the Board of Directors in Promoting Corporate Governance by William F. Browder Managing Director, Hermitage Capital

HERMITAGE CAPITAL MANAGEMENT

The Role of the Board of Directors in Promoting Corporate Governance

by William F. BrowderManaging Director,

Hermitage Capital Management

June 19-20, 2001

OECD: the 4th meeting of the Russian Corporate Governance Roundtable

HERMITAGE CAPITAL MANAGEMENTOverview of Presentation

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

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.


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.

(Source: Russian Company Law. Basic Legislation. Third Edition. Landwell CIS Law Firm, 2000)

Interested Party Transactions

LIST A LIST BPersons 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)

1 Participants or intermediaries in the transaction

2 Officers of the Company (or their close relatives or affiliates)

2 Persons (entities) who possess with affiliates more than 20% of participant or intermediary in the transaction

3 Entities (persons) which jointly with affiliates possess more than 20% of voting stock of the Company (or their close relatives or affiliates)

3 Officers of participant or intermediary in the transaction

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.


Example: Volzhanka Conflict - Baring Vostok vs. minority shareholders


V olzh an k a K on fi Zarya

U n ite d C o n fe c t io n e rie s B V (S la d & C o )M in oritys h areh old ers

50.3%

86.6% 85%

49.7%


Purchasing

New structure is $1.3 mln more expensive than old structure*



O ld S tru c tu re

V o lzh an ka

S u p p lie rsC o n d e n se d M ilk ;D ry M ilk ;S u ga r;C o rn S y ro p , e tc .

s upplie s$

N ew S tru c tu re

V o lzh an ka

S u p p lie rsC o n d e n se d M ilk ;D ry M ilk ;S u ga r;C o rn S y ro p , e tc .

Y u rp ro vid er

S lad & C o

af f i l iate dc o m pany

H igher prices o f inpu tsSpecial fees

s upplie s

s upplie s

$

$

* HCML estimate

HERMITAGE CAPITAL MANAGEMENTInterested Party Transactions


Old Board of Directors New Board of Directors

(before May 31, 2001) (after May 31, 2001)

Valerian Khubulava Valerian KhubulavaAndrei Terekhov Andrei TerekhovAlexei Leonov Dmitri PanovJulia Baunova Inna LebedevaAlla Dos Santos Nadya BrezhnevaVadim Kleiner Vadim KleinerKurt Butenhoff Kurt Butenhoff

Interested Parties

Independent Parties

Interested Parties

Independent Parties

Maybe independent Maybe not

Voted to approve Interested Party Transactions


Unanimity of the Board of Directors

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


Source: Sberbank prospectus.

Example: Sberbank - new share issue

-

5

10

15

20

Before new issue After new issue

Num

ber

of s

hare

s, m

illi

on

Central Bank 61.8%

26.3%to be sold

Others 4.9%

Investment companies 21.4%

Central Bank45.5%

Investment companies 15.8%

226,000individuals 11.9%

226,000individuals 8.8%

Others 3.6%

36% capital increase

14,002,000

19,000,0004,998,000 New shares were sold for approx. $173 mln



Source: Central Bank web-site.

$110 / share

$34.65/share

0

20

40

60

80

100

120

Book Value per share as of 1 Dec 2000 Proposed Issue price

USD

per

sha

re

For each new dollar raised, that will only realize $0.32 of new

market value 31.5%of Book Value




Source: Sberbank quarter reports.


15 investors 10%

Individuals 7%

Other legal entities21%

Central Bank62%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Elected with the support of investors

Voted togetherwith management

• received special permission from Central Bank for offshore registration of Sberbank shares;

• received special allocation in new share issue.


1 Victor Geraschenko Central Bank2 Vladimir Goruynov Central Bank3 Arnold Voilukov Central Bank4 Vladimir Kolbaev Central Bank5 Georgi Luntovski Central Bank6 Victor Melnikov Central Bank7 Vyacheslav Solovov Central Bank8 Alexei Kudrin Ministry of Finance9 Sergei Kolotukhin Ministry of Finance

10 Bella Zlatkis Ministry of Finance11 Sergei Ignatiev Ministry of Finance12 Andrei Kazmin Sberbank13 Alla Aleshkina Sberbank14 Alexander Soloviev Sberbank15 Mikhail Zhivilo MIKOM16 Boris Fedorov UFG17 Ilya Sherbovich UFG

Sberbank's Supervisory board

HERMITAGE CAPITAL MANAGEMENTRestrictions on Sales of Assets

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.


Example: Gazprom

G azp ro mS ib ne fte ga s

T a rk o s a le ne fte ga s

G a zp ro m s ha re s

R o s p a n

3 8 %

2 4 %

4 .8 3 %

$ 1 1 2 -$ 8 9 6 m ln

5 1 %

$ 7 8 -$ 6 2 7 m ln

$ 1 0 4 -$ 3 4 5 m ln

$ 1 9 1 -$ 8 4 6 m ln

Za p s ib ga zp ro m $ 4 3 -$ 3 2 7 m ln

1 4 %

T o ta l V a lue * : $ 2 , 3 2 8 - $ 5 , 2 4 1 m ln

G as co ntracts toITE R A $ 1 ,8 0 0 -$ 2 ,2 0 0 m ln

W o rth

* Based on HCML estimates of comparable market value.


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.


Example: Gazprom

Did this violate the Board resolution? - No.Did this violate the spirit of the Board resolution? - Yes.

G azp ro m

G azp ro m in vesth o ld in g 2 1 % o f

Y u gran eft

S ib u r E n ergyU nd is c lo s e d s u m

J u n e 15 , 2001

HERMITAGE CAPITAL MANAGEMENTInformation on Transactions

Theory:Board of Directors’ regulations insure proper access of Board to all information about the companies activity.


Example: UES purchase of REN-TVUnknown date of purchase of REN-TV

? d au gh terco m p an y X % o f

R E N -T V

? S e lle r o fR E N -T V

U nd is c lo s e d s u m

U E S S o m e tim e in y ea r 2000


Example: UES purchase of REN-TVUnknown date of purchase of REN-TVIn 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?• 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.


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.

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HERMITAGE CAPITAL MANAGEMENT The Role of the Board of Directors in Promoting Corporate Governance by William F. Browder Managing Director, Hermitage Capital