Shareholders At The Gate In Russia

Russian "red directors" dig in their heels as outside investors try to oust them

They sure don't know how to treat stockholders at Novolipetsk Metal Co. When Cambridge Capital Management, an investment fund that owns 17% of the steelmaker, sent two representatives down by overnight train from Moscow in late January with the fund's nominations for the board of directors, they were turned away--despite their appointment. The next day, Cambridge sent four more people to the plant, including two lawyers. Novolipetsk employees locked them out of a clerk's office, and a security guard hustled them off the premises. The lawyers managed to slip the list of Cambridge's board nominations under the clerk's door. But Novolipetsk management now claims that Cambridge missed the Jan. 30 deadline. Cambridge and two other important investors who were denied board seats are taking the steel company to court.

Novolipetsk's burst of hostility may be extreme, but its contempt for shareholder rights is hardly unique in Russia. As domestic and foreign investors beef up their rather impressive stakes in Russia's 18,000 privatized enterprises, the battle for corporate control is growing fiercer. From Moscow to Vladivostok, the Soviet-era "red directors" trying to cling to their remaining power are increasingly up against outside shareholders who want to exercise their privileges. Says Dmitri Vasilyev, chairman of Russia's Federal Commission on Securities Markets: "We are now at the peak of the struggle between insiders and outsiders."

FOREIGN PORTFOLIOS. Shareholder rights are crucial to Russia's economic future. Russian industry desperately needs the capital and management skill of outside investors if it is to restructure and compete successfully in a global market. Foreign portfolio investors, who have pumped $2.8 billion into Russian blue chip stocks over the past six months, rarely take an active role in management. But stocks are growing more expensive. And as a result, many foreign fund managers are now putting their money into direct investment funds, which typically seek management control. Says Joseph R. Blasi, a management professor at Rutgers University and author of Kremlin Capitalism: Privatizing the Russian Economy: "If the Russian Securities Commission can get the support it needs to make further progress in shareholder rights, it will be the difference between $10 billion and $100 billion in foreign investment over the next five years."

Fully aware of the billions at stake, Russia's new reform government has made better corporate governance a priority. Foreign investors were concerned in March when blue-chip utility Mosenergo announced its plans to put a 1% limit on shareholders' voting rights, issue 800 million new shares, and restrict board membership. The proposals came at the initiative of Unified Energy System, the Russian energy monopoly that holds a 49% stake in Mosenergo. But on Apr. 17, four days before the annual shareholders' meeting, the reformers pressured UES to withdraw the measures before shareholders could vote on them. And the European Bank for Reconstruction & Development threatened to halt consideration of a $100 million loan to Mosenergo unless the proposals were dropped.

The insiders are fighting back with every tool at their disposal. Most Russian enterprises are still run by red directors--former Communists who stack their boards with old-regime subordinates or cronies, bully workers into selling their shares back to management, and deny outside shareholders access to their books, boardrooms, and shop floors. Many consolidate control of their companies by issuing large blocks of new shares to company insiders, often at bargain-basement prices.

Take the Lebedinsky Mining & Processing Plant, located on one of Europe's largest ore deposits, near the Russian-Ukrainian border. Six clients of Rossisky Kredit, a Moscow bank, acquired 30% of the company's shares during privatization. After a series of quarrels, Lebedinsky managers barred Rossisky Kredit from the annual shareholders' meeting last spring. While the bank's representatives cooled their heels outside, the company's board approved a share issue that cut the bank clients' stake from 30% to 5%. Since then, Lebedinsky managers have ignored an arbitration-court ruling that the issue was illegal. They also barred the bank from submitting its own board slate at this year's annual meeting on Apr. 3.

Newspaper editors are fighting just as hard as red directors to stay in power. After the giant oil company LUKoil tried to gain control of the influential daily Izvestia, in which it holds at least 41% of the shares, the editors went on the hunt for more cooperative outside investors. Oneximbank and Sidanko, an oil company controlled by Oneximbank, accepted the role of white knight and snapped up a big stake. Izvestia's editors say that they and their allies now own more than 51% of the shares. They plan to push through a new bylaw guaranteeing that the paper's editors will always own a blocking stake and control editorial policy.

INSIDERS. Ironically, minority shareholders have more legal rights in Russia than they do in many developed markets. When the privatization process was launched in the early 1990s, the government decided to placate factory bosses by giving employees big blocks of shares in their own companies. As a counterbalance to insider control, it passed a law that shareholders are entitled to seats on a company's board in direct proportion to their share holdings. In contrast, most of the corporate boards in the U.S. are elected in slates. The winning slate gets 51% of board seats, while losers get no representation. Despite the law, few outside investors in Russian companies have seats equal to their shareholdings. Of 400 Russian companies studied by Rutgers' Blasi, 60% of them say they do not comply with the cumulative voting law.

Protecting sweetheart financial deals is behind much of the hostility to outside investors. Virtually every Russian enterprise, big or small, is surrounded by "independent" companies set up by managers or their families. In many cases, sales and purchasing contracts are structured to go through these firms, raking off profits from the main enterprise. That explains why the fiercest battles for shareholder power are at companies with the biggest cash flows, such as aluminum and steel outfits like Novolipetsk and Lebedinsky. Says Andrei Volgin, president of Moscow investment bank Adamant Financial Corp. and head of the Moscow Shareholder Rights Committee: "Managers of companies with large export revenues are still very hostile, because management has a lot to lose."

Outside investors have had some successes. Adamant has won four hostile takeovers by forcing the managers to recognize their legal right to board seats. And since President Boris N. Yeltsin signed a securities law enshrining shareholder rights late last year, courts are under increasing pressure to rule in favor of investors. On May 8, Novolipetsk managers lost the first of several suits brought against the company by aggrieved shareholders. If the government keeps up the pressure on red directors, investors may not have to deal with their ugly tactics much longer.

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