HERMITAGE CAPITAL MANAGEMENT The Role of the Board of Directors in Promoting Corporate Governance by William F. Browder Managing Director, Hermitage Capital Management June 19-20, 2001 OECD: the 4th meeting of the Russian Corporate Governance Roundtable

HERMITAGE CAPITAL MANAGEMENT Overview of Presentation u In Theory, the Board of Directors has many powers to protect shareholders; u In practice, there are many ways for corporate governance abusers to get around the power of the Board of Directors; u Hermitage Capital suggestions of legal reform to improve corporate governance and effectiveness of Board of Directors.

HERMITAGE CAPITAL MANAGEMENT Power of the Board of Directors is Impressive in Theory u Rules to protect shareholders against interested party transactions; u Rules (in some companies) to require unanimous decisions on certain issues; u Rules to restrict the ability of management to do certain things without Board of Directors approval; u Rules to allow Board of Directors to investigate and gather information on any aspect of the business.

HERMITAGE CAPITAL MANAGEMENT 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

HERMITAGE CAPITAL MANAGEMENT Example: Volzhanka Conflict - Baring Vostok vs. minority shareholders Interested Party Transactions

HERMITAGE CAPITAL MANAGEMENT Purchasing New structure is $1.3 mln more expensive than old structure* Example: Volzhanka Conflict - Baring Vostok vs. minority shareholders Interested Party Transactions * HCML estimate

HERMITAGE CAPITAL MANAGEMENT Interested Party Transactions Example: Volzhanka Conflict - Baring Vostok vs. minority shareholders Old Board of Directors New Board of Directors (before May 31, 2001) (after May 31, 2001)

HERMITAGE CAPITAL MANAGEMENT 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

HERMITAGE CAPITAL MANAGEMENT Source: Sberbank prospectus. Example: Sberbank - new share issue Unanimity of the Board of Directors

HERMITAGE CAPITAL MANAGEMENT Source: Central Bank web-site. Example: Sberbank - new share issue Unanimity of the Board of Directors

HERMITAGE CAPITAL MANAGEMENT Source: Sberbank quarter reports. Example: Sberbank - new share issue Elected with the support of investors Voted together with management received special permission from Central Bank for offshore registration of Sberbank shares; received special allocation in new share issue. Unanimity of the Board of Directors

HERMITAGE CAPITAL MANAGEMENT Restrictions 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.

HERMITAGE CAPITAL MANAGEMENT Restrictions on Sales of Assets Example: Gazprom * Based on HCML estimates of comparable market value.

HERMITAGE CAPITAL MANAGEMENT Restrictions on Sales of Assets 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.

HERMITAGE CAPITAL MANAGEMENT Restrictions on Sales of Assets Example: Gazprom Did this violate the Board resolution? - No. Did this violate the spirit of the Board resolution? - Yes.

HERMITAGE CAPITAL MANAGEMENT Information on Transactions Theory: Board of Directors’ regulations insure proper access of Board to all information about the companies activity.

HERMITAGE CAPITAL MANAGEMENT Information on Transactions Example: UES purchase of REN-TV Unknown date of purchase of REN-TV

HERMITAGE CAPITAL MANAGEMENT Information on Transactions Example: UES purchase of REN-TV Unknown date of purchase of REN-TV In 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.

HERMITAGE CAPITAL MANAGEMENT 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.

HERMITAGE CAPITAL MANAGEMENT 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 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.