Risk & Governance Weekly

Proxy Update: E. Europe/Russia

By Aneta McCoy, International Analyst

The 2008 proxy season in Russia and Eastern Europe has been notable so far for hostile takeover activity and shareholder power struggles. A number of Eastern European countries--such as Poland and Bulgaria--have adopted new codes of corporate governance, which will take effect this year.

The Hungarian proxy season peaks in late April and early May, while annual meetings in the Czech Republic, Poland, and other Eastern European markets occur with more frequency in late April and May. The majority of Russian meetings take place in late May and early June.

Some of the most closely watched shareholder meetings--such as the annual meeting at MOL Hungarian Oil and Gas, and the special meeting at Russian mining firm MMC Norilsk Nickel--took place early in the season.

At the MOL meeting on April 23, 80 percent of investors approved a proposal submitted by OMV, an Austrian energy firm that has been trying to take over MOL since making an initial $15.7 billion bid in 2007. The resolution asked MOL to commission a special audit of management activities since 2005, including a number of share-lending agreements aimed at insulating MOL from a takeover.

When OMV increased its stake in MOL from 10 percent to 18.6 percent in June, MOL had already been building defenses against a possible hostile takeover for two years. Since December 2005, MOL has repurchased $4.8 billion in shares, as well as initiating a number of share lending agreements with companies such as Dutch banking firm ING and the Czech nuclear power company CEZ Group that were considered “friendly” to MOL’s interests. The company also adopted a 10 percent cap on voting rights. In September 2007, OMV raised its offer to around $20 billion, but MOL dismissed the offer again as not in the company’s best interests, according to the International Herald Tribune. MOL officials said a merger would destroy shareholder value, lower competition, and create a regional monopoly.

At the MOL meeting, a management-sponsored resolution for another share buyback program was opposed by approximately 20 percent of shares voted. Share repurchase programs at the company have typically not run into much opposition. A repurchase plan won 99.9 percent shareholder support in April 2007, and similar proposals in 2006 and 2005 were majority-supported, though the company did not disclose results.

The Hungarian government is under investigation by the European High Court of Justice regarding its response to OMV’s takeover bid. In October, the administration of Prime Minister Ferenc Gyurcasny adopted a law called the “Lex MOL,” which applies only to companies like energy firms that are “assets of strategic importance.” The law specifically eliminates the 10-percent voting cap on treasury shares--repurchased shares held by the company--and allows shareholders to approve a limit on the voting rights of an individual or group of shareholders if company bylaws permit it. The law also requires potential bidders to submit a business plan to Hungary’s financial market regulatory agency for approval. As soon as the law was passed, the European Commission announced it would open an investigation and would bring the case before the high court.

OMV’s bid also faces scrutiny. In March, European Union regulators voiced antitrust concerns, saying a merged company may decrease competition in Central Europe. The European Commission plans to rule on the transaction by July 22.

Contentious Russian Meetings

Before the traditional start of the Russian proxy season, private investment firm Onexim Group called an April 8 special meeting to put its own slate of nominees up for election to the board at MMC Norilsk Nickel (Norilsk). The meeting was the culmination of a dispute between its two major shareholders, former Norilsk CEO Mikhail Prokhorov and major shareholder Vladimir Potanin, who have jointly controlled the large-cap mining company since 1995.

Onexim--controlled by Prokhorov--asked Norilsk shareholders to end the terms of current directors early and to elect a new board, including Onexim’s own six nominees. The dissidents also called on shareholders to amend the company's charter to shift some of the CEO's powers to the board and increase the supermajority requirement for transactions that require board approval. Russian board elections are unique in that all are conducted by cumulative voting and often have many more candidates than there are board seats. If they had been elected, the Onexim nominees may only have served until June, though, when Norilsk holds its annual meeting. However, the dissident nominees were never voted on because the resolution to end the current board members' terms failed. The proposed charter amendments were also not approved at the April 8 meeting.

The proxy fight was precipitated by the collapse of a deal made in early 2007 for Prokhorov to step down as Norilsk’s CEO and sell his 22 percent stake to Potanin. Prokhorov did step down as CEO, but apparently had a change of heart in May 2007 about selling to Potanin. He increased his stake to more than 25 percent and formed Onexim with the intent of selling his stake to another Russian mining company, Rusal. In January, Rusal said it intended to create a “global” diversified metals and mining group, leading the Russian press to speculate that it was planning a takeover of Norilsk although Rusal has made no formal bids. Rusal already has three directors on the Norilsk board, and it supported the Onexim candidates. Through Onexim, Prokhorov sold his Norilsk equity to Rusal on April 24.

Meanwhile, Norilsk has also been approached by Russian metals industry holding company Metalloinvest and asked to consider a possible merger with its mining division, Gazmetall. Advisors from Swiss investment bank UBS are consulting with Norilsk management on the merits of the Metalloinvest offer, Russian press reports say. A Rusal takeover is not out of the question, either, as it now holds Onexim's former stake in Norilsk.

Since Russian companies are required to announce the names of board nominees within 30 days of the end of the fiscal year--Jan. 30 in this case--board nominees supporting Prokhorov, and those supporting Potanin, will both be up for election in June. The outcome of this election, as well as Onexim’s sale to Rusal, will affect any future buyout agreements.

The Prokhorov-Potanin dispute extended to another Russian metals company, Polyus Gold, early this season. CJSC Interros Holding, a private investment firm founded by Vladimir Potanin and run by Polyus board member Sergey Batekhin--called a special meeting at Polyus, which was held April 7. Much as was the case at Norilsk, Interros--which holds about 22 percent of Polyus--wanted to remove the current board and put forward ten candidates, including Batekhin, for election. Nine other candidates were proposed by Prokhorov’s Onexim. Interros also proposed a charter amendment similar to the one voted at Norilsk, which would have raised the number of directors required to approve certain transactions.

Interros said it was “deeply disappointed” with Polyus’ underperformance and its failure to capitalize on the rising price of gold. Batekhin also said he was concerned with the board’s lack of independent oversight, especially with regard to attempts by Polyus management to spin off some of the company’s assets into an offshore, non-Russian incorporated company called Polyus Exploration without board or shareholder approval. Batekhin claims that the Polyus assets in the new company would be significantly diluted by a planned share offering when the proposed spin-off is complete.

The resolution to remove the board did not pass, according to company filings. Interros’ proposed charter amendments received the support of 58 percent of shares voted, but failed to meet the vote requirement of 75 percent of shares in attendance to change the charter. The dispute at Polyus likely will continue through its annual meeting in June.

A shareholder conflict will also feature prominently when Russia’s second-largest telecommunications firm, Vimpel Communications (VimpelCom), holds its annual meeting on June 9. The company’s two largest shareholders, the Russian private industrial conglomerate Alfa Group and Norwegian communication firm Telenor, have disagreed for several years over VimpelCom’s strategy for expanding into the Ukrainian market.

Representatives from both shareholders serve on the board, and since Russian board elections feature cumulative voting, Telenor-affiliated directors will be vying for seats with Alfa Group-affiliated directors on June 9. Elections at VimpelCom have been contested since 2005, and company bylaws require that both shareholders nominate four candidates each, including one independent director. Telenor has the option of nominating an additional independent director, but the nomination must be approved by Alfa.

The results may help determine the outcome of a legal battle over potential acquisitions since 2005. Alfa and Telenor have filed lawsuits against one another over VimpelCom’s acquisition of Ukrainian Radio Systems and the 2006 failed bid for another Ukrainian company, mobile phone operator Kyvistar. Most recently, Alfa brought suit against Telenor in March for loss of profit, while at about the same time a district judge in New York upheld some of Telenor’s complaints against Alfa.

New Governance Codes in Hungary, Poland, and Bulgaria

A major development in the Hungarian market this year is the implementation of a new corporate governance code. The Hungarian Corporate Governance Recommendations went into effect in August 2007, replacing a code adopted in 2002. The new code was developed by the Budapest Stock Exchange (BSE), and is voluntary, meaning Hungarian public firms must comply with the recommendations or explain why they choose not to. However, companies listed on the BSE are required by law to report this year on how they applied the code in fiscal 2007, and the report must be ratified by shareholders. No compliance report received significant opposition this year.

The new code recommends that public company boards be “sufficiently” independent--with the majority of key committees such as audit and remuneration committees composed of directors that “have no significant relationship with the company, its executive management, or key shareholders.” However, it is unclear what percentage of Hungarian directors meet the code’s definition of independence.

Poland also adopted a new corporate governance code, which went into force on Jan. 1. The code, entitled “Best Practices of WSE (Warsaw Stock Exchange)-Listed Companies,” replaced a 2005 governance code. Like the Hungarian code, it is based on the “comply or explain” principle, and companies listed on the WSE must provide an annual compliance report to the exchange. Polish firms are also required to post those reports on their company Web sites and attach them to annual reports. However, putting compliance reports up for shareholder ratification is voluntary.

Many of the new code provisions deal with information transmission. One section stipulates that annual meetings be broadcast over the Internet, and stored as audio files on the corporate Web site. Corporate Web sites should also be maintained in both Polish and English.

The code recommends auditor rotation every seven years. Poland has a two-tier board system, and the code stipulates that at least two members of the supervisory board be without significant ties to management or major shareholders. In addition, at least one audit committee member should be independent and possess expertise in finance. As in Hungary, it is difficult to tell how many directors are independent by the code’s standards.

In October 2007, Bulgaria released its National Corporate Governance Code, the country’s first comprehensive set of corporate governance principles. The code is designed to attract foreign investment, and to move Bulgaria closer to international standards since its acceptance into the European Union in January 2007. The principles in the code are based on those put forward by the Organization for Economic Cooperation and Development. Like the Hungarian and Polish codes, all provisions are “comply or explain,” but companies are not required to submit compliance reports for shareholder approval.

Bulgaria goes further than Poland on board independence, urging an entirely independent audit committee. Companies are also asked to allow online proxy voting and to guarantee comprehensive and timely disclosure--especially of measures voted on at annual meetings. To ensure that the code remains current, the Sofia Stock Exchange plans to review it every 18 months.