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Russia has emerged from the ruins of financial default in 1998 to become, in 2001, the second fastest growing economy in the world and the stock market with the largest gains for the year. Investment, very tentatively, is beginning to revive among Russian and foreign investors. A number of recent reforms in Russian corporate and securities laws, regulations, and practices are contributing to this revival, including an innovative Code of Corporate Conduct (CCC) prepared under the direction of the Federal Commission for the Securities Market (FCSM) of the Russian Federation, which articulates "best practice" standards for Russian joint stock companies. These reforms must overcome widespread corporate governance abuses of recent years, which remain all too prevalent.
To evaluate these recent reforms, it is necessary to understand the abusive corporate governance practices that grew out of the privatization of state-owned enterprises in Russia and the transition to a market economy.
Corporate Governance Problems
The problems of corporate governance in Russia are widely known. They can be reduced to a simple malevolence: Powerful controlling shareholders and entrenched management denying minority shareholders the ability to realize the value of their investments and participate in the affairs of the company in a meaningful manner. This malevolence has taken several forms, most notably, share dilution, asset stripping, corporate graft, and thuggery.
Whatever the form, the results are more or less the same: Unaccountable controlling shareholders and management reaping the benefits of a company's business and assets for themselves rather than for its shareholders. Direct tactics to achieve this sordid goal have included driving shareholders out of the company by refusing to recognize their ownership interests on the company's share registry or, in even more extreme cases, deleting their names from the registry altogether. Other tactics have included holding meetings in remote locations at inconvenient times without proper notice. Only slightly more subtle have been the innumerable instances of share dilution whereby management dramatically dilutes the company's shareholders by issuing new shares to entities affiliated or controlled by management.
Asset stripping has taken several forms. Most common is the transfer of key corporate assets at less than fair value to entities affiliated or controlled by management. Such transactions have often been "subdivided" to avoid requirements for shareholder approval of major transactions. More sophisticated variants of asset stripping include: (1) the development of sophisticated offshore tax structures that enable management, by manipulating transfer pricing among "related entities, to drain assets from a company, and (2) increasing the assets in offshore entities in which such shareholders do not participate. Throughout most of the 1990s, this was the method used in the aluminum industry by corrupt foreigners and their Russian allies to manipulate tolling arrangements to ensure that millions of dollars in value were siphoned offshore.
Asset stripping and corporate graft have gone hand in hand. "Interested party transactions" is the term of art for conflicts of interest in Russian company law. Examples abound of Russian managers seizing corporate opportunities for their own benefit, often using companies related to them to provide services or products to the company on terms unfavorable to the company, or simply engaging in a straightforward theft of corporate assets.
The formalism of Russian laws, the legal system, the limited enforcement powers of the securities regulators, and the lack of effective enforcement of such laws and regulations have aided corrupt Russian managers in their onslaught against shareholders. The lack of laws, despite the frequency of this criticism of the Russian legal system, is not, however, the leading cause of Russia's substantial problems of corporate governance practice. There are gaps in substance to be sure, such as the lack of insider trading regulations and the shortcomings of sanctions, such as minor fines for …