43182 v2 Good corporate governance contributes to a company's competitiveness and reputation, facilitatesaccesstocapitalmarkets,andthushelpsdevelopfinancialmarketsandspureconom- ic growth. With this in mind, the International Finance Corporation and the U.S. Department of Commerce have combined their efforts to provide Russian managers, directors, and share- holders with a practical tool to implement good corporate governance practices ­ the Russia Corporate Governance Manual. This Manual refers to and is based on the principal laws and The Russia regulations that apply to open joint stock companies. It follows the recommendations of the FCSM's Code of Corporate Conduct and refers to internationally accepted principles of good corporate governance. Corporate "Corporate governance is vital to the interests of every economy, and government has a role toplayinestablishingtheframeworkforreform-butitiscompaniesthathavethetoughjob ofputtinggovernancereformintopractice. ThisiswheretheCorporateGovernanceManual Governance can provide excellent help. It offers a comprehensive workbook for company directors, offic- ers, and advisers in taking up the challenge of corporate governance improvement. Share- holders and stakeholders alike should applaud IFC for bringing practical, and professional advicewithinreachofeveryboardroom." Anne Simpson, Manager, Manual Global Corporate Governance Forum "Corporate governance reform in Russia is the continuation of the more general processes of changeaffectingthecountryasawhole. Takentogether,thesedevelopmentshavecreateda newenvironment,newrulesregulatingtherelationshipsbetweenthemarketandregulators, between shareholders, shareholders and managers, etc. In the business community there is agrowingawarenessofthebenefitsofcorporategovernancereform,andcompaniesarenow workingonimprovingthequalityoftheircorporategovernance..." II Par t II Good Board Prac tices Ruben K. Vardanian, President of Troika Dialogue; Chairman of the Board, OJSC Rosgosstrakh; and Chairman of the RSPP Corporate Governance Committee "Good corporate governance is a key driver of financial transparency and managerial ac- countability, essential ingredients for national prosperity in a global economy. We con- gratulate the U.S. Department of Commerce and the International Financial Corporation of the World Bank for their initiative in bringing about the publication of the Russia Corporate GovernanceManual." Andrew B. Somers, President, American Chamber of Commerce in Russia Questions on corporate governance An electronic version of the Manual PreparedandPublishedbytheInternationalFinanceCorporation should be addressed to the is available on the website of the and theU.S.DepartmentofCommerce IFC Russia Corporate Governance Project, via International Finance Corporation under CGPRussia@ifc.org www.ifc.org/rcgp InPartnershipwiththeAgencyforInternationalBusiness and the andCooperationoftheDutchMinistryofEconomicAffairs U.S. Department of Commerce under andtheSwissStateSecretariatforEconomicAffairs www.mac.doc.gov/ggp The Russia Corporate Governance Manual Part II Good Board Practices Prepared and Published by the International Finance Corporation and the U.S. Department of Commerce In Partnership with the Agency for International Business and Cooperation of the Dutch Ministry of Economic Affairs and the Swiss State Secretariat for Economic Affairs Part_II_Ch-04-06.indd i Part_II_Ch-04-06.indd 17.09.2004 11:32:45 17.09.2004 11:32:45 First edition: 10,000 copies in Russian, 1,500 copies in English. Published in 6 Parts Printed in Moscow, Russia. ISBN 5-9614-0085-9 Copyright © 2004 International Finance Corporation 2121 Pennsylvania Ave. NW, Washington, DC 20433, United States of America A Member of the World Bank Group Design copyright © 2004 Alpina Business Books All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, for commercial purposes without the prior permission of the International Finance Corporation. Part_II_Ch-04-06.indd ii Part_II_Ch-04-06.indd ii 17.09.2004 11:33:07 17.09.2004 11:33:07 ChapterChapter 4 The Supervisory Board Part_II_Ch-04-06.indd 1 Part_II_Ch-04-06.indd 17.09.2004 11:33:07 17.09.2004 11:33:07 Table of Contents A. THE SUPERVISORY BOARD'S AUTHORITY .....................................................10 1. When to Establish a Supervisory Board ...............................................10 2. An Overview of the Supervisory Board's Authority ..............................11 3. The Supervisory Board's Authority in Relation to Strategic Oversight and Control............................................................................12 4. The Supervisory Board's Authority in Relation to Shareholder Rights.....................................................................................................19 5. The Supervisory Board's Authority in Relation to Assets and the Charter Capital..........................................................................21 6. The Supervisory Board's Authority in Relation to Control, Disclosure, and Transparency................................................................22 B. THE ELECTION AND DISMISSAL OF DIRECTORS ............................................23 1. The Election and Term of Directors ......................................................23 2. The Nomination of Candidates for the Supervisory Board...................24 3. Information About Supervisory Board Nominees..................................25 4. The Election of Directors.......................................................................26 5. The Election of Directors When Lacking a Quorum...............................................................................................29 6. The Dismissal of Directors ....................................................................29 C. THE COMPOSITION OF THE SUPERVISORY BOARD ........................................30 1. The Number of Directors.......................................................................30 2. Who Can Be a Director..........................................................................31 3. Qualifications of Directors .....................................................................32 4. Categories of Directors..........................................................................34 Part_II_Ch-04-06.indd 2 Part_II_Ch-04-06.indd 17.09.2004 11:33:08 17.09.2004 11:33:08 D. THE STRUCTURE AND COMMITTEES OF THE SUPERVISORY BOARD ..............42 1. Chairman................................................................................................42 2. Supervisory Board Committees.............................................................44 3. The Chairman of a Supervisory Board Committee ...............................49 E. THE WORKING PROCEDURES OF THE SUPERVISORY BOARD.........................50 1. The Chairman and Supervisory Board Meetings ..................................50 2. Supervisory Board Meetings .................................................................51 3. The First Supervisory Board Meeting....................................................51 4. The Schedule of Supervisory Board Meetings......................................52 5. Who Has the Right to Convene a Supervisory Board Meeting ............53 6. Proper Notice for Supervisory Board Meetings....................................54 7. The Quorum for Supervisory Board Meetings ......................................54 8. How Directors Can Participate in Supervisory Board Meetings...........55 9. The Consideration of Written Opinions (Absentee Ballots) ..................56 10. Supervisory Board Decisions.................................................................57 11. The Minutes of Supervisory Board Meetings........................................58 12. The Corporate Secretary and Supervisory Board Meetings..................59 F. THE DUTIES AND LIABILITIES OF DIRECTORS................................................60 1. The Duty of Care ...................................................................................61 2. The Duty of Loyalty ...............................................................................61 3. Director Access to Information .............................................................65 4. Liabilities of Directors............................................................................65 5. When Directors Are Relieved from Liability..........................................66 6. Who Can File a Claim Against Directors...............................................67 7. The Minutes of Supervisory Board Meetings and Director Liability .......67 8. Protection from Liability for Directors ..................................................67 Part_II_Ch-04-06.indd 3 Part_II_Ch-04-06.indd 17.09.2004 11:33:08 17.09.2004 11:33:08 G. EVALUATION AND EDUCATION OF THE SUPERVISORY BOARD AND DIRECTORS ........................................................................... 68 1. Self-Evaluation by the Supervisory Board.............................................69 2. Education and Training ..........................................................................69 H. THE REMUNERATION OF DIRECTORS.............................................................70 I. SUMMARY CHECKLIST TO DETERMINE THE SUPERVISORY BOARD'S EFFECTIVENESS .............................................................................................73 Part_II_Ch-04-06.indd 4 Part_II_Ch-04-06.indd 17.09.2004 11:33:08 17.09.2004 11:33:08 The Chairman's Checklist The Supervisory Board's authority: Is the Supervisory Board's focus on protecting the interests of the company and its shareholders? Do all Supervisory Board members understand the role and priorities of the Supervisory Board? Does the Supervisory Board have sufficient powers according to the charter to fulfill its oversight duties? Have these authorities been properly communicated? Does the Supervi- sory Board use its powers in practice? What is the Supervisory Board's role with respect to the company's govern- ance, organization of the General Meeting of Shareholders, protection of company assets, resolution of conflicts, and supervision of internal controls and risk management? How effective is the Board in guiding and setting strategy? Does the Supervisory Board have the tools to properly oversee the operational and financial performance of the company? Is a succession plan in place, in particular for the General Director? Is the Supervisory Board's authority distinct from management's, both on paper and in practice? The Supervisory Board's election: Who nominates candidates to the Supervisory Board? Is sufficient informa- tion provided to shareholders on nominees? How does the Supervisory Board influence the nomination process? Does the Supervisory Board ensure that all shareholders understand how cumulative voting works? The Supervisory Board's composition: Has the Supervisory Board designed, articulated, and implemented policies relating to its size, composition and mix-of-skills, breadth of experience, and other pertinent qualities? Is the Supervisory Board's composition, considering its competencies and mix-of-skills, suited to its oversight duties and the development of its strategy? How effectively does the Supervisory Board work as a team? 5 Part_II_Ch-04-06.indd 5 Part_II_Ch-04-06.indd 17.09.2004 11:33:08 17.09.2004 11:33:08 The Russia Corporate Governance Manual Does the company have independent directors? Is the Supervisory Board constituted of a majority (in the case of companies with an Executive Board, a /4-majority) of non-executive directors? 3 How effective is the Supervisory Board's leadership, both at the Board and committee level? Is the number of directors consistent with the needs of the company? Does the company have enough directors to establish Supervisory Board com- mittees? The Supervisory Board's structure and committees: Does the Supervisory Board have Audit, Nominations and/or Remuneration committees? What are the costs and benefits of these or other committees? Are there sufficient independent (or non-executive) directors to chair and sit on these committees? Do Supervisory Board committees have sufficient resources, both human and financial, to properly fulfill their functions? How well informed are non-committee members about the committee's deliberations? Is the information prepared by the committee for the Super- visory Board adequate for effective decision-making? Do Audit Committee members have sufficient expertise on financial issues? Do they have access to information from the Revision Commission, the External Auditor, the Internal Audit Function, and the executive bodies on the financial and economic activities of the company? The Supervisory Board's working procedures: Has the Supervisory Board identified, prioritized, and scheduled key issues that should be reviewed on a regular basis? Has the Board identified the information it requires to properly analyze these key issues? Does the Chairman take an active role in organizing the work of the Super- visory Board? Does the Supervisory Board meet regularly in accordance with a fixed schedule? Does the Chairman encourage a free and open exchange of views? Are procedures in place that ensure the proper preparation and conducting of Supervisory Board meetings, e.g. advance notification on agenda issues, distribution of materials and documents, proper determination of the quorum, voting through absentee ballots, and preparation of the minutes? How ef- ficient are Supervisory Board meetings in practice? 6 Part_II_Ch-04-06.indd 6 Part_II_Ch-04-06.indd 17.09.2004 11:33:08 17.09.2004 11:33:08 Chapter 4. The Supervisory Board Is the information provided to directors focused, succinct, and to the point, allowing for effective decision-making? Are key issues and risks high- lighted? Do the materials contain annexes with further relevant details? How does the Supervisory Board ensure that it properly oversees the exe- cutive bodies? Does it receive periodic reports and updates from the exe- cutive bodies? Does the Supervisory Board invite members of the executive bodies to Board meetings to inform its members on key issues? How well does the Supervisory Board interact with senior management, including the General Director? Does the Board provide wise counsel and clear direction? Does it challenge management sufficiently? How does it balance oversight against micro-management? The Supervisory Board's duties and liabilities: Do all Supervisory Board members understand their duty to act reason- ably and in good faith in the best interests of the company and its share- holders? Do directors properly prepare themselves for Board meetings? Does the Supervisory Board give proper consideration to the interests of other stakeholders? Does the company have contracts with directors? Do such contracts describe their duties and liabilities? Are directors indemnified? The Supervisory Board's self-evaluation and training: Does the Supervisory Board conduct annual self-evaluations? Has the Board developed performance indicators or benchmarks for its work? Is this process credible and are the results made available to share- holders? Does the Supervisory Board conduct regular training events on corporate governance and other issues? Do all directors attend training sessions? Does the company hold an induction training for new directors to acquaint them with the company's strategy and operations? The Supervisory Board's remuneration: Is the remuneration of directors competitive? Are all directors paid the same amount? Is the remuneration structured in a manner that provides incentives to take on additional responsibilities, for example, the chairman- ship of a committee? 7 Part_II_Ch-04-06.indd 7 Part_II_Ch-04-06.indd 17.09.2004 11:33:08 17.09.2004 11:33:08 The Russia Corporate Governance Manual Does the remuneration package jeopardize a director's independence? Does the total remuneration package constitute a significant portion of a director's total annual income? Does the Supervisory Board and its Nominations and Remuneration Com- mittee periodically review the remuneration paid to directors? Is the remu- neration of directors disclosed on an individual basis? Does the company have a policy in place that prohibits personal loans or credits to its directors? Are executive and non-executive directors compensated in the same man- ner? Does the company have a policy on (not) remunerating executive directors for their service on the Supervisory Board beyond their executive remuneration package? An effective, professional, and independent Supervisory Board is essential for good corporate governance.1 The Supervisory Board acts in the best interests of the company and its shareholders. It sets the strategy of the company, protects shareholder rights, and oversees the executive bodies and financial operations of the company.2 While the Supervisory Board cannot substitute for talented professional man- agers, or change the economic environment in which a company operates, it can influence the performance of the company through its strategic oversight and control over management. Supervisory Board activities may go entirely unnoticed when an economy is strong, share prices are rising, and everything appears to be going well. On the other hand, when things go badly, the Supervisory Board becomes the center of attention and the importance of the Supervisory Board becomes clear. 1 The Supervisory Board in a two-tiered board system corresponds to a Board of Directors in a unitary board system. Although the Company Law in Russia allows both unitary and two- tiered board systems to exist, in addition to a hybrid model, it functionally does not distinguish between the Supervisory Board and the Board of Directors. Throughout this Manual, the term «Supervisory Board» is used. See Part I, Chapter 2, Section B.2 for a more detailed discussion on different Board models. 2 Federal Commission for the Securities Market's Code of Corporate Conduct (FCSM Code), Chapter 3. 8 Part_II_Ch-04-06.indd 8 Part_II_Ch-04-06.indd 17.09.2004 11:33:08 17.09.2004 11:33:08 Chapter 4. The Supervisory Board Mini-Case: Certainly, the catastrophic collapse of Enron in the U.S. served to focus public and government attention on boards and corporate governance. The following illustration shows some of the shortcomings of the Enron Board that contributed to the company's downfall, the loss of many thousands of jobs and pensions, and ultimately a loss in faith in U.S. financial markets. On 7 May 2002, the U.S. Senate concluded the following with respect to the role of the Board in Enron's collapse and bankruptcy:3 · Fiduciary Failure: The Enron Board failed to safeguard Enron shareholders and contributed to the collapse of the seventh largest public company in the U.S. · Lack of Independence: Financial ties between the company and certain Board members compromised the independence of the Enron Board. · Conflicts of Interests: Despite clear conflicts of interests, the Enron Board approved an unprecedented arrangement allowing Enron's Chief Financial Officer to establish and operate private equity funds that transacted busi- ness with Enron and profited at Enron's expense. · Excessive Compensation: The Enron Board approved excessive compen- sation for company executives, failed to monitor the cumulative cash drain caused by Enron's FY 2000 annual bonus and performance unit plans, and failed to monitor or halt a company-financed, multi-million dollar, personal credit line. · High-Risk Accounting: The Enron Board knowingly allowed Enron to engage in high risk accounting practices. · Extensive Undisclosed Off-the-Book Activity: The Enron Board know- ingly allowed Enron to conduct billions of dollars in off-the-book activity to make its financial condition appear better than it was, and failed to ensure adequate public disclosure of material off-the-books liabilities that contributed to Enron's collapse. The legal regime of the Supervisory Board is characterized by mandatory re- quirements, but is also accompanied by a degree of flexibility enabling companies to tailor their internal organization to their own needs and circumstances. 3107th Congress, 2nd Session, Report by the Permanent Subcommittee on Investigations, The Role of the Board of Directors in Enron's Collapse, 8 July 2002. See also: http://www.senate.gov/~gov_affairs/070902enronboardreport.pdf. 9 Part_II_Ch-04-06.indd 9 Part_II_Ch-04-06.indd 17.09.2004 11:33:09 17.09.2004 11:33:09 The Russia Corporate Governance Manual This chapter describes the authority, election and dismissal, composition, structure, working procedures, duties and liabilities, evaluation, and remuneration of the Supervisory Board. It also discusses corporate governance principles and standards found in the Federal Commission for the Securities Market's Code of Corporate Conduct (FCSM Code), and other best practices. A. The Supervisory Board's Authority 1. When to Establish a Supervisory Board A company with 50 or more shareholders with voting right must establish a Super- visory Board.4 Companies with fewer than 50 shareholders with voting rights may choose not to establish a Supervisory Board. Best Practices: Supervisory Boards can add value even to companies with fewer than 50 shareholders, specifically when they take on an advisory function. Such supervisory bodies are often referred to as "Advisory Boards" and can provide outside expertise and guidance to the company's General Director and managers. If a company with fewer than 50 shareholders with voting rights decides not to have a Supervisory Board, then:5 · The charter must identify a person or body to organize the General Meeting of Shareholders (GMS) and approve the agenda of the GMS; and · The GMS has the authority to make decisions on all other matters that fall under the Supervisory Board's authority. A company that wishes to establish a Supervisory Board will want to take the following steps illustrated in Figure 1: 4 Law on Joint Stock Companies (LJSC), Article 64, Clause 1. 5 LJSC, Article 64, Clause 1, Paragraph 2. 10 Part_II_Ch-04-06.indd 10 Part_II_Ch-04-06.indd 10 17.09.2004 11:33:09 17.09.2004 11:33:09 Chapter 4. The Supervisory Board Figure 1: Five Steps in Developing a Supervisory Board Step 5 Develop an orientation training program for new directors. Identify key performance indicators and corresponding materials to be made available during meetings. Step 4 Develop a plan to find and hire directors, possibly using specialized consultancies and/or institutes. Step 3 Identify competencies and mix-of-skills required for the Supervisory Board's composition and develop corresponding profiles for directors (e.g. indus- try experience, integrity, financial literacy, etc.). Step 2 Decide on the Supervisory Board's authorities, structure (committees), and size (total number directors). Step 1 Establish the Supervisory Board's purpose, goal, objectives, and operating activities (e.g. meet- ing schedule, time and place). Source: IFC, March 2004 2. An Overview of the Supervisory Board's Authority The Company Law defines the Supervisory Board's authority.6 The Supervisory Board is responsible for setting the company's strategy and business priorities, as well as guiding and controlling managerial performance, and for making decisions on matters that do not fall under the GMS authority. In essence, the role of the Supervisory Board is to direct and not to manage. In some cases, the charter may delegate certain GMS powers to the Supervisory Board. The charter can assign additional powers to the Supervisory Board as well.7 Best Practices: When additional powers and authorities are granted to the Super- visory Board in the charter, these should correspond with the typical functions of the Supervisory Board to avoid ambiguity with respect to the division of powers between the GMS, Supervisory Board, General Director, and/or Executive Board.8 Matters under the Supervisory Board's authority cannot be delegated to the General Director or the Executive Board.9 6 LJSC, Article 65. 7 LJSC, Article 65, Clause 1, Paragraph 2, Section 18. 8 FCSM Code, Chapter 3, Section 1.5. 9 LJSC, Article 65, Clause 2. 11 Part_II_Ch-04-06.indd 11 Part_II_Ch-04-06.indd 11 17.09.2004 11:33:09 17.09.2004 11:33:09 The Russia Corporate Governance Manual As illustrated in Figure 2, the Supervisory Board has the authority to make decisions in the following areas: · Thestrategicoversightandcontrolovermanagement,aswellastheelection(when providedbythecharter)andoversightoftheGeneralDirectorandExecutiveBoard; · The organization of the GMS; · The charter capital and assets of the company; · Disclosure and transparency; and · Other areas determined by the Company Law and charter. Figure 2: Supervisory Board's Authority According to the Company Law and the FCSM Code Strategic oversight and control Control, Disclosure, and Transparency · Determines the strategic · Requests the Revision Commission to conduct extraordinary inspections direction of the company · Recommends to the GMS the remuneration of Revision Commission members · Establishes the executive bodies · Recommends to the GMS the remuneration of the External Auditor · Terminates the powers of executive · Preliminarily approves the annual report bodies · Determines the list of additional documents that must be kept by the company · Appoints the General Director or · Establishes internal control and risk management mechanisms suspends the powers of the Gen- eral Director if delegated by the Shareholder Rights GMS · The GMS Suspends the External Manager · · Organizes the GMS Appoints an interim Executive · Reviews agenda proposals Board · The Supervisory Board · Places additional items on the Establishes branches and/or repre- agenda and nominates candi- sentative offices · dates Determines the remuneration of the · Approves the agenda executive bodies · · Organizes EGMs Supervises the operations of the executive bodies and requests min- Dividends utes of the Executive Board meet- · Recommends to the GMS the amount Charter Capital and Assets ings of and procedures for paying · Authorizes directors and managers · Increases the charter capital dividends to occupy a position in a governing · Issues non-convertible bonds Transactions & Conflict Resolution body of another legal entity · Issues convertible bonds · Approves extraordinary transactions · Authorizes individuals other than · Determines the market value of assets, · Approves related party transactions the Chairman to sign contracts and the placement and redemption price · Resolves corporate conflicts · Appoints and dismisses the Cor- of shares and other securities porate Secretary · Buys back company shares · Approves by-laws and other inter- · Appoints the company's External Registrar nal documents · Utilizes the company's reserve and other funds Source: IFC, March 2004 3. The Supervisory Board's Authority in Relation to Strategic Oversight and Control The Supervisory Board plays an important role in the company's strategic oversight and control. The Supervisory Board has the following authorities in this area: 12 Part_II_Ch-04-06.indd 12 Part_II_Ch-04-06.indd 12 17.09.2004 11:33:09 17.09.2004 11:33:09 Chapter 4. The Supervisory Board a) Setting Company Priorities and Strategic Direction The Supervisory Board has the authority to determine the priorities and stra- tegic direction of the company.10 Best Practices: The Supervisory Board should:11 · Set the strategic direction of the company; · Approve financial and business plans on an annual basis; and · Establish and oversee internal control procedures. The Supervisory Board sets the company's strategic direction in the context of the market environment, the financial position, and other factors.12 The strategic and business plans of the company should be reviewed and evaluated at least on an annual basis. The evaluation should also cover production, marketing, and planned investments. Finally, the Supervisory Board should approve a single document that contains financial projections for one year. Good corporate governance principles also suggest that: · The General Director and the Executive Board seek the approval of the Supervisory Board for transactions that fall outside the scope of the finan- cial and business plan (non-standard operations);13 · The company develop by-laws or other internal documents with detailed procedures for the General Director and the Executive Board for obtaining the approval of operations that fall outside the scope of the financial and business plan;14 and · The Supervisory Board be given the right to veto the decision of the General Director and the Executive Board to implement any non-standard operations, provided such veto can be justified.15 The Supervisory Board is not, however, involved in the day-to-day manage- ment of the company, which is the responsibility of the executive bodies. 10 LJSC, Article 65, Clause 1, Section 1. 11 FCSM Code, Chapter 1, Sections 3.1. and 7.1. 12 FCSM Code, Chapter 3, Section 1.1. 13 FCSM Code, Chapter 4, Section 1.2. 14 FCSM Code, Chapter 4, Section 1.2; Chapter 8, Section 2.2.3. 15 FCSM Code, Chapter 8, Section 2.2.3. 13 Part_II_Ch-04-06.indd 13 Part_II_Ch-04-06.indd 13 17.09.2004 11:33:10 17.09.2004 11:33:10 The Russia Corporate Governance Manual Company Practices in Russia: The most common functions performed by Su- pervisory Boards of Russian companies include electing and dismissing the Chairman of the Supervisory Board (79%), approving extraordinary transactions (71%), approving operational plans (62%), and approving annual budgets (53%), as depicted in Figure 3.16 In addition, Supervisory Boards generally elect and dismiss the Chairman of the Executive Board (General Director), top managers, and Executive Board members. However, one in four Supervisory Boards decides upon the selection of an independent External Auditor, and 18% elect and dismiss their own members. Under Russian legislation, these rights are reserved for shareholders.17 Companies that violate rules regarding the election of Auditors also tend to violate rules regarding the appointment and dismissal of Supervi- sory Board members. Figure 3: Functions Performed by Supervisory Boards in Russia Elects and Dismisses the Chairman of the Supervisory Board Approves Extraordinary Transactions Initiates Extraordinary Audits Approves Operational Plans of the Company Controls Internal Audit Elects and Dismisses the Head of the Executive Board/General Director Approves Annual Budgets Elects and Dismisses Senior Managers/ Executive Board Members Approves Additional Issue of Company Shares Elects the External Auditor Not a Board Authority Elects and Dismisses Supervisory Board Members % of Companies Source: IFC, Regional Survey on Corporate Governance Practices, August 2003 16IFC Survey on Corporate Governance Practices in Russia's Regions, Section 2.2.1, page 25, August 2003 (see www.ifc.org/rcgp). 17LJSC, Article 48, Clause 1, Sections 4 and 10. 14 Part_II_Ch-04-06.indd 14 Part_II_Ch-04-06.indd 14 17.09.2004 11:33:10 17.09.2004 11:33:10 Chapter 4. The Supervisory Board b) Establishing the Executive Bodies The Supervisory Board has the authority to establish the executive bodies provided that the charter gives this authority to the Supervisory Board.18 If the charter is silent on this matter, then the Company Law dictates that this is a power of the GMS. c) Terminating the Executive Bodies' Powers With the power to create executive bodies comes the authority to terminate them.19 The Supervisory Board cannot, however, terminate the authority of the executive bodies if the authority to elect such bodies lies with the GMS. d) Suspending the Executive Bodies' Powers If the power to create and terminate executive bodies remains with the GMS, the charter can provide the Supervisory Board with the authority to suspend the powers of the General Director and External Manager. The Supervisory Board is not, however, able to suspend the powers of the Executive Board. e) Appointing Interim Executive Bodies When the power to create executive bodies resides with the GMS and the charter provides the Supervisory Board with the authority to suspend the powers of the General Director or External Manager, the Supervisory Board shall appoint interim executive bodies together with the decision on the suspension of powers, as illustrated in Table 1. Table 1: Instances When the Supervisory Board May Appoint Interim Executive Bodies · When the Supervisory Board has exercised the right to suspend the powers of the General Director provided by the charter; or An interim General · When the General Director is unable to fulfill his duties; or Director20 · When the Supervisory Board has exercised the right to suspend the powers of the External Manager provided by the charter; or · When the External Manager is unable to fulfill its duties. 18 LJSC, Article 48, Clause 1, Section 8. See also: LJSC, Article 65, Clause 1, Section 9; Article 69, Clause 3, Paragraph 1. 19 LJSC, Article 48, Clause 1, Section 8. See also: LJSC, Article 65, Clause 1, Section 9; Article 69, Clause 4, Paragraph 2. 20 LJSC, Article 69, Clause 4, Paragraphs 3 and 4. 15 Part_II_Ch-04-06.indd 15 Part_II_Ch-04-06.indd 15 17.09.2004 11:33:10 17.09.2004 11:33:10 The Russia Corporate Governance Manual Table 1: Instances When the Supervisory Board May Appoint Interim Executive Bodies · When the charter has reserved the power to establish the Executive An interim Executive Board for the GMS; and Board21 · When the number of acting Executive Board members is less than the quorum set by the charter or by-laws. In these circumstances, the decision to appoint an interim executive body must be accompanied by a decision to hold an Extraordinary General Meeting of Share- holders (EGM) to elect new executive bodies. Best Practices: A reasonable timeframe to hold the EGM is within 60 days of the appointment of the interim executive body. f) Concluding Contracts with the Executive Bodies The Chairman has the power to sign contracts between the company and members of the executive bodies.22 The Supervisory Board can also designate a person other than the Chairman to enter into contracts with members of the executive bodies.23 Best Practices: Although legislation does not specify who determines the terms of contracts with managers, including their remuneration, it is recommended that the Supervisory Board do this.24 It is common practice internationally for the Supervisory Board's Remu- neration Committee, chaired and comprised of independent directors, to set the remuneration of the General Director and other senior managers. The German Corporate Governance Code, for example, states that the compensation of the Executive Board is determined by the Supervisory Board based on a performance assessment. Criteria for determining the level of compensation are: the tasks of the Executive Board members; their performance; the economic (financial) situation of the company; and, in particular, the performance outlook compared to competing companies.25 For more information on executive remuneration, see Chapter 5, Section G. 21 LJSC, Article 70, Clause 2, Paragraph 1. 22 LJSC, Article 69, Clause 3, Paragraph 2. 23 LJSC, Article 69, Clause 3, Paragraph 2. 24 FCSM Code, Chapter 3, Section 1.4.3. 25The German Corporate Governance Code, 4.2.2. See also: www.ecgi.org/codes/country_documents/ germany/code_200305_en.pdf and www.corporate_governance_code.de 16 Part_II_Ch-04-06.indd 16 Part_II_Ch-04-06.indd 16 17.09.2004 11:33:10 17.09.2004 11:33:10 Chapter 4. The Supervisory Board g) Supervising the Executive Bodies' Operations The executive bodies must be accountable to the Supervisory Board and share- holders.26 Best Practices: The executive bodies normally report to shareholders during the GMS. Most shareholders, in particular minority shareholders, are not able to effectively supervise management. This task is the responsibility of the Supervi- sory Board, which oversees the executive bodies on behalf of all shareholders.27 In order for the Supervisory Board to fulfill its oversight function, the charter needs to provide it with sufficient authorities on a wide range of issues, including the authority to supervise the financial and business operations of the company.28 When establishing and selecting an Executive Board, an appropriate balance must be struck between exercising oversight over the General Director and al- lowing him sufficient autonomy to conduct corporate affairs. The dangers of weak oversight are well known; managers can operate in their own personal interests, and defraud shareholders. There are, on the other hand, dangers associated with excessive oversight; these include micro-management, and the politicization of managerial decision-making. Both weak and excessive oversight can lead to economic inefficiencies and legal problems. As a consequence, charters, by-laws, and other policy documents should be developed with a view towards dividing responsibilities among the governing bodies of the company on the basis of what body is best suited for a particular task. Managerial tasks should, clearly, be left to professional managers. Oversight tasks should be carried out by oversight bodies, such as the Supervisory Board and GMS. The Supervisory Board, for example, has the authority to request the minutes of Executive Board meetings.29 The Supervisory Board further decides whether the General Director or an Executive Board member can occupy a position in a governing body of another legal entity,30 in order to avoid a conflict of interest that may prevent the General Director and other executives from properly fulfilling their functions. 26 LJSC, Article 69, Clause 1. 27 See also: FCSM Code, Chapter 3, Section 1.4.1. 28 FCSM Code, Chapter 3, Section 1.2.1. The FCSM Code recommends that these procedures be developed taking into consideration the requirements of the Law on Countering Legaliza- tion of Income Generated by Illegal Means (Money Laundering). 29 LJSC, Article 70, Clause 2, Paragraph 2. 30 LJSC, Article 69, Clause 3, Paragraph 4. 17 Part_II_Ch-04-06.indd 17 Part_II_Ch-04-06.indd 17 17.09.2004 11:33:10 17.09.2004 11:33:10 The Russia Corporate Governance Manual Best Practices: The Supervisory Board must understand what to monitor. A number of key issues every Supervisory Board will want to closely monitor should include the: · Company's overall performance, especially in comparison to competing companies; · Executive bodies' compliance with law and internal procedures, including on corporate governance, risk management and internal control, as well as ethics; · Executive bodies' performance, both at the team and individual level; · Implementation of the company's strategy; · Company's marketing and sales targets; · Company's financial results; and · Relations with key stakeholders, including the company's shareholders, as well as employees, suppliers, and customers. h) Appointing the Corporate Secretary Although the Company Law is silent about the Supervisory Board's authority to appoint the Corporate Secretary, the Supervisory Board can be vested with this power in the charter.31 Best Practices: Appointing the Corporate Secretary, and defining the terms and conditions of the contract with the Corporate Secretary, including the amount of remuneration, should fall under the Supervisory Board's authority.32 Moreo- ver, the Corporate Secretary should be accountable to and supervised by the Supervisory Board in accordance with the terms and conditions of his employ- ment contract. For more information on the Corporate Secretary, see Chapter 6. i) Approving By-laws The Supervisory Board approves the by-laws and other internal documents, excluding those that must be approved by the GMS or the executive bodies of the company.33 31 LJSC, Article 65, Clause 1, Section 18. 32 FCSM Code, Chapter 5, Section 2.1. 33 LJSC, Article 65, Clause 1, Section 13. 18 Part_II_Ch-04-06.indd 18 Part_II_Ch-04-06.indd 18 17.09.2004 11:33:11 17.09.2004 11:33:11 Chapter 4. The Supervisory Board Best Practices: The FCSM Code advises that the Supervisory Board approve the by-laws dealing with the company's: · Dividend policy;34 · Information policy;35 · Ethical standards;36 · Control and Revision Service;37 · Risk management;38 · Audits of the financial and business activity of the company;39 and · Corporate Secretary.40 For more information on by-laws and their approval, see Part I, Chapter 3, Section B, as well as model by-laws contained in Annexes under Part VI. j) Establishing Branches and Representative Offices The establishment of the company's branches and representative offices lies within the Supervisory Board's authority.41 However, the Company Law does not address the Supervisory Board's authority to terminate branches and representative offices. 4. The Supervisory Board's Authority in Relation to Shareholder Rights a) Organizing the General Meeting of Shareholders42 The Supervisory Board has the authority, and sometimes the obligation, to include items on the agenda.43 34 FCSM Code, Chapter 9, Section 1.1.1. 35 FCSM Code, Chapter 7, Section 4.1.1; Chapter 3, Section 2.3.1. 36 FCSM Code, Chapter 3, Section 4.12. 37 FCSM Code, Chapter 8, Section 1.1.1. 38 FCSM Code, Chapter 3, Section 1.2.2. 39 FCSM Code, Chapter 8, Section 3.1.3. 40 FCSM Code, Chapter 5. 41 LJSC, Article 65, Clause 1, Section 14. 42 The general aspects of organizating the GMS, including the role of the Supervisory Board, are discussed at length in Chapter 8. In this section, this process is approached from the perspective of the Supervisory Board and focuses on the GMS agenda. 43 LJSC, Article 49, Clause 3; Article 54, Clause 2; LJSC, Article 53, Clause 7, Paragraph 2. 19 Part_II_Ch-04-06.indd 19 Part_II_Ch-04-06.indd 19 17.09.2004 11:33:11 17.09.2004 11:33:11 The Russia Corporate Governance Manual The Supervisory Board must include items on the agenda of the GMS upon request of a shareholder (or a group of shareholders) owning at least 2% of vot- ing shares. Items that the Supervisory Board can add to the agenda of the GMS are the approval of:44 · Reorganizations;45 · The composition and liquidation of a Creditors' Committee;46 · The amount of dividends;47 · The transfer of the General Director's authority to an External Manager;48 and · The annual report.49 For more information on who can request an EGM, see Part III, Chapter 8, Section D. There are certain items that only the Supervisory Board may include on the agenda of the GMS, unless the charter also provides this right to shareholders and/or other permitted parties. These items are shown in Figure 4. b) Resolving Corporate Conflicts Best Practices: A key Supervisory Board function is to establish a system of compliance with corporate procedures. The Supervisory Board's responsibility is to take all necessary steps to prevent and resolve conflicts that may arise between shareholders and the company.50 It may appoint officers to implement systems of enforcement. The Supervisory Board may also form a Conflict Resolution Committee to this end. For more information on corporate conflicts and on the Supervisory Board's Conflict Resolution Committee, see Section D.2 of this Chapter and Part V, Chapter 17, Sections G.2 and G.3, respectively. 44 There appears to be an inconsistency between LJSC, Articles 16­21, which provides that decisions of the GMS on different types of reorganization and liquidation of the company can be submitted to the agenda of the GMS only by the Supervisory Board, and LJSC, Arti- cle 49, Clause 3, which states that these decisions can be submitted to the agenda of the GMS by the Supervisory Board if the charter does not provide otherwise. 45 LJSC, Article 16, Clause 2; Article 17, Clause 2; Article 18, Clause 2; Article 19, Clause 2; and Article 20, Clause 2. 46 LJSC, Article 21, Clause 2. 47 LJSC, Article 42, Clause 3. 48 LJSC, Article 69, Clause 1, Paragraph 3. 49 LJSC, Article 88, Clause 4; Article 54, Clause 2. 50 FCSM Code, Chapter 3, Sections 1.3.1-1.3.2. 20 Part_II_Ch-04-06.indd 20 Part_II_Ch-04-06.indd 20 17.09.2004 11:33:11 17.09.2004 11:33:11 Chapter 4. The Supervisory Board Figure 4: Items That Only the Supervisory Board Can Include on the Agenda of the GMS Increase the charter capital Recommend the approval of the Revision Commission's Consolidate or split shares remuneration Approve related party Approve internal Only transactions (unless under documents (by-laws) the Supervisory Board the Supervisory Board's governing the company Can Propose to: authority) Approve participation in holding Approve extraordinary structures, FIGs, associations, transactions or other commercial entities Approve share buybacks Source: IFC, March 2004 5. The Supervisory Board's Authority in Relation to Assets and the Charter Capital The Supervisory Board has the authority to decide on whether to issue non-con- vertible bonds and other non-convertible securities if the charter does not provide otherwise.51 In contrast, the Supervisory Board has the authority to decide on the issue of convertible bonds and other convertible securities only if this authority has not been provided to the GMS in the charter.52 In addition, the Supervisory Board has the authority to set the market value of assets, the placement price, and the redemption price of shares and other se- curities.53 For more information on charter capital, see Part III, Chapter 9, and on bonds and other securities, see Chapter 11. 51 LJSC, Article 65, Clause 1, Section 6; Article 33, Clause 2, Paragraph 1. 52 LJSC, Article 65, Clause 1, Section 6; Article 33, Clause 2, Paragraph 2. 53 LJSC, Article 65, Clause 1, Section 7. 21 Part_II_Ch-04-06.indd 21 Part_II_Ch-04-06.indd 21 17.09.2004 11:33:11 17.09.2004 11:33:11 The Russia Corporate Governance Manual 6. The Supervisory Board's Authority in Relation to Control, Disclosure, and Transparency a) Preliminarily Approving the Annual Report The executive bodies are responsible for preparing financial statements and for financial reporting.54 The Supervisory Board verifies and authorizes the an- nual report and financial statements for submission to the GMS for final ap- proval.55 This must be done no later than 30 days before the Annual General Meeting of Shareholders (AGM) is held. b) Implementing Risk Management The Supervisory Board should ensure that systems for evaluating and manag- ing risks are in place. Some of the key Supervisory Board duties are outlined in the box below and in Figure 5. Best Practices: Risk management is an important function of the Supervisory Board.56 The Supervisory Board should ensure that systems are established that enable the company to assess and control risks.57 Among other things, the Supervisory Board should: · Approve risk management procedures and ensure compliance with such procedures (these procedures should provide that the company and its employees notify the Supervisory Board promptly of all substantial deficien- cies in risk management mechanisms); · Analyze, evaluate, and improve the effectiveness of the internal risk man- agement procedures on a regular basis; · Develop adequate incentives for the executive bodies, departments, and employees to apply internal control systems; · Establish a Risk Management Committee of the Supervisory Board when necessary; and · Ensure that the company complies with legislation and charter provisions. 54 LJSC, Article 88, Clause 2. 55 LJSC, Article 88, Clause 4. 56 Companies engaged in banking, investment, or insurance activities should, at a minimum, follow the risk management requirements established by regulatory authorities of the Russian Federation, such as the Central Bank. 57 FCSM Code, Chapter 3, Section 1.2.2. 22 Part_II_Ch-04-06.indd 22 Part_II_Ch-04-06.indd 22 17.09.2004 11:33:11 17.09.2004 11:33:11 Chapter 4. The Supervisory Board Figure 5: Sources of Assurance Reviews the entire risk management process Interviews the head of operations Reviews risk indicators on a monthly basis The Supervisory Interviews the General Undertakes periodic Board and its Director risk reviews or studies Risk Management and Chief Accountant Committee: Studies the audit Obtains management of financial statements confirmation Reviews early warning mechanism Source: The Institute of Chartered Accountants in England and Wales, Implementing Turnbull, a Boardroom Briefing, 1999. c) Specifying Additional Documents that Must Be Kept by the Company The company must keep certain documents such as the founders' agreement, charter, by-laws, and annual report. Both the Supervisory Board and other govern- ing bodies have the authority to specify additional documents that must be kept by the company.58 For more information on the annual report, see Part IV, Chapter 13, Section C.4 and Part VI, Annex 29. B. The Election and Dismissal of Directors 1. The Election and Term of Directors The GMS elects directors59 for a term that starts from the moment that they are elected until the next AGM.60 If a new AGM is not held within the period pro- 58 LJSC, Article 89, Clause 1. 59 LJSC, Article 48, Clause 1, Section 4. 60 LJSC, Article 47, Clause 1, Paragraph 3. See also: LJSC, Article 66, Clause 1, Paragraph 1. 23 Part_II_Ch-04-06.indd 23 Part_II_Ch-04-06.indd 23 17.09.2004 11:33:11 17.09.2004 11:33:11 The Russia Corporate Governance Manual vided for by the Company Law, i.e. from 1 March to 30 June, the authority of directors terminates automatically, except for their authority to prepare, convene, and conduct the AGM.61 There are no limitations as to how many times a directors can be re- elected.62 Best Practices: Companies can maintain their vitality and ability to adapt to new challenges by changing the composition of their Supervisory Board. Non- executive directors may indeed lose some of their (independent) edge if they remain on a Board too long. A company may wish to impose term-limits, either for the entire Supervisory Board or a certain percentage, to keep its members focused. Either way, reappointment should not be automatic, but a conscious decision by the shareholder(s) and the director concerned. In accordance with French law, for example, a director's mandate may not exceed six years unless the GMS decides to renew this mandate, and directors older than 70 years may not exceed one-third of board membership. In this respect, the Hellebuyk Commission recommends that directors' mandates not exceed four years and the number of directors over 65 years not exceed one- third of the board membership.63 The French Corporate Governance Code (Vienot II) in turn provides that the duration of a directors' term of office, set by the by-laws, should not exceed a maximum of four years, in order to enable shareholders to rule upon their appointment with sufficient frequency.64 2. The Nomination of Candidates for the Supervisory Board A shareholder (or a group of shareholders) owning at least 2% of voting shares has the right to nominate candidates for the Supervisory Board. The procedure for nominating candidates for the Supervisory Board is discussed at great length in Part III, Chapter 8, Section B.1. 61 LJSC, Article 66, Clause 1, Paragraph 1. 62 LJSC, Article 66, Clause 1, Paragraph 2. 63AFG ASFFI (Association Francaise de la Gestion Financiere). Hellebuyck Commission Recommen- dations on Corporate Governance, § II.D.4 (June 29, 1998). See also: http://www2.eycom.ch/ corporate-governance/reference/pdfs/8/en.pdf. 64 Report of the Committee on Corporate Governance ("the Vienot II Report"), July 1999. See also: http://www2.eycom.ch/corporate-governance/reference/pdfs/11/en.pdf. 24 Part_II_Ch-04-06.indd 24 Part_II_Ch-04-06.indd 24 17.09.2004 11:33:12 17.09.2004 11:33:12 Chapter 4. The Supervisory Board 3. Information About Supervisory Board Nominees Information about Supervisory Board nominees must be submitted to persons entitled to participate in the GMS before the Meeting.65 The Company Law itself does not specify what information must be disseminated. It permits the charter to specify the required information.66 Best Practices: Shareholders should receive sufficient information to determine the ability of Supervisory Board nominees to fulfill their duties and, if applicable, to ascertain their independence. Some useful items of information include:67 · The identity of the candidate; · The identity of the shareholder (or the group of shareholders) that nomi- nated the candidate; · The age and educational background of the candidate; · The positions held by the candidate during the last five years; · The positions held by the candidate at the moment of his nomination; · The nature of the relationship the candidate has with the company; · Other Supervisory Board memberships or official positions held by the candidate; · Other nominations of the candidate for a position on the Supervisory Board or official positions; · The candidate's relationship with affiliated persons of the company; · The candidate's relationship with major business partners of the company; · Information related to the financial status of the candidate, and other cir- cumstances that may affect the duties and independence of the candidate as a Board member; and · The refusal of the candidate to respond to an information request of the company. For information on the timeline for the disclosure of this information, see Part III, Chap- ter 8, Section B.4. 65 LJSC, Article 52, Clause 3. 66 LJSC, Article 53, Clause 4. 67 FCSM Code, Chapter 3, Section 2.3.1. 25 Part_II_Ch-04-06.indd 25 Part_II_Ch-04-06.indd 25 17.09.2004 11:33:12 17.09.2004 11:33:12 The Russia Corporate Governance Manual 4. The Election of Directors All directors must be elected with cumulative voting.68 Cumulative voting is a system that helps minority shareholders pool their votes to elect a representative for the Supervisory Board. The election of directors cannot be done if a GMS is held by written con- sent.69 a) How Cumulative Voting Works Cumulative voting works as follows: · Candidates for the Supervisory Board are voted on collectively, i.e. as a group; · Each shareholder has a maximum number of votes equal to the number of directors that must be elected (according to the charter or a decision of the GMS) multiplied by the number of voting shares held; · Shareholders can allocate their votes to one candidate or divide them among several candidates as they please; · The top X candidates with the most votes are considered elected, whereby X equals the number of Supervisory Board members to be elected as specified by the charter or the decision of the GMS. Mini-Case 1: The following mini-case illustrates how shareholders, in particular minority shareholders, can calculate the minimum number of votes required to elect one Supervisory Board member. Once they know this, it will help them organize their collective action to put their representative on the Supervisory Board. In this case, a company has 2,500 minority shareholders holding a total of 3,000 (or 20% of) voting shares, and one majority shareholder holding a total of 12,000 (or 80% of) voting shares. The charter states that the Supervisory Board has nine members. The 2,500 minority shareholders hold 27,000 votes (3,000 shares 9 votes) and the majority shareholder has 108,000 votes (12,000 shares 9 votes). The nine candidates that receive the most votes are elected to the Supervisory Board. 68 LJSC, Article 66, Clause 4, Paragraph 1. 69 LJSC, Article 50, Clause 2. 26 Part_II_Ch-04-06.indd 26 Part_II_Ch-04-06.indd 26 17.09.2004 11:33:12 17.09.2004 11:33:12 Chapter 4. The Supervisory Board A formula can be used to calculate a minimum number of votes to elect one director: nS 9 15,000 -------- + 1 = ------------ + 1 = 13,501 shares D + 1 9 + 1 where D -- the number of directors to be elected, S -- the number of outstanding voting shares and n -- the total number of directors the majority shareholder wants to elect (n = 9 directors in this example). For this formula to work, shareholders must know the number of voting shares the company has in total (S), how many directors must be elected (D), and how many candidates they want to elect to the Supervisory Board. The formula indicates that shareholders must have 13,501 votes to ensure that one director is elected. Minority shareholders in this example hold 27,000 votes which will enable them to elect at least one director, should they vote collectively. b) Cumulative Voting and Collective Action Cumulative voting increases the chance that minority shareholders elect a representative to the Supervisory Board. In order to be effective, minority share- holders must organize themselves to vote. For this, they must: · Have the resources and skills to campaign for candidates; · Make use of the shareholder list to contact other shareholders; and · Be able to use cumulative voting strategically. Mini-case 1 above illustrates the importance of collective action and voting strategy. Company Practices in Russia: Representatives of major shareholders (35%), management and employees (30%) are the most common types of directors, as depicted in Figure 6. Independent directors (18%) and minority shareholder representatives (9%) still constitute a minority on most Supervisory Boards. A positive correlation exists between the number of shareholders in a company and the number of representatives of majority shareholders on the Supervisory Board. Hence, Supervisory Boards of large companies with many shareholders tend to include more representatives of large shareholders.70 70 IFC Survey on Corporate Governance Practices in Russia's Regions, Section 2.2.1, page 25, August 2003 (see www.ifc.org/rcgp). 27 Part_II_Ch-04-06.indd 27 Part_II_Ch-04-06.indd 27 17.09.2004 11:33:12 17.09.2004 11:33:12 The Russia Corporate Governance Manual Figure 6: The Structure of the Average Russian Supervisory Board Company Management and Employees 35% Major Shareholders 30% Independent Directors 18% Minority Shareholders 9% State 8% Source: IFC, Regional Survey on Corporate Governance Practices, August 2003 c) Cumulative Voting and Fractional Shares Fractional shares also count when Supervisory Board members are elected. Fractional votes may not be further divided. Fractional votes may only be cast for one candidate.71 The following mini-case shows how this rule works in practice. Mini-Case 2: Shareholder A has 5.1 voting shares. During the GMS, the shareholders are to elect nine Supervisory Board members through cumulative voting. Shareholder A is able to cast 45.9 votes (5.1 9). In this case, Shareholder A will cast the 45 votes as desired. Shareholder A must cast the remaining 0.9 votes for one candidate and cannot divide the fraction (0.9) into smaller fractions (for example, 0.4 to Supervisory Board candidate B and 0.5 to Supervisory Board candidate C). d) Relationship Between the Number of Directors and the Effectiveness of Cumulative Voting There is a direct relationship between the effectiveness of cumulative voting and the number of directors: the higher the number of directors to be elected, the greater the opportunity for minority shareholders to elect a representative to the Supervisory Board. 71FCSM, Regulation N. 17/ps, on Additional Requirements to the Procedure of Preparing, Calling and Conducting the General Meeting of Shareholders, 31 May 2002, Section 2.14. 28 Part_II_Ch-04-06.indd 28 Part_II_Ch-04-06.indd 28 17.09.2004 11:33:12 17.09.2004 11:33:12 Chapter 4. The Supervisory Board The Company Law requires that a company with less than 1,000 shareholders with voting rights elect a minimum of five Supervisory Board members.72 Thus, a shareholder (or a group of shareholders) holding roughly 16.7% of the total number of voting shares could elect one director.73 A company with more than 1,000 shareholders with voting rights must have at least seven Supervisory Board members.74 Thus, a shareholder (or a group of shareholders) holding roughly 12.5% of the total number of voting shares could elect one director. A company with more than 10,000 shareholders with voting rights must have at least nine Supervisory Board members.75 In this case, a shareholder (or a group of shareholders) holding a mere 10% of voting shares can secure one position on the Supervisory Board. 5. The Election of Drectors When Lacking a Quorum Commonly, if the number of directors becomes less than the quorum, the Super- visory Board no longer can make valid decisions. It must subsequently organize an EGM to elect a new Supervisory Board. This should be done as soon as pos- sible to have a Supervisory Board that is able to make valid decisions.76 For more information on the Supervisory Board's role in preparing for the EGM, see Part III, Chapter 8, Section D. 6. The Dismissal of Directors In the ordinary course of business, directors are elected at every AGM. Only the GMS can dismiss directors before the end of their term.77 Since the Super- visory Board is elected with cumulative voting, the GMS can only terminate the authority of all directors collectively, not of individual members.78 Such a GMS will in practice be an EGM. 72 LJSC, Article 66, Clause 3, Paragraph 1. 73 Using the figures in the mini-case in section B.6.a) then ((1 15,000)/5+1))+1 = 2,501 shares. (2,501/15,000) 100% = 16.7% 74 LJSC, Article 66, Clause 3, Paragraph 2. 75 LJSC, Article 66, Clause 3, Paragraph 2. 76 LJSC, Article 68, Clause 2. 77 LJSC, Article 66, Clause 1, Paragraph 3; Article 48, Clause 1, Paragraph 4. 78 LJSC, Article 66, Clause 1, Paragraph 3. 29 Part_II_Ch-04-06.indd 29 Part_II_Ch-04-06.indd 29 17.09.2004 11:33:13 17.09.2004 11:33:13 The Russia Corporate Governance Manual Best Practices: The Company Law does not specify the grounds for dismissing Supervisory Board members. Grounds may include providing false information to the company as a candidate for the Supervisory Board, willful neglect of Supervisory Board responsibilities, or conviction of a criminal act. C. The Composition of the Supervisory Board 1. The Number of Directors The total number of directors must be fixed in the charter or by decision of the GMS.79 The Company Law provides for the following minimum number of directors depending on the number of shareholders:80 · At least five directors for companies with 1,000 and fewer shareholders with voting rights; · At least seven directors for companies with more than 1,000 shareholders with voting rights; and · At least nine directors for companies with more than 10,000 shareholders with voting rights. The charter or decision of the GMS can, however, provide for a greater number of directors than the minimum number legally required. Best Practices: Companies should choose a Supervisory Board size that will enable it to:81 · Hold productive and constructive discussions; · Make prompt and rational decisions; and · Efficiently organize the work of its committees, if these are established. 79 LJSC, Article 66, Clause 3, Paragraph 1. 80 LJSC, Article 66, Clause 3, Paragraphs 1 and 2. 81 FCSM Code, Chapter 3, Section 2.1.4. 30 Part_II_Ch-04-06.indd 30 Part_II_Ch-04-06.indd 30 17.09.2004 11:33:13 17.09.2004 11:33:13 Chapter 4. The Supervisory Board The number of directors should be guided by legal requirements, and the spe- cific needs of the company and its shareholders. Most companies in Russia tend to have between six and ten directors.82 Having either too few or too many directors can be a problem for effective decision-making. A small Supervisory Board may not allow the company to benefit from an appropriate mix-of-skills and breadth of experience; a larger Supervisory Board is typically more difficult to manage, and can make consensus building time-consuming and difficult. The challenge in selecting the correct Supervisory Board size is striking an appropriate balance. 2. Who Can Be a Director There are legal requirements of eligibility for directors: · Only individuals with "full dispositive capacity" can be directors. Directors should have the capacity to acquire and exercise civil law rights by their ac- tions, be able to create civil law obligations, and fulfill these rights and obliga- tions;83 · A legal entity cannot be a director, although an individual who happens to be a representative of a legal entity can be elected to the Supervisory Board. In this case, the individual elected to the Supervisory Board may only serve in his capacity as a director and not as a representative of the legal entity, i.e. he must act in the interest of the company on whose Supervisory Board he is sitting and not of the company he is representing;84 For more information on the fiduciary duties of a director, see Section F.2 in this Chapter. · Revision Commission members cannot be directors;85 · Counting Commission members cannot be directors;86 and 82 FCSM-ISMM-INVAS Survey; 2002 (see www.rid.ru). 83 Civil Code (CC), Article 21. 84 LJSC, Article 66, Clause 2, Paragraph 1. 85 LJSC, Article 85, Clause 6 Paragraph 1. 86 LJSC, Article 56, Clause 2. 31 Part_II_Ch-04-06.indd 31 Part_II_Ch-04-06.indd 31 17.09.2004 11:33:13 17.09.2004 11:33:13 The Russia Corporate Governance Manual · An Executive Board member or the General Director of Company A can only be a director of Company B after the Supervisory Board of Company A has given its consent.87 Best Practices: To avoid conflicts of interest, individuals should not be elected to the company's Supervisory Board when they are:88 · A director of a competing company; · A manager of a competing company; or · An employee of a competing company. Nominees for the Supervisory Board should also not be related to sup- pliers, affiliated persons, as well as employees of the independent External Auditor. 3. Qualifications of Directors Directors should possess the necessary skills and experience to contribute to the work of the Supervisory Board. Figure 7 illustrates the personal characteristics and competencies required for this task. Figure 7: Recommended Characteristics and Competencies for Supervisory Board Members Personal Characteristics Competencies ·····Leadership Industry Experience Integrity Business Judgment Accountability ···Special Skills, for example: Maturity · Finance and Accounting; Work Ethic · Risk Management and Internal Control; or · Strategic Management Source: IFC, March 2004 87 LJSC, Article 69, Clause 3. 88 FCSM Code, Chapter 3, Section 2.1.3. 32 Part_II_Ch-04-06.indd 32 Part_II_Ch-04-06.indd 32 17.09.2004 11:33:13 17.09.2004 11:33:13 Chapter 4. The Supervisory Board Company Practices in Russia: As indicated in Figure 8, Russian companies feel that work experience within the company and the industry, as well as per- sonal maturity are important criteria when electing directors. Other popular criteria include contacts and loyalty to the company. On the other hand, crite- ria such as independence, expertise, and leadership are not mentioned.89 It can thus be inferred that the benefits of independent directors are not fully understood by Russian companies. Figure 8: Main Criteria Used in Electing Supervisory Board Members Work Experience with the Company Personal Maturity Work Experience in the Industry Useful Contacts Loyalty Other % of Companies Source: IFC, Regional Survey on Corporate Governance Practices, August 2003 There are no legal requirements with regard to the qualification criteria of directors. As a consequence, such criteria need to be specified elsewhere. For example, companies may find useful to include qualifications in their internal company documents, as described in the following box. Best Practices: The charter should set forth the qualification criteria of direc- tors.90 Directors should have the following qualifications: · The trust of shareholders, other directors, managers, and employees of the company; · The ability to relate to the interests of all stakeholders and make well-rea- soned decisions; · The professional expertise and education needed to be effective; 89 IFC Survey on Corporate Governance Practices in Russia's regions, Section 2.2.1, page 25, August 2003 (see www.ifc.org/rcgp). 90 FCSM Code, Chapter 3, Section 2.1.3. 33 Part_II_Ch-04-06.indd 33 Part_II_Ch-04-06.indd 33 17.09.2004 11:33:13 17.09.2004 11:33:13 The Russia Corporate Governance Manual · International business experience, knowledge of national issues and trends, knowledge of the market, products, and competitors; and · The ability to translate knowledge and experience into solutions. It may, however, be difficult for the company to determine whether a potential director possesses these qualifications. Moreover, a brief description of such qualifications in the company's charter may lead to ambiguity and thus be of little use. Instead, companies may wish to include the above criteria in their by-laws or other internal documents. Indeed, many companies in the U.S. use corporate governance guidelines for this purpose. Shareholders should be informed of the directors' qualifications, and the list of candidates for the Supervisory Board should indicate whether, at the time of election, the candidate is or will be:91 · The General Director; · An Executive Board member; · An officer or employee of the company; and · Able to meet the qualifications of an independent director. The background of candidates for the Supervisory Board should be checked for a criminal record and for past administrative offences that are not de minimis in nature. Both are likely to preclude the membership of such candidates on the Supervisory Board as the FCSM Code calls for directors with impeccable character.92 4. Categories of Directors International practice and domestic law distinguish between different categories of directors according to the degree to which such directors are involved in the affairs of (or are related to) the company. The three categories are executive, non-execu- tive, and independent directors. Company Practices in Russia: Many Russian companies are controlled by a single shareholder or a group of shareholders (often the General Director and/ or the Chairman) who are well informed about the affairs of the company and able to closely monitor the company's management. The remaining ownership is often widely dispersed and many of these, often minority, shareholders lack the resources and information to effectively monitor management and defend themselves against the potential abuses of large shareholders. In these types of companies, independent directors take on special importance. A survey of companies in Russia's regions found that only 18% of companies follow the FCSM Code's recommendations that independent directors make up at least 91 FCSM Code, Chapter 3, Section 2.3.3. 92 FCSM Code, Chapter 3, Section 2.1.1. 34 Part_II_Ch-04-06.indd 34 Part_II_Ch-04-06.indd 34 17.09.2004 11:33:13 17.09.2004 11:33:13 Chapter 4. The Supervisory Board 1/4 of the Supervisory Board, and no less than three people (see Figure 6 above). Further, only 29% of companies have any independent directors (Figure 9).93 Minority shareholders are also poorly represented, with 70% of the surveyed com- panies having no minority shareholder representative on their Supervisory Board. Figure 9: Companies that Do Not Have Certain Categories of Directors State or Regional Authorities Independent Directors Minority Shareholders Major Shareholders Executive Board Members Management and Employees % of Companies Source: IFC, Regional Survey on Corporate Governance Practices, August 2003 Figure 10 shows that among Supervisory Boards that have both executive and non-executive members, the overall ratio of executives to non-executives is one to four.94 The ratio of independent to non-independent directors, at one to nine, leaves much room for improvement on the average Russian Supervisory Board. Figure 10: Ratio of Different Categories of Directors Independent/Non-Independent Directors Executive/Non-Executive Directors % of Supervisory Board Members Source: IFC, Regional Survey on Corporate Governance Practices, August 2003 93 IFC Survey on Corporate Governance Practices in Russia's Regions, Section 2.2.1, page 25, August 2003 (see www.ifc.org/rcgp). 94 IFC Survey on Corporate Governance Practices in Russia's regions, Section 2.2.1, page 21, August 2003 (see www.ifc.org/rcgp). 35 Part_II_Ch-04-06.indd 35 Part_II_Ch-04-06.indd 35 17.09.2004 11:33:14 17.09.2004 11:33:14 The Russia Corporate Governance Manual a) Executive Directors Executive directors can be defined as those that also hold an executive position in the company, namely that of: · The General Director; · An Executive Board member; or · A manager of the company who is not an Executive Board member. The Company Law does not refer to executive directors as a general category; it does, however, limit the number of Executive Board members that can be Su- pervisory Board members. Executive Board members can occupy a maximum of 1/4 of the total number of Supervisory Board seats.95 Best Practices: Many Russian companies have Supervisory Board dominated by executive directors. To circumvent the above-mentioned legal provision, stating that Executive Board members can occupy a maximum of /4 of the 1 total number of Supervisory Board seats, many Russian companies simply choose not to create an (or disband an already existing) Executive Board. However, Russian companies wishing to adhere to good corporate governance practices should not follow the letter but rather the spirit of the law, and limit the number of executives, rather than Executive Board members, to /4 of to 1 total number of directors. Further, the General Director cannot serve as the Chairman of the Super- visory Board at the same time (in international practice, so-called "CEO-dual- ity").96 Executive directors are, by definition, not independent. b) Non-Executive Directors Non-executive directors are Supervisory Board members that do not hold an executive position in the company. Effective non-executive directors should have the following personal attributes: 95 LJSC, Article 66, Clause 2. 96 LJSC, Article 66, Clause 2. 36 Part_II_Ch-04-06.indd 36 Part_II_Ch-04-06.indd 36 17.09.2004 11:33:14 17.09.2004 11:33:14 Chapter 4. The Supervisory Board · Integrity and high ethical standards; · Sound judgment; · The ability and willingness to challenge and probe; and · Strong interpersonal skills. Best Practices: Most international and national codes of corporate governance recommend that (Supervisory) Boards be composed of a majority of non-executive directors who contribute: · An outside perspective and greater impartiality in their judgments; · Additional external experience and knowledge; and · Useful contacts. In Germany, for example, no more than two former members of the Executive Board or Vorstand may be members of the Supervisory Board so as to ensure the Supervisory Board's independent oversight capability.97 In most EU countries, non-executive directors normally exercise oversight of the financial and strategic decision-making functions of the company. Apart from these, there are three areas in need of disinterested monitoring by non-executive directors:98 · Nomination of directors; · Remuneration of senior managers and directors; and · Internal and external audit. In the U.K., the Higgs report groups the role of the non-executive director around four issues:99 1. Strategy: Non-executive directors should constructively challenge and con- tribute to the development of strategy. 2. Performance: Non-executive directors should scrutinize the performance of management in meeting agreed upon goals and objectives, and monitor the reporting of performance. 97 The German Corporate Governance Code, 5.4.2. See also: www.ecgi.org/codes/country_documents/ germany/code_200305_en.pdf. 98 Report of the High Level Group of Company Law Experts on a Modern Regulatory Frame- work for Company Law in Europe, November 2002, page 60. See also: europa.eu.int/comm/ internal_market/en/company/company/modern/consult/report_en.pdf. 99 Derek Higgs, Review of the role and effectiveness of non-executive directors, January 2003. See also: www.dti.gov.uk/cld/non_exec_review/pdfs/higgsreport.pdf. 37 Part_II_Ch-04-06.indd 37 Part_II_Ch-04-06.indd 37 17.09.2004 11:33:14 17.09.2004 11:33:14 The Russia Corporate Governance Manual 3. Risk: Non-executive directors should satisfy themselves that financial infor- mation is accurate, and that financial controls and systems of risk manage- ment are robust and defensible. 4. People: Non-executive directors are responsible for determining appropriate levels of remuneration for executive directors, have a prime role in appoint- ing, and where necessary removing, senior management, and in succession planning. The Company Law refers to non-executive directors in the context of restrict- ing the number of executive directors that may sit on the Supervisory Board. Table 2 summarizes the relevant legal provisions concerning executive and non- executive directors' functions. Table 2: Restrictions on Executive and Non-Executive Directors100 Can a director be a member of the Executive Board? Yes, but Executive Board members can- not occupy more than 25% of Supervi- sory Board seats. Can a director be a General Director? Yes, unless prohibited by the charter. Can the Chairman of the Supervisory Board be No. the General Director? Can the Chairman of the Supervisory Board be a member Yes, unless prohibited by the charter. of the Executive Board other than the General Director? Non-executive directors may, depending on their ties to the company, be in- dependent or non-independent. c) Independent Directors Russian law does not define the concept of independent directors. The Com- pany Law does, however, refer to independent directors under specific circum- stances to determine the position of individuals engaged in related party transac- tions and to prevent possible conflicts of interests. For these purposes, the 100 LJSC, Article 66, Clause 2, Paragraph 2. 38 Part_II_Ch-04-06.indd 38 Part_II_Ch-04-06.indd 38 17.09.2004 11:33:14 17.09.2004 11:33:14 Chapter 4. The Supervisory Board requirements for the "independence" of directors are wider than those for a non- executive position. In this respect, an independent director is defined as an indi- vidual who has not been in any of the following positions at the time of the approval of a business transaction, or during one year immediately preceding the approval of such a transaction:101 · The General Director, the External Manager, an Executive Board member or a member of the governing bodies (Supervisory Board, General Director and Executive Board) of the External Manager; or · A person whose spouse, parents, children, brothers, and sisters by one or both parents are the External Manager or hold a position in the governing bodies of the External Manager; or · A person whose adoptive parents or adopted children are the External Manager or hold a position in the governing bodies or the External Manager; or · An affiliated person other than a director of the company. For more information on affiliated persons, see Part III, Chapter 12, Section B.1. Best Practices: Independent directors can make a substantial contribution to important decisions of the company, especially in evaluating executive perform- ance, setting executive and director remuneration, reviewing financial statements, and in resolving corporate conflicts.102 Independent directors give investors additional confidence that the Supervisory Board's deliberations will be free of obvious bias. Companies are advised to disclose information about independent directors in the annual report.103 In contrast to the Company Law, the FCSM Code discusses the concept of independent directors and defines which Supervisory Board members can be defined as independent. More specifically, the FCSM Code disqualifies directors from being independent if they answer "YES" to one or more of the following questions in Table 3: 101 LJSC, Article 83, Clause 3, Paragraph 2. 102 FCSM Code, Chapter 3, Section 2.2.2. 103 FCSM Code, Chapter 3, Section 2.2.5. 39 Part_II_Ch-04-06.indd 39 Part_II_Ch-04-06.indd 39 17.09.2004 11:33:14 17.09.2004 11:33:14 The Russia Corporate Governance Manual Table 3: Are Directors on Your Supervisory Board Independent According to the FCSM Code? Yes No Is the director an officer or an employee of the company, or the External Manager of the company? Has the director been an officer or an employee of the External Manager of the company over the last three years? Is the director an officer of another company in which any of the officers of the company is a member of the Nominations and Remuneration Committee of the Supervisory Board of that company? Is the director an affiliated person of an officer of the company, of the Ex- ternal Manager or of an officer of the External Manager of the company? Is the director an affiliated person of the company or an affiliated person of persons affiliated with the company? Is the director a party to a contract with the company whereby the director could acquire property of the company (or receive money) with a value of 10% or more of the total annual income of the said director, excluding the remuneration he receives for his work as a director? Is the director a major business partner of the company (i.e., a business part- ner involved in transactions with the company where the total annual amount of transactions is 10% or more of the book value of company assets)? Is the director a representative of the state? Has the director been a Supervisory Board member of the company during the last seven years? If a director ceases to be independent, the director should immediately notify the Supervisory Board with an explanation of why the criteria of independence as specified in the FCSM Code no longer apply.104 The Supervisory Board is then advised to: · Notify shareholders that the director is no longer independent; · Call an EGM to elect new Supervisory Board if the number of independent direc- tors is below the minimum that is recommended by the FCSM Code;105 and · Disclose information about independent directors in the annual report of the company, giving shareholders the opportunity to verify any changes in the status of independent directors.106 104 FCSM Code, Chapter 3, Section 2.2.4. 105 FCSM Code, Chapter 3, Section 2.2.4. 106 FCSM Code, Chapter 3, Section 2.2.5. 40 Part_II_Ch-04-06.indd 40 Part_II_Ch-04-06.indd 40 17.09.2004 11:33:14 17.09.2004 11:33:14 Chapter 4. The Supervisory Board In any event, independent directors should refrain from actions that may com- promise their independent status. The minimum number of independent directors should be at least /4 of the 1 total Supervisory Board seats and no less than three.107 This should enable independent directors to influence the decision-making process of the Super- visory Board and introduce a wider spectrum of opinions to Supervisory Board deliberations. While these minima are useful benchmarks, they are by no means sufficient to ensure an absence of bias. The circumstances of each Supervisory Board are likely to be different. In some cases, the minimum may be sufficient for balanced deliberation; in others, a larger number of independ- ent and assertive directors may be necessary to counterbalance a dominant General Director. Other international and national codes of corporate governance have stricter definitions for independent directors. In the U.K. for example, a non-executive director is considered independent when the Board of Directors determines that the director is independent in character and judgment, and there are no relation- ships or circumstances which could affect, or appear to affect, the director's judgment. Such relationships and circumstances would include those, in which the director:108 · Is a former employee of the company or group until five years after employ- ment (or any other material connection) has ended; · Has, or has had, within the last three years, a material business relationship with the company either directly, or as a partner, shareholder, director, or senior employee of a body that has had such a relationship with the company; · Has received or receives additional remuneration from the company apart from a director's fee, participates in the company's share option or a per- formance related pay scheme, or is a member of the company's pension scheme; · Has close family ties with any of the company's advisers, directors, or senior employees; · Holds cross-directorships or has significant links with other directors through involvement in other companies or bodies; · Represents a significant shareholder; or · Has served on the Supervisory Board for more than 10 years. 107 FCSM Code, Chapter 3, Section 2.2.3. 108 The Combined Code on Corporate Governance, July 2003, Section 1, A.3.1. See also: www. fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf. 41 Part_II_Ch-04-06.indd 41 Part_II_Ch-04-06.indd 41 17.09.2004 11:33:15 17.09.2004 11:33:15 The Russia Corporate Governance Manual The large number of definitions with their detailed qualifications may give rise to confusion. In reality, understanding and defining independence need not be complex. The Council of Institutional Investors (CII), a grouping of some of the world's largest institutional investors, defines an independent director plainly in the following way: "Stated most simply, an independent director is a person whose directorship constitutes his or her only connection to the corporation." This cuts to the heart of the matter. For those interested in learning how to apply this simple definition in practice, the CII also lists specific circumstances that compromise independence.109 Finally, it should be noted that director independence is not a panacea. The New York Stock Exchange is a telling example. In 2003, the exchange was enveloped in a scandal over the excessive compensation of its chief executive officer, despite the fact that compensation levels had been approved by a com- mittee staffed and chaired by independent directors. For the IFC's definition on independence, see Part VI, Annex 18. D. The Structure and Committees of the Supervisory Board 1. Chairman The Supervisory Board members elect their Chairman by a simple majority vote of all directors if the charter does not provide otherwise.110 The Supervisory Board may re-elect its Chairman at any time. Another Supervisory Board member may substitute for the Chairman in his absence.111 The Chairman must be a Supervi- sory Board member and cannot be the General Director.112 Best Practices: The ability of the Chairman to properly discharge his duties depends on his being vested with sufficient and appropriate powers, and on his personal and professional qualifications. The Chairman should have an out- 109For more information on the CII and their definition of director independence (in English), see: http://www.cii.org/independent_director.asp. 110LJSC, Article 67, Clause 1. 111LJSC, Article 67, Clause 3. 112LJSC, Article 66, Clause 2, Paragraph 2. 42 Part_II_Ch-04-06.indd 42 Part_II_Ch-04-06.indd 42 17.09.2004 11:33:15 17.09.2004 11:33:15 Chapter 4. The Supervisory Board standing professional reputation and should be of the highest integrity, be com- mitted to the interests of the company, and enjoy the trust of shareholders and the other directors.113 There should be a clear division of responsibilities at the head of the company between the running of the Supervisory Board and the executive responsibility for the running of the company's day-to-day operations -- both on paper, as required by law, and in actual practice. Companies should define the authority of the Chairman, as well as that of the General Director, in as much detail as possible in the by-laws or other internal documents.114 The Chairman has the authority to:115 · Prepare, organize, and preside over Supervisory Board meetings; · Preside over the GMS when the charter does not provide otherwise; · Enter into contracts with the General Director, Executive Board members, and the External Manager;116 and · Perform any other duties as specified in the charter and by-laws. Best Practices: The Chairman's other duties, or responsibilities, should be defined in the by-laws for the Supervisory Board. In addition, the company may wish to draft a position description, or terms of reference, which could contain the following elements:117 The Chairman: · Provides leadership and ensures for the Supervisory Board's effective- ness; · Establishes, implements, and reviews procedures that govern the Supervi- sory Board's work; 113 FCSM Code, Chapter 3, Section 4.1.1. 114 FCSM Code, Chapter 3, Section 4.1.1. 115 LJSC, Article 67, Clause 2. 116 LJSC, Article 69, Clause 3, Paragraph 2. 117 These model terms of reference contain elements from the "Review of the Role and Effec- tiveness of Non-executive Directors," by Derek Higgs, January 2003; and the Report of the NACD Blue Ribbon Commission on Director Professionalism, Appendix B. 43 Part_II_Ch-04-06.indd 43 Part_II_Ch-04-06.indd 43 17.09.2004 11:33:15 17.09.2004 11:33:15 The Russia Corporate Governance Manual · Schedules a Supervisory Board meeting calendar and coordinates it with the Board's committee chairs; · Organizes and presents meeting agendas, and ensures that all directors receive appropriate information on a timely basis; · Periodically interacts with the General Director, and acts as a liaison between the Supervisory Board and executives; · Ensures for accurate, timely, and clear information to and from the other directors; · Ensures for effective communication with shareholders; · Arranges regular evaluations of the Supervisory Board's performance, as well as of its committees and individual directors; · Facilitates the effective contribution of non-executive and/or independent directors, and enables constructive relations between executive and non- executive directors; and · Carries out other duties as requested by the GMS and the Supervisory Board as a whole, depending on need and circumstance. 2. Supervisory Board Committees As the business environment continues to become more complex, the demands on and responsibilities of the Supervisory Board and its members continue to grow. Supervisory Board committees are widely considered a key tool for Supervisory Boards to effectively deal with such challenge. More specifically, committees: · Permit the Supervisory Board to handle a greater number of complex issues in a more efficient manner, by allowing specialists to focus on specific issues and provide detailed analysis and recommendations back to the Board; · Allow the Supervisory Board to develop subject-specific expertise on the company's operations, most notably on financial reporting, risk, and internal control; and · Enhance the objectivity and independence of the Supervisory Board's judg- ment,insulatingitfrompotentialundueinfluenceofmanagersandcontrolling shareholders. 44 Part_II_Ch-04-06.indd 44 Part_II_Ch-04-06.indd 44 17.09.2004 11:33:15 17.09.2004 11:33:15 Chapter 4. The Supervisory Board It is of crucial importance that committees are understood to be part of the Supervisory Board. It is the Supervisory Board that establishes committees, sets their terms of reference through committee by-laws, appoints their members, and turns their recommendations into actions. It is of particular importance that Board committees make recommendations to the Supervisory Board and not make deci- sions on its behalf. To streamline the operations of committees, the Supervisory Board should approve by-laws for each Supervisory Board committee.118 Company Practices in Russia: Of the companies that participated in the IFC's regional survey, only 3.3% have specialized Supervisory Board committees. Of these, not a single one is chaired by an independent director. The prevalence of Supervisory Board committees is low regardless of the Supervisory Board's size.119 a) Types of Committees The FCSM Code recommends that companies establish a number of commit- tees. However, caution is called for. A large number of committees can be hard to manage and may lead to a fragmentation of the Supervisory Board. It is advis- able to establish committees as the need arises, starting with the most critical ones, and then establishing others as experience is gained. The Supervisory Board may establish either permanent or ad-hoc Board committees. The most important committee from the shareholder perspective is the Audit Committee. Some of the committees that a company should consider establishing are described in Table 4. 118 FCSM Code, Chapter 3, Section 4.7.2. 119 IFC Survey on Corporate Governance Practices in Russia's Regions, Section 2.2.1, page 25, August 2003 (see www.ifc.org/rcgp). 45 Part_II_Ch-04-06.indd 45 Part_II_Ch-04-06.indd 45 17.09.2004 11:33:15 17.09.2004 11:33:15 The Russia Corporate Governance Manual Table 4: Different Types of Committees Recommendations for the Functions Committee's Composition · Develops recommendations for the Supervisory Board on the selec- The Audit Committee should be tion of the External Auditor; composed entirely of independent · Interacts with the company's External Auditor and Revision Com- directors. If this is not possible, mission; the Audit Committee should be · Supervises the company's financial and business operations, and chaired by an independent direc- 120 the implementation of the financial and business plan; tor and be composed solely of · Monitors the Internal Audit Function; non-executive directors. · Evaluates internal control procedures; Committee · Develops internal control and risk management procedures; and The charter (or by-laws) should · Develops recommendations for the Supervisory Board's approval set forth the qualifications of Audit of non-standard operations.121 Committee members. In particu- For more information on the Audit Committee, see Part IV, Chap- lar, Audit Committee members ter 14, Section C, and Annex 7. need to be financially literate, and understand accounting and fi- nancial reporting.122 · Defines strategy and objectives, as well as key performance indica- (No specific recommendation and 123 tors; made by the FCSM Code.) Mem- · Determines operational priorities; bers of the Committee need ex- · Develops dividend policy; and perience in the industry in which Planning Committee · Evaluates the long-term productivity of the company's opera- the company is active. The Com- tions. mittee will likely benefit from For a model by-law for the Supervisory Board's Strategic Planning members with other areas of Strategic Finance and Finance Committee, see Part VI, Annex 10. expertise such as finance and operations. · Ensures that the company complies with ethical standards and (No specific recommendation 124 contributes to the creation of an atmosphere of trust within the made by the FCSM Code.) Mem- company. bers of the Committee must be · Detects and prevents violations by the company of legislation and of the highest integrity, enjoy the Committee ethical standards. trust of all shareholders, and be knowledgeable on legal and Ethics For a model Code of Ethics, see Part VI, Annex 5. ethical standards. 120 FCSM Code, Chapter 3, Sections 4.8­4.12. 121 FCSM Code, Chapter 3, Section 4.9; Chapter 8, Sections 1.1.2, Paragraphs 2, 1.2, 1.4, 2.2, and 2.3. 122 FCSM Code, Chapter 8, Section 1.3.2. 123 FCSM Code, Chapter 3, Section 4.8. 124 FCSM Code, Chapter 3, Section 4.12. 46 Part_II_Ch-04-06.indd 46 Part_II_Ch-04-06.indd 46 17.09.2004 11:33:15 17.09.2004 11:33:15 Chapter 4. The Supervisory Board Table 4: Different Types of Committees Recommendations for the Functions Committee's Composition · Defines the qualifications of Supervisory Board members; The Nominations and Remu- · Develops the company's remuneration policy, specifies basic prin- neration Committee should be ciples and criteria for determining the amount of remuneration composed of independent direc- payable to: tors. If this is not possible, the ­ Supervisory Board members; Committee should be chaired ­ The General Director; by an independent director and ­ Executive Board members; and be composed of non-executive 125 ­ Heads of major divisions of the company. directors.126 · Develops criteria for the performance evaluation of these persons; · Performs periodic evaluations of the General Director and Executive Committee Board members; · Defines benefits available to these persons (including life insurance, health insurance, and non-governmental pension benefits); · Determines qualifications of candidates for positions in executive bodies and heads of major divisions of the company; Remuneration · Prepares the terms and conditions of employment contracts between and the company and the General Director and Executive Board mem- bers; · Conducts preliminary assessments of candidates for the positions of General Director and Executive Board members; Nominations · Prepares recommendations for the Supervisory Board with respect to the reappointment of the General Director and Executive Board members; and · Considers the company's personnel policy, including matters re- lated to wages and salaries. For a model by-law for the Supervisory Board's Nominations and Remuneration Committee, see Part VI, Annex 9. · Ensures that shareholder rights are appropriately and specifically The Corporate Conflicts Resolu- defined in the company's charter, by-laws, and company-level tion Committee should be com- corporate governance code, and develops policies and procedures posed of independent directors. Resolution for the protection of these rights; When this is not possible, an 127 · Develops and periodically conducts reviews of the company's independent director should conflict resolution policy and procedures; and chair the Committee. Members Conflicts · Develops recommendations for the Supervisory Board on how to should, at a minimum, be non- Committee effectively deal with corporate conflicts between and among the executive directors. company, its shareholders, directors, and managers. Corporate For a model by-law for the Supervisory Board's Corporate Govern- ance Committee, see Part VI, Annex 8. 125 FCSM Code, Chapter 3, Section 4.10.1. 126 FCSM Code, Chapter 3, Section 4.10.3. 127 FCSM Code, Chapter 10, Section 2.1.2. 47 Part_II_Ch-04-06.indd 47 Part_II_Ch-04-06.indd 47 17.09.2004 11:33:16 17.09.2004 11:33:16 The Russia Corporate Governance Manual b) Authority of Supervisory Board Committees The Supervisory Board is a collective body in which: · All members have equal rights and duties (the charter may provide that the Chairman have a decisive vote in case of a tie vote); · All members bear joint and several liability; and · Members act together as a body according to specific decision-making procedures. This implies that although certain tasks can be delegated to Supervisory Board committees, the ultimate decision-making responsibility rests with the entire Su- pervisory Board. Committee members do not have more legal rights than any other Supervisory Board member, although they will have additional responsi- bilities and obligations. c) The Composition of Supervisory Board Committees Supervisory Board committees should only be composed of Supervisory Board members. Other parties, most notably managers, may be invited to present or elaborate on particular issues, but have observer status only, i.e. are precluded from conferring or deciding on particular issues. Best Practices: Experienced and knowledgeable directors should staff Super- visory Board committees.128 There needs to be a sufficient number of directors to accomplish the work at hand. Since the work of Supervisory Board commit- tees may involve time-consuming reviews, the participation of directors in mul- tiple Supervisory Board committees should be restricted. Supervisory Board committees may, from time to time, require the assistance of outside advisors to assist committees with their work. These advisors must, however, not receive Supervisory Board member status. Many stock exchanges further recommend that Supervisory Board committees be composed of and/or chaired by independent directors. The listing require- ments of some stock exchanges, for example the NYSE, go further and require a majority of independent directors, as well as the Audit and Nominations and Remuneration Committees to be composed solely of independent directors. 128FCSM Code, Chapter 3, Section 4.7.1. 48 Part_II_Ch-04-06.indd 48 Part_II_Ch-04-06.indd 48 17.09.2004 11:33:16 17.09.2004 11:33:16 Chapter 4. The Supervisory Board d) The Role of the Chairman in Relation to Supervisory Board Committees Best Practices: The Chairman should:129 · Take into account the views of directors on the need to create commit- tees; · Nominate directors for positions in committees; and · Take necessary administrative measures to ensure that committees perform their tasks. 3. The Chairman of a Supervisory Board Committee The Chairman of a committee is responsible for its effectiveness, regardless of his other duties. The committee Chairman forms an effective team, organizes productive committee meetings, and provides intellectual leadership on complex issues. Best Practices: The Chairman of a committee plays an important role in organ- izing its work. Committees should be chaired by non-executive directors.130 Ideally, these directors should also be independent. This holds particularly true for the Audit and Nominations and Remuneration Committees which, according to best corporate governance practices, are to be chaired by independent direc- tors. Committee chairmen should keep the Chairman of the Supervisory Board in- formed about their work. In addition, the committee chairmen should be present at the GMS to respond to shareholder questions.131 129 FCSM Code, Chapter 3, Section 4.1.5. 130 FCSM Code, Chapter 3, Section 4.7.3. 131 FCSM Code, Chapter 2, Section 2.1.1. 49 Part_II_Ch-04-06.indd 49 Part_II_Ch-04-06.indd 49 17.09.2004 11:33:16 17.09.2004 11:33:16 The Russia Corporate Governance Manual E. The Working Procedures of the Supervisory Board The Supervisory Board is a governing body, which operates according to a proce- dure defined by the Company Law, the charter, or the by-laws. 1. The Chairman and Supervisory Board Meetings The Chairman has the authority to:132 · Call, organize, and preside over Supervisory Board meetings; · Prepare the minutes of Supervisory Board meetings; · Cast a deciding vote at Supervisory Board meetings in case of a tie vote (if this is provided for by the charter); and · Sign the minutes of the Supervisory Board meeting (when it is presided over by him). Best Practices: More specifically, the Chairman facilitates the work of the Supervisory Board by:133 · Setting the agenda of the meetings; · Facilitating decision-making on agenda items; · Encouraging open discussions on issues in a friendly and constructive at- mosphere; · Providing Supervisory Board members with an opportunity to express their points of view on matters being discussed; and · Steering the Supervisory Board towards a consensus. In doing so, the Chairman should act with conviction and, at all times, in the best interests of the company. Moreover, the by-laws or other internal docu- ments should impress upon the Chairman the responsibility to:134 · Take steps to ensure that all directors receive information required for the resolution of agenda items in a timely fashion; · Encourage directors to freely express their opinions on agenda items and other issues; · Openly discuss opinions of directors; and · Initiate the drafting of the Supervisory Board's decisions. 132LJSC, Article 67, Clause 3; Article 68, Clauses 3 and 4. 133FCSM Code, Chapter 3, Sections 4.1.2-4.1.3. 134FCSM Code, Chapter 3, Section 4.1.2. 50 Part_II_Ch-04-06.indd 50 Part_II_Ch-04-06.indd 50 17.09.2004 11:33:16 17.09.2004 11:33:16 Chapter 4. The Supervisory Board 2. The Supervisory Board Meetings The Supervisory Board must follow legal requirements in making valid decisions, or risk having them overruled by the courts upon complaints.135 Best Practices: Directors should ensure that Supervisory Board and committee meetings are well-organized and held on a regular basis. Directors should actively participate in Supervisory Board meetings, and each director should: · Take part in discussions and voting; · Participate in the work of Supervisory Board committees; · Demand a Supervisory Board meeting to discuss matters of concern;136 and · Notify the Supervisory Board when they are unable to attend meetings.137 In addition, Supervisory Board members should have sufficient time for the performance of their functions. The Supervisory Board should develop rules to regulate the participation of its members on Supervisory Boards of other com- panies.138 For example, in Australia, a chairmanship of a listed company is considered the equivalent of three directorships, and the maximum acceptable number of directorships or equivalent positions for an individual should not exceed five.139 The general rule for directorship on several Supervisory Boards should however be based on time-constraints: if a director does not have the time, he should not take on the responsibility. 3. The First Supervisory Board Meeting Best Practices: The first meeting of a newly elected Supervisory Board should be held no later than one month after it is elected. As a matter of convenience, the first Supervisory Board meeting can be organized to follow the GMS. The 135 LJSC, Article 68, Clauses 2 and 3. 136 FCSM Code, Chapter 3, Section 3.2.2. 137 FCSM Code, Chapter 3, Section 3.2.1. 138 FCSM Code, Chapter 3, Section 3.2.3. 139 Australian Certified Public Accountants, Corporate Governance Health Checks, Financial Reporting Framework -- The Way Forward (www.cpaaustralia.com.au/07_information_centre/ 16_media_releases/2002/1_0_20020708_mr.asp). 51 Part_II_Ch-04-06.indd 51 Part_II_Ch-04-06.indd 51 17.09.2004 11:33:16 17.09.2004 11:33:16 The Russia Corporate Governance Manual Chairman of the Supervisory Board is typically elected during this meeting. In addition, it is recommended that the first Supervisory Board meeting:140 · Define and confirm the priorities of the Supervisory Board; · Establish committees if appropriate; and · Elect committee chairmen. A company may also wish to develop an induction training for new Supervisory Board members that covers, among other topics, an overview of the compa- ny's: · Industry and sector of operation; · Business operations; · Current financial situation; · Strategy; · Business risks; and · Key employee background and skills. 4. The Schedule of Supervisory Board Meetings The charter or the by-laws must specify the procedures for convening and con- ducting Supervisory Board meetings.141 Best Practices: The Supervisory Board should have a working plan in addition to a schedule for meetings that includes the topics to be addressed.142 The Su- pervisory Board should hold regular meetings. According to the FCSM Code, the Supervisory Board should meet every six weeks.143 The Supervisory Board may, however, wish to hold meetings as often as deemed necessary. Here is some guidance on conducting productive and efficient Supervisory Board meetings: · Develop an annual calendar of meetings. This will allow directors to slot the meetings in their agenda. Note that this calendar should serve as a guide, i.e. the Supervisory Board should hold additional meetings when warranted and, vice-versa, cancel meetings when there are no issues to be resolved. 140FCSM Code, Chapter 3, Section 4.2.2. 141LJSC, Article 68, Clause 1. 142FCSM Code, Chapter 3, Section 4.2.1. 143FCSM Code, Chapter 3, Section 4.2.1. 52 Part_II_Ch-04-06.indd 52 Part_II_Ch-04-06.indd 52 17.09.2004 11:33:16 17.09.2004 11:33:16 Chapter 4. The Supervisory Board · Set an agenda well in advance. Directors will thus be able to properly focus on and prepare for the task at hand. The Chairman may wish to send a draft agenda in advance, allowing for comments and sugges- tions. · Place important issues at the beginning of the agenda. Directors often have other commitments and might need to leave early. Scheduling meetings for the early, rather than latter part of the day is thus often more conducive to foster interactive discussions. In addition to regular meetings, the Supervisory Board needs to organize a meeting to review and approve the annual report.144 This Board meeting needs to take place at least 30 days prior to the AGM. Company Practices in Russia: According to the latest surveys, Supervisory Boards of Russian companies meet between eight145 and 11 times a year.146 5. Who Has the Right to Convene a Supervisory Board Meeting The Chairman normally convenes regular Supervisory Board meetings. He also has the obligation to convene a Supervisory Board meeting upon the request of the following parties:147 · Supervisory Board members; · The Revision Commission; · The External Auditor; · The General Director and the Executive Board; and · Other persons specified by the charter.148 144 LJSC, Article 88, Clause 4. 145 IFC Survey on Corporate Governance Practices in Russia's Regions, Section 2.2.1, page 26, August 2003 (see www.ifc.org/rcgp). 146 FCSM-ISMM-INVAS Survey (2002), see also: www.rid.ru. 147 LJSC, Article 68, Clause 1. 148 For example, a shareholder or a group of shareholders holding 2% or more of voting shares of the company. See FCSM Code, Chapter 3, Section 4.2.3; Chapter 3, Section 4.13. 53 Part_II_Ch-04-06.indd 53 Part_II_Ch-04-06.indd 53 17.09.2004 11:33:16 17.09.2004 11:33:16 The Russia Corporate Governance Manual 6. Proper Notice for Supervisory Board Meetings Best Practices: Directors should properly prepare themselves to participate effectively in meetings.149 They should not vote on items on which they have not been fully informed or which they do not understand. The necessary infor- mation and materials should be sent to director together with the notice of the Supervisory Board meeting sufficiently in advance of the meeting to enable each director to thoroughly review the information.150 Two weeks can be considered sufficient. The by-laws or other internal documents should determine the form of the notice and the way materials are delivered that is most convenient and acceptable to all directors (for example by mail, telegraph, teletype, telephone, or e-mail).151 7. The Quorum for Supervisory Board Meetings A quorum is the minimum number of directors that must participate in a meeting for decisions to be valid. The charter must specify the quorum, which cannot be less than one half of the number of elected directors.152 If the number of acting directors becomes less than the required quorum, the Supervisory Board no longer has the authority to make decisions other than to convene an EGM for the election of new directors.153 Best Practices: For a few very important corporate actions, the charter, by-laws, or other internal documents should establish stricter quorum requirements than those set by the Company Law. A quorum of /3 of the total number of direc- 2 tors should be required to:154 · Approve strategic plans, and the financial and business plan; 149FCSM Code, Chapter 3, Section 4.5. 150FCSM Code, Chapter 3, Section 4.5.2. 151FCSM Code, Chapter 3, Section 4.5.3. 152LJSC, Article 68, Clause 2. 153LJSC, Article 68, Clause 2. 154FCSM Code, Chapter 3, Section 4.15. 54 Part_II_Ch-04-06.indd 54 Part_II_Ch-04-06.indd 54 17.09.2004 11:33:17 17.09.2004 11:33:17 Chapter 4. The Supervisory Board · Approve the company's dividend policy and recommend dividend payments; · Submit to the GMS a proposal for the reorganization or liquidation of the company; and · Decrease or increase the charter capital. In addition, the quorum should be set so as to ensure that independent directors are required for the quorum to exist.155 8. How Directors Can Participate in Supervisory Board Meetings Directors can participate in voting when they are: · Physically present at the meeting; · Participating by conference call or other means of communication (when allowed by the charter or by-laws); or · Absent, but have presented a written opinion (when allowed by the charter or by-laws). Best Practices: Certain items are of such importance that directors need to be physically present. These items include:156 · The approval of the strategic plan, and the approval of the company's fi- nancial and business plan; · Calling the AGM, and making decisions on items related to the organization of such Meeting; · The preliminary approval of the annual report of the company; · Convening or refusing a request by third parties to convene an EGM; · The election of the Chairman; · The creation and early termination of the authority of executive bodies; · The suspension of the General Director and the appointment of an interim General Director; · The reorganization or liquidation of the company; and · Increasing the charter capital and issuing shares. 155 FCSM Code, Chapter 3, Section 4.14. 156 FCSM Code, Chapter 3, Section 4.4. 55 Part_II_Ch-04-06.indd 55 Part_II_Ch-04-06.indd 55 17.09.2004 11:33:17 17.09.2004 11:33:17 The Russia Corporate Governance Manual A director cannot delegate his right to vote at a Supervisory Board meeting to another person, including to another director.157 Best Practices: When participating in Supervisory Board meetings, each direc- tor should: · Listen and understand oral presentations; · Ask questions. This is particularly important for presentations or reports given by executives during Supervisory Board meetings, especially when these materials are presented in a complex or ambiguous manner; and · Request supporting materials. When presented with a particular issue that does not correspond to the director's area of expertise, additional informa- tion in the form of studies, independent appraisals or opinions, and other documentation on the subject should be requested prior to the meeting. 9. The Consideration of Written Opinions (Absentee Ballots) The charter or by-laws can specify that written opinions of directors can be con- sidered in determining the existence of a quorum for Supervisory Board meetings, and the validity of the voting results.158 Best Practices: The charter, by-laws, or other internal documents should enable Supervisory Board members to make decisions by absentee vote. However, for resolutions required by the charter to be adopted by voting in person, the votes of absentees expressing their opinion in written form should not be counted for the quorum.159 Companies should develop procedures for absentee voting, including the deadline for the delivery of voting ballots and deadline for the return of completed ballots. It should give directors enough time to receive the ballots and make decisions on agenda items.160 157LJSC, Article 68, Clause 3, Paragraph 2. 158LJSC, Article 68, Clause 1. 159FCSM Code, Chapter 3, Section 4.3.1. 160FCSM Code, Chapter 3, Section 4.3.2. 56 Part_II_Ch-04-06.indd 56 Part_II_Ch-04-06.indd 56 17.09.2004 11:33:17 17.09.2004 11:33:17 Chapter 4. The Supervisory Board 10. Supervisory Board Decisions Supervisory Board decisions must be approved by a simple majority vote unless the Company Law, the charter, and/or by-laws require a higher percentage of votes.161 Table 5: Decisions That Must Be Made Unanimously or by a Supermajority Vote of All Directors Supervisory Board decisions requiring Supervisory Board decisions requiring unanimity: the approval of a /4-majority: 3 · Increasing the charter capital by issuing and · Suspending the powers of the General Direc- placing additional shares (when the Supervisory tor or the External Manager for any rea- Board has this authority).162 son.164 · Approving an extraordinary transaction.163 · Approving an interim General Director. For more information on extraordinary transac- · Conducting an EGM to approve the new Gen- tions, see Part IV, Chapter 12, Section A. eral Director or the External Manager.165 How decisions on related party transactions are approved depends on the number of shareholders. More specifically:166 · A simple majority of directors that are not interested parties in companies with 1,000 or fewer shareholders with voting rights; · A simple majority of independent directors that are not interested parties in companies with more than 1,000 shareholders with voting rights. 161 LJSC, Article 68, Clause 3, Paragraph 1. 162 LJSC, Article 28, Clause 2. 163 LJSC, Article 79, Clause 2. 164 If the formation of executive bodies falls within the authority of the GMS, and if the char- ter gives the right to approve the decision to the Supervisory Board. 165 LJSC, Article 69, Clause 4, Paragraph 3. 166 LJSC, Article 83, Clauses 2 and 3. 57 Part_II_Ch-04-06.indd 57 Part_II_Ch-04-06.indd 57 17.09.2004 11:33:17 17.09.2004 11:33:17 The Russia Corporate Governance Manual 11. The Minutes of Supervisory Board Meetings The Supervisory Board must keep minutes of its meetings.167 Minutes must be prepared within three days after the meeting and must be kept in the company archives. At a minimum, the minutes must contain the following: · Location and time of the meeting; · Names of the persons who participated in the meeting; · Agenda of the meeting; · Agenda items and the voting results; and · A description of Supervisory Board decisions. The Chairman is responsible for the accuracy of the minutes and must sign them.168 Best Practices: As legal and regulatory requirements of directors become more onerous, minutes are an important record to show that the Supervisory Board has discharged its duty of care. Under good corporate governance practices, the minutes will include the voting of each individual director.169 The company may also consider having each director sign the minutes. For more information on the importance of minutes for the liability of directors, see Section F.7 of this Chapter. The Supervisory Board is often required to designate a secretary of the Super- visory Board to take notes and help prepare the minutes. In international practice, the Corporate Secretary often serves as the secretary of the Supervi- sory Board and may sign the minutes as well. To view a model set of minutes, see Part VI, Annex 16. Minutes only provide a brief summary of the Supervisory Board meeting. Verbatim reports, however, contain a word-for-word account of discussions held. 167LJSC, Article 68, Clause 4; Article 89, Clause 1. 168LJSC, Article 68, Clause 4. 169FCSM Code, Chapter 3, Section 4.16.1. 58 Part_II_Ch-04-06.indd 58 Part_II_Ch-04-06.indd 58 17.09.2004 11:33:17 17.09.2004 11:33:17 Chapter 4. The Supervisory Board Best Practices: Regardless of whether the company chooses to keep minutes and/or verbatim reports, the following documents should be preserved together with these reports:170 · The voting ballots; and · The written opinions of directors who were not able to attend. Each director should also be given a summary of the deliberations of the Su- pervisory Board. The company should establish a procedure which ensures that all directors will be provided with:171 · Copies of the minutes and/or verbatim reports; and · Reports detailing the outcome of the voting. This should be done within a reasonable amount of time after the meeting, but no later than the next Supervisory Board meeting. 12. The Corporate Secretary and Supervisory Board Meetings Best Practices: The Corporate Secretary should be responsible for administra- tive and organizational matters with respect to preparing and conducting Su- pervisory Board meetings.172 While the decision to conduct a Supervisory Board meeting is made by the Chairman, the Corporate Secretary should be respon- sible for handling such matters as:173 · Notifying all directors of Supervisory Board meetings; · Sending voting ballots; · Collecting completed ballots and absentee ballots; · Ensuring compliance with the procedures for Supervisory Board meetings; and · Keeping the minutes and verbatim reports.174 For more information on the Corporate Secretary, see Part II, Chapter 6. 170 FCSM Code, Chapter 3, Section 4.16.1. 171 FCSM Code, Chapter 3, Section 4.16.2. 172 FCSM Code, Chapter 5, Section 1.2.1. 173 FCSM Code, Chapter 5, Section 1.2.2. 174 FCSM Code, Chapter 5, Section 1.2.3. 59 Part_II_Ch-04-06.indd 59 Part_II_Ch-04-06.indd 59 17.09.2004 11:33:17 17.09.2004 11:33:17 The Russia Corporate Governance Manual F. The Duties and Liabilities of Directors Directors shall act in good faith, with diligence and due care, and in the best in- terests of the company. Best Practices: In some countries, including Russia, the Supervisory Board is legally required to solely act in the interest of the company (without specifying the interest of the company towards its shareholders and/or stakeholders). Act- ing solely in the best interest of the company can however encourage manage- ment to entrench themselves, and shareholders (and indeed the legislator) will need to carefully consider whether to require directors to act in the best interests of shareholders as well. Standards for the interpretation of the terms "good faith," "due diligence," and "due care," as well as standards for professional behavior, develop over time in a country's judicial system, economy, and corporate culture.175 The Company Law dictates that directors must act reasonably and in good faith.176 There is also a general requirement for a person authorized to act on behalf of the company, based on law or the charter, to act "reasonably and in good faith".177 It is important to note that when a court action is brought against an individual and there is a question of whether this individual acted reasonably and in good faith, reasonableness and good faith are presumed.178 However, neither the Company Law nor the Civil Code defines "good faith" or "reasona- bleness." Turning to other jurisdictions for guidance, for example the U.S. and U.K., the concepts of reasonableness and good faith are viewed as fundamental principles of a director's duty, notably that of care and loyalty. 175When explaining these duties, the Manual refers to general provisions of the Civil Code and the Company Law on the one hand, and the FCSM Code and internationally recognized corporate governance principles on the other. 176LJSC, Article 71, Clause 1. 177CC, Article 53, Clause 3. 178CC, Article 10, Clause 3. 60 Part_II_Ch-04-06.indd 60 Part_II_Ch-04-06.indd 60 17.09.2004 11:33:17 17.09.2004 11:33:17 Chapter 4. The Supervisory Board 1. The Duty of Care Supervisory Board members are responsible for exercising their rights and discharg- ing their duties in good faith, with care, and in a professional manner. Best Practices: A director should:179 · Act honestly and in good faith; · Refrain from being passive; · Use care and prudence to the maximum extent that could be expected from a good director in a similar situation under similar circumstances; · Not cause the company to act unlawfully; · Regularly attend and actively participate in Supervisory Board meetings; · Place matters on the agenda of Supervisory Board meetings, and demand such meetings when necessary; · Ensure that an efficient and effective system of internal control is in place; · Demand that the General Director and Executive Board members provide adequate information to the Supervisory Board so that its members are properly informed on corporate matters;180 and · Exercise a reasonable amount of supervision over management. 2. The Duty of Loyalty The duty of loyalty is of central importance to the governance framework, un- derpinning the effective implementation of key corporate governance issues, for example, monitoring of related party transactions and establishing remuneration policies for managers and non-executive directors. The duty of loyalty requires directors to exercise their powers in the interests of the company as a whole. Simply put, directors should not allow personal in- terests to prevail over the company's interests. The duty of loyalty usually pro- hibits directors from: · Participating in a competing company; · Entering into any transaction with the company without first disclosing the transaction and obtaining Supervisory Board or GMS approval; 179 FCSM Code, Chapter 3, Section 3.1.1. 180 FCSM Code, Chapter 3, Section 3.1.2. 61 Part_II_Ch-04-06.indd 61 Part_II_Ch-04-06.indd 61 17.09.2004 11:33:18 17.09.2004 11:33:18 The Russia Corporate Governance Manual · Using corporate property and facilities for personal needs; · Disclosing non-public, confidential information; and · Using company information or business opportunities for private advantage, i.e. personal profit or gain. It is also a key principle for directors who are working within the struc- ture of a group of companies: even though a company might be controlled by another enterprise, the duty of loyalty for a director relates to the com- pany and all its shareholders, and not to the controlling company of the group.181 Best Practices: The duty of loyalty requires the director to act in the best inter- est of the company regardless of:182 · Who nominated and elected such member; and · Pressures from other directors, shareholders, or other individuals to take actions or make decisions that are not in the best interest of the com- pany. It is of fundamental importance that, in carrying out its duties, the Supervisory Board should not be viewed, or act, as an assembly of individual representatives for various constituencies.183 While specific directors may indeed be nominated or elected by certain shareholders (and sometimes contested by others), it is an important feature of the Supervisory Board's work that directors when they assume their responsibilities carry out their duties in an even-handed manner with respect to all shareholders. This principle is particularly important to es- tablish in the presence of controlling shareholders that are able to select all directors. Further, directors and affiliated persons (for example, family, friends, and busi- ness partners) should not accept gifts from persons interested in Supervisory Board decisions, or accept any other direct or indirect benefits. An exception can be made for symbolic gifts that are given as a common courtesy or sou- venirs that are given during official events. These exceptions should be described in by-laws or other internal documents of the company. 181 OECD Principles of Corporate Governance, Annotations to Principle V.A. on the Responsibility of the Board. See also: www.oecd.org. 182 FCSM Code, Chapter 3, Section 3.1.3. 183 OECD Principles of Corporate Governance, Annotations to Principle V.B. on the Responsibility of the Board. See also: www.oecd.org. 62 Part_II_Ch-04-06.indd 62 Part_II_Ch-04-06.indd 62 17.09.2004 11:33:18 17.09.2004 11:33:18 Chapter 4. The Supervisory Board a) Conflicts of Interest A director should not discharge his duties if there is a conflict of interest between him and the company and its shareholders. Best Practices: A conflict of interest may arise when:184 · The company enters into a transaction in which a director is inter- ested; · A director, directly or indirectly, acquires shares of the company; · A director accepts an official position on the Supervisory Board of a com- peting company; and/or · When a director enters into contractual relations with a competing com- pany. The Company Law addresses the issue of conflicts of interest within the con- text of related party transactions.185 For more information on related party transactions and the role of directors in such transactions, see Part III, Chapter 12, Section C.3. Directors should refrain from actions that may potentially result in a con- flict between their own interests and the interests of the company. They are also advised to refrain from voting in situations where they have a personal interest in the matter in question. Directors should immediately inform the Supervisory Board through the Corporate Secretary about any potential conflicts of interest. A director must disclose to the Supervisory Board, the Revision Commission and the External Auditor information about:186 · Legal entities in which he, either individually or together with affiliated par- ties, possesses at least 20% of the equity;187 184 FCSM Code, Chapter 3, Section 3.1.4. 185 LJSC, Article 83, Clauses 2 and 3. 186 LJSC, Article 82. 187 However, holdings of less than 20% of the equity in other legal entities should not be neces- sarily construed as an absence of a potential conflict of interest. 63 Part_II_Ch-04-06.indd 63 Part_II_Ch-04-06.indd 63 17.09.2004 11:33:18 17.09.2004 11:33:18 The Russia Corporate Governance Manual · Legal entities in which he holds a position in the Supervisory Board and/or executive bodies; and · Any pending or planned transactions of the company in which he can be considered an interested party. b) Confidentiality of Information Best Practices: Directors should not disclose confidential information or use their access to company information for their personal interests or the interests of third parties. The personal use of confidential information ultimately damages shareholders.188 It is recommended that:189 · Directors take steps to protect confidential information; · Directors not disclose information or use it in their own interests; · Standards for the use of confidential information be specified in the internal documents of the company; and · Contracts between the company and directors stipulate the obligation of directors to not disclose confidential information for a period of ten years after they leave the company. To create an effective mechanism to prevent the unauthorized use of confiden- tial information, the company should require directors to:190 · Notify the Supervisory Board in writing of their intention to enter into trans- actions that involve securities of the company or its subsidiaries; and · Disclose information about previous transactions with securities of the com- pany in accordance with the procedures for disclosing material facts as specified by securities legislation. c) Formalization of the Duties of Directors Best Practices: The company should develop and incorporate into its internal documents a list of clearly defined duties of Supervisory Board members.191 For a list of duties of directors, see the model by-law for the Supervisory Board in Part VI, Annex 6. 188FCSM Code, Chapter 3, Section 3.3. 189FCSM Code, Chapter 3, Section 3.3. 190FCSM Code, Chapter 3, Section 3.3. 191FCSM Code, Chapter 3, Section 3.4. 64 Part_II_Ch-04-06.indd 64 Part_II_Ch-04-06.indd 64 17.09.2004 11:33:18 17.09.2004 11:33:18 Chapter 4. The Supervisory Board 3. Director Access to Information Best Practices: It is essential for directors to have access to the information they need to properly discharge their duties, including full and accurate re- sponses to their inquiries from members of the executive bodies, and other company officers.192 The company should create a mechanism to ensure that directors are provided with information about the most important financial and business developments of the company, as well as other developments that may have an impact on shareholder interests. The by-laws or other internal documents should provide that the General Director, Executive Board members, and heads of major divi- sions have the duty to promptly submit full and reliable information to the Su- pervisory Board.193 The company's internal documents should include the right of directors to de- mand information from the executive bodies.194 See Part VI, Annex 6 for a model by-law for the Supervisory Board and a list of materi- als to be made available to directors prior to Supervisory Board meetings. 4. Liabilities of Directors Directors can be held liable for losses caused to the company resulting from their wrongful behavior.195 The preconditions for establishing liability are: · Specific conduct or a failure to act; · Fault, including both negligent and intentional conduct; · Losses to the company; and · Causality between the director's behavior and losses. If there are several directors that caused losses to the company, they are jointly and severally liable.196 The representatives of state or municipal entities on 192 FCSM Code, Chapter 3, Section 4.6. 193 FCSM Code, Chapter 3, Section 4.6. 194 FCSM Code, Chapter 3, Section 3.4. 195 LJSC, Article 71, Clause 2; CC, Article 401, Clause 1. 196 LJSC, Article 71, Clause 4. 65 Part_II_Ch-04-06.indd 65 Part_II_Ch-04-06.indd 65 17.09.2004 11:33:18 17.09.2004 11:33:18 The Russia Corporate Governance Manual the Supervisory Board are liable to the same extent as other directors.197 It is important that customary business practices and other relevant circumstances be taken into consideration to determine the grounds and the amount of liability of directors.198 Best Practices: The company should:199 · Encourage directors to perform their duties in a proper way; · Take measures to terminate the authority of directors who are responsible for inflicting losses; and · Hold directors responsible when they do not fulfill their obligations towards the company. 5. When Directors Are Relieved from Liability Managing the affairs of a company is a complex process with the risk that decisions made by the Supervisory Board, acting reasonably and in good faith, will ultimately prove wrong and entail adverse consequences for the company. Directors cannot generally be held liable for decisions made in good faith. Moreover, directors cannot be held liable for losses if they:200 · Voted against the decision taken by the Supervisory Board that resulted in adverse circumstances; or · IftheydidnotparticipateintheSupervisoryBoardmeetingwhensuchadecision was made. (This means that the presence of the directors was not counted for the quorum of the Supervisory Board meeting.) Directors are not relieved from liability after they have resigned from the Supervisory Board or when they are dismissed from the Supervisory Board for actions and decisions made during their tenure as a director. 197LJSC, Article 71, Clause 6. 198LJSC, Article 71, Clause 3. 199FCSM Code, Chapter 3, Sections 6.1.1 and 6.1.2. 200LJSC, Article 71, Clause 2. 66 Part_II_Ch-04-06.indd 66 Part_II_Ch-04-06.indd 66 17.09.2004 11:33:18 17.09.2004 11:33:18 Chapter 4. The Supervisory Board 6. Who Can File a Claim Against Directors The company or a shareholder (or a group of shareholders) holding at least 1% of common shares have the right to file a claim in court against directors to cover the losses of the company that resulted from decisions taken by the Super- visory Board.201 7. The Minutes of Supervisory Board Meetings and Director Liability Best Practices: To effectively enforce provisions that regulate the liability of directors, it is recommended that the company keep detailed minutes (and possibly verbatim reports) of meetings.202 As stated above, if a decision passed by the Supervisory Board results in the company incurring losses, only those directors who voted for such a decision are liable. Therefore, it is important for the Supervisory Board to keep detailed minutes of Supervisory Board meetings to determine who voted for a certain decision and who can be held liable.203 8. Protection from Liability for Directors Best Practices: Most companies should allow their directors to protect them- selves from, or at least limit the liability for, losses incurred while they fulfilled their duties. Such mechanisms are:204 · Officer and director liability insurance; and · Provisions in the charter and by-laws that indemnify directors against claims, litigation expenses, and liabilities in certain circumstances. 201 LJSC, Article 71, Clause 5. 202 FCSM Code, Chapter 3, Section 4.16.1. 203 FCSM Code, Chapter 3, Section 4.16.1. 204 In Western companies, directors are often protected by the presumption that if they acted in good faith and in a manner they considered to be in the best interests of the com- pany, they should not be held liable for losses caused to the company by their decisions. This is called the "business judgment rule" and it can be used to protect directors from liability. 67 Part_II_Ch-04-06.indd 67 Part_II_Ch-04-06.indd 67 17.09.2004 11:33:18 17.09.2004 11:33:18 The Russia Corporate Governance Manual Companies may reimburse a director for expenses incurred in defending a claim related to his role as a Supervisory Board member, if he acted: · Honestly; · In good faith; · In the best interests of the company; and · In compliance with law, the charter, and by-laws. A company may wish to obtain liability insurance for directors to cover the risk that their actions might result in losses to the company or third parties. Liability insurance for directors should allow the company to use civil law remedies more productively. It is also often needed to attract competent directors.205 G. Evaluation and Education of the Supervisory Board and Directors To be effective, Supervisory Boards should have the necessary resources to develop and maintain the knowledge and skills of its directors. Training programs, based on periodic evaluations of the Supervisory Board and its members, are fundamen- tal to this end. Best Practices: The importance of Supervisory Board evaluations is widely recognized in the international business community. The FCSM Code also recommends that:206 · The Supervisory Board evaluate its performance annually; and · The annual report reflect the results of the performance evaluation. The performance evaluation of the Supervisory Board and its members may be carried out by: · Directors through self-evaluation; and/or · Consultants, professional associations, and corporate governance rating organizations. 205FCSM Code, Chapter 3, Section 6.1.2. 206FCSM Code, Chapter 3, Section 5.1.3. 68 Part_II_Ch-04-06.indd 68 Part_II_Ch-04-06.indd 68 17.09.2004 11:33:18 17.09.2004 11:33:18 Chapter 4. The Supervisory Board An alternative approach calls for confidential Supervisory Board peer evaluations coordinated by an external party, such as legal counsel or specialized consultants. 1. Self-Evaluation by the Supervisory Board A self-evaluation is a useful tool for the Supervisory Board to privately assess the quality of its work. Through critical reflection and self-evaluation, directors can be more responsive to shareholders, investors, and other stakeholders. Self-evalu- ation methods include: · Organizing a retreat and inviting an outside facilitator; · Organizing a special Supervisory Board meeting to evaluate the work of the Supervisory Board or, alternatively, setting aside time during a regular meeting to address performance issues; · Designing checklists that Supervisory Board members can use to assess their work; and · Participating in specialized training programs, thereby providing directors the opportunity to critically reflect on their performance, and develop and share new ideas. See the model checklist for the Supervisory Board's self-evaluation in Part VI, Annex 17. Best Practices: Another useful way to evaluate the Supervisory Board is to invite a consultant, advisor, institute of directors, or rating agency to independ- ently assess the Supervisory Board. Rating agencies for example, not only evaluate the Supervisory Board, but also evaluate other aspects of the com- pany's corporate governance system. 2. Education and Training The evaluation of the Supervisory Board and its members can reveal important insights into the Board's strengths and weaknesses. This information can also be used by the Supervisory Board to identify training needs, both collectively and individually. Corporate training events take on added importance in the context of transition economies, as directors need to be kept abreast of changes to the legal and regulatory framework, as well as best practices. All this makes a company 69 Part_II_Ch-04-06.indd 69 Part_II_Ch-04-06.indd 69 17.09.2004 11:33:19 17.09.2004 11:33:19 The Russia Corporate Governance Manual education policy for the Supervisory Board and its directors a key success factor in developing and supporting a competent, knowledgeable, and vigilant Board.207 Company Practices in Russia: Only 5.6% of companies organized paid train- ing events for directors during 2002.208 On average, such companies spent U.S. $ 9,671 per year. Larger companies tend to pay more attention to the organization of trainings for directors. 14% of companies with over U.S. $ 3.3 million in turnover organized trainings on corporate governance for their directors during the last year, compared to 6.1% of companies with turnover of U.S. $ 1.6 to 3.3 million. Even fewer companies (3.9%) used the services of consulting firms to assist them on corporate governance issues. Overall, fees spent on consulting ser- vices were U.S. $ 15,333 on average per company per year. H. The Remuneration of Directors Directors may be remunerated for their work. The amount of such remuneration is determined by the GMS.209 The issue of director remuneration is one of the more contentious in the field of corporate governance, and companies are advised to choose a cautious and circumspect approach to the question of Supervisory Board remuneration. Exces- sive compensation plans are often perceived as an unjustified privilege of power. As a consequence, it is of the utmost importance that director compensation be competitive, yet stay within reasonable limits. An important distinction in this respect must however be made between executive and non-executive directors. As a rule, executive directors do not receive additional fees for their participation on the Supervisory Board. Their executive compensation packages are generally thought to include Supervisory Board duties. Non-executive directors, on the other hand, should be remunerated. The most 207At present, there are several organizations that offer director education programs in Russia, including the Independent Director Association (www.independentdirector.ru) and the Rus- sian Institute of Directors (www.rid.ru). The IFC and its Russia Corporate Governance Program also offer corporate training events on corporate governance (www.ifc.org/rcgp). 208IFC Survey on Corporate Governance Practices in Russia's regions, Section 2.2.1, pages 26­27, August 2003 (see www.ifc.org/rcgp). 209LJSC, Article 64, Clause 2. 70 Part_II_Ch-04-06.indd 70 Part_II_Ch-04-06.indd 70 17.09.2004 11:33:19 17.09.2004 11:33:19 Chapter 4. The Supervisory Board common form of remuneration for non-executive directors is a monetary fee. For example, directors can receive: · An annual fee (which may be paid in the form of shares in lieu of cash); · A fee, based upon meeting attendance; · Fees for additional work, such as for work on Supervisory Board committees; and · Fees for additional responsibilities, such as for serving as the Chairman of the Supervisory Board or one of its committees. Directors can also be reimbursed for travel costs and other business expenses. Best Practices: The remuneration payable to directors should be equal for all non-executive directors.210 Moreover, the fees that a company pays should be competitive, i.e. sufficient to attract competent individuals. They should be set so that they are neither very much below nor above director fees paid at a peer group of companies. Setting a reasonable level of director remuneration is particularly important in order not to jeopardize the special status of independ- ent directors. Independent or not, a director's judgment may be clouded if he receives a significant percentage of his total income in the form of a director fee. A director who relies on Board compensation for his livelihood will soon become beholden to the company, and may not be relied upon to fill his re- sponsibilities in an unbiased manner. The Supervisory Board should regularly review the remuneration of directors. Best Practices: Ideally, this should be done either by a remuneration commit- tee, composed entirely of independent directors, or by the independent directors. The company should disclose its remuneration plan and the remuneration of each director, either on an individual basis or in the aggregate, in its annual report. The former is easiest to implement when all Board members receive the same fees with a simple statement in the annual report: "All non-executive directors receive fees of RUR _____ per year." Great care needs to be exercised in establishing performance-based remunera- tion, in particular, stock-based remuneration. Performance-based remuneration is generally considered a factor that impinges director independence. 210 FCSM Code, Chapter 3, Section 5.1. 71 Part_II_Ch-04-06.indd 71 Part_II_Ch-04-06.indd 71 17.09.2004 11:33:19 17.09.2004 11:33:19 The Russia Corporate Governance Manual Best Practices: While stock-based remuneration is common in the U.S., it is a good deal less common elsewhere and considerable controversy still surrounds it. Stock-based remuneration plans and, in particular, stock option plans are complex arrangements. While they are generally thought to provide incentives for managers and directors, they can also have a significant impact upon the company and shareholders. · Stock options, it is argued, cause directors to focus on short-term perform- ance and stock price movements. · If stock option grants are large, they may also create complicity between directors and executives who stand to make enormous sums from short-term price movements. · Shareholders risk share dilution when large option plans are granted. · Finally, large option grants have not prevented managers from manipulating companies and financial information to their benefit. Consequently, option plans are coming under increasing scrutiny. Such plans require careful consideration, good planning, and special disclosure. Companies may be best served by avoiding stock options for directors. If a company chooses to implement stock option plans, it should be transparent about the costs in terms of share dilution. The company should also be transpar- ent about the accounting methods used to measure the costs of stock and option grants. Best practices would call for shareholder approval of stock- or option- based compensation plans that could dilute shareholder value or affect profits. Personal loans or credits to the company's directors are also a minefield and a potential source of controversy that companies would be well advised to avoid. Company Practices in Russia: Some 70% of companies do not have a re- muneration policy for Supervisory Board members.211 The average annual compensation of Supervisory Board members in companies with less than 1,000 shareholders is U.S. $ 475. Larger companies tend to pay higher fees. Com- panies with over 1,000 shareholders pay fees of U.S. $ 1,200 per annum. The low level of remuneration compared to the importance of the Supervisory Board is striking. Whatever the explanation, it seems clear that director remu- neration needs to receive greater attention. Transparent systems of remunera- tion, capable of attracting qualified directors, need to be put in place. 211IFC Survey on Corporate Governance Practices in Russia's Regions, Section 2.2.1, page 21, August 2003 (see www.ifc.org/rcgp). 72 Part_II_Ch-04-06.indd 72 Part_II_Ch-04-06.indd 72 17.09.2004 11:33:19 17.09.2004 11:33:19 Chapter 4. The Supervisory Board Finally, as a matter of good practice, directors that are remunerated for their services should sign a contract with the company. I. Summary Checklist to Determine the Supervisory Board's Effectiveness212 Questions Yes No 1. Has the Supervisory Board recently devoted a significant amount of time and serious thought to the company's longer-term objectives, and to the strategic options open to it for achieving them? If so, have these delib- erations resulted in a Board consensus or decision on its future objectives and strategies, and have these been put in writing? 2. Has the Supervisory Board consciously thought about and reached formal conclusions on what is sometimes referred to as its basic corporate phi- losophy that is, its value system, its ethical and social responsibilities, its desired `image' and so forth? If so, have these conclusions been set forth in explicit statements of policy, for example, in respect of terms of employ- ment? Does the company have formal procedures for recording and promulgating major Supervisory Board decisions as policy guidelines for line managers? 3. Does the Supervisory Board periodically review the organizational structure of the company, and consider how this may have to change in future? Does it review and approve all senior appointments as a matter of course? Are adequate human resource development programs in place? 4. Does the Supervisory Board routinely receive all the information it needs to ensure that it is in effective control of the company and its management? Have there been any unpleasant surprises, for example, unfavorable results or unforeseen crises that could be attributed to a lack of timely or accurate information? 5. Does the Supervisory Board routinely require the General Director to present his annual plans and budgets for their review and approval? Does the Board regularly monitor the performance of the General Director and his immediate subordinate managers in terms of actual results achieved against agreed plans and budgets? 212 Source: Parker, Hugh, Letters to a New Chairman, (1990) London: Director Publications, pp. 12­14. (As cited in Cadbury, Adrian, Corporate Governance and Chairmanship, (2002) Oxford University Press, pp. 47­48.) 73 Part_II_Ch-04-06.indd 73 Part_II_Ch-04-06.indd 73 17.09.2004 11:33:19 17.09.2004 11:33:19 The Russia Corporate Governance Manual 6. When the Supervisory Board is required to take major decisions on ques- tions of future objectives, strategies, policies, major investments, senior appointments, etc., does it have adequate time and knowledge to make these decisions soundly -- rather than finding itself overtaken by events and, in effect, obliged to rubber-stamp decisions already taken or commit- ments already made? If the answers to all of these questions are yes, it is safe to say that the com- pany's Supervisory Board can be considered effective. If the answers are negative, or perhaps not clear, then the company needs to re-evaluate the composition and role of its Supervisory Board. 74 Part_II_Ch-04-06.indd 74 Part_II_Ch-04-06.indd 74 17.09.2004 11:33:19 17.09.2004 11:33:19 ChapterChapter 5 The Executive Bodies Part_II_Ch-04-06.indd 75 Part_II_Ch-04-06.indd 75 17.09.2004 11:33:19 17.09.2004 11:33:19 Table of Contents A. THE EXECUTIVE BODIES AND THEIR AUTHORITIES........................................78 1. The Authority of the General Director...................................................80 2. The Authority of the Executive Board ...................................................80 3. The Authority and Qualifications of the External Manager...................83 B. THE COMPOSITION OF THE EXECUTIVE BODIES.............................................84 1. Who Can Be a General Director or an Executive Board Member..................................................................................................84 2. Qualifications of the General Director and Executive Board Members................................................................................................85 3. The Composition of the Executive Board..............................................86 C. THE FORMATION AND TERMINATION OF THE EXECUTIVE BODIES...................87 1. The Election of the Executive Bodies by the General Meeting of Shareholders......................................................................................88 2. The Appointment of the Executive Bodies by the Supervisory Board......91 D. THE WORKING PROCEDURES OF THE EXECUTIVE BODIES.............................92 1. The Chairman of the Executive Board...................................................92 2. Executive Board Meetings .....................................................................92 3. The Right to Call an Executive Board Meeting.....................................93 4. Meeting Notification...............................................................................94 5. The Quorum of Executive Board Meetings ...........................................94 6. Voting During Executive Board Meetings..............................................95 7. The Minutes of Executive Board Meetings ...........................................95 E. THE DUTIES AND LIABILITIES OF THE MEMBERS OF THE EXECUTIVE BODIES...........................................................................96 F. PERFORMANCE EVALUATIONS........................................................................96 G. THE REMUNERATION AND REIMBURSEMENT OF THE EXECUTIVE BODIES.......97 1. Remuneration Policy..............................................................................98 2. Employment Contracts for Executives...................................................99 3. Severance Payments to the General Director and Executive Board Members ...................................................................................101 Part_II_Ch-04-06.indd 76 Part_II_Ch-04-06.indd 76 21.09.2004 16:00:10 21.09.2004 16:00:10 The Chairman's Checklist Does the company have a clear delineation and separation of authorities between shareholders, directors, and managers? Has the company properly established an Executive Board? Does the charter clearly dis- tinguish the powers of the General Director from those of the Executive Board? Do the General Director and all Executive Board members possess the knowledge and skills necessary to manage the company? Do they perform their functions on a full-time basis? Is there a transparent division of tasks among the Executive Board members, such as operations, marketing, fi- nance, and legal? Who elects members of the executive bodies? Is the General Director suf- ficiently involved in the nomination process or other executives? Do the executive bodies meet regularly to discuss the affairs of the com- pany? Are these meetings well prepared with an agenda and reference materials distributed in advance (in writing and/or electronically)? Do the General Director and the Executive Board regularly and adequately inform the Supervisory Board about all operations of the company? Do the executive bodies provide all relevant information to the Supervisory Board, the Revision Commission, and the External Auditor in a timely manner? Do all members of the executive bodies clearly understand their duties to act reasonably and in good faith in the best interests of the company? Does the Supervisory Board take measures to ensure that managers who fail to act in accordance with these duties are held liable under civil, ad- ministrative, and/or criminal law? Are thorough performance reviews of the executive bodies based on key performance indicators periodically conducted? Does the Supervisory Board rigorously evaluate executives at least annually, if not more frequently? Does the Supervisory Board clearly link performance and remuneration when deciding on executive remuneration? Do all directors fully understand how stock options function? Are all direc- tors and shareholders aware of the different methods of recording and re- porting the cost of stock options? Has the Supervisory Board critically examined the use of options as an incentive tool, ensured that option grants are not merely a management giveaway, and communicated this fully and effectively to shareholders? 77 Part_II_Ch-04-06.indd 77 Part_II_Ch-04-06.indd 77 17.09.2004 11:33:20 17.09.2004 11:33:20 The Russia Corporate Governance Manual The executive bodies manage the company's day-to-day activities. They implement the strategic direction set out by the Supervisory Board and/or the General Meeting of Shareholders (GMS), and are an essential part of the com- pany's governance structure.213 This chapter describes the authorities, composition, formation, and working procedures of executive bodies, as well as their interac- tion with the Supervisory Board, their duties and liabilities, evaluation, and re- muneration. A. The Executive Bodies and Their Authorities According to the Company Law, executive bodies can be either:214 · A single-person executive body, i.e. General Director; or · A collective executive body, i.e. the Executive Board, consisting of the General Director and one or more managers. A company must always have a General Director. The formation of the Ex- ecutive Board and the employment of an External Manager are, on the other hand, optional. Best Practices: The Federal Commission for the Securities Market's Code of Corporate Conduct (FCSM Code) recommends that the company establish an Executive Board.215 It argues that the management of the company's day-to-day activities is complex, requiring a collective rather than individual approach. An Executive Board also facilitates discussion and coordination among key manag- ers on important issues. The Executive Board assembles the key resources at the General Director's disposal to help achieve the company's goals. As a rule, the executive bodies have the authority to decide all issues that do not fall under the authority of the GMS and/or the Supervisory Board.216 Matters 213Law on Joint Stock Companies (LJSC), Article 69, Clauses 1 and 2; FCSM Code, Chapter 4, Introduction. 214LJSC, Article 69, Clause 1. 215FCSM Code, Chapter 4, Section 1.1. 216LJSC, Article 69, Clause 2, Paragraph 1. 78 Part_II_Ch-04-06.indd 78 Part_II_Ch-04-06.indd 78 17.09.2004 11:33:20 17.09.2004 11:33:20 Chapter 5. The Executive Bodies that do fall within the authority of the GMS and/or the Supervisory Board cannot be delegated to the executive bodies.217 Furthermore, the charter must specify the authority of the executive bodies.218 Company Law allows the company to employ an External Manager, which is typically either a commercial organization (management organiza- tion) or an individual entrepreneur (manager), to fulfill the role of an exe- cutive body. Company Practices in Russia: An ever increasing number of Russian com- panies have Executive Boards. A survey of governance practices in Russia's regions shows that the larger the company, the more likely it is to have an Executive Board.219 Larger companies may need an Executive Board to deal with more complex business models and organizational structures. Smaller companies typically have simpler business models and fewer resources to es- tablish formal structures. (See Figure 1.) Figure 1: Existence of an Executive Board (EB) EB an Have That Companies of % 50­1000 1001­10,000 more than 10,000 Number of Shareholders Source: IFC, Regional Survey on Corporate Governance Practices, August 2003 217 LJSC, Article 48, Clause 2; Article 65, Clause 2. 218 LJSC, Article 11, Clause 3, Paragraph 1. 219 IFC Survey on Corporate Governance Practices in Russia's regions, Section 2.2.2, page 29, August 2003 (see www.ifc.org/rcgp). 79 Part_II_Ch-04-06.indd 79 Part_II_Ch-04-06.indd 79 17.09.2004 11:33:20 17.09.2004 11:33:20 The Russia Corporate Governance Manual Best Practices: The work of the executive bodies should be guided by a finan- cial and business plan that is approved annually by the Supervisory Board.220 The financial and business plan should contain basic guidelines for the daily operations of the company. Good corporate governance principles further rec- ommend that:221 · The General Director and Executive Board seek the approval of the Super- visory Board for transactions that fall outside the scope of the financial and business plan (non-standard operations);222 · The company develop by-laws or other internal documents detailing proce- dures for the General Director and Executive Board to obtain such ap- proval from the Supervisory Board; and · The Supervisory Board have the right to veto decisions made by the General Director and Executive Board to implement non-standard opera- tions. 1. The Authority of the General Director The authority of the General Director is defined by the Company Law and sum- marized in Figure 2.223 2. The Authority of the Executive Board If the company establishes an Executive Board, the charter must define the authority of the General Director and the Executive Board,224 in particular since the Company Law does not do so. Such division of authority is at the discre- tion of the company. 220FCSM Code, Chapter 1, Section 7.1. 221FCSM Code, Chapter 4, Section 1.2. 222FCSM Code, Chapter 8, Section 2.2.3. 223LJSC, Article 69, Clause 2, Paragraphs 1­3; Article 88, Clause 2. FCSM Regulation No. 17/ps on Additional Requirements to the Procedure of Preparing, Calling, and Conducting the General Meeting of Shareholders, 31 May 2002, Section 3.7. 224LJSC, Article 69, Clause 1, Paragraph 2. 80 Part_II_Ch-04-06.indd 80 Part_II_Ch-04-06.indd 80 17.09.2004 11:33:20 17.09.2004 11:33:20 Chapter 5. The Executive Bodies Figure 2: The Authorities of the General Director Manages the day-to-day activities of the company Acts on behalf of the company Conducts transactions on behalf with statutory power of attorney, of the company, subject to the including representation of the restrictions stipulated by the company in Russia and abroad Company Law and the charter The General Approves staffing structures Leads and guides employees Director: Submits the annual report and Presides over Executive Board financial statements to authorities meetings when the company has formed one Signs the annual financial statements Source: IFC, March 2004 Best Practices: The company charter should define the Executive Board's authority to:225 · Develop documents on the priority area(s) of the company's operations; · Develop the business plan(s) of the company; · Approve by-laws or other internal documents; · Approve transactions with a value of 5% and more of the company's assets with the requirement that the Supervisory Board be immediately notified; · Approve real estate transactions and loans that are not part of the ordinary course of business; · Appoint the heads of the company's branches and representative offices; · Approve issues on the agenda of the GMS of wholly-owned subsidiaries unless these issues must be approved by the Supervisory Board of the parent company; · Appoint individuals who represent the company during the GMS of wholly- owned subsidiaries and instruct them on how to vote during the GMS; · Nominate candidates for the General Director, the Executive Board, the External Manager, the Supervisory Board, and other governing bodies of wholly-owned subsidiaries; 225 FCSM Code, Chapter 4, Sections 1.1.2 -- 1.1.5. 81 Part_II_Ch-04-06.indd 81 Part_II_Ch-04-06.indd 81 17.09.2004 11:33:21 17.09.2004 11:33:21 The Russia Corporate Governance Manual · Approve internal work schedules; · Approve job descriptions for all management-level employees of the com- pany; · Approve employment contracts for mid-level managers; and · Approve collective labor contracts. Company Practices in Russia: Both the Company Law and the FCSM Code define the authorities of the governing bodies. However, these bodies often confuse their authorities in practice. This holds particularly true for executive bodies. While misunderstandings may go unnoticed, they are technically illegal and may result in the reversal of decisions and, in some cases, even litigation. Figure 3 illustrates how executive boards in a sample of Russian companies have assumed some powers of the Supervisory Board and the GMS.226 Figure 3: Functions Performed by Executive Boards (EB) Approves Operational Plans of the Company Controls Internal Audit Approves Extraordinary Transactions Approves Annual Budgets of the Company Initiates Unscheduled Audits Elects the Independent External Auditor Elects & Dismisses Managers/ Executive Board Members Elects and Dismisses the Head of the Executive Board Elects and Dismisses the Chairman of the Supervisory Board Elects and Dismisses Executive Board Members Approves Additional Issue Not an Authority of the EB of Company Shares % of Executive Boards Source: IFC, Regional Survey on Corporate Governance Practices, August 2003 226 IFC Survey on Corporate Governance Practices in Russia's regions, Section 2.2.2, page 30, August 2003 (see www.ifc.org/rcgp). 82 Part_II_Ch-04-06.indd 82 Part_II_Ch-04-06.indd 82 17.09.2004 11:33:21 17.09.2004 11:33:21 Chapter 5. The Executive Bodies 3. The Authority and Qualifications of the External Manager The GMS can delegate the authority of the General Director to an External Ma- nager by written agreement.227 Best Practices: The GMS can only delegate the authority of the single-person executive body. Thus, in cases when the General Director is the Chairman of the Executive Board, the GMS must first dissolve the Executive Board and then delegate the General Director's authority. The GMS can only decide on the delegation of the authority of the General Director to an External Manager upon the recommendation of the Supervisory Board. Best Practices: The Supervisory Board should provide the GMS with a clear justification for the use of an External Manager and explain the:228 · Reasons; · Risks; · Costs; · Individuals who are accountable to the Supervisory Board on behalf of the External Manager; · Other companies that are managed by the External Manager; and · Identity of the Supervisory Board members, executive bodies and major shareholders of the External Manager, as well as any and all information that may be required to identify potential conflicts of interests. The External Manager fulfills the functions of the General Director and is accountable to the Supervisory Board and the GMS. The Company Law does not specify the requirements of the agreement with the External Manager other than that the Chairman, or another individual who is duly authorized, sign the contract on behalf of the company.229 227 LJSC, Article 69, Clause 1, Paragraph 3. 228 FCSM Code, Chapter 1, Section 4.2; Chapter 4, Sections 2.1.7 ­ 2.1.9. 229 LJSC, Article 69, Clause 3, Paragraph 2. 83 Part_II_Ch-04-06.indd 83 Part_II_Ch-04-06.indd 83 17.09.2004 11:33:21 17.09.2004 11:33:21 The Russia Corporate Governance Manual Best Practices: The Supervisory Board and the GMS should have access to:230 · Documents that prove that the External Manager has sufficient financial resources or adequate liability insurance in the event of failure to perform obligations in accordance with the contractual agreement with the company, as well as the External Manager's financial statements; · The charter of the External Manager (if it is a legal entity); and · The contract with the External Manager including the:231 - Goals that the External Manager is asked to achieve; - Remuneration of the External Manager; - Standards of liability applicable to the External Manager; - Procedures for the removal of the External Manager (contract termi- nation clause); - List of reports, which the External Manager must submit to the Su- pervisory Board and the GMS, including the periodicity of these re- ports. Further, the External Manager should not work for a competing company in any capacity or have any significant connections with such company. The GMS may terminate the authority of the External Manager at any time.232 Note that the contractual agreement between the company and External Manager will also need to be terminated and that (additional) compensation may be payable to the External Manager for premature termination of his employment agreement. B. The Composition of the Executive Bodies 1. Who Can Be a General Director or an Executive Board Member Any individual can be the General Director or an Executive Board member. Re- strictions do, however, exist: · Only individuals with "full dispositive capacity" can be members of the exe- cutive bodies. This means that a person must have the capacity to acquire 230FCSM Code, Chapter 4, Section 2.1.9. 231FCSM Code, Chapter 4, Section 2.1.10. 232LJSC, Article 69, Clause 4, Paragraph 1. 84 Part_II_Ch-04-06.indd 84 Part_II_Ch-04-06.indd 84 17.09.2004 11:33:21 17.09.2004 11:33:21 Chapter 5. The Executive Bodies and exercise civil law rights by his actions, be able to create for himself civil law obligations, and be able to fulfill these rights and obligations;233 · A legal entity cannot be an Executive Board member; · The Chairman of the Supervisory Board cannot be the General Director;234 · Revision Commission members cannot be a member of the executive bodies;235 · Counting Commission members cannot be a member of the executive bodies;236 and · A member of the company's executive bodies can only be a member of the executive bodies or Supervisory Board of another company after the Supervisory Board has given its consent.237 Best Practices: Best practices dictate that individuals should not be appointed to executive bodies when they are:238 · Directors of a competing company; · Managers of a competing company; or · Employees of a competing company. The General Director should not be engaged in any business activities other than those related to the management of the company and the governance of its subsidiaries.239 2. Qualifications of the General Director and Executive Board Members Members of the executive bodies can only be effective when they have adequate financial and human resources, as well as the necessary knowledge, skills, time, and experience to exercise their duties.240 233 Civil Code (CC), Article 21. 234 The General Director can, however, hold any other position on the Supervisory Board, includ- ing the position of Deputy Chairman. 235 LJSC, Article 85, Clause 6. 236 LJSC, Article 56, Clause 2. 237 LJSC, Article 69, Clause 3, Paragraph 4. 238 FCSM Code, Chapter 4, Section 2.1.3. 239 FCSM Code, Chapter 4, Section 2.1.4. 240 FCSM Code, Chapter 1, Section 4.2; Chapter 4, Section 2.1.4. 85 Part_II_Ch-04-06.indd 85 Part_II_Ch-04-06.indd 85 17.09.2004 11:33:21 17.09.2004 11:33:21 The Russia Corporate Governance Manual Best Practices: The charter or by-laws should specify the qualifications of members of the executive bodies as well as heads of major divisions.241 Mem- bers of the executive bodies, including the External Manager, should generally satisfy the following requirements:242 · To enjoy the trust of shareholders, directors, other managers, and employees of the company; · To own the ability to relate to the interests of all stakeholders and to make well-reasoned decisions; · To possess the professional expertise and education to be an effective General Director and manager; · To possess (international) business experience, knowledge of national eco- nomic, political, legal, and social issues, as well as trends and knowledge of the market, products, and competitors (national as well as international); and · To have the ability to translate knowledge and experience into practical solutions that can be applied to the company. Moreover, a background check on candidates should be conducted for a pos- sible record of criminal or administrative offenses. Evidence of such offenses would likely result in the rejection of a candidate. 3. The Composition of the Executive Board The number of Executive Board members, together with their duties and respon- sibilities, is set forth in the company's charter.243 Company Practices in Russia: A Russian company's Executive Board will typically consist of the General Director and between five and seven other members. Figure 4 illustrates the number of Executive Board members in Rus- sian companies of different sizes.244 The size of the Executive Board will need to be adapted to the specific circum- stances of the company and, consequently, will vary in composition. The Ex- ecutive Board might include the following persons: 241 FCSM Code, Chapter 4, Sections 2.1.1 and 2.1.8. 242 FCSM Code, Chapter 4, Section 2.1.4. 243 LJSC, Article 11, Clause 3. 244 IFC Survey on Corporate Governance Practices in Russia's regions, Section 2.2.2, page 29, August 2003 (see www.ifc.org/rcgp). 86 Part_II_Ch-04-06.indd 86 Part_II_Ch-04-06.indd 86 17.09.2004 11:33:22 17.09.2004 11:33:22 Chapter 5. The Executive Bodies · The General Director; Figure 4: The Number of Executive Board (EB) · The Chief Operating Officer; Members · The Chief Financial Officer; · Chief Legal Counsel; · Marketing and Sales Director; Members · Head of Purchasing; EB · Head of Research and Deve- of lopment; · Head of Information Techno- Number logy; The less than 50 51­300 301 and more · Head of Public/Investor Employees number Relations; Source: IFC, Regional Survey on Corporate Governance, August 2003 · Heads of Business/Product Lines; · The General Director of a dependent company or subsidiary; and/or · The Human Resources Director. C. The Formation and Termination of the Executive Bodies The Company Law is flexible on who elects the executive bodies. It allows for the following options:245 · The election of the General Director and Executive Board members by the GMS; or · The election of the General Director and Executive Board members by the Supervisory Board if the charter provides so; or · The election of the General Director by the GMS and of Executive Board members by the Supervisory Board if the charter provides so. Best Practices: High-level personnel decisions, in general, and the selection of Executive Board members, more specifically, are best accomplished by the General Director, in tandem with the Supervisory Board. Personnel decisions 245 LJSC, Article 48, Clause 1, Section 8; Article 65, Clause 1, Section 9; Article 69, Clause 3, Paragraph 1. 87 Part_II_Ch-04-06.indd 87 Part_II_Ch-04-06.indd 87 17.09.2004 11:33:22 17.09.2004 11:33:22 The Russia Corporate Governance Manual should not be political decisions. The assessment of the skills and qualifica- tions of potential Executive Board members is best done by someone who works day in and day out with potential candidates. Shareholders or Super- visory Boards that insist on close control over this process may be better served by developing policies that specify outcomes rather than getting involved in the details of selection. Drafting precise and effective terms of reference for key executive positions is but one example. At the very least, proposals for membership on the Executive Board should be closely coordinated with the General Director, by having him nominate and the Supervisory Board ap- prove candidates. 1. The Election of the Executive Bodies by the General Meeting of Shareholders Best Practices: The involvement of the GMS in the election of executive bod- ies can empower shareholders to decide on who should run the company. It is also better suited to protect the rights of shareholders since they not only vote on managers but also have the right to propose candidates. The FCSM Code recommends that the GMS elect the executive bodies.246 On the other hand, almost every other corporate governance system has the Supervisory Board elect the General Director. The Supervisory Board is in a better position compared to shareholders to set the key criteria for what kind of General Director the company needs, organize proper succession planning, and search for such a person. For this purpose, the Supervisory Board may even establish an independent Nominations Committee, which will be in charge of making a recommendation as to potential candidates for the position of General Director. Shareholder interests are not adversely affected, as the Supervisory Board members are bound by their duties of loyalty and care to act in the best interests of the company and its shareholders. It is especially advisable to delegate this power to the Supervisory Board in countries in tran- sition such as Russia, where Supervisory Boards are nascent in their develop- ment vis-a`-vis controlling shareholders, and need to be strengthened. Finally, because management oversight is one of the Supervisory Board's main au- thorities, the Board's authority to dismiss the General Director should coincide with the authority to elect this important individual. 246 FCSM Code, Chapter 1, Section 4.2. 88 Part_II_Ch-04-06.indd 88 Part_II_Ch-04-06.indd 88 17.09.2004 11:33:22 17.09.2004 11:33:22 Chapter 5. The Executive Bodies Legislation does not specify the minimum and maximum periods for which members of the executive bodies are elected. The charter, by-laws, or the employ- ment agreement can specify the period for which the General Director and Exe- cutive Board members are elected. Members of the executive bodies can be re- elected at will. Company Practices in Russia: In practice, the executive bodies are often elected for a period between three and five years. This is considered sufficient time for a manager to become acquainted with the company's business and not to be constrained by short-term goals. a) Nomination of Candidates for Executive Bodies The procedure for nominating candidates for the executive bodies is discussed in Part III, Chapter 8, Section B.1. b) Information About Candidates for the Executive Bodies Information on candidates for the executive bodies must be submitted to shareholders before the GMS. Best Practices: Shareholders should have the opportunity to receive sufficient information (in writing and/or electronic form) about candidates for the position of General Director and the Executive Board before the GMS. Up-to-date informa- tion should also be made available to all shareholders during the GMS.247 The information about candidates for the executive bodies should include the:248 · Identity of the candidate; · Age and educational background of the candidate; · Position(s) held by the candidate during the last five years; · Position(s) held by the candidate at the moment of his nomination; · Relationship(s) that the candidate has with the company; · Membership(s) of the candidate in the Supervisory Board of other legal entities, or any other positions held in such entities; · Information on the nomination(s) of the candidate for a position in the exe- cutive bodies and other positions of other legal persons; · Relationship(s) of the candidate with affiliated persons; 247 LJSC, Article 52, Clause 3, Paragraph 3. 248 FCSM Code, Chapter 4, Section 2.2.1. See also: LJSC, Article 53, Clause 4. 89 Part_II_Ch-04-06.indd 89 Part_II_Ch-04-06.indd 89 17.09.2004 11:33:22 17.09.2004 11:33:22 The Russia Corporate Governance Manual · Relationship(s) that the candidate has with major business partners of the company; · Information related to the financial status of the candidate and other circum- stances that may affect the duties of the candidate as a member of the executive bodies; and · Refusal of the candidate, if any, to provide information to the compa- ny.249 It is recommended that candidates present a written statement to the GMS that indicates their willingness to accept the position of General Director or Executive Board member, should they be elected.250 In the absence of such statement, candidates should verbally confirm that they are willing to accept the position during the GMS. Companies may include provisions in the charter specifying the information that must be provided to shareholders about candidates for the executive bod- ies.251 c) The Election of the Executive Bodies by Written Consent The Company Law does not prohibit shareholders from electing members of the executive bodies during a GMS that has been conducted without the physical presence of shareholders.252 It is possible, therefore, to elect members of the ex- ecutive bodies during a GMS that has been held by written consent. d) The Election of Members of the Executive Bodies When the Executive Board Has an Insufficient Number of Members If the number of Executive Board members becomes less than the quorum specified by the charter or by-laws, the Supervisory Board must:253 · Appoint an interim Executive Board; and · Organize an Extraordinary General Meeting of Shareholders (EGM) to elect a new Executive Board. 249 FCSM Code, Chapter 4, Section 2.2.1. 250 FCSM Code, Chapter 2, Section 1.3.6. 251 LJSC, Article 53, Clause 4; FCSM Code, Chapter 2, Section 2.1.4. 252 LJSC, Article 50, Clause 2. 253 LJSC, Article 70, Clause 2. 90 Part_II_Ch-04-06.indd 90 Part_II_Ch-04-06.indd 90 17.09.2004 11:33:22 17.09.2004 11:33:22 Chapter 5. The Executive Bodies e) The Suspension of the General Director's Authorities In circumstances where the power to form and terminate executive bodies belongs to the GMS, the charter can provide the Supervisory Board with the au- thority to suspend the powers of the General Director or External Manager. For more information on the suspension and appointment of interim executive bodies, see Chapter 4, Section A.3. f) The Authority of the Interim General Director An interim General Director has the same authority as the General Director unless the charter specifies otherwise.254 Best Practices: An example of a limitation of an interim General Director's authority could be a prohibition to conclude significant transactions without prior Supervisory Board approval, or to conclude transactions in excess of a certain monetary threshold. It is also good practice to limit the power of the interim General Director to make decisions regarding the hiring and firing of personnel. g) The Termination of the Authority of the Executive Bodies The GMS can terminate the authority of executive bodies it has established.255 Members of the executive bodies are dismissed by a simple majority vote of share- holders participating in the GMS.256 The GMS cannot terminate the authority of the executive bodies if the charter gives the Supervisory Board the authority to establish the executive bodies. 2. The Appointment of the Executive Bodies by the Supervisory Board The procedures for the appointment and dismissal of members of the executive bodies are less onerous when the Supervisory Board has the authority to establish executive bodies. When the charter allows, the executive bodies are appointed by the Supervisory Board and can be dismissed at any time by this same body. The company will, however, as mentioned above, need to comply with employment 254 LJSC, Article 69, Clause 4, Paragraph 6. 255 LJSC, Article 48, Clause 1, Section 8. 256 LJSC, Article 49, Clause 2. 91 Part_II_Ch-04-06.indd 91 Part_II_Ch-04-06.indd 91 17.09.2004 11:33:22 17.09.2004 11:33:22 The Russia Corporate Governance Manual contracts regarding notice, cause, and possible severance payments. A simple ma- jority of votes of Supervisory Board members is sufficient to appoint members of the executive bodies, unless the charter or by-laws require a higher percentage.257 D. The Working Procedures of the Executive Bodies 1. The Chairman of the Executive Board The General Director presides over Executive Board meetings.258 For Executive Board meetings, the General Director (or Chairman of the Executive Board) has the authority to:259 · Convene, organize, and preside over Executive Board meetings; · Sign all documents, decisions, and minutes of the Executive Board; and · Perform any other duties as specified in the charter and by-laws. Best Practices: In addition, the Chairman of the Executive Board can: · Facilitate discussions and decision-making, and create a constructive atmos- phere; and · Take steps to ensure that all members are sufficiently prepared to contribute to the work of the Executive Board. 2. Executive Board Meetings The charter and the by-laws shall establish:260 · The frequency of Executive Board meetings; · The procedures for organizing and conducting Executive Board meetings; and · The procedures for making decisions during Executive Board meetings. Best Practices: The precise frequency of meetings should, however, ultimate- ly depend on the unique circumstances of each company. 257LJSC, Article 68, Clause 3. 258LJSC, Article 69, Clause 1. 259LJSC, Article 70, Clause 2. 260LJSC, Article 70, Clause 1. 92 Part_II_Ch-04-06.indd 92 Part_II_Ch-04-06.indd 92 17.09.2004 11:33:23 17.09.2004 11:33:23 Chapter 5. The Executive Bodies Company Practices in Russia: The effectiveness of an Executive Board is likely to be greatly enhanced by frequent meetings. The FCSM Code recom- mends that the Executive Board meet at least once a week.261 The IFC survey shows a large gap between this recommended number and actual practice.262 In fact, only 3% of Executive Boards follow the FCSM Code's recommendation. It is interesting to note that, based on survey results, greater frequency of Exe- cutive Board meetings correlates with an increase in profitability (see Figure 5). Figure 5: Executive Board Meetings and Profitability y Profitabilit less than 5 6­10 11­20 21­50 50 and more Number of Executive Board Meetings Per Year Source: IFC, Regional Survey on Corporate Governance, August 2003 3. The Right to Call an Executive Board Meeting The General Director has the right to convene a meeting of the Executive Board.263 Best Practices: The Executive Board is a hands-on, problem-solving mechanism. Other Executive Board members should also have a voice in calling Executive Board meetings and setting the meeting agenda.264 261 FCSM Code, Chapter 4, Section 4.1.1. 262 IFC Survey on Corporate Governance Practices in Russia's regions, Section 2.2.2, page 29, August 2003 (see www.ifc.org/rcgp). 263 LJSC, Article 70, Clause 2. 264 FCSM Code, Chapter 4, Section 4.1.1. 93 Part_II_Ch-04-06.indd 93 Part_II_Ch-04-06.indd 93 17.09.2004 11:33:23 17.09.2004 11:33:23 The Russia Corporate Governance Manual The charter or by-laws must specify the procedures for convening and con- ducting Executive Board meetings.265 4. Meeting Notification Since the Executive Board is a management tool, it will likely need to respond to the changing demands of the company and its external environment, and be prepared to act quickly. While rapid response is necessary, it may make careful and exten- sive preparation for meetings difficult and, in some cases, impossible. Obviously, Executive Board members should be as well prepared as practical. To the extent possible, they should be notified in advance to give them time to prepare in order to effectively participate in meetings. Best Practices: Executives should not vote on agenda items unless they are well informed. Whenever possible, materials should be sent to Executive Board members in advance, together with the notice and the meeting agenda.266 This may, however, not always be the case and, under some circumstances, sound decision-making may not be possible. Decision-making may be postponed when members: · Cannot be notified in a timely manner; or · Have not received the required information on time; or · Have not been provided with sufficient time to prepare for the meeting. The by-laws or other internal documents should determine the form in which notice and materials are to be delivered to Executive Board members in the most convenient and appropriate way. 5. The Quorum of Executive Board Meetings The quorum of Executive Board meetings refers to the number of members that must participate in the meeting before it can make a valid decision. The charter or by-laws set the quorum, which cannot be less than one half of the total number of Executive Board members.267 Any Executive Board meeting that lacks a quorum cannot make valid decisions. 265LJSC, Article 70, Clause 1. 266FCSM Code, Chapter 4, Sections 4.1.3 ­ 4.1.4. 267FCSM Code, Chapter 4, Section 4.1.4. 94 Part_II_Ch-04-06.indd 94 Part_II_Ch-04-06.indd 94 17.09.2004 11:33:23 17.09.2004 11:33:23 Chapter 5. The Executive Bodies 6. Voting During Executive Board Meetings A simple majority of Executive Board members who participate in the meeting is sufficient to approve Executive Board decisions, unless the charter or by-laws require a supermajority vote.268 The Company Law does not however envisage a supermajority vote for any Executive Board decision. The Company Law prohibits the transfer of the right to vote from one Exe- cutive Board member to another.269 Each Executive Board member has one vote. The charter can specify that the Chairman of the Executive Board can cast a de- ciding vote in the case of a tie. 7. The Minutes of Executive Board Meetings The Executive Board must keep minutes of each of its meetings.270 The Company Law does not specify when the minutes must be prepared, though it stipulates that minutes must be kept in the company archives.271 Best Practices: The minutes of Executive Board meetings should include the following information: · The location and time of the meeting; · The names of the persons present at the meeting; · The agenda of the meeting; · The issues on the agenda, as well as the voting results on an individual basis; · The decisions made by the Executive Board; and · The rationale for the decisions. The Chairman of the Executive Board must sign the minutes.272 The minutes of the Executive Board meeting must be made available upon the request of: · Revision Commission members; · The External Auditor; · Supervisory Board members;273 or 268 LJSC, Article 70, Clause 2, Paragraph 1. 269 LJSC, Article 70, Clause 2, Paragraph 4. See also: FCSM Code, Chapter 4, Section 4.1.6. 270 LJSC, Article 70, Clause 2. 271 LJSC, Article 89, Clause 1. 272 LJSC, Article 70, Clause 2. 273 LJSC, Article 70, Clause 2. 95 Part_II_Ch-04-06.indd 95 Part_II_Ch-04-06.indd 95 17.09.2004 11:33:23 17.09.2004 11:33:23 The Russia Corporate Governance Manual · A shareholder (or a group of shareholders) possessing at least 25% or more of voting shares.274 Best Practices: The minutes of the Executive Board should also be made available to the Control and Revision Service (Internal Audit Function) of the company.275 If the company does not have an Executive Board, the decisions of the Gen- eral Director must also be kept in the company archives. The charter should, in such cases, describe the procedures for the General Director to file his decisions. E. The Duties and Liabilities of the Members of the Executive Bodies The members of the executive bodies have the same duties of care and loyalty as Supervisory Board members, and are subject to the same liability standards as Supervisory Board members, unless either the charter, by-laws, or employment contract provide for stricter standards. For more information about the duties and liabilities of directors, see Chapter 4, Section F. F. Performance Evaluations Periodic performance evaluations of the executive bodies are an important oversight tool. They can help create a system of constant performance management and improvement. Best Practices: The charter or by-laws can stipulate that the performance of the executive bodies be evaluated by the Supervisory Board at least annually, if not more frequently. The Supervisory Board may also find it useful to receive evaluations on the performance of the executive bodies that are carried out by the General Director and Executive Board members themselves, through self-evaluation within the frame- work of the company's HR performance evaluation and planning process. For an example of a self-evaluation framework, see Chapter 4, Section G. 274LJSC, Article 91, Clause 1. 275FCSM Code, Chapter 4, Section 4.1.5. 96 Part_II_Ch-04-06.indd 96 Part_II_Ch-04-06.indd 96 17.09.2004 11:33:23 17.09.2004 11:33:23 Chapter 5. The Executive Bodies G. The Remuneration and Reimbursement of the Executive Bodies The Company Law does not explicitly regulate who determines the remuneration of the executive bodies. Best Practices: Executive remuneration is an important aspect in attracting managerial talent. Excessive executive remuneration packages on the other hand are often perceived as an unjustified privilege of power. Consequently, it is of the utmost importance that executive compensation be competitive, yet stay within reasonable limits, ideally in relation to a peer group of com- panies. The remuneration of executive should not be left to the sole discretion of the executive bodies themselves.276 This should fall under the Supervisory Board's authority.277 Companies should state in their charters that the approval of ex- ecutive remuneration is a prerogative of the Supervisory Board. It is important that the Supervisory Board take into consideration performance-related factors that are based on the company's key performance indicators when determining the remuneration of executives. Some of the issues that have a bearing on remuneration are:278 · Scope of responsibilities; · Required type and level of qualifications; · Experience of the candidates; · Personal and business qualities of the candidates; · Typical level of remuneration in the company and in the industry in general; and · The financial performance of the company. An executive's base salary is usually a function of his background and experi- ence, whereas variable compensation is generally based upon the executive's performance. 276 FCSM Code, Chapter 3, Section 1.4.3. 277 FCSM Code, Chapter 1, Section 3.4. 278 FCSM Code, Chapter 3, Section 4.10.2. 97 Part_II_Ch-04-06.indd 97 Part_II_Ch-04-06.indd 97 17.09.2004 11:33:23 17.09.2004 11:33:23 The Russia Corporate Governance Manual 1. Remuneration Policy The remuneration of managers can consist of both a fixed and a variable com- ponent. The fixed component typically consists of a base salary. The most important factor in determining an executive's base salary is compensation practice among a peer group of similar companies. The most important factor in determining an executive's variable remuneration is his contribution towards the short and long-term financial performance of the company. The variable component often consists of an annual bonus and is based on key performance indicators. Variable compensation has come to represent a large part of an executive's remuneration package in many countries, to better motivate performance. Best Practices: The FCSM Code recommends that remuneration be based upon performance-related criteria.279 There is a multitude of ways to link execu- tive pay to individual and company performance. Some common financial in- dicators utilized in variable compensation plans are: · Earnings before interest, taxes, depreciation and amortization (EBITDA); · Operating profit; · Return on Assets (ROA); · Return on Investment (ROI) or Equity (ROE); · Return on Capital Employed (ROCE); · Economic Value Added (EVA); and · Achievement of specific individual objectives. There are many other financial indicators. Non-financial indicators are equally important and valuable in managing executive performance, and can be organ- ized around: · Customers -- for example, customer satisfaction levels, retention rates and customer loyalty, and acquisition; · Operational processes and efficiency -- for example, quality measures, cycle time measures, cost measures, and after sales service; and · Internal growth/knowledge management -- for example, training programs, employee satisfaction rates, employee absenteeism, and employee turnover. The Supervisory Board will want to carefully develop key performance indicators, and link executive remuneration to these indicators. 279FCSM Code, Chapter 4, Section 5.1.2. 98 Part_II_Ch-04-06.indd 98 Part_II_Ch-04-06.indd 98 17.09.2004 11:33:23 17.09.2004 11:33:23 Chapter 5. The Executive Bodies Moreover, executives often receive benefit plans consisting of a pension plan, medical and dental plan, savings plan, life insurance plan, and a disability plan. Other perquisites for senior executives include club memberships, use of a company car, chauffeurs, and similar perks. Finally, some companies in western countries provide their executives with long-term incentive systems that may include stock options. Best Practices: While remuneration is generally considered a responsibility of the Supervisory Board, stock- and option-based compensation is increasingly an issue for which shareholder approval is required. The reason is that equity compensation contains considerable hidden costs for shareholders. These costs are hidden since accounting practices do not generally reveal the true price-tag of option-based compensation plans. For this reason, more and more compa- nies are attempting to disclose the true cost of option compensation. In addition, some exchanges such as the NYSE and the NASDAQ now require shareholder approval of all equity-based compensation plans.280 While remuneration plans may serve to attract top executive talent and motivate better performance, the field of executive remuneration is both complex and a lightning rod for shareholder and public criticism. Companies that introduce such plans, in particular stock-option plans, should do so with a good deal of circumspection and a maximum of transparency. 2. Employment Contracts for Executives Legislation requires that the company conclude employment contracts with the General Director and Executive Board members.281 These contracts must in- clude:282 · The name of the General Director, or Executive Board member; · The name of the company; · The starting date of the contract; 280 New York Stock Exchange Corporate Accountability and Listing Standards Committee, June 6, 2002. 281 Labor Code, Article 275. 282 Labor Code, Article 57. 99 Part_II_Ch-04-06.indd 99 Part_II_Ch-04-06.indd 99 17.09.2004 11:33:24 17.09.2004 11:33:24 The Russia Corporate Governance Manual · The rights and duties of the General Director, or Executive Board member; · The rights and duties of the company; · Remuneration; and · The term of the contract. Best Practices: The contract should include additional items such as: · Sanctions to be applied for failing to carry out one's responsibilities; · Benefits and other privileges (e.g. discounts on purchases of company shares, health insurance, reimbursement for housing costs); · Indemnification; · Confidentiality clauses during the term of the contract and after the execu- tive leaves the company regardless of the reason for leaving; · Non-competition clauses during the service period and after the executive leaves the company for whatever reason; · A commitment to protect the interests of the company and its sharehol- ders; and · Grounds for early termination. The Company Law is not explicit with regard to who is responsible for nego- tiating contracts with members of the executive bodies. Best Practices: The GMS is not expressly vested with the power to negotiate contracts. Good business sense and a reasonable interpretation of the Com- pany Law suggest that the Supervisory Board should do so. At a minimum, good corporate governance practices would require the Supervisory Board to approve contracts with members of the executive bodies. Regardless, executives should never determine their own remuneration. The Supervisory Board and, ideally, an independent Remuneration Committee should do so. To avoid potential conflicts of interest, executive directors should not vote on their own employment contracts.283 In summary, it is recommended that: · Executive directors be counted for the quorum of the Supervisory Board; and · The votes of executive directors not be counted when approving the terms and conditions of their own employment contracts. 283FCSM Code, Chapter 3, Section 1.4.3. 100 Part_II_Ch-04-06.indd 100 Part_II_Ch-04-06.indd 100 17.09.2004 11:33:24 17.09.2004 11:33:24 Chapter 5. The Executive Bodies 3. Severance Payments to the General Director and Executive Board Members Executives may, under certain circumstances, be dismissed without cause and yet receive severance payments. This may occur when a company has been acquired and the acquirer wishes to install new management. These severance plans are sometimes referred to as golden parachutes. Golden parachutes can be defined as a clause in an executive's employment contract specifying that he will receive large benefits in the event that the company is acquired and the executive's employment is terminated. These benefits can take the form of severance pay, a bonus, stock- options, or a combination thereof. Like other forms of compensation, golden parachutes are often the object of criticism. Severance agreements may, however, be in the interest of shareholders since they can avoid prolonged and costly litigation and public relations problems. Nevertheless, caution should be applied when putting them in place, and the assistance of competent outside advisors should be sought. The approval of severance payments should be a priority for the Supervisory Board and, possibly, the GMS. Best Practices: The FCSM Code recommends that the employment contracts of the General Director and Executive Board members include a provision for severance payments when their employment contracts are terminated prema- turely.284 284 FCSM Code, Chapter 4, Section 5.1.3. 101 Part_II_Ch-04-06.indd 101 Part_II_Ch-04-06.indd 101 17.09.2004 11:33:24 17.09.2004 11:33:24 ChapterChapter 6 The Role of the Corporate Secretary Part_II_Ch-04-06.indd 103 Part_II_Ch-04-06.indd 103 17.09.2004 11:33:24 17.09.2004 11:33:24 Table of Contents A. THE ROLE OF THE CORPORATE SECRETARY...............................................106 1. The Need for and Importance of the Corporate Secretary.................106 2. The Qualifications of a Corporate Secretary .......................................108 3. The Independence of the Corporate Secretary ...................................110 4. The Appointment of the Corporate Secretary .....................................111 B. THE AUTHORITY OF THE CORPORATE SECRETARY ......................................113 1. General Provisions...............................................................................113 2. Developing Corporate Governance Policies and Practices .................114 3. Supporting the Supervisory Board......................................................114 4. Protecting Shareholder Rights.............................................................117 5. Providing for Information Disclosure and Transparency ....................119 C. PROFESSIONAL ASSOCIATIONS OF CORPORATE SECRETARIES ......................121 Part_II_Ch-04-06.indd 104 Part_II_Ch-04-06.indd 104 17.09.2004 11:33:24 17.09.2004 11:33:24 The Chairman's Checklist Does the company have a Corporate Secretary? Does the company need a Corporate Secretary? What contributions can a Corporate Secretary make to the company's governing bodies? Is the position of Corporate Secretary filled on a full-time basis, or does the Corporate Secretary combine his functions with other duties? Does the Corporate Secretary have an adequate mix of professional and personal skills and competencies? How does the company regulate the activities of the Corporate Secretary? Has the company mentioned the position of Corporate Secretary in its charter or by-laws, or even drafted a by-law for the Corporate Secre- tary? Does the Supervisory Board ensure that the Corporate Secretary has ac- cess to all information necessary to perform his duties? Are directors and managers obliged to provide the Corporate Secretary with all information requested or needed by the Secretary to properly fulfill his duties? Does the Corporate Secretary serve as an effective link between the Supervi- sory Board and executive bodies? What is the Corporate Secretary's role in ensuring timely and material disclosure to investors and the public? Does the Corporate Secretary work together with the company's legal and investor relations depart- ments? What role does the Corporate Secretary play in planning and organizing the General Meeting of Shareholders? How does the Corporate Secretary assist the Supervisory Board in pre- paring for and conducting Board meetings? Does the Corporate Secre- tary play a meaningful role in Supervisory Board training and evalua- tion? 105 Part_II_Ch-04-06.indd 105 Part_II_Ch-04-06.indd 105 17.09.2004 11:33:24 17.09.2004 11:33:24 The Russia Corporate Governance Manual The work of the Corporate Secretary is essential to the governance and adminis- tration of a company.285 The Corporate Secretary helps the governing bodies perform their duties and execute their responsibilities. This chapter focuses on the functions, qualifications, and authorities of the Corporate Secretary, and the role that the Cor- porate Secretary plays in implementing good corporate governance practices. A. The Role of the Corporate Secretary 1. The Need for and Importance of the Corporate Secretary Many companies have Supervisory Board secretaries. The Corporate Secretary, on the other hand, is a position relatively new to most Russian companies. Though not mentioned in legislation, considerable time is devoted to the Corporate Sec- retary's responsibilities in the Federal Commission for the Securities Market's Code of Corporate Conduct (FCSM Code). The Corporate Secretary ensures that the governing bodies follow existing internal corporate rules and policies, and changes them, or institutes new ones, when appropriate. The Corporate Secretary can also assist in establishing and maintain- ing clear communication between the various governing bodies of the company in compliance with the company's charter, by-laws, and other internal regulations. In addition, the Corporate Secretary helps to ensure that the governing bodies adhere to all relevant regulatory requirements, both domestic and possibly foreign. Accordingly, the Corporate Secretary, often acts as an adviser to directors and senior executives on regulatory requirements, listing rules, and legislation related to corporate governance. The Corporate Secretary may also identify gaps in cor- porate governance matters and propose ways to address such weaknesses. Figures 1 and 2 demonstrate the increasingly prevalent view that the Corporate Secretary can play an important role in Russian companies, and also indicates the types of companies that might benefit the most from the creation of such a position. 285Because this chapter is largely based on recommendations of the Federal Commission for the Securities Market's Code of Corporate Conduct (FCSM Code) on the Corporate Sec- retary, as well as international best practices, such recommendations are not highlighted in the "Best practices" boxes as in other chapters of this Manual to ensure user-friendly reading. 106 Part_II_Ch-04-06.indd 106 Part_II_Ch-04-06.indd 106 17.09.2004 11:33:25 17.09.2004 11:33:25 Chapter 6. The Role of the Corporate Secretary Company Practice in Russia: An increasing number of companies in Russia are introducing the position of Corporate Secretary. 47% of surveyed companies stated that they have a Corporate Secretary whose main function is to provide legal support to the Supervisory Board.286 An increasing number of companies also understand that Corporate Secretaries contribute to improved corporate governance. Figure 1: Does the Corporate Secretary's Work Improve Corporate Governance? Yes Rather Yes, Than No Difficult to Answer Rather No, Than Yes No Source: IFC-RID Survey on the Work of Corporate Secretaries, April 2003 Most companies consider the position of Corporate Secretary of great importance for joint stock companies, especially for companies with more than 1,000 share- holders. Figure 2: Types of Companies that Require a Corporate Secretary All Joint Stock Companies 44.9% Companies With More Than 1,000 36.7% Shareholders All Types of Companies 18.4% Holding Companies 14.3% Only Listed Companies 8.2% Other 2% Source: IFC-RID Survey on the Work of Corporate Secretaries, April 2003 286 IFC -- Russian Institute of Directors Survey on the Work of Corporate Secretaries in Russian Companies, April 2003 (see also: www.ifc.org/rcgp). 107 Part_II_Ch-04-06.indd 107 Part_II_Ch-04-06.indd 107 17.09.2004 11:33:25 17.09.2004 11:33:25 The Russia Corporate Governance Manual 2. The Qualifications of a Corporate Secretary A full-time staff member, exclusively dedicated to this task, can best fulfill the functions of the Corporate Secretary.287 When selecting a Corporate Secretary, the Supervisory Board should look for an individual with the highest qualifications and skills. The Supervisory Board will need to assess the candidate's education, work experience, professional qualities, and skills. The charter should outline the general requirements for candidates,288 while the by-laws for the corporate secretary should contain more detailed and specific criteria for evaluating such candidates. A detailed job description is the responsibility of the Supervisory Board, and needs to be developed in conjunction with the contract. The core qualifications for Corporate Secretaries are illustrated in Figure 3. Figure 3: Qualifications and Skills of Corporate Secretaries Understands corporate and securities law Mediates and achieves consensus Has «presence» and good communication skills Is intuitive and sensitive Understands The Corporate to what the General Director the company's business Secretary: and directors are thinking and feeling Is detail-oriented, flexible, Reads signals on the horizon and creative and provides early warning to management Knows how to overcome bureaucratic thinking in the company Source: IFC, March 2004 287 FCSM Code, Introduction to Chapter 5. 288 FCSM Code, Chapter 5, Section 2.2.1. 108 Part_II_Ch-04-06.indd 108 Part_II_Ch-04-06.indd 108 17.09.2004 11:33:25 17.09.2004 11:33:25 Chapter 6. The Role of the Corporate Secretary The Corporate Secretary needs to be a person with an impeccable reputation.289 While the FCSM Code suggests that a company should avoid appointing indi- viduals with a record of criminal or significant administrative offenses,290 it is better practice to exclude all such individuals from consideration for the position of Corporate Secretary. Company Practice in Russia: Many Russian companies that have Corporate Secretaries appear to understand the required qualifications and mix-of-skills, as illustrated in Figure 4.291 Figure 4: The Skills and Qualifications Required of a Corporate Secretary Knowledge of Corporate Law Higher Education Knowledge of the Company's Business Personality Characteristics (Communicative, Responsible) Organization Skills Special Professional Training Analytical Skills Loyalty to the Company Other To a high degree To some degree To a minimum degree Source: IFC-RID Survey on the Work of Corporate Secretaries, April 2003 More than 93% of surveyed companies feel that the Corporate Secretary would benefit from specialized training to more effectively meet the requirements of the position. Over 79% of companies were confident that it was necessary to develop a professional set of standards for Corporate Secretaries to ensure the highest degree of professionalism. 289 FCSM Code, Chapter 5, Section 2.2.2. 290 FCSM Code, Chapter 5, Section 2.2.2. 291 IFC -- RID Survey on the Work of Corporate Secretaries in Russian Companies, April 2003 (see also: www.ifc.org/rcgp). 109 Part_II_Ch-04-06.indd 109 Part_II_Ch-04-06.indd 109 17.09.2004 11:33:25 17.09.2004 11:33:25 The Russia Corporate Governance Manual 3. The Independence of the Corporate Secretary To act in the interests of the company and its shareholders at all times, the Cor- porate Secretary must be shielded from undue influence from management and other parties. The Corporate Secretary should thus be accountable to and control- led by the Supervisory Board.292 He should not be an affiliated person of the company or its officers, e.g. a family member of the General Director or business partner of the company.293 Company Practice in Russia: Figure 5 shows that, in practice, most Corporate Secretaries surveyed have been subject to some degree of influence by execu- tives that could compromise their independence. Approximately 43% report directly to either the General Director or the Executive Board.294 Figure 5: The Corporate Secretary Is Accountable to the: Executive Board 42,6% Supervisory Board 40,7% General Meetings of Sharefolders 11,1% General Director 5,6% Source: IFC-RID Survey on the Work of Corporate Secretaries, April 2003 The Corporate Secretary should devote sufficient time to his responsibilities and duties. Therefore, companies with a large number of shareholders, a large Supervisory Board and/or numerous Supervisory Board committees should pro- hibit the Corporate Secretary from concurrently holding other positions within the company or other legal entities.295 In smaller companies, the Legal Counsel or person holding a similar position, may carry out the duties of the Corporate Secretary. 292 FCSM Code, Chapter 5, Section 2.1. 293 FCSM Code, Chapter 5, Section 2.2.4. 294 IFC -- Russian Institute of Directors Survey on the Work of Corporate Secretaries in Russian Companies, April 2003 (see also: www.ifc.org/rcgp). 295 FCSM Code, Chapter 5, Section 2.2.3. 110 Part_II_Ch-04-06.indd 110 Part_II_Ch-04-06.indd 110 17.09.2004 11:33:26 17.09.2004 11:33:26 Chapter 6. The Role of the Corporate Secretary 4. The Appointment of the Corporate Secretary The procedure for selecting the Corporate Secretary should be set forth in the charter.296 The company's by-laws may, however, be better suited to regulate this issue in detail. The Corporate Secretary is designated either by appoint- ment.297 Although the Company Law is silent about the authority to appoint a Corporate Secretary, the FCSM Code delegates this authority to the Supervi- sory Board. The Supervisory Board should define the terms and conditions of the employment contract, and specifically address the issues of remuneration, and termination.298 a) Information About Candidates A nominee for the position of Corporate Secretary should provide the Super- visory Board with sufficient information to evaluate his candidacy. Candidates should, at a minimum, be required to provide information on: · Educational background; · Employment in other companies; · Any relationship they may have with affiliated persons and/or major business partners of the company; and · The number and type (class) of company shares they own, if any; · Any other aspects and circumstances that may influence their performance as Corporate Secretary. This information may be supplemented by personal references and interviews with directors and, in particular, with the Chairman, since a good personal rapport between the Chairman and other directors, and the Corporate Secretary will be important in maintaining effective working relationships. The Corporate Secretary should notify the Supervisory Board immediately of any changes in circum- stances that may influence his ability to effectively serve as the company's Cor- porate Secretary.299 296 FCSM Code, Introduction to Chapter 5. 297 FCSM Code, Introduction to Chapter 5. 298 FCSM Code, Chapter 5, Section 2.1. 299 FCSM Code, Chapter 5, Section 2.2.5. 111 Part_II_Ch-04-06.indd 111 Part_II_Ch-04-06.indd 111 17.09.2004 11:33:26 17.09.2004 11:33:26 The Russia Corporate Governance Manual b) The Contract with the Corporate Secretary The Supervisory Board may offer an employment contract to the Corporate Secretary. An employment contract can be a fixed, short-term contract.300 A fixed, short-term employment contract cannot be longer than five years.301 As mentioned above, large companies are well advised to employ the Corporate Secretary on a full-time basis to allow them to properly execute their duties. For a model employment contract with the Corporate Secretary, see Part VI, Annex 15. c) The Office of the Corporate Secretary Large companies may even find it necessary to establish an Office of the Corporate Secretary, staffed by several assistants. Additional staffing may be use- ful for companies with a large number of shareholders, a large Supervisory Board and/or numerous Supervisory Board committees. Best Practice: Many foreign companies, particularly publicly listed companies, have an Office of the Corporate Secretary with several staff members. Figure 6 shows the situation in U.K. companies. Figure 6: Correlation Between the Company's Size and the Number of Staff in the Corporate Secretary's Office Company Turnover (in m) All Under 10 10­49 50­99 100­499 500­1,000 Over 1,000 % % % % % % % Number of Staff in the Corporate Secretary's Office 1 Employee 25 58 50 10 20 5 5 2 Employees 23 23 21 43 27 18 8 3 Employees 23 16 26 24 22 32 19 4 Employees 11 3 13 19 14 14 5­10 Employees 16 3 10 11 27 49 Over 10 Employees 2 1 4 5 Source: Company Secretaries Responsibility and Salary Survey 2000/2001, Institute of Chartered Secretaries and Administrators 300 Labor Code, Article 58. 301 Labor Code, Article 58; Article 59, Clause 16. 112 Part_II_Ch-04-06.indd 112 Part_II_Ch-04-06.indd 112 17.09.2004 11:33:26 17.09.2004 11:33:26 Chapter 6. The Role of the Corporate Secretary Should a company want to establish an Office of the Secretary, it may wish to specify the responsibilities of the Secretary's Office in the by-laws or other internal documents.302 B. The Authority of the Corporate Secretary 1. General Provisions The Company Law does not discuss the position and authority of the Corpo- rate Secretary. The FCSM Code recommends that the charter, by-laws or other internal documents define the Corporate Secretary's authority, and the duty of all governing bodies to assist the Corporate Secretary in discharging his duties.303 Figure 7 provides an overview of the Corporate Secretary's authorities. Figure 7: The Authorities of the Corporate Secretary Ensures the development of, compliance with, and periodic review of the company's governance policies and practices Supports the Supervisory Board Ensures that the company by organizing Board meetings, discloses material information The Corporate Secretary: channeling information to and on a timely basis and from the Board, and advising in a transparent manner on corporate governance Protects shareholder rights by organizing a proper GMS, liaising during control transactions, and helping to resolve corporate conflicts Source: IFC, March 2004 302 FCSM Code, Chapter 5, Section 1.6.2. 303 FCSM Code, Chapter 5, Section 1.6.1. 113 Part_II_Ch-04-06.indd 113 Part_II_Ch-04-06.indd 113 17.09.2004 11:33:26 17.09.2004 11:33:26 The Russia Corporate Governance Manual Company Practice in Russia: Figure 11, at the end of this Chapter, illustrates that the authority of Corporate Secretaries in Russian companies corresponds in practice to those recommended by the FCSM Code. 2. Developing Corporate Governance Policies and Practices The Corporate Secretary is ideally suited to help the company and its Supervisory Board develop a system of corporate governance. More specifically, the Corporate Secretary can play an important role in the development of, compliance with, and periodic review of the company's governance policies and practices. In developing an explicit and clearly stated plan to improve the company's corporate governance policies and practices, the Corporate Secretary lays the groundwork for reforms in this area. Perhaps more importantly, he can demon- strate the company's committment to corporate governance by monitoring compli- ance with these policies, and informing the Supervisory Board of any breaches. Finally, by reviewing the company's policies on a regular basis (by keeping abreast of the latest developments in corporate governance, changes in the legal and regulatory framework, and international best practices) the Corporate Secretary ensures that the company's governance standards remain high and up-to-date. 3. Supporting the Supervisory Board Most of the Corporate Secretary's time will be spent supporting the Supervisory Board as depicted in Figure 8. a) Organizing Supervisory Board Meetings The Corporate Secretary is responsible for organizing Supervisory Board meet- ings.304 Although Supervisory Board meetings are ultimately the responsibility of the Chairman, the Corporate Secretary handles all administrative and organiza- tional matters such as: · Helping the Chairman to prepare the agenda; · Developing presentations on substantive and procedural issues under discus- sion; and · Preparing model briefs for boardroom discussions. 304 FCSM Code, Chapter 5, Section 1.2.1. 114 Part_II_Ch-04-06.indd 114 Part_II_Ch-04-06.indd 114 17.09.2004 11:33:27 17.09.2004 11:33:27 Chapter 6. The Role of the Corporate Secretary Figure 8: The Functions of the Corporate Secretary in Relation to the Supervisory Board Resolves organizational matters for Supervisory Board meetings Explains the procedural Notifies all directors of Supervisory requirements of laws, the charter, Board meetings and by-laws of the company within the scope of its authority Communicates to and The Conducts induction trainings collects voting ballots from Corporate for newly elected directors directors; collects written Secretary: opinions of directors Assists directors in accessing Ensures compliance with the information and familiarizes them procedure for conducting with corporate documentation meetings Takes the minutes of Supervisory Board meetings Source: IFC, March 2004 It is also advisable that the Corporate Secretary give notice of Supervisory Board meetings to all directors and:305 · Distribute voting ballots to directors; · Collect completed ballots and the written opinions of directors who are not physically present at the meeting; and · Forward the ballots and written opinions to the Chairman. In addition, the Corporate Secretary should help ensure that procedures for Supervisory Board meetings are followed. Along with the Chairman, the Corporate Secretary is advised to draft the minutes of Supervisory Board meetings.306 The Corporate Secretary should brief newly elected directors on:307 · The corporate procedures that regulate the operations of the Supervisory Board and other governing bodies; 305 FCSM Code, Chapter 5, Section 1.2.2. 306 FCSM Code, Chapter 5, Section 1.2.3. 307 FCSM Code, Chapter 5, Section 1.3.2. 115 Part_II_Ch-04-06.indd 115 Part_II_Ch-04-06.indd 115 17.09.2004 11:33:27 17.09.2004 11:33:27 The Russia Corporate Governance Manual · The organizational structure and officers of the company; · The company's internal documents; · The decisions of the General Meeting of Shareholders (GMS) and the Super- visory Board that are in effect; and · The availability of information required by directors for the proper discharge of their duties. b) Providing the Supervisory Board with Access to Information The Corporate Secretary plays a key role in assisting directors in obtaining the information they need for sound decision-making. The Corporate Secretary pro- vides directors with timely and full access to:308 · The minutes of Executive Board meetings; · Decisions approved by the General Director and the Executive Board; · Documents from the General Director and the Executive Board; · The minutes of meetings and reports prepared by the Revision Commission and the External Auditor; and · Financial documents. The company may wish to describe this role in the by-laws for the Supervisory Board, for the Corporate Secretary and/or on Information Dis- closure. c) Providing Legal Assistance to Directors on Governance Issues The Corporate Secretary should assist directors with interpreting legal and regulatory acts related to corporate governance, including listing rules, corporate governance codes, and international regulations and developments. This also holds true for procedural issues regulated in the charter, by-laws, and/or other internal documents relating to preparing and conducting the GMS and Supervisory Board meetings, and on information disclosure.309 The Corporate Secretary should not, however, render legal advice that falls outside the scope of his duties. The duties of the Corporate Secretary should be clearly defined in relation to those of the company's Legal Counsel. 308FCSM Code, Chapter 5, Section 1.3.1. 309FCSM Code, Chapter 5, Section 1.3.3. 116 Part_II_Ch-04-06.indd 116 Part_II_Ch-04-06.indd 116 17.09.2004 11:33:27 17.09.2004 11:33:27 Chapter 6. The Role of the Corporate Secretary The Corporate Secretary should directly notify the Chairman of any possible violations of corporate procedures, if and when he becomes aware of such viola- tions.310 Such violations may include, among others: · Alleged illegal acts or omissions of corporate officers or other corporate employees in fulfilling their legal duties and obligations; and · Violations of procedures regulating the organization of the GMS, Supervisory Board meetings, the disclosure of information and protection of shareholder rights. 4. Protecting Shareholder Rights a) Organizing the General Meeting of Shareholders The Corporate Secretary plays an important role in organizing the GMS. Fig- ure 9, shows the functions of the Corporate Secretary in this regard:311 Figure 9: The Functions of the Corporate Secretary in Relation to the GMS Ensures that the list of shareholders of record is prepared Answers procedural questions during the GMS, and resolves Notifies shareholders of the GMS disputes related to preparing and conducting the GMS Communicates The Distributes materials the report on the results Corporate (documents) for and of the GMS to shareholders Secretary: during the GMS Ensures that minutes Collects voting ballots and on the voting results and transfers them to the Counting the GMS minutes are kept Commission Ensures compliance with the procedures of registration for the GMS Source: IFC, March 2004 310 FCSM Code, Chapter 5, Section 1.7. 311 FCSM Code, Chapter 5, Section 1.1. 117 Part_II_Ch-04-06.indd 117 Part_II_Ch-04-06.indd 117 17.09.2004 11:33:27 17.09.2004 11:33:27 The Russia Corporate Governance Manual b) Liaising Between Shareholders During Control Transactions The Corporate Secretary acts as a liaison between the controlling shareholder(s) in a buyout of common shares (and securities convertible into common shares) and the other shareholders of the company during a control transaction.312 The Corporate Secretary does this by ensuring that the mandatory offer is distributed to all shareholders. The Corporate Secretary should follow the procedures for the distribution of the mandatory offer to non-controlling shareholders as established in the Company Law. c) Assisting in Enforcing Shareholder Rights The Corporate Secretary: · Ensures that the company takes proper notice of all duly submitted share- holder petitions; and · Channels all duly submitted shareholder inquiries to the appropriate governing bodies and departments of the company.313 The Corporate Secretary should try to resolve any conflicts, especially those concerning the maintenance of the shareholder register, promptly and fairly. If an External Registrar maintains the shareholder register, the Corporate Secretary should have the full authority to demand adequate and timely explanations regarding shareholder complaints directly from the Registrar. The terms and conditions of the agreement between the company and the Registrar should include the duty of the Registrar to give adequate and timely written explanations to the Corporate Secretary.314 d) Assisting in Resolving Corporate Conflicts The Corporate Secretary is responsible for recording corporate conflicts.315 The Corporate Secretary registers inquiries, letters, or demands filed by shareholders, reviews these, and duly transmits them to the governing bodies that have the au- thority to resolve the conflict. The effectiveness of the company in preventing 312FCSM Code, Chapter 6, Section 2.4. 313FCSM Code, Chapter 5, Section 1.5. 314FCSM Code, Chapter 5, Section 1.5. 315FCSM Code, Chapter 10, Section 1.1.2. The FCSM Code, Introduction to Chapter 10, defines corporate conflicts as conflicts between the governing bodies and shareholders, as well as conflicts among shareholders if such conflicts can substantially affect the company. 118 Part_II_Ch-04-06.indd 118 Part_II_Ch-04-06.indd 118 17.09.2004 11:33:27 17.09.2004 11:33:27 Chapter 6. The Role of the Corporate Secretary and resolving conflicts depends on its responsiveness to all legitimate complaints. The Corporate Secretary also needs to periodically follow up on the status of complaints in order to make sure that they have been properly and fully addressed, and either resolved or rejected. Conflicts can arise among Supervisory Board members, executives, and shareholders. The Corporate Secretary should notify the Chairman of any po- tential or existing conflict so that they can be dealt with appropriately.316 Best practice suggests that the Corporate Secretary act as a liaison in case of conflicts among Supervisory Board members.317 5. Providing for Information Disclosure and Transparency The Corporate Secretary plays an important role in helping the Supervisory Board and General Director fulfill their respective obligations to disclose material infor- mation on a timely basis to the company's shareholders and financial markets. The Corporate Secretary's authority related to information disclosure is shown in Figure 10.318 Figure 10: The Authorities of the Corporate Secretary Related to Information Disclosure Ensures that the company operates in compliance with procedures for the maintenance and disclosure of information about the company Certifies copies of documents Guarantees the safekeeping before they are given The Corporate Secretary: of corporate documentation to shareholders Ensures unrestricted access for all shareholders to information in accordance with the Company Law Source: IFC, March 2004 316 FCSM Code, Chapter 4, Section 3.1.4. 317 FCSM Code, Chapter 3, Section 3.1.4. 318 FCSM Code, Chapter 5, Section 1.4; Chapter 7, Section 3.1.1. 119 Part_II_Ch-04-06.indd 119 Part_II_Ch-04-06.indd 119 17.09.2004 11:33:27 17.09.2004 11:33:27 The Russia Corporate Governance Manual The Corporate Secretary also helps to ensure for transparent control procedures. More specifically, he acts as a liaison between the Revision Commission and the Supervisory Board and its Audit Committee, if established, when the Revision Commission conducts an inspection of the financial and economic activities of the company.319 The results of the Revision Commission's inspection should be presented to the Supervisory Board's Audit Committee, and the initiator of the inspection together with the Corporate Secretary, within three days after the in- spection of the Revision Commission has been completed. Company Practice in Russia: Figure 11 illustrates the views of some Russian companies on the role that the Corporate Secretary plays in providing informa- tion about the company.320 Most companies agree that the Corporate Secretary should provide information in support of Supervisory Board meetings, and to management and shareholders. There is, however, considerably less agreement with respect to the Corporate Secretary's role in providing other types of infor- mation to outsiders, for example, control and supervisory authorities. Figure 11: Percentage of Companies Where the Corporate Secretary Coordinates Information Flows For Supervisory Board Meetings From the Supervisory Board to Managers From the Company to its Shareholders Internal Documents From the Company to Other Stakeholders To Control and Supervisory Authorities From the Company to Mass Media From Expert Organizations Other 319 FCSM Code, Chapter 8, Section 3.1.5. 320 IFC -- Russian Institute of Directors Survey on the Work of Corporate Secretaries in Russian Companies, April 2003 (see also: www.ifc.org/rcgp). 120 Part_II_Ch-04-06.indd 120 Part_II_Ch-04-06.indd 120 17.09.2004 11:33:28 17.09.2004 11:33:28 Chapter 6. The Role of the Corporate Secretary C. Professional Associations of Corporate Secretaries The position of Corporate Secretary is fairly new in the Russian market, although an increasing number of companies are establishing this position. This position requires a unique skills-set, as shown in Figure 3 above. Ad-hoc efforts are currently being implemented to promote the benefits of having a Corporate Secretary; training efforts are also being organized to train the nascent profes- sion. In foreign markets, professional associations or institutes of corporate secretaries often perform this role.321 Typically, such organizations unite cor- porate secretaries and have several functions, such as to: · Promote good governance, management, and efficient administration of companies; · Support and protect the character, status, and interests of member Corporate Secretaries; · Promote the efficiency and usefulness of the service and standard of professional conduct provided by Corporate Secretaries; · Train Corporate Secretaries; · Comment on proposed and existing laws, rules, and regulations in areas of particular interest to member Corporate Secretaries; and · Promote and assist in the voluntary exchange of information and experience relating to the duties, problems, and practices of Corporate Secretaries and their companies. Establishing such a professional association in Russia would be an important step towards effectively promoting the introduction of Corporate Secretaries in Russian companies. 321 For more information, see www.icsa.org.uk/news/guidance_intro.php. 121 Part_II_Ch-04-06.indd 121 Part_II_Ch-04-06.indd 121 17.09.2004 11:33:28 17.09.2004 11:33:28 FOR NOTES Part_II_Ch-04-06.indd 122 Part_II_Ch-04-06.indd 122 17.09.2004 11:33:28 17.09.2004 11:33:28 FOR NOTES Part_II_Ch-04-06.indd 123 Part_II_Ch-04-06.indd 123 17.09.2004 11:33:28 17.09.2004 11:33:28 FOR NOTES Part_II_Ch-04-06.indd 124 Part_II_Ch-04-06.indd 124 17.09.2004 11:33:28 17.09.2004 11:33:28 FOR NOTES Part_II_Ch-04-06.indd 125 Part_II_Ch-04-06.indd 125 17.09.2004 11:33:28 17.09.2004 11:33:28 FOR NOTES Part_II_Ch-04-06.indd 126 Part_II_Ch-04-06.indd 126 17.09.2004 11:33:28 17.09.2004 11:33:28