Oda Russian Commercial Law 2007-1

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metres on the ground that the transaction was an interested party transaction, but nevertheless, the appropriate procedure was not followed.

A member of the board and at the same time, the general director, L.G.Lipnik, who gave a power of attorney to P.E.Demb for the transaction held, in conjunction with his af liated persons, more than 20% of the shares of Gala Inform. The plaintiff argued that Lipnik held 40% of a closed joint stock company which owns 50% of a limited liability companies Tovarishchestvo Flesh and Flesh Markt respectively. The latter owned 50% of the former, who is the sole founder of Gala Inform. The value of the building was 1,608,000 roubles, which was more than 2% of the assets of the plaintiff company. According to Art.83 of the Law on Joint Stock Companies, interested party transactions over 2% of the assets of the company need to be approved by the general shareholders’ meeting, but this did not take place, since Lipnik did not disclose to the board that he was interested.

The lower courts dismissed the claim of the plaintiff on the ground that Lipnik was not an immediate party to the transaction and did not take part in the transaction as a representative or an intermediary. However, the Supreme Commercial Court did not uphold this view. The Court ruled that Lipnik was a board member and the general director and held 20% interest in Gala Inform. The fact that Lipnik was not a party to the transaction does not exclude the possibility that this was an interested party transaction. The conclusion of the lower courts that Lipnik did not take part in the transaction is wrong, since he, as he general director, has acted in the name of the company and Demb merely acted as his representative based upon the power of attorney.188

Open joint stock company, Samarskaia Metallurgicheskaia Kompaniia (SAMEKO), brought an action against the joint stock company, Inkombank, at the Commercial Court of the City of Moscow, for recognition of a loan agreement as void on the ground that the transaction had been effected with an interested party without following the appropriate procedure.

The agreement was signed by the president of Inkombank on behalf of the Bank and by the general director, V.I.Bogocharov on behalf of the debtor, SAMEKO. At the time of conclusion of the agreement, Bogocharov was also vice president of Inkombank and a member of the top management body of the Bank. The rst instance court and the court of the cassation instance acknowledged this transaction as null and void, since the procedure as required by the Law on Joint Stock Companies had not been followed.

However, upon protest, the Supreme Commercial Court quashed the judgment of the lower court and referred the case for a new hearing, since a contract of assumption of debt had been concluded between Inkombank and another company, Saianskii aliuminevyi zavod, and therefore, it was questionable whether or not SAMEKO was the appropriate plaintiff.189

188Decision of the Presidium of the Supreme Commercial Court, June 27, 2000, Case 8342/99.

189Decision of the Presidium of the Supreme Commercial Court, January 18, 2000, Case 6309/99.

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The general director of a company who sold shares to another company, a limited liability company, was interested, since he owned more than 20% of the quota of this limited liability company at the time it was established. There was neither a decision of the board or the resolution of the general shareholders’ meeting which endorsed this transaction. The rst instance court found the transaction invalid. However, the appellate court ruled that the general director had since then disposed of the quota in the limited liability company, and was not a member of this company at the time of the transaction, thereby quashing the decision of the lower court.190

8)Audit – Audit Committee (revizionnaia komissia) and the External Auditor

Companies are under an obligation to carry out bookkeeping and preparenancial reports as required by the Law. It is the duty of the executive bodies to organise bookkeeping and ensure its truthfulness as well as to provide nancial reports to the relevant bodies. They are also responsible for providing information on the activities of the company to shareholders, creditors and the mass media (Art.88, paras.1 and 2).

Supervision of the “ nancial and economic activities” of the company is entrusted to the audit committee (revizionnaia komissia) (Art.85, para.1). Normally, there are three members of the committee, but in smaller companies it is possible to have one member (revizor) only. Members of the audit committee are elected exclusively by the general shareholders’ meeting. Shares which belong to the members of the board of directors and other bodies of the company are not given a vote when appointing members of the audit committee. Members of the committee cannot simultaneously be a member of the board or occupy other positions in the company’s management (ibid., para.6).

The audit committee supervises the accounting of the company and ensures that nancial documents are properly prepared for the shareholders’ meeting. The committee’s responsibilities include checking the correctness of the accounts, particularly the checking of the inventory of assets and debts of the company, and supervision of accounting discipline.191

This provision does not limit the scope of power of the audit committee to “ nancial economic activities” of the company. By theArticles of Incorporation, the audit committee may be given power to monitor the “purpose and ef ciency of the operation of the company”.192

190Item 14, Information letter No.62 of the Supreme Commercial Court, March 13, 2001.

191Tikhomirov, supra, pp.347-348.

192Shapkina ed., supra, p.341.

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Supervision of “ nancial-economic activities” is conducted on the basis of the annual result of the activities of the company, but also on the initiative of the audit committee, by a resolution of the general shareholders’ meeting or the decision of the board of directors. Shareholders with not less than 10% shares are entitled to request an inspection by the audit committee (ibid., para.3).

Upon request of the audit committee or its members, persons who occupy a position in the management body are obliged to submit documents concerning the nancial-business activities of the company. However, there is no sanction against non-compliance, and therefore, the effectiveness of this provision is doubtful.

The audit committee is empowered to request the board to convene an extraordinary shareholders’meeting (ibid., para.5).

In addition to the audit committee, open joint stock companies and some closed joint stock companies are required to have an external auditor (auditor). The legislature was not content merely with the system of audit committee, since its members are elected by the shareholders who, for their judgment of the suitability of the members, have to rely on the recommendation of the board.193

According to the Law on Joint Stock Companies and the Law on Audit Activities, audit by an external auditor is required of:

i) all open joint stock companies, regardless of their size, are required to have an external auditor audit the accounts;

ii) closed joint stock companies, which issue bonds and other securities by public offer must have an external auditor. Annual audit has to be made during the period the securities are in circulation;

iii) closed joint stock companies whose turnover of sale of goods or provision of service exceeds by 500 thousand times the statutory minimum wage in one year or the assets on the balance sheet exceeds, at the end of the nancial year, by 200 thousand times the statutory minimum wage.

In addition, audit by an auditor is mandatory upon the request of a shareholder who holds 10% of more of the capital (the Civil Code, Art.103, para.5).194

External auditors can be either an individual or a rm, but must be a person or entity with no proprietary relations with the company or its members.

The external auditor checks the “ nancial-economic activities” of the company based upon a contract with the company. The purpose of the audit is to prepare an opinion on the truthfulness of the nancial reports of the company and

193Krapivin and Vlasov, supra, p.305.

194Mozolin and Iudenkov, supra, p.384.

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on the observance of law in bookkeeping.195 The external auditor is appointed by the general shareholders’meeting. The remuneration is determined by the board of directors (Art.86).

The Law on Accounting Activities was enacted in 2001.196 Auditing is a licensed profession; there is a cabinet decision which sets out the procedure for attestation and the grant of a license. All the major global accounting rms now operate in Russia.

Upon completion of the audit of the “ nancial-economic activities” of the company, the audit committee and the external auditor prepare an opinion which includes:

i) con rmation of the truthfulness of the information contained in the annual report and other nancial documents of the company;

ii) information on the facts of breaches of laws and statutes on accounting andnancial reporting and the legislative acts of the Russian Federation in the course of conducting “ nancial-economic activities” if there were any.

While the opinion of the audit committee is intended for internal purposes of the company, the auditor’s opinion is not only intended for the company, but also for third parties such as creditors and investors who need a clear representation of the state of nance of the company. Therefore, the form of the auditor’s opinion is set by the Law on Audit Activities.197

Accounting standards are provided by the Law onAccounting as well as cabinet decisions and normative acts of the Ministry of Finance.198 At present, the only methodological basis for accounting and reporting for companies (except for banks) is the Statute on the Accounting and Reporting which was enacted in 1994 in the form of an order of the Ministry of Finance.199 In 1997, the government embarked on a reform of the accounting system for approximation with the International Accounting Standards. However, the “evolutionary approach” which has been adopted seems to be taking time.200

195Krapivin and Vlasov, supra, p.304.

196Law no.119-FZ of August 7, 2001.

197Mozolin and Iudenkov, supra, pp.385-386.

198Law No.129-FZ of November 21, 1996.

199Krapivin and Vlasov, supra, p.312.

200R.W.McGee et al., “Problems of Implementing Accounting Standards in a Transition Economy: A Case Study of Russia,” 2004, SSRN http://ssrn.com, p.9.

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9)Reorganisation of Companies

The Russian concept of “reorganisation” covers merger (sliianie and prisoedinenie), division (razdelenie), spin-off (vydelenie) and conversion (JSCLArt.8).

Provisions on reorganisation are surprisingly sparse. There are only two provisions on mergers, and one each for other types of reorganisations. There is almost nothing regarding the protection of shareholders on such occasions, not even the rights of the shareholders to be informed of the proposed reorganisation or to familiarise themselves with the documents. The introduction of such provisions is being proposed.201

There are two categories of merger. Sliianie is de ned as an emergence of a new company with the transfer of all the rights and obligations of several existing companies to the new company and with the termination of those existing companies. Prisoedinenie is the absorption of one company by another with the transfer of all the rights and obligations to the other (Arts.16 and 17).

Companies taking part in the merger are required to conclude an agreement of merger which determines the procedure and conditions of the merger as well as the procedure of converting shares of these companies into the shares of the new company. The merger needs to be approved by the general shareholders’ meeting of each company. The adoption of the Articles of Incorporation and the appointment of the board of directors of the newly established company take place at the joint general shareholders’meeting of the companies which are parties to the merger in cases of sliianie (Art.16, para.3). In cases of prisoedinenie, the parties conclude an agreement which determines the procedure and terms of the merger, but also the procedure of the conversion of the shares of the company which is to be absorbed into the shares of the surviving company. Each company holds its own general shareholders’meeting to approve the agreement (Art.17, para.2). In both cases, the transfer act (peredatochnyi akt), which is a document certifying the transfer of rights and obligations, has to be approved by the shareholders.

The Law on the Protection of Competition requires the advance consent of the Federal Anti-Monopoly Service for mergers with the total assets on the balance sheet exceeding 3 billion roubles or the annual turnover exceeds 6 billion roubles (Art.27, paras.1 and 2).

In a division (razdelenie) of a company, the company ceases to exist, while the rights and duties of the company are transferred to several newly established companies. The board of directors of the company proposes the division to the general shareholders’ meeting and the form, procedure, terms of the division,

201 Mozolin and Iudenkov, supra, p.73.

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and other matters concerning the creation of new companies and the method of conversion of shares and securities. The general shareholders’ meeting of each newly set up company adopts a resolution on the approval of the Articles of Incorporation and the appointment of the board of directors. In a division of a company, all the rights and obligations of the company are transferred to the newly established companies in accordance with the divided balance sheet (Art.18).

It should be added that the Civil Code as well as the Law on the Protection of Competition provide for the possibility of compulsory division of a company. This is possible if a company with a dominant position repeatedly effects monopolistic activities (the Civil Code, arts.10, 57, paras.1 and 2, Law on the Protection of Competition, Art.38).

In a spin-off (vydelenie), a company creates one or several new companies and transfers part of its rights and duties, but the company stays in existence (Art.19). The procedure is basically the same as in division.

Conversion (preobrazovanie) means transformation of a joint stock company to another type of commercial organisation. The Law provides for conversion either to a limited liability company or production cooperative, and if all shareholders agree, to a non-commercial organisation (Art.20).

All such reorganisation requires a quali ed majority vote of the general shareholders’ meeting (Art.49, para.3). Those shareholders who voted against reorganisation or were not present at the shareholders’meeting have an appraisal right (Art.75, para.1).

Within 30 days of the adoption of the general shareholders’meeting regarding reorganisation, creditors must be informed in writing and the resolution must be published in the media which publishes information on company registration. If the creditors wish to require the company to terminate or perform the obligation ahead of the due date, they are entitled to do so in writing as well as to compensation (Art.15, para.6).

7THE RUSSIAN SECURITIES MARKET

The Russian securities market emerged as a result of the voucher privatisation which took place in 1992 and 1993. Auctions organised by the government for selling shares in privatised companies in return for vouchers contributed to the emergence of a class of private investors. The government began issuing short term government bonds in 1993 and accordingly, a market for government bonds was created.

TheRTSStockExchangewhichconsolidatedseparateregionalsecuritiestrading oors started operation in 1995. By the end of 2004, more than 300 securities

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were traded on the RTS Stock Exchange, including more than 40 bonds.202 The number of listed companies in Russia is rather small compared with other former socialist countries.

The basic law which regulates the nancial market is the Law on the Securities Market of 1996. The Law underwent major amendments in 2002 and 2004. There is also the Law on the Protection of Rights and Legal Interests of Investors in the Securities Market of 1999 as amended. The latter sets out requirements which apply to professional participants in the market providing a service to investors who are not professionals, and also “additional requirements” concerning public offer as well as measures for the protection of investors (Art.2, para.1). It is not clear why there need to be two separate laws.

The agency in charge of implementing the law in this area is the Federal Service of Financial Markets which succeeded the Federal Commission on Securities. At the time the 2002 amendments were prepared, there was a serious debate on the problem of how a civilised securities market could be established in Russia, and particularly, how and to what extent the market should be regulated. From the viewpoint of the need for the “harmonious coexistence” of the government regulatory body and the self-regulatory bodies, the Commission was criticised for its “excessive expansion of power”. This was supported by the President’s administration and in the end, the Commission was replaced by the newly established Federal Service on Financial Markets.203 According to the decision of the government, the basic functions of the Service are:

i) state registration of securities and receiving reports on the result of the issuing;

ii) ensurance of disclosure in the securities market;

iii) supervision of the issuing companies of the securities, professional participants in the securities market, their self-regulatory body, investment funds etc.

Government regulation of the securities market operates via the following means:204

i) setting of mandatory requirements and standards for the activities of the participants in the securities market;

ii) state registration of issuing of securities and prospectus and supervision of the observance of the terms;

202www.rts.ru

203V.A.Vaipan ed., Kommentarii k Federal’nomu zakonu o rynke tsennykh bumag, 2nd edition, Moscow 2005, pp.50-51.

204Ibid., pp.54-61.

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iii) licensing of the activities of the participants in the market;

iv) creation of a system for the protection of the holders of securities and supervision over the observance of their rights by the issuers and the professional participants in the securities market.

The Law on Securities Market provides for the licensing regime of the “professional participants in the securities market”, which are involved in the types of businesses set out in the Law. These include brokerage, dealing, clearing, managing of share registers, depositing and trading activities. A license is also required for the handling of share registration and for the stock exchange.

The 2002 amendments added a new chapter on stock exchanges to the Law. Before the amendments, only non-commercial organisations were allowed to set up a stock exchange, but now, joint stock companies may also organise it (Art.11, para.1). However, a single shareholder and af liated persons may not have more than 20% of the same category of shares. Stock exchanges may also combine their activities with those of foreign currency exchange, commodity exchange and clearing activities.

Participants in the trading at the stock exchange can only be brokers, dealers and managers of the trust. Others must trade only through these intermediaries.

Stock exchanges are under an obligation to constantly supervise transactions effected on the exchange in order to expose insider trading and manipulation of prices and also to supervise the observance of the law by the participants in the stock exchange and the issuers of listed securities (Art.13, para.2).

The Law sets out the procedure for the issuing of securities. Issuing of securities is subject to state registration. Only after registration can the securities be issued, except for the shares which are issued at the time of establishment of a company.

Breach of the procedure can be a ground for the refusal to register, the recognition of the issuing as invalid, or the suspension of the issuing by the registration body. If the issue has been completed but was found to be null and void, the issued securities must be retrieved by the issuer and the payment must be reimbursed to the investors (Art.26).

Circulation (obrashchenie) of securities is prohibited until they have been paid in and the report on the result of their issue has been registered. Circulation in this context means not only on-exchange trade, but also offering of securities to an inde nite scope of people, including offering through advertisements.205

The Law on Securities Market also provides for the disclosure of information. The Law de nes disclosure of information as the ensurance of the availability

205 Ibid., p.39.

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of information to all interested persons regardless of the purpose of receiving it (Art.30).

Once the issuer registers the prospectus, the issuer is under an obligation to disclose information in the form of:

i) a quarterly report;

ii) publicising of material facts involving the nancial-economic activities of the issuer.

The quarterly report is submitted to the registering body. It is signed by the single executive body of the issuer and the chief accountant. The report is provided to the holders of securities upon their request.

The Law also provides for a list of material facts which include information on the facts which may result in uctuation in the value of assets or net pro t/loss of more than 10% (Art.30). Such information is forwarded to the Federal Service and also publicised by the issuer within 5 days of the occurrence of the facts in the mass media which is “accessible to a majority of the holders of the issuer’s securities”.

Holders of the securities are also under an obligation of disclosure. Except for holders of bonds which are not convertible to shares, the holders must report to the Federal Service when:

i) the holder has come to hold 20% or more of the issued securities of the issuer;

ii) each time the holder has increased the holding by 5% above 20%; iii) any changes over or below 5, 10, 15, 25, 30, 50 or 75%.

Professional participants in the market also bear obligations of disclosure with regards to their own activities.

Insider trading is regulated under the heading of “the use of business information (sluzhebnaia informatsiia) in the securities market” (Arts.31-33). Business information is de ned as any information regarding the issuer and the issued securities which is not generally accessible and which the person who came to possess such information through their business position, employment relations, or contract concluded with the issuer would obtain a superior position in comparison to others. The persons who are potentially in possession of such information are:

i) Members of the management body of the issuer and the professional participants in the market in contractual relations with the issuer;

ii) Auditors or professional participants in the market in contractual relations with the issuer;

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iii) Government employees, who, by virtue of supervisory power and other powers, have access to such information.

These persons are not allowed to use the information in possession to effect transactions, or remit the information to a third party to effect transactions (Art.33).

The Law also has provisions on advertisements. Advertisements, such as those disseminating false information for the purpose of misleading or deceiving holders of securities and other participants in the market, those publicising the expected return, or guaranteeing a certain return are prohibited (Art.34).

Despite the amendments in 2002, the Law, as a whole, is far from perfect. It is merely a skeleton or a patchwork of what securities laws are required to cover. The power of the regulatory body is very limited, while the reliability of the self-regulatory bodies is yet to be tested. The sanctions available for breaches do not seem to be suf cient. Most violations are covered by administrative sanctions which basically amount to a ne of 200-300 times the minimum wages. Even criminal sanctions, on rare occasions where they are available, are mostlynes, and at the most amount to 2 years of corrective labour, which is milder than imprisonment.

The State Programme for the Protection of the Rights of Investors 19981999 has pointed out the following:

Insider trading and manipulation of prices in the securities market are regulated in an extremely lax manner. The regulation of transactions with af liated persons is at an early stage. Regulators do not have suf cient power to ensure the implementation of the law.206

This situation has not changed much by the 2002 amendments.

8LIMITED LIABILITY COMPANIES

The Law on Limited Liability Companies was enacted in 1998, two years after the Law on Joint Stock Companies. Learning from the experience of implementing the latter Law, the Law on Limited Liability Companies bene ted from “higher level of legislative technique”.207 The Law, in comparison to the Law on

206M.K.Treushnikov ed., Formy zashchity prav investorov v sfere rynka tsennykh bumag, Moscow 2000, p.294.

207M.Iu.Tikhomirov ed., Kommentarii k Federal’nomu zakonu ob obshechestvakh s ogranichennoi otvetstvennost’iu, 3rd edition, Moscow 2005, p.4.