Out of Step With Russia?

Out of Step With Russia?

By David Hoffman, The Washington Post, April 18, 1999 published: “The new shares are being sold in a closed subscription to little-known offshore companies. Critics say Khodorkovsky is trying to dilute the holdings of minority shareholders and effectively transfer control of the company to obscure offshore entities, which the critics suspect are secretly controlled by Khodorkovsky”.

“At the palatial meeting hall of the Russian oil giant Yukos, the cars pulled up to a gate with armed guards. The shareholders of a subsidiary oil company, Yuganskneftegaz, presented their papers to a clerk for admittance, and some got in.

Not John J. Papesh. He asked for a pass but was refused. Papesh--representing billionaire investor Kenneth Dart, who holds more than 10 percent of the shares of Yuganskneftegaz--was presented with a court order from a provincial judge issued only a few days earlier. The decision effectively froze Dart's shares, on a technicality. Papesh was left out in the cold.

Inside the meeting, however, the Yukos subsidiary made some big decisions. It issued 77 million new shares--more than doubling the existing 53 million--to be sold to four offshore companies. The result: Dart's holdings in Yuganskneftegaz were dramatically diluted.

The episode offers a small glimpse of a formidable contest shaping up in Russia over the rights of shareholders, one of the most contentious and important factors in Russia's zigzag path to market capitalism.

In place of the Soviet command economy, Russia adopted a Western-style model of corporate governance, with stocks, exchanges and boards of directors. But critics say the securities laws have been poorly enforced and shareholder rights badly trampled by secrecy, corruption and insider dealing.

Now a group of minority shareholders in Yukos and its subsidiaries is challenging one of Russia's most prominent business tycoons in what could become a critical test of their rights. The fight is replete with charges of blackmail and theft, with baffling court decisions and a roster of mysterious offshore firms. The implications go well beyond one company. At stake, analysts say, is whether Russia can reclaim the confidence of foreign investors in the aftermath of last year's economic crash. A key factor for Western investors is whether Russia can protect shareholder rights by law, or whether the rules of the game will continue to be set by powerful magnates who run circles around a weakened government.

The latest struggle is centered on Yukos, the second-largest Russian oil company in terms of production, ranked fourth in the world in reserves. Yukos is the biggest asset in the financial-industrial empire of Mikhail Khodorkovsky, a one-time Communist Youth League leader who became one of the powerful Russian "oligarchs," a group of business tycoons with close ties to the government. Khodorkovsky built Bank Menatep, one of the biggest before the crash, and Rosprom, an industrial conglomerate.

Hustling Fortunes

Most of the Russian tycoons got their start as young, ambitious hustlers in the final years of the Soviet Union, just as the command economy was withering and new forms of business were springing up. They started the first banks and made their early fortunes by speculating on the fast-changing ruble-dollar exchange rate at a time of high inflation in the early years of Russia's market economy. Later, they all benefited from government largess, including the use of lucrative government deposits, and the purchase of formerly state-owned factories, mines, airlines, television channels and oil refineries at rock-bottom prices.

When President Boris Yeltsin was running for reelection in 1996, facing a Communist challenger, seven of the magnates banded together and pumped millions of dollars into Yeltsin's reelection. Despite their favored position, they suffered badly with the economic crash last August. Many of them had huge portfolios of short-term government treasury bonds known as GKOs, on which the state defaulted, and found they could not pay back loans they had taken from Western banks. Although each of the seven has fared differently, all of them have had their backs to the wall since the August devaluation of the ruble. They have been struggling to hold on to those assets still producing cash, while trying to fend off creditors.

Khodorkovsky remains well connected politically. When Prime Minister Yevgeny Primakov recently set out for Washington to meet Vice President Gore, Khodorkovsky was on his plane. (Primakov aborted the trip in mid-flight because of the NATO attack on Yugoslavia.) A spokesman said that Khodorkovsky, 35, was going to participate in the meetings with Primakov and to show his willingness to "cooperate with honest American investors."

In 1997, Khodorkovsky declared his intention to turn Yukos into one of the world's top 10 non-state oil companies. But Russia's economic crisis and the oil price collapse put a crimp in his ambitions.

The bank he founded, Menatep, has defaulted on loans to Western banks. Menatep had pledged about 30 percent of the shares in Yukos for a $236 million loan from three Western banks, but when it was unable to make payments on the loans, the banks took stakes in Yukos, weakening Khodorkovsky's control over the oil company.

Diluted Holdings

What has since aroused the ire of minority shareholders is a scheme to issue millions of new shares in three major Yukos production subsidiaries, the companies that actually take the oil out of the ground. The companies are Yuganskneftegaz, Samaraneftegaz and Tomskneft.

The new shares are being sold in a closed subscription to little-known offshore companies. Critics say Khodorkovsky is trying to dilute the holdings of minority shareholders and effectively transfer control of the company to obscure offshore entities, which the critics suspect are secretly controlled by Khodorkovsky.

Yuganskneftegaz shares are being sold to Asbury International Inc. of the Bahamas, Rennington International Associates Ltd. of Ireland, Thornton Services Ltd. of the Isle of Man, and Brahma Ltd. of the Isle of Man. The offshore firms will own 59 percent of Yuganskneftegaz. Samaraneftegaz is effectively being sold to Bloxon Co. Inc. and Donia Holdings Inc. of the British Virgin Islands, Tenton International Inc. of the Marshall Islands, and Lorrin Management Co. of Niue Island. The offshores will own 64 percent of Samaraneftegaz. Five companies registered in Cyprus will own 75 percent of Tomskneft. In effect, once the new shares are issued, the offshore firms will control Yukos. The losers will be those who currently have shares in Yukos and its subsidiaries--the Western banks, Dart and others.

Bernard Black, a professor of law at Stanford University who helped draft Russia's corporate statute, said it has protections against self-dealing. If Khodorkovsky and his allies are behind the offshore companies, he said, they must not be allowed to vote for the new share issues. The minority shareholders claim that Yukos is behind the offshore companies, but so far they have provided no proof.

"There are plenty of violations here, and the problem is, there is no quick enforcement," Black said. "Why isn't the government stepping in? Why isn't the Securities Commission, or the Central Bank, acting? It sure doesn't look like the government is on top of this the way it should be."

A Yukos spokesman, Andrei Krasnov, would not comment on the relationship of the offshore companies to Yukos. Krasnov said the shares are being issued to "replenish the working capital" of the subsidiaries, which he said would help them at a time of "dire financial straits" in Russia's economy.

But company documents show that the new shares are being paid for not by cash but by promissory notes, known in Russia as "veksels." Critics point out that the notes in each case are issued by one of the other three Yukos subsidiaries--in other words, the new shares are being bought by the offshore companies using IOUs from the Yukos daughter companies.

"This is the Russian version of theft in the executive suite," said Papesh, the Dart representative. "It is red-collar crime."

Dart, whose investment companies are also based offshore, bought into the Russian oil production subsidiaries in the early years of Russian privatization. The shares were cheap; Dart bought more than 10 percent of each of the three oil-production companies. Later, however, the companies were combined into Yukos. Khodorkovsky won control of Yukos in 1995 in a series of controversial Russian cash privatizations known as loans-for-shares.

Targeting Dart

Yukos has repeatedly attacked Dart, and twice, just before the recent shareholder meetings, Dart representatives were excluded by surprise court orders. Krasnov, the Yukos spokesman, said, "The essence of this conflict is, the Dart group has resorted to greenmail tactics toward Yukos," seeking to force Yukos to buy out the Dart holdings. "We consider the current Dart group campaign to be information blackmail against Yukos," he said.

Sharon Cornwell, a spokeswoman for Dart, replied: "This greenmail accusation is a diversion. Yukos share dilutions will injure all minority shareholders. If Yukos is successful, all of these minority shareholders will see their economic and voting rights dramatically diminish."

Other minority shareholders are also angry about the Yukos plan. A spokesman for Daiwa Europe Ltd., one of the banks that got a stake in Yukos when Menatep defaulted, said: "The actions that Yukos is taking cause us great concern, and we are in discussions with the appropriate authorities. We are concerned that the assets being transferred to these offshore companies may be irretrievably lost from Yukos and the production facilities."

Bernard Sucher, managing director of Troika Dialog, a leading Moscow brokerage house, said: "There is some good news in all of this. The violations perpetrated by this organization are so outrageous that they establish a benchmark of unacceptable behavior against which we can measure all progress. And we are going to have progress to measure."

The Federal Securities Commission, headed by Dmitri Vasilyev, has announced a full-scale investigation. "The commission has received a large number of complaints," Vasilyev said in an interview. "The complaints are about dilution of capital, which is in our jurisdiction." If the complaints are valid, he said, the commission can refuse to register the new shares. But he also said some of the investors "must be more active" and should turn to the courts. Sucher said new legislation that took effect March 11 strengthened the securities commission. "Unfortunately for the bad guys," he said, "they are in their final stages of this conquest just as the cavalry has been given guns, horses and stables."

A Struggle Over Securities

Russian financial mogul Mikhail Khodorkovsky is at the center of a major controversy over Russian oil giant Yukos, his biggest asset. A plan to issue millions of new shares in three major production subsidiaries of Yukos has angered minority shareholders of those companies. Critics say these offshore firms are secretly controlled by Khodorkovsky, who is trying to dilute shares of minority holders. Here is how the voting shares of these companies would break out under the current proposals. The minority shareholders at Yuganskneftegaz, for instance, would see their shares reduced from 37 percent to 15 percent.


The new buyers

* Asbury International of the Bahamas

* Rennington International Associates of Ireland

* Thornton Services and Brahma, both of Isle of ManThe new buyers


The new buyers

* Bloxon and Donia Holdings, both of the British Virgin Islands

* Trenton International of the Marshall Islands

* Lorrin Management of Niue Island.


The new buyers (all registered in Cyprus):

* Montekito Holding

* Chellita

* Sagiman Holding

* Wilk Enterprises

* Telular Holdings

NOTE: Because of rounding, figures do not add up to 100.

New voting shares: 66%

15% Other minorities (currently 37%)

17% Yukos (currently 51%)

New voting shares: 70%

13% Other minorities (currently 37%)

15% Yukos (currently 51%)

New voting shares: 80%

9% Other minorities (currently 37%)

10% Yukos (currently 51%)

SOURCES: Materials from board meeting of Yuganskneftegaz, Samaraneftegaz and Tomskneft”. notes The Washington Post in the article “Out of Step With Russia?


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