LCV

NEWS ABOUT CORPORATE GOVERNANCE - January-February/2005

Year IV – No. 38

Corporate Governance News

Editor: Luciano Carvalho Ventura

Editorial

Corporate Governance in Russia.

After the collapse and dismemberment of the USSR (Union of Soviet Socialist Republics), only one economic alternative remained for its leader republic, Russia, and this was capitalism. It is also a fact that nowadays, in no country, is there such a thing as a strong capital market without some level of Corporate Governance being practiced by its listed corporations. Thus, in 2001, Russia began the lengthy and complex process of forming a domestic capital market run along the lines of the West. Were they alive today, the old Communist leaders and theoreticians would be absolutely appalled by such events. In May 1999, the Russian Securities Commission (known as the Commission) was created, with an elected President, Igor Kostikov, member of the Russian Academy of Sciences, a Specialist in Public Finances and International Economy, and author of dozens of books, articles, and publications. The Commission’s objective was to organize and bring transparency to the Russian capital market and to reinforce the confidence of domestic and, especially, international investors. The aim here is to enable Russian companies to raise funds at low cost and in amounts that meet their needs in a country so deficient in private capital.

Each well-chosen move produced results. In 2001, after official approval of the Bond Issue Standards, the market began to flourish. Just to give our readers an idea of the contribution made by this measure promoting the growth of such a vital segment of any capital market, in 2000, bond trading did not even amount to US$0.5 billion. By the close of 2003, it had attained US$3.5 billion, with the capacity to double this figure quarterly, depending on the market. The regulating and structuring process of the Financial Derivatives Market led to growth levels from US$260 million in 2001 to US$7 billion in April 2004. In 2001, the Commission also introduced the prerequisites necessary to enact and approve Investment Fund Legislation. With this, the regulatory infrastructure for Mutual Funds was created, thus establishing an individual savings system as a new and vital investment source for the emerging Russian economy.

Also in 2001, the Commission turned its attention to Corporate Governance in its listed corporations, for which it had the support of government bodies and the country’s financial and business community. Together, they drew up the Russian Code of Corporate Governance”, which was passed by the Federal Government in November of that same year. This new Code completely reversed the philosophy of listed Russian corporations, became the national Corporate Governance standard, and was transformed into a landmark in the history of the country’s capital market. The Commission also ordered listed companies to disclose their Corporate Governance practices, a requirement that was willingly and voluntarily implemented by almost all the leading Russian corporations. As part of its Corporate Governance work, the Commission sought and intensified international cooperation with development agencies and other related organizations. It also began working with the World Bank, the EBRD, the International Financial Corporation, the International Corporate Governance Network, and the Financial Stability Forum, and a number of other leading global institutions.

This first mission of the Committee requiring transparency in the Russian capital market that, in the specific case of Corporate Governance, with its principles equity, accountability, and corporate liability, became the four-pillar base of business values. So successful was this advance, that it became a part of the Russian Criminal Code and, in 2004, fallacious disclosure or non-disclosure of investor information acquired criminal status.

In June 2004, together with some of his Commission colleagues, Kostikov published a book entitled “Economic Liberalism and State Regulation in Russia: The Creation of an Efficient Capital Market”, published by Nauka of the Russian Academy of Science. Among many other interesting topics, the book describes how Russia created a capital market based on transparency, fair share prices, equitable treatment of investors, and continuous improvement of Corporate Governance levels in its listed companies. It also revealed that one of the first measures taken in this context occurred in 2001 with the enactment of the country’s Code of Corporate Governance Practices, that has the force of law.

These five years of extraordinary work by the Commission was hailed by the Russian and global capital market and by that most demanding of judges, the investors. By March 2004, the market value of listed Russian corporations that, at the close of 2001, amounted to US$42 billion had soared to US$276 billion. During this period, the performance of the Russian capital market was one of the most outstanding worldwide in terms of profitability for emerging markets.

At the close of 2004, Igor Kostikov, whom the editor of this Newsletter has the privilege of knowing personally, resigned from his position as president of the Commission after a five-year term of office, secure in the knowledge that he had more than fulfilled his mandate.

The IBGC (Brazilian Institute of Corporate Governance)

At 1600h on Thursday, March 31, 2005, the IBGC will issue a summons to its Annual General Meeting, in the Abrolhos Room on Floor E3 of the Renaissance Hotel, Alameda Jaú 1620, São Paulo. This will include the election of its Board of Directors that, as part of its good Corporate Governance practices, occurs annually, and where members may be re-elected for an unlimited number of terms of office. There are twelve (12) board member candidates up for election for the nine (9) vacant positions, in a process that, with every passing year, becomes more competitive, democratic, and transparent, as required by best Corporate Governance practices. The major innovation for this year is the guideline for members on the importance of regional representation on the Board, in view of the increasingly active involvement of the Southern and the Rio de Janeiro Chapters. With all the improvements introduced as from 2003, the involvement of members in the election process has become greatly simplified. Now, in addition to the traditional voting process by presence at the meeting, votes can be registered by fax and on the Internet, all officially monitored by Deloitte Touche Tohmatsu. The newly elected Board members will meet immediately after the vote count, to elect their new Chairman and two Deputy Chairmen. The results will be announced on election day and details will be available on the IBGC website (www.IBGC.org.br).

America’s most distinguished economist discusses the present and seems to have made less than accurate predictions for the future

With good reason, the legendary US economist, John Kenneth Galbraith, still fully active at the age of 96, has roundly criticized recent huge corporate frauds in leading US and European companies, in his latest book, bearing the intriguing title, “The Economics of Innocent Fraud: Truth for Our Time”. In this book, using Enron as his example, Galbraith points out how power was transferred from shareholders or their representatives to senior executives who, with the astonishing and unlawful collaboration of their independent auditors, perpetrated what he calls a massive robbery. It is the opinion of the dean of leftwing US economists (a group that never directly attacks capitalism but believes, nevertheless, that the State has a vital regulatory role to play in the economy) that nobody should imagine that the joint monitoring work of boards and stockholders is sufficient to prevent executive abuse of power. He points out that corrective action and safeguarding mechanisms must be legally enforced, otherwise this excessive power and abuse by executives, in addition to their personal enrichment, will never cease to exist. Galbraith seems to have forgotten that the corporate scandal he used as an example, and the many others that followed in its footsteps, culminated in the US Government rapidly and severely intervening in the capital market. In July 2002, the seven hundred (700) articles of the Sarbanes-Oxley Act approved by Congress and immediately sanctioned by President George W. Bush, represented the most radical legal changes for US companies since the nineteen thirties. The Sarbox Act, as it is commonly known, impacted fourteen thousand listed companies in the US, among them 1.2 thousand non-US corporations listed on US stock exchanges.

Even now, it is almost impossible to accurately predict its impact and tangible effects on listed companies in other companies and on unlisted companies in general. But some transformations have already been noted in the business world: boards of directors are more active, executives “better behaved and obedient” or, at least, more low profile.

This step taken by the US Congress was perfectly aligned with Galbraith’s ideas in respect of government intervention to rectify the effects of these corporations’ actions on the economy. Also, even if not completely, it will reduce the power and its abuse by executives in mega corporations, by returning ownership control to the real owners, the shareholders and their representatives. In the words of the Brazilian poet, “from now on, it will all be different”.

The Walt Disney Corporation will celebrate its fiftieth anniversary as it struggles to recover from its own corporate scandals.

At the beginning of May 2005 the world’s first and largest theme park, created by the unrivalled genius of Walt Disney, Disneyland in Anaheim, California, will celebrate its 50^th anniversary. The festivities to continue for 18 months will not be limited to California, but will extend to the World Disney Resort in Florida, the Tokyo Disneyland in Japan, the Paris Disneyland Resort, and the Hong Kong Disneyland, this last to be inaugurated in December 2005.

However, all these celebrations are being held in an environment of successive corporate scandal in the US courts. This is due to the abysmal quality of the Corporate Governance practiced by the Disney Corporation, chiefly in respect of the conflict of interests of the Chairman of the corporation’s Board of Directors and the majority of its members. There is the case brought by investors nearly ten years ago at the State of Delaware Supreme Court against the members of the company’s Board of Directors, allegedly for the fact that the latter frequently and deliberately ignored shareholder interests. Since then, new data has emerged, such as service agreements at exorbitant prices drawn up by companies owned by members of the Disney Corporation’s Board of Directors. Michael Eirner, the leader of this fraudulent operation, who masked all these irregularities, for over twenty years ran one of the world’s best known trademarks, is about to be replaced at which time he will, finally, be required to render accounts of his actions to the US courts of justice.

The latest news is that millionaire Scrooge McDuck decided to break his self-imposed pact of silence on this topic and limited himself to answering three questions at a press conference in Anaheim, California. Although not directly related to the Disney corporate scandals, the first question reflected global curiosity in respect of this individual’s unmatched personal fortune. Asked the journalist, “What was your secret for becoming so wealthy?” The famously ill-humored McDuck dryly answered, “It’s very simple. I’ve always spent less than I earned and multiplied the difference”. The second question, straight to the bull’s eye of the interview’s core topic, was “Are you a Disney Corporation shareholder?” Uncle Scrooge replied, “I have been a small shareholder in the past, since, given the nature of my professional involvement with the company, I never wished to be a major shareholder, in order to avoid potential conflicts of interest. On becoming aware of the appalling quality of the company’s Corporate Governance, I tried to convince the members of the board that this policy would not add value to the company and that, on the contrary, it would destroy share value. Since I was unsuccessful, in line with Client Theory, I sold my stock and bought shares in another company that implemented good Corporate Governance practices”. The last question put to McDuck, who was clearly anxious to depart, was “What would be your advice to multiply the difference between earnings and expenditures?” Clearly exasperated and making his exit, he answered “By diversifying investments and, in the case of stock, by only buying from companies with a high level of Corporate Governance. A very good afternoon to you all”.

Another major multinational company separates the position of Chairman of the Board of Directors from that of the CEO.

Recently, the French chain, Carrefour, a serious competitor in many areas of the world’s largest retail organization, Wal-Mart Stores, announced the resignation of Daniel Bernard, who had hitherto combined the position of CEO and of Chairman of the Board. Two versions of this story are doing the rounds of the market. The first is that Bernard disagreed with the company’s new organizational structure separating the two positions and opted for resignation. The second version is that the Board lost confidence in his capacity to recuperate the company’s operation in France, which had seriously weakened over the last few years. But, the fact is that what matters is that these two positions really seem to have been split: the new Chairman of the Board is Luc Vandevelde and José Luis Duran has taken up the position of CEO.

Best Corporate Governance Practices

- Quoted from the Best Corporate Governance Practices Code - Brazilian Institute of Corporate Governance – IBGC - Third Edition, March 2004 – Brazil.

2. The Board of Directors

2.01. The Board of Directors

Any company should have a forum for its governance. In most cases this would be a Board of Directors.

1.02. The mission of the Board of Directors

The mission of the Board of Directors is to protect the equity and to add value to the company and to maximize the return on the investment of the owners.

The Board of Directors should endeavor to uphold the company’s values and the owners’ principles and purposes in the company’s activities. These matters should be discussed, reviewed and approved in meetings of the Board of Directors.

2.03. Responsibilities

The responsibilities of the Board of Director are established in the Company Law. These involve defining strategies, electing and removing the CEO, supervising Officers and Management and naming and removing Independent Auditors.

The activities of the Board of Directors should be further specified in an internal instruction clarifying its roles and responsibilities with special emphasis on the relationship with the CEO and the Officers.

The Board of Directors should approve the company’s code of ethics.

2.04. Committees

Several activities of the Board of Directors need more thorough analyses, which may exceed the meeting time available. Different committees, each made up of a few members of the board, may be set up. For example: nominating committee, audit committee, remuneration committee, etc. The committees study issues in their specific areas and submit the proposals accordingly. Only the full Board can make decisions.

Each company should at least have an audit committee.

2.05. Size

Boards of Directors should be as small as possible and may vary in size between 5 and 9 members, according to the needs of the company.

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