The last 10 to 15 years, have witnessed a tremendous improvement both in the quality of the members and the operation of boards of directors of many Russian companies. While, of course, examples can be found of boards that do not meet the high standards demanded by Russian and foreign investors, both the legislation and the market practice in Russia have evolved to the point where it is now a common practice for companies and their shareholders to ask questions:

Do our directors have the expertise and experience to guide our company in the coming year?

Is our board representative of our shareholder base, including an appropriate number of independent board members?

Is our board functioning efficiently and in a manner that encourages value creation for our shareholders?

Could we better organize our board's activities to achieve our company's stated goals?

Although the current legislation and corporate governance standards applicable to the boards of directors of Russian companies are not generally mandatory for Russian companies, they provide guidance to Russian companies in answering these questions. Below is a comparison of Russian and US corporate governance standards, particularly Rule 10A-3 of the Securities Exchange Act of 1934, as amended (Rule 10A-3), and the New York Stock Exchange (the NYSE) corporate governance rules in Section 303A of the NYSE listed company manual.

Legislative background

In 1995, Russia enacted the Law On Joint Stock Companies (the JSC Law), which remains the fundamental corporate law governing publicly traded Russian companies. In 2002, a major step was taken with the enactment by the then-Federal Commission on the Securities Markets of the Russian Code of Corporate Governance (the Code), which is now adhered to by many publicly traded Russian companies. According to the introduction to the Code, it was enacted in recognition of the fact that "legislation alone cannot be expected, and is inherently unable to, regulate all issues related to the management of companies." The Code draws on internationally recognized corporate governance principles, including, in particular, those developed by the Organization for Economic Cooperation and Development (OECD), and it addresses an array of corporate governance issues, including board composition and function.

Election of boards of directors of Russian companies

Before turning to board composition and function, it is instructive to look at director nomination and election procedures under Russian law. Russian joint stock companies with more than 1,000 holders of voting stock are required to have boards with at least seven members and companies with more than 10,000 holders of voting stock are required to have boards with at least nine members. As most investors active in the Russian market are aware, any shareholder, or group of shareholders, holding in the aggregate at least 2% of the outstanding voting shares of a Russian company has the right, within the first 30 days of the fiscal year, to nominate candidates for the board of directors for election at a company's annual general meeting of shareholders. This provides an interesting counterpoint to US board election practices, where director nomination by shareholders is not common and is the subject of hot debate.

Cumulative voting for directors, which is generally viewed as a safeguard for minority shareholders, is another noteworthy difference between Russian and US board election practices. The JSC Law requires companies to hold elections on a cumulative basis. The Code also stresses the importance of cumulative voting, stating that the goal of taking into account "the opinions of all shareholders..., including those with small holdings...may be achieved only by electing members of the board of directors by cumulative voting." Cumulative voting is permitted but not required under US state corporate laws and is not in widespread practice.

Director independence criteria

As a general matter, the JSC Law provides little guidance with respect to director independence, establishing two board independence criteria: (i) the general director (chief executive officer) of a company cannot simultaneously serve as the chairman of the board of directors; and (ii) members of the management board, which may act as a company's executive body in conjunction with the company's general director (CEO), may not constitute more than one-fourth of the total number of members of the board of directors of a company.

On the other hand, the Code provides extensive guidance with respect to director independence. The Code divides directors into three categories: executive, non-executive and independent. Executive directors are those members of the board who are also the general director (CEO) or hold positions within the management board of the company. The Code does not give a definition or set out specific standards for independent directors. Rather, the Code advises companies to consider a number of specific independence criteria when crafting their own independence standards. The Code states that independent directors are generally considered to be persons who are "independent from the officers of the company and their affiliated persons and from major business partners of the company, and do not have any other relations with the company that may affect the independence of their opinions." Interestingly, the Code also includes the recommendation that a person who has served more than seven years on the board should not be considered "independent."

The Rule 10A-3 independence criteria for members of the audit committee focus on: (i) independence from management (in terms of direct or indirect compensation to the director); and (ii) stock ownership of the director or the director's ability to influence the policies of the company (focusing on whether a director is an affiliate of the company, as defined by US securities laws). The NYSE rules, which provide additional specific independence criteria for members of the audit committee, focus primarily on a director's independence from management and do not view stock ownership by itself as a bar to an independence finding. Neither Rule 10A-3 nor the NYSE rules require seperation of the CEO and the chairman of the board. The specific independence criteria proposed by the Code are broad and generally encompass the concepts of the independence criteria of Rule 10A-3 and the NYSE rules in that the Code's criteria focus both on independence from management and a director's relationship with the company.

Interestingly, while the JSC Law does not address director independence in general, it establishes specific independence criteria for members of the audit commission. The JSC Law requires Russian companies to have an audit commission that is tasked with the responsibility of financial oversight, which at a minimum includes annual review of financial results (under Russian statutory accounting). JSC Law Article 85.6 prohibits audit commission members from simultaneously serving on a company's board of directors or holding any office in the management bodies (that is, general director/CEO) of the company. JSC Law Article 85.6 also states that members of the board and management may not vote their stock in audit commission elections.

Board composition

As discussed above, the Code permits companies to establish their own director independence standards, advising them to take into account considerations set out in Code Paragraph 2.2.2. However, the Code does not specify which managerial body (the board, management or the shareholders) determines whether a specific director is independent. By contrast, the NYSE rules require the board of directors to affirmatively determine whether an individual director is independent (that is, has no material relationship with the listed company). Like the Code, both Rule 10A-3 and the NYSE rules require disclosure about compliance with their respective independence standards.

Under the JSC Law, members of the managerial board, which may act as a company's executive body in conjunction with the company's general director (CEO), may not constitute more than one-fourth of the total number of members of a company's board of directors. Additionally, the Code states that independent directors should comprise at least one-fourth of the total number of members of the board of directors and recommends that a company's charter should require it to have at least three independent directors. This means that Russian companies with more than 10,000 shareholders and at least nine board seats could potentially have a majority of executive or non-independent directors. By contrast, the NYSE rules require listed companies to have a majority of independent directors to "increase the quality of board oversight and lessen the possibility of damaging conflicts of interest."

Executive participation on the board may be beneficial in many respects, but some argue it may also create the potential for compromising the board's independence from management. In the future, Russian law or securities regulators might develop a standard requiring or recommending non-executive director sessions, which would be similar to a requirement in the NYSE's corporate governance rules, for instance.

The absence of an enforcement mechanism is one shortcoming of Russian board composition standards. The Code states that the JSC Law "fails to provide the procedures needed to enforce" such standards and "there is no procedure for ensuring the required number of independent directors." Conversely, non-compliance with the Rule 10A-3 and NYSE independence rules could prevent a company from listing its shares on the NYSE or in a de-listing of listed shares. The onus is on Russian companies to voluntarily establish and comply with their own board composition standards and independence criteria.

Committees of the boards of directors

The JSC Law states that the board's function is to "exercise general direction over the activity of the company, except for the deciding of matters relegated by the [JSC Law] to the authority of the general meeting of shareholders." Once the board is elected, perhaps one of the most important immediate questions is how to accomplish this objective most efficiently and effectively. US and other international practice has evolved to the point where boards of directors routinely form committees that specialize in critical areas, such as financial oversight, and director and executive nomination and compensation. Russian corporate governance standards have recognized the usefulness of specialized board committees.

Although the JSC Law is silent with respect to board committees, the Code includes a recommendation to establish committees for the "preliminary consideration of the most important matters assigned to the authority of the board of directors." It is envisioned that these committees would make considered recommendations to the boards of directors. The Code recommends the establishment of a strategic planning committee, an audit committee, a human resources and remuneration committee, and a corporate conflicts resolution committee, and, in certain instances, a risk management committee and an ethics committee. These committees might be seen to be similar to certain committees that are typically formed in the US either voluntarily or in response to recent corporate governance standards established by Rule 10A-3 and the NYSE corporate governance rules.

The Code proposes that the strategic planning committee plays a role in defining the strategic goals and objectives of the company, including in the areas of operations and dividend payments. The NYSE rules do not require boards to have committees with similar functions. US boards sometimes have finance committees, which often recommend annual budgets and monitor investment policies, and this committee might be the most comparable to the Code's strategic planning committee, albeit different in important respects.

The Code envisions that the human resources and remuneration committee focuses on assisting the board when filling managerial positions, including board nominations (because the board of directors is viewed as a managerial body of the company), and should set compensation standards for these positions. By contrast, the NYSE rules contemplate a nominating/corporate governance committee whose authority should include, among other things, nomination of directors (but not necessarily executive officers), and a separate compensation committee, whose authority should relate to compensation of executive officers (but not necessarily directors).

The Code recommends that the corporate conflicts resolution committee be responsible for resolving disputes arising out of internal corporate conflicts and between the company and its shareholders. There is no analogous committee under US standards. US boards tend to form ad hoc committees to deal with sensitive matters.

The Code also provides a softer recommendation for an ethics committee that can be charged with advising the board with respect to guidelines on what are commonly viewed in the US as social issues (for example, compliance with environmental and safety regulations, and improvement of labour conditions) and the use of insider information. Along these lines, the NYSE rules require companies to adopt a code of business conduct and ethics. Additionally, the NYSE rules require companies to establish a nominating/corporate governance committee that, among other things, develops and recommends to the board a set of corporate governance guidelines that address director qualification and responsibilities, responsibilities of board committees and director compensation.

Audit committees: a point of converging standards

Russian and US corporate governance standards converge on audit committees, providing an interesting reference point for analyzing the current state of Russian corporate governance practices. The Code's recommendation for audit committee functions parallels the audit committee functions required by US corporate governance standards in certain respects. The Code states that the audit committee should ensure "proper supervision of the company's financial and business operations by the board of directors." According to the Code, the audit committee should be tasked with enabling the board "to control implementation of the company's financial and business plan, and to ensure the efficiency of its internal control and risk management systems." Importantly, the Code recommends that the audit committee assist the company with the selection of an outside auditor and interact with the auditor and the company's audit commission.

Rule 10A-3 and the NYSE rules require the establishment of an audit committee and provide guidance on the function of the audit committee. Like the Code, US corporate governance rules task audit committees with financial oversight, internal control and risk management, and interaction with outside and internal auditors.

However, US and Russian audit committee standards differ in several significant ways. First, audit committees are required to be composed solely of independent members both under Rule 10A-3 and the NYSE rules. Second, the NYSE rules require each audit committee member to be "financially literate as such qualification is interpreted by the listed company's board in its business judgment." The Code does not propose analogous independence and financial literacy standards. On the other hand, while US governance standards require the audit committee to be "directly responsible for the appointment, compensation, retention and oversight" of the outside auditor, Russian law makes shareholders responsible for selection of the outsider auditor and the board of directors for approving the auditor's compensation. Despite these differences, it should be recognized that Russian regulators, like their US counterparts, acknowledge the importance of audit committees.

The final word

The foregoing provides a broad overview of certain Russian board composition and practice standards and compares them with their US counterparts. This comparison shows that, in certain important respects, Russian board standards are similar to US standards. While it cannot be said that practice always matches these standards, corporate governance issues are being discussed and more sophisticated standards exist and are being implemented in the Russian market. A revolution in the minds of Russia's corporate leaders and securities regulators is taking place and should not be overlooked by the investment community.

Author biographies

Melissa J Schwartz Akin Gump Strauss Hauer & Feld Melissa J Schwartz's practice focuses exclusively on transactions involving companies in Russia and other states of the former Soviet Union. Schwartz represents Russian issuers, as well as portfolio and strategic investors, in structuring and implementing investments in Russia and abroad. She has handled numerous public and private debt and equity financings, and mergers and acquisitions for Russian clients. Schwartz has also advised Russian companies on restructurings and reorganizations, in workout situations and in preparation for public offerings. Before relocating to Washington DC, Schwartz was the partner in charge of the Moscow office, and was resident in the New York office. Schwartz received her BA with distinction in Russian and Soviet studies and economics from Cornell University in 1988 and her JD cum laude from Harvard Law School in 1991. She is fluent in Russian. Schwartz is a member of the District of Columbia Bar. Felix Saratovsky Akin Gump Strauss Hauer & Feld Felix Saratovsky focuses his practice on corporate and securities matters. Saratovsky received his BA with high honours in social studies and Russian language and literature from Wesleyan University in 1995 and his JD in 2001 from the University of Michigan Law School, where he was executive articles editor of the Michigan Journal of International Law. He is fluent in Russian. Saratovsky is a member of the New York Bar.