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The main category of speculative activitywas the purchase of shares at a voucher auction in order to resell them to aclient not present, as well as to ensure the purchase of rather large packetsof shares (5-15% of the authorised capital) of the enterprises being privatisedfor the sole purpose of future resale to the administration of the enterprises(through all sorts of `dummy firms' controlled by the management), and purchaseof shares in privatised enterprises to the order of clients.

Yet a majority of funds are low incomeyielding or even loss-making, so dividends may be received only by theshareholders of a very limited number of funds. For example, out of 150funds analysed by the Skif association in 1993, less than 30% were makingprofits. GKI experts believe that on average each share in voucher fundscarries 4 rubles of losses. Even the largest funds recognise that theycould not provide gains for their shareholders. More than half of thefunds decided that they should pay no dividends after their 1993 results andfor those funds which did make payouts the dividend did not exceed 2000-5000rubles per share (Shimov, 1994). GKI estimated that the funds that didpay dividends for 1993 paid 130% per annum (with the spread of the declareddividend size varying form 10% to 200%) (`on some results...', 1994).There are funds that paid dividends in the form of shares.

Although the largest funds do havedifficulties of their own, it is the small funds that face the largestproblems. they have neither their own analytical base, nor enough freemoney to cover their current expenses, and often they are `eating up' theirauthorised capital. And although the possibility of merger of fundsexists, this does not save them from the prospects of going bankrupt. Asyet there are no legislative mechanisms to regulate the process, nor mechanismsto protect the shareholders or to control the operations of the fundmanagers.

One problem for the funds is the questionof taxation. Actually the shareholders of the funds were subject to taxesindirectly, through the imposition of taxes on the profits of enterprises whoseshares are in the portfolio of the fund (32%), dividend tax when the fundreceives dividends as a legal entity (15%) and the tax imposed on naturalpersons (shareholders of the fund). The second state programme ofprivatisation (December 1993) freed voucher funds (for the first two years fromthe time of registration) from the dividend tax when these dividends were paidout by enterprises on shares owned by these funds, from the transfer of theadvance tax payments on profit, and the tax payable when a prospectus for theissue of securities is registered. Yet that programme was adopted bydecree of the President of the RF, while according to the law, all questionsrelating to matters of taxation are within the province of the legislativebranch. This makes it likely that the decisions may bereconsidered.

Only half of the operating funds had heldgeneral meetings of shareholders by September 1994 and approved their resultsfor 1993. In addition to the technical problems (how to arrange a meetingof the millions of shareholders of the largest funds or shareholders in variousregions of the country), the characteristic feature of most meetings - when afirst attempt was made to get together - that a quorum of 50% of votes couldnot be obtained. When there was a second meeting, when decisions weretaken by a simple majority of votes among those present, it was quite evidentthat the basic rights of the main mass of small shareholders wereviolated.

Many experts believe one of the most acutemedium-term problems will be that of the illiquidity of the assets of voucherfunds. Now there is practically no secondary market in the shares of theinvestment funds. And while at the early stage the voucher fundsvirtually faced no competitors in selling their shares for the population'svouchers, now the secondary market means sale of the shares for cash and thischanges the situation drastically. The point is that large investors mayhave no interest in such funds. there is a hard struggle for the freecapital of the population and the funds face competition from commercial banksand certain companies whose efficiency from the point of investment is muchhigher, both in terms of the size of dividends paid and in terms of theliquidity of their securities. it is quite clear that only some of thefunds can ensure the liquidity of their shares (see INIOR, 1994). To agreat extent the destiny of the voucher funds will depend on the strategy theyadopt (or on the lack of such strategy), the legal regulations on theconversion of voucher funds into `common' investment funds, as well as on thesecurities situation in Russia and the macroeconomic situation.

7.6. Investment Contests and Other Methods ofInitial Sale

In addition to closed subscription forshares and voucher auctions, the following types of privatisation are likely inaccordance with the second state programme:

- sale of blocks of sharesthrough an investment tender;

- auction for money of 10% of theshares from those sold for privatisation vouchers;

- sale of enterprises that arenot joint stock companies by auction or commercial tender (including a limitednumber of participants);

- sale of property (assets) ofactive enterprises, those that are being liquidated and construction projectsstill in progress, by auction or tender (including an investmenttender);

- sale of defaulting debtorenterprises;

- privatisation of leasedproperty.

Though on the surface there are a number ofways to effect privatisation for a large investor who wants to have acontrolling block or close to a controlling interest, the choice in fact is nottoo great. One may, of course, participate in auctions and tenders forthe acquisition of an enterprise as a whole, primarily municipal ones, but inthat case a permit must be obtained from the local authorities (for a foreigninvestor). Moreover, as practice in 1993 showed, the main interest oflarge investors is concentrated on the items of federal property which areincorporated. As to purchase of a defaulting enterprise as such, or apart of its assets, this is also hardly possible today without considerableprocedural and legal difficulties. As a rule, leased enterprises arebought out by the workers of those enterprises themselves. Finally, thereis a money auction on the basis of the provisions of the order on sellingshares at auction for rubles up to 10% of the total number of shares of thestock companies sold at a specialised voucher auction. Shares can beacquired there, but even the simplest calculation shows that one can not getmore than 2-3% of the authorised capital.

In this connection, the most promising andactually the only means that will make it possible to acquire a controllinginterest or a packet of shares close to a controlling interest is an investmenttender. Under the Russian law the tender can only be open, and thecriterion for selection of the victor is the amount of investment, discountedover the entire period of investment at the rate of the Central Bank of Russiaat the time the tender is held. The period for making investments shallnot last more than 3 years, with the payment for the packet of shares acquiredbeing on the basis of the nominal price.

In the course of the initial distributionof shares the winner at the tender may count on some 18-22% of the authorisedcapital, but after his investment is completed (amounting to not less than 50%of the authorised capital) the joint stock company must, if the tender winnerwishes, make a second issue of shares and transfer shares to him equal to 50%of the authorised capital formed at the moment of creation of the joint stockcompany. In other words, an outside investor who is the victor in atender may rather rapidly, legitimately and without considerable expensesbecome the owner of the controlling block of shares.

By the beginning of 1994 privatisationplans in Russia provided for some 280 investment tenders, out of which 160 hadbeen carried out by January 1994 (3.1% of the number of mandatorilyincorporated enterprises); the average size of the block of shares offered was18-22% (Isaev & Minaev, 1994).

Because the blocks offered were split, thenumber of tender winners reached 208, including a few foreign investors - 15foreign companies proper and 7 joint ventures. One can also mention herethe participation of two commercial banks. The total sums to be investedamount to 1.2 trillion rubles, $1 billion and DM 35.6 million, with an averageinvestment programme running for some 2-3 years. So in principle eventhis small experience has shown that this method may be applied quiteefficiently from the point of view of the attraction of resources and for thatreason it is thought that in 1994-1995 the share of investment tenders amongall methods of sale should be considerably increased.

Naturally, this kind of sale is not withoutproblems. The first is that the tender winners may not carry out theirinvestment commitments and to avoid this they resort to some techniques thatare on the verge of legality. For example, a considerable problem for mayregions (and the reason for the failure of many tenders) is the absence ofinvestors and resources for investment. Many enterprises with a promisingfuture are hoping for mobilisation of investment resources once they areprivatised. For a serious investor the assigned period of one month isnot enough to research the market and take a decision on participation in atender.

Today one of the main reasons forparticipation by a foreign firm in an investment tender is to secure a certainsegment of the Russian market. For example, the British morgan CrucibleCo., which controls 24% of the world market for electrical carbon, acquired 15%of the shares of Uralelektrougli on condition that it invests $1.5 million andwith the right to increase the authorised capital. At the same time(Boreiko, 1994) a primary goal of the British firm today is just finding aplace for itself in the Russian market.

In the view of some experts, one of thegoals of those few foreign investors which did directly participate inprivatisation bids is just their desire to weaken potential Russian competitorsin the promising Russian market. Thus, analysing the policies of Proctorand Gamble Co. with reference to Tula Novomoskovskbytkhim, A. Kosorogov,Chairman of the Board of Directors of Alfa Capital investment fund, put it thisway: `what they want is to absorb the plant and then brush it aside as acompetitor on that market'. Moreover, according to the same source,despite the apparently impressive volume of investment programmes, on the basisof the results of the tenders already held (as reported in May 1994), `not asingle enterprise, when the investment bidding was won by foreign firms, hasyet provided its money' (Privalov & Chernakov, 1994, p.4).

Nor is it a secret that now the system ofinvestment tenders (albeit open) is nothing but a veiled form of direct sale toa previously determined investor, who participates in the elaboration of theinvestment programme from the very beginning and is involved in setting theterms of the tender.. The best example is just formalising existingbusiness relations, as was the case with Proctor and Gamble withNovomoskovskbytkhim (Tula) and Illingworth Morris with Bolshevichka(Moscow). Technically it is not difficult to do (and in a number of casesit is necessary), but for an investor who lacks direct contacts with anenterprise an additional obstacle arises - the difficulty of `sensitive' talkswith the management of the enterprise and the officials of the correspondingdepartments. In the case of a `hostile' investor a whole battery oftricks may be used: concealing information on the tender and its terms(Kransnodark Tobacco Factory in favour of Phillip Morris), refusal to extendthe period for submission of applications (this way the Hilton Group was cutoff from participation in the bidding for the Hotel Moskva), arbitrariness indetermining the best bid and the price of the packet and otherproblems.

It may also involve direct violation of thelaw, and these violations may be committed by the creators of the lawthemselves: the GKI instruction no. 255-p or 4 February 1994 wascertainly against the law (it was issued when a voucher auction of Avtovaz washeld). According to this instruction 7% of the shares of Avtovaz were tobe transferred to the authorised capital of All-Russia Automobile Alliance(thus the share of the investment tender was effectively reduced from 22.5% to15.5%). An amendment may be made to the privatisation plan which affectsthe second issue of shares for the winners of the tender. And all this isdone despite a strict ban on changing a privatisation plan in the process of avoucher auction for all other subjects.

7.7. Qualitative Results of Implementation of theMass Privatisation Programme

First of all, the expiry of the validity ofthe voucher marks the end of the first stage of Russian privatisation/31/. this stage started in 1992 and was completed on 20 June 1994.Despite various economic, political and social problems connected with thecirculation of the voucher, the real basic task formulated in section 7.1 - themass redistribution and fixing of property rights throughout Russia has beenfulfilled. It may be objected that it was done formally and not always inthe most civilised way, but all the same it is due to this privatisation thatby the middle of 1994 Russia has:

- a corporate sector in itseconomy;

- an exchange and off-exchangesecurities markets, including an infrastructure for trading privatisationvouchers, a system of auctions for privatisation and a secondary market inshares of privatised enterprises (see also Chapters 8-9);

- a system (so far of atransitional type, but quite powerful nevertheless) of institutional investorsin the form of voucher investment funds and other structures;

- a social stratum which, withall the reservations about it, and taking into account its heterogeneity andlegal weaknesses, we can nonetheless call a stratum of owners.

We can also say that in many respects it isdue to the privatisation programme carried out in 1992-1994 that it would bedifficult to revert to the old monopoly and administrative and bureaucraticcontrol of Russian enterprises, although it is too early to discard such apossibility completely. And from a broader perspective, we can say thatthe gigantic changes at this time in the area of property relations paved theway for modification of the power relations in Russian society too.

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