Towards an Ethical Corporate Governance in Russia and South Korea - Who, If Not You?

The principles of good governance are at the heart of Legatum’s ethical framework in all its incarnations.

Legatum Article Corporate Governance

In 2000, a book was published to critical acclaim, edited by William Vanden Heuvel, former US representative to the United Nations. The Future of Freedom in Russia was a study of that country’s transition from communism to the free market, one that needed to be understood from not only an economic perspective, but also with regard to its impact on existing legal and social infrastructures.

The text details the democratic institutions already present in Russia at the turn of the last century, which were deracinated by the effects of World War One. It retains a notable strain of optimism in relation to future democracy, which, from a 2016 perspective, has not yet been fully realised. As well as many interesting essays, the book’s appendix, entitled Seven Steps to Prosperity, was noteworthy. This document, a rigorous manifesto, had appeared in 1999 and was circulating among members of the Federal Duma as well as within the international investment community. The unsigned open letter that accompanied it began: ‘Russia needs moral reform, not only economic reform.’

While its recommendations were specific to the time and place, its underlying ethos was remarkable for its commitment to a more just society. This, coupled with its forensic clarity about what needed to be done and why, made it the most talked about paper of the year. Its anonymity (though an open secret in some quarters) was intriguing.

Two decades later, answering a researcher’s question on the subject of corporate governance, Legatum founder Christopher Chandler had reason to revisit this text. He was, of course, its author. Past and present collided through his consistent vision of putting principles before profit. Over the three decades since he and his brother Richard founded Sovereign Asset Management, difficult investment decisions have been enacted; decisions which in some cases have helped shape the future of nations in transition.

In 2006, the Chandler brothers de-merged Sovereign, and while Richard Chandler headed the Chandler Corporation, Christopher Chandler, along with Mark Stoleson, Alan McCormick and Philip Vassiliou, founded the investment company Legatum, deriving its name from the Latin word for ‘legacy’ or ‘gift’. This article aims to trace its subsequent genealogies.

Legatum embodies the ethos of its founders, whose desire is to model a principled approach to investment. Christopher Chandler’s personal philosophy grew from an epigram by Heraclitus, who left us only fragments of his wisdom: ‘Character is destiny.’ This quote has since been expanded upon and variously attributed to ancient Chinese thought, as well as to Gandhi, but the spirit of the journey from the inner self to the outer world is its essence: ‘Your thoughts become your actions, your actions become your habits, your habits become your character, your character determines your destiny.’ Within the rhythm of this phrase, a deep sense of personal responsibility is located, coupled with an insistent and ripening progressiveness. It is from this moral framework, expressed across continents, from investment to philanthropy, consistently enshrining a legacy of good corporate governance, the journey began.

Your thoughts become your actions, your actions become your habits, your habits become your character, your character determines your destiny.


Sovereign was the largest investor into this new market, on the journey towards the opening of the Russian stock exchange in 1995. Taking risks means acknowledging the instability inherent in transition economies and understanding their vulnerabilities and weak points. To take the example of Russia, coming out of decades of communism, infrastructure was not in place to support the needs of a truly free market, neither legally, politically nor culturally. This offered the opportunity to try to instill the principles of good corporate governance into what was known colloquially at the time as ‘The Wild East.’

It’s essential to understand something of the febrile atmosphere of the origins of the emerging free market in the former Soviet Union into Yeltsin’s new Russia, with the introduction of private banks, commodities exchanges, and the stock exchange. Vanden Heuvel described it in his introductory preface to his book: ‘In the transition from Communism, its resources have been plundered and greed has replaced creed.’. Yeltsin failed to implement the necessary legal structure to galvanise these dramatic reforms. Moscow was thus propelled into a future it hadn’t prepared for, or, as Peter Pomerantsev perceived it a few years later, in his book about 21st century Russia, Nothing is True and Everything is Possible: ‘… a city living in fast-forward, changing so fast it breaks all sense of reality, where boys become billionaires in the blink of an eye.’

Having arrived in Russia with a substantial investment fund, being the fruits of years of investing in Asia and Latin America, by the end of 1994, Sovereign owned 4% in Unified Energy Systems, 11% in Mosenergo, and 5% in Yukos Oil. They invested in Russia’s largest company, Gazprom, which produced 19% of the world’s natural gas and owned 6% of the world’s reserves. They also acquired 15% of Novolipetsk Steel (NLMK) in the mid 1990s, which would increase to 25%, after divesting their shares in Yukos when Menatep, led by Mikhail Khordokovsky, took control of the oil company via state auction.

Khordokovsky’s personal trajectory over the next two decades would be as tumultuous as that of the economy itself. In some ways he personified the mood of those early years of the ‘free’ market. Despite amassing a significant business group, he ended up spending nine years in a bleak prison colony on charges of fraud and tax evasion. Thus incarcerated, he made good use of his time and wrote a perceptive series of vignettes, My Fellow Prisoners, in which he described his country as a ‘society where goodness and empathy are seen as synonymous with madness.’

NLMK, meanwhile, looked like an extraordinarily astute investment; the company had 41,000 employees and revenues of $2 billion dollars per year. But something unexpected happened over the next two years: NLMK’s profits took a deep dive, declining by 90%, from $480 million to $40 million. It turned out that the company’s management company were engaging in the practice of ‘tolling’, in which the company’s products were sold below market value to an off-shore trading company, and then re-sold at full price. In this way, the profits were neatly siphoned out of the country. This practice was common in Russia at the time.

Such business practices were anathema to Sovereign; as was the presence of an armed guard that prevented entry to Sovereign representatives at the 1996 annual meeting. Their response to this volatile environment was to begin a reform group, partnering with the Sputnik Fund, controlled by Russian financier Boris Jordan and backed by Soros Fund Management and Harvard Fund Management Company. This union meant that between them, Sovereign and Sputnik now held 51% of the equity.

This reform group argued for board representation and an independent audit of the steel mill; yet their requests were ignored by the incumbent management. In 1997, their campaign for reform made legal history by having shareholder rights recognized in a landmark court decision. It was the first time a Russian company’s management had ever been successfully sued by a shareholder. And although case law was created, it proved impossible to enforce the court’s judgement.

Soon after, Sputnik sold its 25% share to NLMK management, weakening the ability of Sovereign to continue the battle for justice. In 1999, after the announcement of a dilutionary share issue, Sovereign was forced to sell its shareholding. The longer-term effect of Sovereign’s activism served to intensify scrutiny of tolling arrangements, which have now virtually disappeared from the Russian economic scene.

The Russian economy was in meltdown by 1998, when it defaulted on its domestic debt obligations. This was not a crisis borne of lack of funds, but of corruption. Parallels were drawn with Lenin’s repudiation of the debts of his predecessor; yet the IMF saw fit to offer a loan of $4.8 billion to salvage the flailing economy. Boris Fyodorov, another key reformer and Russian patriot, who had worked in the finance ministries of Gorbachev and Yelstin, warned that foreign aid often served to exacerbate pervasive corruption, by removing the need for the country to change the infrastructure that permitted the crisis to take place. His warning was not heeded.

The financial crisis led directly to the total dissolution of the Soviet Union, which resulted in 15 sovereign states in various states of disrepair, despite the profound cultural richness of former Soviet citizens and the extraordinary natural resources of the land. And what of the loan? As the Moscow Times reported on 29 July 2000, special prosecutor Nikolai Volkov said he would urge Russian authorities to join Swiss investigations into possible misuse of the loan, which reportedly disappeared upon receipt into offshore bank accounts. Ironically, the loan, like others before it, was granted only with the proviso of economic reform, which never happened. It was this culture of corruption, as well as the notorious loans-for-shares scheme, which led directly and inevitably to the rise of the oligarch in Russia, and turned the gap between the powerful and the disenfranchised into a chasm.

It was this lack of a shared culture of honesty and transparency in Russia that motivated Sovereign once more to try to bring about principled engagement and ethical corporate governance. They saw Russia as a country rich in resources and potential workforce, as aforementioned, but were awake to the fact that continued failure to implement good practice would result in potential catastrophe. This was the climate in which the manifesto Seven Steps to Prosperity was written. As well as the memorable first line ‘Russia needs moral reform, not only economic reform’, the accompanying letter which was circulated among members of the Federal Duma, asked some pertinent questions:

‘Weren’t the young shoots of economic growth choked by the weeds of short-term self-interest as people at all levels seized what they could, regardless of the interests of others?’

‘Which of you does not remember those moments of despair when your personal attempts to make a difference in your own sphere collided with the outrageous inefficiency of the current system, when you needed to scale the walls of bureaucracy, indifference, incompetence, and self-interest in order to accomplish any task?’

‘Who, if not you, has the power to start acting in accordance with your true principles here and now?’

This passionate call to peaceful and ethical arms was supported by an action plan via which those core values could be put into practice. The Seven Steps called for a fairer, simpler, more efficient tax code; a bankruptcy law; investor protection, to conform with international standards; reform of the banking system in which the market should be opened up to foreign retail banks in a ground-breaking technology transfer; land reform, which would enable Russians to own their own homes; social responsibility and the development of morality; and a restructuring of domestic debt. The sixth step in that list is appealing to a different register and is worth dwelling upon. As its author knew well, the development of morality is not something that can be imposed by a law court, or even a president. It was a bold, and in some ways surprising, addition to the list, but it pierced the very heart of the problem: ‘Many Russians seem to see capitalism as an amoral system of “every man for himself”,’ wrote Christopher Chandler. ‘The cronyism and uninhibited misappropriation of Soviet assets under the pretense of reform has given real capitalism a bad name.’

This word to note in that sentence is ‘pretense’. Peter Pomerantsev, who has lived and worked in Russia since 2001, and was a senior research fellow at Legatum, also noticed the nation’s propensity for make believe, and saw its seeds being sewn in preceding decades: ‘… the great drama of Russia is not the “transition” between communism and capitalism, between one fervently held set of beliefs and another, but that during the final decades of the USSR no one believed in communism and yet carried on living as if they did, and now they can only create a society of simulations.’

The cronyism and uninhibited misappropriation of Soviet assets under the pretense of reform has given real capitalism a bad name.

Sovereign wanted real reform. Since its very earliest investments in Russia, they were operating in a territory very few international investors understood. The government was actively working to move state assets to private control, in an attempt to combat corruption and improve productivity.

By 2000, Sovereign’s attempts to modernise the management of Gazprom were becoming more active. Along with other minority investors, Sovereign voted for the appointment of Boris Fyodorov to the board of directors. Fyodorov was an ex-Finance Minister and known to be honest. His mindset was focused on nurturing attempts to develop a free market. He then challenged the company management by insisting on transparency and accountability, and by calling out insider dealing.

Boris Fyodorov continued to encourage Gazprom’s largest shareholder, the Russian state, to take governance reforms seriously. With the Russian State owning around 34% of Gazprom, it was in Putin’s own interest to act, and indeed a change at the top ensued: Alexei Miller replaced Rem Vyakhirev as CEO, and became openly supportive of the minority shareholders’ calls for higher governance standards.

Some two years after his appointment, Miller acknowledged Sovereign’s essential role, saying: ‘Sovereign’s unwavering support as a long-term shareholder has played a major role in the development and introduction at Gazprom of higher corporate governance standards. This, in turn, has helped Gazprom to reinforce its position among leading international energy companies.’

Sovereign’s unwavering support as a long-term shareholder has played a major role in the development and introduction at Gazprom of higher corporate governance standards

Today, although Gazprom is not yet a model of perfect corporate governance, it turned a profit in 2010 of $30 billion, remaining the world’s most profitable company until 2012. The last word on Sovereign’s enduring legacy in Russia should go to Fyodorov: ‘Sovereign played a significant role in corporate governance reform in Russia for a decade. They displayed great focus, perseverance and patience in seeking to create a more professional, honest and transparent business culture in Russia. When most foreign investors deserted Russia after the 1998 government debt default, Sovereign was one of the few that stayed and continued to promote reform.’

South Korea

When Sovereign invested with SK Corp in 2003, the economic landscape and culture of South Korea were not comparable with Russia, though the effects of a complex legacy were similarly prevalent. Korea’s chaebol model, which is structured through far-reaching family ties and affiliated holdings, had played a significant role in the powerplay of contemporary politics. As well as seeing investment potential in this burgeoning economy, Sovereign realised there was an opportunity to reimagine business practices in South Korea; to encourage ethical leaders to allocate capital efficiently and to protect shareholder rights. This would have the two-fold benefit of increasing the SK Corp’s valuation on the stock market, while at the same time bringing an ethical approach to governance practice to a new territory.

Prior to Sovereign’s investment, the chairman of SK Corp, the country’s third largest conglomerate, had been convicted of a $1.2 billion fraud at a sister company, and, along with nine other executives. Sovereign embarked upon a two-year campaign to oust chairman and CEO Chey Tae Won, who had been released on bail and returned to run the company, but, ultimately, they lost the battle in the courts to oust him. Much time and energy was expended on this important principle. Sovereign foresaw the necessity for the leaders of the South Korean shareholders to fully represent the interests of shareholders, if there were to be any serious foreign investment in South Korea, but theirs was a lone voice.

Sovereign demanded amendments to the rules around public companies: automatic termination of office in the event of criminal conviction carrying a prison sentence; and a requirement that the board set up a separate committee to oversee related-party transactions. These important principles were never enshrined into South Korean law, which meant Sovereign had no choice but to cut its losses, admit defeat in its bid for good corporate governance, and bow out.

Despite the public criticisms that Sovereign had been too aggressive, or not sufficiently culturally sensitive, many among South Korea’s political and business leadership privately encouraged Sovereign to continue to drive the change that could only come from an outsider. The truth spoken by Sovereign about malpractice and corruption was considered both profoundly challenging, and long overdue. The entire foundation of corporate Korea was rocked and this was, unsurprisingly, transformational for all involved. The dispute between Sovereign and SK Corp was the top news story in South Korea for two years running.

Though the multi-billion-dollar fraud was never fully investigated, Sovereign achieved one small change in South Korea: to bring the question of good corporate governance into discourse at the very highest levels. This is an example of principles before profit in action. As Sovereign doggedly pursued its principles in the courtroom, the economic peak in South Korea came, and just as quickly, went. Though a brief conversation took place about whether to sell at the peak and run, it was never pursued as a serious idea. They took the governance battle all the way to the Supreme Court - and lost. At this point, Sovereign divested. The difference in profit, had they sold at the peak, was estimated at $300 million. That was the cost in real terms of sticking to one’s principles in South Korea. In addition, Sovereign invested $6 million in a public information campaign, called “Stand Up Korea”, which encouraged shareholders to stand up and make their voices heard.

Chey Tae Won is still believed to control SK Corp from his prison cell, where he is serving a four year sentence for stealing vast sums of money from companies that formed part of the intricate chaebol. In 2013, he received a salary from SK Corp’s IT unit, despite it being one of the companies he defrauded.

Most recently comes the news in April 2015 that SK is to merge with its IT service provider SK C&C, which would go some way to simplifying the labyrinthine structure of the conglomerate, and towards paving the way for improved corporate governance for the future. The ‘Sovereign Effect’ has established a prominent legacy in Korea. According to Professor Kim Wi-Saeng, from the Graduate School of Management at the Advanced Institute of Science and Technology, Daeieon: ‘Of all the benefits, direct or indirect, brought to Korea by Sovereign, the most important is the understanding that the owner of a company is its shareholders … The ‘Sovereign effect’ is concretely measurable at shareholders’ meetings across Korea, where it is no longer a rarity to see outside shareholders voice their objections to proposals by company management or confront chief officers with questions.

Of all the benefits, direct or indirect, brought to Korea by Sovereign, the most important is the understanding that the owner of a company is its shareholders … The ‘Sovereign effect’ is concretely measurable at shareholders’ meetings across Korea, where it is no longer a rarity to see outside shareholders voice their objections to proposals by company management or confront chief officers with questions

Towards Good Corporate Governance

The principles of good governance are at the heart of Legatum’s ethical framework in all its incarnations. Working in new economies has been a challenging and often imperfect practice, which has led inevitably to criticism about its perceived secrecy as an organisation. Secrecy implies that something is being hidden. As a private company, Legatum hides nothing, but is discerning in the information which it publishes. There is no requirement to divulge financial results, and, especially during the first stages of an investment, detail in the public sphere is kept to a minimum, to protect early investments. It is essential that Legatum is fully accountable to its investors, for example, but not at all essential for the public to know about the private lives of the company founder or employees. This commitment to privacy is not synonymous with a lack of transparency, which is of course a cornerstone of good governance practice.

As well as providing an ethical framework, good governance has additional benefits. According to a Deutsche Bank lecture by Professor Ailsa Roell of Princeton University in 2004, studies reveal a very substantial impact of corporate governance on corporate performance; as much as an 8% difference in annual stock return. Similarly, the OECD Policy Dialogue of 2006 quoted a Harvard Law School study which showed that to disregard shareholder rights causes lower firm valuations to the tune of a 7.4% difference per annum.

It is perhaps not surprising that the will to work ethically and fairly has financial benefits too. The 1999 advice from Christopher Chandler to Russia holds true today for the entire global financial community: if you want to be part of it, you must show you can exercise the moral responsibility that accompanies this privilege. Legatum has, as best it can, aligned its principles and profits in the same constellation, which in turn shines its light back on all involved, from the company to the shareholder to the community to the individual.

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