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Moscow Times
June 30, 2004
Harvard Files Surgut ADRs Test Case
By Caroline McGregor
Staff Writer

For Harvard University, Russian studies and Russian cash are entirely different subjects.

A day after suffering an embarrassing legal defeat over its role in Russian privatizations during the 1990s, the celebrated institution of higher learning went on the offensive Tuesday, filing a class-action lawsuit against oil major Surgutneftegaz for depriving Harvard's pension fund of millions of dollars in dividends.

The pioneering claim against Surgut, in which Harvard owns an estimated $130 million worth of preferred shares of stock via American Depositary Receipts, could end up costing the closely held oil company hundreds of millions of dollars.

In the papers it filed with the American Arbitration Association, Harvard alleges that Surgut has paid holders of its preferred shares only 20 percent of the dividends to which they are entitled.

Harvard is seeking $3.7 million in unpaid cash distributions.

Under Surgut's charter, preferred shareholders are entitled to receive 10 percent of annual net profits. The company meets that obligation, but only on a technicality, using its own definition of net profits in order to artificially lower the figure.

The business world generally defines net profits as profits after tax, but Surgut has included the additional deduction of capital expenditures and other expenses under a legal loophole.

William Browder, CEO of Hermitage Capital Management, another minority shareholder, estimates that over four years, from 1999 to 2002, Surgut underpaid preferred share dividends by $397 million.

In 2003, Surgut raised its total payout to around $200 million from $60 million in 2002, but still below what the market would like to see it paying.

The company's opaque ownership structure and its Soviet-style attitude toward shareholders have irritated minority investors for years, but the Kremlin doesn't see it that way. On a recent trip to Siberia, President Vladimir Putin praised the company as an exemplary corporate citizen, in contrast to Yukos.

Surgut general director Vladimir Bogdanov justified the modified calculation in a letter to then-Prime Minister Mikhail Kasyanov in 2001, writing that if the dividends were paid out in full, the company would be sending "a considerable part" of its cash flow to shareholders abroad, contributing to capital flight.

Alexander Branis, whose Prosperity Capital Management has sued Surgut unsuccessfully in regional courts to recover unpaid dividends, said the Surgut management mentality goes like this: "If you aren't investing money into the company, you don't have the right to take money out. Portfolio investors should be content to profit from share price appreciation, not dividends."

Harvard's claim was filed on behalf of all those who hold preferred shares in Surgut via ADRs, but it is not clear how many potential claimants there are.

Harvard said any decision by the arbitration panel in New York would be binding under international treaties Moscow has signed, but Surgut counters that agreements covering ADRs held by Harvard allow recourse to Russian courts.

Jurisdiction is the most interesting issue, Browder said. "It's never been done before, but if they succeed, it opens up a whole new avenue for enforcing corporate governance problems in Russia," he said.

Surgut brushed off the announcement of Harvard's claim. "News of the latest minority shareholder suit is very likely no more than a way of heating up the market," Surgut said in a statement Tuesday. "Our company acts, and has always acted, within the law."

Ironically, the Harvard arbitration demand came the day after a judge in Boston ruled that two Harvard advisors posted to Russia in the 1990s defrauded the U.S. government by cashing in on the market reform advice they were being paid to give to the Russian government.

Under the decision, Harvard may have to repay $34 million in money given by the U.S. Agency for International Development to support the "Russia Project" run by the Harvard Institute for International Development to support Russia's transition to a market economy.

Top HIID officials Andrei Shleifer, an economist, and lawyer Jonathan Hay, meanwhile, could face triple those damages, or up to $102 million, for deliberately breaching the terms of the university's contract with USAID by making personal investments in Russia, directly and through family members, while advising the Boris Yeltsin administration.

Originally prosecutors sought $102 million from the university, too, but that was reduced after Judge Douglas Woodlock ruled Harvard did not know that Hay and Shleifer were violating the conflict-of-interest policy Harvard signed with USAID.

In an upbeat statement, Harvard was confident the damages it ultimately pays will be "only a fraction of the damages originally sought by the [U.S.] government."

Shleifer, who remains a tenured economics professor at Harvard, has argued that as a consultant to HIID, he was not clearly bound to the terms of the contract, which forbid any type of financial transactions in the project country. Woodlock said he could not rule on the allegations against Shleifer and the issue will go to a jury trial if it is not settled out of court.

But because Hay, who was on the staff at HIID, violated the policy, Harvard as his employer remained in breach of its contract.

Woodlock had previously dismissed some of the lawsuits filed three years ago by the U.S. Justice Department under the False Claims Act, including those against Hay and Shleifer's wives.

The judge set a hearing for July 19 to discuss how much money the defendants will have to pay.

"It will be very interesting to see how the university acts now, given that the university's president [Lawrence Summers] is so close to Shleifer, it will pose a real test," said Marshall Goldman, a specialist on Russian economics at Harvard's Davis Center for Russian Studies, who has long found fault with the way the shock therapy reforms, prescribed by Shleifer and others, took place.

Summers had been treasury secretary under U.S. President Bill Clinton and a firm supporter of the privatizations advocated by former Deputy Prime Minister Anatoly Chubais.

"It's also tricky business for Harvard's economics department. Shleifer is viewed as one of their superstars, but clearly this is quite embarrassing," he said.