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Moscow

At present a fairly large number of Russian legal entities are registered as joint stock companies, around which a dynamic securities market is taking shape. As the Russian securities market is a relatively new phenomenon, the legal framework governing securities transactions is still in the process of forming. Two laws, “On Joint Stock Companies” and “On the Securities Market,” constitute the foundation of the legal framework. In addition, the new Civil Code has played a significant role in the development of legal regulation of the securities market. The ongoing rapid legal changes concerning securities transactions reflect major economic and political developments currently underway in Russia.

Securities registration institutions play a key role in the legal infrastructure that has emerged around joint stock company activity. From the beginning of corporate activity in Russia, shares of stock were issued as registered securities and therefore purchasers were required to register their title with the appropriate authorities. It is unnecessary to register specific rights arising from share ownership (such as voting or dividend rights), as they are fundamental to the existence of the security and vary only according to the type of security (e.g. preferred shares). Title to shares, on the other hand, must be registered, as it is the only way that share circulation may be controlled; and if the stocks are issued without certificates, title registration is the only method of formalizing shareholder’s rights.

Notwithstanding the substantial development of the legal framework governing securities transactions over the last few years, title registration procedures applicable to shareholders remain legally and technically cumbersome, particularly for non-Russian shareholders. The title transfer mechanism is complicated and opaque, and title transfer documents must be executed and filed with the proper registering authorities who may be located quite a distance from the concerned party.

As security of title is a principle concern of any entity engaging in securities transactions in the Russian market, the registration procedures merit closer study. This article reviews in more detail the key aspects of the title registration and re-registration procedures.

There are currently three instruments for formalizing title to shares of stock:

1. The share acts as a formal instrument in and of itself (bearer stock);

2. Recording title in the purchasers’ account in a shareholder register; or

3. Recording title in the purchasers’ deposit account in a depository.

Shares as Formal Instruments (Bearer Stock)

Article 25, paragraph 2 of the Law “On Joint Stock Companies” stipulates that all shares must be registered to a specific individual or legal entity. The rights accorded to a shareholder, such as the right to receive dividends and vote in the general shareholders meeting, are only enforceable if the shares have been registered.

On the other hand, paragraph 3 of Article 2 of the Law “On the Securities Market” stipulates that bearer shares may be issued in proportion to the issuer’s paid-in authorized capital, as set by the Federal Securities Market Commission. Since with bearer shares, title is transferred together with the transfer of the share certificate to the new owner without requiring extra registration, these laws contradict each other. As the Law “On the Securities Market” was enacted later, its provisions should prevail over the Law “On Joint Stock Companies." However, in Russia the proportion of bearer shares to the total amount of outstanding stock is negligible.

Recording Title in the Shareholder Register

The operation of the shareholder register and the procedures for registering title to securities are worthy of a closer look, as they take place within a rigidly formalized procedural framework binding on all registered entities.

If there are less than 1000 shareholders, the joint stock company itself may maintain the shareholder register. Where there are more than 1000 shareholders, Russian law requires that the registry be kept by either an independent registrar, a bank, or a depository. Procedurally, banks and depositories function essentially identically with regards to title registration; this article treats them under the discussion of depositories below.

There are several conditions that necessitate the keeping of a shareholder register. A shareholder bears certain rights with respect to the issuer, such as the right to receive dividends, to receive a portion of its assets upon liquidation, and to take part in the company’s management via shareholders’ meetings. However, a share does not in and of itself incorporate a mechanism that allows its owner to be able to exercise these rights in full. The register serves as a link between the equity owner and issuer, facilitating the flow of information from one to the other and making it possible for the shareholder to exercise these rights.

The laws currently in force define the shareholder register as a coordinated system of records listing material information about the joint stock company. In addition to stating the size of its authorized capital, the register lists the number, par value and classes of authorized shares, and any records of splits, consolidations, dividend payments, and share transactions made without the involvement of nominee holders, transfer agents, or depositories (these entities are described in further detail below). The register also contains any other evidence of title to shares, including whether an owner’s shares are subject to any liabilities, and it lists any treasury shares, their number, par value and classes.

The principal activity of the registrar comprises keeping records on each shareholder. Shareholders may be either a natural person or a legal entity who stands in the register as the owner (holding securities on the strength of title) or a nominee holder (holding securities on another’s behalf) of registered securities of a specific par value and class. Registration is mandatory not only for the owners and nominee holders but also pledges (liabilities that the shares upon a person’s or legal entity’s shares).

Article 149 of the first part of the new Civil Code, which concerns licenses for share registrars, refers to a type of security called a “paperless security” where the bearer’s rights derive not from a representation of the security itself, but from the registration of title in a computerized or written register. Shareholders are not issued share certificates, although they or other authorized parties may request extracts from the registrar evidencing equity ownership.

The institution of computerized registration of share title was first formalized by the Presidential Decree “Measures to Safeguard Shareholders’ Rights” of 1993. However, this decree was interpreted to recognize only a written register, with each entry signed by two authorized officials and affixed by the registrar’s seal, as an original shareholders’ register. Computerized registers were effectively relegated backup status. The detailed documentation required by law to effectuate any entry into the written register significantly complicated the registrar’s work and prolonged the recording process, thereby slowing down transactions. In order to ease the process of share circulation, the legislature enacted a number of laws, notably the Statute “On the Joint Stock Company Shareholders’ Register” of April 18, 1994, that secured the “equality” of the electronic and hard copy forms of registration, allowing registrars to elect which form of register they will maintain.

Each registered shareholder has a personal registry account which lists the shareholder’s identity, the quantity, nominal value and category of securities registered to its name, any liabilities the securities are subject to, and any transactions involving the securities. When registering for the first time, new shareholders must present the registrar certain documents in order to open a personal account — the company charter for a legal entity, a passport or other form of identification for an individual. Current legislation requires a new shareholder to fill out a standardized application in order to open an account. Furthermore, registrars generally require legal entities to submit samples of the company seal and all signatures of officials authorized to make transactions on the entity’s behalf.

All shareholder accounts are numbered. The current legislative framework provides for five types of accounts: Owner, new issue, nominee holder, pledgee, and transfer agents.

New Issue Accounts

This accounts records the number of securities of a given issue. A new issue is registered in its own account, listing the number of shares and their nominal value. As the securities are acquired and registered under their new owners’ accounts, they are deleted from this account. Thus, the balance of this account shows the number of unplaced shares.

Accounts of Nominee Holders

A nominee holder is a party entered into the registry who holds shares on behalf of the real owner based on a contractual agreement. Nominee holders do not hold title to the shares, but rather act as middlemen between the registrar and the real owner.

The institution of nominee holdings has developed principally as a matter of convenience to individual shareholders, as it relieves them of the burden of maintaining contact directly with the registry in order to receive dividends, engage in share transactions, and obtain information on the company’s current activities and shareholders’ meetings. Placing one’s shares with a nominee holder is particularly convenient for non-local owners and volume investors, as it saves them a trip to the relevant registry each time they want to buy or sell any shares. Nominee holdings may increase the liquidity of shares, as no changes need be made in the registry for transactions between parties using the same nominee.

Pledgee Accounts

Like other forms of property, shares may be pledged in order to guarantee the terms and conditions of a contract or some other obligation. When paperless securities are pledged, the registrar opens a special pledgee account and credits the pledged block of securities to it. In addition, a special sub-account is created in the pledgor’s account, describing the subject and terms of the pledge.

Accounts of Transfer Agents

A transfer agent is a legal entity that enters into a contract with a registrar to act as a intermediary between the registrar and any registered parties and their authorized representatives. The transfer agent’s responsibilities include registering securities transactions; issuing certificates (forms) of securities and/or register extracts to registered parties; providing the registrar information on transactions involving the issuer’s securities and on any changes to the listed data of registered parties; providing account holders or their empowered representatives information from the registrar; and in some cases verifying the authenticity of signatures of registered parties.

Transfer agents, like nominee holders, are entities created in order to simplify the process of registering and re-registering securities. They alleviate the obvious difficulties presented by the cumbersome registration procedures to a shareholder in New York or Vladivostok wishing to conduct an operation through a register held in Moscow. Furthermore, as many individual registrars have established their own formal requirements for executing transactions, transfer agents save shareholders the trouble of sorting through the different procedures, a matter of particular importance to institutional investors and other market players. By effectively serving as middlemen between the registrar and the individual shareholder, transfer agents increase the ease of securities transactions and therefore play an important role in the creation of a liquid securities market in Russia.

The Activities of the Registrar

Registering Transactions

When title to shares is transferred from one registered party to another, the registrar removes the shares from the transferor’s account and enters them into that of the transferee. Before executing the transaction, the registrar must be provided with the contract upon which the transfer is based, a transfer instruction (described below) and, if applicable, the agreement granting power of attorney to the party submitting these documents.

A registered party or its authorized representative gives a transfer instruction to the registrar requesting the latter to execute the transfer of registered securities or to record any liabilities that the securities have been subjected to. These forms are not standardized, and the eagerness of each registrar to introduce its own form slows down the transaction process.

Issuing Documents

One of the principal tasks of the registrar is the issuance of certificates, generally called extracts from the shareholders register. Extracts are most commonly requested by individual registered shareholders requiring proof of title for the purposes of engaging in a transaction involving their securities. In addition, the company management or a shareholder holding more than 1% of the company’s placed shares may request an extract listing the names and holdings of every registered shareholder. The 1% threshold may be raised or lowered by a decision of the company’s shareholders.

The registrar may also issue a record of operations through an account, which lists all the transactions that have passed through the requester’s account. Such an extract from the operations ledger is extremely useful to an institutional investor or broker, as it provides a record of all purchases and sales made over any particular period of time.

A registrar regularly transacts not only with brokers and shareholders, but with issuers as well. Issuers and registrars enter into a contract for the maintenance of a shareholders’ register. In addition to performing the tasks mentioned above, the registrar also acts as an informational link between the company and the shareholders. Through the registrar, the company stays informed of the composition of its ownership, and shareholders learn of upcoming shareholders meetings, accrual and payment of dividends, liquidation, and other key company information.

The company may request the registrar to “close” the register. Upon such a request, the registrar compiles a list of shareholders on a date specified by the company. Companies “close” their registers generally to determine who is entitled to announced dividends, although it may decide to establish such a shareholder list for other reasons, such as resolving inheritance issues.

Deposit Account Entry at the Depository

The principal tasks of a depository are to store securities in their physical form, to keep track of their owners, and serve as a nominee holder. Depositories are used by individuals and legal entities holding various types of securities. There are currently twelve licensed private depositories in Russia.

The register system can be cumbersome for buyers and sellers of securities. In order to simplify the circulation of securities, security owners may submit their certificates and shares to a depository registered in the issuer’s registry as a nominee holder. The securities are placed in storage and deposit certificates issued in their place. Such securities generally lose their ability to physically travel, as they are rarely transferred from one storage place to another. Thus, shares held in a depository assume many of the characteristics of paperless shares.

Depositories operate differently from a registry even though the systems have much in common. Like a registry, a depository places accepted share certificates in open or closed storage. These two types of storage vary in their record-keeping methods. In closed storage, each security certificate is numbered and registered to a specific owner. In open storage, securities within a certain category are not personalized to particular owners.

Securities are inventoried in a depository through a system of deposit accounts. These accounts are opened to record securities and are divided into active accounts, which record the quantity of securities kept in the given place, and passive accounts, defining the securities belonging to the clients. In order to open an account, a client has to execute a deposit agreement with the depository. The client may include in the deposit agreement provisions assigning certain tasks to the depository, such as the right to use the client’s dividends to purchase more securities, or engage in other operations much as any nominee holder would do.

To execute a transaction involving securities held in a deposit account, a client presents the depository with a transfer instruction. An account holder wishing to transfer his shares has the option of transferring the shares into an escrow-like account. While in such an account, the transferor still holds title to the securities but may not further use or alienate them. Upon receipt of payment confirmation, the depository transfers the securities into the deposit account of the transferee and the transferor loses all rights to them. When presenting a client with information on its deposit account, the depository furnishes information on the storage status of its securities. This information is of particular importance to a client who conducts a large volume of transactions on the securities market.

It is likely that the role of depositories in the securities market will increase significantly over time. However, there is no centralized system unifying the twelve licensed depositories, meaning that any securities transactions between owners of shares held in different depositories requires the depositories to engage in the cumbersome procedures required for making changes in the relevant share registries. There are currently a number of competing plans to create a unified depository system in Russia, but until this is accomplished, the securities market will continue to suffer from restricted liquidity.

Conclusion

The aforementioned systems are the methods for securing and exercising investors’ rights in Russia. In many instances, a shareholder is faced with a number of difficulties when trying to exercise his rights or transfer his shares. The registry and depository systems are largely fragmented and unstandardized, and this remains the biggest obstacle to creating a liquid market in securities. With further development of the capital market in Russia, it is probable that the process of securities transfers will be further simplified, and the Russian securities market will become attractive to investors from throughout the world. It is conceivable that registration procedures will be streamlined to the point where share transactions may be executed by an electronic card, in the same manner as bank transactions.

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