Russian Corporate Governance Plays by Its Own Grim Rules

(Bloomberg) -- The story I’m about to tell is one of those tales that make you wonder why anybody does business in Russia. It’s a country that really doesn’t play by anybody’s rules but its own.

Sometimes, these stories involve huge companies like BP Plc, which, you may recall, once had a joint venture with a consortium of Russian oligarchs. Then the oligarchs decided that they wanted the whole venture for themselves and made life for BP so miserable that Robert Dudley, the lead BP executive, had to flee the country in 2008.

In this case, though, the story involves a single hapless American who found himself unable to break free of the Russian company he foolishly tried to help. The American is Paul Ostling, 69, a former high-ranking executive from Connecticut of Ernst & Young LLP.

At Ernst & Young, Ostling had spent the latter part of his career doing a good deal of work in Russia and Eastern Europe. So when he left the firm in 2007, he decided to make a second career out of sitting on boards and occasionally running companies in that part of the world. His competitive advantage, as he saw it, was that he could be a flag bearer for Western-style corporate governance and transparency.

Among the companies whose boards he sat on were Uralkali, the giant potash manufacturer; MTS, Russia’s largest cell phone operator; and Brunswick Rail LLC, a Moscow-based company that made Ostling its chairman in 2012. Though only eight years old at the time, Brunswick was already the leading rail car leasing company in Russia, with 24,000 rail cars and adjusted earnings of around $255 million.

Though Brunswick Rail’s founders, Martin Andersson and Gerard De Geer, were Swedes, they were well versed in the ways of Russian business. They had moved to Moscow in the early 1990s, just as Russia was embracing capitalism. After working as advisers to the government, they opened an investment bank that quickly became one of the linchpin firms during that era, doing business with many of the men who would go on to become Russian oligarchs.

As Ostling understood it, he had been brought on the Brunswick Rail board to show the company how to conform to the rules as set down by such institutions as the U.S. Securities and Exchange Commission and the U.K.’s Financial Services Authority.

Why would this matter to a Russian company? For two reasons. First, if a little-known Russian company could show that it was transparent in the way the West demands — with honest financials, and regular and appropriate disclosures — it would have an easier time raising money from the likes of Goldman Sachs and Fidelity Investments.

It would also have an easier time going public, which is what Brunswick Rail hoped to do. Indeed, not long after it sold $600 million in Eurobonds in late 2012, its chief executive, Vladimir Lebekov, went to London where he appeared on CNBC. The very first question he was asked was when the company would go public.

The IPO was not to be, however. Not long after the Eurobond deal, which Ostling had been instrumental in putting together, the Russian economy went into a tailspin. Exacerbating the problems were sanctions placed on Russia by the U.S. and Europe after its invasion of Crimea. The downturn hit Brunswick Rail hard. Between 2013 and 2015, as leasing rates fell from 1,500 rubles a day (about $50) to 325 rubles a day (less than $7), the company’s adjusted earnings dropped to $60 million.

The Eurobond deal was due to be repaid in November of 2017, but it was clear by late 2015 that the company lacked the means to pay it back. Which meant that it would have to go through a negotiated restructuring, the kind that would require compromise and pain for both the bondholders and the shareholders. To that end, the board asked Ostling to take over the chief executive role in October, 2015. Although he remained on the board, he ceded the chairmanship to Andersson.

And this is where Ostling discovered, as he would later describe it to me, that Brunswick Rail didn’t appear to be interested in Western governance and transparency after all.

The details of what happened during the next 13 months are complex in the extreme, but they amounted to this: In Ostling’s view, Andersson and a handful of cronies, who were also shareholders, “began to implement a scheme to defraud its creditors and certain other shareholders — many of whom were U.S. investors — in order to protect their own financial interest,” according to a legal complaint he filed last year. Because Ostling believed that some of their moves would violate U.S. and U.K. securities laws, he was adamant about stopping them.

So long as Ostling was the CEO, he was able to hold Andersson and the others at bay. In some cases, he was able to block their moves, because he had two allies on the five-member board. In other cases, the bondholders turned down the company’s proposals.

Finally, Ostling claims in legal filings, Andersson spearheaded a maneuver to force Ostling and one of his board allies to resign, at which point the shareholders allied with Andersson controlled the board and could do what they wanted. They then failed, by Ostling’s account, to immediately disclose a material fact — that one of the creditors had sent Brunswick Rail a letter declaring the company to be in default. And they put together business projections for 2017 that appeared to lowball the revenue they were likely to receive.

Although he was no longer with the company, Ostling still felt a responsibility to the company’s various stakeholders, so when this information was leaked to him by a junior executive at Brunswick Rail, he in turn shared it with the independent auditor, several shareholders, and the bondholders. Less than a month after discovering these leaks, Brunswick Rail sued Ostling in U.S. federal court for misappropriating “trade secrets.”

The company’s position, documented in its own legal filings, is that Ostling had no right to divulge information to those it was negotiating with — and that his leaks costs the company tens of millions of dollars. It also says that everything it did was aboveboard — for instance, those business projections were well-intentioned guesstimates, as any projections into the future have to be.

In addition it has accused Ostling in court documents of purposely destroying evidence contained on a company-owned computer used by the junior executive who leaked information to him. In response, Ostling’s lawyer points out in a court document filed earlier this week that his client has never so much as seen the computer in question, much less erased its hard drive.

For his part, Ostling says that as a shareholder, he had every right to speak to other stakeholders. Further, he says, because he and his team had put together the projections for 2017, he felt a responsibility to inform the others that they had been changed.

Brunswick Rail’s lawsuit against Ostling has now been going on for 17 months. There has been scant progress. Brunswick Rail has since been sold. Andersson, De Geer and their allies are no longer shareholders. It’s hard to even know what “trade secrets” the company is accusing Ostling of stealing because it blacked out big parts of the court documents.  Brunswick Rail is demanding $200 million in damages, which of course Ostling doesn’t have. It would be hard to imagine more pointless litigation.

Unless, of course, the purpose isn’t to reclaim $200 million but to punish its former chief executive for getting in the way of its attempt to outmaneuver the bondholders. That is precisely what Ostling believes is happening. That would mean that a Russian company was using an American court to gain retribution for events that took place in Russia.

And it’s working. So far, Ostling has paid over $3 million in legal fees and owes another $2 million. He obsesses about the case. “Paul has become depressed because of it,” said Sir Robert Margetts, who sits on the Uralkali board with him. “It hasn’t affected his judgement, but it has worn on him.”

Although Ostling continues to travel to Russia when he has to attend board meetings, he moves in and out of the country as quickly as possible, fearful that Brunswick’s lawyers will find him and manage to have him detained. He was in Russia in early March when the former Russian spy Sergei Skripal and his daughter were poisoned with a nerve agent in an attack the U.K. government blamed on Moscow. When I spoke to him during that trip, he seemed spooked.

I remember years ago having dinner with Klaus Kleinfeld, who was then the chief executive of Acronic, the giant aluminum company. At the time, he was also the head of the U.S.-Russia Business Council, which promotes commercial relations between American and Russian companies. The dinner took place not long after I had begun writing about the difficulty of doing business in Russia, which lacked not only transparency and Western governance, but the rule of law itself.

When I questioned Kleinfeld about doing business in Russia, he insisted that things were getting better, and that so long as you were careful and willing to play by Russia's rules, it was a place you could do business. What Ostling’s story suggests is something else: Russia remains a country where you do business at your peril.

  1. He is now BP’s chief executive. Upon dissolving the joint venture, which had been enormously profitable for BP, the company took a 19.75 percent stake in Rosneft Russia's state-run oil company. It owns that stake to this day.

  2. Earnings before interest, tax, depreciation and amortization, or Ebitda.

  3. They ultimately sold it to UBS for around million, inflation adjusted.

  4. Brunswick Rail says that Ostling resigned voluntarily upon the request of the shareholders.

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