NORTH WEST TELECOM (NWT)

November 12, 2002 NORTH WEST TELECOM (NWT) Russian Federation Analysts: Julia Kochetygova Moscow Tel: +7-095-745-2903 Email: Julia_Kochetygova@ standardandpoors.com Vladimir Tutkevich Moscow Tel: +7-095-745-2919 Email: Vladimir_Tutkevich@ standardandpoors.com Nick Popivshchy Moscow Tel: +7-095-745-4519 Email: Nick_Popivshchy@ standardandpoors.com For important information on Corporate Governance Scores, please see the last page of this report. Overall Company Score (CGS) Component Scores: CGS 5.6 (maximum CGS 10) Ownership structure and influence 5.5 (maximum 10) Financial stakeholder rights and relations 6.3 (maximum 10) Financial transparency and information disclosure 5.3 (maximum 10) Board structure and process 5.3 (maximum 10) Executive Summary North West Telecom ( NWT ) is a fixed-line telecommunications service provider based in the city of St.Petersburg and is one of the seven supra-regional telecom operators in Russia formed as a result of the inter-regional consolidation of the industry. The company has been merged with eight other telecom operators in the Northwest region. However, the governance structure is yet to be fine tuned. Shareholders of the united company expect to have their first joint meeting in early 2003. NWT is a company where traditional Russian governance weaknesses arise from the highly concentrated influence of one major shareholder, its dominance in the decision-making process and the lack of independent controls. However, most recent changes in the board composition of NWT suggest that a stronger control and governance system is likely to develop in the future. The ownership structure and influence component of our analysis, and the company s aboveaverage score of 5.5 for this component, reflects the fact that the beneficial owners, owning 54.2% of the shares, are identified. It also reflects a number of other factors: (i) the sometimes controversial influence that the majority government-owned Svyazinvest has (holding 51% of the voting capital of NWT) as a consequence of the significant political and social sensitivity of the telecommunications industry, (ii) the high degree of regulatory influence and (iii) the limited commercial freedom enjoyed by the company. In addition, the significant influence possessed by Svyazinvest may, in certain circumstances, represent a risk to minority shareholders, created by the possible conflicts of interest within the Svyazinvest group and the lack of transparency in the decision making process, including the absence of tender procedures or rationales for significant transactions entered into by NWT, either directly or via an intermediary entity established by a group of Svyazinvest subsidiaries. On a positive note, Svyazinvest s stated aim - to improve stock liquidity and the value of its subsidiaries - is beneficial for all shareholders. Further, Svyazinvest and the company s management are in the process of establishing independent elements of oversight at the board and board committee level.

We positively assess the financial stakeholder rights and relations component of our analysis, assigning an above-average score of 6.3. All major shareholder rights appear to be respected and shareholder-meeting procedures are well articulated and observed. Information provided before a meeting is usually adequate, although financial disclosure could be improved in our opinion. It is a negative governance feature that the company s new share registrar is appointed and is indirectly controlled by Svyazinvest. Accordingly, it cannot be fairly regarded as totally independent. Also negative is the lack of a clearly articulated dividend policy. NWT s standards of financial disclosure and transparency, receiving a score of 5.3, are affected by the continued absence of published U.S. GAAP financial reports, although the company has produced these for a number of years for internal use. However, we understand that NWT plans to publish them later this year and we view this as a positive development. It is a negative governance feature that, in its annual report, the company does not provide a discussion of its operations nor does it provide segment analysis or analytical forecasts. Some transactions, including those where potential or actual conflicts of interest cannot be ruled out, are not fully transparent with regard to their terms, counterparties, alternatives and efficiency analyses etc. Management backgrounds and the remuneration of key executives, except for directors, are not always disclosed. There is also a lack of transparency with regard to the auditor s fees and also the fees and mandates that the auditor receives from an intermediate entity affiliated with NWT and other Svyazinvest subsidiaries. A review of the board and management structure and process, where we assigned a score of 5.3, reflects moderate board practices, although superior to many other Russian companies. The board composition includes significant, although minority (one third of the total), representation of outside shareholders interests and an independent component. Although representatives of Svyazinvest dominate the board, they appear to play a constructive role in board discussions, although we note that most board sessions are held via mail voting). Major governance weaknesses include the lack of detailed rationales for certain decisions proposed by Svyazinvest and the company s management and the lack of board discussion about certain transactions, including those with parties related to NWT, either directly or via their affiliation with Telecominvest (to which NWT has historically strong links). governance features include the increasingly transparent executive remuneration policy and the establishment of four board committees (three of which include independent directors or their representatives), which, if they prove to be effective, will improve governance processes. NWT COMPANY PROFILE OJSC North-West Telecom is evolving from a monopoly fixed-line telecommunications service provider in the city of St. Petersburg the 2 nd largest city in Russia with a population of about 5 million people, to becoming a supra-regional provider for the whole North- Western region of Russia with a population of about 15 million people. After the industry restructuring, initiated by the Ministry of Telecommunications in Russia back in 2000, NWT is now in the final stages of a merger with eight regional telecommunications companies via a share swap arrangement. Prior to the merger, the company s share capital consisted of 473,056,966 ordinary and 114,440,851 preferred shares and an additional 262,896,773 ordinary and 87,646,542 preferred shares that were authorized and subsequently issued for the swap with the merging companies. The Federal Commission of the Securities Market (FCSM) approved the registration of the prospectus associated with the NWT shares issued for conversion into shares of the merging companies in October 2002. The eight merged companies have already been excluded from the state register of legal entities, thus leaving NWT as a supra-regional entity with nine regional operating branches. Formally, the restructuring will be finalized after the general shareholder meeting (GSM) of the new joined company takes place, likely in February 2003. Standard & Poor s Corporate Governance Score NORTH WEST TELECOM (NWT) 2

Table 1. Key financial highlights of NWT (conforming to RAS) 2001 2000* 1999 1998 Sales $ 000 135,291 66,272 55,728 101,344 EBITDA -"- 32,856 30,016 27,353 54,727 EBT -"- 23,669 20,494 4,873 (51,485) Net Income 12,467 13,411.7 3,726.2 (52,405.3) Total assets -"- 266,364 272,917 191,989 251,497 Shareholders Equity -"- 205,908 213,095 131,092 177,038 Operating margin % 30.3 46.4 52.4 52.6 ROA -"- 4.5 4.9 1.8 (10.1) ROE -"- 5.8 6.3 2.6 (11.9) Debt/Equity ratio X 0.29 0.28 0.46 0.37 Market Cap $ 000 212,876 156,525 132,890 137,099 Source: Svyazinvest, NWT * Beginning with 2000, financials reflect NWT merger with SPMMT and SP Telegraph, which legally took place as of December 28, 2000 NWT is controlled by OJSC Svyazinvest (50.9% of the company s common stock). After consolidation, the capital structure of the combined entity will be similar, as the merged companies will have almost identical shareholder structures. The shares of NWT are traded on several Russian exchanges (RTS, SPBEX, SPCEX, MICEX) and, since September 2001, the Level 1 ADRs have been traded over-the-counter in the USA. However, stock liquidity is relatively low. The principal services provided by NWT include the provision of local telephone connections, international and long-distance domestic connections through the network operated by Rostelecom (Russia s national long distance carrier, which is also a subsidiary of Svyazinvest), channel lease-out, telegraph, data transmission, wired radio, internet access, information services, etc. Revenues from high value-added services made up 10.8% of the company total revenues in 2001. After the merger, NWT will continue to benefit from servicing one of the most industrialized regions in Russia. The eight companies merging with NWT are expected to add aggregate revenues of $ 300 million and their aggregate net income in 2001 was $ 20 million. November 12, 2002 www.standardandpoors.com 3

Component 1: Ownership Structure and Influence Component Score 5.5 1.1 Transparency of Ownership Public disclosure of NWT s ownership structure includes minimal detail. Only the names of the holding company and one other institutional shareholder, that in aggregate own 54.2% of voting shares, have been disclosed. Others are nominees. NWT provides information on the beneficial owners of 54.2 % of its voting shares. Individual directors and executives direct shareholdings are disclosed. Beneficial owners of 35.3% of voting shares cannot be identified, but the company believes that this ownership is highly dispersed. Neutral Public disclosure of NWT s ownership structure contains the name and ownership structure of its largest shareholder Svyazinvest (50.94 % of votes and 41.02 % of total capital,), the name of Lindsell Enterprises Limited representing a private equity fund (2.71 % of votes and 4.59 % of total capital) and the names of four nominees that together hold 35.3 % of voting shares and 37.77 % of total capital (see Table 2). We understand that even when names of the holders of nominee accounts are identified, this adds very little as the holders are mostly offshore-registered shell companies established to avoid disclosure of the interests of Russian or foreign owners. Accordingly, we are unable to determine to what extent, if any, the interests of these shareholders are connected. Table 2. Disclosure of NWT ownership structure as of October 2002 Owner Status Common shares Preferred shares Share in capital, % OAO Svyazinvest Owner 240,975,894 0 41.017 ZAO Brunswick UBS Warburg Nominees Nominee 101,183,225 13,697,753 19.554 ZAO ING Bank Eurasia Nominee 38,538,657 14,948,214 9.104 ZAO DKK Nominee 35,725,293 6,610,655 7.206 Lindsell Enterprises Limited Owner 15,620,239 11,266,898 4.576 KB J.P.Morgan Bank International Nominee 11,622,590 10,000 1.980 The company s public reports disclose the personal interests of NWT s managers and directors. Among the non-executive directors, only the Chairman and the former CEO have stakes in NWT (0.218 and 0.004 % of the capital, respectively), and the aggregate disclosed stake of managers is 0.1263 % of the capital (we note that there is no disclosure of the share of votes). We are unable to determine whether managers and directors have indirect interests in NWT via nominee shareholders. In our opinion, it is a negative governance feature that Svyazinvest s own ownership structure is not fully transparent. Svyazinvest is 75 % owned by the Russian government through the Ministry of Property Relations of the Russian Federation (50 % plus 1 share) and the Russian Federal Property Fund (25 % less 2 shares). However, 25 % plus one share is owned by a non-transparent Cyprus-based entity, Mustcom Limited. When this entity bought a stake in Svyazinvest from the government in 1997, it was formed by a consortium of the interests of George Soros Quantum Fund, Morgan Stanley and a Russian FIG (financial-industrial group) Interros, headed by Vladimir Potanin. Subsequent changes in the ownership structure of Mustcom have not been disclosed. This makes an analysis of Mustcom s influence over Svyazinvest difficult. Given below is a list of the nine largest shareholders, each with more than 1 % of the company s voting shares, as provided by NWT s management to Standard & Poor s (Table 2). These are the shareholders prior to the merger with the other telecom operators. Information on the ownership structure of the newly consolidated company is yet to be finalized by the company s registrar. However, we understand that the change in the shareholder structure and its transparency will be not significant. Standard & Poor s Corporate Governance Score NORTH WEST TELECOM (NWT) 4

Table 3. Large holders of voting shares (with more than 1 %) as of October 1, 2002 Owner Address % age of common stock JSC Svyazinvest Moscow 50.94 Stotter Limited Nicosia, Cyprus 12.30 Machaon Limited Lima, Peru 6.74 Fenway Services Limited Nicosia, Cyprus 3.82 DCL-KF Corporation George Town, Cayman Islands 5.46 Lindsell Enterprises Limited Nicosia, Cyprus, 2.71 Roubor Asset Management Stockholm, Sweden 2.78 Nikitas Brokerage Limited Nicosia, Cyprus 2.23 ZAO Stock Center Tantiema Moscow, Russia 1.97 Total 88.95 1.2 Concentration and Influence of Ownership In our opinion, the political and social sensitivity of commercial policies in the telecom sector, combined with a high level of regulation, hampers the commercial success of NWT. Although the influence of NWT s majority shareholder is, to a large extent aimed at increasing the company s value, increased disclosure of the rationale for certain types of investment decisions and commercial transactions would be a positive governance step.. The company s developing internal control system at board level is expected to provide more safeguards for shareholders. The telecommunications industry in Russia is highly regulated, primarily through tariffs, which reflects strong political control and social sensitivity of commercial policies applied in this sector. Svyazinvest, which owns 51.3% of voting shares, exerts significant control over the company s decisions. This control is mostly aimed at increased shareholder value and stock liquidity. Certain transactions, proposed by Svyazinvest, have taken place in less than transparent circumstances. It is therefore difficult to assess whether these disadvantage other shareholders. Although the ultimate influence of minority investors is limited, the internal control system at board level is improving. We do not expect significant changes in the company s ownership influence as a result of the consolidation of NWT with six other telecom operators, as the shareholder structure is expected to remain largely unchanged. Neutral Neutral NWT will remain majority-owned by Svyazinvest after the merger. As Svyazinvest is 75 % owned by the government, and also because fixed-line telecommunications is a highly regulated industry in Russia, NWT is subject to significant government influence. This influence takes several forms: All of the core business lines are licensed and the licensees take an obligation of providing consistent and secure telecommunications linkage for residential and governmental subscribers in their regions. Even though commercial factors (e.g. late or non-payment of bills) may determine it, licensees are not allowed to disconnect those subscribers who are part of the social or governmental infrastructure (hospitals, army, police, etc.). As monopolies, regional telecom operators tariffs for fixed line communications are regulated by the anti-monopoly ministry. Subscribers fees for governmental and residential customers are subsidized by higher tariffs for business customers and traffic-based fees for long-distance and international connections. The difference between subscriber fees for business customers and for residential customers is significant. Tariff rebalancing has long been articulated as a goal, but the process is slow due to its social and political sensitivity. The introduction of perminute billing is hampered by social policies. Such a situation limits the commercial success of telecom operators and makes them less attractive to investors. November 12, 2002 www.standardandpoors.com 5

Although the government provides direct subsidies to certain categories of low-income subscribers, which are paid directly to the telecom companies, these payments are usually late and result in substantial bad debts. However, the situation improved following the appointment of a new Telecommunications Minister in 2000 who introduced a new expenditure item in the state budget to provide for these subsidies. However, bad and doubtful debts still amounted to $20.6 million in 2001. Although the government cannot be treated as an interested party under Russian law, we believe that disclosure of the terms of commercial relations with governmental subscribers could be improved. It is positive to note that, associated with its decision to sell a further 25% (less two shares) stake in Svyazinvest; the government has established targets for the improvement of the financial standing of its subsidiaries and therefore better aligns the interests of the government with the interests of other shareholders. Svyazinvest also has significant responsibility for the strategic decisions of its subsidiaries (including NWT) particularly those that ensure improvements in the value of the business. Svyazinvest has specific departments that are responsible for the monitoring of its subsidiaries activities and its representatives normally dominate every stage of discussion at board meetings, although in the case of NWT, this dominance has recently become more balanced by the increased involvement of minority shareholders (See Section 4). At the same time, we note that a number of decisions proposed to its subsidiaries by Svyazinvest often lack transparency and appropriate justification and are not always accompanied by tender procedures. This in turn obscures an assessment of the efficiency gains of these transactions. We were able to identify a number of such decisions: 1. Appointment of consultants for inter-regional consolidation. We saw no evidence to suggest that NWT used a tender process for the selection of a consultant to advise on the merger with regional telecom companies. Instead, we understand that Svyazinvest proposed the consultants on the basis of one consultant for all the companies in the supra-region. In the case of NWT and other companies of the Northwest region, the merger advisor was Renaissance Capital, the same company who had earlier helped NWT to merge SpbMMT and SPT. Although there is no evidence to suggest that shareholders were unhappy with the merger terms and that economies of scale resulted from the use of one advisor, we believe governance practice would have been enhanced if a separate advisor, hired by each side of the merger, had been selected via tender even though we do not question Renaissance s effectiveness as an advisor 2. Projects financed via intermediate entities. Svyazinvest uses the cashflows of its subsidiaries to finance certain projects via an intermediary, the Non-commercial Partnership - Center for Research of the Telecommunications Development Problems ( NP CRTDP ). These projects require Svyazinvest s subsidiaries to transfer 1% of their annual revenues on a quarterly basis and are approved by the companies boards as permanent transfers of funds with the following limited explanation - for the financing of intra-corporate needs. NWT transferred $ 637,000 in 2001 and around $ 1.1 million in the first nine months of 2002. While we appreciate a need for large-scale consulting projects, the selection of contractors by Svyazinvest without a tender and full discussion by the board of NWT, is not, in our opinion, an adequate standard of corporate governance. 3. Selection of auditor and registrar. Both the auditors (Andersen, and later Ernst & Young as an external auditor) and the registrar (Registrator-Svyaz) were proposed to all major Svyazinvest subsidiaries with the approval of shareholders and boards. However, there was little evidence of a tender process or any explanation of the competitive advantages that would be obtained. Again, despite obvious economic synergies of a single auditor and a single registrar for all Svyazinvest-controlled companies, we cannot assess this practice as positive in the absence of tenders and full disclosure of terms. In the case of auditor selection, the situation may be further complicated by (i) the fact that Ernst & Young (previously Andersen) simultaneously serves as an advisor and (ii) the lack of disclosure of the terms of each arrangement. 4. Procurement policy. Svyazinvest appears to have a high degree of influence over NWT s procurement policy, in particular its purchases of telecom equipment. Svyazinvest recently completed a tender for certain classes of equipment and recommended nine producers and a leasing company for all leasing projects. According to industry analysts, there were no tender for suppliers, and although the ultimate terms of contracts may be beneficial due to economies of scale, this is not clear from available materials. We note that during the board meeting held to discuss a leasing agreement with RTK-Leasing in July 202, two outside directors of NWT expressed their concerns and did not support this decision. We also note that the ownership structure of RTK-Leasing is not transparent. There are other examples where there is lack of clarity about procurement and investment decisions. Standard & Poor s Corporate Governance Score NORTH WEST TELECOM (NWT) 6

5. Disposals of assets. In our previous report we noted the lack of transparency regarding the decision-making process associated with the disposal of assets and the potential conflicts of interest. An example of this was the decision made by NWT, in late 1999, to transfer the rights and obligations of its contract with Lucent Technologies (for the construction of a transit network and where a substantial part of the work had been already accomplished) to Petersburg Transit Telecom (a subsidiary of Telecominvest), a company with a non-transparent ownership structure. In Spring 2002, we also noted the lack of transparency with regard to a decision made by the board of NWT to sell NWT s stake in Delta Telecom, an operator of the NMT-450 mobile cellular network in the St.Petersburg area. Our concerns centered on the absence of an open tender, non-disclosure of the ownership structure of the buyer and the ambiguous results following two different valuations of the stake. We note, however, that the sale of the stake in Delta Telecom was later cancelled, although we did not find any evidence of board discussion on the subject. We believe that risks of possible conflicts of interests would be mitigated if Svyazinvest had a more clearly articulated position with regard to its priorities in developing value added services through its subsidiaries versus other affiliates, particularly given growing competition in this area. For instance, we understand that NWT is one of the five largest Internet providers in the St.Petersburg area (with $1.6 million of revenues derived from internet activities) and is likely to be competing with a nation-wide Internet provider RTComm.ru that is reportedly controlled by RTK Leasing, Rostelecom, Svyazinvest and NP CRTDP. We positively view the actions to improve independent control over procurement and other commercial policies at NWT as a consequence of increased representation by independent elements on the board (see Section 4). For instance, at the meeting on October 25, 2002, the board decided to develop an internal regulation on the policy for tendering. November 12, 2002 www.standardandpoors.com 7

Component 2: Financial Stakeholder Rights and Relations Component Score 6.3 2.1 Voting and Shareholder Meeting Procedures (including: Regularity of, Ease of Access to, and Information on Shareholder Meetings). Procedures and disclosures related to shareholder meetings are adequate. The only problem, common for all Russian companies, is the remaining vote split limitation for the ADR depositary bank. The notification procedure is in line with legislation and practices of the leading international companies. Most materials relevant to shareholder meetings are available on the company s website. Information provided to shareholders does not include full notes to annual financial statements. The registration for shareholder meetings does not close until voting on the last question of the agenda takes place. At the latest shareholders meeting the role of the chairman of the meeting was taken by the Chairman of the board. Previously this had been taken by the Chief Executive Officer. The time provided for speeches and questions is sufficient for full discussion. There are potential problems for ADR holders over voting rights Neutral It is positive that shareholders are given 30 days notice in advance of meetings, that delivery of notices and voting ballots are sent individually via registered mail and that notices are published in a widely circulated newspaper and on the company s web site. A comprehensive information package with materials on the issues proposed for voting is posted on the web site and is made available at the company headquarters. However, notes to financial statements are not included. A strong governance feature is the fact that the materials for the Extraordinary General Meeting concerned with the company s reorganization in November 2001, included comprehensive reports on calculation of swap coefficients, draft merger agreements, reports on stock appraisal for buyout purposes and minutes of the board meeting. However, the combination of resolutions for the approval of swap coefficients and with the approval of the merger itself is considered as a negative governance feature, as it did not give shareholders the opportunity to vote separately on these two major issues. However we note the high level of approval of the merger terms, which suggests that minority shareholders believe potential conflicts of interests to be minimal. It is also a strong governance feature that meeting procedures are adequate and allow for questions and full discussion and that votes are verified by an independent registrar. Full records of the meetings are published on the web site. A further potential governance problem may arise from the provision in Russian law under which it is not possible for a depository bank to split those votes that have been cast by ADR holders i.e. all have to be voted for or all against a resolution. This provision deprives ADR holders of the right to vote on matters other than the election of the board as a consequence of cumulative voting procedures. Standard & Poor s Corporate Governance Score NORTH WEST TELECOM (NWT) 8

2.2 Ownership and Financial Rights, Including Dividends All major ownership rights are well articulated and observed. Affiliation of the company s registrar with the controlling shareholder is viewed by Standard & Poor s as a negative governance feature. The company changed its registrar in 2002 to one affiliated with Svyazinvest. Rights attached to ordinary and preferred shares are in accordance with Russian company law and is reasonably protective to shareholders. The charter limits the range of questions that can be put on the GSM agenda exclusively by the board, thus enhancing shareholders rights. Shareholders having at least 5% of voting shares can call a board meeting. There is an absence of a clear dividend policy in the company. In 2002, following a proposal by Svyazinvest, the board of NWT decided to transfer its register to ZAO Registrator Sviaz (the share registrar used by most Svyazinvest companies). Whilst the objective of the exercise was to have a single registrar for all subsidiaries, the absence of a tender supervised by the board or senior management for such a competitive service, and the affiliation between Registrator Sviaz and Svyazinvest (Svyazinvest together with Rostelecom directly own 10% of the registrar charter capital, and indirectly controls another 15%) is assessed by us as a negative governance feature. However, it is a positive governance feature that NWT s charter restricts the number of items that can be placed exclusively by the board of directors, despite a provision in Russian law that allows it. These include a number of items which, in our opinion, are fundamental shareholder rights including the approval of by-laws, share buy-backs, share splits and consolidation. We note also that the company has not articulated a dividend policy and there have been significant fluctuations in the dividend paid (ranging from 12% to 36%) during the last three years. 2.3 Take-over Defenses and Corporate Control Issues It is a positive feature that there are no structural anti-takeover defenses in the company s bylaws. However, government control via Svyazinvest, and the current strategic interests of the government in the telecommunication industry, would likely hamper a change in control. There are no anti-takeover provisions in the company s by-laws (no restrictions on takeovers and a classified board is not allowed). Supermajority provisions exist but they are positive because of the existence of a majority owner. The CEO s contract contains a very modest severance agreement of one year s fixed salary in case of premature termination of his contract initiated by the company or following the liquidation of the company. A change in control is unlikely because of the government strategic interests. Although a change of control is unlikely, due to the strategic and social importance of the telecommunications industry, any proposed change would be predicated on the government s agreement and minority shareholders would have little or no influence. Nevertheless, we view as positive the lack of structural anti-takeover provisions. November 12, 2002 www.standardandpoors.com 9

Component 3: Financial Transparency and Information Disclosure Component Score 5.3 3.1 Qualities and Content of Public Disclosure In our opinion, improved public disclosure is necessary to fully inform investors. Although U.S. GAAP financials have been produced for a number of years, they are not published. There is also limited disclosure of the details of certain contracts (consulting, medical insurance, equipment lease and, rent of a building). Accounting statements conforming to US GAAP have been produced since 1997 but these are not disclosed. Information concerning shareholder meetings, the restructuring and reorganization programme and shareholding structure is disclosed in detail. Some transactions, including those where there may be potential conflicts of interest, are not fully transparent with regard to terms, parties, alternatives, efficiency analysis, etc. Revenue and earnings forecasts are not disclosed. The management team s backgrounds and details of the remuneration of key executives, except for directors, are not always disclosed. Auditor s fees are not disclosed. Financial transparency of NWT is hampered by the absence of publicly available financial reports conforming to international accounting standards, although we understand that the company s international auditors have performed US-GAAP audits for a number of years. The audited accounts that comply with Russian Accounting Standards provide us with limited information about related party transactions, the quality of receivables, the true value of assets etc. although the accompanying notes are comparatively comprehensive. We also consider the fact that the company s annual reports omit a discussion of risks, market analysis and segment analysis (e.g., volumes and efficiency breakdown by types of services and customers) as a negative feature of the company s governance practices. However, on a positive note, the recent decision by the board to include, in the financial reports, the provision for bad debts is a useful development in financial disclosure. 3.2 Timing of and Access to Public Disclosure The website is comprehensive and regularly updated, although most parts are only in Russian. Filings to regulators are produced on time. Improvements in access to information are expected in the near future following the adoption of an investor relations program, which will increase the amount of information that is disseminated by the company. However, there is scope for improvements in the company s responsiveness to inquiries and in the quality of comments received following those enquiries. The company s website is highly informative and regularly updated, particularly the Investor Relations section. The English version of the website is not complete. Statutory reports are filed on time and published on the corporate website. Statutory filings and the company s website are the primary sources of disclosure but the quality of annual reports has deteriorated. The company conducts meetings with analysts and answers queries from interested parties on a regular basis. Specialists from the Shareholders and Securities Department are responsive. A program of enhanced information disclosure has been adopted. Standard & Poor s Corporate Governance Score NORTH WEST TELECOM (NWT) 10

It is strong governance feature that the company s web site (http://www.nwtelecom.ru/) includes almost all public information (licenses, ownership structure, dividend history, filings to the FCSM, by-laws, shareholder meetings materials, annual reports, materials on the company reorganization, etc.). However, it would further improve access for international investors if the site included all of these items in English. A one-year investor-relations program, approved by the board in August 2002, includes a number of improved channels of dissemination of information to the public, such as the publication of presentations to analysts, specialized conferences, upgraded disclosure via the website and an expansion of information provided to the media. Most of the planned measures have yet to be implemented. However, we also note that the investment community has occasionally criticised the company for its lack of responsiveness to inquiries for details of certain transactions where full details were not publicly available. These include the use of funds transferred to the NP CRTDP, the recently deferred sale of the stake in Delta Telecom and the major purchase of a billing system. 3.3 Independence & Standing of Auditor NWT has a reputable external auditor for its RAS and IAS financial statements although a negative governance feature is the absence of a tender for the appointment of the auditor. Also negative is the fact that fees and the amount of non-audit work performed by the auditor are not disclosed. It is positive that an independent Committee on Reporting and Remuneration has started to monitor the audit process. NWT has employed an international audit firm to audit RAS and GAAP accounts since 1997. To date there have been no public disclosure of accounts audited under international standards. There are no tender procedures for auditor selection. The auditor (previously a Russian branch of Arthur Andersen, and most recently, Ernst & Young) is involved in a number of large-scale consulting projects with the company directly and via an intermediate entity. Fees for consulting work are not disclosed Audit fees are not disclosed The auditor has limited liability for damages. The board recently appointed a Reporting and Compensation Committee to be responsible for the company s relationship with the auditor It is a negative governance feature that, in addition to the non-disclosure of the audited financial statements under U.S. GAAP, there was also an absence of a tender process for the formal selection of the auditor that was recommended by Svyazinvest. We were also unable to determine the level of fees for audit and non-audit work paid to the company s recently appointed auditors, Ernst & Young and note also that the previous auditor s (Andersens) audit team has joined Ernst & Young. It is our understanding that Andersens conducted significant amounts of non-audit work for NWT and Svyazinvest. In our opinion, the lack of information about audit and non-audit fees is a negative governance feature. It is a positive governance development that a board committee has been created with responsibility for ensuring the auditor s independence, although we are not yet able to assess its effectiveness. November 12, 2002 www.standardandpoors.com 11

Component 4: Board Structure and Process Component Score 5.3 4.1 Board structure and composition The current structure of the board mirrors the shareholding structure. Accordingly, representatives of the main shareholder dominate the board. The number of minority representatives on the board increased from two to three in 2002. The board has established four specialized committees for key control functions. Most directors are representatives of the majority shareholder Svyazinvest. At the 2002 annual shareholders meeting, three representatives of minority shareholders were appointed to the board, compared to two in 2001. The board has established four committees, three of which include independent directors. The Chairman of the board is the CEO of Svyazinvest, the company's majority shareholder Neutral The board of directors consists of nine members. Five of these are employees of Svyazinvest, one is a former Chief executive Officer of NWT (he resigned a month after he was elected in 2002), and three are the nominees of minority shareholders. Since 2001, the list of Svyazinvest-related directors has remained virtually unchanged, except that Mr.Khazarchiev, a former Chairman of NWT, was replaced by Mr.Belov. The number of minority representatives increased from two to three as they managed to consolidate the votes of other minority shareholders to support them. Table 4. The board of directors of North West Telecom, as elected by the AGM in 2002 Name Member of the board since Nominated by Position Votes received*, % Valery N. Yashin 1993 Svyazinvest Svyazinvest, CEO 9.06 Anton I. Osipchuk 2000 Svyazinvest Svyazinvest, First Vice- President 8.62 Vadim E. Belov 2002 Svyazinvest Svyazinvest, Vice- President Irina M. Ragozina 2000 Svyazinvest Svyazinvest, Director of Corporate Governance Dept Yuri A. Bilibin 2000 Svyazinvest Svyazinvest, Assistant to the CEO Sergey V. Soldatenkov 2000 Group of shareholders and Svyazinvest Dmitry V. Levkovsky 2000 Lindsell Enterprises Limited Non-disclosed (ex-ceo of NWT) Lindsell Enterprises Limited Ivan I. Rodionov 2002 Stotter Limited AIG Brunswick Moscow office, Managing Director Oleg A. Lebedinets 2002 Stotter Limited Brunswick Capital Management, Director of Research * %age of votes received in cumulative voting at the 2002 AGM. In governance terms, the establishment, on the initiative of newly elected minority directors, of four board committees in July 2002 (Reporting and Compensation, Budget, Corporate Finance and Investments and Corporate Governance) is seen by us as a major step forward. The first three committees include independent directors or their representatives, and one of them, the Reporting and Compensation Committee, consists entirely of independent members. 8.62 8.68 8.62 8.86 16.70 12.39 12.30 Standard & Poor s Corporate Governance Score NORTH WEST TELECOM (NWT) 12

Although it is too early to assess the effectiveness of these committees, it is also a positive step that they are strengthened by regulations that specify the range of responsibilities for each. Table 5. NWT Board committees Committee Chairman Members Reporting and Compensations Committee Corporate Finance and Investments Committee Budget Committee Corporate Governance Committee I.Rodionov, AIG Brunswick S.Soldatenkov, Svyazinvest, ex-ceo of NWT (current job not disclosed) A.Osipchuk, Svyazinvest, First Vice-President I.Ragozina, Svyazinvest, Director of Corporate Governance Dept O.Lebedinets, Head of Research at Brunswick Investment Research Ltd;B.Wilkening, AIG Brunswick. Y.Bilibin, Svyazinvest, Assistant to the CEO;D.Levkovsky, Lindsell Enterprises Limited. A.Shalagin, NWT, Deputy CEO on Economy and Finance;E.Zabuzova, Svyazinvest, Deputy Head of Department for Economic and Tariff Policy. N.Bredkov, NWT, Deputy CEO on Corporate Management;O.Petrova, Svyazinvest, Deputy Head of Methodology Department. The Chairman and the CEO positions are separated at NWT, as required by Russian Company Law. After the 2002 annual shareholders meeting, Mr. Yashin, the CEO of Svyazinvest was appointed Chairman. This, along with the majority of board members, provides Svyazinvest with a leading role on the board and reinforces the significant influence that it has. We positively assess Mr. Levkovsky s appointment as Deputy Chairman, as he has proved to be an active and independent director throughout the term of his directorship (although he has no formal authorities other than in the absence of the Chairman). 4.2 Role and effectiveness of the Board The board of directors has significant authority, including the approval of strategic plans, performance evaluation and control. The balance of interests is in favor of Svyazinvest, which allows it to pursue a common policy towards its major subsidiaries. This is demonstrated by the fact that several board decisions have not necessarily been consistent with the interests of minority shareholders. The board regularly discusses strategic plans, financial and operating performance evaluation, risk management policies, approves drafts of annual budgets and major plans of actions. The board evaluates the performance of the Chief Executive Officer on a quarterly basis and approves his quarterly and annual bonuses. The board approves the appointment of key executives. There have been a number of occasions when the board approved transactions with insufficient disclosure of underlying information. It is difficult to assess to what extent these transactions could be subject to potential conflicts of interest. The board does not discuss the company s regular transactions with its direct and indirect affiliates, many of whom have non-transparent ownership structures. The board does not identify whether its members have other directorships or interests. Four newly established board committees are intended to strengthen the board's control function. The company s charter has lowered the threshold for large transactions requiring board approval compared to that required by law. The company s by-laws allow shareholders with 5% of votes to call board meetings November 12, 2002 www.standardandpoors.com 13

From an inspection of the minutes of board meetings and NWT s by-laws and our discussions with the company, the board of directors appears to control the company and its management within the scope of its exclusive responsibility. Among particular issues considered by the board are approval of strategic plans, including the company s restructuring program and material investment decisions, evaluation of risks, collection of receivables and investor relations plans. The board is actively involved in monitoring operating and financial performance on a quarterly basis and it determines quarterly bonuses for the Chief Executive Officer. Nomination of key executives, including the Chief Executive officer, is also the function of the board. It is a very positive feature that the charter provides for a lower threshold for large transactions to be approved by the board than the law requires (1 % of assets compared to 25 %). However, and despite the foregoing, we also note that a negative feature of board practice is the lack of tendering procedures for the approval of transactions including the hiring a leasing company (RTK Leasing was approved in July 2002), the sale of a 43.1% % stake in the mobile operator, Delta Telecom in Spring 2002, and in a number of other transactions proposed by either Svyazinvest or the company s management. We also noted the lack of board discussion concerning control over the merging companies of the North West during the merger process. It would also be a positive governance feature if the Reporting & Compensation Committee was mandated to address the issue of NWT s regular transactions with its subsidiaries and affiliates and those companies where NWT managers have seats on the boards or other interests. In our 2001 report on NWT, we noted that the company s compliance with procedures for the approval of these transactions was weak, particularly given the non-transparent ownership structure of the counterparties. The company informed us that there will be a number of proposals that will be adopted later this year that are designed to enforce better disclosure and compliance of related party transactions. Currently, NWT follows the disclosure and voting procedures for related party transactions prescribed by Russian law, but in a very simple form, i.e. the company treats only new transactions as related party transactions, and not those where relationships exist in the form of long-going framework agreements. However, most of the transactions with affiliates are recurring from previous years under existing arrangements. Those transactions that merit closer scrutiny include equipment rental and connection fees collected from a number of mobile and digital fixed-line operators (Peterstar, Megafon, Delta Telecom, Neva Paging) that are affiliated with the company directly, or via its stake in Telecominvest (a holding company that has historically strong links to NWT (NWT was a 49 % shareholder and founder of Telecominvest together with SpbMMT, until a further share issue reduced its stake to 15 %)). Many of these fees are not subject to government regulation and the size of these arrangements cannot easily be understood from the company s financial reports, as connection fees and rent revenues are included under Revenues from Telecommunications Services in RAS reports (the reports disclose only that cash revenues from equipment rentals in 2001 was $1.8 million). We know also that Svyazinvest had long ago begun a process of unification of connection agreement terms with alternative telecom operators for all its subsidiary companies and made them public. However, the calculation methodologies for the fees associated with these connection agreements have yet to be made fully transparent. Other transactions with affiliate parties include ongoing commercial relations with Petersburg Transit Telecom, Neva Cable, North-West Telecombank and Medexpress to whom NWT pays for services. The board discussed few of these in 2001-2002. It is a negative governance feature that NWT does not keep a register of related party transactions and does not generally disclose their terms beyond what is prescribed by the FCSM disclosure rules regarding large RPTs. The degree of the company s and managers affiliation with other parties also cannot be assessed from public disclosure (although we understand it is disclosed only to the Ministry of Antimonopoly Policy). The FCSM reports include lists of current and previous positions of company directors and managers including their board seats, but do not provide names of other companies where they have equity stakes. It is positive to note that the company has improved risk management, which is particularly important given the company s debt to equity ratio. A Corporate Finance and Investments Committee has been established and we positively assess the fact that Mr. Levkovsky, who has been one of the more active directors, was appointed to this committee. Although early days yet, we are optimistic that the Budget Committee, which includes another representative of institutional investors (Mr. Wilkening), and also the Corporate Governance Committee will also play active roles, including budgeting, key management nominations and investor relations. We positively note that the current board is intensively involved in the nomination and performance Standard & Poor s Corporate Governance Score NORTH WEST TELECOM (NWT) 14

assessments of key executives and also approvals of outside directorships of the CEO. ly, outside directorships of other directors, although they are numerous, have not been considered. 4.3 Role and independence of non-employed directors The three directors that were nominated by minority shareholders can be considered as truly independent. They are becoming more influential since the recent establishment of board committees. Six non-executive directors representing Svyazinvest are active in executing control over the company in the interests of the main shareholder. There have been examples when their actions were not fully transparent. One of them, the former CEO, has not disclosed his current employment and interests. Outside directors balance the role of other directors to some extent. There is no information about the current employment of Mr. Soldatenkov. We acknowledge that the influence of the directors who represent Svyazinvest is mostly aimed at improving NWT s performance, but this is not always consistent with other shareholders interests. Directors representing the main shareholder, have corporate rather than individual membership on the board, as they always vote in coordination and in accordance with Svyazinvest s recommendations. Three minority representatives can be considered independent. Independent directors actively participate in board functions including recent membership of the newly created committees. Information submitted to outside directors prior to board meetings is not always comprehensive. The company articles (in accordance with law) require unanimous voting on certain issues, although this is degraded as non-unanimous decisions can be brought to the shareholders meeting and can be decided by a simple majority. In these circumstances, Svyazinvest s majority position will prevail. Neutral All directors are non-executives, including Mr. Soldatenkov, who though an ex-ceo, resigned from NWT in July 2002, one month after he had been elected to the board. The fact that NWT is unwilling to disclose details of his current employment is a negative feature as we are unable to assess his interests in relation to NWT s interests. Svyazinvest s influence is further reinforced by the obligation that all Svyazinvest-nominated directors have, including the former CEO, to sign a special agreement, which requires them to vote in accordance with the instructions of Svyazinvest. We access this as a negative governance feature as these agreements may have the effect of requiring the directors nominated by Svyazinvest to act in its interests rather than the interests of the company (NWT). This is unlike other major economies such as the US, UK, Germany and France where the laws and statutes requires directors to act in the interest of the companies on whose boards they sit. In our view, all of the directors that were nominated by minority shareholders are independent. Mr. Levkovsky (vice-president of NCH Advisors Inc. and a representative of Lindsell Enterprises Ltd, a portfolio investor owning 3.42 % of common shares in NWT) has been on the board since 2000. He is an active director and studies the backgrounds of proposed transactions carefully. This is borne out by the fact that he has voted against or has abstained from voting on a number of occasions when disclosure of the rationale and details of transactions was insufficient. Mr. Lebedinets, who joined the board in June 2002, holds an executive position at Brunswick Capital Management; he represents clients of Brunswick UBS Warburg s custody services. Mr. Rodionov of- AIG Brunswick Capital Management, together with his business partner Mr. Wilkening, (a member of the Budget Committee of NWT), represent direct investors in two of the companies currently merging with NWT. We believe that the addition of these gentlemen to the board is positive, particularly as they have wide experience of the governance of telecom companies and have a shared interest in increasing the value of NWT. Their increased influence is demonstrated by their proposal to introduce board committees and November 12, 2002 www.standardandpoors.com 15

their willingness to vote against proposals where they see a lack of transparency or the absence of a properly articulated rationale. However, it is obvious that despite their good intentions, the independent directors are unable to fully counterbalance the interests of Svyazinvest s directors who vote en masse. Nevertheless, there are some counterbalancing features that provide some checks and balances including the additional weight given to minority shareholders via the legal requirement for a unanimous vote of directors for the approval of major transactions (exceeding 25% of the company assets) and the issue of additional shares or convertible bonds (exceeding 25% of outstanding shares). However, these transactions are likely to be very rare and the law reduces the impact of these requirements by allowing issues that do not receive approval at board meetings, to be decided by a shareholder meeting, where they are approved by a simple majority voting. We view this as a negative governance feature, as we believe that a voluntary expansion of the list of the most important issues, requiring unanimous or qualified majority approval of the board, would increase the role of outside directors and increase representation of minority shareholders rights. It is positive to note however, that minority directors express the opinion that Svyazinvest s representatives enter into constructive discussion over most voting matters and do not unilaterally exercise their power. 4.4 Board and Executive Compensation, Evaluation and Succession Policies Directors and executives compensation is well articulated by internal documents and contain performance-related elements. The board discusses remuneration of the CEO. Individual compensation arrangements and amounts are not fully publicly disclosed. There are no board evaluation and succession policies, but an independent board committee has been established to undertake this role.. Compensation for the Chief Executive officer is largely performance-driven with a substantial 'at-risk' component. The board regularly approves all issues relating to the Chief Executive Officer s compensation and bonuses plus his contract terms. Individual remuneration of executives is not fully disclosed. The compensation committee includes only independent directors and their representatives. The board approves nominations for executive positions. Shareholders define directors remuneration as a portion of operating profit. No evaluation procedures for board members. The Chief Executive Officer s compensation plan is comparatively sophisticated and includes a substantial 'at risk' component, which can reach up to 70% of his total compensation. The contract does not include share options, and the variable component is largely attached to the company's operating, rather than financial, performance. This reflects the conflict of priorities of the government rather than shareholders. We do not have information about the compensation scheme for other executives. Shareholders approve the annual compensation of non-executive directors, which we note represents a specified % age of the profit before tax to be distributed among directors. It is a positive governance feature that the newly established Reporting and Compensation Committee is responsible for reviewing the system of remuneration, incentives and evaluation of the Chief Executive Officer, senior executives and board members. However, it is a negative governance feature that the company does not have criteria for the evaluation of the board's and individual director's activities. It is also negative that there are no succession plans for directors or senior. The company does not have criteria that can serve as a formal basis for executive director s resignation. ly, the board approves the list of replacement candidates for company executives in cases of their resignation. However, the appointment of the acting CEO Mr. Sysoev to replace Mr. Soldatenkov in July 2002 (to be later approved by shareholders at an extraordinary meeting) was made on a non-alternative basis, which we assess as a negative. Standard & Poor s Corporate Governance Score NORTH WEST TELECOM (NWT) 16

Corporate Governance Scores A Corporate Governance Score ( CGS ) reflects Standard & Poor s assessment of a company s corporate governance practices and policies and the extent to which these serve the interests of the company s financial stakeholders, with an emphasis on shareholders interests. These governance practices and policies are measured against Standard & Poor s corporate governance scoring methodology, which is based on a synthesis of international codes, governance best practices and guidelines of good governance practice. Companies with the same score have, in the opinion of Standard & Poor s, similar company specific governance processes and practices overall, irrespective of the country of domicile. The scores do not address specific legal, regulatory and market environments, and the extent to which these support or hinder governance at the company level, a factor which may affect the overall assessment of the governance risks associated with an individual company (see below Country Factors ). A CGS is articulated on a scale of CGS 1 (lowest) to CGS 10 (highes). CGS 10 and CGS 9 a company that, in Standard & Poor s opinion, has very strong corporate governance processes and practices overall. A company in these scoring categories has, in Standard & Poor s opinion, few weaknesses in any of the major areas of governance analysis. CGS 8 and CGS 7 a company that, in Standard & Poor s opinion, has strong corporate governance processes and practices overall. A company in these scoring categories has, in Standard & Poor s opinion, some weaknesses in certain of the major areas of governance analysis. CGS 6 and CGS 5 a company that, in Standard & Poor s opinion, has moderate corporate governance processes and practices overall. A company in these scoring categories has, in Standard & Poor s opinion, weaknesses in several of the major areas of governance analysis. CGS 4 and CGS 3 a company that, in Standard & Poor s opinion, has weak corporate governance processes and practices overall. A company in these scoring categories has, in Standard & Poor s opinion, significant weaknesses in a number of the major areas of governance analysis. CGS 2 and CGS 1 a company that, in Standard & Poor s opinion, has very weak corporate governance processes and practices overall. A company in these scoring categories has, in Standard & Poor s opinion, significant weaknesses in most of the major areas of analysis. GovernanceWatch A GovernanceWatch designation may be used to highlight the fact that identifiable governance events and short-term trends have caused a CGS to be placed on review. GovernanceWatch does not mean that a change to the CGS is inevitable. GovernanceWatch is not intended to include all CGSs under review, and changes to the CGS may occur without the CGS having first appeared on GovernanceWatch. Important Note A CGS is based on current information provided to Standard & Poor s by the company, its officers and any other sources Standard & Poor s considers reliable. A CGS is neither an audit nor a forensic investigation of governance practices. Standard & Poor s may rely on audited information and other information provided by the company for the purpose of the governance analysis. A CGS is neither a credit rating nor a recommendation to purchase, sell or hold any interest in a company, as it does not comment on market price or suitability for a particular investor. Scores may also be changed, suspended or withdrawn as a result of changes in, or unavailability of such information. Country Factors Although Standard & Poor s publishes country governance analyses from time to time, it is important to note that Standard & Poor s does not currently score individual countries. However, consideration of a country s legal, regulatory and market environment is an important element in the overall analysis of the risks associated with the governance practices of an individual company. For example two companies with the same Company Scores, but domiciled in countries with contrasting legal, regulatory and market standards, present different risk profiles should their governance practices deteriorate i.e. in the event of deterioration in a specific company s governance standards, investors and stakeholders are likely to receive better protection in a country with stronger and better enforced laws and regulations. However, in Standard & Poor s opinion, companies with high corporate governance scores have less governance related risk than companies with low scores, irrespective of the country of domicile. For a full explanation of Standard & Poor s criteria for measuring corporate governance standards, please refer to the latest edition of Corporate Governance Criteria & Methodology. Published by Standard & Poor s, a Division of The McGraw-Hill Companies, Inc. Executive offices: 1221 Avenue of the Americas, New York, NY 10020. Editorial offices: 55 Water Street, New York, NY 10041. Subscriber services: (1) 212-438-7280. Copyright 2002 by The McGraw-Hill Companies, Inc. Reproduction in whole or in part prohibited except by permission. All rights reserved. Information has been obtained by Standard & Poor s from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, Standard & Poor s or others, Standard & Poor s does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or the result obtained from the use of such information. Ratings are statements of opinion, not statements of fact or recommendations to buy, hold, or sell any securities.