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By John Helmer in Moscow

The FSA investigation of Polyus Gold’s affairs hears duck quacking.

Last February, Interros, the Moscow asset holding of Vladimir Potanin, was getting ready to go to the High Court in London to enforce Potanin’s rights in KM-Invest, a special purpose vehicle Potanin controlled with disgruntled partner, Mikhail Prokhorov.

At stake was a 7.4% stake in Polyus Gold, Russia’s leading gold miner, which KM-Invest held for the two men. KM-Invest’s establishment documents provided for UK court jurisdiction, in the event of disputes.

At the time, 7.4% of Polyus was worth about $775 million. Last week, it reached $1.1 billion, before falling again. The gyrations of share value are part of the conflict between Potanin and Prokhorov, as Mineweb has already reported, as Potanin tries to gather the votes himself, and the support of minority shareholders, to stop Prokhorov from carving-out the exploration assets of the company, and starting an entirely new company, Polyus Exploration, under his exclusive control.

Prokhorov’s ally, and Polyus chief executive, Evgeny Ivanov is reported in a Moscow newspaper this week as claiming he will not proceed with the new company plan without full support from the board. This means that whoever controls the 9-member board will decide what asset value will remain in Polyus Gold, and what will be transferred to Polyus Exploration.

But back in February, Potanin didn’t file in the High Court. That was because he and Prokhorov had managed to agree on a settlement. This provided Potanin and Interros with the full KM-Invest stake in Polyus, while Prokhorov got other assets in exchange.

That still leaves the shareholder strengths precariously balanced. It is believed in the market that Potanin now controls about 30% of Polyus; and Prokhorov, also about 30%. The board’s recent voting, however, indicates that Prokhorov commands 5 votes, one of them the purported independent, Valery Braiko, while Potanin is supported by 3 votes, with another independent, Lord Patrick Gillford, voting against the carve-out option.

When Gillford made clear his opposition on this issue to Ivanov, Ivanov attacked his standing as an independent. It was then arranged last week for the board to vote him off the slate of new directors to be elected at the AGM. That is scheduled for June 26.

Gillford’s office told Mineweb he is contesting re-election against the Prokhorov-Ivanov candidate, Christophe Charlier.

Despite a lucrative career serving Prokhorov, Charlier hasn’t had business relationships “with any of the parties involved” for three years, according to Ivanov. Charlier, who is on the board of a Toronto-listed junior gold prospector, Ecometals Ltd., has not responded to inquiries left for him at Ecometals. The company, with prospecting opportunities in Brazil and Ecuador, is currently worth about C$80 million. Its share price is trading at 35 Canadian cents, below the mid-point of its value for the past 52 weeks. It was recently obliged to suspend prospecting in Ecuador. Ecometals is run by Daniel Major; until last month, he was working in Moscow for Oleg Deripaska.

Two fresh independents, Assaad Jabre and Robert Buchan, have also been backed for the new Polyus board by Interros in a campaign for support of the minority shareholders of Polyus. Jabre is from the IFC; Buchan from Kinross and now Allied Nevada Gold Corporation.

It is unclear exactly how many minority shareholders are eligible to vote at the AGM, and what percentage of Polyus’s 191 million shares the free float currently comprises. An informed estimate is that about 60 institutions, funds or individuals in the free float control about 30% of the voting shares. In theory, and according to Interros, the free-float independents ought to have 3 directors on the board.

These estimates allow for a bloc of between 5% and 10%, part of which is owned by the Jennington offshore unit of the Polyus group. Although the Jennington shares are treasury shares, and ought not to be voted in the contest between Potanin and Prokhorov, in fact they are being counted by Prokhorov on his side.

Since it is near-certain that independent directors would favour a strategy of conserving value in Polyus Gold and oppose the carve-out, independence is now the key to the outcome of the fight between the two major shareholders. Prokhorov is therefore campaigning for Charlier to take his side. He is also proposing the AGM accept a change in the corporate governance charter to allow a bloc of 4 votes — Prokhorov’s 3 plus Charlier — the power to veto decisions supported by the majority of 5. This appears to sandbag Ivanov’s position as chief executive.

The fight over KM-Invest didn’t bring the contest to London. But now, as the theme music for the second episode starts up again — naturally, Sergei Prokofiev’s “Peter and the Wolf” — the spotlights fix on stage the trusting boy, his bad-tempered grandfather, the escaping duck, and the grey wolf. The stage belongs in this episode to the UK regulator, the Financial Services Authority (FSA).

Last Thursday, May 22, the FSA sent Polyus Gold’s management a letter, signalling that it had opened an investigation of the share price gyrations of the preceding few days. Polyus stamped May 26 as the date of receipt. Following a Russian newspaper report of the letter, Polyus issued a press release, confirming the FSA notice of “a preliminary review into the compliance by Polyus Gold with the UK’s Disclosure and Transparency Rules.”

The FSA does not say whether or not it is investigating a target. However, the FSA has confirmed that Marcus Feller, the signatory on the letter Polyus received, is a member of the FSA’s company monitoring section.

Feller is familiar to Russian businessmen operating in London, and he has been a participant in a rolling roadshow promoting Russian investment through the London market, called the Bull & Bear Banquet. What Feller said in his letter to Polyus was, according to one source, nothing more than a routine inquiry, asking Ivanov what information the company has regarding the cause of the share price oscillation. The source does not believe the FSA intends to investigate beyond that; and that Ivanov is under no obligation to say more than that he has no idea at all.

A source close to FSA operations says the agency operates stock monitoring programmes, and these routinely trigger alerts when share prices behave in an unusual manner. The company monitoring team, to which Feller belongs, is part of the FSA’s markets division. According to the FSA’s website, “the Company Monitoring team is responsible for monitoring companies’ compliance with their continuing obligations of disclosure under the Listing Rules and the Disclosure Rules The team’s primary role is to ensure the timely and accurate disclosure of inside information”.

If Ivanov tells Feller there is no inside information, and everything has been disclosed to the market, will Feller close the file?

According to a London due diligence specialist, “it’s perfectly reasonable to think that the Markets division may have spread their net wider in the FSA since they wrote the letter.”

The FSA has other divisions which may be interested. The Financial Crime and Intelligence Division, for example, headed by Philip Robinson, aims, according to the FSA website, “to reduce the extent to which regulated persons and unauthorised businesses can be ‘used for a purpose connected with financial crime’.” One of the targets of Robinson’s group is to ensure “the FSA is satisfied that persons of questionable integrity do not manage, own or control firms operating in the UK financial sector.”

On this occasion, the FSA investigation is the first ever publicly revealed of a London-listed Russian company. Because of the circumstances, however, and the sensitivity of the charges exchanged between shareholders, and driving market speculation, it is possible the FSA is looking into the record of Polyus transactions, which Prokhorov as board chairman, and Ivanov as chief executive, have carried out. The evidence is available, but for the FSA to peer into the murk would be unprecedented.

The FSA letter, and its leak into a Moscow newspaper, just a day after receipt, reveal how sensitive the market has become to relatively small shifts of share ownership, as the showdown between the Potanin and Prokhorov bloc approaches June 26, the date of the AGM. Following the disclosure by reporter Julia Fedorovina on Tuesday, Polyus’s share price fell another 6% to the $62 level. It has now dropped 23% since its $80 high on the RTS exchange on May 21.

As Mineweb has already reported, the share movements, which Feller is investigating, followed an offer from London-based Kazimir Partners to buy a 2.5% bloc of Polyus shares, controlled by management, for a share price of $73.44. At the time, the offer represented a substantial premium to the prevailing price, which then rose to meet it, before collapsing again.

At its board meeting on May 21, chief executive Ivanov refused to allow a discussion or vote on the Kazimir proposal. Instead, he deferred a decision. Yesterday, he seemed to give the thumbs down, but carefully avoided giving a unilateral no.

The company announcement is entitled “Polyus Gold’ management stance on the offer received from Kazimir Partners.” At the start of the year, the statement claims, there was $1.4 billion in cash, enough to “finance new gold mine construction and development without raising debt from the market, up until the year 2010”. The statement implies that it isn’t a good idea to sell the shares from Jennington’s stake now, when they might be worth more later, and when “placement of excessive cash either in either bank deposits or through asset management schemes will not allow it to achieve profitability comparable to that of investments in gold-linked assets.”

A report by UBS noted that “in our view, the above statements indicate a recommendation to the Board to not accept the offer.”

Analyst reports on Polyus Gold have been less optimistic that the company has the will to spend the cash required in the short run to lift gold out from the 1.2 million-ounce mark achieved last year, but unchanged since 2006. Rising costs are eating into the Ebitda, which was $299 million in 2006. Ivanov has told investors it will be between $300 and $320 million in 2007(excluding a $130 million charge for share options).

Ivanov has also acknowledged that, in order to reach a production target of 3.9 million oz by 2015, Polyus must spend at least $5 billion. At least half of that is required for Natalka (Matrosov), the undeveloped deposit in Magadan which, with 41 million estimated oz, represents 60% of Polyus’s reserves

Right now, however, the board is riven by uncertainty over the carve-out scheme, which threatens to remove some of the “gold-linked assets” yesterday’s statement refers to. Uncertainty also over the eventual terms of the Potanin-Prokhorov settlement, and over the possibility of intervention by a state-owned acquiror, has also contributed to support for the Kazimir proposal.

Although there has been no overt sign of Putin administration interest in the shareholder conflict to date, this is bound to materialize, if and when the Sukhoi Log licence comes up for a decision. Sukhoi Log, in Irkutsk region, holds at least 33 million oz in reserves, possibly equal to, or more than, Natalka. It has been held back from development by the Kremlin for a decade, while more lucrative resource concessions have been awarded, or re-awarded, in oil, gas, iron-ore, coal, copper, aluminium, steel, titanium, and other metals.

It is a fair bet that if the outcome of the war over Polyus looks like producing a victor who is not accepted by the Putin administration, Sukhoi Log will go to someone else. Paradoxically, it may yet turn out that the strength of the independent free float of shareholders may be more persuasive to Kremlin strategy than foreign investors have been guessing.

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