State agency at the President of the Russian Federation PRIVATE LAW RESEARCH CENTER 8 Il'inka Street, Moscow 103132 Tel.: 206-36-39 Fax: 206-36-57 OPINION Prepared at the request of the "Infrastructural Institute" Financial Research Development Foundation   The "Infrastructural Institute" Financial Research Development Foundation requested the Private Law Research Center to provide a legal opinion about issues that arose in the course of discussion of the Concept of the Draft Law "On the Central Depository" developed by the FSFM of Russia, which assigns the Central Depository the status of single nominee holder in registers of holders of registered securities. 1. Will the provisions of the Federal Law "On the Central Depository" assigning the Central Depository the status of the single nominee holder in the register of security holders be lawful? According to paragraph 2, Article 8 of the Federal Law "On the securities market", nominee security holder is an individual registered in the register maintenance system, including depository depositor, who is no holder with respect to such securities. Professional securities market participants can play the role of nominee security holders. Depository can be registered as a nominee security holder under a depository contract. Broker can be registered as a nominee security holder under his contract for the provision of services to the client. It follows from this definition that various properly licensed professional securities market participants can play the role of nominee holders registered in the register maintenance system. In considering this issue, as well as other issues covered in this Opinion, one should also have it in mind that the term "nominee holder' itself as used in the current legislation on the securities market has no proper support or substantiation in Russian civil legislation. Said term is known to have been mechanically introduced in the Russian legislation and corresponds to non of the legal property titles known to Russian civil la, including property rights. This fact cannot but create difficulties for practical implementation of the legislation on securities, especially in controversial situations due to unclear ownership of non-documentary securities. It is unclear in the context of civil law, what is nominee holder's status with respect to the holder of non-documentary securities - attorney, commissioner, or trust manager. Under these conditions, concentration of all nominee holding functions in a single Central Depository may have rather negative legal effects and is legally doubtful. The concept of the Federal Law "On the Central Depository" implies construction of a three-level nominee holding system where the Central Depository is the only level 1 holder registered as a nominee holder in registers of holders of registered securities of all joint-stock companies in temperature territory of the Russian Federation. Thus, all other depositories will become level 2 and level 3 nominee holders and will have no direct access to registers of holders of registered securities. It means that a considerable part of the services provided by depositories as nominee holders in the register of holders of registered securities to their clients and comprising the subject of depositories' entrepreneurial activities on the professional securities market will be artificially monopolized by the Central Depository, which may considerably increases investors' costs and negatively affect the investment attractiveness of the Russian securities market. One can assume on the whole that assigning the status of single nominee holder in the system designed to maintain holders of registered securities is no mandatory prerequisite for the functioning of this institution. Moreover, it contradicts the constitutional legal principle of unacceptability of restrictions on competition, and may result in violation of the rights and lawful interests of the individuals investing money in shares or other securities in connection with the monopolization of nominee holder services and lack of right to choose a professional securities market participant providing such services. 2. Will the requirement of the Federal Law "On the Central Depository" for professional securities market participants providing depository services to conclude contracts for inter-depository relations with the Central Depository be lawful? According to the current legislation, security holders (invest ors) have the right to conclude depository contracts with any professional securities market participants licensed to provide depository services. The depositories that accept securities from their clients for registration and storage, in their turn, can register themselves as nominee holders in issuer's register, and conclude a contract with another depository. Thus, relations between the parties participating in securities storage and registration of rights to securities are built on private law and principles of freedom of choice of the counterpart and freedom of contract. If the Federal Law "On the Central Depository" requires that professional securities market participants providing depository services conclude contracts for inter-depository relations wit h the Central Depository, then said freedoms will be essentially restricted. Firstly, conclusion of such contract with the Central Depository will become a necessary prerequisite for professional securities market participants to exercise entrepreneurial activities in the form of depository service provision. It is unclear from the concept developed by the FSFM of Russia whether the Central Depository will be obliged to conclude appropriate contracts with all willing professional securities market participants licensed to provide depository services, or it will be able to arbitrarily select depositories, which, in his opinion, meet necessary requirements to exercise the powers of level 2 nominee holders. In the latter case,, the Central Depository will receive an opportunity to establish terms of competition on the depository services market, which is inconsistent with the principle and letter of the antimonopoly legislation. Secondly, creation of a rigid three-level system of registration of rights to securities implies that security holders will most probably be able to pass securities for storage to level 2 or 3 (and probable only level 3) depositories, which will ultimately result in growth of investment costs. The above said suggests that introducing a duty to conclude contracts for inter-depository relations with the Central Depository for professional securities market participants providing depository services will restrict civil rights of both depositories themselves and security holders willing to pass their securities into nominal holding. Meanwhile, paragraph 2, Article 1 of RF Civil Code states that civil rights can only be restricted as far as it indicators s required to protect the basics of the constitutional order, morals, health, rights, and lawful interests of other individuals, as well as to ensure the defense of the country and security of the state. One can assert that none of these grounds for civil rights restriction exist in this case, and so a statutory provision establishing the duty of concluding a contract with the Central Depository would certainly contradict the fundamental principal of the civil legislation. As this principle directly relies on part 3, Article 55 of the RF Constitution, such provision may raise doubts about its constitutionality. 3. Does the multilevel nominal holding system proposed in the Concept ensure the rights of security holders established in the norms of the civil legislation? As already mentioned above, the nominal holding concept was artificially introduced in the Russian legislation from outside, and has no certain place in the system of institutions of the Russian civil law. According to paragraph 2, Article 8 of the Federal Law "On the securities market", nominee security holder is an individual registered in the register maintenance system, including depository depositor, which is no owner of such securities. It only follows from this definition that the nominee holder exercises the functions of a technical intermediary between the holder of right (securities owner) and securities issuer. However, it gives no idea of the legal nature of relations between securities owner and nominee holder or legal content of this legal institution. In contrast, for example, to German Civil Law (╖╖ 855, 868, etc.), which differentiates the concept of direct ownership, indirect ownership (or "dependent holding" as it is sometimes named in legal literature), and actual domination over an object in the interests of another person, The Civil Code of Russia does not define holding as a legal title to property separated from ownership. Maybe the only RF COMBUSTOR provision indirectly providing a ground to suppose that the domestic legislator still recognizes the possibility of stable implementation of actual domination over an object by a person without title of ownership is contained in Article 689, which states that the object is passed to the loanee under contract for free use (loan agreement) into free temporary use (not into holding and use as under lease contract). However, the legal doctrine and practice have drawn no serious conclusions from this provision, and the loanee is still considered an owner, and transfer of an object i nto free use is accordingly considered a way of object disposal. Under the conditions of such legal uncertainty with respect to the very concept of nominee securities holder, any system of registration of rights to securities built on such concept will unavoidably have defects capable of resulting in a violation of security holder rights. Therefore, the answer to this question depends on the ability of the multilevel nominee holding system proposed in the Concept to guarantee validity of determination of the fact that securities belong to an authorized person at a certain moment of time. One can note in this connection that the Concept provides no convincing arguments for the ability of the proposed system of registration of rights to securities to create a more reliable mechanism for protection of security holder rights. In addition to failure to increase the level of investor's rights protection, the concept essentially restricts the freedom of their action, ie an investor willing to pass his securities to a nominee holder represented in the system designed to maintain holders of registered securities will have to apply solely to the Central Depository. Thus, the Central Depository as the only nominee holder in the register maintenance system accumulates rights to securities in its individual account, which belong to an unlimited number of persons, and we will demonstrate it below that these rights will be mixed in a common mass (depersonalized). As a result, the Central Depository's individual account can be arrested in case of property of one of such persons being charged, which will result in violation of rights of a tremendous number of other security holders who will not be able to use them, as it is impossible to separate securities belonging to an owner from securities belonging to a different owner in the individual account. In addition, one can suppose that concentration of level 1 nominee holding functions in the Central Depository will increase the risk of occasional loss of rights to securities due to registration errors for many investors. 4. Does the Central Depository status proposed in the Concept solve the problem of determining the owner of securities transferred to accounts of nominee holders? According to Article 2 of the Federal Law "On the securities market", the owner of non-documentary securities is established on the basis of a record in the security holder registration system or, if securities are deposited, on the ground of a record in the depo account. According to Article 28 of said Federal Law, the rights of owners of non-documentary emission securities are certified in the register maintenance system by records in register holder's individual accounts or, in case of rights to securities being registered in a depository, by records in depo accounts with the depositories. Thus, if the rights to securities registered in depo accounts with a depository are transferred to another person, then the information recorded in ndividual accounts in the register maintenance system is not modified, as the quantity of securities left in the nominee holder's individual account in the register maintenance system is the same as before their transfer. As a result, the owner of securities can be determined using records in depo accounts alone, which actually means depersonalization of registered securities, ie impossibility of establishing the owner of such securities using register data. As a result, securities belonging to various persons are mixed in a unified mass in the nominee holder's individual account. This peculiarity organically inherent in any system of registration of rights to securities based on nominee holding is convenient in some aspects, but it creates the danger of situations where it is impossible to establish the owner of securities at a certain moment of time. This problem also arises in transfer of securities from a registered person's (securities owner) account to a nominee holder's (depository) account in the register maintenance system. If a multilevel nominee holding system is created where the Central Depository becomes the only nominee holder in the system designed to register holders of registered securities, said danger cannot be eliminated, and will most probably increase because of increased number of intermediaries between securities owner and securities issuer. G.E.Avilov Deputy Chairman o f the Board Private Law Research Center September 21, 2005