Brazil is gearing up for a second wave of corporate governance reforms. These will focus on providing greater transparency for investors in areas such as shareholder conflicts of interest and clarity on remuneration as well as proposals to make voting at meetings easier. Some measures are being resisted by companies and the test of strength is just beginning.
Last year was not the best one for Brazilian corporate governance thanks to a scandal involving some of Brazils biggest exporters. They were speculating on derivatives and two companies losing hundreds of millions of dollars apiece. At the same time, the loss of foreign investors has removed a key source of impetus for improving governance, even though Brazilian funds are increasingly stepping into the breach (see box).
The derivatives scandals were whopping in size. Meat processor Sadia was forced to post a R$545 million write-down to cover the third quarter on bets against the dollar that went sour when the real fell sharply against the greenback in the second half of last year. The company dismissed its CFO and this February dismissed a further four directors, without indicating whether their sackings were related to the scandal. Paper and pulp company Aracruz saw $2.13 billion in losses stemming from similarly wrong bets.
Sadia was trading at R$4.80 February 4 compared to a 52-week high of R$12.49 reached in June last year while Aracruz has fallen from a high of R$17.5 in May to R$12.6, its fall partly mitigated by a take-over bid from rival Votorantim.
These losses have encouraged typically passive institutional investors to become more involved in corporate governance. In a widely-watched action, Previ, the influential pension fund of the countrys largest bank, called for an extraordinary general meeting of food and meat company Sadia, which was held in November. The fund wanted explanations on how the manager had flouted internal rules on hedging and called for greater transparency and control.
Some investors are now litigating to recoup some of the losses, notes Sandra Guerra, founder of Better Governance in São Paulo, which monitors and pushes for better standards. They may well have a case. Boards blamed the financial director of the company, but it would be surprising if the boards themselves did not know their level of exposure, she remarks. This is part of a CEOs responsibility. You really cant manage a company without knowing this, Guerra says.
The CVM has enforcement procedures in two cases concerning derivatives (it is unable to name the two companies). Brazilian law requires board and officers of companies to exercise utmost care. We will judge them by these standards, says Marcos Pinto, at the market regulator, the Comissão de Valores Mobiliários (CVM).
The good news is that the scandal has made investors much more aware of the importance of the nuts-and-bolts of reporting lines and authority, thinks Guerra. Investors are asking who does what and who has authority to sign for what. They are seeking to identify who has overall responsibility, she notes.
Initiatives at the CVM
It looks a timely moment then for the CVM to be designing new rules that will help further develop the corporate governance agenda in Brazil. The new focus is on achieving real gains, not superficial, perception-based initiatives, Guerra believes.
The CVM is working to foster greater transparency. The first big planned change is the release for public consultation of new rules on the information that companies need to provide to the market and this covers all companies listed as well as those that issue bonds, albeit with different levels of disclosure according to market segment. The proposed rules will increase the level of disclosure substantially, says Pinto.
These new rules would compel listed companies to give basic information regarding remuneration of managers, conflict of interest between controlling shareholders and more detailed general information on the business of the company, Pinto says.
The part on remuneration has been particularly controversial as it proposes revealing total packages paid to all executive rather than provide one universal number for the companys directors, says Pinto.
The reaction has been mixed, Pinto confesses. Many investors say they want this information and see it as critical for judging management. Companies are protesting that its not necessary to provide such a detailed break-down and that releasing global information should be sufficient. The consultation period is slated to end this month.
The measures to mitigate conflicts of interest focus on disclosure, in line with the CVMs mandate. Were being very strict about disclosure of information on related-party transactions says Pinto. The new law will require companies to disclose each related-party transaction (between managers and related companies) and provide comparison with market transactions.
Brazilian corporate law states that companies have to be fair to all shareholders, Pinto notes. The Bovespa has attracted many companies with controlling shareholders that have stakes in other companies and relationships between themselves. Its very important for minority shareholders to know which transactions are happening so they can spot and avoid conflicts of interest, he says.
The CVM reforms come at the same time as the Institute of Brazilian Corporate Governance is planning on making comprehensive changes to its code of governance, adds Guerra. The new code will be much more detailed in relation to risk and tighten control over the boards responsibility in this area. This is likely to promote the role of audit committees and comes as many listed firms are trying to better understand and mitigate their exposure to risk as the economy deteriorates, says Guerra.
The measures should dovetail with the CVMs moves. The two organisations talk extensively and generally participate in each others public releases and consultations. The two operate in slightly different planes with the CVM focusing on disclosure and the IBGC focusing on best practice.
Another significant change is soon to be released for consideration and affects the key area of attendance and voting at general meetings (GMs), long a contested area in Brazil thanks to restrictive requirements that require shareholders to appear in person at meetings. Given the size of Brazil and the number of foreign participants, that has effectively deterred participation and quora are often not met.
Last year, the CVM decided that shareholders should be able to participate in annual GMs via the internet, notes Pinto. The CVM is now floating an idea for a new rule that will oblige companies to provide for shareholders to vote through proxy solicitation. Once we have given shareholders more information on the companies they are willing to vote in, they will be more willing to participate in meetings and better able to monitor the activities of controlling shareholders, reckons Pinto.
The moves will help stimulate investors to think more carefully about the role of corporate governance and promote more vigilant policies, thinks Guerra. In 2005-07, the years of sustained market rises, many investors interest in corporate governance went only so far as to know if a company intended to list on the Novo Mercado (the segment with the most stringent listing rules), she points out. If the answer was yes, they thought they had completed due diligence. They will now be looking to get under the surface, she believes. Investors will also be more closely monitoring the decisions by individual board members and electing members with more knowledge of their background and voting patterns, she predicts. That could help promote more conversations between the board and investors.
Finally, she sees more tie-ups similar to that between UK pension fund Hermes and Brazilian fund Previ. Previ has launched a guide for companies on how to conduct annual GMs, a list of dos and donts. Hermes has supported the measure. When you get big funds like this working together, its pretty powerful, Guerra says.
Brazilian funds start to push tough governance agenda
In January, a group of key Brazilian fund managers came together to force an extraordinary general meeting (EGM) on Telemig, a mobile phone company 100% owned by Telefonica and Portugal Telecom, marking a milestone. They were calling publicly on the company to distribute some of its large cash pile and were finally defeated in their motion. The show of corporate governance muscle is very rare for Brazil, where the few actions have been mostly initiated by foreign investors.
Telemigs EGM was watched closely both by other cash-rich Brazilian companies, trying to figure out what is prudent to keep on hand for a rockier year ahead, and Brazilian fund managers, who are starting to scrutinize practices of companies more closely to wring out more value in a time of poor market performance.
Prior to the meeting, Telemig twice declined written requests to distribute some of its R$714 million in net cash, citing the current poor economic outlook and investment needs. The four Brazilian activists, Polo Capital; Claritas; GAP; and Vinson who own some 8% of Telemig, argued that it is precisely in testing times that companies needs to focus on efficiency and purging excesses and add that investments needs are small compared to EBITDA. Capex needs are some R$200 million against cash flow of R$450 million next year, according to their calculations.
The activists also point out that Telemigs policies seem out of line with those pursued by parent companies Telefonica and Portugal Telecom, which both have net debt to EBITDA ratios of more than two times while Telemigs net cash position gives it a negative ratio of 1.70. Telefonicas own policies state the company should be prioritizing shareholders returns for the use of free cash flow, they say.
Telemig would certainly not be alone in Brazil in pursuing a share buyback programme, says Marcelo Mollica, senior analyst at GAP, who points out that from September to November, 14 Brazilian firms started buy back programmes against just four in the preceding eight months. Companies are returning cash to investors where its not needed, he says.
The move by the four managers is unusual for Brazil in its level of coordination. And with so many foreign investors having pulled out of the Brazilian stock markets over the last 12 months, its going to be more key than ever to get Brazilian shareholders involved in monitoring their own companies, concludes Mollica.