Transcript The Third Meeting Of The Latin American Corporate Governance Roundtable Main Board Issues in Latin America Eliane Aleixo Lustosa Mexico City, April 8th -

The Third Meeting Of The Latin American
Corporate Governance Roundtable
Main Board Issues in Latin America
Eliane Aleixo Lustosa
Mexico City, April 8th - 10th, 2002
1
Summary
1. Brazilian Pension Funds Industry: brief overview
2. Petros Investment Policy
3. PF and Capital Market: regulatory framework
4. PF and Corporate Governance: empirical evidence
5. Conclusions
2
Brazilian Pension Funds Industry:Brief Overview
Assets of Pension Funds / GDP
18,00%
16,00%
14,00%
12,00%
10,00%
8,00%
6,00%
4,00%
2,00%
0,00%
1990
1991
Source: ABRAPP
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
3
Brazilian Pension Funds Industry: Brief Overview
 Pension Funds’ Total Assets : US$ 62.0 billion (15% of GDP) (1)
 Pension Funds’ Investments In Equity
(1)
:
- Present - US$ 19.5 billion (32% of Total Assets)
- Potential - US$ 37.2 bilhões (60.0% of Total Assets)
 Pension Funds’ presence in the Stock Markets
(2)
- Present - 11.7%
- Potential - 22.3%
(1). Source: Abrapp. August, 2001.
(2) Considering Brazilian MarketCap of US$ 166.7 billion.
4
Brazilian Pension Funds Industry: Brief Overview
Monthly average
trading volume in
Bovespa, NYSE and
Nasdaq from Jan to
May, 2001
US$ billion
(A)
1 day
Brazil
US
Total Pension
Funds’ Equity
investments
US$ billion
(B)
1 month
0.3
6.5
19.5
47.6
1,000
5,000
Source: NYSE, BOVESPA, ABRAPP, BLOOMBERG, Petros
OBS: Time necessary to divest the whole portfolio: Brazil= 3 months, USA= 5 months
5
Petros Investment Policy

Petros is a non-profit private organization, established in
1970 as the pension fund for the employees of Brazil’s stateowned oil company, Petrobras;

Petros is a multi sponsored Plan. Currently, it has 23
sponsors, 17 are private companies and 6 are state-owned;

Petros has more than 90 thousand participants;

Petros is the second largest pension fund in Brazil (US$ 6.2
billions assets);
6
Petros Investment Policy
Assets
FIXED INCOME
December 2001
US$ thousands
(%)
4.334.556
70,45%
Governament Bonds
2.777.876
45,15%
Private Bonds
1.556.679
25,30%
1.065.265
17,31%
REAL ESTATE
400.125
6,50%
LOANS TO PARTICIPANTS
142.889
2,32%
VARIABLE INCOME
PROJECT FINANCE
TOTAL
209.685
6.152.520
3,41%
100,00%
7
Petros Investment Policy
EQUITY PORTFOLIO: US$ 1.10 BILLION
Energy
10.72%
Mining
6.71%
Telecom
3.20%
Food
2.52%
Pulp & Paper
1.57%
Petrochemical 0.78%
Others
2.70%
INDEXED TO IBOVESPA
28%
PROJECT FINANCE
20%
CONTROLLING STAKE
29%
PRIVATE EQUITY
FUNDS
3%
STOCK PICKING
20%
8
Petros Investment Policy

As a major shareholder, Petros has the ability to indicate
members of Board of Directors in 14 listed Companies,
operating in sectors such as: energy, telecom, capital goods,
food, textile and petrochemicals;

Petros also appoints 5 members of “Consejos Fiscales” in
different companies.
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Petros Investment Policy

In the past, Petros’ used to appoint Petrobras’ retired employees
that had not exactly the right profile to accomplish their duties as
Directors and members of “Consejos Fiscales”;

Main problem: they usually became captive of the managers’
objectives and were not concerned about the investment return
for the shareholders they were supposed to represent;

Nowadays Petros appoints only external professionals and its
own executives and officers with experience in corporate issues
and the ability to perceive eventual controlling shareholders and
management misbehavior;
10
Pension Funds and Capital Market:
Regulatory Framework
GOVERNAMENT ENTITIES

Conselho Monetário Nacional (CMN) - council that, amongst other
responsibilities, rules the investment of pension funds’ assets and
reserves;

Secretaria de Previdência Complementar (SPC) -
Ministry of Social
Security’s agency in charge of supervising pension funds;

Comissão de Valores Mobiliários (CVM) - agency that encompass all
matters related to the Brazilian Securities Market. CVM is equivalent to
the Securities Exchange Commission (SEC) in the USA.
11
Pension Funds and Capital Market:
Regulatory Framework
Federal Constitution - Art. 202 determines that pension funds’ legal
framework is independent from the Social Security System. Joining a
private pension fund is facultative
Resolution CMN 2.829 and 2.850
Set guidelines for asset allocation, investment policy and other
procedures
Federal Law 6.404
The Brazilian Corporate Law
Law 10.303
Alters and adds provisions to Law 6.404 and Law 6.385, which governs
the securities market and creates the Brazilian Securities Commission,
respectively.
12
Pension Funds and Capital Market:
Regulatory Framework
Improvements in the Brazilian corporate governance scenario
The
Brazilian Development Bank (BNDES) intends to adopt more
selective criteria in terms of corporate governance in order to
finance companies;
The Brazilian Securities Commission (CVM) made a great effort to
approve a new Corporate Law, that brings additional protection to
minority shareholders;

Bolsa de Valores de São Paulo (BOVESPA) created three different
levels of companies, according to their corporate governance rules;

Brazilian Federal Agency in charge of supervising pension funds
(SPC) determined that they shall publicize their votes in
Shareholders Meetings.

13
Pension Funds and Capital Market:
Regulatory Framework
New Brazilian Corporate Law: main improvements
Tag Along - in case of direct or indirect transfer of control.
Condition: public offer to acquire the voting shares owned by the
remaining shareholders, paying 80% of the amount granted, per
share, for the controlling block;

Board of Directors’ Election - shareholders representing 15% of
shares without voting rights or with restricted voting rights shall
have the right to elect and remove a member from the board of
directors in a separate election;

Non voting shares - the number of non voting shares, or subject to
restriction on voting rights, may not exceed fifty percent of all issued
shares;

14
Pension Funds and Capital Market:
Regulatory Framework
New Brazilian Corporate Law: main improvements
Delisting of a publicly-held corporation. Condition: public offer
to acquire all the outstanding shares for a fair price. Criteria: a) net
assets appraised at market value; b) discounted cash flow; c)
comparison by multiples; d) share price in the stock market;

Disclosure of the “Consejero Fiscal” opinion, including all
dissident votes, in the Annual Shareholders Meeting;

Prohibition to officers to hold a position in a competing
company, specially in the board of directors or “Consejo Fiscal”;

Arbitrage: corporations’ by-laws may establish that any disputes
can be solved by arbitrage.

15
Pension Funds and Capital Market:
Regulatory Framework
New Brazilian Corporate Law: main backward step
Most of the Shareholders’ Agreements signed by Pension Funds,
basically during the 90’s, established a very limited role to the
Directors elected under the terms of the Agreement: all the
subjects are decided in a so called “Shareholders’ Previous
Meeting” (Reunião Prévia), where the major shareholder has all the
power to decide alone what will be the votes in the Board Meetings;

Pension Funds have learned, from their own recent experience,
that simply following a previously taken decision (in the Reunião
Prévia) may seriously harm the company’s interests;

16
Pension Funds and Capital Market:
Regulatory Framework
New Brazilian Corporate Law: main backward step
Unfortunately, the new Corporate Law brought a major
retrogression concerning the independence of Directors in relation
to decisions of shareholders;

According to art. 118, the failure to attend a general shareholders’
meeting or a Board of Directors’ meeting, as well as the failure to
vote on subjects specified in the shareholders agreement, by any
part, or by members of the Board of Directors, elected under the
terms of a shareholders’ agreement, assures the damaged party the
right to vote with the shares belonging to the shareholder who is
absent or remiss.

17
Pension Funds and Capital Market:
Regulatory Framework
Law 10.303/01 main backward step: an example
The management of a Telecom company was asked to provide
information about the company’s participation in an airplane consortium
The CFO brought some amazing information:
- after taking part in the consortium, the company’s overall traveling
expenses increased, instead of decreasing;
- the company prepaid, in April, the whole year consortium expenses,
although a significant part were variable costs, that depends on the
hours of flight.
As the company controlling shareholder also controlled the consortium,
and was the main beneficiary of the airplanes, he tried to constrain the
Directors appointed under the terms of the shareholders’ agreement:
“the company already has a regular auditing and it would be expensive
to hire a special one ...”
18
Pension Funds and Capital Market:
Regulatory Framework
Law 10.303/01 main backward step: an example
The Directors, disobeying the recommendation, asked for a special
auditing of the consortium financial statements;
With the new art. 118 in Corporate Law, it will be much more difficult for
Directors
to
disobey
a
decision
coming
from
the
controlling
shareholder.
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PF and Corporate Governance: empirical evidence
Brazilian stock market is underdeveloped and preferred shares
cannot be considered as “parts” of the company;

Pension
Funds intended to use Shareholders´Agreements to
have additional protection to balance the lack of minority rights in
the capital market;
In
the 90’s, with the beginning of Brazilian Privatization Program,
Pension Funds decided to acquire shares in controlling stakes to
be more close to the company’s day by day decisions;
a consequence, PF became “minority shareholders” that took
part in a “controlling shareholders’ block”;
As
PF´s
fiduciary duties obliged them to be active shareholders.
20
PF and Corporate Governance: empirical evidence
Pension Funds have been working together with BNDES , Bovespa
and CVM (Brazilian Securities Commission) in order to achieve sound
standards in Corporate Governance.


The main measures adopted by Pension Funds to accomplish this task are:
- Appointment of board members who are highly qualified for the position;
- Joint actions, including legal initiatives;
- Close attention and assessment of strategic decisions taken by the
executive boards;
- Pressure for higher level of disclosure and transparency;
- Supporting initiatives aimed at respecting minority investors interests;
- Supporting changes in the legal framework related to capital markets.
21
PF and Corporate Governance: empirical evidence
How to achieve “nose in fingers out”?
Case n. 1: valuation of assets controlled by a related party, to be
bought by a listed company
Controllers were already highly leveraged. The acquisition of the assets
could be an opportunity to socialize their debt;

As a demand of the financing banks, the controllers needed minorities’
approval in the board of directors;

Pension Funds signed a MOU, with controlling shareholders, including
the following main clauses:

- In order to avoid conflict of interests, the valuation of any asset
owned by the controlling shareholder should be made by a top
investment bank;
22
PF and Corporate Governance: empirical evidence
cont.
at controlling the company’s leverage after the acquisitions,
the MOU determined covenants such as debt / EBITDA ratio and
interest coverage ratio;
- Aiming
For the first acquisition performed by the company, an investment bank
was hired to make an “independent valuation”;

The
bank did its job;
The
result of the valuation came to the Board of Directors to be approved;
Petros’ officers did a very careful analysis of the assumptions and the DCF
calculations;
Conclusion: the investment bank had to acknowledge two huge mistakes:
one concerning the price of raw materials projections; the other related to
the way they calculated the perpetuity. Those mistakes represented a US$
200 million increase over the correct price.

23
PF and Corporate Governance: empirical evidence
Case n. 2: capital goods company
Consultants were hired by minority shareholders to make a diagnosis
and concluded that the company had a good operational situation, but
was financially weak (imminent default) because of mismanagement.

Based on the consultants report, minority shareholders were
committed to rescue the company under certain conditions. The signed
MOU established: i) dilution of controlling shareholders and ii) new
management team in order to develop a restructuring plan;

The MOU also defined changes in the company’s by-laws: i) free
convertibility from ON to PN; ii) tag along rights; iii) absence of a clear
controlling block; iv) deals involving subsidiaries and the parent
company have to be approved by the Board of Directors.

24
PF and Corporate Governance: empirical evidence
cont.
Ongoing changes
The company is negotiating with suppliers and banks to reduce
total debt;


Assets out of the core business are being sold;
Dilution of majority shareholders will happen as a consequence of
conversion of debentures bought in the past by minority
shareholders;

Follow-up and pro-active contribution to the process by a
Committee that includes minority shareholders.

25
PF and Corporate Governance: empirical evidence
Case n. 3: entertainment sector company

Business plan damaged by environmental problems + exchange
rate devaluation;

Company over leveraged (debt to equity ratio 5.5x);

Visitors and attendance below expectations (overestimated in
business plan)  insufficient cash flow;


Company in imminent default status;
Controlling
shareholders
proposed
unacceptable
capital
restructuring: only minority shareholders would have to subscribe
new equity, injecting huge amount of cash and converting debentures
into stocks under unfair price subscription.
26
PF and Corporate Governance: empirical evidence
Cont.
Solution
 Pressured by Pension Funds,
shareholders and creditors (banks)
made a tour de force in order to solve the financial imbalance and
capital structure:
- postponement of loans and debenture maturity;
- 50% of debentures (held by minorities) were converted (at
book value per share);
- only 30% of total cash initially proposed by controlling
shareholders were injected;
A new shareholder´s agreement was signed, with clauses
aiming to guarantee: corporate governance best practices,
management auditing, veto power in specific subjects, right of
first refusal, tag along and drag along clauses.

27
PF and Corporate Governance: empirical evidence
Case n. 4: telecom sector companies
WAP services, provided by XXX company, were offered to 4 mobile
telecom companies, under disadvantageous conditions. XXX company
was controlled by the same group that controlled the telecom
companies.

Board
Members had to study the technical details of the proposal
compared to the alternatives.
Advantages of doing the job in house, instead of hiring XXX:

Lower operational costs;

Keep the strategic information related to clients (value added);

High potential for other internet revenues;
Foreign operators chose to make it “in house” because of poor
track record.

28
PF and Corporate Governance: empirical evidence
What happened
Initial proposition
Final proposition
1) One contract for each telecom, not
1) One proposition for all
considering synergies.
operators with economies of scale
related to cost per client;
2) Different conditions for each
telecom company;
3) High % of revenues transferred to
XXX;
2) Same conditions for all
companies;
3) Reduction of the %;
4) No warrants concerning database
ownership (clients);
4) Warrant of database ownership
included;
5) Telecom companies investment
estimated in R$ 12.6 million.
5) Reduction of R$ 2.6 million of
the total amount.
29
Conclusions
The Brazilian capital markets scenario, specially the ability of
minority shareholders to protect their investments, have improved a
lot in the last two years;

- there is a huge concern of Brazilian regulatory agencies with
the importance of minority shareholders´ protection to enhance
capital markets;
- relevant institutional investors, like Pension Funds, are much
more active in Shareholders Meetings and are beginning to be
represented in Boards of Directors and “Consejos Fiscales” by
more qualified professionals;
- the Brazilian Development Bank (BNDES) also plays a very
important role in this process: if the Bank uses good corporate
governance criteria when selecting the projects that will be
financed, and denies credit to those companies who don’t follow
good corporate governance guidelines  companies will have to
look for financing in capital markets  they will have to cope
with more organized and active minority shareholders.
30
Conclusions

More disclosure should be given to episodes of conflict
of interest involving controlling shareholders (related
parties). In case of misbehavior of third parties, specially
banks, the regulatory agencies (CVM and the Central
Bank) should have the appropriate instruments to punish.
It is quite often that banks choose to favor the controlling
shareholder, because of present and future relationship.
31
Conclusions

International financial investors should have the
opportunity to exchange more information and discuss
specific cases with local active minority shareholders.

It would be valuable if international agencies like
OECD and IFC help them to establish very strict criteria
to invest and exert voting powers in publicly owned
companies.
32