The international spread of modern corporate governance theory is relatively new. Many trace it to a committee chaired by Lord Cadbury in the United Kingdom that in 1992 published what is now commonly known as the Cadbury Report.

The Cadbury Report itself resulted from a series of financial scandals that occurred in the UK during the 1980s and a growing perception that dangerous market disruptions resulted from the way directors, executives and auditors were carrying out their respective fiduciary duties.

The growing gap between shareholders and the persons managing and determining the fate of their investments and the resulting discontent also played a role in causing improved corporate governance to come to reality by creating stricter rules in various countries, including Brazil, the predominant and largest market in Latin America.

In Brazil, the development of modern corporate governance principles can be traced to 1995, when the Brazilian Institute of Board Members (IBCA) was created. This was followed in 1997 by the enactment of legislation that had a profound impact on the rights of minority shareholders (Law 9.457/97).

However, it was not until 1999 that the true watershed for Brazilian corporate governance took place, when the IBCA became the Brazilian Institute for Corporate Governance (IBGC), which launched the "Code of the Best Practices in Corporate Governance." This code was very well received by participants in the Brazilian capital market.

In 2000, another major development in corporate governance occurred in Brazil when the Brazilian Stock Exchange (BOVESPA) created three new compliance levels for companies that intend to abide by stricter rules of transparency and corporate governance.

On the legislative front, 2001 was a remarkable year with the entry into force of Law 10.303/2001, which revised the Corporations Law (Lei das Sociedades Anônimas) granting substantial powers to minority shareholders and reducing the maximum percentage of non-voting preferred stock.

With this background, it was a natural development when the Comissão de Valores Mobiliários or CVM (the counterpart of the U.S. Securities and Exchange Commission) promulgated a set of corporate governance recommendations in 2002. This action was welcomed by the market and helped create an atmosphere in which corporate governance principles and compliance could take root and grow.

Recommendations

Aware that greater transparency in the capital market would optimize the profitability of the companies and help protect investors, the CVM issued its 2002 corporate governance recommendations (Recomendações da CVM sobre Governança Corporativa) to encourage corporations to change their bylaws and related corporate documents.

Although the recommendations of the CVM are advisory and not mandatory, they were conceived as a guide to be used in addition to existing rules.

The first section of the recommendations is devoted to transparency of shareholders meetings, corporate structure and control. It provides that all meetings are to be easily accessible to each and every shareholder. Furthermore, the matters to be discussed are to be announced to all shareholders in advance. When complex subjects are involved, at least 30 to 40 days' prior notice is mandatory.

In addition, all shareholders are to have access to any agreement between a shareholder and the company, and the company is to facilitate access to a list of shareholders.

The CVM's recommendations also suggest the suitable structure for a corporation's management, set forth its principal duties, and provide that the directors should conduct business so as to increase the profits of the corporation. Although the Brazilian Corporations Law requires a minimum of three board members, the CVM's recommendations state that the board should have between five and nine qualified members and that at least two of them should have expertise in finance and accounting.

In addition, as a means of protecting the preferred stockholders, the CVM's recommendations provide that preferred stockholders should be permitted to freely elect one of the members of the board. The recommendations also state that all stockholders, regardless of class, should have the right to vote on questions relating to the following:

• Modification of the objective or purpose of the corporation;
• Reduction of the minimum statutory dividend;
• Incorporation, merger or spin-off; and
• Any relevant related party transactions.

Moreover, the tag-along right is given a more equitable treatment by the CVM's recommendations. Under the Brazilian Corporations Law, when the direct or indirect control of the corporation is to be transferred, the buyer has an obligation to make a public offer to buy the remaining common stock for at least 80 percent of the value paid for the controlling shares. The CVM's recommendations, however, provide that every share, irrespective of its class, should be included in such a public offer and that the price paid must be the same for control and non-control shares.

Finally, the CVM's recommendations indicate that related party transactions are very much to be avoided. In cases when such transactions are necessary, the contracts should always reflect the market price, and the respective amounts should be accounted for using the international standards of IFRS or U.S. GAAP.

Sector Listings on BOVESPA

In addition to the actions of the CVM, the capital market or stock exchange known as BOVESPA has been voluntarily changing its structure in a demonstration of its willingness to conform to international corporate governance standards.

The sector listings of BOVESPA can be divided into three levels, Nível 1, Nível 2 and Novo Mercado, each having a certain degree of transparency and corporate governance rules in addition to what is required by Brazilian corporate legislation.

Neither Level 1 and 2 (Nível 1 and Nível 2) nor the New Market (Novo Mercado) is mandatory. They are voluntary programs to which companies decide to adhere in order to demonstrate to investors that they are committed to a stricter level of corporate governance.

Nivel 1 and Nivel 2 were designed for companies that already had their securities trading on BOVESPA. When a company is at Nivel 2, it means it has already fulfilled all the requirements of Nivel 1 and it has fulfilled the necessary steps for Nivel 2. The same works for a company listed in Novo Mercado.

As an example, a Nivel 2 company is committed to the following:

• Disclosing financial information in accordance with IFRS or GAAP;
• Having a board of directors with at least five members (at least 20 percent of whom are independent) and a term of up to two years;
• Granting the right to vote to preferred stock in relevant matters;
• Granting tag-along rights to all common stock; and
• Adhering to the Internal Chamber of Arbitration of the Market as the sole vehicle to resolve disputes.

The main purpose of the Novo Mercado level, on the other hand, is to attract companies that want to go public and make them abide by rules that will have an even stronger component of corporate governance and transparency.

The Novo Mercado has proven to be a major success. As of October 2008, 45 companies are at Nivel 1, 18 are at Nivel 2, and 101 are committed to the rules of the Novo Mercado.

The fact that so many Brazilian companies have decided to move forward and embrace a new era in the country's corporate environment is a very visible sign that the capital markets in Brazil have matured along with the country's increasingly significant economy.

A company that is willing to have its securities traded under the Novo Mercado rules must, together with its majority shareholder and management, enter into an agreement with BOVESPA committing to adherence to the Novo Mercado rules which cover major corporate governance matters. Those rules include the following:

• Preferred stock: A company listed on the Novo Mercado may issue only common stock and may not issue preferred stock, with an exception to this rule for public entities when they are privatized;
• Bookkeeping: in addition to the financial statements required by law, corporations must make available consolidated financial statements prepared in accordance with IFRS or U.S. GAAP standards in the English language accompanied by independent audit notes;
• Related party transactions: Corporations must advise BOVESPA of all related party transactions whenever the amount of such transactions on an annual basis is BRL 200,000 (approximately U.S. $90,000) or, alternatively, 1 percent of net assets;
• Transfer of control, tag-along right: A transfer of control must be preceded by a public offer to acquire all the remaining stock of the corporation for the same price applied to the controlling stocks, giving the minority shareholders equal treatment. It is not necessary that the majority shareholder effectively controls the company — only that the shares to be transferred confer the power to control the corporation.
  Additionally, successive acquisitions of shares in stepped transactions give rise to the obligation to make the public offer when the buyer acquires shares from the majority shareholder.
• Leaving the Novo Mercado: As it is a voluntary program, participating corporations are allowed to leave the Novo Mercado at any time, provided that they give BOVESPA a 30-day prior written notice and that the shareholders have approved such decision at a regularly held meeting. In such circumstances, the majority shareholder also has an obligation to make a public offer to acquire all the remaining stock in circulation.
• Arbitration clause: At the time a corporation becomes subject to the Novo Mercado rules, all relevant parties (i.e. the corporation, its majority shareholder and the management) agree to be bound by an arbitration clause and all disputes must be finally and exclusively settled by the Arbitration Chamber of BOVESPA under its rules.

The Novo Mercado rules have a very extensive set of provisions that aim, in the first place, to protect investors and, as a consequence, the market itself. These rules will continue to evolve as the Brazilian capital markets and economy develop.

Perspectives

As discussed above, numerous substantive measures have been adopted in the last 10 years by the Brazilian government, private entities and the Brazilian Stock Exchange in order to make it possible for investors to make informed decisions and to develop and encourage the transparency necessary for a healthy capital market.

The increasing number of companies that are willing to abide by stricter corporate governance rules indicates that the Brazilian capital market is being built on a stronger foundation. This will enable it to contribute to the increasingly progressive growth of the largest market in Latin America as Brazil makes the transition to become one of the world's dominant economies.

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.