The majority of the minority (or The Paper Accepts Everything)

In December, Amec participated in the announcement of an important partnership between CVM (the Brazilian Securities and Exchange Commission) and Columbia University. The objective is to share information to help drive the development of our capital market. The partnership is a result of the regulatory agency’s efforts towards fostering the financial education and the progress of regulatory issues consistent with the best international practices.
One of the aspects discussed was the protection of investors in corporate restructurings. The topic is well known by Amec’s members and maybe one of the major threats stock investors have to deal with in Brazil. We have been seeing recurrent operations through which values are transferred among different groups of shareholders – usually from minority shareholders to controlling ones – under the formal legal cloak offered by the coldest interpretations of the corporate legislation. Although our law in this area needs to be reviewed, Columbia’s professors have taught us that a lot can be done to protect investors even with no changes to the legislation.
First of all, it is clear that it has been more and more difficult – not to say impossible – to judge the lawfulness and correction of any specific operation without analyzing its ground of action. Both in Brazil and in the United States, regulatory and self-regulatory entities have been applying a formula that sets a number of formalities, including apparently diligent processes, but that are not able to reach the effective objective of dealing with each of the parties on a fair basis. In the end of the process, the ones who are responsible for more “aggressive” corporate transactions have been allowed to protect themselves by meeting formalities. Advisors, opinions, committees and other tools have been used to reinforce the operations announced. In writing, everything works perfectly to avoid abuses. In practical terms, these tools become actual smokescreens that eventually attest these abuses.
CVM has tried hard to suppress these problems through the issue of Opinion # 35 that, among other procedures, recommends the creation of actually independent committees to “discuss” the exchange relation in cases of corporate transactions involving related parties. Although it has been a well-meant initiative that has positively impacted many transactions, it has not solved the global problem in these situations: in fact, it has eventually attested significant abuses. Not even independent members’ complaints about the lack of both diligence and duty of loyalty of these committees prevented undue transactions from taking place or led any of its members to be considered accountable for them.
Columbia’s professors reported that both the US judicial system (primarily Delaware’s) and the Security Exchange Commission (SEC) – regulatory entity of the capital market – have been increasingly focusing on the activities developed by these advisors, including not only members and committees, but also assessors and issuers of fairness opinions. The documents issued by these “specialists,” which used to be considered only in their formal aspects by the regulatory body, are now being analyzed in its essence, seeking signs that may mean damages for any of the parties. It is indeed a revolution in the regulatory approach, mainly in the case of a country that values highly the business judgment rule concept – that is, the idea that the essence of business decisions must not be punished even when they represent losses for shareholders once administrators can make mistakes. This new approach suggests that, as the saying goes, “to err is human,” but “to err too much is inhuman.” An interesting point to be more deeply analyzed by our regulatory body, which historically has also been showing resistance to issue opinions about the merit of such opinions and reports.
It is important to point out that in Brazil, opinions and reports play an important role established by the law: the regulation and the self-regulation. An assessment report, for example, is the only way through which shareholders can protect themselves in the case of companies that give up participating in Novo Mercado. If the report is feasible to be “influenced” in a way it eventually does not offer an effective protection, all the remaining protections of Novo Mercado go down the drain. Since the paper accepts everything and sometimes the grayish zone is too broad, it is crucial that these reports reflect the reality and that the ones that do not do that are exemplarily refuted.
Another important topic discussed during the event was the majority of the minority concept. In conflicting transactions, the best way to assure its correction is by providing those who are not directly involved in the business with the power to decide. That is, those who do not have private benefits – turning to a broadly known expression of our law. It is true that the Brazilian law already recommends that. It’s even truer that this recommendation has been reinforced by CVM’s decision in the Tractebel case, in which some controlling shareholders were not allowed to vote in specific situations. However, none of the actions we have been seeing to date have been enough.
As professor Robert Jackson stated, so that the majority of the minority concept reaches its objective, it has to be dealt with in an extremely transparent way. If any shareholder directly or indirectly interested in the business manages to participate in the decision, the mechanism is irreversibly damaged – and starts to play against (defeat the purpose) its own objectives. Not only the desired result is not reached, but the conclusions about the transaction are falsely attested.
We are well away from this immaculate reality of the majority of the minority concept. Recently, shareholders have been authorized to participate in decisions in which they had clear conflicting interests with the company and/or remaining shareholders. Even playing the role of counterparts or beneficiaries of the decision, they could vote for different reasons. In one situation, the controlling shareholder was banned from voting with his ordinary shares, but authorized to vote with his preferred shares, as if he was not actually the same person. In another situation, a shareholder clearly interested in the political consequences of a specific and disastrous decision for the company was not banned from voting.
Today, there are restructuring processes announced in which some of the parts have interests that clearly diverge from the publicly-held company’s interests – and it is not clear whether these parties will be allowed to participate in the decisions. By the way, the mere uncertainty already shows that our capital market does need to evolve. Some controlling shareholders will be selling apparently overvalued assets for the company. Other ones benefit from the assumption of significant debts. And finally, some controlling shareholders are creditors, what means they benefit more from the recovery of their credits than from the appreciation of shares’ values.
Situations like that demand strong and timely actions from the regulatory body so that the majority of the minority principle is not damaged.
Fortunately, a very auspicious decision was taken in the end of 2013. Regarding a 2011 restructuring process, CVM decided that a specific shareholder, who in practical terms was part of the company’s controlling group, could not be considered part of the minority group. Although it may seem a very obvious fact for laypeople, the decision represents a very important legal milestone in our capital market.
No doubt there are a number of challenges yet to be met. In the above-mentioned case, the shareholder who violated the majority of the minority concept was punished with a fine corresponding to 0,03% of the mentioned public offer. If this shareholder’s vote avoided an increase of 10% so that the offer reached its objective, we can say that the “crime paid.”
Accordingly, the challenge our capital market has to respond to today goes beyond the deep analysis of the essence of conflicting transactions, but to do that in a timely and effective basis so that investors have the necessary piece of mind to know that if they buy 1% of a specific company, they will have 1% of its value.