In the past few years, related-party transactions (RPTs) have been a frequent cause of corporate conflict and, according to several fund managers heard by Viewpoint Amec, the problem is far from being over. That’s because the Brazilian market still has a long way to go to enhance its approach to RPTs, which worsens due to issues like regulatory gray areas and a lack of corporations.
In principle, such transactions may involve resources, services, or obligations between companies of the same group, usually aiming to enjoy synergies and boost efficiency. However, it is not rare to come across cases when such operations lack transparency and do not abide by market conditions. In this case, minority shareholders often feel harmed.
For Robeco’s Portfolio Manager, Daniela da Costa Bulthuis, conflicts of interest increase in companies amid “setbacks and a clear deterioration of governance conditions.”
One may think the problem only happens in Brazil, but that’s not quite true. “It is a global issue. Because foreign parent companies often carry our related-party transactions with international subsidiaries. However, fragile regulation and lack of enforcement by the Brazilian Securities and Exchange Commission (CVM) worsen the scenario in Brazil,” says Ms. Costa Bulthuis.
One of the aspects managers criticized the most is the lack of criteria regarding which operations should go through shareholders’ assemblies. Corporate legislation demands that the assembly should examine sales of at least half of a company’s assets if they involve related-party transactions. However, experts such as CVM’s former board member Luciana Pires Dias (read full interview) consider such a threshold is excessively high. Thus, it is not effective to avoid conflicts.
Managers such as Ricardo Magalhães, a partner at Argucia Capital — one of Amec’s founding members — suggest that the general assembly should also vote on relevant transactions other than corporate transactions.
“We should lower our standards for when it comes to taking matters to the assembly. Unfortunately, many related-party transactions are not even analyzed by the board members, just by the managers,” notes Mr. Magalhães, adding that the regulation should set the requirements to define the transaction’s relevance. Then, depending on how significant it is, the company should submit the deal to the management, board, or assembly’s approval.
Robeco’s Ms. Bulthuis adds that controlling shareholders should not be allowed to vote in assemblies debating financially-significant transactions. It’s important to note that companies with high-governance standards have already adopted such practices.
Mr. Magalhães proposes the need for an RPT committee in companies. This committee should have at least one independent member chosen by minority shareholders. “A working committee would improve the process to evaluate such transactions, providing a better analysis and approving the transaction’s technical reports,” he notes.
Works of fiction
André Gordon, Managing Partner at GTI, suggests that fragile evaluation reports are some of the causes of lack of transparency in related-party transactions. “There are gray areas in the regulation. For instance, many appraisal reports are costly and become works of fiction,” he says.
GTI’s manager reckons RPTs are not inherently a problem. As long as they are transparent and follow market conditions, they are legitimate. “Related-party transactions should be extremely transparent, more than a typical transaction. We must prevent one of the parties from getting harmed,” he says.
Mr. Gordon notes that the royalties paid to Iberdrola by subsidiary Neonergia for the use of its brand were an example of a “transaction that failed in complying with transparency.” Both companies agreed with the transaction as of March 2021 but only disclosed it in December.
Back then, Amec’s CEO, Fabio Coelho, noted that to ensure the transaction’s transparency, Neoenergia should share the documents used to estimate the brands’ valuation, “most of all, because it is part of B3’s Novo Mercado listing segment.”
Argucia Capital’s Mr. Magalhães agrees that the Neonergia-Iberdrola deal had several issues, including the fact that an independent board member failed to take the necessary measures to let shareholders know the conditions of the deal. He says that, without enough data, it is hard to evaluate whether the operations have followed market conditions.
The role of investors
Although there is room to improve the regulation, investors cannot shy away from carefully scrutinizing companies’ corporate governance if they really want to avoid problems with related-party transactions.
For Marcelo Nantes, partner and Portfolio Manager at Tower Three, regulatory changes could help but would hardly solve the problem in companies with a bad corporate governance track record. For instance, he names preventing controlling shareholders from voting when there are conflicts of interest in related-party transactions as one of such changes.
“We must do our job. Fund managers should analyze companies to understand the risk they are taking. Then, they must focus on the ‘G’ of governance, analyzing the controlling shareholder’s governance track record,” he says.
At the end of the day, investors’ opinion becomes evident in prices, as fund managers warn that a compromising track record for related-party transactions leads to lower valuations.