Fund Managers And Experts Evaluate Distortions And Potential Uses For Poison Pills In Brazil

Every once in a while, poison pills call the attention of the Brazilian capital markets. Recently, at least two cases stirred controversy: an episode involving meatpacker BRF, amid a troubled follow-on, and the other involving the restaurant chain IMC, in which the most significant shareholder suggested removing the clause to increase its share.

In the past, the use of poison pills as entrenchment clauses in companies’ bylaws led to significant distortions in its use, protecting controlling shareholders most of the time. “Companies did not use poison pills properly since the first time they were adopted in Brazil, around 2004 or 2005. They were often used as immutable clauses, and shareholders had no right to change them. The truth is that controlling shareholders used it to keep their hegemony, in a kind of stiffening,” says the Chairman of Amec’s Deliberative Board, Pedro Rudge, who is also a founding partner at Leblon Equities

The problem was partially solved when the Securities and Exchange Commission of Brazil (CVM) published its view regarding entrenchment clauses. The regulator’s view was made clear by the Legal Opinion n. 36/2009, in which former CVM board members Otávio Yazbek (read the interview) and Marcos Pinto helped to draft.

“ CVM’s Legal Opinion aimed to separate the wheat from the chaff. It did not point out whether poison pills were good or bad, but it said they could not be considered immutable clauses. It solved the main reason for inadequate use of poison pills, which prevented transactions that were good for shareholders,” says Marcos Pinto. He is currently a partner at Trindade Sociedade de Advogados law firm. The lawyer explains that considering it as immutable clauses could stiffen the company’s capital structure, which could help the management to stay in power. “It petrified the company’s management somehow,” he notes.

Another inconvenience of poison pills in Brazil was fixing trigger prices. “Companies and the market go through different phases. In one moment, the price is adequate but during a crisis, the price becomes unrealistic. It is a problem to use a static price index for an offer,” says Mr. Rudge.

Walter Mendes, CEO of pension fund Vivest and a member of Amec’s Board, also points out there were discrepancies in poison pills when they were first used in the country. “For instance, one of the discrepancies that happened in the Brazilian market is that any offer to shareholders should have a previously established price, with price limits way above reasonable levels. And some companies even put them as immutable clauses in the bylaws, which made things even worse,” he says.

He points out that poison pills were often used as traps to defend controlling shareholders instead of protecting minority shareholders. Because, in his view, it is ultimately better for minority shareholders to have a better controlling shareholder who takes an important role in the company.

Guilherme de Morais Vicente, a partner at Onyx and Amec’s Vice-President, says that poison pills become troublesome in corporations. In such companies, the management or reference shareholders use this kind of clause to stay in power for longer. “The Brazilian Law has a clear definition for changing control, but not about its constitution,” he explains. Due to this legal loophole, poison pills were used in widely different ways in Brazil. However, without aiming to protect minority shareholders in most cases.

Mr. Vicente states that it is high time to have a specific regulation for poison pills. “We need regulations to set the norms for creating control in companies and for defining the circumstances for mandatory public acquisition offers,” says Mr. Vicente.

For two times, the stock exchange B3 tried to add new rules for poison pills in the Novo Mercado. “It would be a way to reinstate the proper concept of poison pills as it exists in England or in Europe. But companies rejected the proposal, which shows there isn’t much interest in coming up with more generic clauses that benefit minority shareholders,” says Mr. Mendes. He believes that the change should come from self-regulation measures. However, as this has not been the case in Brazil, the alternative is to reform the Brazilian Corporate Law (Lei das S.A.).

Such reform will be increasingly necessary as many corporations have been popping in Brazil in the past few years. “I believe that a change in the law acknowledging the market’s situation would be an appropriate adjustment, an interesting adaptation of the law. It also would ensure that CVM acts rigorously to halt discrepancies in poison pills,” says Mr. Mendes.

Mr. Pinto doesn’t think poison pills have a negative impact in Brazil. “There could be abuses, but this tool also has a positive role that deserves to be highlighted. For example, a competitor of a  company that has no controlling shareholder could acquire it through several stock purchases, thus changing the company’s situation and acting motivated by other interests than minority shareholders’, without making an offer to all minority shareholders,” he explains.

He says that, in companies that do not adopt poison pills, an eventual acquirer may not want to negotiate: “He goes to the market and obtains the control of the company. But, if there is a poison pill, the bidder is forced to call the board and negotiate the purchase of the control. And, during this negotiation, board members can obtain a huge value to shareholders.”

The lawyer admits, however, that sometimes the clauses can be abusive and used against their original purpose. “Using poison pills as immutable clauses to prevent their removal from bylaws was quite common. It was very bad because it could limit good deals for shareholders. Another example of abusive use is establishing a low trigger, preventing shareholders from buying a relevant stake in the company.”

He supports that, despite the distortions, it is not adequate to regulate poison pills. “We do not need further regulations on the matter. Poison pills are hardly used as immutable clauses anymore. Most companies scrapped them from their bylaws. So this is no longer a relevant issue. The remaining issues should be dealt with by the market, instead of regulation”, says Mr. Pinto, a former CVM board member.

Investors have to correctly estimate the price of companies that have reference shareholders protected by poison pills. Mr. Pinto adds that, had the Novo Mercado reform been approved, poison pills would no longer be necessary for Brazil. The proposal foresaw the need for a mandatory public acquisition offer (OPA) when a shareholder hit a relevant share in a company. “However, as the reform was not implemented, I believe poison pills remain relevant to ensure an equal treatment (between shareholders), to force a bidder to negotiate and, above all, to avoid coercive offers,” he says.

Mr. Rudge agrees that there should be self-regulation guidelines for poison pills. “The most interesting solution would be including it in Novo Mercado, almost like a tag-along offer triggered by their share in the company. This proposal should be discussed once again,” he notes, adding it is necessary to create tools to protect shareholders. “There should be rules instead of a fixed price. There should also be a reference for triggering it, which I think should be of 30% of shares”. Amec will keep monitoring the debates on this issue, which should drag longer before leading to self-regulation proposals, a CVM norm, or even a change in the law.