Related-party transactions: from the original idea to the cases of lack of transparency

Recent conflicts of interest in Related-Party Transactions (RPTs) caused significant losses to minority shareholders, putting the Brazilian market on alert. The situation sparked the debate about the need for changes in the regulation to give the Securities and Exchange Commission of Brazil (CVM) more powers to carry out enforcement actions.

But, after all, what is an RPT? Such an operation consists of transferring resources, services or duties between the company and a related party that belongs to the same economic group. It is common for companies which are part of the same group or, in other words, belong to the same controlling shareholders, to organize transactions between each other. According to the Brazilian Institute of Corporate Governance (IBGC), their goal is to enjoy synergies, improve operating efficiency, and improve their results.

It’s worth noting that RPTs are very common and, many times, are legitimate. However, some transactions do not follow market conditions and harm shareholders. In fact, many transactions involve international parent companies headquartered abroad looking for better tax conditions.

Kinds of RPT

Conceptually, experts organize the transactions into three groups. The first is for corporate transactions, which must be submitted to the assembly. The second includes business relations, in which the controlling shareholder usually deliberates in favor of the related-party transaction. The third one includes daily operational transactions, such as shared service centers, legal departments serving several companies, and others.

According to André Camargo, CEO of the Brazilian Institute of Business Law (Ibrademp) and a partner at the law firm Tozzini Freire Advogados, the contrast between RPTs justifies differences in the regulation.

“When it comes to a corporate transaction, it is reasonable that the regulation requires deliberation in the assembly,” says Mr. Camargo.

Experts diverge on the matter of business transactions. Some say they should also be regulated, but others believe it is unnecessary to create specific rules for these cases. Instead, the company and its shareholders should set their own regulations for daily operational transactions.

Governance

The debate about the need for strengthening RPT regulations aims to reduce conflicts among shareholders. However, Mr. Camargo warns that creating rules is not enough. It is imperative to improve the company’s corporate regulations.

The proper RPT governance starts with the company bylaws, which must establish what is decided by the shareholder’s assembly, the board of directors, or the management. Then, there must be an internal policy to regulate the issue and a specific department or set of departments that carry out the enforcement, which is usually the audition committee’s job. “It is important to manage the related parties and inform the market,” explains the expert.

Creating and maintaining an RPT-specialized committee to support public companies’ boards is another topic for debate. Some companies already have such committees, but there is no legal requirement.

“In theory, assembling a group with technical, independent experts who have market expertise and no conflicts of interest would add credibility to the most relevant transactions. It is a good idea, but I think it requires further analysis,” notes Mr. Camargo.

Nowadays, regulators demand only a few kinds of documents, including a report that must be sent to CVM up to seven days after the transaction is finished. Such transactions also need to be informed in item 16 of the form of reference, besides the governance report.

RPTs must also be included in the explanatory notes in the balance sheets, according to the guidelines set by the Comitê de Pronunciamentos Contábeis (roughly, Accounting Policies Committee). In addition, the conditions of the transaction, the equivalences, the deadlines, and the warranties must be included.

From a material point of view, there are several kinds of guidelines for drafting a written report and negotiating and establishing a price. “We have a pipeline of procedures, and we have contents. In other words, it is necessary to rely on a complex system to deal with RPTs,” explains Mr. Camargo.

The quality of information disclosure is a point of attention for independent auditors who must certify operations – and the documents are not always enough to subsidize a proper analysis.

In this scenario, the technical director of the Institute of Independent Controllers (Ibracon Brasil), Rogério Mota, says controllers’ most difficult challenge is identifying the risks of a distorted use of RPTs. They often face hurdles in determining if the deal involves a related party or not. “The risky areas that involve large economic groups must be on the controller’s radar. It’s not always easy to spot them,” says Mr. Mota.

International experience

Two economies have recently published specific regulations for RPTs. One of them is Italy, which carried out an extensive review of the capital markets in 2017, before the Covid-19 pandemic. As a result, Italians fast-tracked daily operational transactions, processing them more quickly.

The second international benchmark comes from Chile, which recently created a system that groups related-party transactions according to their kind, as corporate, business, or operational transactions.