Self-regulation in Listing Segments Should Create Standards for Poison Pills

Lawyer Otávio Yazbek has dealt with poison pills on at least two occasions: first, when he was a board member at the Securities and Exchange Commission of Brazil (2009-2013) and, later as the Chairman of the Brazilian Mergers and Acquisitions Committee (CAF) from 2015 to 2021. With this experience, he analyses the twists and potential uses for this kind of statutory clause in the Brazilian market.

As a partner at Yazbek law firm, he recalls his time at CVM, when he worked side by side with former board member Marcos Pinto, to draft CVM’s Legal Opinion n. 36. The document set relevant guidelines to end the use of poison pills as fundamental terms in company bylaws.

Given the current need for developing more rules and guidelines for using poison pills, Mr. Yazbek says that self-regulating B3’s Novo Mercado listing segment is a way to improve the mechanism. “Self-regulation could, eventually, regulate poison pills,” he said in an exclusive interview to Viewpoint Amec. Check the full interview below:

How have poison pills been used in Brazil? How do you evaluate this use?

Broadly speaking, poison pills became fashionable in the local market after the IPO wave in 2004 and 2005. In Brazil, companies usually have a more concentrated capital structure and, in parallel, the rules of Novo Mercado demand a bigger free-float. Poison pills came as a way to protect the controlling shareholder, reinforcing their power. This is a kind of distortion. So, companies adopted poison pills and added them as entrenched clauses in their bylaws.

So, there was a distortion regarding the original purpose?

Undoubtedly there was a distortion. Originally, poison pills were used by corporations as a way to protect shareholders from hostile takeovers. Here, they were used in an environment where many companies have a controlling shareholder. Thus, they often protected controlling shareholders.

What are the consequences of using poison pills in this way?

This tool prevented some legit corporate reorganizations. Because you are not thinking about the future when you add a poison pill to the company’s bylaws and then go public. In the future, you can go through a crisis, and you may need to carry on a corporate reorganization. Then, you begin to find even more detailed poison pills. So, someone came up with increasingly “clever” ideas, tying it with more knots. In the end, such clauses became real obstacles for legit reorganizations. Back then, CVM decided to address the issue publicly, with the Legal Opinion 36, issued in July 2009.

Please, tell us about the origins and the development of this initiative.

It was board member Marcos Pinto who proposed it. After I took office as a board member, Marcos and I worked together on the project. We prepared a memorandum explaining the vulnerabilities caused by using them as entrenched clauses. Based on it, CVM ruled it would not adopt sanctions if it were necessary to break these immutable clauses for removing poison pills from companies’ bylaws. In other words, if a company decided to call an assembly to remove a poison pill and there were clauses blocking such a removal – as some of them forced shareholders to make an offer for all shares if they voted in favor of the removal – CVM would not open sanctioning processes. It was an important signal to the market.

So, the idea was to “untie” the knots in entrenched clauses?

Precisely. Because at least we warned investors and the company’s management that we would not punish shareholders if they disobeyed that rule. It is important because, at first, the rules for poison pills in Brazil are private because they belong to company bylaws. CVM should not oversee such operations. It should not check poison pills. However, it must act when the disobedience of a statutory clause can lead to abuse of controlling power, abuse of voting rights, or breaches in management’s duties. But in this specific case, CVM said that “if you fail to comply with these rules, we will not go after you.” This made some corporate reorganization processes or acquisitions of control easier.

Do you think we need a specific law or self-regulation for poison pills?

I don’t think we need federal regulation for that. Because CVM would be interfering in company bylaws, which is a contract between the parties involved. So, CVM would be unrightfully interfering in the parties’ free will. The law allows CVM to regulate many things, even more than what is typical for market regulators in other countries. However, although Brazilian law is more comprehensive, it does not allow CVM to establish duties concerning rules established in bylaws or to curb the parties’ ability to sign contracts with provisions within the law.

Is there a limit regarding contract issues and bylaws?

Yes. In practice, the boundaries are tested. But the fact is that this regulation would be disproportional and excessive in my opinion. Self-regulation could, eventually, regulate poison pills. For instance, when B3 tries to regulate them in different levels of corporate governance. Thus, it makes sense to have a minimum regulation on poison pills because eventually, they can be used inadequately, causing the distortions I mentioned. So it makes sense to have such provisions.

How hard is it to regulate poison pills, for instance, in the Novo Mercado?

The challenge in these levels is that they operate under an collective adhesion model, and their rules demand that every company approves it. So, you have a market that naturally rebels against what is often seen as an excessive intervention in the stock exchange. There is some resistance because companies prefer to have more flexibility to define their rules.

Speaking of self-regulation, has the now-extinct Mergers and Acquisitions Committee (CAF) dealt with poison pills while operating?

Poison Pills are not necessarily part of CAF’s field. But, depending on the consequences, they can lead to the acquisition of original control. A high-volume acquisition on the stock market could work as a trigger. So, such cases would not fall into CAF’s areas of competencies. However, CAF’s code had a series of principles that might be observed in corporate reorganizations, which eventually could clash with the design of concrete poison pills. In some cases, the incidence of poison pills could lead to distortions. And, had CAF carried on a more effective operation, poison pills would certainly come to the table because it is the kind of topic that comes up in several corporate reorganizations.

How to foster the use of such clauses to develop the market?

When we talk of the role of poison pills for market development, we must separate the wheat from the chaff. If it is used in companies with controlling shareholders, maybe it is not about protecting the market. In this case, it is more about the protection of controlling shareholders. We must interpret this in the proper way. I can’t say this means protecting the market as a whole. But it makes sense to use them in companies with a less concentrated capital structure. But, even in such companies, poison pills can be used improperly to protect management. In this context, we must think of something that might come from self-regulation: standardization.

A standard for poison pills could mean progress?

The biggest challenge about poison pills is the many possibilities for crafting them. On one hand, it is good thing. However, the wide variety brings legal risks. Each person will interpret that in a way. Standardization benefits because it reduces uncertainties regarding “semantic imprecision,” which I describe as things that can be interpreted differently. So, a standard can be useful to reduce uncertainties. And self-regulation is perhaps the main way to establish a standard. It could even be fully voluntary self-regulation.

Who could provide this kind of voluntary self-regulation?

It could be a market organization that does not have the stock exchange’s ability to impose some behaviors. This organization might say, “we will make a poison pill handbook with standard clauses.” If everyone adopts it, it is a way to create a standard. In my view, reducing complexity is one of the most important things.