The Brazilian Exchange and Securities Commission – CVM – made a mistake.
The decision taken by CVM’s board in March about the restructuring of Grupo Oi may be the most worrying and negative precedent in years and years for investors who have believed in the Brazilian capital market. In addition to the damages caused to Oi’s shareholders, it creates precedents that, if maintained, open the doors for the institutionalized abuse against minority shareholders, in addition to putting the effectiveness of CVM in the Brazilian market at stake.
First of all, it’s necessary to understand the background of events. Oi is a result of a privatization process of the former Telebrás. Older readers will recall that, for a long time, Telebrás was the main way to invest in the Brazilian Stock Exchange. Brazilians and foreigners who believed in Brazil used to buy Telebrás’ stock.
The privatization in 1998 undermined the credibility of our market by repealing the Article 254 of the Corporate Law, allowing the government to sell its equity interest without making any offer to minority shareholders. The result was (1) the obtaining of astronomical controlling premiums that reached 2,200%; and (2) the creation of leveraged controlling structures, also with government or quasi-government funding, which further reduced the buyers’ economic commitment.
The result could be envisioned by almost any student starting his/her studies on corporate governance: a distorted structure of incentives that put, on one side, the company’s controlling shareholders and, on the other side, minority shareholders. By the way, the payment of such huge premiums would only make sense if it was based on the assumption that minority shareholders – as a matter of fact, owners of 83% of the companies’ capital – were duly expropriated over time.
And that was the ‘script’ from 2008 to 2014. Telecommunication companies extracting, in the most different ways, value from the companies – value also owned by the investors who have believed in Brazil – to justify the high premiums paid. Rarely, they had to deal with regulatory obstacles. In fact, most of the abuses went unharmed.
However, maybe there has been no other company that abused, innovated and dared so much as the former Tele Norte Leste, then Telemar, and currently Oi. Serial restructurings, more and more leveraged with official subsided funds, have increasingly strengthened businessmen who believed not only in Brazil, but also in the Brazilian way of making ends meet. And the worst of all is that this account is apparently closing, in green for them and in red for minority shareholders.
Oi’s aggressive posture in its restructuring processes has expanded in geometric progression with the permissiveness of regulatory bodies in every single opportunity the company had to manifest itself. The company has prepared increasingly complex operations, always with the objective of gaining financial results disproportional to the controlling shareholders’ interest in the company’s capital. While shares were devalued, controlling shareholders assured, for themselves, advantages disproportional to their interest in the capital, always at the expense of minority shareholders.
The current restructuring proposal, presented in 2013, followed this same logic.
The company’s situation is worrying because the leveraging of its control structure and poor operating performance has led its stock price to drop rapidly. It does not matter whether the controlling structure is bankrupt (liabilities > assets) – but that final controlling shareholders enjoy the values already extracted from the company. Law alchemists were once again called to ‘generate value’ for controlling shareholders. Making use of the products of previous operations, they presented the pseudo-lifesaver for the company, crowned by its joining in Mercado Novo and the outstanding future perspectives. However, the main gain was to get rid of parasitic controlling shareholders, even that it would take three years to happen, once they proposed to choose, in advance, the names of all members to sit in the Board of Directors. They gave up the controlling interest widely used to gain benefits, allowing a huge capitalization. But they charged their price.
If specific measures – such as rational dividend and capital increase policies – were necessary in the company’s best interest, controlling shareholders had the duty to propose them and approve them, with no conditions(Article 116, sole paragraph of the Corporate Law). Let alone the operation to transfer their debts to minority shareholders. And it’s also worth mentioning that the operation proposed did not even reduce the company’s final leverage.
Still, it advanced.
Meanwhile, at Rua Sete de Setembro, tenacious professionals were taking turns to improve the regulatory body’s understanding of these issues. Based on a law that has its merits, but that was designed for a reality of 40 years ago, they geared all their efforts towards applying the best hermeneutics to refine concepts such as the private benefits and the conflict of interest.
The first opinions and decisions on the topic used to define these concepts on a very restrictive basis. It was even said that the private benefit would not be of a financial nature, but of any other obscure nature. Others used to say that the benefit was limited to something received by the shareholder ‘while shareholder,’ excluding indirect benefits of specific decisions. Both alternatives used to make the private benefit an empty set of something. It would never be possible to discuss the voting impediment based on this elusive concept.
The same happens with the conflict of interest. The initial learned opinions stated that the conflict of interest could only be checked ex post facto. This was the same as to throw the concept into the dustbin. And for two reasons. First, because it would relegate the decision to an eventual legal action that, at best, would take two decades to come to a final conclusion. And, at worst, analyzed by judges who are not properly prepared to understand how the capital market actually operates.
But even this condemnable process would probably never happen. And it would never happen because the stock market is inherently pulverized. Investors hold minimum portions of the companies’ capital. Additionally, their investment horizon is quite limited – from 2 to 3 years at the best. With the perverse pressure on the quarterly performance, the real horizon is much shorter. And costs and expenses are high for any minority shareholder, whereas the operation’s legal expenses are paid by the Company – not by controlling shareholders. Therefore, the market’s institutional structure does not allow one to assume that the act of resorting to the judiciary system is an effective option against the abuse of controlling shareholders. And to assume the contrary is the same as resigning from the supervision.
Brazil lacks a perception of the diffuse interest in the credibility of the capital market. The Public Prosecutor’s Office crawls in engaging with the issue. And the so-called derivative suits(Article 246) – so efficient in other jurisdictions – are frustrated by the short-sighted decisions of superior courts (an example is the Petroquisa Case, STJ, RESP 745.739).
For all these reasons, CVM has been developing, yet slowly, basic precepts about the meaning of private benefit and conflict of interest. The process achieved its highest point in the evolution of the Tractebel case, in which it was decided that controlling shareholders could not vote in operations in which they were the counterpart, regardless they were submitted to the Independent Committee.
CVM’s decision on the Oi case puts all this evolution at stake.
Based on well-informed complaints presented by institutional investors, the Office of the Superintendent of Companies (SEP) repeatedly manifested itself aligned with the above-mentioned evolution. Yet focusing on the private benefit issue, SEP was absolutely clear about the fact that the corporate mirror game presented by Oi could be summarized in an operation through which controlling shareholders’ debts were being passed to minority shareholders, having the overvaluation of Portugal Telecom’s assets as the means of such operation. That simple: shareholders benefited by the operation were barred from voting.
And the dissenting vote was not different. More than that, it was clear that the operation included both the private benefit and the conflict of interest once, in essence, it was an operation between the company and its controlling shareholders who, accordingly, were not allowed to vote.
Surprisingly, there was a contrary vote, followed by the other members of the CVM board. How was it possible to revert such a long historical evolution through the winning vote?
The winning vote, after undeniable research efforts, presented discussions and disagreements in the decisions that allowed the evolving of the discussions around the voting impediment, arguing that, in essence, there were many dissenting opinions about the topic.
No doubt there were dissenting opinions. All cases presented were approved by the majority. But there is something that must not happen: to consider this fact as an indicator that the topic was not being directly addressed by CVM, floating “with the changes in the committee’s structure.”
In addition to emphasizing the divergences arisen in these discussions, the mentioned vote made that out of the context. Worse than that, the explanations seek to destroy the temporal evolution of the mentioned discussion. The vote borrows, from opinions issued decades ago, the same importance that it places on CVM’s conclusions regarding Tractebel’s decision. And by doing that, it puts a great emphasis on the “instructor” that is one of the partners of the law firm contracted by the company.
By muddling the discussions and ignoring the evolution of the topic, the winning vote suggests that the majority of the members of CVM’s current committee understands that the regulatory body must definitely stick to past decisions and learned opinions – without worrying whether such conduct opens the way for future operations that are harmful for minority shareholders. Apparently, CVM must be tied to a pre-historical version of its concepts, whereas lawyers evolve in their creativity to (even more easily) circumvent these same concepts.
By the way, here we have maybe the first message brought by this decision, which can be extremely harmful for the Brazilian market in the long term. It seems that CVM is saying to the companies: “Bring operations sufficiently complex and I’ll ignore the essence of what’s happening.” That’s what happened in this decision.
The message to investors is not less scary. The winning vote recycles the recurrent ghosts of the “minority abuse” – something as effusive as widely divulged. And what’s worse: the winning vote resorts to biased concepts by suggesting that minority shareholders – those who “invest in the future of Brazil,” as in CVM’s former slogan – can be speculators, “short” investors, in which there can be “the separation between the economic interest and the political power.”
While it focuses on the bad faith of speculative minority shareholders, CVM praises the good faith of the company, not only by means of the winning vote, but also by other decisions related to the case. Good faith? It seems that there has been a collective amnesia about the several operations and attempts prepared by the company to dilute minority shareholders. And also about the company’s recurrent tricks when it announced that the controlling shareholders’ positions are based on the good faith.
Additionally, the winning vote also analyzes CVM’s role. And it seems it is saying that it’s not up to CVM to solve “controversies and disputes among shareholders.” They must resort to the Judiciary. Or even wait for the outcome of an eventual Administrative Sanctioning Process.
Once again, this is the same as giving up supervision. And we do not need to go into the debate about the obstacles of our Judiciary, already addressed above. We only need to recall the outcome of the Administrative Sanctioning Process in UOL Case, which considered the co-controlling shareholder guilty and imposed him a fine of 0,05% of the operation value. And there is more: subject to an appeal in Conselhinho. And no indemnification was paid to UOL’s minority shareholders – none to those involved in dozens of other similar cases.
The comments by the winning vote about the evaluation report were also unfortunate. It mentions that “there is nothing in the records and appeals that questions the appraisal presented by Banco Santander.” There is, but that’s not the main point. The appraisal does not act as an independent evaluation of assets. It is born with an original sin– a congenital blemish, that is, the fact that controlling shareholders’ approval is a sine quan non condition for the carrying out of capitalizations of the controlling structure, which absorb controlling shareholders’ debts. Portugal Telecom even established, in the first published Material Fact, what this amount should be. And the contracted appraiser “coincidently” reached that same amount. It does not seem, therefore, a report that meets the basic principles of an independent evaluation.
And even if it were, its acceptance in the capitalization operation brings another issue that is recurrent in minority shareholders’ nightmares: the evaluation of assets unified through two different approaches. The assets supplied by Portugal Telecom were evaluated in a report and the shares it received were priced at market values. Actually, not even at market values: but based on a huge share issue that significantly brought down the issue price, as previously admitted by Oi’s own administrators. If the shares issued were priced based on the same assumptions (for example, capex lower than depreciation in the entire estimate, something that has never happened in the telecommunications industry), no doubt the result would have been different.
Appraisals are a serious problem in the Brazilian regulatory environment. After all, they are nothing but simple spreadsheets. Any skilled analyst knows that a spreadsheet can show any number, and for that it’s only necessary to adjust some assumptions. But this is a topic to be addressed in another article.
The report that brings assets values significantly above market values, and that, at the same time allows the absorption of controlling shareholders’ debts, is an undeniable evidence of the abuse against minority shareholders. The coincidence between the overvalued assets and the $ 4.5 billion Reais referring to the debt (temporarily) assumed by Portugal Telecom would call the attention of any analyst. But CVM preferred not to look at that. It decided to trust in the company’s ‘good faith’ and in the judiciary calvary as a remedy for shareholders.
The problem created by the deviation adopted by CVM related to the voting impediment issue almost lets other important precedents judged in this case to go unnoticed. The protection on the preferences of one of its class of shares, protected by law by the withdrawal right, now has an alternative: it’s only necessary that a company is incorporated by another one so that shares are not entitled to this preference. All this sanctioned by CVM.
With respect to the withdrawal right of common stock, CVM managed to make a situation that was already bad even worse. Its precedents established that, to be entitled to such protection right, shareholders must uninterruptedly keep the shares in their portfolios, from the publication of the first material fact to the date of the meeting in which the operations is approved. This can take months or years, and investors are condemned to sit on their shares to assure their legal right – something incompatible with the stock market reality. Even in the event of redemptions, managers cannot sell the assets.
And in addition to this uncertainty, there is also the doubt about the rights effectiveness, once it’s only possible to check the existence of liquidity or dilution on the meeting’s date. In other words, companies have all this flexibility to make the legal protection irrelevant, and investors bear the entire burden to protect their precious capital. A true Frankenstein.
In the bargain, the decision represented a severe blow on the excellent work developed by those who are part of the so-called ‘technical area’ – not only SEP, but all other superintendencies, including the Registry one. Amec’s members are solidary to these professionals.
And the consequences go beyond that. CVM’s decision is so surprising that many investors have developed conspiring theories about its motivations. After all, what would be behind this decision? Is there any political pressure that has led CVM to solemnly ignore investors’ expectations? Has CVM maybe lost its independence?
Amec does not believe in this hypothesis. CVM has been excelling among Brazilian regulatory agencies for the competence and independence of its directors and technical team. In general terms, it has been exempt from the political pressures that have contaminated some similar bodies. Its directors have been bravely resisting the attempts to distort its decision process, despite paying the price of being subjected to its illegal financial ‘strangling’ (in contrast to the ‘financial budget autonomy’ established by the Law 6.385).
But the regulatory body’s credibility makes Caesar’s wife principle applicable to it: to be above suspicion is not enough. It must seem above suspicion. Unfortunately, decisions like this, which differ so deeply from the convictions consolidated in the market makes CVM subject to this type of conspiracy theories.
CVM’s role as the guardian of the credibility of our capital market is irrevocable. Especially now that Brazil’s image has been questioned by local and foreign investors. We depend on the incisive and unbiased work of the regulatory body to get definitely rid of specific practices that have been tainting our market for decades. There is an important pipeline of decisions on CVM’s hands that can eventually represent opportunities for the body to reiterate its role of an unbiased and independent agency. CVM must take advantage of these opportunities to show its vision to the market and suppress, on a preventive basis, abuses like those in Oi case.
The world will be keeping an eye on it. It´s that simple.
The Brazilian Exchange and Securities Commission – CVM – made a mistake.