LCV

NEWS ABOUT CORPORATE GOVERNANCE - September-October/2003

Year IV – No. 30

Corporate Governance News

Editor: Luciano Carvalho Ventura

Editorial

The IFC and Corporate Governance.

- Over the last four years alone, the IFC (International Finance Corporation), the financial branch of the World Bank, has invested over US$5 billion in Latin America and the Caribbean. This region ranks in first place in the IFC’s investment portfolio, and its volume of investments and knowledge of the region qualify it as a powerful patron of Corporate Governance in both listed and private companies.

- The IFC views Corporate Governance as representing the basic structure for managing and controlling companies, and believes that good Corporate Governance contributes significantly to sustainable economic development, enhances company performance, and facilitates access to overseas sources of capital. Today, the IFC is seen as the world financial leader in implementing good Corporate Governance practices at every stage of its diversified investment processes; it applies this philosophy because it believes that good Corporate Governance adds value for clients.

Its role as a good Corporate Governance induction agency is performed mainly via its own Corporate Governance Department, whose chief mission is to guarantee that its investment operations take good Corporate Governance practices into consideration.

The main activities of the IFC’s Corporate Governance Department are:

a) To provide organizational support and information on Corporate Governance to the Global Corporate Governance Forum and to Corporate Governance Regional Round Tables, sponsored by the OECD/World Bank Group; and

b) To act as secretary to the Private Sector Consulting Group of the Global Corporate Governance Forum. Members of this group are institutional investors, among them TIAA-CREF, CalPERS, Capital Group, Hermes, and DWS, and specialized professionals coordinated by Ira Millstein, one of the world’s most distinguished Corporate Governance leaders.

The full text of two articles giving further details on the IFC’s crucial role in promoting Corporate Governance, “Corporate Governance” and “The IFC and Corporate Governance” can be found in the Technical Material of the LCV website (www.lcvco.com.br).

IBGC (Brazilian Institute of Corporate Governance)

Everything is in place for the Fourth National Corporate Governance Congress to be held at the Grand Hyatt São Paulo Hotel, Av. Nações Unidas 13301, Brooklin, São Paulo, SP. The Congress will start with an inaugural dinner on November 9th and will continue throughout the day of the 10th. As in past years, the Congress will include distinguished Brazilian and foreign speakers. The inaugural dinner speaker will be Minister of State, Luiz Fernando Furlan, and Minister of Finance, Antônio Pallocci, is expected to take part in the following day’s proceedings. Among the international speakers, one name that merits mention is that of Canadian, Randall Morck of the University of Alberta Business School, who will discuss Corporate Governance in family businesses. The number of registrations has surpassed 300, thus beating last year’s record of 280 attendees.

During this year’s Congress, the Third Version of the Brazilian Code of Best Corporate Governance Practices will be introduced and will be available for public comment (www.ibgc.org.br) through to December 20, 2003. This new extended version added to the second version introduced in April 2001, 11,000 copies of which were distributed, was imperative. This is was due to an increasingly mature market in the context of Corporate Governance and its natural growth, also as a result of the many round tables held throughout Latin America on this topic and recent corporate scandals. The chief innovations relate to Risk Management, the Audit board, the Audit Committee, Extra Services, Auditor Rotation, Ongoing Education of Boards of Directors and Substituting Directors.

Brazilian Pension Funds increasingly include good Corporate Governance standards in their investment selection criteria.

In a recent presentation during a monthly IBGC event, the Financial Director of FUNCEF (Federal Savings Bank Employee Foundation), Luiz Afonso Simões Silva stated that the implementation of good Corporate Governance is the most effective mechanism for upgrading the quality of pension fund investments, as it enhances procedures for selecting these assets. FUNCEF is Brazil’s third largest pension fund, with assets of R$13.3 billion (US$4.5 billion).

From October 27 through 29, ABRAPP (Brazilian Association of Private Pension Funds) held its 24th Brazilian Pension Fund Congress in São Paulo, with record attendance of over 2,000. The main topic of the congress was “Promoting Complementary Pension Plans as a Social Inclusion Mechanism”. The event took place just as ABRAPP, which this year celebrates its 25th anniversary, starts a bold new growth cycle, arising from the Federal Government’s many incentive measures in this area. The opening ceremony was attended by Ministers Ricardo Berzoini (Social Security and Welfare) and Luiz Gushiken (Government Communications and Strategic Management), ABRAPP CEO Fernando Pimentel, and Complementary Pension Funds Secretary, Adair Reis. Asset growth projections for these important institutional investors predict a leap from the current threshold of R$215 billion (US$74 billion) to R$442 billion (US$152 billion) in a few years.

Corporate Governance and Punctuality

Punctuality is one of Corporate Governance’s most highly prized virtues, and is a characteristic of the type of person involved with Corporate Governance. Most of these individuals work on a carefully planned and extremely tight agenda, where unpunctuality causes great problems to the individuals themselves and to all others involved, due to the great number of commitments undertaken. In relation to this problem of unpunctuality, Brazil’s dean of Independent Board Members, Roberto Teixeira da Costa, with his long experience of Corporate Governance, split people who are consistently late into the following four (4) groups: 1) The pathologically late, who are incapable of ever arriving on time; 2) The punctually late who time their arrival based on the principle that all events start late; 3) The circumstantially unpunctual who apologize profusely and, whenever possible, advise that they are going to be late; and 4) Absentees who simply fail to arrive and never give an explanation for their absence. Any professional who fits into one of Teixeira da Costa’s categories has little hope of a long career in Corporate Governance.

More losses for Brazilian and foreign minority shareholders.

The BOVESPA, LATIBEX, and NYSE share markets were surprised by a decision taken on October 2, in the General Shareholders’ Meeting of COPEL - Companhia Paranaense de Energia, a company controlled by the Government of the State of Paraná, and one that will result in enormous losses for thousands of minority shareholders. Despite a strong public protest by ANIMEC (National Association of Capital Market Investors), formalized on the eve of this meeting, the State Government exercised its voting power as the controlling shareholder. According to market watchdogs, this decision was in the political interests of the State Government, will result in serious losses for the company, and could seriously jeopardize its future. The decision taken relates to a 25.27% adjustment of electric energy tariffs, as authorized by ANEEL (National Electric Energy Agency) that, despite being lower than the annual General Price Index variation of 31.51%, was not applied by the company. Through a simulated financial benefit for the company, the Government of the State of Paraná applied the full adjustment with a 100% discount on this adjustment to its defaulting consumers. Its supporting argument was based on the theory that, in this way, the company would reduce the high level of consumer delinquency and would obtain financial gains sufficient to offset the failure to adjust the tariffs. Market calculations have proven that this is not the case, particularly when the decision is analyzed within a short and long-term context. Although the company has thousands of minority shareholders, due to the inveterate absence of such shareholders from Brazilian listed corporation assemblies, only four (4) such shareholders were present to vote against the decision. According to ANIMEC, this decision was purely in the political interests of the company’s controlling shareholder, the Paraná State Government. The minority shareholders that voted against the controlling shareholder’s abuse of power were Fundo Bradesco Templeton de Valor e Liquidez, Fundo de Invest. Ações Sumatra, Cafés Brasil S.A., and João Antônio Lian. There is every indication that, after this example of political mismanagement by the majority shareholder, the next step will be legal action against the company’s directors on the grounds of abuse of power and negligent management.

Proven efficiency of some Brazilian family businesses.

It is a fact that the alignment of management and shareholder interests in conjunction with the long-term view of adding value for shareholders, are an integral part of good Corporate Governance. According to the vice-president of Bain & Company consultants, Jean-Claude Ramirez, this was clearly indicated in his company’s survey of 285 BOVESPA listed companies. The results of this survey showed that, of the thirteen (13) companies reporting consistently increased revenues and profits from 1995 through 2002, the following seven (7) are family businesses: Bradesco, Confab, Itaú, Gerdau, Marcopolo, Pão de Açúcar, and WEG. The merit of these family business is even greater if we consider that they all operate in highly competitive sectors. Possibly, the quality of management discussed in the preceding item, justifies the fact that the group of thirteen (13) listed companies providing the highest returns for their shareholders, did not include a single state organization. Further to this interesting survey, family businesses represent 35% of BOVESPA listed companies, or 28% if we only consider the net worth of the twenty largest listed companies. As a curiosity, Bain & Company noted that, in terms of market value, the percentage of family businesses among the twenty largest listed companies was as follows: United Kingdom (4%), USA (8%), Germany (13%), France (24%), and Belgium (32%).

Once again, corporate conflict displays its capacity to undermine value for company shareholders.

For four (4) years now, the majority shareholders of Brasil Telecom have been waging war. O8n one side, are the Previ (of Banco do Brasil), Petros (of Petrobrás), and Funcef (of Caixa 8Econômica Federal) pension funds and, on the other, Banco Opportunity. This long drawn out corporate conflict, evidence of the absence of good Corporate Governance, has impacted the company’s share performance in the stock market. During the first two weeks of September, the company’s preference shares were the only ones to devalue, unlike the rest of the Brazilian telecommunications sector. While these shares dropped by 0.5%, Telemar reported a 4.5% gain and Telesp a 5.0% gain. Recently, these shareholders resumed a battle fought once before in the market and investors are discounting this from the price of its papers. While Petros Georgio, of Sudameris Corretora states that “the company’s operational side is excellent, the only problem is “the legal aspect”. HSBC’s Fábio Zaggatti believes that the company’s shares will remain pressured for such time as this conflict between the majority shareholders continues. However, Fator Doria Atherino brokerage analyst, Jacqueline Lison, more accurately states that the fight between the shareholders is hindering the strategic decision process and could seriously undermine company management. The long-awaited climax of this conflict was that, on October 6, in a general assembly of shareholders, the pension funds dismissed Banco Opportunity as company administrator. If the market regards this move as a definitive solution for corporate conflict and, if harmonious relations between the majority shareholders are restored, thereby favorably impacting share prices, we shall see yet further evidence that good Corporate Governance practices add value for shareholders.

Meanwhile, in Australia.

In the wake of recent US corporate scandals, shareholders have exhibited considerable interest in executive share option packages.

The notorious Rupert Murdoch was forced to recant on his intended approval of a controversial share option package for New Corporation senior executives in the face of strong opposition from institutional Australian investors and institutional Corporate Governance monitoring bodies. Not only did the package include Murdoch’s two sons, but it was also not linked to executive performance, a basic requirement of the Australian stock exchange, which establishes that “there must be a clear relationship between performance and recompense”. In his capacity as chairman of the general shareholders’ meeting of this important media group, Murdoch withdrew voting on the package from the meeting agenda and stated “we are very, I repeat, very conscientious about our shareholders’ state of mind”.

This was the first time in Australia where local institutions not only publicly opposed a listed corporation’s share option package, but also succeeded in blocking it.

The fox that took over the chicken coop.

Not even one of Richard “Dick” Grasso’s most ferocious critics would deny his enormous contribution to the NYSE and to the US stock market, up until his richly deserved dismissal as CEO of this institution, generally viewed for much of its 211 years of existence, as the Mecca of American capitalism.

The product of a poverty stricken childhood, Grasso was raised by his mother and two aunts in the Queens district of New York, and never attended college. In 1968, aged 22, he started working at the NYSE, on a salary of US$82.50 a week. In 1995, he was appointed CEO. During the eight (8) years in which he led the world’s most important stock exchange, he directed this institution with enormous skill throughout the advance of its chief rival, Nasdaq and other computerized trading systems, and successfully maintained and attracted new companies to the NYSE. He was greatly acclaimed for resuming stock exchange operations in record time – six (6) days after the attack on the World Trade Center on September 11, 2001.

However, even these impressive achievements were not enough to mitigate a number of transgressions unacceptable in any member of a Corporate Governance environment, particularly one that should be an example to be followed by thousands of other board members and executive directors in the USA and the world. Grasso was universally criticized for conflict of interest situations. Among them were: a) that he was a member of the board of directors of Computer Associates, which came under the scrutiny of the sheriff of the US stock market, the SEC; b) that he appointed the then Citigroup CEO, Stanford Weil, to the NYSE board (Weil was later ordered to pay US$ 400 million in fines for illegal transactions involving the bank and some brokerage houses; and c) that he pressured a leading brokerage house right on the stock exchange floor to increase its purchase of AIG (American International Group) stock, in compliance with a written request of the latter’s CEO, Maurice “Hank” Greenberg, himself a former stock exchange director.

But the final straw was the renewal of his term of office through 2007 and the public disclosure of his supplementary benefits package, in addition to his annual salary of US$1.4 million. This package amounted to no less than US$139.5 million in benefits, incentives, and a retirement package. It was later discovered that he would also have been entitled to a further US$48 million that, in a last desperate move to save his “job”, he offered to waive. All payments received by Grasso were legal and established in his contract. However, the only problem was that this contract had been “approved” by individuals who reported directly to Grasso. Of the 26 NYSE board members, 19 were company executives and brokerage houses regulated by the NYSE, employees of the NYSE, and financiers and attorneys involved in the purchase and sale of shares.

Under pressure from some of its members, institutional investors, particularly the leading US pension funds, stock exchange floor operators, and politicians, a NYSE Board majority decided to accept Grasso’s “compulsory” resignation. His departure did not affect NYSE performance, since on the first trading after his resignation, the two chief indices closed at the highest levels recorded since June 2002. This was a clear indication that, in the light of recent corporate scandals in the US, the market has become increasingly interested in applying good Corporate Governance practices.

Under its new leadership, the New York Stock Exchange encourages companies to appoint independent board members.

Both the NYSE and the Nasdaq have drawn up rules requiring listed companies to have a majority of independent members on their boards. This is causing a veritable uproar on US Boards. In the case of the NYSE, this example should come from in-house, particularly in the wake of the Grasso scandal. NYSE interim chairman appointee, John Reed intends to reduce the number of board members from twenty-seven (27) to ten (10) or twelve (12), thereby assuring investors of increased powers, about which he stated categorically “We shall apply all the Corporate Governance standards that we require of our listed companies, and this involves having a majority of independent members on our board of directors”.

This enhanced value of the independent board member is not restricted to the capital markets of the developed world. Anyone interested in further knowledge of the role of independent board members in one particular emerging country, South Africa, should peruse an interesting article by Jorge Araujo, in which he summarizes his presentation at the World Conference, “Corporate Governance in an International Marketplace” sponsored by CILS (Center for International Legal Studies – www.cils.org) held in Austria from June 26 through 29, 2003. The full text of this article entitled, “The Non-Executive Board Member: the Minority Shareholders’ Defender” can be found in the Technical Material of the LCV website (www.lcvco.com.br).

CVM (Brazilian Securities Commission)

- Quote from “CVM Recommendations on Corporate Governance”.

III. MINORITY SHAREHOLDER PROTECTION (cont.)

Voting Rights of Preferred Shares When Dividends Are Not Paid

III.5 The company’s by-laws should determine that, if the general meeting does not declare payment of dividends to shares with rights for fixed or guaranteed-minimum dividends, such shares immediately attain the right to vote. If the company does not pay dividends for three years, non-voting shares will acquire the right to vote.

Shares with fixed or guaranteed-minimum dividends shall immediately acquire voting rights if the owed dividends are not declared or paid. Any non-voting share that does not receive dividends for three years acquires voting rights.

Arbitration for Corporate Questions

III.6 The company’s by-laws should establish that divergences between shareholders and the company or between controlling shareholders and minority shareholders will be solved by arbitration.

The adoption of arbitration aims to speed up the solution for stand offs, with no resultant loss of quality in the judgements. The efficacy of such a measure depends on the choice of an arbitration panel composed of members with ample experience and expertise in corporate matters.

Best Corporate Governance Practices

- Quote from the Best Corporate Governance Practices Code – Brazil.

The Board of Directors (cont.)

2.27. Relations with the Owners

The Board of Directors is elected by the Owners whom it represents and to whom it is accountable for the performance and the actions of the company.

2.28. Relations with the CEO and Officers

The Board of Directors elects and removes the Chief Executive Officer and establishes his/her remuneration.

The Board of Directors decides on proposals submitted by the CEO in regard to election of Officers.

The Board supervises the action and the performance of the CEO, Officers and the top Management.

The Board of Directors should pay a special attention to the manner the CEO and Officers are handling relations between the company and its Stakeholders.

The Board of Directors should not interfere with the CEO, Officers and Management in operational matters.

2.29. Relations with the Independent Auditors

The Board of Directors, representing the Owners, selects and removes the Independent Auditors.

It should approve the audit plan and negotiate the fees.

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