LCV

NEWS ABOUT CORPORATE GOVERNANCE - March-April/2004

Year IV – No. 33

Corporate Governance News

Editor: Luciano Carvalho Ventura

Editorial

The new IBGC (Brazilian Institute of Corporate Governance) Best Corporate Governance Practices Code.

- Founded in November 1995, the IBGC is an organization dedicated exclusively to promoting Corporate Governance in Brazil. Today, it is unquestionably the country’s chief motivator of practices and discussions on this topic, and has received domestic and international acclaim. It is a non-profit Brazil-wide organization whose mission is “to be the leading national reference in Corporate Governance, to develop and disclose best Corporate Governance concepts and practices in Brazil, to contribute to improved performance of business organizations, and, consequently, to a juster, more responsible, and transparent society.”

- The IBGC gives courses and presentations, is involved in research, annual congresses, among many other activities on the topic of Corporate Governance. During its monthly meeting held on March 30, 2004, it launched the third edition of its “Code of Best Corporate Governance Practices”. Eliane Lustosa, Board Member and Coordinator of the IBGC Code Review, was responsible for this work. The purpose of this reviewed and expanded third version was to incorporate into the previous version launched in April 2001, all the changes that have occurred in corporate, legislative, and regulatory areas. In this way, the position of the IBGC, in relation to Corporate Governance practices is maintained in a modern and up-to-date context, always aligned with the challenges of its time. In addition to playing an important teaching role and facilitating the application of good Corporate Governance practices in Brazil, this new and more detailed version ranks the IBGC Code among the most complete and wide-ranging in the world today. Since it was first launched in May 1999, there has been a marked growth in Brazil’s institutional and corporate environments. The IBGC is always alert to these changes and, for this reason has updated the Code, the chief manifestation of its jurisprudential interpretation of Corporate Governance.

- The Code’s core aim is to indicate routes for all types of organizations, be these private or publicly traded companies, limited liability or civil associations, seeking to: a) increase the company’s worth; b) improve its performance; c) simplify its access to capital at a lower cost; and, d) contribute to its longevity. The Code is divided into the following six (6) chapters: 1) Ownership (Partners); 2) The Board of Directors; 3) Management; 4) The Independent Auditors; 5) The Audit Board; and 6) Conduct and Conflict of Interest. The Code’s basic principles are Transparency, Equity, Accountability, and Corporate Responsibility.

- The full text of the third version of the “Code of Best Corporate Governance Practices” can be found in the IBGC Website (www.IBGC.org.br) and, as in the case of the second version, will be published in extracts, in the final section of this newsletter. Lastly, the English language version of the Code, which has been approved by the ad hoc Committee, will also shortly be available in the IBGC Website.

More IBGC News.

- The IBGC held its Annual General Meeting on March 30, 2004, and the chief item on the order of the day was the election of its Board of Directors. In accordance with good Corporate Governance practices, this occurs annually, and any board member may be re-elected, for an unlimited number of terms. Re-elected board members were: Adhemar Magon, Eliane Lustosa, Fernando Alves, José Guimarães Monforte, Maria Helena Santana, Mauro Rodrigues da Cunha, and Miguel Poul. New board members were: José Luiz Osório and José Roberto Ópice. In their first meeting immediately following the annual general meeting, the board elected José Guimarães Monforte as Chairman and José Luiz Osório and Maria Helena Santana, as Deputy Chairmen. Monforte is an economist, has been a member of boards of directors for eight years, and a member of the IBGC Board for the last two years. He is currently a member of boards of six companies, among them Natura and Sabesp.

- It is a well known fact that giving high level courses is an IBGC mechanism for raising the standards of Corporate Governance in Brazil, one of its chief objectives. These courses, which have been given since 1998, are highly regarded by Brazilian companies and have been attended by over one thousand students. One particular course, thanks to its very practical nature, increasingly attracts the attention of professionals interested in Corporate Governance: The third edition of “The Board of Directors – A Case Study”, will be given in São Paulo on June 3 and 4, 2004 by Deloittes in association with Spencer Stuart. In this Board Case, as it is also known, the students take part in simulated Board Meetings and other Committee meetings. Anyone interesting in obtaining further details of the structure of this program should visit the Website (www.IBGC.org.br).

International Corporate Governance Network - ICGN

- We are getting closer to what is generally considered to be the most important Corporate Governance event in the world, which, this year, will be held for the first time in the southern hemisphere, specifically in the stunning city of Rio de Janeiro, from July 7 through 9, 2004. The ICGN, arguably the world’s most important body dedicated to Corporate Governance, includes among its members institutional investors with a great interest in this topic, such as the California Public Employees Retirement System (CalPERS) and the College Retirement Equities Fund (TIAA-CREF), in addition to highly influential professional associations such as the US Council of Institutional Investors, the Cadbury’s Association of British Insurers and the National Association of Pension Funds, both from the UK, among many others, all of which will attend this important event. The event will be sponsored by the IBGC, the CVM (Brazilian Securities Commission), and Bovespa (The São Paulo Stock Exchange). Latest estimates show that the assets administered by ICGN members exceed US$10 trillion. This figure speaks for itself and attests to the scope of the IGCN’s importance and influence in the global financial market. Fifty speakers from sixteen countries will take part in twelve of the event’s sessions (panels and presentation). Over five hundred (500) enrollments by Brazilians and foreigners interested in the topic of Corporate Governance are expected. This will be a record number of attendees for the ten conferences held by the ICGN since its foundation. The opening reception will be held at the top of the Pão de Açúcar (Sugar Loaf Mountain), Rio de Janeiro’s best known postcard scene and the gala dinner will be held at the Copacabana Palace Hotel, inaugurated in 1923, and recognized as Rio’s most traditional and luxurious hotel. Further details on the event can be found in the IBGC Website (www.IBGC.org.br) or in the ICGN Website (http://www.icgn.org).

Once again, the Takaoka Company is cited as a Corporate Governance reference in Brazil.

- Y. Takaoka is in the news again. It was Brazil’s first family business to draw up its own Corporate Governance practices code, formally approved by its Board of Directors and placed at the disposal of any one of its related parts and the business community in general. In 2002, the company was once again cited as a Corporate Governance reference in Brazil by no less than the eminent Instituto Ethos de Empresas e Responsabilidade Social. In its newsletter for the week of March 18 to 24, 2004, the Institute published an article in the Case Study section, in its Website (www.ethos.org.br) entitled “Takaoka Invests in Corporate Governance to Improve Management”. The article described how the company introduced its Corporate Governance system, which is fully aligned with best Brazilian and global practices. The article is available in full in the Technical Material section of the LCV Website (www.lcvco.com.br).

- Y. Takaoka, the Takaoka Group holding company, originated in the split of Construtora Albuquerque Takaoka S.A., and one of its founders was entrepreneur Yojiro Takaoka. Albuquerque Takaoka, as it is known in the Brazilian construction market, planned, developed, and built more than 80 buildings in Greater São Paulo, including the celebrated Ilhas do Sul Condominium (130.000m² of constructed area), the Alphaville venture (16.400.000m²), and Aldeia da Serra (4.400.000m²). Today the Takaoka Group is run by Yojiro’s son, Marcelo Vespoli Takaoka, and its business includes building, earthmoving, paving, works of art, buildings, large structures, and urban planning. Highlights among its current major ventures, carried out in association with other companies, are the Gênesis I and Gênesis II plots, whose development focuses on the environmental preservation of the Alphaville-Tamboré region, where only one-fifth of the total area is utilized as plots for building single family residences, and whose successful sales exceeded all initial expectations.

The Sarbanes-Oxley Act and Brazilian companies traded in US stock exchanges.

- On June 4, in São Paulo, the Brazilian Association of Publicly Traded Corporations is sponsoring an interesting workshop. This is in response to requests by its member companies and others interested in this topic to discuss and clarify doubts about implementing the measures required to comply with the Sarbanes-Oxley Act, particularly in relation to the Audit Committee and internal controls. The event is most timely for all thirty-three (33) Brazilian companies in the process of complying with this exacting US law affecting all companies trading in the US capital market. It is a well-known fact that the Sarbox Act was the US Government’s response to recent corporate scandals. When it came into force in July 2002, it established a time schedule for compliance with its seven hundred (700) articles, which is now close to its implementation limit date, despite the fact that many doubts arising from its requirements have not been clarified. The details of this event, promoted by ABRASCA and coordinated by SB Eventos, sponsored by Ernst & Young and Pinheiro Neto Advogados, with the support of the IBRI and APIMEC, are available in the ABRASCA Website (www.abrasca.org.br/eventos).

The Audit Committee Institute is founded in Brazil.

- In February 2004, the Brazilian branch of the Audit Committee Institute (ACI), sponsored by the KPMG audit firm was founded. Its chief aim is to “provide communication and interaction opportunities among members of Audit Committees and other groups that interact with the former in performing their roles”. The ACI has been in place in the US since 1999 and is present in over ten (10) other countries, including Germany, Canada, China, and Switzerland. In Brazil, it plans to hold quarterly round tables, always to discuss topics selected from its members’ computerized votes. It is a well-known fact that the auditors play a major role in the structure of monitoring Corporate Governance. Accordingly, this ACI is expected to attract a large number of professionals involved in this area. Anyone interested in obtaining more details information on the ACI should visit the following Website (www.kpmg.com.br) or email acibrasil@kpmg.com.br.

McDonalds’ good example on succession to the CEO

- The editorial of the March/April 2003 edition of the LCV News discussed an important Corporate Governance topic, the transition of a company’s CEO. The editorial began by stating, “The CEO occupies an important niche in any Corporate Governance structure. It is he or she who is the chief link between the regulating body, the board of directors and the regulated body, senior management, and the remainder of the organization. The CEO is also first on the ladder of liability for the company’s operating performance and for striving to maintain one of Corporate Governance’s most important values, transparency.” Further on, it continues, “For obvious reasons, the unforeseen transition process is significantly riskier than a planned succession. Among the main reasons for an unexpected transition are sudden death…”. And this is precisely what happened at the multinational fast food corporation of McDonald’s. One Monday, its CEO, 60-year old Jim Cantalupo died of a massive heart attack and, exceptionally, only hours later, the Board of Directors announced that its Director-General of Operations, Charlie Bell, 43, would be Cantalupo’s definitive successor. The speed of this decision and the fact that the choice was final, gave the corporation’s staff, franchises, investors, and the market in general the sensation that the food giant still has a leader who knows the company well, and who is fully qualified to guarantee the continuity and performance of its strategies.

- The majority of companies have only one (sometimes none) plan of succession to deal with the unexpected death of the CEO but, as a general rule, this plan provides only for a provisional successor. In plans such as this, the board of directors usually appoints a former board member, a retired CEO, or a young fast track executive to take up the position on a provisional basis, in the event of the sudden death of the CEO. But, experience has shown that, in most cases, temporary leaders are not the solution and, in fact, can exacerbate the problems caused by the absence of a formally appointed leader, and hinder the company’s recovery after the culture shock of this sudden loss.

- Unlike these organizations, McDonald’s had an excellent emergency plan in place. In his comments on the case, Harvard Business School’s Professor Jay Lorsch, one of the world’s most highly regarded Corporate Governance authorities, pointed out that “Their speedy action was exactly what one would hope for, but few companies are as well prepared for such calamities as McDonald’s appeared to be”.

The high price paid for the absence of good Corporate Governance practices

- Far from what many may believe, Corporate Governance has never considered itself as a magic formula for curing the problems of the business world. In fact, good Corporate Governance can: a) aid in strengthening any capital market; b) add value to the company and reduce its capital costs; and, c) help to protect the assets of the company’s shareholders.

- Further to this last contribution that Corporate Governance can give to companies in general, the market is overflowing with examples of the high price that many shareholders have been forced to pay, due to the absence of good Corporate Governance practices. Without dredging up yet again all the notorious US scandals, it is worth examining the case of Royal Ahold NV, the Dutch company that, in addition to sharing the somewhat pretentious prefix of “Royal” with Royal KLM and Royal Dutch/Shell, the only three Dutch organizations to hold this title, is the world third largest supermarket operator. This ranking was attained by a number of acquisitions in the country where self-service was practically invented and most certainly developed on a huge scale, the US, and Royal Ahold has become the leader in this market on the West Coast. All was going well until, in February 2003, it announced its discovery of certain accounting irregularities, and promptly dismissed the CEO and financial director. In June 2001, the company attained a record market value of no less than US$35 billion, but the impact of the disclosure of these irregularities was an immediate drop of sixty-three percent (63%) in share value, drastically reducing its market value to US$3.5 billion. These discrepancies occurred in the company’s US and Argentine subsidiaries, for totally different reasons. In the case of the US, the inconsistencies identified at US Foodservice were limited to accounting fraud that inflated profits by more than US$500 million with proportional benefits for senior management in the incentive plans. According to its spokesman, In the case of the Argentine subsidiary, this was “a case of code of conduct” and led to the four directors of the Disco chain being summarily dismissed. The total loss to shareholders has not yet been calculated, since this figure is divided: a) into the initial figure estimated by the new auditors appointed after the disclosure, i.e., over US$1 billion; and b) the decreased value of the healthy assets that the company will be obliged to sell to settle with its demanding creditors. An example of this situation is the recent sale of Bompreço, The biggest supermarket chain in the northeast of Brazil that, according to the market, was sold for half the price at which it was acquired a few years ago.

- The questions arising at the end of these comments are: (a) Where was the Board of Directors of Royal Ahold in the Netherlands, chaired by former Royal Dutch/Shell executive Henny Meurs, that had failed to monitor the activities of the worldwide CEO, to have motives for dismissing him summarily on learning of these irregularities? b) As the existence of irregularities became clear, what was their composition and how did the boards of directors of the US and Argentine subsidiaries work? c) What quality Corporate Governance practices did Ahold and its branches apply?

- Possibly, the answers to these three simple questions will partially explain the, as yet incalculable, losses suffered by the shareholders of Royal Ahold.

The unprecedented behavior of the US capital market’s sheriff

- It would seem that the majority of the members of the US capital market continue to react to the country’s corporate scandals. It is a well-known fact that the first reaction came from Congress that, after the scandals, immediately merged two draft laws in the process of being examined, whose authors were two senators from different political parties, Senators Sarbanes and Oxley. Congress approved this law that came to be known as the Sarbanes-Oxley or Sarbox Act. It is currently the most important legal change, since the nineteen thirties, for US or foreign companies traded in US stock exchanges, and, in July 2002, was immediately sanctioned by President George W. Bush. This law was duly regulated by the SEC that, as a result, acquired a degree of power, previously unimaginable, throughout its history as a regulating body. The second reaction came from these companies’ shareholders, mainly the institutional investors, particularly the powerful US pension funds that took a greater activist approach as shareholders of such companies. This was mainly effected by increased monitoring of management and pressure for good Corporate Governance practices on the boards of directors, CEO’s, and the Independent Auditors. What appeared to be just another temporary episode in the mercurial US capital market has put down roots and grown. It has evolved to the point that the big board member and CEO headhunters have experienced considerable difficulty in locating candidates for these hitherto attractive positions, mostly due to their inherent risk levels. An astute observer of the trends of US market shareholders can clearly see that they are increasingly rigorous in monitoring the management of their assets.

- And what is the reaction of the market sheriff, the SEC? Could it be that, after arresting a handful of baddies, wrapping up its investigations, and make a few more rounds of town, it has returned to its desk in the sheriff’s office to await further allegations or complaints from the citizens to start some kind of action or investigation? All evidence points to a resounding “no”. A recent note in The Wall Street Journal pointed out the changes in the SEC’s monitoring policies, which now takes the attack position; and tends to investigate an entire sector upon identifying signs of irregularities in a single company, regardless of whether or not there are indications of irregularities anywhere else in the respective sector. Examples given in this eminent economic newspaper, are those of the oil and high technology sectors. In the case of the oil sector, the SEC is currently analyzing the manner in which this sector recorded its exploration reserves, after the discovery that the Royal Dutch/Shell Group under calculated its reserves, and also whether these companies’ bonus and other incentive systems encouraged their executives to exaggerate oil reserves. In the high technology sector, the SEC is currently examining executive compensation systems and accounting techniques for recording results. Since boards of directors, as protectors of shareholder assets, are expected to prevent, or be jointly liable for, errors of executive management, particularly those in benefit of the people who issue the orders, as an independent board member of eight European Groups, W. Schmidt, said recently in São Paulo, “the role of a board member has become a risky profession”.

CVM (Brazilian Securities Commission)

Extract from “Recommendations of the CVM on Corporate Governance”

IV. ACCOUNTING AND AUDITING

Relationship with the Independent Auditor

IV.3 An audit committee, composed of members of the board of directors with experience in finance and including at least one board member representing minority shareholders, should supervise the relationship with the auditor. As part of the analysis of the company’s financial statements, the fiscal board and the audit committee should meet regularly and separately with the auditors, without the presence of executive officers.

This recommendation seeks to ensure that specialists capable of analyzing the company’s financial statements examine and discuss them in detail, and propose to the board of directors any alterations needed to better reflect the company’s financial, economical and assets situation. Naturally, if a company executive is a member of the board of directors, he or she should not participate in the audit committee. Any member of the audit committee may request an individual meeting with management or auditors when necessary.

Auditor

IV.4 The board of directors should prohibit or restrict hiring the company’s auditor for other services that may present conflicts of interest. When the board of directors allows the hiring of the auditor for other services, they should , at least, establish for which other services the auditor may be hired, and what maximum annual proportion such services could represent in relation to the auditing costs.

Good governance practices recommend the auditors’ complete independence as a requisite for the quality of their service. The restriction to render other services aims to avoid the loss of this independence over time.

Access to Information

IV.5 The company should make information available at the request of any member of the fiscal board, with no limitations regarding prior terms, as long as such information is related to matters currently under analysis, and with no limitations on subsidiaries or related companies, as long as it does not violate the secrecy imposed by law.

The fiscal board’s supervisory capacity shall be the broadest possible, due to responsibilities imposed by law in the case of misconduct. All documents and information which have any influence on the numbers under analysis should be made available, unless access is restricted by legal secrecy obligations.

Best Corporate Governance Practices

- Quoted from the Best Corporate Governance Practices Code, Third Edition, March 2004 – Brazil.

Corporate Governance is the system whereby companies are run and monitored, involving relationships between Shareholders/Quotaholders, the Board of Directors, Senior Management, the Independent Auditors, and the Audit Board. The aim of good Corporate Governance practices is to add value to the company, facilitate its access to capital, and contribute to its longevity.

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