LCV

NEWS ABOUT CORPORATE GOVERNANCE - May-June/2004

Year IV – No. 34

Corporate Governance News

Editor: Luciano Carvalho Ventura

Editorial

The leading Brazilian Investment Funds that focus on Corporate Governance in companies.

- Halfway through 2000, under the title of “Good Corporate Governance Quantified at Last”, the LCV News announced “Despite the fact that Corporate Governance, as it is now known, has always added value to publicly quoted corporations, this added value was never quantified”. For the first time, this was confirmed empirically and subsequently, a special survey was carried out by consultants McKinsey & Co, entitled “Investor Opinion Survey”. This involved interviewing 200 administrators worldwide that at the time administered asset portfolios which, together, totaled the impressive amount of US$3.25 trillion. Two particular Corporate Governance conclusions attracted attention in the survey results. The first was that investors were willing to pay a premium anywhere between 18.3% and 27.6% for shares of companies that implemented good Corporate Governance practices. The second related to the excess amount payable by the investors, where the less developed the company’s governance structure, the greater the excess payment. According to McKinsey consultant, responsible for the Latin American section of the survey, Jean-Marc Laouchez, premiums tended to be higher in Latin America and Asia because the levels of Corporate Governance could be improved and value added to the companies. In the US and UK where Corporate Governance was more highly developed, the premium was lower. According to the survey, at the time, the average premiums payable for some emerging countries’ shares were as follows: Venezuela (27.6%), Colombia (27.2%), Indonesia (27.1%), Thailand (25.7%), Malaysia (24.9%), Korea (24.2%), Brazil (22.9%), Mexico (21.5%), Argentina (21.2%), and Chile (20.8%). It is, of course, likely that with the advance of Corporate Governance in the companies of some of these countries, these premiums have changed.

- So, what has happened to the Brazilian investment funds whose investment selection criteria included the respective companies’ Corporate Governance levels, and which prepared themselves to “capture” the goodwill identified in line with the above survey, insofar as they were able to work together with the companies and upgrade their Corporate Governance systems?

- The four main investment funds that focus on Corporate Governance in Brazil are as follows (in alphabetical order): Bradesco Templeton de Valor e Liquidez, Dynamo, Fator Sinergia, and Investidor Profissional.

- FVL – Fundo Bradesco Templeton de Valor e Liquidez prides itself on investments in companies with good Corporate Governance practices. With its active policy, it seeks to cooperate with these companies’ efforts to constantly upgrade their performance, thereby generating value and liquidity for their shareholders. The FVL started operations in December 1998 with R$231 million of its capital of R$350 million paid up. Today, it is one of Brazil’s largest equity investment funds with assets of R$640 million (US$210 million), even after paying out R$148 million (US$61 million) to its shareholders, having had an early return on some of its investments. It is a fixed term fund (seven and a half years) and its principal shareholders are the BNDES, Fundo de Participação Social, and Bradesco group companies, in addition to pension funds and other institutional investors. In addition to its policy of equitable treatment of all its shareholders, regardless of their size, an FVL priority is total transparency before such shareholders, to report on its management, and to faithfully fulfill its trusteeship. It is worth noting that, to date, the FVL is the sole investor to have joined the Market Arbitration Committee, instituted by Bovespa (São Paulo Stock Exchange), as part of its New Market.

In 2002, when the IBovespa (Bovespa Index) dropped by 17%, the FLV’s short-term profitability of over 50% earned it the Gazeta Mercantil 2002 Investment Fund Seal – Best Funds. Since it started operations, the FVL’s long-term accumulated profitability was 436%, versus the Ibovespa valuation of 202% for the same period. In 2004, the Fund has increased in value by 20% as against a 3% IBovespa drop. FVL shares are traded at Bovespa under code TPLT11.

- Dynamo, which specializes in administering variable income funds, and recently celebrated its eleventh year of activities in the financial market, has always utilized Corporate Governance as an investment management tool. Today, its first fund, Dynamo Cougar, which started operations in 1993, numbers among the leading Brazilian capital market equity funds, with assets of R$ 350 million (US$115 million). Dynamo’s strategy consists of identifying and benefiting from differences between Brazilian capital market share prices and the value of the assets, where the basis of its management plans is built on the following three foundations: i) fundamentalist analysis – as deep and wide ranging as possible; ii) an active approach to the companies in order to encourage corporate decisions that reduce these differences; and iii) a medium and long-term investment horizon involving the timing required for the recommended improvements to impact the financial statements and be perceived by the market. It is in this context that Dynamo views Corporate Governance as a tool for creating value for all shareholders. It is almost impossible to “fix” a bad or unethically run company with management activism. According to Dynamo, Corporate Governance is most effective when there is value to be redeemed and where healthy interests only require some alignment. And this is precisely what Dynamo has sought to achieve in its investment portfolio companies. Over the years, Dynamo Cougar’s profitability has clearly shown the soundness of its investment strategy, evidenced by the fact that, since its foundation in September 1993 to date, it has obtained a return in US dollars of 1.790%, representing 31.1% p.a. in dollars, or 30.2% p.a. above the IGP-M, or even 21.3% p.a. above IBovespa.

- The Fator Sinergia investment fund managed by Banco Fator focuses on Corporate Governance. Its main business activity is to administer the positions of low liquidity or excessively devalued shares, to maximize the value of their shareholders’ investments, as these companies upgrade their Corporate Governance practices and increasingly honor minority shareholder rights. It was founded in 1997 with a fixed term of seven and a half (7½) years. Among its chief shareholders are BNDES, PREVI, PETROS, and PORTUS. The Fator Sinergia Fund’s strategy is centered on asset management and on Corporate Governance activities. Its asset management policy focuses on seeking purchase and sale opportunities based on the analysis of background and future prospects for the companies. In Corporate Governance terms, Fator Administração de Recursos, of Banco Fator, was one of pioneers in incorporating into its variable income asset management methods, the promotion of good Corporate Governance practices in investments of funds and administered portfolios, notably for the Fator Sinergia Fund. A number of different legal mechanisms and practices are implemented by the managers in their work to improve these companies’ Corporate Governance practices, such as transparency, equity, particularly in the treatment of minority shareholders, and accountability to the market, especially to shareholders and creditors. One of the Fund’s principal mechanisms to upgrade Corporate Governance practices in companies where it holds a significant investment, is active involvement in its General Assemblies, electing the members of the Board of Directors and audit boards. Today, even after paying out R$155 million to its shareholders, the Fator Sinergia Fund has assets of R$ 480 million (US$ 158 million) and, even more interestingly, since it is a fixed term organization, its work will be continued by Fundo Fator Sinergia II, formed in September 2002 and already holding assets of R$ 96 million (US$32 million).

In terms of profitability, since its formation, the Fator Sinergia Fund has achieved accumulated profitability of 418.4% compared with IBovespa return of 126.1% for the same period. In turn, since its formation in September 2002, Fundo Fator Sinergia II shows accumulated profitability of 130,6% compared with 106.3% to June 2004 of Ibovespa.

- Fundo IP – Participações was founded in 1993. Its strategy is to prioritize quality management in companies, mainly Corporate Governance and business potential, in its asset selection process, without too much concern for other traditional analysis indices, among them low share liquidity. This strategy, the brainchild of mega investor Warren Buffet, resulted in unprecedented levels of success in the history of Brazilian equity funds. An integral part of its philosophy was to uphold the implementation of mechanisms ensuring alignment of interests between the companies’ controlling and minority shareholders and senior management, aimed at maximizing value for all shareholders. When it started out with its most successful cases, such as Elevadores Atlas in 1996 and Saraiva Livreiros in 2000, the expression Corporate Governance was unknown in Brazil. Recent examples of successful operations in the Brazilian capital market, where Corporate Governance was an important factor, were those of Marcopolo, CCR, Natura, Gol, and All, proving that the Professional Investor and other pioneers that have always believed that Corporate Governance is synonymous with value, had been right all along. In respect of profitability, it is worth mentioning that, in the short term, in June 2004, the profitability of Fundo IP – Participações was 7.84% in reais, net of all costs. In the long-term, since February 1993, when its management was taken over by the Professional Investor, Fundo IP – Participações has already accumulated value of 805% in US dollars. This represents average profitability equivalent to 22% p.a. also in dollars, as compared with the average performance of the IBovespa of 12% p.a., also in US dollars, and the CDI of 15% p.a., in US dollars.

- The above example of the performance of these four funds clearly underscores the fact that, for some considerable time now, Corporate Governance practices add value for shareholders. It is clear that now, and in the future, with the growing democratization and wider distribution of capital, aligned with the market’s increasing perception of the importance of Corporate Governance as an investment selection parameter, there is no doubt that, improved Corporate Governance levels in companies in general, will be unavoidable.

IBGC – Brazilian Institute of Corporate Governance.

The IBGC has already announced the Fifth National Corporate Governance Congress to be held in São Paulo, beginning with the opening dinner on November 7^th. It will continue throughout the day of November 8^th, and, as in past years, will involve presentations by a number of prominent speakers. Registration are now being accepted and the program, which is available in full on the IBGC website (www.ibgc.org.br), will focus on Corporate Governance in the Brazilian business environment.

ABRAPP - Brazilian Association of Private Complementary Pension Companies.

- An association of over 350 Brazilian pension funds, jointly with ICSS and SINDAPP, from June 7 through 14, ABRAPP held yet another of its traditional international seminars, this one entitled “The Structure of Pension Funds in Europe”. During this period, 29 directors and Officers of Brazilian pension funds visited England, Switzerland, and Sweden, where they made some excellent contacts with Government bodies, trade union leaders, directors and Officers of leading local pension funds, fund managers, and prominent professors. The seminar was sponsored by ABN Amro, Societé Generale, Icatu Hartford, and Shroders. The main topics covered related to pension systems, but some important comments on governance matters, in the context of pension funds and of Corporate Governance merit attention.

- In respect of pension fund governance, it is important to remember that when compared with the legislation of the above three countries, Brazilian pension fund legislation guarantees a more active pension fund member involvement in management and monitoring of the pension funds. In the context of communication with pension fund members, in terms of transparency, both here and there, there are certain barriers to communication between members and the respective pension funds. There is very little shareholder activism by Swiss and Swedish pension funds. On the other hand, by their very nature, British pension funds are extremely vocal company shareholders, infinitely more so than their US counterparts, despite the latters’ public image to this effect, and for a very simple reason: the majority of US legislation is state legislation, which inhibits national movements. This is not the case in the UK, and, thus British pension funds act jointly throughout the country.

One of the hallowed pillars of Corporate Governance, transparency becomes a special UNCTAD topic

- In June, São Paulo hosted UNCTAD – the United Nations Conference on Trade and Development. Among the many events was the round table held at Bovespa (São Paulo Stock Exchange) to discuss an important topic, “Corporate Transparency and Investments”. This was sponsored by a number of Corporate Governance connected organizations, such as Bovespa itself, the IBGC, Apimec, Fipecape, and Ibracon. The chief aim of the round table was to discuss the importance of transparency in encouraging investments, by recuperating and reinforcing investor confidence and revealing recent corporate transparency developments. Among those present, were Nelson Carvalho, President of the UNCTAD Accounting Research Group, Raymundo Magliano Filho, Bovespa President, Henrique Meirelles, Brazilian Central Bank President, Donald Johnston, Executive Secretary of the OECD, Marcelo Trindade, CVM President, G. Kharlamov, President of the Russian Regulatory Body, and André Baladí, ICGN Founding Member.

- We have two relevant quotes from the many statements made during this round table. The first came from Donald Johnston, Executive Secretary of the OECD: “Investments are going to regions that apply very clear Corporate Governance criteria.” The second was made by Henrique Meirelles, Brazilian Central Bank President: “Every country that has succeeded in sustained growth for long periods of time has also expanded its pension fund network.” For those familiar with the topic, there is no need to reiterate the importance of pension funds in strengthening good Corporate Governance in companies.

The obstacles created by the Sarbanes-Oxley Act in the US capital market.

- As could only be expected, a law with the range and inflexibility of the Sarbox Act, considered by many to be the greatest legal amendment for the US companies since the thirties, is not only beneficial to thousands of anonymous and local shareholders, but also represents considerable problems for the US capital market and, indeed, the world. Recent news from the specialized media cite the example of Emergisoft, whose CEO, Ash Huzenlaub discontinued his efforts to go public due to the costs and additional risks created by this new Act. Emergisoft is one of 120 US companies that withdrew from going public, since it would cost each one US$740 thousand to comply with the law, in addition to the fact that the cost of maintaining a publicly quoted corporation has increased by 150%, without considering the additional risks for their administrators. It’s true that we are talking about 120 companies, mostly small and medium size, in a world of 14 thousand corporations traded in US stock exchanges that, as a result of the new law, have improved their Corporate Governance levels, which will most certainly strengthen the US capital market and, as a result, the entire capitalist system.

- There remains the unanswered question. Will US stock exchanges continue to attract new foreign companies to join the 1.3 thousand that today are part of this universe of 14 thousand corporations in such a stringently regulated business environment?

A big Canadian company joins the ranks of accounting fraud

- Nortel, formerly the jewel in the crown of the Canadian business world, has joined the USA’s Enron and the Netherlands’ Royal Ahold in the ranks of accounting fraud. In yet another corporate scandal, whose ingredients never seem to vary, thousands of shareholders have incurred staggering losses that could have been avoided, or at least, minimized had the company implemented good Corporate Governance practices. As we all know, the Board of Directors is the heart of Corporate Governance and its omission is at the root of all destruction of value for the shareholder, and Nortel is no exception to the rule. People who are intimately familiar with the case confirm that the Board members allowed themselves to be deceived by senior management which, by doctoring the financial statements, earned millions of fictitious profit based dollars. Immediately after discovery of the fraud, the summary dismissal by the Nortel Board of CEO Frank Dunn, Financial Director Douglas Beatty, and Controller Michael Gollogly with the promise that “the company will fully review the wrongly paid bonuses”, is unlikely to have any positive effect, since it has come too late. Nortel has already warned the market that it will have to review its 2000, 2001, and 2002 financial statements, as well as those for the first and second quarter of 2003, without even mentioning that the first quarter report for 2004 has not yet been disclosed. The scant consolation left for the shareholders is the law, since Nortel is under SEC investigation in the US and by the US Department of Justice, in addition to the Canadian regulatory bodies and courts. However, unfortunately, all of this is unlikely to replace lost assets.

The CVM (Brazilian Securities Commission)

- The new CVM President, Marcelo Trindade who, on June 7, 2004, took over this vital and complex role in the Brazilian capital market, has accepted an invitation from the Rio de Janeiro branch of the IBGC, to give a talk at noon on August 23, at the American Club, Av. Rio Branco 1254/21^st floor, Rio de Janeiro, on “Corporate Governance limits and the relationship between regulation and auto-regulation”. Trindade is an attorney, Professor at PUC/RJ, Coordinator of the Corporate Law and Capital Market Course at the Fundação Getúlio Vargas, and former director of the CVM from December 2000 through April 2002. In view of his vast knowledge and wide experience in this area, he is regarded with positive expectations and confidence as the person at the helm of the Brazilian capital market’s most important regulatory and monitoring body. In addition to being supported by the outstanding CVM team, he has also appointed as Head of his Cabinet, the brilliant attorney Aline de Menezes Santos, renowned for years of extremely competent professional work through the IBGC, to promote improved Corporate Governance in Brazil.

Best Corporate Governance Practices

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

Objectives and Basic Principles (from the Code of Best Corporate Governance Practices of the IBGC)

The main object of this Code is to provide guidelines to all kinds of companies - publicly – or privately-held corporations, limited liability companies, service providers and nongovernmental organizations – with the purpose of:

Increasing company value
Improving corporate performance
Facilitating access to capital at lower costs1
Contributing to the long term survival of the company

1. "Access to capital" should be understood as the public or private offering of shares, long-term loans, and even reinvestment of cash flow funds.

The Code is divided into 6 sections:

Ownership
Board of Directors
Management
Independent Auditing
The Fiscal Council
Conduct and Conflicts of Interest

The basic principles of the Code are:

Transparency
Fairness
Accountability
Corporate Responsibility

Transparency

More than the duty to inform, Management should cultivate the desire to inform, knowing that good internal and external communications, particularly when spontaneous, straightforward and fast, lead to an atmosphere of trust, both internally and externally.

Communications should not be confined to the economic and financial performance, but also contemplate other aspects – including intangible values – which drive managerial actions, such as the market, strategies, and activities leading to the creation of value.

Fairness

Fairness typically conveys fair and equal treatment of all minority groups, whether of owners or other stakeholders, such as associates, customers, suppliers, or creditors. Discriminatory attitudes or policies, under any pretext, are entirely unacceptable.

Accountability

Corporate governance agents should account for their actions to those who have elected them, and fully answer for all their acts throughout their terms of office.

Corporate Responsibility

Directors and Officers must gear their efforts to the life-long existence of their organizations (long-term vision, sustainability) and should therefore include social and environmental concerns in defining businesses and operations of their company. Corporate responsibility is a broader view of corporate strategy, contemplating all kinds of relations with the community

where the company operates. The "social role" of the company should include the creation of wealth and job opportunities, work force skills and diversity, promotion of scientific advancements through technology, and improved standards of living through educational, cultural, social, and environmental initiatives. This principle should include preferred treatment of local people and resources.

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