LCV

NEWS ABOUT CORPORATE GOVERNANCE - November-December/2004

Year IV – No. 37

Corporate Governance News

Editor: Luciano Carvalho Ventura

Editorial

On attaining its 100^th anniversary, PREVI, Latin America’s biggest pension fund is the topic of a Corporate Governance postgraduate dissertation .

- Formed on April 16, 1904 by 52 members before the concept of social security existed in Brazil, with the name of Caixa Montepio dos Funccionários do Banco da Republica do Brazil, today PREVI (Caixa de Previdęncia dos Funcionários do Banco do Brasil) (www.previ.com.br), today with 120 thousand members, is now Latin America’s largest pension fund, with a worldwide ranking in 77th place in terms of net assets. PREVI is a private pension fund of which Banco do Brasil personnel and PREVI’s own staff are members. The Fund’s objective is to guarantee pension benefits to complement Brazil’s social security payments, in order to contribute to an improved quality of life for its members and their dependents. To this end, it invests funds deriving from member contributions into company shares, realty, securities, etc. These investments guarantee benefit payments. Moreover, since in Brazil it invests in companies whose corporate objectives are based on social responsibility, in addition to benefiting its members, PREVI also contributes to the community in general.

- PREVI is managed and supervised through the combined actions of a Board of Directors, an Executive Management Board, and an Audit Board. The Board’s of Directors current Chairman is Henrique Pizzolato, with Sergio Ricardo Silva Rosa chairing the Executive Board, and José Bernardo de Medeiros Neto responsible for the Audit Board.

- In view of the huge volume of funds involved, the many investee companies, the unusually large number of appointed members of the different boards, even by world standards, a commitment to Corporate Governance is absolutely essential for closely monitoring these investee companies, as one of the means for ensuring a level of returns sufficient to pay member benefits, PREVI’s organizational structure consists of two management areas dedicated exclusively to monitoring share investments, under the auspices of an Investment Board headed by Renato Chaves. It would appear that PREVI is the sole Brazilian pension fund whose corporate structure includes two management areas with such specific objectives. In the specific case of this pension fund, this innovative structure is not only justifiable but, in our opinion, essential. They are GEPAR (Relevant Investments Management) that manages PREVI’s interests in boards of directors and/or audit boards in its investee companies and fosters unity between the companies, and GEGOV (Corporate Governance Management), responsible for managing the PREVI Corporate Governance Model by selecting, supervising, and evaluating board members, investee companies, and the funds and portfolios managed, focusing on Corporate Governance and liquidity. We draw our readers’ attention to PREVI’s concern with the aptitude of the board members it recommends to its investee companies. Since December 1994, during the first training seminar held at CCBB (Cultural Center of the Banco do Brasil), entitled “Training Seminar for Members of Boards of Directors and Audit Boards”, PREVI has continued to promote events involving presentations, debates, exchanges of experiences, always aimed at upgrading participants’ knowledge in these fields. Recently, these events were formalized as “Board Member Meetings”, with the same objective of qualifying and training board members to aid the latter to improve their respective companies’ performances. Anyone seeking more in-depth knowledge of PREVI’s Corporate Governance mission should consult the “PREVI Best Corporate Governance Practices Code” launched in November 2004 and available on its website.

- Today PREVI has 421 representatives on the boards of its investee companies. These are comprised of 142 titular board members and 107 deputies, in addition to 87 titular Audit Board members and 85 deputies. This clearly underscores the enormous influence held by PREVI at Corporate Governance level in Brazilian business. And, it is for this reason that the Fund has become a postgraduate dissertation topic.

- In “CORPORATE GOVERNANCE – Mechanisms Built by Institutional Investors – the PREVI Case History”, the verbal defense given by author Roberto Martins Ribeiro de Jesus (robertor@uninet.com.br) led to his Master’s Degree dissertation being approved by the Getúlio Vargas Foundation Public Administration School in July 2004. His dissertation was guided by Prof. Fátima Bayma de Oliveira, a Doctor in Education. The aim of the work was to identify and analyze the behavior of the chief historical and institutional factors that, in some way, have contributed to the formation of the current Corporate Governance mechanisms implemented by PREVI in relation to the companies in which it has material investments.

- Ribeiro de Jesus arrived at the conclusion that the PREVI Corporate Governance mechanisms were formed gradually, and arose due to the increased volume of significant share investments and to the increased number of seats held on boards of directors and audit boards.

- During the course of this work, the following eight relevant Corporate Governance mechanism points were identified:

1) 1991 – PREVI invests in the capital of companies and increases its presence on boards. It takes part in the first Brazilian privatization auction and acquires the right to recommend an USIMINAS board member. (Editor’s comment: the first board member nominated by a Brazilian pension fund);

2) 1993 – PREVI’s new board is elected and, among other measures, promotes the implementation of Corporate Governance in investee companies;

3) 1995 – for the first time a seminar for board members is given by the consulting firm of LCV Governança Corporativa, to commence coordinated action in recommending members to the boards of its investee companies. This same firm then advised PREVI on drawing up its first board member recommendation guidelines, and the formation of the Monitoring and Evaluation Committee, the forerunner of today’s Investment Management Department;

4) 1997 – PREVI’s new bylaws create the Investment Board, in charge of GEPAR (Securities Investments Management), whose duty is to “monitor and evaluate the performance of companies” and which replaced the Committee;

5) 2000 – The PREVI Corporate Governance Model is formed under the guidance of the Dom Cabral Foundation and is approved by the PREVI Board;

6) 2001 – the presence of a Tax Director indicated in December 2003 by the Complementary Pensions Secretariat, and of the Intervener in mid-2002, impact PREVI administrative actions;

7) 2002 – In August, Nieto Auditores e Consultores are contracted to advise on the implementation of the PREVI Corporate Governance Model. The work is only concluded in February 2004. GEGOV (Corporate Governance Management) is created in December 2002;

8) 2003 – as part of PREVI’s strategic planning, the new board members, appointed by Banco do Brasil under the Lula Government, establish compliance with Corporate Governance practices in investments as a method of adding value and maximizing returns of invested capital.

- Ribeiro de Jesus also believes that, “in relation to Corporate Governance practices in investee companies, PREVI’s organizational procedures have undergone a hands-on apprenticeship, without the aid of pre-defined models to direct their actions.”

- A summary of Ribeiro de Jesus’ dissertation, based on a text selected by the XXVIII EnANPAD (National Administration Research Association) Meeting held in September 2004 in Curitiba, can be found in the Technical Material section of the LCV website (www.lcvco.com.br)

- The content of Ribeiro de Jesus’ dissertation is fully aligned with the observations of this editor, in his privileged role as a member of the Brazilian Corporate Governance environment, during the many years in which he was a member of boards of directors. In other words, we can appreciate the crucial importance of the role played by PREVI and still carried out in its capacity as shareholder of Brazilian companies on the growth of Corporate Governance in this country. In our opinion, this importance derives from three basic factors: its vast propensity for long-term investments in its capacity as a pension fund; the political desire of its directors to exercise, in the name of PREVI members, its true owners, the Fund’s rights as a company shareholder, and its entitlement to recommend a growing number of board members of its investee companies, where, from indicating a single board member in 1991, today it boasts the unusually high number (unusual even by global standards) of 229 titular board members, the majority of them the first external members in a group of controlling shareholders, in a capital market, noted for its excessively concentrated position in control terms.

- In this year-end closing edition, on its 100th anniversary I pay homage to the important role played by PREVI in developing Corporate Governance in Brazil.

IBGC (Brazilian Institute of Corporate Governance).

- As happens every November, this year the IBGC held its congress in Săo Paulo. Now in its fifth year, this has become the leading Latin American event dedicated to the topic of Corporate Governance. Once again it has surpassed its attendance records: 360 attendees.

- It is worth quoting the short retrospective talk given by the IBGC’s ever-active secretary-general, Heloisa Bedicks, during the last presentation of the year. The IBGC closes 2004 with 555 individual members, 43 corporate members, and ten sponsor members. Eleven presentations were given in Săo Paulo, four in Rio Grande do Sul, and four in Rio de Janeiro. Two Debate Forums were held in Săo Paulo and a further two in Rio de Janeiro. Another record was broken by the nine in-house courses given in companies. As part of its mission to “train professionals to qualify for boards of directors, audit, advisory, and other boards), in 2004, the IBGC gave open courses to 576 individuals, which now total 1,500 professionals trained since its foundation. In administrative terms, the IBGC’s physical space and staff have both doubled during the year. Lastly, it comes to the end of the year with fifteen technical committees and sub-committees, involving the work of 160 members, all of them on a voluntary basis.

- A last reminder for the January 2005 presentation, which will be given on February 3rd. The speaker will be Mark Mobius, a pioneer in emerging market investments, and responsible for administering US$13 billion in a number of different countries. Author of many books on investments, Mobius has become actively involved in the Corporate Governance of the companies in which he invests, and was considered one of the “ten best Asset Managers of the Twentieth Century” in a survey carried out by the Carson Group in 1999. The event will be held at the Gran Meliá Mofarrej Hotel, Al. Santos, 1437, Săo Paulo and enrollments can be made on the following telephone numbers: 11-3043.7008 / 7009 or by e-mail: ibgc@ibgc.org.br.

Corporate Governance in “the Brigadier’s Sky”

- GOL Linhas Aéreas Inteligentes, the only Brazilian airline operating on a low-cost, low fare basis acquired 22% of the Brazilian market over only three and a half years of operations. On December 22, 2004 it took off into the global market when it inaugurated its first international flight to Buenos Aires. Despite the crisis that hit many Brazilian and international airlines, GOL just continues to grow. In the month of its first international flights, the airline confirmed its purchase of four new Boeing aircraft, to be delivered in 2006. With these acquisitions, the company closes the year with total orders for 21 aircraft with Boeing, as compared with its initial projection of nineteen. The company has a purchase option, as yet unconfirmed, on a further 22 aircraft, a total loan operation of US$3.4 billion with Eximbank.

- This corporate success foresaw or enabled GOL’s easy access to the capital market. In June 2004, it went public at BOVESPA (Săo Paulo Stock Exchange) and at NYSE. And since then, despite its recent arrival, it has served as an excellent example to longstanding companies in the Brazilian capital market, by implementing stringent Corporate Governance policies. This started with its adherence to Level 2 of BOVESPA’s Corporate Governance Practices Policy, achieved through its level of transparency in relation to the market. This alone earned the airline a finalist position in the Anefac-Fipecafi-Serasa Transparency Trophy, and by the professional qualities of the independent members of its board of directors, Álvaro de Souza, Antônio Kandir, and Luiz Kaufman.

- That most ruthless of judges, the capital market, has demonstrated its satisfaction with GOL’s strategic and operational results, and the quality of its Corporate Governance practices. Since its stock exchange debut on June 24, 2004, the airline’s shares have increased in value by sixty-eight percent (68%) as compared with the IBOVESPA of twenty-five percent (25%) for the same period.

Is accountability’s hour approaching?

- It is a well-known fact that Corporate Governance as it is understood today was first introduced in the US and in the UK. It is based on the three pillars of transparency, equity, and accountability and, recently incorporated a fourth pillar – corporate accountability. When Corporate Governance first began to be implemented, the US capital market was concerned with corporate transparency, mainly demanded by market agents. This preoccupation was later transferred to the equitable treatment of all shareholders, demanded by market regulating bodies. It was only with the growing trend to separate management from ownership that the market agents realized that the Agent Theory, the theoretical basis of Corporate Governance, should be stringently practiced. Thus, since they were accountable to the regulating agents, in other words, the shareholders, the regulated agents, i.e., senior management and even board members had to render accounts to the former. It is safe to say that, of the three original and great Corporate Governance concepts, accountability is the last of these great ideals, and must be firmly implemented in the market. It is the last frontier of traditional Corporate Governance values to be marked out. UK and US institutional investors, in that order, particularly pension funds, have played a crucial role in showing management and even board members that they must be accountable to the real “owners of the money”. A number of Corporate Governance scholars believe that Corporate Governance arrived to return power to the shareholders, a power that, after the separation of management and ownership, was forfeited to senior management. In addition to this increasingly successful institutional investor movement, note should be taken of the as yet immeasurable effects of the Sarbox Act that, besides establishing clear responsibilities and severe penalization of senior management, will enforce accountability.

- And what of Brazil in this context? A recent article by Roberto Teixeira da Costa, one of the first and always up-to-date Corporate Governance authority, takes an inspired approach to the topic of accountability that, in Portuguese Corporate Governance terminology becomes confused with rendering accounts. Based on the CVM’s (Brazilian Securities Commission) decision on the Banco Nacional case, where businessman Marcos Magalhăes Pinto, majority shareholder, former Chairman and CEO and Arnoldo de Souza Oliveira, former vice-CEO received the maximum penalty applicable to accounting fraud between 1987 and 1995. On commenting on the statement of the former Banco Nacional CEO who, in his own defense, argued that the preparation or disclosure of the bank’s financial statements was not his responsibility and that, accordingly he did not contribute to the fraud, Teixeira da Costa categorically stated that it is “unacceptable for the CEO of a corporation to use arguments of this nature in his defense”. He further pointed out that, with this statement, Magalhăes Pinto was, to all intents and purposes, admitting that he had not performed his role adequately and properly, since the pretext of lack of information was indefensible. Interestingly, later on Teixeira da Costa quotes Joseph E. Stiglitz, who also, in a previous article on this topic and discussing the Enron case entitled “The Boss is Accountable” enquires, “if the CEO isn’t accountable, who is?”. Teixeira da Costa answers Stiglitz’s question by stating that, not only the CEO but also the entire board of directors of a corporation have the duty to always be fully informed of all legal acts and facts of the importance of those that occurred in Enron and Banco Nacional.

- Roberto Teixeira da Costa’s article “The Responsibilities of the Board of Directors” is reproduced in full in the Technical Material section of the LCV website (www.lcvco.com.br)

Another good example of Banco Itaú’s Corporate Governance.

- Banco Itaú, which celebrates 60 years of very successful activities in 2005 and ranks in second place among Brazilian banks, is a Corporate Governance example in the Brazilian market. It is this newsletter’s policy to publicize the more important examples and now we shall look back. Our March/April 2001 edition announced that, for the first time in its 56 years of business, the Bank had elected two professionals to its Board of Directors who had no links with the controllers’ families, nor were they members of the Bank’s executive management nor staff members. In early 2002, the March/April newsletter recorded that the Bank’s controlling shareholders had surprised the market by extending tag-along rights, partially guaranteed to its minority common shareholders, to the preferred shareholders. This decision was in line with the principle of equitable treatment of all shareholders. And now, the Bank’s good Corporate Governance example relates to a highly apposite matter in today’s context: the timely and accurate disclosure of information to the market. In an unusual communiqué to the Brazilian market, Banco Itaú took the initiative of announcing that, in view of its responsibility to provide “the information demanded by capital market to be given agents in a satisfactory and transparent manner, thereby enabling democratic access by all”, would reclassify its financial statements for the third quarter of 2004, to ensure a clearer comparison between its own results and those of its competition.

- And meanwhile, in the cradle of Corporate Governance,

Donald Duck was naked.

- Thanks to Denmark’s Hans Christian Andersen, the world is familiar with the story of the king who hired two confidence tricksters to make him some new clothes. These bogus tailors succeeded in convincing the king and his court that only intelligent people could see these new garments, and actually made no clothes at all. Not a soul dared to expose the truth of the matter for fear of being thought stupid. All went very well until the day the king paraded his “new clothes” in public and, after an initial stunned silence in the crowd, a little boy yelled, “The king is naked!” thereby making a fool of the king, his court, and all his subjects who had been fooled by the con artists. Now the story has repeated itself, this time involving a personage who so well represents the global amusement empire, none other than the ever-popular Donald Duck, created by Walt Disney, whose memory did not deserve this.

- Now in its final lap at the Delaware Supreme Court, more specifically in the hands of Judge William B. Chandler III, is the case brought nearly ten years ago by investors alleging the negligence of the Walt Disney Company Board of Directors in 1995, by deliberately ignoring the interests of the shareholders in approving Michael Ovitz, who had no qualifications for this position, as the company’s CEO, based solely on the fact that he was “a partner and longstanding friend of the then Chairman of the Board, Michael Eisner”. According to Graef Crystal, an expert in celebrity remuneration packages, this was the most highly paid contract in the corporate history of the United States. Proof of this is the fact that Ovitz was contracted in October 1995 and dismissed in December 1996 with a golden handshake of US$140 million.

- There is no doubt that these other board members were guilty of omission or, possibly, in the case of some of them, of collusion, in relation to this irresponsible appointment and, particularly, in view of the fraudulent negotiations between the Chairman of the Board and a candidate for the company’s most important executive position.

- As the case continues in the US courts, the business community and the general public are becoming increasingly aware of the disgraceful quality of the Corporate Governance practices in place at that time at the Walt Disney Company.

- The analogy here with Hans Andersen’s story is that, even before Ovitz was contracted, a few market agents had begun questioning the corporation’s Corporate Governance practices. Nobody paid the slightest attention, so a group of investors played the role of the child in the story and shouted to the world that “Donald Duck was naked.”

The most powerful Executive and the most admired Executive

- Recently the international press announced the name of the most powerful executive in Europe. The Financial Times and the FT Deutschland elected the CEO of Nokia Network, a cutting edge technology company with over 15 thousand employees and sales of close to US$8 billion, Finland’s Sari Baldau, (49).

- In turn, the world’s most admired executive, according to the ranking prepared seven (7) years by the distinguished consulting firm PricewaterhouseCoopers (PwC) is Brazilian Carlos Ghosn, the CEO of Japan’s Nissan Group. In May 2005, he will combine this position with that of the CEO of France’s Renault.

- What attracts the most attention in the Corporate Governance context is that administrative geniuses, such as these two, no longer combine their CEO position with that of Chairman of the Board. The tycoon era of individuals such as Jack Welch and many others who reigned supreme in their corporations, is at last over.

Once again, and very suddenly, McDonald’s is involved in the succession of its CEO

- The March/April 2004 LCV Newsletter editorial covered the unexpected succession to the position of McDonald’s CEO, sixty-year old Jim Cantalupo, who died of a massive heart attack in April. The editorial commented favorably on the efficient manner in which this succession was handled since, at the time, the Board of Directors had an updated succession plan, an unusual feature in most companies. By a whim of destiny, less than a year later, the Board once again had to deal with a transition process due to the death from cancer of its new CEO who, in April, had substituted Cantalupo, Australian, Charlie Bell, the first non-American to head this giant fast food multinational. This time, the transition was not unexpected and, once again, the Board was ready to rapidly reach a definitive decision. The organization’s employees, franchises, investors, and the market in general were relieved with the appointment of veteran executive, vice-president Jim Skinner, with his in-depth knowledge of the company and full capacity to guarantee the continuity and implementation of company strategies.

Best Corporate Governance Practices

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

1 OWNERSHIP

1.6 Acquiring Control

The offer to buy shares resulting in the transfer of controlling ownership should be offered to all owners, not just those who are part of the controlling group of the company. All owners should have the option of selling their shares under the same conditions. If the purchaser pays a control premium, this should be shared among all owners. If the buyer has no intention of buying all the shares, the bid should equally be shared among all owners. The price for which control is being sold should be transparent. If the entire controlling block of shares is sold, the buyer should make a public bid to all owners under the same conditions enjoyed by the previous controller (tag along).

1.7 Leaving the Company

The bylaw or article of association of the company should clearly set forth the rights of an owner to leave the company and the corresponding conditions that should be based on economic value. All company transformation (including incorporation, split-up, merger, or going private) should meet the interests of the organizations involved. The conditions for owners to leave, or for the company to go private should be clearly stated and detailed in the bylaws/articles of association, and should never be below the economic value.

1.8 The use of Insider Information

The use of insider information, not yet disclosed to the market and protected by secrecy, should be prohibited to any of the persons mentioned in the following paragraph, as it could

bring unfair advantage to the insider or to third parties while trading shares in the insider’s own name or on behalf of a third party. The company should have a relevant information disclosure policy in place, in addition to rules establishing times when share trades by insiders with access to privileged information are expressly forbidden. The adherence to this policy of information disclosure and the prohibited use of insider information shall be mandatory to all owners, Directors, Officers, Audit Board members, members of technical or advisory units, as well as persons who, on account of their positions, are deemed insiders with access to confidential information. The company should adopt controlling mechanisms to enforce these rules.

1.9 Arbitration

Conflicts between owners, or between owners and the company, should preferably be settled by arbitration. This should be included in the bylaws and, if possible, individually signed and executed on a separate document.

1.10 The Family Council

Family companies should consider setting up a Family Council. A Family Council is a small group set up to discuss family matters and organize expectations regarding the company. The main responsibilities of the Family Council include: drawing the line between family interests and company interests; preserving family values (history, culture, shared vision);

establishing and agreeing on policies to protect company property, growth, diversification, and securities and real property management; succession, property transfer and inheritance planning; viewing the company as a factor of aggregation and family continuity; tutoring family members regarding succession within the company, vocational aspects, professional future, and continuing education; and establishing criteria to appoint members to make up the Board of Directors. Family Council objectives should not get mixed up or confused with those of the Board of Directors, which are company-oriented.

1.11 Free float

Publicly-held companies should make an effort to keep in circulation as many shares as

possible, and support their free float, to enhance their liquidity when trading.

Free float (shares in circulation): Number of shares available for trading on a capital market, i.e., all the shares issued by a company, except: (i) those held by the Controlling Shareholder, his/her spouse, companion, and dependents included as deductions in his/her annual income tax return; (ii) treasury shares; (iii) held by company-related parties, as well as other companies in the same group; (iv) held by the parties related to the controlling shareholder, as well as companies in the same group; and (v) special preferred shares granting their holders specific political rights exclusive to the privatization authority.

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