LCV

NEWS ABOUT CORPORATE GOVERNANCE - March-April/2005

Year IV – No. 39

Corporate Governance News

Editor: Luciano Carvalho Ventura

Editorial

At last, Good Corporate Governance in all Brazilian pension funds.

In the broadest sense, all institutions, regardless of their nature, among them governments, companies, non-governmental organizations, religious organizations, cooperatives, and pension funds, need a specific Corporate Governance system. This system is simply a set of practices in place to improve operating performance and stakeholder relationships. The importance of effective Corporate Governance in a company is a direct function of the importance of the respective organization to the local community. Within this context, over the last few years, so important has the Brazilian Pension Fund System become, that the way in which each pension fund is governed, now warrants special attention.

During the opening quarter of 2005, total estimated Brazilian pension fund (close to 400) assets were in the region of R$320 billion (approximately US$120 billion) or less than 20% of the country’s GDP, a negligible percentage when compared with the world’s more developed economies. But it serves to underscore the potential of this sector given favorable conditions and these are in the process of being formed.

In addition to their sizeable and constantly increasing volume of assets, today, Brazilian pension funds are paying out over R$1.2 billion (US$450 million) per month to approximately 600 thousand Brazilians. There is no doubt of the importance of these pension funds to Brazil both today and even more so in the near and distant future. Just as a comparison, at the end of the first quarter of 2005, the resources involved in all 390 publicly traded Brazilian Corporations and where practically the entire improved Corporate Governance efforts are concentrated, amounted to a market value of US$348 billion. This was at a time when, as pointed out above, total Brazilian pension funds amounted to US$120 billion, i.e., thirty-three percent (33%) of the total value of all publicly traded corporations. Alternatively, if we compare the total reserves of all Brazilian pension funds with the market value of the fifty (50) companies in the Brazilian capital market with a Corporate Governance policy in place, as members of the New Market and Bovespa’s (São Paulo Stock Exchange)Level One and of Level Two, we see that these reserves represent eighty- six percent (86%) of the market value of these companies that jointly amounted to R$372 billion (US$140 billion) at the close of this first quarter.

The question here is, does this substantial volume of funds involving a universe of one million, eight hundred thousand active members, 600 thousand beneficiaries, and four million, two hundred thousand dependents, given that active members and beneficiaries are similar to corporation stockholders, not require a good Corporate Governance system? Of course it does. It is for this very reason that many pension funds voluntarily apply good governance.

The latest development is that, as a result of Resolution No. 13, issued by the Complementary Pension Management Council on October 1, 2004, good Corporate Governance has now become compulsory for “all and every” Brazilian pension fund. This Resolution established governance and internal control principles, regulations, and practices to be followed by private complementary pension funds, and set time limits for such compliance. In other words, by March 31, 2005, all Brazilian pension funds must have their own plan and time schedule complying with the chief principles, regulations, and practices of governance, management, and internal controls covered by this Resolution. These should consider the size, complexity, and inherent risks of each fund’s benefits plans, and implementation must be concluded by December 31, 2005.

It would appear that this resolution took into consideration many aspects of the Sarbox Act. It is divided into four chapters, namely, governance structure, risk, and monitoring roles, disclosure of information, and manifestation by the shareholder appointed audit board. It also transfers increased accountability to pension fund directors in their management capacity. This change in government position is accompanied by a severe penalization system for these directors, under the Disciplinary Structure now regulated by Decree-Law No. 4942 enacted on December 30, 2003.

The various topics of Resolution No. 13 require multiple specialties in their treatment and, so far only one company in Brazil, specializing in actuarial consulting services has taken the trouble to enter into association with consultancies specializing in Corporate Governance. This was Watson Wyatt, which entered into association with LCV Governança Corporativa and Proxycon. These organizations have already begun rendering consulting services to small, medium, and large pension funds, in relation to the new environment created by Resolution No. 13 of October 1, 2004.

Lastly, a recommendation for all those interested in applying Corporate Governance in other Brazilian companies: observe and examine the feasibility of measuring the level of Corporate Governance in publicly traded corporations, with particular attention to the development of the New Market and the two other Bovespa customized Corporate Governance levels, and compare these with the level of Corporate Governance practiced by all Brazilian pension funds during the first quarter of 2006.

IBGC – Brazilian Institute of Corporate Governance.

The IBGC held its Annual General Meeting in São Paulo on March 31, 2005. The agenda included approval of the 2004 Annual Report and election of the Board of Directors. The following individuals were elected for a one-year term of office, to fill the nine (9) vacancies available: Eduardo Câmara, Fernando Alves, Francisco Mesquita Neto, João Laudo de Camargo, João Verner Juenemann, José Guimarães Monforte, Maria Helena Santana, Mauro Rodrigues da Cunha, and Paulo Conte Vasconcellos. The elected members met immediately after the vote count and chose José Guimarães Monforte as Chairman of the Board and Fernando Dantas Alves Filho and Maria Helena Santana as Deputy Chairmen. The Annual Report was unanimously approved and was sent, firstly via email and subsequently in printed hard copy to all IBGC members and the full text can be found in the IBGC website (www.ibgc.org.br). We take this opportunity to highlight certain topics in the Report:

The issue of the third edition of the “IBGC Code of Best Corporate Governance Practices“; Membership increase of 29%; Formation of a second IBGC Chapter, the Rio de Janeiro Chapter; Ongoing implementation of the Institute’s Strategic Planning; Increase in associates on Corporate Governance related projects; and, lastly, jointly with Bovespa and the CVM (Brazilian Securities Commission), promotion of the Tenth Annual International Corporate Governance Network (ICGN) Conference in Rio de Janeiro.

International Corporate Governance Network - ICGN

Speaking of the ICGN, this year’s annual conference will be held in London from July 6 through 8, the core topic being “Constructive Dialog for Long-Term Promotion of Value”. Two major Corporate Governance celebrities will speak on the opening panel: the UK’s Sir Adrian Cadbury and Ira Millstein from the US. It is a fact that the annual ICGN conference is considered the most important Corporate Governance event in the world. This is chiefly because it brings together, among others, institutional investors of the order of CalPERS (California Public Employees Retirement System) and TIAA-CREF (College Retirement Equities Fund) and influential professional associations such as the Council of Institutional Investors in the US, Cadbury’s Association of British Insurers, and the UK’s National Association of Pension Funds. Another major attraction is the face that recent estimates show the assets managed by ICGN members were in excess of US$10 trillion. This figure speaks for itself and highlights the degree of magnitude and strength of the IGCN in financial markets worldwide. Further information on this event can be found in the ICGN website (http://www.icgn.org).

Bovespa (São Paulo Stock Exchange) continues to promote good Corporate Governance.

There is absolutely no doubt that, of Bovespa’s many projects aimed at improving the degree of Corporate Governance in publicly traded Brazilian companies, the creation of the New Market and of Corporate Governance Levels 1 and 2, have produced the most practical results. It is worth recalling that on creating these incentives, Bovespa also took the time and trouble to create a mechanism for measuring the performance of the stocks of companies that are steadfast in their compliance with these unique Corporate Governance practice criteria. And, in 2001, Bovespa formed the IGC (Index of Special Corporate Governance Shares) that today includes the papers of no less than fifty-one (51) companies. The performance of this Index from June 2001 to April 2005 of one hundred and forty-five percent (145%) as compared with the Ibovespa performance of seventy-one percent (71%) for the same period, is yet further evidence that investors willingly pay a premium for the stock of companies with good Corporate Governance practices in place, or that companies that are an attractive investment opportunity also implement Corporate Governance practices. Regardless of the reason, what interests the investor is increased share value, as compared with the rest of the market. Presently, Bovespa is examining the possibility of launching a new Corporate Governance related index. This would include one of the most solid minority shareholder rights, tag-along rights, the right to receive the same amount or percentage as that offered to the controlling shareholder, in the event of the sale of company control. This is the method identified by Bovespa to bring the market’s attention to companies offering tag-along rights higher than those currently required by Brazilian Corporation Legislation (80% for common stock) and that, since they do not meet the other New Market Levels 1 and 2 prerequisites, do not have this valuable minority shareholder right. For the reader to have some idea, today, there are 48 companies traded on Bovespa offering tag-along rights higher than the legally required levels. According to market experts, this new index that would involve only companies offering this right at a level higher than legally required, would encourage new companies to implement this practice. In conclusion, we examine the conclusions reached on the study carried out by FEA-USP Professor Alexandre di Miceli of the (Faculty of Business Administration and Economics of the University of São Paulo), showing that, of the 160 companies listed with Bovespa, the share prices of those offering tag-along rights to their minority stockholders, are significantly above average in the Brazilian market. Miceli further asserts the existence of a close correlation between tag-along and other good practices, such as transparency of information, and an independent board of directors

Excellent results in the quasi one-way street of social responsibility

Social or corporate responsibility, the fourth pillar recently incorporated into the other three Corporate Governance pillars, namely transparency, equity, and accountability, has increased in importance in the business world. Its practice is regarded by the majority of market agents as being capable of adding further value to companies.

According to the IBGC, the board of directors and senior executives of a company must strive for the longevity of the company and focus on the long-term, thus incorporating community and environment related considerations into defining their business and operations. This stated, what can be said about the outstanding results of the so-called “vice funds” as compared with socially responsible funds, that have recently been front-page news in the specialized press?

Over the last twelve months, the Vice Fund, managed by Dan Ahrens, now has a net worth of US$500 million, and invests at least eighty percent (80%) of its capital in the stock of companies that, according to some exceptionally severe criteria, are deemed to be socially “irresponsible” (organizations such as casinos, distributors of alcoholic beverages, cigarettes, weapons, etc.), and recorded a performance of twenty percent (20%), the highest increase among the 84 funds monitored by Bloomberg. These funds have assets of at least US$500 million and concentrate their investments in companies generating higher than average profits. This performance far outranked that of the Sierra Club Stock Fund, the unchallenged leader in the socially responsible sector, which grew by a mere six point seven percent (6.7%) over the same period. To add insult to injury, Amy Domini, the investment management company that succeeded in obtaining US$2 billion in the market with its proposal to avoid companies involved in alcoholic beverages, tobacco, gambling, and weapons in its share portfolio, Domini Social Equity Fund (Amy Domini’s chief investment fund) recorded a performance of only three point nine percent (3.9%) over the same period. What conclusions can be drawn from this evidence? Quite a number, if more data were available. Since more detailed information is not accessible, a factually based supposition could be formulated: that investors still do not attribute as much value to the corporate responsibility pillar as they do to the other Corporate Governance pillars of transparency, equity, and accountability. It is quite possible that, very often, these socially “irresponsible” companies that compose the “vice funds’” share portfolio implement better Corporate Governance practices than the socially responsible organizations, thus offering direct benefits to their shareholders. Not to mention, of course, the fact that being or not being socially responsible does not necessarily have any correlation with a company’s potential to generate profits, at least, in the short-term. Or, as Ahrens says, “No matter what the market does, people will always drink, smoke, and gamble”.

The important role of the Board of Directors in any Governance System

A company’s Governance System is based on a number of pillars including, among others, the annual general meeting, the board of directors and its technical committees, the CEO, and the auditors. Each one of these pillars is crucial to the company, although the board of directors should be regarded as the core of any Governance System. As a rule, whatever Governance System rating method is used, any Corporate Governance Evaluation System will give a high grade or special attention to the company’s board of directors. Thus, having a good board of directors seems to result in half the battle being won in relation to a good level of Corporate Governance. In an interesting article in the specialized press, entitled “The Ideal Board of Directors”, Paulo Conte Vasconcellos, a brilliant professional in the new generation of independent board members, begins by calling our attention to the need for all boards to evaluate their own performance, by answering seven basic questions. He further recommends that in the event of a negative answer to any question, the election of a new board of directors should be considered. He goes on to list the duties of the board of directors, which, to his mind, should be: to monitor, to decide, and to advise. Vasconcellos also recommends that less time should be wasted in meetings analyzing past performance, and more devoted to discussing the future, chiefly, plans and actions strongly impacting the company. He concludes the article by recommending that full advantage be taken of the board of directors by utilizing each member’s time more productively, providing quality and timely information, developing improved processes for monitoring company operations and its executives, and most important of all, by holding more effective meetings. Vasconcellos’ articles can be found in the Technical Material section of the LCV website (www.lcvco.com.br)

Insecurity in the insurance segment

US corporate scandals continue to flourish and, this time involving the largest insurance company in the world, the American International Group – AIG. The company publicly announced some irregularities in the preparation of its financial statements. And this was AIG, hitherto deemed by most US analysts to rank among the most irreproachable corporations listed on the New York Stock Exchange. It all began on March 14, 2005, with the fall of Maurice “Hank” Greenberg as CEO, after a well nigh absolute reign of forty years, over the jewel in the crown of the global insurance market. The company’s official statement made immediately after the departure of one more corporate tycoon, included a plea to the US authorities to delay disclosure of its financial statements audited in 2004, and advising there and then that its net equity would be reduced by two percent (2%), a figure that could be considered on the low side, were the company’s net worth not US$82.9 billion and the amount of the reduction a considerable US$1.7 billion. In this same written statement, the company said that some suspicious transactions “appear to have been structured for the sole and chief purpose of generating a desired book result”. Subsequent investigations showed that the reduction in net worth could be as much as US$2.9 billion and that compensations to certain AIG executives were deferred and not recorded as expenses in one of the Group’s private companies.

And to close, here is the comic aspect of the story. The office of the now former AIG CEO was decorated with a Remington sculpture, a nineteenth century neo George III desk, Chinese vases, and the famous Van Gogh painting, “Brook between the Bushes”, this last valued at US$6 million. After his dismissal, Greenberg sent around a moving truck to remove these and other objects from the AIG head office, such as letters from his mother, his Maltese hound’s medical records, bath towels, oral hygiene equipment, etc. Upon the advice of the company’s legal counsel, the truck returned empty. Greenberg was furious but also naïve, to the point of suggesting that the stalemate was caused by a strange variety of arbitration. This was how he described the opinion of the man who, during the fifties, was personal assistant to the now deceased founder of AIG, and who undertook to state in good faith which items he believed really belonged to Greenberg. With the obvious exception of personal possessions, the remainder is under litigation and has become an intrinsic part of the one of the most complex divorces in the recent history of US corporations.

The world’s most admired executive continues flying even higher

In late April 2005, the world’s most admired executive, according to the ranking prepared for the last seven (7) years by the eminent consulting firm, PricewaterhouseCoopers (PwC), Brazil’s Carlos Ghosn, CEO of the Japanese Group Nissan was appointed CEO of the French company, Renault. He will retain both positions, dividing his time between Japan, France, and the US. This change in the command structure of Renault-Nissan had been decided since 2003, and Louis Schweitzer, Ghosn’s predecessor, will remain as Chairman of the Board of Directors. The résumé of this brilliant fifty-one year old, the son of Lebanese immigrants, born in Porto Velho, Rondônia, Brazil, shows his remarkable achievement of multiplying by five times the value of Nissan in the stock market, of having rescued the company from near bankruptcy, and guiding it to one of the world’s most lucrative positions. His new challenge will be to place the Renault-Nissan alliance among the three largest automobile groups in the world.

As mentioned in our previous newsletter, what most attracts attention in the context of Corporate Governance is that administrative geniuses, such as Ghosn, no longer combine or do not need to combine, their CEO functions with that of Chairman of the Board.

In fact, with each passing day, this trend becomes more firmly entrenched. A recent article in The Economist, entitled “Keeping two positions united and swimming against the tide” states that, in the United Kingdom, the separation of these two positions has become standard procedure over the last ten years. In France, where this is less common, the article discusses the recent separations of these two positions in companies of the size of Alcatel, L’Oreal, Carrefour, and Renault, and points out that, in Switzerland, this is standard policy in most large companies. The article closes with the advance of this trend in the US, the country that is perhaps the most reluctant to adopt this excellent and important Corporate Governance practice. In 2002, one quarter of the Fortune 500 companies had split these two positions. This proportion now stands at one third. It is a lethargic but, most certainly, irreversible change.

Best Corporate Governance Practices

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

2. The Board of Directors

2.06. Internal and external Directors

There are three kinds of directors:

- independent (see 2.16)

external (directors who do not work in the company, but are not independent)

internal (directors that are officers or employees)

The Board of Directors should supervise Officers and Management. Supervising yourself is a typical conflict of interest situation. Therefore, the Owners should avoid electing the CEO, Officers and other Management personnel to the Board of Directors.

2.07. Executive sessions

The Board of Directors evaluates continuously the CEO, Officers and top Management. In order to do this without constraints, the independent and external directors should meet regularly in the absence of these people. The Chairman of the Board of Directors should subsequently give a feedback to the CEO, Officers and top Management.

2.08. Invitations to attend Board meetings

Key people from the company or technical assistants may occasionally be invited to the Board meetings in order to give information and/or discuss their activities.

The CEO should be invited to attend the whole meeting with the exception of the executive session.

2.09. Evaluation of the Board and the Individual Directors

A formal evaluation of the Board and each of the board members should be made every year. The evaluation method should be adapted to the circumstances of each company.

2.10. Director qualifications

Every director should:

be trustworthy

be capable of reading and understanding financial statements

have no conflicts of interest

have time available

be motivated

be aligned with company values

be knowledgeable about the codes of best practice of corporate governance

The following experiences and knowledge should be present among the Directors:

experience of good boards, i.e., known for their excellence

experience as Chief Executive Officer

experience of crises management

knowledge of finance

knowledge of accounting

knowledge of the company’s business

knowledge of local and international markets

have strategic vision

connections of interest to the company

A Majority of the Board Members should be independent (see 2.16.). The Board, as a whole, should be characterized by diversity of knowledge, experience and background.

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