ENRON, PARMALAT? NEW CHALLENGES TO CORPORATE GOVERNANCE
REGULATORY SUPERVISION – THE IMPACT IN BRAZIL
AND
Walter Douglas Stuber and Vera Lucia Pereira Neto*
I – INTRODUCTION
The purpose of this paper is to present an overview of Enron, Worldcom and
Parmalat scandals and discuss the impact of the main worldwide consequences
thereof on Brazilian Companies particularly as far as corporate governance is
concerned. 1
II - OVERVIEW OF ENRON SCANDAL
In December 2001 the newspapers announced Enron’s Chapter 11 filings, one of
the biggest financial scandals in the corporate history of the US.
Enron was considered a US giant in the electric industry.
Enron’s executives were accused of accounting and banking fraud,
misrepresentation, inside trading and lying about the Enron’s financial situation.
Enron’s executives tried to show to its shareholders and investors the false
appearance of financial strength in a moment that Enron was already broken.
They tried to hide debts and increase profits artificially by means of irregular
accounting practices.
Millions of employees were laid of and investors saw the price of Enron’s shares
plunge down to cents. Enron’s executives though became wealth by selling their
shares before Enron’s real financial situation came to light.
One year before the scandal, Enron reported US$ 101 billion gross sales from
operations that ranged from oil tanker services to other investments.
*
Walter Douglas Stuber and Vera Lucia Pereira Neto are founder partner and associate lawyer
of Stuber -Advogados Associados, respectively. Both are Brazilian corporate lawyers.
This paper has been prepared for the program on “Enron, Parmalat? New Challenges to
Corporate Governance and Regulatory Supervision” organized by the International Financial
Services Committee to be held on October 14, 2004 for the American Bar Association, Section
of International Law Fall Meeting 2004.
1
Av. Pres. Juscelino Kubitschek, 1400, 2º andar - São Paulo - SP - Brasil - 04543-000
Telefone: 55 11 3702-9911 - Telefax: 55 11 3702-9983
World Wide Web: http://www.stuberlaw.com.br
Walter Douglas Stuber
Manoel I. T. Monteiro
Adriana M.Gödel Stuber
Pedro Anan Junior
Marcelo A. Nemer
Vera L. Pereira Neto
Analúcia L. O. C. Carloni
Fernanda dos S.Teixeira
Adriana S.de Figueiredo
Fabiola C. Keramidas
Fernanda G.de Lara Campos
Fabio Luis Florentino
Daniela Mastrorocco
Mareska T. Salge
Maria Beatriz Martinez
Cássio D.Mendes de Almeida
Roberta B. M. Hung Prado
Felipe Pagni Diniz
Renata B. Regino
Juliana G. Latorre
Vanessa Inhasz Cardoso
Renata de Oliveira Silva
Roberta Dias R. Queiroz
Jaime M. Machado Júnior
Tibério Graco A. Lérias
In July 2004, the US Bankruptcy Court approved Enron’s recovery plan. The
plan establishes payment of US$12 billion out of the approximately US$ 63
billion owing to most of the 20 thousand creditors of Group Enron.
The corporate name Enron disappeared. Of the remaining of Enron, 3 companies
were created. Two of them have not yet been sold: CrossCountry Energy and
Portland General Electric. The third company, called Prisma Energy
International is the controlling partner of distributor Elektro, which is present in
the State of São Paulo.
If those companies are not sold this year, as expected, US$ 11 billion will be
paid to creditors: 92% in cash and 8% in Prisma’s shares. If one or the two
companies are not sold, the creditors will receive less cash and more shares in
Prisma.
Enron’s regular independent auditing company was Arthur Andersen and after
the scandal, is lost credibility in the market and disappeared. Many of Arthur
Andersen’s offices in the US were acquired by Ernst and Young acquired and in
Brazil, by Deloitte & Touche.
III – OVERVIEW OF WORLDCOM SCANDAL (NOWADAYS MCI INC.)
In July 2002, Worldcom filed Chapter 11 bankruptcy petition, after
accumulating US$ 41 billion in debts and the balance sheet fraud of about US$
11 billion revealed.
Worldcom was the second largest US long-distance communication company. In
Brazil, Worldcom was the controlling shareholder of Embratel.
As with Enron, Worldcom’s executive tried to conceal debts and increase profits
artificially by way of irregular accounting practices in 2000.
After Worldcom admitting to have underreported US$ 4 billion in June 2002,
countless lawsuits for accounting fraud started to pour. After a while, the amount
involved in the scandal jumped to about US$ 11 billion and the debt hit US$ 41
billion.
Furthermore, Worldcom’s executives submitted false information to the SEC
(Securities and Exchange Commission) and many investors relied on that
information when deciding to invest in Worldcom.
After 21 months processing the Chapter 11 bankruptcy, MCI Inc. (former
Worldcom), eliminated US$ 74 billion of income before taxes.
2
The ownership of MCI Inc. was assigned to holders of securities, including to
Mr. Carlos Slim, controlling shareholder of Telmex, which purchased the
Brazilian Worldcom-controlled company, Embratel.
In May 2004, the Financial Group Citigroup made an out-of-court agreement
with Worldcom’s shareholders who will receive US$26 billion in exchange for
the waiver of the lawsuit brought against Worldcom. Holders of Worldcom
securities sued the Salomon Smith Barney Bank alleging involvement in the
Worldcom’s fraudulent actions, specially because they acted on the Bank’s
recommendations when acquiring securities.
IV – OVERVIEW OF PARMALAT SCANDAL
Parmalat Finanziaria SpA was the Holding Company of Parmalat Group, which
performed in the food industry in 30 countries. The controlling shareholder was
the Tanzi Family.
Grant Thornton (auditing company) issued an unqualified opinion to Parmalat’s
2002 balance sheet.
However, facts have shown that Parmalat’s 2002 financial report was false, as
confirmed by PricewaterhouseCoopers retained in December 2003 to check
Parmalat’s assets and liabilities.
PricewaterhouseCoopers concluded that Parmalat’s net assets were insignificant
and debts were underreported in Euro 14.5 billion.
Parmalat Italy is currently undergoing Chapter 11 bankruptcy and the proposed
recovery plan confirms operations in as low as 10 countries, as compared to the
30 presently: the US and Asian markets will be abandoned, and the LatinAmerican market will be kept partially.
In Latin America, Parmalat will try to keep operations in Colombia, Nicaragua,
and Venezuela.
Assets in Argentina, Dominican Republic, Ecuador, Uruguay and Paraguay will
be sold soon, Chile has just started the sale and Mexico will “probably” be sold.
The future of Parmalat Brazil is still uncertain. Parmalat Brazil filed for
composition with creditors and is to pay its creditors in two years: 40% of
credits in the first year and 60% of credits in the second year, at interest of 4%
per annum.
The headcount will decrease from 32 to 17 thousand, and further in the near
future.
3
Parmalat Italy has been busy suing (i) Credit Suisse First Boston for US$306.3
million and said it may seek more damage from the investment bank, (ii)
Deloitte & Touche and Grant Thornton, its former independent auditors, for
US$10 billion in a US Court in a bid to breach the protective walls that big
accounting firms have built to insulate operations in one country from missteps
in another, (iii) Citigroup Inc., of the US, in a New Jersey court in relation to
financial transactions that the world’s largest bank undertook with the dairy
company; and (iv) UBS AG of Switzerland and Germany’s Deutsche Bank AG
in Italian courts in an effort to recover fees that the banks earned for deals they
have arranged for Parmalat in 2003.
V – IMPACT OF ENRON, WORLDCOM AND PARMALAT SCANDALS
The major impact of Enron, Worldcom and Parmalat scandals worldwide
caused:
a) the application of new Corporate Governance rules;
b) the search for accounting harmonization/standardization; and
c) the enactment of the Sarbanes-Oxley Act (SOX Act).
In Brazil, the impact will be commented on ahead.
VI – IOSCO REPORT
In February 2004, the Technical Committee of Iosco (International Organization
of Securities Commissions), organization gathering the major securities and
exchange commissions worldwide, created a “task-force” to study Parmalat’s
mishap.
A preliminary report showed that the Parmalat and Enron scandals originated
from a wrong structural corporate governance in those companies, among others
factors.
Boards of Directors were accused of lacking independence from the Boards of
Officers, specially of not overseeing the corporate performance and approving a
series of transactions with interrelated parties, including transfer of assets to
executives and controlling shareholders.
Another allegation was that large banks, Parmalat’s main creditors, had a better
treatment than owners of debts instruments issued by Parmalat.
4
VII - CORPORATE GOVERNANCE IN BRAZIL
From July 7 to 9, 2004, Brazil hosted the most important corporate governance
event of the world: the 10th Annual Congress of the International Corporate
Governance Network (ICGN).
It was the first ICGN Congress to be held in an emerging country and was seen a
special reward for three decades of efforts in the search of continual
improvement and development of good business practices.
The local stock market is still relatively small when compared to the Brazilian
economy, which is among the largest economies on the planet.
Several local companies have closed their capital in recent years but a
considerable number of corporations with professional management – many of
them with American Depositary Receipts (ADRs) traded on the New York Stock
Exchange (NYSE) – have shown themselves to be increasingly welcoming of
the modern practices and more responsive to demands of minority shareholders
and stakeholders with different interests.
There are already 37 Brazilian companies listed on NYSE.
In Brazil, the Brazilian Institute of Corporate Governance (Instituto Brasileiro
de Governança Corporativa - IBGC)2 was founded in 1995 and is a nonprofit
entity focused on corporate governance to be created. Nowadays, IBGC is
recognized nationally and internationally as one a major player in the
introduction of corporate governance in Brazil.
The Code of Best Practices designed by IBGC had several releases, the last
(third one) being approved and published in March, 20043.
According to the IBGC, “Corporate Governance is a corporate managing and
monitoring system, involving relations with the Owners, Board of Directors,
Officers, Independent Auditors, and Fiscal Council. Good Corporate
Governance practices are geared to add value to a company, facilitates its
access to capital and contribute to its perpetuation.”
The term owners “also refer to shareholders, quotaholders, partners, members of
associations, etc.”
2
www.ibgc.org.br
3
www.ibgc.org.br/ibConteudo.asp?IDp=864&IDArea=945
5
The Sox Act had a decisive influence on the Code, which took into account the
close connection between the US and Brazilian Economies. But other documents
from the United Kingdom, Germany and South Africa were also considered.
The goal of the Code “is to provide guidelines to all kinds of companies –
publicly– or privately-held corporations, limited liability companies, service
providers and non-governmental organizations” to: (i) increase company value;
(ii) improve corporate performance; (iii) facilitate access to capital at a lower
cost (“access to capital” understood as the public or private offering of shares,
long-term loans, and even reinvestments of cash flow funds); and (iv) contribute
to the long term survival of the company.
Fundamental principles of modern corporate governance are enshrined in the
IBGC Code:

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 to 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 values.”
(Summary: Transparency institutes a coherent business culture with the “desire
to inform” instead of the “obligation to inform”, including intangible factors
besides economic-financial results);

Equity: “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.
(Summary: Equity ensures fair and equal treatment for all minority groups, be
they capital-related or other interested parties such as collaborators, customers,
suppliers and creditors)

Accountability: “Corporate governance agents should account for their
actions to those who 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 is defining businesses and operations of their company.
6
Corporate responsibility is a broader view of corporate strategy,
contemplating all kinds of relation 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.”
(Summary: Corporate responsibility is a broader vision of business strategies
covering all relationships with the community: job opportunities, training and
workforce diversity, encouraging scientific development and improving the
quality of life. Board members and executives should care for the continuity of
the organization, considering the social and environmental order when defining
business and operations strategies.)
The Code is divided into 6 sections (i) Ownership; (ii) Board of Directors; (iii)
Management; (iv) Independent Auditing; (v) The Fiscal Council; (iv) Conduct
and Conflicts of Interest.
A few years ago, the São Paulo Stock Exchange (BOVESPA)4 created three
levels of governance (Level 1, Level 2 and the New Market – “Novo Mercado”)
with an increasing order of requirements.
Thirty companies have already qualified for Level 15. Level 26 and the New
Market7 have been sporadically met bust most of the share issues projected for
2004 and 2005 are aimed at qualifying for the highest rank - which requires
4
www.bovespa.com.br
5
In August, 2004: (i) São Paulo Alpargatas S/A; (ii) Aracruz Celulose S/A; (iii) Banco Bradesco
S/A; (iv) Bradespar S/A; (v) Brasil Telecom Participações S/A; (vi) Brasil Telecom S/A; (vii)
Braskem S/A; (viii) Cia Fiação Tecidos Cedro Cachoeira; (ix) Cia Energética Minas Gerais; (x)
Cia Hering; (xi) Gerdau S/A; (xii) Gerdau S/A; (xiii) Metalúrgica Gerdau S/A; (ivx) Banco Itau
S/A; (xv) Itausa Investimentos Itau S/A; (xvi) Klabin S/A; (xvii) Mangels Industrial S/A; (xviii)
Cia. Brasileira de Distribuição; (xix) Perdigão S/A; (xx) Randon Participações S/A; (xxi) Ripasa
S/A Celulose e Papel; (xxii) Rossi Residencial S/A; (xxiii) Sadia S/A; (xxiv) Suzano Bahia Sul
Papel e Celulose S/A; (xxv) Cia Transmissão Energia Paulista; (xxvi) Unibanco União de
Bancos Brasileiros S/A; (xxv) Unibanco Holdings S/A; (xxvi) Cia. Vale do Rio Doce; (xxvii)
Votorantim Celulose e Papel S/A; (xxviii) SA Fábrica Produtos Alimentícios Vigor; (xxix)Weg
S/A.
6
In August, 2004: (i) All América Latina Logística S/A; (ii) Centrais Elétricas de Santa Catarina
S/A; (iii) Gol Linhas Aéreas Inteligentes S/A; (iv) Marcopolo S/A; (v) Net Serviços de
Comunicação S/A.
7
In August, 2004: (i) CCR Companhia de Concessões Rodoviárias; (ii) Cia. Saneamento Básico
do Estado de São Paulo; (iii) Natura Cosméticos S/A.
7
commitment to transparency, accountability and equal treatment to all
shareholders, in addition to more involvement of the audit council.
To BOVESPA, “the Novo Mercado is a listing segment designed for the trading
of shares issued by companies that voluntary undertake to abide by corporate
governance practices and disclosure requirements in additional to those already
requested by Brazilian laws and regulations.
The inclusion of a company in the Novo Mercado implies the adhesion to a
series of corporate rules, know generically as ‘good practices of corporate
governance’ which are more rigid than those required by the current laws and
regulations in Brazil. These rules, consolidated in the Listing Regulation,
increase shareholder’s rights and enhance the quality of information, commonly
provided by companies. Additionally, the creation of a Market Arbitration Panel
for conflicts resolution between investors and companies offers a safer, faster
and specialized alternative to investors.
The main innovation of the Novo Mercado, when compared to the current laws
and regulations, is that non-voting shares may not be issued. However, this is
not the only difference between what is required of listed companies at present.
In summary, the publicly listed company that participates in the Novo Mercado
has the following additional obligations:








The holding of public share offerings through mechanisms that favor
capital dispersion and broader retail access;
Maintenance of a minimum free float equivalent to 25% of the capital;
The same conditions provided to majority shareholders in the transfer of
the controlling stake will have to be extended to all shareholders (‘Tag
Along’ rights);
Establishment of a single one year mandate for the entire Board of
Directors;
The annual balance sheet to be made available in accordance with
USGAAP or IAS GAAP;
Introduction of improvement in the quarterly information report, among
which is the requirement of consolidated financial statements and special
audit revision;
Obligation to hold a tender offer by the economic value criteria should a
decision be taken to delist from the Novo Mercado;
Adherence to disclosure rules on the negotiation of assets issued by the
company in the name of the controlling shareholders or the company
management.
A contract signed between BOVESPA and the company with the participation of
the controllers and the management ensures the company’s acceptance to the
Novo Mercado, enabling its entrance in this segment.”
8
Level 1 Corporations (“Companhias Nível 1”) “largely undertake to improve
methods of disclosure to the market and to disperse their shares among the
largest number of shareholders possible. Thus, the principal practices required
of a Companhia Nível 1 are:


Maintenance of free-float of at least 25% of the capital;
Holding of public offerings for placing shares through mechanisms that
favor capital dispersion to a broader spectrum of shareholders;
Improved disclosure of quarterly information including the obligation of
reporting consolidated figures and special audit revision;
Adherence to the disclosure rules for transactions involving assets
issued by the company on the part of the controlling shareholders or
company management;
Disclosure of shareholders agreements and stock options programs;
Provision of an annual calendar of corporate events.




To be classified as a Corporation Level 2 (“Companhia Nível 2”), “in addition
to the obligations of Nível 1, the company and its controlling shareholders must
apply and observe a much broader range of corporate governance practice and
minority shareholder rights. In summary, the criteria for listing as a Companhia
Nível 2 are:






A single year mandate for the entire Board of Directors;
The annual balance sheet to be made available in accordance with US
GAAP or IAS;
Granting to all holders of common shares the same condition obtained
by the controlling shareholders on the transfer of the control of
company and 70% of this conditions for preferred shareholders;
Voting rights granted to preferred shares in certain circumstances such
as transformation, incorporation, spin-off and merger of the company
and approval of contracts between the company and other companies
of the same group;
Obligation to hold a tender offer by the economic value criteria should
the capital be closed or registration as a Companhia Nivel 2 be
cancelled;
Adherence to the Market Arbitration Panel as the vehicle to resolve
corporate disputes.
The rules of both Levels 1 and 2 “are consolidated in the Listing Regulations,
the adherence to which is voluntary. The commitment entered into by the
company, its controlling shareholders and its management are signed via a
contract to which these entities and BOVESPA are parties.”8
8
http://www.bovespa.com.br/indexi.htm
9
Nowadays, Brazil owns one of the best corporate governance systems of all
emerging countries. Brazil’s governance standards are already known and
celebrated internationally. So much so that the World Bank encouraged other
countries to use the BOVESPA method.
For José Monforte’s predecessor at IBGC, industrialist Paulo Villares, most
local companies are migrating from a traditional business model to an emerging
model. Some organizations, obviously, can be already defined as having attained
a market model. The three stages are the following:
1) Current model: A company managed by a few controlling shareholders,
with informal governance practices;
2) Emerging model: A company led by a few controlling shareholders, with
formal governance and access to capital for executing its strategies;
3) Market model: A company with formal governance, aspirations and the
financial capacity to compete globally. At this stage, practices of sharing
control, values and ideals have become consolidated, with the concept
and practice of social responsibility also having matured.
VIII – SOX ACT AND BRAZILIAN CORPORATIONS
Foreign companies with shares traded in the US stock market have until 2005 to
adjust to the SOX Act.
From 2005 on, new principles of corporate governance will no longer be simple
strategic decisions of managers and will become law, regulated and supervised
by the Securities and Exchange Commission (SEC).
The SOX Act was enacted in 2002 as an answer from the George W. Bush’s
Administration to corporate scandals such as the Enron and Worldcom events
that shook the stock market’s credibility worldwide.
The SOX Act is a host of new responsibilities assigned and sanctions applicable
to managers to restrain harmful practices to shareholders or that may submit
them to high levels of risk. In this sense, administrators and officers become
explicitly responsible for establishing, assessing, evaluating and overseeing the
effectiveness of internal controls over financial reports and disclosure of material
information. The purpose here is to discourage executive statements such as
unawareness of irregular activities of companies in financial frauds.
10
Discussions about the SOX Act revolves largely around Sections 302 and 404.
Brazilian companies with shares in the USA stock market are exerting best
efforts to adjust to such Sections.
Section 302 came into force in 2003 and establishes that officers and the
principal officer or officers, or persons performing similar functions shall certify
in each annual or quarterly report that:
(i)
(ii)
(iii)
(iv)
the signing officer has reviewed the report;
based on the officer’s knowledge, the report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary in order to make the statements made, in light of the
circumstances under which such statement made, not misleading;
based on such officer’s knowledge, the financial statements, and
other financial information included in the report, fairly presented in
all material respects the financial condition and results of operations
of the issuer as of, and for, the periods presented in the report;
the signing officers:
(a) are responsible for establishing and maintaining internal
controls;
(b) have designed such internal control to ensure that material
information relating to the issuer and its consolidated
subsidiaries is made known to such officers by others within those
entities, particularly during the period in which the periodic
reports are being prepared;
(c) have evaluated the effectiveness of the issuer’s internal controls
as of a date within 90 days prior to the report; and
(d) have presented in the report their conclusions about the
effectiveness of their internal controls based on their evaluation
as of that date.
The Section 404 establishes an annual evaluation of the internal controls and
procedures used in the preparation of financial reports. Additionally, the
company’s independent auditor must issue report certifying the effectiveness of
those internal controls and procedures.
Some Brazilian companies accepted the recommendations for internal controls
issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), which is the dominant model used by the companies
worldwide, specially by the US companies.
The COSO’s structure divides internal control in five interrelated components:
(i) Control Environment, (ii) Risk Assessment, (iii) Control Activities, (iv)
Information and Communication, and (v) Monitoring.
11
(i) Control Environment
“The control environment sets the tone of an organization, influencing the
control consciousness of its people. It is the foundation for all other components
of internal control, providing discipline and structure. Control environment
factors include the integrity, ethical values and competence of the entity's
people; management's philosophy and operating style; the way management
assigns authority and responsibility, and organizes and develops its people; and
the attention and direction provided by the board of directors.”
(ii) Risk Assessment
“Every entity faces a variety of risks from external and internal sources that
must be assessed. A precondition to risk assessment is establishment of
objectives, linked at different levels and internally consistent. Risk assessment is
the identification and analysis of relevant risks to achievement of the objectives,
forming a basis for determining how the risks should be managed. Because
economic, industry, regulatory and operating conditions will continue to
change, mechanisms are needed to identify and deal with the special risks
associated with change.”
(iii) Control Activities
“Control activities are the policies and procedures that help ensure management
directives are carried out. They help ensure that necessary actions are taken to
address risks to achievement of the entity's objectives. Control activities occur
throughout the organization, at all levels and in all functions. They include a
range of activities as diverse as approvals, authorizations, verifications,
reconciliations, reviews of operating performance, security of assets and
segregation of duties.”
(iv) Information and Communication
“Pertinent information must be identified, captured and communicated in a form
and timeframe that enable people to carry out their responsibilities. Information
systems produce reports, containing operational, financial and compliancerelated information, that make it possible to run and control the business. They
deal not only with internally generated data, but also information about external
events, activities and conditions necessary to informed business decision-making
and external reporting. Effective communication also must occur in a broader
sense, flowing down, across and up the organization. All personnel must receive
a clear message from top management that control responsibilities must be
taken seriously. They must understand their own role in the internal control
12
system, as well as how individual activities relate to the work of others. They
must have a means of communicating significant information upstream. There
also needs to be effective communication with external parties, such as
customers, suppliers, regulators and shareholders.”
(v) Monitoring
“Internal control systems need to be monitored--a process that assesses the
quality of the system's performance over time. This is accomplished through
ongoing monitoring activities, separate evaluations or a combination of the two.
Ongoing monitoring occurs in the course of operations. It includes regular
management and supervisory activities, and other actions personnel take in
performing their duties. The scope and frequency of separate evaluations will
depend primarily on an assessment of risks and the effectiveness of ongoing
monitoring procedures. Internal control deficiencies should be reported
upstream, with serious matters reported to top management and the board.”
Some companies agree that setting up internal controls is worthwhile, because it
brings costs down and increases efficiency despite of the efforts.
Punishment for corporate frauds can be of up to 20-year imprisonment, for top
management members, and penalties of US$ 5 million.
The costs of adjusting to the Act may put many companies in a quandary as to
whether or to withdraw from the US stock market because SOX Act is
considered an attempt to raise the corporate governance’s standards and,
therefore, the market community could assume that the withdrawing companies
lack the necessary transparent conduct.
Even so, some US companies have decided to go private because of the SOX
Act, and consequently because of the costs involved.
In Brazil, the new rules do not seem as scary. None of the 30 companies listed
on the SEC has so far withdrawn the US stock market. On the contrary, they all
have set up to adjust themselves to SOX Act.
Although it is not a critical situation, it is far from being adequate. There is a
great gap in many companies between employees performing the control
activities and the officers making strategic decisions about corporate
governance. Most of them lack – and prior to the SOX Act were not required to
have – a direct link between employees and officers.
13
Another difficulty faced by the companies to adjust to Section 404 relates to
personnel. People are the main element in the internal control and some
companies need to hire personnel to raise effectiveness of internal controls.
The Audit Committee is another requirement of SOX Act.
The Audit Committee has the following main duties:
(a) to assist the Board of Directors with the oversight of financial reports,
independency of auditors and performance of internal and external
auditing;
(b) to be responsible for the nomination, remuneration and oversight of
external auditors;
The Audit Committee must be made of independent members of Board of
Directors, that is (i) the Audit Committee members cannot receive any payment
related to consulting or advice, from companies with securities and stock traded
in the stock market or their subsidiaries, except for remuneration as Audit
Committee members; and (ii) the Audit Committee members cannot be persons
affiliated to companies with securities and stock traded in the stock market or of
their subsidiaries.
The Audit Committee members must be Board of Directors members, but the
Fiscal Council members cannot be Board of Directors members.
The Brazilian Corporation Law does not assign the supervision of external
auditing to any body in the company but assigns the responsibility of electing
and removing independent auditors to Board of Directors, subject to veto by the
Board members elected by the minority shareholders, and this such
responsibility cannot be delegated to any other body.
In April, 2003 the Securities and Exchange Commission (SEC) issued a
document, by which some corporations will not be required to have Audit
Committee, provided that they (i) have committee of auditors or a similar body,
(ii) such committee is separated from Board of Directors and made of, even if
partially, members that are not in the Board of Directors; and (iii) the members
of the committee of auditors are not elected by administrators and are not
officers of the company that have securities and stock traded in the stock market.
That document mentions the Brazilian Fiscal Councils as one example of body
similar to Audit Committee. It was also mentioned that there would not be
conflict of interests in relation to nomination of independent auditors by the
committee of auditors, in the case of jurisdictions that prohibit to delegate such
function.
14
The major obstacle for a Brazilian Corporation to have an Audit Committee is
that they do not have independent members in the Board of Directors and a
finance expert.
Financial institutions or entities duly authorized to operate by Brazilian Central
Bank (“Bacen”) must create an Audit Committee, according to regulations
issued by the Brazilian Monetary Council9, provided that at the end of the two
last financial years (i) has an equity equal to or above R$1 billion; or (ii) is
responsible for management of third party funds equal or exceeding R$1 billion
or (iii) has raised a total amount of deposit plus third party management funds
equal or exceeding R$5 billion.
The Audit Commit will report directly to its Board of Directors or, in the
absence thereof, to its Board of Officers, and it will consist of at least three
members, which term of office shall not exceed five years for the publicly-held
institutions with shares negotiated at stock exchange and without fixed term of
office for the closely-held institutions.
The number of members, the nominee criteria, the procedure for their
replacement and remuneration, the term of office and the duties and powers of
the Audit Committee must be expressly provided for in the company’s by-laws
or articles of association. At least one of the committee members must have
proven knowledge and expertise in accounting and auditing. A member can only
be nominated for the Audit Committee of the same institution after a minimum
three-year period counted as from termination of his/her previous term of office.
The following are conditions to being a member of the Audit Committee: (i) the
individual is not, or was in the last twelve months an officer of the relevant
institution or of its connected companies (the only exception is the closely-held
institution, in which case this restriction is not applicaple), or an employee of the
instituion or of its connected companies; or the head technician, officer,
manager, supervisor or any other member, with managerial duties, of the team
involved with the company’s auditing; or a member of the Tax Council
(Conselho Fiscal) of the institution or of its connected companies (ii) the
individual is not a direct or collateral relative or even by affinity, up to second
degree relative of the individuals mentioned in item I other than a member of the
Tax Council; (iii) the individual does not receive any compensation from the
company or its connected companies other than that regarding their duties as
member of the Audit Committee. In the case of a closely-held institution, the
option between the remuneration of an officer or of a member of the Audit
Committee is admitted.
9
Regulations attached to Resolution 3081, of May 29, 2003 as amended by Resolution 3170, of
January 30, 2004
15
The attributions of the Audit Committee are as follows: (i) Establishment of the
rules of the Audit Committee operation in writing, subject to approval of the
Board of Directors or, in the absence thereof, the Board of Officers; (ii) formal
recommendation for use or replacement of audit firm; (iii) review of annual
reports and auditor’s opinions prior to their publication; (iv) assessment of the
effectiveness of independent and internal auditing for compliance with legal and
regulatory provisions and applicable internal rules and codes; (v) confirmation
of the implementation by the company’s management of the independent and
internal auditors’ recommendations; (vi) establishment and publication of
procedures for reception and handling of information about events of noncompliance and internal regulations and codes, including arrangements to
protect any disclosing party and confidentiality of information;
(vii)
recommendation of amendments or improvements to the company’s policies,
practices and procedures; (viii) meeting with the company’s management,
independent and in-house auditors on a quarterly basis to check for adherence to
any recommendation, including recommendations as to audit work planning; (ix)
checking for adherence to recommendations, if any, by the company’s board of
officers; and (x) other measures as determined by the Bacen are duties of the
Audit Committee.
Additionally, within its authority, an Audit Committee may hire the services of
expert, however, it will not be discharged from its responsibilities.
A semi-annual report, for semesters ending June 30 and December 31, will be
prepared by the Audit Committee indicating the Committee’s operation in the
period; evaluation of the effectiveness of internal control systems, and proof of
any determined shortcomings; described recommendations to the board of
officers and any recommendation not adhered to and justification; assessment of
the effectiveness of independent and internal auditing for compliance with legal
and regulatory provisions and applicable internal rules and codes; assessment of
the quality of financial statements, specially adherence to the Brazilian generally
accepted accounting practices and compliance with the Bacen rules and
regulations with proof of any determined shortcomings. In this respect, Audit
Committees must make available its report to the Bacen and the company’s
Board of Directors for at least five years of its preparation. Another duty of the
Audit Committee is the publication of a summary of the main aspect of its report
together with the company’s financial statements.
IX – CVM ( THE BRAZILIAN SECURITIES AND EXCHANGE COMMISSION)
Law nº 6,385 of December 7, 1976 that created the CVM (the Brazilian
Securities and Exchange Commission)10 - (“CVM Law”) established that it
should observe the following objectives:
10
www.cvm.gov.br
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(i) to assure the proper operation of the exchange and over-the-counter markets;
(ii) to protect all securities holders against fraudulent practices and illegal acts
by company managers, controlling shareholders, or mutual fund managers;
(iii) to avoid or curb all kinds of fraudulent or manipulative conduct that may
give rise to artificial pricing of the securities market;
(iv) to assure public access to all relevant information about the securities
traded and the companies which have issued them;
(v) to ensure that all market participants have fair trading practices;
(vi) to stimulate the formation of savings and their investment in securities; and
(vii) to promote the expansion and efficiency of the securities market and the
capitalization of Brazilian publicly held companies.11
In 2001, the CVM Law was reformed and gave CVM greater functional
independence.
In conjunction with the reform of CVM Law, the reform of Corporation Law
was finally completed after overcoming significant opposition in Congress. The
reform strengthens the rights of minority shareholder and raises the standards of
disclosure, with improved laws on tag-along rights, de-listing, non-voting shares,
election of board members by minority shareholders and private arbitration.
In June 2002, CVM launched the “CVM Recommendations on Corporate
Governance”.12
According to CVM, the application of the good corporate governance practice
“usually implies higher behavior standards than those required by Act, or by
CVM itself. This is why non compliance with this code is not subject to
punishment of CVM.”
However, “CVM will soon require that public companies include their level of
adherence to these practices in their annual filings, in the form ‘comply or
explain’. If a company does not act on a recommendation, it should explain its
reasons.”
Such Code has four main Titles: (i) Transparency and Ownership and Control,
Shareholders Meetings; (ii) Structure and Responsibilities of the Board of
Directors’; (iii) Minority Shareholder Protection and (iv) Accounting and
Auditing.
11
www.cvm.gov.br/ingl/indexing.asp
12
www.cvm.gov.br/ingl/indexing.asp
17
CVM has issued a serious of regulations to adjust Brazilian publicly-held
corporations to practices used abroad, such as:
(a) Instruction 308, of May 14, 1999, which establishes the turnover of
independent auditors, which is in force this year (2004): independent auditors
(legal entities or individuals) cannot render auditing services to the same client
for more than 5 consecutive years and a minimum 3 years period is required to
re-hire the independent auditor.
(b) Instruction 381, of January 14, 2003, which establishes that publicly-held
companies must disclose any service rendered by audit company, other than
auditing services.
Both Instructions above aim at keeping independency of auditors and avoiding
conflict of interests.
X - ACCOUNTING IN BRAZIL
One of the greatest difficulties Brazilian companies are confronted with is the
Accounting Law. At the time of its effectiveness, 1976, the Corporation Law
was modern and adequate. But it has been outdated in today’s scenario.
Furthermore, changing a Law is lengthy and procedure-intensive.
Bill of Act nº 3741, of 2000, creates an institution combining the Governmental
and private sectors to suggest amendments to Accounting Law to bring Brazil in
line with global rules. Unfortunately, such Bill of Law is still in the House of
Representatives, together with many other Bills of Law.
For example, the Bill of Law proposing the matching of privately-held
companies to publicly-held ones in terms of transparency was proposed in 2000
but so far has not been passed yet. This Bill proposes that up to a certain amount
of assets or billing, the privately-held companies will have to follow the same
accounting rules established to publicly held companies.
The world is said to be in search of “accounting standardization”, but that could
be a violation of a country’s sovereignty. The right thing to say is that the world
is in search of “accounting harmonization.” There is a great endeavor worldwide
for the results of a company to be able to be understood anywhere, wherever the
company may be domiciled or whether its financial statements are prepared
based on the Law of any other country.
Discussions about need to apply similar accounting rules and standards in
various countries started in 70’s sponsored by the International Organization of
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Securities Commissions (IOSCO), organization which gathers regulator agents
of stock markets, as SEC and CVM.
Financial crises in Asia, which caused stock exchanges to dive worldwide in the
early 90’s, and more recently the Enron, Worldcom and Parmalat scandals
accelerates the search for accounting rules that allow companies’ results to be
sufficiently clear to avoid loss to invertors, suppliers, employees of companies
with shares listed in the main stock exchanges of the world.
In this sense, similar rules and standards must be applied in accounting, auditing
and comptrollership.
In 2002, a host of accounting rules called “International Financial Reporting
Standards” (IFRS) was created.
IFRS is a revision and updating of old rules called “International Accounting
Standards” (IAS), and made the rules applied in the U.S.A. and Europe more
alike.
The IAS had two purposes: (i) to create high-quality rules, and (ii) to promote
globalization of those rules.
Although Americans and Europeans apply greatly different rules, both are
exerting efforts to reduce those differences.
Americans intend to reduce the differences between IFRS and US Generally
Accepted Accounting Principles (USGAAP).
Europeans companies are already applying IFRS because they will be required
to publish their financial statements according to IFRS starting 2005.
The accounting harmonization/standardization is also of interest to international
entities, such as World Bank and Inter-American Bank for Development (BID),
which expect to see somehow implemented in 2007.
More transparency and less cost are the main purposes searched by the
organizations involved in the search of accounting rules unification, among them
the Federal Accounting Standard Board (FASB), responsible by the US
accounting standard, the USGAAP, and the International Accounting Standards
Board (IASB), which gathers representatives of many countries and devised and
approved the IFRS.
However, according to a Deloitte Touche Tohmatsu study completed in July
2004 – a comparison of 100 accounting principles of the USGAAP and IFRS the negotiations will be hard, because the differences between the two standards
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are significant and numerous. As an illustration, IFRS allows a series of
alternative accounting treatments consequently companies of same size and in
the same sector may have assets in amounts totally different, depending on the
method used. Bellow are a few examples of the differences between USGAAP
and IFRS:
a) revaluation of assets:
. USGGAAP: assets are accounted based on the value of asset cost;
. IFRS: assets are accounted at the market value, which takes into account
many events, such as exchange devaluation.
b) financial costs of new investments
. USGAAP: the interest must be capitalized (this expense relates to the
acquisition of new assets);
. IFRS: companies may choose to account interest expenses on profits and
loss.
c) results of mergers and acquisitions
. USGAAP: accounted by the equity method;
. IFRS: the accounting record may be consolidated.
d) Tax law differences
. USGAAP: changes to tax will be accounted if legally required only;
. IFRS: changes to law promoted by a Provisory Measure, for instance, will
be automatically accepted and accounted.
According to the Brazilian Institute of Independent Auditors (IBRACON –
Instituto Brasileiro dos Auditores Independentes) the main advantages of
applying the IFRS are the following:
a) Easy access to local market by foreign investors;
b) Reduced costs, with the end of different balance sheets prepared for
several international audiences;
c) Lower cost to lure investments, with a possibility of attracting foreign
investors without being listed in stock exchanges markets;
d) Lower exposure to risks generated by foreign laws for local
administrators;
e) Reduced costs with foreign consulting for securities trade abroad.
On the other hand, applying the IFRS in Brazil has a few obstacles:
a) The Brazilian legislative System: changing a law is lengthy and
procedure-intensive;
b) Lack of experts in IFRS to advise companies;
c) Lack of familiarity with the English language by accountants.
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Furthermore, there are a lot of differences between Brazilian accounting rules
and the IFRS:
a) capital investment:
. IFRS: by market value;
. Brazilian rules: by market value in the banking sector, but it is not used in
other sectors.
b) Research and Development
. IFRS: research expenses are accounted as liabilities and development
research as assets;
. Brazilian rules: total expenses are accounted as assets and are amortized
after the development of product is completed.
c) Realization of income
. IFRS: not before products are delivered to clients;
. Brazilian rules: at the time invoices are issued.
d) Leasing
. IFRS: operation is accounted as assets and liabilities and financial expenses
are deducted from results;
. Brazilian rules: accounted as leasing expenses.
XI - CONCLUSION
With Enron, Worldcom and Parmalat scandals, millions of employees were laid
off and investors saw the price of their shares plunge down to cents.
The high profile corporate governance failures worldwide drew the world’s
attention to corporate administration, accountability and auditing.
And as consequence, the stock markets felt the need to search for credibility,
which involved the application of Corporate Governance rules, the discussion
about accounting harmonization/standardization and the enactment of SOX Act.
Brazil was largely affected by those scandals, both because those companies had
subsidiaries in Brazil and some Brazilian companies have securities traded on
the New York Stock Exchange (NYSE).
Another factor is the challenge to Brazilian market to tap local and international
sources of capital, that is, to raise new capital or maintain liquidity of Brazilian
securities.
In this sense, Brazil is dedicating great efforts to adjust its rules to the world’s
new setting, mainly as far as corporate governance is concerned.
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Nowadays, the Brazilian is one of the best corporate governance systems in any
emerging country, specially as a result of initiatives of IBGC, BOVESPA and
CVM.
Brazilian companies with shares in the USA stock market are exerting best
efforts to adjust to Sections 302 and 404 of SOX Act, which encompass
certification of annual or quarterly report, setting up of internal controls and
procedures and creation of Audit Committee.
The major difficulty to Brazilian companies regards accounting, related to
harmonization/standardization of rules, because changing a Law in Brazil is
lengthy and procedure-intensive.
Despite of the efforts worldwide, mainly in Brazil, one cannot state that the
world will no longer see any scandal, as with Enron, Worldcom and Parmalat.
Strictly speaking, Luiz Leonardo Cantidiano, former President of CVM, says
that corporate scandals in Brazil, especially those involving banks (Banco
Nacional and Banco Econômico) were different from those involving Enron and
Worldcom.
In the past, executives of US companies had call options as part of their
remuneration. This encouraged the publication of a great corporate performance,
valuation of shares so that they could sell their shares at greater profits.
In Brazil, executives usually do not seek to increase the company’s value;
instead, they seek to hide financial ordeals because increasing profits in Brazil
means paying more taxes.
Another distinguishing aspect is the concentration of ownership and defined
control in Brazilian companies that allow enhanced management control, as
opposed to millions of owners in US companies.
São Paulo, September 10, 2004
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