The BRIC Project -- BRAZIL -- BOVESPA’s Corporate Governance Level 1 & Level 2 Listing Requirements (Part 5)

In the previous Brazil post, we introduced Brazil’s largest - and the world’s third largest - stock exchange, BOVESPA, or the São Paulo Stock Exchange.  Since compliance with the Brazilian Securities Market Commission’s (CVM) corporate governance standards is only voluntary, Bovespa’s three-tiered scheme of listing requirements now plays the most significant role in setting progressive corporate governance standards in Brazil. (HSBC).  While compliance with the scheme is also voluntary, Bovespa’s efforts represent some important first steps in a jurisdiction otherwise devoid of a meaningful approach to corporate governance. 

As noted on Bovespa’s corporate governance website, the Brazilian Institute of Corporate Governance (IBGC) defines “corporate governance” as the “system by which companies are directed and monitored, concerning Shareholders, the Board, Directors, Independent Audit and Fiscal Council.”  The website also notes that “[g]ood practices of corporate governance aim to increase the value of the company, facilitate its access to capital and contribute to its sustainability,” and that “the adherence to Bovespa’s ‘Special Corporate Governance Levels’ better advertises the efforts of the company to improve the relation with its investors and increases the potential for appreciation in asset value.” 

We will now outline the prominent aspects of the most lenient tier, Level 1, and the middle tier, Level 2. 

Corporate Governance Level 1 (Nível 1):         

Bovespa’s Corporate Governance Level 1 listing requirements represent the most lenient set of listing requirements among the three-tiered scheme of the Novo Mercado. (See NÍVEL 1 Listing Rules).  Bovespa’s cited goal for Level 1 companies is “to improve methods of disclosure to the market and to disperse their shares among the largest number of shareholders possible.”  Currently there are 35 companies listed on Level 1. (See list).  Bovespa’s Level 1 requires compliance with the following principal practices:

1. Maintenance of a free-float of at least 25% of the capital. (§3.1(ii)). “Free Float” is defined as all shares issued by the company, except for those held by the controlling shareholder, the company’s senior managers, and the holders of the company’s special or preferred shares that have attached voting and policy-making rights.
2. Improvement in quarterly reports, including the disclosure of consolidated financial statements and special audit revision.  Companies are required to prepare and disclose quarterly financial statements that include detailed information regarding the companies’ cash flow statements and consolidated performance reports.  (§3.1(iii)). Companies must report the quantity and characteristics of the companies’ securities directly or indirectly held by any controlling shareholder and senior managers (§4.2(iii)-(vi)). The reports must also comply with CVM rules and be accompanied by verification from an independent auditor who is registered with the CVM.  (§4.2.3).  Companies must also meet similar requirements when filing annual reports.
3. Monthly disclosure of trades involving equities issued by the company on the part of any controlling shareholders.  Controlling Shareholders must report the volume and characteristics of the Company’s securities that it holds directly or indirectly to Bovespa, including derivatives. (§6.1).  The Controlling Shareholders must submit this report to  Bovespa within ten days of the end of the month during which the trade occurred. (§6.1.1).  These requirements extend to any trades of qualifying securities or derivatives executed by controlling shareholders’ spouse, domestic partner, or dependents as stated on annual income tax returns. (§6.1.2).
4. Companies must disclose an annual corporate calendar with a schedule of corporate events.  (§3.1(v); §4.5).  
5. “In all public share offerings, the Company will make its best effort to achieve widely dispersed share ownership.” (§5.1).   This provision broadly states that “special procedures” shall be implemented during all public share offerings, such as “ensuring access to all interested investors,” or “allocating at least 10% of the offering to individuals or non-institutional investors.”  (§5.1(i)-(ii)).

Lastly, it is also important to note that companies must disclose information regarding related-party contracts valued in excess of R$200,000 (≈US$112,000) that are entered into between the company and its controlled companies and associated companies, senior managers and the controlling shareholder, and between the company and controlled companies and associated companies of its senior managers and controlling shareholder.   (§3.1(vi); §4.6).

Corporate Governance Level 2 (NÍVEL 2):

Level 2 represents the middle ground between the relatively lax listing requirements of Level 1 and the strictest level of corporate governance listing requirements of the Novo Mercado. (See, Level 2 Listing Rules)  According to the Bovespa website for Level 2, “[t]o be classified as a Level 2 company, in addition to the obligations of Level 1, the company and its controlling shareholders must adopt and observe a much broader range of corporate governance practices and minority shareholder rights.”  Currently, there are 19 companies on Level 2.  (See, list)  The website outlines the prominent aspects of the Level 2 listing requirements:

1. Establishment of a two-year unified mandate for the entire Board of Directors, which must have five members at least, of which at least 20% (twenty percent) shall be Independent Members.  (§5.1-5.7).

a.     “Independent Member” is a member of the Board of Directors who: (i) has no ties to the Company except for owning an equity share of its capital stock; (ii) is not a Controlling Shareholder, the Controlling Shareholder’s spouse or a relative to the second degree, is not or has not been linked in the last 3 (three) years to a company or entity with ties to the Controlling Shareholder (this restriction does not apply to people linked to governmental institutions of education and research); (iii) has not been a Senior Manager of the Company or employed by or worked for the Company, the Controlling Shareholder or any other company controlled by the Company; (iv) is not a direct or indirect supplier or purchaser of the Company’s services or products or both, to a degree that results in loss of independency; (v) is not an employee or manager of a company or entity that supplies services or products or both to, or buys these from, the Company; (vi) is not a spouse or a relative to the second degree of any Senior Manager of the Company; (vii) does not receive any compensation from the Company except for that related to its activities as member of the Board of Directors (this restriction does not apply to cash from equity interests in the capital stock).  (§2.1).

1. Disclosure of annual balance sheet according to standards of the US GAAP or International Financial Reporting Standards.  (§6.2-6.3)
2. If case majority shareholders sell their stake, the same conditions granted to them must be extended to common shareholders, while preferred shareholders must get, at least, 80% of the value/conditions (tag along). (§8.1.3)
3. Voting rights granted to preferred shares in circumstances such as incorporation, spin-off and merger, and approval of contracts between the company and other firms of the same holding group, when deliberated at general meeting. (§4.1(v)).
4. Obligation to hold a tender offer by the economic value criteria, in case of delisting or deregistration process.  (See, Cancellation of Registration As a Publicly-Held Company §10.1-10.4). “‘Economic Value’ is the value of the Company and its shares as determined by a specialized company and based on reputable methodology or on any other CVM criteria.” (§2.1).
5. Admission to the Market Arbitration Panel for resolution of corporate disputes. (§13.1).

In the next post, we will introduce readers to Bovespa’s strictest tier of corporate governance listing rules, the Novo Mercado.