A setback for SOEs

The state-owned enterprises (SOEs), grew signficantly in the 20th century, as a result of the social choice made by the Brazilians to have a state with a significant participation in the country’s economic activities. They are therefore an integral and relevant part of our capital markets. Like it or not, it’s a legitimate choice that must be respected. It’s up to the public administrators and other stakeholders to find a model that ensures that the public objectives of such choice are efficiently managed.

The listed SOE model meets this reality well. Private investors have the opportunity to become partners of the State in a profitable activity that also seeks to satisfy the public interests established by the law. As a result, public investments can be leveraged with the support of private funds. At the same time, it’s possible to add transparency and implement good corporate governance practices to improve the efficiency of the entity controlled by the state.

In theory, it seems to work.

However, in practical terms, we have been witnessing a sequence of disasters in the management of this corporate model that has been destroying the value of public and private investments. The lack of ability to meet the social objectives has been corroding the credibility of the Brazilian capital markets. The losses imposed to Petrobras’ and Eletrobras’ investors in recent years, for example, have acquired epic dimensions, close to hundreds of billions of reais. The whole speech around transparency, good governance, scrutiny and good financial perspectives has been destroyed by a combination of public interference, corruption and disastrous business decisions.

Complacency has been part of the problem.  Honest executives who silenced in the face of clearly mistaken (sometimes even illegal) decisions were complacent. Employees who “followed the orders,” although they knew that some decisions were neither rational nor sustainable, were complacent. Banks that funded megalomaniac projects with insignificant rates of return, believing they were too important to fail, were complacent. Investors who bought the securities of companies that do not apply appropriate controls or governance considering the size of the projects in which they invested were complacent. Industry regulators that accepted or allowed breaches of contracts, illegal transactions and the destruction of competitive markets were complacent. Capital market regulators that permitted suspicious issues of shares or took too long to investigate them were complacent. In short, everyone was complacent.

After that the damage was done, we have entered a positive cycle of “putting the house in order.” The companies most affected by the political storm hired principled and competent executives to change the direction of these behemoths. Petrobras has implemented a new strategy to become more focused and, therefore, “manageable” – emphasizing its competitive advantages and fostering the creation of competitive markets. Eletrobras has been speaking out against political nominations for its subsidiaries and implemented a significant process to downsize its workforce.

Simultaneously, there are strong signs that privatization processes will be resumed. Assets of the state-owned enterprises themselves are being sold and the possibility that some SOEs, such as BR Distribuidora, IRB and Infraero, may go public is being considered. The São Paulo State Government intends to sell its energy company and the Municipal Government has announced an ambitious asset sale plan, including the iconic Anhembi.

Supervisory bodies have been conducting thorough investigations. The Federal Court of Accounts (TCU), the Office of the Comptroller General (CGU), the Public Prosecutor’s Office (MP) and the Brazilian Securities and Exchange Commission (CVM), among others, have dozens of pending cases against state-owned enterprises and/or their former executives.

One of the first and most relevant steps of this “reaction” was the CVM’s decision, in 2015, to punish the Federal Government for the abuse in the exercise of its voting power in Eletrobras’ 2012 General Shareholders’ Meeting. With a masterful vote cast by the then director Luciana Dias, CVM’s board unanimously concluded that the Federal Government damaged Eletrobras and its shareholders by voting in favor of the adhesion to the then Provisional Measure 579. The decision not only represented economic and accounting losses of billions of reais to the company, but also barred it from requesting the revision of the due values in court, different from what most of the remaining electricity companies not controlled by the Federal Government did.

And then the advancements achieved in the governance sphere and the feasibility of the SOEs suddenly faced a counterattack and were hardly hit by the outdated face of Brazil.

In June 2017, the National Financial System’s Council of Appeals (the so-called “Conselhinho”), a body composed on an equitable basis, with 4 (four) members nominated by the Federal Government and 4 (four) members chosen by entities from the capital market, overruled the decision in a tight vote of 5×4, counting on the decisive vote of the body’s chair, nominated by the Ministry of Finance. In other words, the defendant’s representatives not only participated in the judgment, but also determined the final result by casting the tie-breaking vote to acquit the Federal Government.

The Conselhinho’s decision was a hard blow to the CVM, to investors, to the Brazilian Government and, ultimately, to the Conselhinho itself.

CVM’s significant efforts to prevent SOEs from being politically used fell apart.  Despite the symbolic nature of the decision (after all, the Treasury would actually pay to itself), it showed the extent to which the government could damage listed SOEs. It showed the importance of being specifically attentive to the “public interest” based on which the SOE was created, interpreting it on a restricted basis, as it should be. It was the indication that some practices, such as the subsidized prices or tariffs to control inflation rates – which most of the times were limited to the political or electoral interest, – had come to an end. With the Conselhinho’s decision, such efforts went right back to square one and the overall impression was that “anything goes.”

The decision particularly and immediately affected the investors. The broad interpretation of the Article 238 given by the winning vote in the Conselhinho makes it virtually impossible to stop the interventionist urge of governments and politicians who see the SOEs (and primarily the listed state-owned enterprises) as real “gold mines” for their not-very-republican objectives, from the most “honest” ones, who seek to “benefit the population,” to the most criminal ones, who hide their acts behind poor management decisions.

The message given by the Conselhinho to the investors is: Don’t invest in SOEs. After all, based on the body’s interpretation, the controlling shareholders can interfere as they want, even to the detriment of the company’s sustainability. Once again, the government proves to be a partner one cannot trust in as it has the legal right to do whatever it wants with the private funds invested by the minority shareholders. Regardless the admiration one has for a specific government, democracy implies that the “representative” can change every four years and, accordingly, the morals of his/her successors are unknown. How can one assess the present value of a company with such characteristics, mainly when he/she is aware of its background?

This takes us to the damages caused to the Brazilian government itself. While writing this article, the news was announcing IPO plans for at least three state-owned enterprises – IRB, Infraero and BR Distribuidora. Who, in one’s right mind, would pay a fair price for the shares of a company whose controlling shareholder can go unpunished, as shown by the Conselhinho? In fact, such IPOs can be eventually affected or even called off by such decision. In this case, it will backfire on the Conselhinho’s members who voted to acquit the Federal Government.

And this is where the decision damaged the body itself. The Conselhinho was up until now successfully revising its internal processes, reducing its backlog and increasing the structure allocated to it. An amazing work whose effects are already being felt by the market’s participants.

The decision in the Eletrobras case spoiled the body’s entire work. In addition to the myopic and outdated posture that permeated the winning vote, the voting process itself called great attention. The tight 5×4 vote would be enough to raise doubts as to the result, but the fact that it was decided by the tie-breaking vote cast by the representative of the National Treasury showed a very serious problem in terms of governance, that clearly affected the body’s credibility.

How can the defendant be the judge and even cast the decisive vote? This is a clear example of a conflict of interest. While board members representing entities as the CVM and the Central Bank could be allowed to vote, given their independent nature, the representatives of the National Treasury should have been barred from voting in the matter. And what about the votes cast by the board members nominated by the public sector – with the bold and honored exception of the member nominated by the CVM – in favor of the Union’s appeal? Was it a mere coincidence?

No doubt that, given the vote by the CVM’s representative, the result would have been different if it hadn’t been for the mistaken vote cast by the board member nominated by Abrasca, who found the Union not guilty. However, it’s important to analyze the Conselhinho’s governance structure. If a clear abstention rule[1] in situations of conflicts of interest is not established, the body will continue to be seen as a longa manus of the Federal Government, incapable of setting limits when the government is the regulated entity (when it is the controlling shareholder, for example). Such decision has tarnished the recent advancements and brought us back to an outdated Brazil where the government can do whatever it wants and the citizens can do nothing but accept that.

Although the decision represents a giant setback, let’s end this article with a positive note. On the same day of the trial, the CVM closed its 07/2017[2] Notice to the Market with the following sentence:

Although the CVM respects CRSFN’s decision and the final verdict, conducted in compliance with the legal requirements, it reaffirms the position of its Board at the time the matter was tried in the first instance.

In other words, the CVM boldly seeks to preserve the rules set forth in the corporate legislation, setting limits to the damages caused by the controlling shareholders of state-owned enterprises. It indicates that, if a similar case is to be tried in the future, the decision will be the same, that is, the defendant will be punished. It shows that the Conselhinho’s decision does not represent a definite understanding of the issue. The matter will be analyzed again, hopefully with the revising body with a different composition and a more mature posture when dealing with conflicts of interest so that the correct decision is confirmed.

Accordingly, the treatment to be given to the abuses committed by the SOEs’ controlling shareholders has not been buried, but postponed. We hope that’s the case and that the setbacks experienced in June prove to be only temporary.

 

[1] Theoretically, such rule is already part of CRSFN’s regulations, but it seems it does not work: Article 18. Board Members and the National Treasury’s Attorney are banned from participating in the judgments when they have: (…) II – direct or indirect economic and financial interest in the case; further explained: §3 Direct or indirect economic or financial interest is when the Board Member or the National Treasury’s Attorney in charge of judging the case has realized, between the date of the trial and the two years preceding the filing of the appeal or request for review, any remuneration to the defendant or its representative  §4º The impediment or suspicion must be informed by the Board Member or the National Treasury’s Attorney…

[2] http://www.cvm.gov.br/noticias/arquivos/2017/20170628-3.html