Instructed Vote

A major shareholder of a listed company sells his/her share interest. Immediately thereafter, the Board member nominated and elected by that shareholder resigns from his/her position.

What seems the natural course of the facts actually hides one of the most negative aspects of the corporate governance in Brazilian companies: the notion that a Board member ‘belongs’ to a specific shareholder.

One does not need to go further in our legislation to notice the impropriety of such factoid. The Law 6,404 of 1976 clearly states, in the first paragraph of Article 154, that “directors elected by a group or class of shareholders have, for their company, the same duties that all Board members, and cannot fail in their duties, not even to defend the interest of those who elected them”.

In other words, once the Board member is elected, he/she represents ALL shareholders and not only those who elected him/her. That’s exactly for this reason that referring to the “representative” of the shareholder A or B in the Board of Directors is a serious mistake. Previ – Brazil’s largest institutional investor – has recently changed its governance code to reflect this view. The document no longer mentions ‘representatives’ of specific shareholders or classes of shareholders.

This truth is valid both for Board members elected by controlling shareholders and for those elected by minority shareholders. The reasoning is the same, although it may seem counterintuitive for laymen and, unfortunately, for many of the directors of important companies.

It is usual to see decisions taken without the necessary debate, even when they can be harmful for the company, and approved by the Board members nominated by the controlling shareholder. It’s claimed – although the reasons are not recorded in the minutes – that it’s “what the controlling shareholder wants,” and that the controlling shareholder has the power of command (actually recognized by the law), reason why it’s quite natural to vote according to his/her opinion.

Such view misrepresents the corporate law and places Boards of Directors in an irrelevant position. If the Board of Directors is nothing but the bureaucratic conduit to express the controlling shareholder’s opinion, there is no reason for its existence.  Accordingly, we put an end to a fallacy, waste of time and legal contortionisms. Everybody benefits from that. However, such situation can represent a great damage to our already weakened capital market if we think that not even the illusion that a maximum body to protect all shareholders exists. It would be the corporate dictatorship, perfectly legitimate (although it’s not the best solution) for privately-held companies. But entirely inappropriate for companies with partners that do not participate in management. In other words, it would be the denial of the separation between the ownership and the management, what has probably been the major driver for the development of the Western World for the past 500 years.

It’s legitimate to question the existence of a Board member nominated by the controlling shareholder who does not agree with the shareholder who indicated him/her. In fact, it’s a problematic situation; there is an ‘unstable balance’ that must be solved. Never through the conformism that violates the consciousness, but through the consistence in taking decisions. If opinions are in fact irreconcilable, the member must leave the Board. Whether through his/her resignation – in this case a justified decision that is usually made public – or through the calling of a general meeting by the shareholder for the carrying out of a new election.

The problem is the same in the case of Board members elected by minority shareholders. Our legislation considers that it’s important for minority shareholders to have the capacity of electing directors to ensure an impartial Board of Directors. This was already true in 1976 and became even more in 2001, when the Law 10,303 provided non-controlling shareholders with greater possibilities of electing directors. Mechanisms such as the multiple and the separate vote – although confused – are extremely effective to ensure a balanced Board of Directors.

But if the Board member elected by an important minority shareholder considers himself/herself the representative of such minority shareholder – or the longa manus, to use the expression preferred by scholars – the system fails. Instead of mitigating the conflicts among controlling and minority shareholders– something that a cautious, independent and balanced Board is perfectly capable of doing – members who consider themselves the “representatives of minority shareholders” or the “representatives of the fund A” make the situation become even more conflicting. As much as they seek the company’s interest, if they feel they have a direct fiduciary duty to the shareholders who elected them – and not to all shareholders – the resulting conflicts can be very harmful for the company. Examples of that can include different strategic views, return horizons, perception of risks, etc.

In the specific case of members elected by the separate vote of minority shareholders, they have an additional responsibility. CVM jurisprudence considers them “directors that cannot be fired” ad nutum. Accordingly, even those shareholders that did not participate in a meeting have, in that member, the guarantee of an independent view – therefore skilled to defend all shareholders and not only a specific group. If this Board member resigns when the shareholder who elected him/her sells his/her share interest, he hurts the remaining shareholders that usually cannot elect another independent Board member before the end of the subsequent mandate (depending on the company’s bylaws). That’s the confession of the instructed vote, which once again places the Board of Directors in an irrelevant position.

The same happens in the case of members elected by the multiple vote. Although they can be fired – they lose their positions in the event any member resigns – their presence in the Board is not subject to the permanence of the shareholders who elected them. Their fiduciary duty with all other shareholders remains. The resignation without good reason – or motivated only by the selling of shares by a voting member – represents a breach of trust and confidence among the professional and the company’s investors.

If we want to build a healthy capital market, it’s essential to start to respect the principles that govern the corporate legislation and the best corporate governance practices. Board members that act as representatives of specific groups do a disservice to the company, to the market and, accordingly, to Brazil. Shareholders – controlling or minority shareholders – who demand this same posture from Board members commit the same sin.

If our regulators consider fiduciary duties and governance practices essential for our market, they must promptly act to suppress the instructed vote.