To rescue our SOEs

There’s consensus that something must be changed in the way Brazilian state-owned enterprises (SOEs) are managed. Regardless the ideological bias, that is, whether one defends free markets or state-owned enterprises, there’s no doubt that the Brazilian Government plays an important role in the country’s economic activities and that SOEs are an important vehicle of such participation. The DEST alone – Department of Coordination and Governance of State-Owned Enterprises – supervises 144 federal SOEs. Not to mention small companies that are outside the department’s scope and the several other companies controlled by state and local governments.

In view of this reality, it’s a priority for all Brazilians that these companies are well managed. If they do not properly pay their cost of capital, they destroy value for the society as a whole – and push up the public debt. On the other hand, if they are well managed, they can be powerful drivers to leverage public interests.

This thought is particularly true when it comes to listed state-owned enterprises – which raise funds from private investors but are partially owned by the government. If they succeed, investors will show interest for leveraging public funds, making social gains more dynamic.

Unfortunately, the historical context is not good. Let’s not spend time on diagnosing that given the obviousness it represents. It’s sufficient to remember that Petrobras has destroyed approximately USD 330 billion in the past 6 years – including the opportunity cost adjusted to the company’s risk. Cases like that encourage several efforts to reformulate the governance in state-owned enterprises.

The Brazilian Stock Exchange (BM&FBovespa), for example, is preparing a specific program for them, in which it suggests some governance practices they must implement to be recognized by the stock exchange and investors.

Likewise, politicians have been reacting to the situation. Today, we have identified at least three bills under consideration in Congress aimed to improve governance practices in state-owned enterprises and “shield” them, in same cases, against political interference.

The existence of a number of bills aimed to prevent the recurrence of the problems facing our SOEs in recent years is a firm and healthy response of a Legislative Branch that seeks to perform its duties. However, before we start to suggest laws, it’s important to question: is a new law the proper response to the hurdles facing our state-owned enterprises?

It’s easy to criticize the law. In the search for a healthier capital market, we can mention one or two dozens of articles of the Corporate Law that could be enhanced. Many Amec’s members have actively participated in the discussions that resulted in the Law 10,303, which made significant changes to the Law 6,404. With it, we have learned that the democratic activity can actually improve the legislation, but changes often bring about more problems than solutions.

Just look around and we will find potential improvements that can be made to our legal system. Each citizen will have his/her own opinion; and they are often contradictory. Quoting the US writer Henry Louis Mencken, “for every complex problem there is an answer that is clear, simple and wrong”. That’s why it’s important to structure this debate.

The three main bills currently under consideration related to the governance issue in state-owned enterprises are (1) the Senate Bill No. 343/2015, worded by the Senator Aécio Neves (“Aecio Bill”); (2) the Bill submitted by the presidents of the House of Representatives and the Senate (“PMDB Bill”); and (3) the Substitute Bill to the Senate Bill No. 167, under consideration in the mixed commission that has been analyzing the fiduciary duties of state-owned enterprises, presided by the Senator Tasso Jereissati and whose rapporteur is the Representative Artur Maia (“Tasso Project”).

The three bills have positive and negative points. They also have points in common and points of difference and the three together can eventually be more important than each one on a separate basis. The scopes of the projects are different. While Tasso Project covers federal, state and local owned enterprises, the other two deal only with federal SOEs.

The first point in common in the three bills is the ban on ‘authorities’ in SOEs’ Boards of Directors. It’s a positive policy in absolute terms. There’s nothing to question. The ‘authority’ in the Board of Directors is, by definition, imbued with a conflict of interests that affects his/her good performance. That does not necessarily mean a bad director, but that such conflict conspires to a poor performance. The scopes of the three bills are different, and Aécio Bill’s scope is broader. But the three of them seem to agree on the mentioned ban.

Another point in common is the need of setting and preserving the limits of the “public interest that justified its creation” – expression employed in the Article 238 of the Corporate Law and that has been extensively debated. The Tasso Bill, for example, establishes the preparing of a yearly letter about the costs related to such public interests. Additionally, it establishes that public interest costs are to be calculated and reimbursed to the society (in the case of listed state-owned enterprises). The PMDB Bill also establishes the clear definition of the public interest and the calculation of its economic cost.

Yet the Aécio Bill suggests a change to the Article 238: that the exception included in the article becomes void in the case of listed state-owned enterprises, that is, those that receive funds from private investors.

However, it’s necessary to analyze the need and the convenience of that change. The Article 238 has been considered the “villain” among the investors who had losses with state-owned enterprises’ shares. But maybe this is a superficial view. Let’s see: the Article 238 does not exempt directors from their duties. On the contrary, it has a RESTRICTED wording of the eventual exception. It’s focused on the controlling shareholder, not on the directors and is limited to the actions taken by the controlling shareholder related not to any public interest, but to a specific public interest, that is, the public interest that has led to the creation of the SOE.

A number of specialists have already expressed this same opinion, among whom the former presidents of the Brazilian Securities and Exchange Commission (CVM), Mr. Ary Oswaldo Mattos Filho and Mr. Luiz Leonardo Cantidiano, in addition to the jurists Mr. Nelson Eizirik and Mr. Modesto Carvalhosa.

The article 238 has been corrupted. It was turned into an excuse, into an actual blank check used to justify all types of abuses against state-owned enterprises. It’s a simple, clear and wrong interpretation (remember Mencken). The solution is simple: article 238 MUST BE OBEYED. If it is obeyed in its essence, a legal change may not be necessary. No doubt that to be obeyed, such public interest needs to be clear. And here there’s an important lesson that can be applied in several situations: in the law dealing with the creation of state-owned enterprises, in the preparing of their bylaws, in their listing registration when they go public, etc. The public interest must always be clear and restrictive and part of a real agreement between the controlling shareholder and the company.

It’s also important to say that a public interest is the crucial condition to justify the existence of a SOE. To exclude the preponderance of this interest over the remaining duties of directors and controlling shareholders in listed state-owned enterprises may lead to the question: why must the company exist under the control of the government?

Regarding the improvement of the definition of public interest, it could be considered unnecessary. The very existence of the Article 238 demands such definition, what unfortunately has not happened in a number of cases. Therefore, more than a legislative fault, there’s noncompliance with the law. If the existing law is observed, the new provision is not necessary. In the same way, the preponderance of the fiduciary duty of directors to protect the interests of minority shareholders has been recently confirmed in CVM’s decisions about Eletrobras and EMAE cases. Such decisions, despite new, lead to the right path under the auspices of the existing legislation.

Another point in common among the projects is the attempt to establish the creation of governance bodies, policies and practices in the law. The PMDB Bill, for example, establishes the creation of Audit Committees. The Aécio Bill suggests (1) Compensation and Human Resources, (2) Financial and Investments, (3) Audit, and (4) Ethics and Conduct Committees. Yet the Tasso Bill focuses on the policies, but also incudes the establishing of additional governance practices already established in Novo Mercado, such as a minimum percentage of outstanding shares and the tag along, among others.

Although they are positive initiatives, their legal imposition can bring adverse consequences. There is a high risk of establishing, through the law, the creation of structures that can eventually become mere instruments to get formalities approved only to meet the law; structures that lack transparency and bring about diffuse duties, opening space for all types of problems, in addition to the creation of unnecessary jobs. The creation of more and more bodies only for show is definitely something we do not need.

The same can be said for the rules regarding the composition of the boards, such as the number of members, their level of independence, etc. Once again, the ideas are good, but they may not deserve a new law.

Corporate governance concepts evolve over time. The IBGC Code, for example, is now being revised for its 5th edition. The same happens with other governance documents recognized around the world. Yet a law is prepared to last, despite the fact that it can be reformulated in the future, considering the hard job inherent to the legislative activity. The independence of the board, for example, has been widely discussed. Should it be 20 percent? 30 percent? The majority? We do not know. This is an issue to be analyzed on a case-by-case basis and according to the maturity of the economic system.

Accordingly, the law does not seem to be the best option for such prescriptions. They are valid today, but change over time. That’s the purpose of the non-statutory levels governing our companies.

Another issue addressed in the bills, yet on a distinctive basis, is related to the legislative confirmation (“sabatina”) of board members in state-owned companies. The Tasso and Aécio Bills establish that all members nominated by the controlling shareholder are to be confirmed by the Senate. Yet the PMDB Bill establishes that such procedure must take place only in the case of CEOs.

The Senate’s willingness to follow up and express itself when it comes to the nomination of those who will manage state-owned enterprises is legitimate. However, this procedure will have little effect on the creation of more effective boards. On the contrary, it will bring about the risk of politicizing a process that must be essentially apolitical. Delegating the task of analysis and approval of dozens of directors to the Federal Senate brings about the risk of creating an even more ineffective process to be based on political interests and not on the merits of the candidates. The Senate plays a crucial role in following the nominations of directors to state-owned companies, but such task must not be performed on an individual basis. It must take place as part of the PROCESS.

The formula suggested in the PMDB Bill – of assessing the CEO – seems even more risky. By relying on the Senate confirmation of the Chief Executive, the Board of Directors is deprived of one of its main functions, that is, to select, supervise and dismiss members of the Executive Board, including the CEO. This creates the “perfect excuse” for the Board to exempt itself from its duties on everything, after all, the CEO “was approved by the Senate.” Denying the Board of Director’s function is not the solution for our SOEs. It’s the opposite: the Board must be valued.

Similar comments can be made to the other proposals, such as the creation of committees and boards. They are structures whose flexibility to adjust to each specific state-owned company is very important. Once again, we may be creating several bodies only for show. Several positions, more red tape and little efficacy. The same can be said of the compulsory policies. Here we can mention Petrobras: it had ALL imaginable policies. Some were good, others were not. All followed in the form, but often – and always during critical moments – not in the essence. To establish the creation of policies, therefore, will not solve the problem. Mainly if it is done through the law.

There are also attempts of rewriting parts of the Corporate Law, including some timely changes. Attorneys usually say that “a good law is an old law.” If there’s no strong reason to change a law, it’s better to keep it the way it is as the jurisprudence makes it more effective. In this specific case, the repetition of legal provisions, sometimes to emphasize their application in the SOEs, would reinforce their exceptional quality – what would lead to risks, not advantages. The legislator of 1976 that included listed state-owned enterprise in the same category as that of other companies was quite wise, also when it comes to the directors’ fiduciary duties, with only one exemption to the Article 238 that unfortunately, as we have seen, has been wrongly taken far beyond their authors could imagine. The eagerness of creating a legal system for SOEs, along the line of Article 173 of the Brazilian Federal Constitution, must not be mistaken for the deconstructing of the relationship among listed state-owned companies and the remaining listed companies, according to the systematic aspect of the Corporate Law.

It is also worth mentioning the attempts of making some requirements for the exercising of positions in the executive board or in the board of directors into a law – requirements that can either be the best ones or not, but that would be eternalized in the legal documents, if approved. The PMDB Project, for example, establishes that CEOs of listed stated-owned companies must have occupied a similar position in other listed companies. It is an innocuous and also an excessively restrictive measure. Considering that today there are some 360 listed companies in Brazil, the universe of skilled candidates would be significantly reduced.

The condition of imposing commitments to results in the investiture of board members seems a well-intentioned measure, but it would bring about serious problems in practical terms. How can we imagine that, even before occupying the position, someone will have to agree with goals whose creation he/she have not participated in? This provision can definitely drift away the most serious and experienced executives from our SOEs, mainly considering that the PMDB Project establishes the immediate dismissal of such executives in the event goals are not reached for two years.

The projects follow their own paths in other fields. The Tasso Project, for example, rewrites the bidding rules applicable to state owned-companies – an issue that would require an additional analysis to be addressed in another article. Compared to the other ones, it innovates by establishing that listed state owned-companies’ capital must be formed exclusively by common shares. It is a highly beneficial measure that aims to reduce the unbalance between decision makers’ interests and the interests of those that suffer their impacts. Experience demonstrates that leveraged control structures – that make use of non-voting shares, multiple-voting shares or pyramidal structures – are at the heart of almost all corporate governance problems worldwide. They are loopholes for the unbalance of interests that can also be harmful in SOEs.

In brief, the suggestions presented in the three projects are overwhelmingly positive. If our SOEs eventually incorporate these changes, they will be better than they are today. No doubt that there are exceptions, as in the case of assessing candidates for the boards and the lack of incentive to find the best executives for these companies. But in general terms, the three of them bring good ideas.

The heart of the problem is in the convenience of establishing these standards into the law. What’s the best way then?

Amec understands that the reformulation of state-owned enterprises must start not through direct prescriptions to them, but to their overall structures. We are basically talking about the ownership and control issues – key elements of the corporate governance system.

Who is currently Petrobras’ “controlling shareholder”? We can say that the company is linked to the Ministry of Mines and Energy. It is also linked to the Ministry of Finance as its head has chaired the company’s Board of Directors for a long time. It is formally subject to the Department of Coordination and Governance of State-Owned Enterprises (DEST) that, in turn, is linked to the Ministry of Planning. Can we say that DEST represents Petrobras’ controlling shareholder? No. The votes in General Shareholders’ Meetings are exercised by a representative from the Federal Attorney General’s Office. Does this representative choose the members? No. So, who is it? Nobody knows. In practical terms, the “boss” is the President of the Republic. To make things worse, Petrobras’ shares are now spread among the Treasury, the Sovereign Fund, the Brazilian National Bank for Social and Economic Development (BNDES) and the Federal Savings Bank (CEF)…

This ownership structure is an open door for having duties dissipated throughout the chain. We are talking about a key factor of the corporate governance: accountability.

It’s exactly for this reason that the cornerstone of SOEs’ restructuring all over the world is the creation of a centralized body that personify the state-owned enterprise’s “controlling shareholder.” Many countries that adopted this model have been successful.

In fact, the concentration of the “ownership” activity in a specific governmental agency is one of the main recommendations of OECD Guidelines on Corporate Governance of SOEs.

OECD guidelines are the foundation for a decade-long work aimed at the enhancement of state-owned enterprises worldwide. Whenever a country applies to join OECD, the organization carries out a diagnosis of the country’s adherence level to its recommendations – also in relation to SOEs’ governance. This has happened to Chile, Costa Rica and is starting with Colombia. Peru, while not formally a candidate to the OECD is doing an informal benchmarking in relation to the Guidelines.

In brief, the process to adhere to OECD involves very clear requirements about the enhancement of SOE-related practices. Instead of recommending that practice A or B are brought to the law, the organization focuses on processes – mainly on the ownership, control and transparence processes of state-owned enterprises.

Amec believes that, before revising the law, Brazil should apply to OECD process, applicable to all candidates to become members, regarding SOEs’ corporate governance. From that point on, the necessary legal changes, under the vision of OECD’s recommendations, would be identified.

Therefore, the objective would be the creation of a National Agency of State-Owned Enterprises or of a holding comprising all federal SOEs. This entity would be directly controlled by the Legislative Branch, as it happens with other agencies. Maybe it would deserve an even stricter control. It’s important to highlight that such proposal must not involve a broader participation of the government in the economy. It would be created from existing structures, such as the DEST, but with major changes in its structure and mission. These missions would include:

  • Ensure that the creation of a SOE meets the legal principles.
  • Ensure that the social interests that have led to its creation are clearly defined, supervised, assessed and continue to exist over time.
  • Define, whenever necessary, the ways through which social interests’ costs would be reimbursed.
  • Establish the governance policies and practices applicable to the companies
  • Establish the process for the selection of Board of Directors’ members, including bans on ‘authorities.’
  • Delegate powers so that these boards, in turn, hire, supervise, reward and punish directors, according to pre-established goals (in real management agreements)
  • Exercise voting rights
  • Recommend the transfer or shutdown of companies that eventually do not meet their objectives.

There a number of examples, we only need to copy them: Singapore, Chile, Peru, Colombia, Vietnam and even China.

This reformulation would go further. There is at least two other key dimensions for the enhancement of SOEs: their ownership structure and transparency.

Regarding ownership structures, today we experience an actual control ‘web’ that significantly affects their effectiveness. The number of bodies to which SOEs are subject is incredible. Federal Court of Accounts (TCU), Internal Affairs Department (CGU), Department of Coordination and Governance of State-Owned Enterprises (DEST), Participations Coordination at the Ministry of Finance (COPAR), Office of Federal Budget (SOF), Attorney General’s Office (AGU), in addition to the sector regulators (National Agency of Petroleum, Gas, and Natural Fuels [ANP], National Electricity Agency [ANEEL], The Central Bank of Brazil [Bacen], etc.) and market regulators (CVM, BM&FBovespa, etc.).

Accordingly, it’s necessary to reorganize control structures that reign over our SOEs. Not to create a new structure, but to restructure what already exists, avoiding duplicities, rework and darkish areas.

With respect to transparency, it continues to be the best detergent. And this is even truer when it comes to state-owned enterprises. In the ideal SOE’s Board, strengthened and made accountable by the mentioned body, the principles on the Access to Public Information Act should prevail. The disclosure must be the rule, the confidentiality, the exception. Maybe from 60 to 80 percent of the work carried out by a Board could be perfectly made public, but it is not.

It’s necessary to put an end to all this. We will never have a transparent society if its highest bodies continue opaque as they are today. The transparency in management acts through complete and timely records is a key factor to have Boards that work properly.

That must be our final objective.