On 16 July 2003, the Brazilian Securities and Exchange Commission ("CVM") laid down Instruction No. 391 that makes provisions on the organization, operation, and management of the so called private equity funds. These funds are closed condominiums, of 8 to 10-year maturity, formed to acquire equity holdings. The sector has long been waiting for regulation of the activity, which to date followed the rules of variable income funds.
According to Instruction No. 391, these funds are the combination of resources intended for the acquisition of shares, debentures, subscription warrants, or other securities or stock that may be converted into or exchanged for shares issued by publicly- or privately-held companies, and consequently taking part of the invested company’s decision-making process with effective influence in the definition of strategic and management policies, specially by appointing members of the Board of Directors (Conselho de Administração), but also, and alternatively, by holding shares in the controlling stock; by entering into shareholders’ agreement or other agreement securing such decision-making privilege. When investing in companies effectively or probably undergoing reorganization, these funds may pay quotas by means of assets or rights, credits included, provided that such assets and rights are tied to the recovery of the invested company and provided, further, that the value thereof is substantiated by expert report.
An internal regulation will establish the eligibility criteria for publicly-held companies. As far as privately-held companies, the following procedures are mandatory: (i) no founder’s shares may be issued or be outstanding; (ii) all members of the Board of Directors will hold office for one (1) year; (iii) disclosure of agreements made with related parties, shareholders’ agreements and share option programs or the like; (iv) acceptance of arbitration as the dispute settlement procedure in corporate disputes; (v) adhesion to special industry category of stock exchange or supporting over-the-counter entity ensuring, at least, differentiated levels of corporate governance practices in the case of companies going public; and (vi) annual audit of financial statements by independent auditors accredited by CVM.
Investments may be made by way of commitments, whereby the investor undertakes to fully pay committed capital to the extent that the fund manager makes calls, based on a fixed schedule, decision-making processes and other procedures established in the respective investment commitment.
The name of the fund must include the following sentence (in Portuguese) "Fundo de Investimento em Participações" (Equity Holding Fund) and no word may be used that is misleading with respect to the purpose, investment policy or intended public.
Operation of these funds is conditioned on prior registration with the CVM, which will be automatically granted upon filing of the following documentation: (i) three copies of the charters and regulation, all properly initialed and signed, plus certificate of registration of fund with the relevant records office; (ii) certificate indicating name of independent auditor; (iii) disclosure of the maximum and minimum numbers of quotas to be distributed, value, all costs incurred, and other distribution information; (iv) promotional material for the distribution of fund quotas, including the prospect, if any; (v) any additional information that may be disclosed to potential investors; (vi) brief description and professional background of the manager’s and trustee’s expert ensemble, if any, running portfolio; and (vii) where fund is not ran by financial institution participant of the distribution system, the fund’s manager shall contract with institution legally authorized to provide quota distribution and treasury services, such as (a) opening and operation of bank accounts on behalf of the fund; (b) receipt of funds originating from the issuance or full payment of quotas and payment of amortization or redemption, by the fund, of quotas or upon liquidation of the fund; (c) receipt of dividends and any other income; and (d) financial settlement of all fund’s transactions.
Only investors qualified under terms of regulation issuing from the CVM with respect to securities and stock investment funds may invest in these funds, at the minimum subscription price of one hundred thousand Brazilian reals (R$ 100.000,00).
The equity holding fund’s regulation must contain and indicate the following: (i) deadline for full payment of quotas composing the minimum initial equity established for funding, starting on the CVM accreditation date; (ii) identification of the institutional manager and, as the case may be, trustee; (iii) investment policy to be adopted by manager, and identification of assets that may compound the portfolio and explanation about potential risks of portfolio concentration and non-liquidity of these assets; (iv) rules and call deadline, due respect being given to the investment commitment signed by subscriber; (v) rules and criteria for fixing the term of investments made for the acquisition of shares, debentures, subscription warrants, or other securities or stock that may be converted into or exchanged for shares issued by publicly- or privately-held companies, as of the date of each full payment of capital and about the reimbursement of capital or extension of term, in the event the investment cannot be made within the fixed time; (vi) procedures for any new investment commitment, and detailed criteria about the valuation of quotas acquired after the initial subscription; (vii) admission and/or withdrawal fees to be paid by each member and how said fees are fixed; (viii) determination of book value of the fund’s assets, including the procedures used in investment provisions and write-offs; (ix) remuneration of manager or criteria for fixing remuneration, which may include management and performance fees; (x) information to be made available to members, reporting intervals and means of publication; (xi) fund expenses and charges; (xii) repayment possibilities, and respective conditions, due respect being given to the issuance, placement, negotiability and repayment requirements provided in the Instruction; (xiii) authority of the Members’ Meeting, criteria and requirements to call it and for deliberations; (xiv) life of fund and conditions of any extension; (xv) disclosure of any potential conflict of interest; (xvi) decision-making process with respect to investment or divestment by the fund; (xvii) members and operation of the advisory, investment, technical or other committee, if any; (xviii) rules for replacement of manager; (xix) how to deal with rights deriving from assets of the fund’s portfolio, including but not limited to income, dividends and interest on the company’s own capital and distribution or reinvestment of said rights; (xx) events of fund liquidation; (xxi) possibility of using assets and rights, including securities, for repayment of quotas, as well as liquidation of fund, and establishment of detailed and specific criteria for adopting these procedures; and (xxii) closing date of fiscal year.
Funds may not perform transactions with derivatives, except to the extent that such transactions are performed solely to protect the fund’s assets and offer options whose underlying asset are securities or stock of the fund’s portfolio or with a right of conversion.
The fund will be run by legal entity accredited by CVM to manage securities and stock portfolios.
Originally published in July, 2003.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
