A CVM E O PRODIN

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S e r v i ç o P ú b l i c o F e d e r a
l Protecting Those Who Invest in the Future of
Brazil
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CURRENT ISSUES ON DELISTING REGULATION

• The need to strengthen the delisting regulation
  was highlighted by the growing number of
  delistings that took place since the end of 1998.
• This process began with privatization and the
  general capital restructuring that started to
  take place in Brazil in the mid 90s.
• The low valuation of companies in Brazil created
  an opportunity for foreign controllers to buy
  back shares, thus delisting the Brazilian
  subsidiary, since they could raise capital at
  much better valuations in their country of
  origin.

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NUMBER OF DELISTINGS
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MAIN CONCERNS WITH THE DELISTING PROCESS

• Lack of liquidity and high concentration of
  volume traded in a few stocks.

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MAIN CONCERNS WITH THE DELISTING PROCESS

• Low free-float
• Lack of equity culture. No retail market
• Petrobras recent issue helped fuel Brazils
  equity Culture
• Internet trading

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DISGUISED DELISTING 1 -- BYPASSING INSTRUCTION
229

• Controllers were delisting companies in a
  disguised way by circumventing CVM Instruction
  229 of 1995, which regulated the delisting
  process.
• They would simply acquire shares in the market
  until no liquidity remained and them they would
  make a tender offer to buy the remaining shares.

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DISGUISED DELISTING 2 -- PROBLEMS WITH
INSTRUCTION 299

• CVM puts out Instruction 299 in February 1999 to
  regulate voluntary regular tender offers.
• According to Instruction 299, if a controller
  wants to buy more than 10 of the free-float, he
  has to make an offer to acquire all shares in the
  market.
• This gave birth to another kind of disguised
  delisting, which we will call disguised delisting
  2.

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DISGUISED DELISTING 2 -- PROBLEMS WITH
INSTRUCTION 299

• In disguised delisting 2, controllers offer to
  acquire all free-float, but without intending to
  cancel the CVM registration, i.e., to officially
  go private.
• At this point it is important to mention that
  companies can buyback all shares and still be
  rated as a public company. Many companies go
  public in Brazil to issue debt instruments, but
  they do not list shares in the stock exchange.
• As we mentioned before, Instruction 229 regulates
  the process of going private (also known as
  delisting).

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DISGUISED DELISTING 2 -- PROBLEMS WITH
INSTRUCTION 299

• Controllers would file for Instruction 299
  (voluntary tender offfer) and not for Instruction
  229 (going private). The difference is that the
  former is much less protective than the latter.
• According to Instruction 229, the delisting is
  only possible if 67 of free-float agrees to
  sell. In this case, a put option is offered to
  the shareholders remaining in a private company.
  Instruction 299 did not have such provisions.

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DISGUISED DELISTING 2 -- PROBLEMS WITH
INSTRUCTION 299

• Many companies were artificially delisted with
  this scheme and sometimes were left with less
  than 5 of free-float in the market.

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DISGUISED DELISTING 2 -- PROBLEMS WITH
INSTRUCTION 299

• This new kind of artificial delisting created
  what we call the liquidity dilemma.
• In deciding whether or not to sell their shares
  in a tender offer, minority shareholders would no
  longer see the fairness of the price offered as
  the only variable to be taken into account.
• Minority shareholders would have to find out
  whether or not large shareholders will agree to
  sell. In case they do, the risk of remaining with
  an illiquid stock, drives minority shareholders
  decision to sell even if they think the price is
  unfair.

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MORE PROBLEMS WITH OLD TENDER OFFER
INSTRUCTIONS 229 AND 299

• Liquidity issues also reduced the protection
  effect of Instruction 229 (delisting), because
• If a group of shareholders was active enough to
  join some 35 of free-float against the delisting
  process and therefore no official delisting would
  occur, it may seem that this group was successful
  in their aim, but what did they really got out of
  it?
• The answer is a huge problem, since 65 of the
  free-float would have been bought by the
  controller and the remaining 35 would not have
  the put option since the delisting did not occur.
• Thus, the 35 successful group was left with an
  illiquid stock.

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FIRST STAGE OF REFORM OF INSTRUCTIONS 229 AND
299

• Instruction 345 of September 2000 rescued the
  spirit of the delisting and tender offer
  instructions through the reestablishment of an
  effective protection against the liquidity
  dilemma.
• Currently, over a period of 2 years, a controller
  unable to acquire 67 of the free-float, will not
  only lose the opportunity to delist the company,
  but he also will only be allowed to buy 1/3 of
  the free-float.
• In this way, there is no buy-back between 33 and
  67 of the free-float. 33 seems to be a
  reasonable figure to avoid liquidity shrinks and
  67 seems to be a number high enough to
  legitimate the choice for delisting.

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FIRST STAGE OF REFORM OF INSTRUCTIONS 229 AND
299

• Furthermore, Instruction 345 has also eliminated
  disguised delisting 2.
• It allows controllers to acquire all shares
  without officially delisting the company. They
  will file for instruction 299 with CVM. However,
  in order to acquire all shares, he will always
  also have to follow rules included in
  instructions 229 and 345, which are more strict
  and determine that there is no buying back
  between 33 and 67.
• Some controllers might wish to acquire all shares
  without officially delisting the company in light
  of privatization rules forbidding delisting
  and/or wish to remain public to issue debt
  instruments.

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FIRST STAGE OF REFORM OF INSTRUCTIONS 229 AND
299

• Another critical change introduced by instruction
  345 was the granting of a put option to everyone
  remaining in the company after a 67 buyback --
  even if the controller did not wish to officially
  delist the company.
• However, instruction 345 was issued in a hurry in
  order to immediately cease the liquidity
  dilemma. There are several other issues
  deserving significant changes in instructions 229
  and 299.
• A new and complete reform of all delisting
  instructions (229, 299 and 345) should be issued
  in April. The main changes compared to the
  present rules should be

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FIRST STAGE OF REFORM OF INSTRUCTIONS 229 AND
299

• n

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SECOND STAGE OF REFORM OF INSTRUCTIONS 229 AND
299

• n

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SECOND STAGE OF REFORM OF INSTRUCTIONS 229 AND
299

• n

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SECOND STAGE OF REFORM OF INSTRUCTIONS 229 AND
299

• n

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SECOND STAGE OF REFORM OF INSTRUCTIONS 229 AND
299

• n

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CONCLUSIONS ABOUT DELISTING AND TENDER OFFFER
PROCESSES

• A guiding principle for equitable treatment of
  shareholders in delisting or tender offer
  processes is to ensure that investors will be
  able to focus on the fairness of the price
  offered instead of having their decision
  influenced by other factors such as a liquidity
  dilemma.
• It is not the task of the regulator to avoid
  delistings and tender offers -- in fact, in our
  opinion, if a company does not have the proper
  culture to be a public company, then it should
  really file to go private or to acquire all its
  shares.
• However, the regulator has to ensure that the
  rules of the process are fair and that the
  disclosure level is appropriate to feed investors
  with sufficient information to decide whether to
  sell or not.

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CHANGES IN CAPITAL STRUCTURE
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REGULATION ON STOCK ISSUANCE

• According to our Corporate Law, (Article 168) the
  Bylaws can rule about the authorization to
  increase capital. This authorization should
  specify
• the limit of increase
• whether the GSM or the Board of Directors will be
  responsible for deciding about the issues
• in which conditions shareholders will have
  preemptive rights or not (article 172).
• Article 172 determines that the Bylaws can
  provide for a capital issuance with no preemptive
  rights if
• the sale is made either on the stock exchange or
  through a public offering.

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EXPERIENCE WITH RESPECT TO STOCK ISSUANCE

• The majority of companies choose to grant
  preemptive rights in capital issuance.
• In case of significant capital increases aiming
  to reach a large number of new investors, most
  companies grant 30 days to current shareholders
  to exercise their preemptive rights.
• However, there are cases of small capital
  increases or newly listed companies disclosing a
  need to raise capital constantly, in which
  preemptive rights of only 2 to 5 days are granted.

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MAIN CONCERNS IN STOCK ISSUANCE

• The guiding principle for equal treatment in
  capital increases has been the fairness of the
  dilution resulting from the capital increase.
• The regulator has been focusing on ensuring the
  enforcement of article 170, which establishes
  that the issue price has to be determined by one
  of the following parameters (1) market value
  (2) book value (3) profitability perspectives.
• The aim is to avoid an unjustifiable dilution of
  the stake of minority shareholders.

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SHARE BUY-BACKS

• CVM Instruction 10 established that companies are
  allowed to buy back a maximum of 5 of
  outstanding shares.
• In 1997, CVM amended instruction 10 to allow a
  buy back of 10 of outstanding shares because the
  overall stock market was going through a low
  valuation period (Asian crisis).
• A return of the 5 limit is under study --
  however, the 10 limit could be allowed in cases
  of a later cancel off of the shares acquired.

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