S e r v i ç o P ú b l i c o F e d e r a l

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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 CURRENT ISSUES ON DELISTING REGULATIONDELISTING 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 DELISTINGSNUMBER OF DELISTINGS

-50

0

50

100

150

Listing Delisting Balance

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MAIN CONCERNS WITH THE MAIN CONCERNS WITH THE DELISTING PROCESSDELISTING PROCESS

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

1998 1999 2000Market Capitalization (US$billion) (1) 160.9 228.5 225.5(dec)

Daily Volume–BOVESPA (US$million) (1) 569.0 347.6 410.2Brazilian ADRs ( listed in NYSE)–DailyVolume (US$ million) (2)

385.8 214.7 291.9(jan-nov)

Market Capitalization/GDP(4) 21.6% 41.2% 38.9%

Concentration (10 most negociated) (3) 77.1% 56.7% 55.4%(1)Bovespa; (2)Bovespa; (3) CNBV/Bovespa; (4)Bovespa

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MAIN CONCERNS WITH THE MAIN CONCERNS WITH THE DELISTING PROCESSDELISTING PROCESSLow free-float

Lack of equity culture. No retail marketPetrobras recent issue helped fuel Brazil`s equity CultureInternet trading

Bovespa's Traded Volume in 2000 by Type of Investor

Individuals19%

Financial Institutions

37%

Foreign Investors22%

Companies4%

Institutional Investors

17%

Other1%

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DISGUISED DELISTING #1 -- DISGUISED DELISTING #1 -- BYPASSING INSTRUCTION 229BYPASSING 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 -- DISGUISED DELISTING #2 -- PROBLEMS WITH INSTRUCTION 299PROBLEMS 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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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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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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Many companies were artificially delisted with this scheme and sometimes were left with less than 5% of free-float in the market.

% of ON free-

float acquired

% of PN free-

float acquired

% of ON shares left

over as Free-float

% of PN shares left

over as Free-float

Coelba 94,5% 98,5% 5,5% 1,5%Cesp

Paranapanema75,8% 95,9% 24,2% 4,1%

CPFL 81,1% 63,6% 18,9% 36,4%

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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 MORE PROBLEMS WITH “OLD” TENDER OFFER INSTRUCTIONS #229 AND #299OFFER 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 FIRST STAGE OF REFORM OF INSTRUCTIONS #229 AND #299INSTRUCTIONS #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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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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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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n Current FutureIn order to delist a company,more than 2/3 of minorityshareholders stating theiropinion about the delistingmust agree with the proposal.Example: In a company with100 shares, the controller has51 shares. Out of the 49shares composing the free-float, only 21 shares replied tothe proposal. Out of this 21, atleast 14 shares have to agreewith the delisting or the dealis canceled.

In order to delist a company,more than 2/3 of the entire free-float have to be in favor of thedelisting.Example: In a company with 100shares, the controller has 51shares. Out of the 49 sharescomposing the free-float, 2/3 or33 shares must agree with theproposal. If only 21 shares showup to state its opinion, this willnot be enough to reach theminimum quorum. The controllerwill have to look for theremaining 12 shares (33-21) andconvince them to agree with thedelisting. We believe this willsignificantly enhance theguaranty of a fair price.

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SECOND STAGE OF REFORM OF SECOND STAGE OF REFORM OF INSTRUCTIONS #229 AND #299INSTRUCTIONS #229 AND #299

n Current FutureThe auction is set upwith a given price whichcannot be changed if the2/3 quorum is notreached.Another proposal canonly be made in 2 yearstime.

If, during the auction, theproposed price is only able toconvince less than 67% of thefree-float to sell their shares,the controller will have theoption to offer a higher priceright away and see if he canget 67% to agree. All this willoccur during the auction. If thecontroller does not wish toraise his offer price to reachthe 67% minimum quorum,then, another offer will only bepossible in 2 years time.

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nCurrent Future

The broker dealeradvising the controllerhas to declare if he hasany mutual funds underhis managementpossessing shares ofthe company to bedelisted. If he has, thisshareholder positionhas to be disclosed andthe intention to acceptthe offer or not has alsoto be disclosed.

We are broadening theconcept by including notonly funds under theadvisor management, butalso groups linked to theadvisor, such asinsurance companies,asset managers and soon. But they will not haveto disclose their intentionas to wheter or not toaccept the offer.

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nCurrent Future

The controller choosesthe offer price andprovides CVM with avaluation reportjustifying the price.There is no explanationfor the valuation criteriachosen, neither anyinformation about whatthe price would beunder other criteria.

The controller has to delivera valuation reportdisclosing the price under 3criteria: i) net worth; ii)average of stock priceduring the last 12 months;iii) economic value(discounted cash flow ormultiples). Then, he has tojustify why he chose any ofthese criteria.

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n Current FutureThe shareholders listis not included as anecessary documentto be delivered toCVM in order to getour approval.

Shareholders list willbe included as anecessary documentto be delivered and itwill be available forthe public during theoffer. This willfacilitate a proxy fight.

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CONCLUSIONS ABOUT DELISTING CONCLUSIONS ABOUT DELISTING AND TENDER OFFFER PROCESSESAND 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 CHANGES IN CAPITAL STRUCTURESTRUCTURE

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REGULATION ON STOCK ISSUANCEREGULATION 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 increasewhether 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 EXPERIENCE WITH RESPECT TO STOCK ISSUANCESTOCK 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 MAIN CONCERNS IN STOCK ISSUANCEISSUANCE

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-BACKSSHARE 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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http://www.cvm.gov.br

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