CVM Explanatory Note 16/80

CVM EXPLANATORY NOTE NO. 16/80.
Ref.: CVM INSTRUCTION NO. 10, of February 14, 1980, which provides for the acquisition by open companies of shares of their own issuance, for cancellation or retention in treasury, and their subsequent disposal.

Law No. 6.404, of December 15, 1976, in its Article 30, § 1, item "b", extends to all companies the option to acquire shares of their own issuance, a right previously restricted to companies with authorized capital under the provisions of Law No. 4.728/65.

The treatment given by Law No. 6.404/76 to the scenario of trading by companies of their own issued shares relaxed the principle of generic restriction, allowing, on an exceptional basis, among other operations, the acquisition for cancellation or maintenance in treasury, as well as the subsequent disposal of these securities.

The generic restriction is a consequence of the basic principles that inform the concept of share capital and stem from the need to preserve its intangibility, ensuring the interests of creditors and shareholders alike.

In the case of open companies, this restriction is further justified by the protection of investors against the possibility of manipulation in share prices.

Thus, aiming to prevent possible abuses, § 2 of Article 30 of Law No. 6.404/76 determines that "the acquisition of its own shares by an open company shall comply, under penalty of nullity, with the rules issued by the CVM".

The CVM deemed it appropriate to address the need to implement the legal command contained in that provision, with a view to regulating the use of this mechanism, a possibility awaited even in times prior to the enforcement of Law No. 4.728/65, and to normatize, in complement, the disposal of shares in treasury, based on the competence attributed to it by the sole paragraph, item III, of Article 22 of Law No. 6.385/76.

The Instruction was drafted in strict observance of the principles governing law, especially corporate law, as well as those that preside over the regular and orderly functioning of the securities market, adding that the responsible use of the mechanism by administrators, always supported by criteria of broad disclosure, ensures the successful implementation of its adoption.

In this sense, for example, it should be noted that it became unnecessary to make express mention of the obligation to observe the interests of the company in the transaction, as this is a precept commitment of all those who have the power to decide on the destiny of the society.

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The requirements and impositions introduced in the body of the Instruction suggest the real scope of the operations of acquiring own shares or their subsequent disposal, leaving no room for interpretations that are too extensive, tending to recognize the mechanism as a market instrument for the purposes of price support or liquidity of shares. These are functions that, moreover, should belong to the agents of the securities distribution system.

The type of operation, although exceptionally accepted, constitutes an unequivocally administrative procedure, with the managers of the society deciding on the convenience or necessity of its use. For this reason, the admitted objectives in this type are not listed, either taxatively or exemplarily, safeguarding only the compliance with the requirements regarding respective disclosure, together with the other insurmountable requirements appearing in the Instruction.

The acquisition by an open company of shares of its own issuance constitutes a relevant fact, subject to the requirements of broad disclosure, reiterated in the act now issued.

The rule of Article 1, relating to the requirement that the bylaws attribute powers to the board of directors to authorize the operations, aims to give immediate knowledge of the legal permission, warning investors and shareholders in advance that the company, if there is interest, may use the mechanism.

It also aims to make the procedure more operational, ensuring greater decision-making speed and more efficient administrative mobilization, dispensing with other formalities, such as the prior holding of a general meeting to authorize each operation.

Note that this provision does not prevent the general meeting, within its original competence, from dimensioning the level of freedom of the administrators, specifying, upon the reform of the bylaws, conditions or objectives.

The various broad disclosure criteria adopted in the Instruction have the scope of informing the market about the relevant fact throughout the entire process of the operation, alerting it to the consequences of the decision taken by the administrators and enabling an adequate assessment of its effects.

Occurrences identified as artificial conditions of demand, supply, or share prices, or those considered unfair practices, are already defined in CVM INSTRUCTION NO. 8, of October 8, 1979. Nevertheless, it is necessary to repeat them in Article 2, item "c", as a prohibition, because the acquisition of own shares is, in all its constituent factors, aggravated with the penalty of nullity imposed by Law No. 6.404/76.

The breadth of this clause of Article 2, which in each case may give rise to interpretations, invokes the responsibility of public administration, which, in the exercise of the portion of discretionary power that belongs to it, is subject to inhibitory brakes dictated by public law, interested in avoiding excesses or abuses of power. The limited freedom of administrative action is rather to defend institutions and citizens' rights, than to repress or hinder them.

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The wide range of duties imposed on the controlling shareholder, by virtue of the natural access to the decision-making sources of the society, recommends the removal of their shares for the purposes of acquisition by the company, so as to avoid the emergence of situations of privilege before the shareholder community.

The basic rules, whose fulfillment enables the company to practice the operations treated here, could not fail to mention a limit to the quantity of titles to be kept in treasury, since the effective capacity of the company to influence the market for its own shares requires the scope of the created instrument to be delimited, in order to avoid distortions harmful to the regular and orderly functioning of this market.

The maximum percentage fixed at 5% (five percent) of each class of share, allied to the parameter "shares in circulation", was the average considered most convenient to fix the limit, below which, decisions to buy own shares would dispense with prior CVM approval, with which greater decision-making mobility is ensured to companies.

It is important to clarify that the delimitation of this percentage of shares, despite excluding the need for prior examination, does not mean immeasurable freedom to act. In addition to the obligation to comply with the other basic requirements cumulatively, any and all acquisition of shares by the company that issued them will be the target of administrative attention, since, it is worth remembering, in a large number of joint-stock companies, percentages lower than those fixed in the Instruction represent volume capable of definitively altering control through market trading.

Law No. 6.385/76 expressly admits the existence of open companies with their shares traded on a stock exchange or in the over-the-counter market.

Law No. 6.404/76, in turn, for the purposes of the provisions of its Article 30, § 1, does not establish any distinction between these companies, which prevents, despite the lower visibility of the over-the-counter market, restricting the use of the mechanism to companies that operate on the stock exchange.

The CVM, due to the other rules contained in the Instruction, especially regarding the information to be provided, will have the possibility of observing transactions carried out in the over-the-counter market, only excluding private transactions due to the obvious absence of visibility and equal conditions for all shareholders or potential investors.

Despite the express prohibition imposed by Law No. 6.404/76 on the use of the legal reserve for the acquisition of own shares, the principle of the intangibility of share capital requires that the prohibition be extended to other reserves constituted with financially unavailable resources, such as the revaluation reserve, which represents a mere book increase in assets, and the reserve for profits to be realized.

The exceptional regime surrounding the constitution of the special reserve for mandatory dividends results in the characterization of these resources as unavailable, since, when not absorbed by losses, their distribution in the following fiscal year is mandatory.

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The monetary correction reserve is excluded because it does not constitute a capital reserve proper, but rather an update of the monetary expression of share capital, the integrity and reality of which must be preserved.

The obligation to dispose of shares in treasury that exceed the balance of profits and available reserves, as per Article 14, is a mere corollary of the limitation of these balances for this special purpose.

Indeed, since the resources available for the acquisition of own shares are limited to the value of the balance of profits and available reserves, the reduction of these indices imposes the disposal of the excess titles, in order to maintain the legal principle of the intangibility of share capital and the protection of creditors and shareholders.

The disposal of the excess within the established period, depending on the volume, will imply only the selection of the most adequate operational mechanism for its realization according to the market in which the shares are being traded, in order to guarantee the orderly formation of prices.

For exceptional situations, such as difficulties in reinvesting shares in the market within the stipulated period, Law No. 6.404/76 itself points to the solution of canceling the excess shares.

The CVM is responsible for monitoring the price formation processes, with the aim of avoiding distortions and ensuring a regular and disciplined functioning of the market. However, any interference by the regulatory body in the objective fixing of share prices is inappropriate, which must be determined by the natural laws of the market.

The imposition, in Article 12, of the limit of the price to the market value for the shares to be acquired positions the regulatory body within the margin of its competence and evidences, on the other hand, the prohibition of using the mechanism for the purposes of price manipulation.

The defense of a regular price formation process authorizes the inclusion, in Article 15, of the warning that, in the event of disposal of shares in treasury, under conditions capable of substantially affecting the orderly functioning of the market, a special procedure approved by the CVM must be observed, even in previous acts and with a purpose different from that provided here, which must, always, meet the need to give broad disclosure of the operation.

Shares while held in treasury will not have financial or political rights.

This rule implies the suspension of all rights inherent to shares, which means the temporary impossibility of their exercise, due to an express recommendation of law.

The temporary sterilization to which treasury shares are subject aims to eradicate any possibility of the company acting as a shareholder of itself.

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The most expressive doubts that may arise with respect to this article will, for the most part, be linked to bonus scenarios. Moreover, these will not offer difficulties of solution, either because the mere alteration of the monetary expression of capital, in the case of the incorporation of the monetary correction reserve, has no financial significance, or because the undeniable gain obtained by shareholders with the capitalization of profits and reserves would not be extended to the company, under penalty of making it a partner of itself.

Indeed, in this second circumstance, the reserves to be incorporated constitute net profits, calculated in cash, which, for a period of time and due to the economic need of the company, were diverted from their natural purpose of distribution as dividends.

Logically, bonusing treasury shares, as a result of the capitalization of profits and reserves, would imply allowing the company to participate in social profits.

The CVM, regarding the impossibility of visualizing all factual scenarios with respect to treasury shares, does not definitively rule out the use of the expedient when, even without compliance with any provision, other than the insurmountable ones, provided for in the Instruction, the acquisition or sale of own shares can be carried out without prejudice to the company, the shareholder, or the market.

For this purpose, the prior examination, provided for by Article 23, aims to enable the use of the mechanism on an exceptional basis.

The penalty of nullity is provided for in Law No. 6.385/76 for operations that deviate from the rules of the Instruction. Obviously, whenever the possibility of prejudice is detected at any level - and this is perfectly presumable in the transgression of regulatory norms - the operation will not produce effects, by virtue of the applicable sanction.

Moreover, it is entirely convenient to clarify that the penalty of nullity will only affect transactions in which the norms directly linked to the operations of acquiring own shares are infringed.

The circumstantial commands that do not integrate the operational nature of the acquisition, such as, for example, the subsequent accounting registration, cannot give rise to nullity, under penalty of causing the emergence of incalculable losses to the investors themselves, resulting from the allegation of the invalidity of the act for issues of minor relevance, capable of correction and more specific sanctions regarding the responsibility of the administrators, not affecting third parties in good faith.

These are the considerations brought to public for the aid of understanding the norms now embodied in the form of Instruction. The other provisions are self-explanatory, taking as a line of interpretation the general principles that presided over the elaboration of the normative act that enters into force.

RIO DE JANEIRO, FEBRUARY 14, 1980.
Original signed by
JORGE HILÀRIO GOUVÊA VIEIRA
President