CVM Orientation Opinion 4: Aspects of Law No. 6,404/76 Applicable to the Adjustment of Financial Statements of Publicly Held Companies

SUMMARY: Aspects of Law No. 6,404 of December 15, 1976 (Law of Corporations), applicable to the adjustment of financial statements of publicly held companies.

1. This matter concerns the process of adjusting the financial statements of publicly held companies to LAW NO. 6404/76 and includes the interpretation of some of its provisions.

2. From the beginning of the CVM's effective operation, an orientation was developed aimed at a better understanding of the policy and disclosure of information by all participants in the securities market, in view of the philosophy of the new Law of Corporations.

3. In this first year of adjustment to the standards established in the legislation, regarding the preparation and disclosure of financial statements, it was the CVM's responsibility to examine and monitor this adaptation with respect to publicly held companies.

4. A sample of 100 companies was evaluated regarding the incidence of deviations verified in compliance with the relevant legal and regulatory provisions concerning financial statements.

5. Based on the analysis results, it was concluded that, despite a significant improvement in the presentation of financial statements, the incidence of inaccuracies remains substantial, a fact that suggests the need to alert all publicly held companies to strictly observe the norms prescribed in the current legislation in future publications of their financial statements.

6. With the objective of contributing to the minimization of such deviations, the CVM deems it appropriate to highlight legal aspects related to such deviations, which will serve as guidance for the adjustment of financial statements to LAW NO. 6404/76.

7. Management Report
The management report should be published together with the financial statements, providing information on corporate business and the main administrative events of the closed fiscal year, in accordance with Article 133 of Law 6404/76, as well as listing the company's investments in affiliated and controlled companies and mentioning changes that occurred during the fiscal year in accordance with Article 243.

8. Explanatory Notes
The explanatory notes provided for in Article 176, § 5, are considered a minimum to be followed by the company, which must prepare others as necessary to clarify the financial position and results of the fiscal year. The main deviations occurred in the following explanatory notes:

1. Relevant investments in other companies
Law 6404/76, in its Article 247, determines the information that must be provided regarding relevant investments in affiliated and controlled companies and their relationship with the company. CVM INSTRUCTION NO. 01 of 27.04.78, item XXXIV, supplemented this article. The required information that must appear in an explanatory note is:
a) name of the affiliated or controlled company, share capital, and net equity; b) number, type, and class of shares or equity interests held by the investor or controlling company, and the market price of shares, if any; c) net profit for the fiscal year; d) credits and obligations between the investor or controlling company and the affiliated or controlled companies, specifying terms, financial charges, and guarantees; e) revenues and expenses in transactions between the investor or controlling company and the affiliated or controlled companies; f) amount of the adjustment resulting from the valuation of the investment by the equity method and the effect on the fiscal year's results and on accumulated profits and losses; g) basis and rationale adopted for the amortization of goodwill or bargain purchase; and h) conditions established in a shareholders' agreement regarding influence on management and distribution of profits. It should be noted that in letters d and e, it is important to specify credits and obligations, terms, financial charges, revenues, and expenses, by affiliated and controlled company.

2. Equity Method
Article 248 of Law 6404/76 prescribes the method to be adopted by companies that evaluate investments at the value of net equity.
CVM INSTRUCTION NO. 01 regulated this procedure, and specifically regarding the difference resulting from this valuation, in its items XXVI to XXX.
Thus, this difference should be accounted for:
a) as operating income or expense, when resulting from profit or loss determined in the affiliated or controlled company; b) as non-operating income or expense, when resulting from actual gain or loss due to variation in the percentage of ownership of the investor or controlling company in the share capital of the affiliated or controlled company; c) as a revaluation reserve, when resulting from the revaluation of assets, accounted for in the Revaluation Reserve in the affiliated or controlled company. This information must appear in an explanatory note.

3. The increase in asset value resulting from new valuations - The Law prescribes in Article 182, § 3, that the counterparts of value increases attributed to asset elements should be classified as revaluation reserves.
The new valuation must be based on a report prepared by three experts or a specialized company, approved by the general assembly, in accordance with Article 8. These procedures must be included in an explanatory note.

4. Real encumbrances constituted on asset elements, guarantees provided to third parties, and other eventual or contingent liabilities.
The omission of this information in an explanatory note prejudices the analysis of the company's actual economic-financial situation.

5. Rates, due dates, and guarantees of long-term obligations.
The currency in which the obligations were incurred, whether they are subject to monetary correction, as well as interest, terms, guarantees, and other information deemed relevant, must also appear in an explanatory note.

6. Number, types, and classes of shares of share capital
Article 11 of the Law stipulates that the company's bylaws shall fix the number of shares into which the share capital is divided and establish whether the shares will, or will not, have a par value.
Thus, for each type and class, the respective quantity and par value of the shares, if any, must appear in an explanatory note.
The advantages and preferences conferred to the various classes of shares must be included in the explanatory note.

7. Adjustments of prior periods
Adjustments of prior periods are considered those resulting from the effects of a change in accounting criterion, or the correction of an error attributable to a specific prior fiscal year, and which cannot be attributed to subsequent events, in accordance with Article 186, § 1. These effects must be stated in an explanatory note.

8. Subsequent events to the end of the fiscal year that have, or may have, a relevant effect on the financial situation and future results of the company.
These events, provided for in item i, of § 5, of Article 176, are those verified in the interval between the end of the fiscal year and the preparation and disclosure of the financial statements.
These events must appear in an explanatory note.

9. Disaggregation of participations in results
The requirement to disaggregate the participations of debenture holders, employees, administrators, and beneficiaries, and contributions to institutions or funds for employee assistance or pension, is expressly provided for in Article 187, item VI, of Law 6404/76. Regarding the participation of administrators, the Law provides in its Article 152, § 1, their maximum limits:

• annual remuneration of administrators; or
• one-tenth of profits.
  The lower of these limits prevails. Consequently, it is necessary to disclose the amount of remuneration paid to administrators in the statement of results for the fiscal year.

10. Presentation of the amount of dividend per share of share capital
The company must indicate the amount of the dividend per type of share of share capital in the statement of accumulated profits or losses or, if it prepares and publishes, in the statement of changes in equity, in accordance with Article 186, § 2.

11. Consolidated Statements
Article 249 determines:
"A publicly held company that has more than thirty percent of the value of its net equity represented by investment in controlled companies must prepare and disclose, together with its financial statements, consolidated statements in accordance with Article 250." Two aspects deserve emphasis:
a) only investment in controlled companies should be considered; and b) the obligation to publish consolidated statements together with the controlling company's financial statements.
The CVM, in accordance with the sole paragraph of this article, will issue an Instruction on the subject.

12. Allocation of Profit
It was noted that only 23% of the publicly held companies in the sample allocated the entirety of their profits in their financial statements, with 40 of them leaving 50% or more of the fiscal year's net profit in accumulated profits, without any mention of profit retention.
Article 176, § 3, of Law 6404/76 determines that: "Financial statements shall record the allocation of profits according to the proposal of the administrative bodies, assuming its approval by the general assembly."
The same Law, in its Articles 193 to 199 and 202/203, deals with alternative allocations of profit, specifying when they may or must occur, discussing the purpose, criteria for the constitution of reserves and profit retention, limits, as well as aspects related to the disclosure of information regarding statutory reserves, reserves for contingencies, profit retention, and mandatory dividends. Combining the legal aspects mentioned above with the entire philosophy that governed the preparation of Laws 6404 and 6385/76 regarding the disclosure of information, and further, the fact that the mandatory dividend must be understood as the minimum and not the maximum to be distributed, it becomes necessary to extensively justify the creation of reserves and the retention of profits, without which shareholders may question the company on this matter.

13. Finally, it is worth recalling that the observations currently set forth in this opinion constitute a great relevance for improving the understanding of each company's financial statements by its shareholders and other market participants, and as such, must be complied with by all publicly held companies upon the preparation of their respective financial statements.

Signed originally by
ROBERT EDUARD WIL
Superintendent of Corporate Relations