CVM/SIN Circular Letter 01/2010

CVM/SIN CIRCULAR LETTER No. 1/2010
Rio de Janeiro, January 8, 2010
Subject: Interpretation of Provisions of CVM Instruction No. 409/04

Dear Sirs,

This Circular Letter aims to guide the administrators of investment funds regulated by CVM Instruction No. 409/04 regarding the Board's interpretation of the application of (i) Articles 39 and 40, II and IX, concerning funds that combine investment in shares of open companies and derivatives, which together impose on the fund's profitability a behavior different from that observed for the acquired shares (hereinafter referred to as "Funds"); and (ii) Article 41, VII, regarding the stipulation of a fixed administration fee expressed as a percentage of the fund's net asset value.

The primary objective of these clarifications is to seek to standardize market practices on two matters deemed sensitive by our Superintendence: the disclosure of information in structured funds under CVM Instruction No. 409/04, and the charging of administration fees in funds not intended exclusively for qualified investors.

In the risk-based supervision processes carried out by this technical area for investment funds registered with the CVM, we verified that the treatment given by the market to these points was not homogeneous, which reinforced our finding regarding the need to standardize these understandings, in line with Board decisions that addressed the matter (CVM Processes No. RJ20087977 and RJ20081974).

Here we define as "structured funds under CVM Instruction No. 409/04" those that invest predominantly in a specific financial asset, but whose performance does not replicate that of the asset in many circumstances, due to a structured operation that may have various purposes (prevent loss of invested principal, reduce the volatility of the fund's return relative to the performance of the invested asset, among others) for the fund.

At this point, with this Circular Letter, the technical area aims to disclose to the market what would be the minimum information considered necessary by the Superintendence for investors to understand the main risks involved in funds with these characteristics.

Regarding the charging of administration fees, this technical area found that some market participants had been including, in the calculation of the fees charged, formulas that conferred on them a behavior that was often difficult for the target audience of the fund to understand, and which also made it difficult to compare the expenses paid by the unit holder for this purpose with those they would pay in other funds with similar investment policies.

With regard to this issue, the Circular Letter has as its main objective to clarify to the market the limits and criteria for the formula for charging this fee in funds not intended exclusively for qualified investors, in order to ensure that this charge is always made on bases easily understandable and verifiable for the target audience to which it is directed, and also to ensure comparability between funds that fosters competition in this market.

1. Articles 30, 39, and 40, II and IX – Funds

Articles 39 and 40, II and IX, stipulate that the fund's prospectus "must contain all information relevant to the investor," including those related to the "investment policy" and the "identification of risks assumed by the fund."

The Board, in the meeting held on May 5, 2009 (CVM Process No. RJ20087977), when deliberating on the application of the aforementioned provisions to a concrete case, expressed itself in the sense that "the specifications and clarifications [regarding the fund's investment policy and risks] whose inclusion was requested by the SIN would belong (...), unequivocally, in the Funds' Prospectuses."

Thus, compliance with such provisions, in the case of Funds, must encompass the provision of information, in the corresponding prospectuses, at a level of clarity and simplicity compatible with the target audience, at minimum regarding:

a. The nature and essential characteristics of the acquired derivatives, in clear and accessible language for that target audience;

b. Complete data on all possible fund performance scenarios in response to the alternative behaviors of the shares of open companies in which the fund invests;

c. If a descriptive exposure does not address all these possibilities clearly, the prospectus must use tables, graphs, simulations, or whatever else is considered necessary to ensure the investor's full understanding of all fund return alternatives, highlighting and quantifying clearly the fund's return profile in the worst-case scenario for the unit holder;

d. Special attention must be dedicated, in the above description, to events such as, but not limited to, hypotheses of fund performance different from or unexpected relative to its benchmark, possibility of invested capital protection or loss limitations, eventual need for additional resource contribution, hypotheses of decoupling (divergent behavior) between the fund's return and

the acquired shares, or continuity solutions, such as in cases of early liquidation, delivery of shares, knockout, or any other that implies extinction of the derivative, instantaneous or sudden change in payments, or substantial change in the portfolio composition or the fund's investment policy;

e. Warning about the counterparty risk assumed by the fund in contracting the derivative, whenever it does not have the settlement guarantee provided for in Article 86, § 3, II, and § 4, of the Instruction.

Still in line with the Board's deliberations, we alert that, pursuant to Article 4, sole paragraph, of the Instruction, for Funds that do not have the predominant objective of pursuing the behavior of the acquired shares throughout their entire duration, reference to such shares should be avoided in their denomination, given that it could mislead potential investors.

The same caution should be taken when classifying the fund into one of the classes provided for in Article 92 of the Instruction, avoiding the use of a class that does not adequately represent all possible behaviors of the fund regarding the predominant risk factors to which it will be exposed, throughout its entire duration.

In passing, we recall the irregularity, cited in the aforementioned Board decision, represented by the constitution of investment funds that provide for the automatic reclassification of one of the classes provided for in Article 92 of the Instruction to another.

Still in conformity with the Board's decision, we record that the Adhesion Term, as provided for in Article 30 of the Instruction, being a document of an informational nature and with a specific scope – to highlight, for the unit holder, their duty to become aware of the investment risks – is not suitable to supply information that must appear in the fund's own documents – Bylaws and Prospectus.

Similarly, the Adhesion Term is not the appropriate means or instrument for the investor to grant consents of other nature to the administrator, such as, for example, prior authorizations for the practice of future acts or mandates to act on behalf of the subscribing unit holder.

In this sense, it is worth highlighting, for example, the irregularity of adopting mechanisms of prior consent in the Adhesion Term, in cases of matters that require prior approval by the general meeting of unit holders, that is, those concerning any of the matters provided for in Article 47 of the Instruction.

Finally, we inform that this Superintendence has already included in its supervision procedures the verification of the adequacy of the Bylaws of funds registered with this CVM to the conditions cited above.

2. Article 41, VII – Fixed Administration Fee

The Board, in the meeting held on June 23, 2009 (CVM Process No. RJ20081974), expressed its understanding that in funds not intended exclusively for qualified investors, the stipulation of administration fees with a fixed minimum floor does not satisfy the provision of Article 41, VII, of the Instruction, which requires the charging of a fixed fee, which must be expressed as a percentage of the fund's net asset value.

As other examples of administration fee formulas that would infringe the norm, we cite those that contain provision for charging percentages that vary according to some term or condition, or still, according to the evolution of the fund's net asset value, its time in operation, or its profitability.

It is worth highlighting, furthermore, that, pursuant to Article 61, §2, of the Instruction, under no circumstances may administration fees be increased without prior approval by the general meeting of unit holders, although their unilateral reduction by the administrator is possible. In the latter case, the reduction must be communicated immediately to the CVM and to the unit holders, amending the Bylaws and Prospectus, if applicable.

Finally, referring to the Board's determination to verify compliance with the aforementioned rule "by any other retail vehicles regulated by Instruction 409/04, registered with the CVM," we inform that this technical area has already included the action in its supervision procedures.

Sincerely,

Signed original by
Claudio Gonçalves Maes
Superintendent of Institutional Investor Relations in exercise

Signed original by
Daniel Walter Maeda Bernardo
Manager of Records and Authorizations