Circular Letter CVM/SNC No. 01/00: Role of the Independent Auditor in the Securities Market

CIRCULAR LETTER CVM/SNC No. 01/00
Rio de Janeiro, December 29, 2000.
Subject: Role of the Independent Auditor in the Securities Market.

Dear Sirs,

As a result of monitoring the performance of independent auditors during the 2000 fiscal year, we have identified deviations in audit opinions and reports on the limited review of quarterly information (ITR) that are inconsistent with current professional standards and with the interests of the securities market.

2. The sampling conducted based on the financial statements submitted to this Agency presented audit opinions and reports with deviations from the Fundamental Accounting Principles, Law No. 6.404/76, and CVM Standards, resulting in inquiries to the respective independent auditors. Among the items identified as "recurrent," we highlight:

a. recognition as prior period adjustments of items that should be part of the period's result; b. improper allocation of results, especially regarding the establishment of the Reserve for Realized Profits, with effects on mandatory dividends;
c. improper use of Revaluation Reserve;
d. charging to the result pre-operational expenses and revenues; e. non-compliance with standards for consolidation and disclosure of consolidated information; f. improper establishment of Contingency Reserves instead of Provisions for Contingencies; g. inadequate or insufficient disclosure in explanatory notes, such as information on financial instruments, credits resulting from tax losses, improper accounting of contingent assets and liabilities, and transactions between related parties.

3. Another aspect that drew our attention was the improper treatment, as an emphasis paragraph, for deviations that violate the Fundamental Accounting Principles, which should have been treated as qualifications in audit opinions and reports, such as: recording of contingent assets, failure to account for contingent liabilities, break in uniformity, and change in accounting criterion. We also observed the occurrence of audit opinions with qualifications that, due to the quantity of qualifications and emphases presented and their relevance, should have been issued with an "adverse opinion."

4. It is relevant to note, also, that several qualified deviations or subjects of emphasis were not quantified, and their effects on the companies' equity and on the result of the audited period were not revealed. The totality of the opinions with qualifications also failed to reveal the effects on the accounts/subgroups of assets, liabilities, result, equity, and on dividends, as well as earnings per share, as required by art. 25, item IV, of CVM Instruction No. 308/99.

5. In addition to the above, some additional considerations must be presented:

I RELATED PARTIES

An important item that has been concerning the CVM concerns the disclosure of information regarding transactions with related parties, as required by CVM Deliberation No. 26/86. This is fundamental information, mainly for non-controlling shareholders, in that the effects of these transactions can significantly impact current and future results, thereby influencing decision-making by those shareholders and investors in general. Related parties, in a broad sense, are considered to be natural or legal persons with whom the company has the possibility to contract, to carry out operations, under conditions that are not those of commutativity and independence that characterize transactions with third parties unrelated to the company, its management control, or any other area of influence.

The Federal Council of Accounting, through CFC Resolution No. 820/97, which approved NBCT11, determines that the auditor must examine relevant transactions with related parties, applying the necessary procedures to obtain information on the purpose, nature, and extent of the transactions, with special attention to those that seem abnormal. Therefore, the auditor must verify if these transactions are properly disclosed, and if not, mention it in his audit opinion.

It should be clarified, furthermore, that the mere fact that two or more entities represent related parties does not necessarily mean that transactions carried out between them cause any situation of favoritism. However, because they are related parties, their disclosure is fundamental.

II CONFLICT OF INTEREST

Another fundamental point to be emphasized is the possibility of the existence of a conflict of interest in the work of independent auditors. CVM Instruction No. 308/99 establishes that the Independent Auditor - Natural Person, the partners, and other members of the technical staff of Independent Auditor - Legal Entity cannot perform independent audit when there is a violation of the independence standards of the Federal Council of Accounting - CFC, nor can they purchase, acquire, or maintain securities issued by the audited entity, or by the same economic group, nor provide consulting services that may characterize the loss of their objectivity and independence. Currently, some auditors, through judicial injunctions obtained, have questioned the aforementioned Instruction, regarding the provisions related to conflicts of interest. The CVM, however, believing in the importance of this measure for the market, has been using its own resources to seek reform of the decisions rendered so far, expecting that, in the end, the Judiciary will recognize the legitimacy of the norm.

There are 3 presuppositions that the CVM considers essential, regarding independent audit in the securities market, which are:

• the market must have highly qualified auditors;
• at the same time, these auditors must enjoy a high degree of independence;
• and the need for the auditor to be aware that his primary responsibility is with the external public, users of the audited financial statements.

Independence is a fundamental issue, and the most relevant aspect is not the fact that the auditor is independent or maintains his attitude of independence in relation to his client, but rather, and this is the crucial point, if he, in addition, appears to have independence. To the extent that the auditor's independence is put on trial by society, the information they audit tends to undergo the same process.

CVM Instruction No. 319/99 determines that, in processes of merger, consolidation, or spin-off involving open companies, the companies and professionals who have issued opinions, certifications, reports, appraisals, evaluations, studies, or provided any other services, must clarify, prominently, in the body of their respective documents, if they have direct or indirect interest in the company or in the operation, as well as any other relevant circumstance that may characterize a conflict of interest.

We have observed that some of the reports issued by independent auditors mention that there are no conflicts of interest regarding the companies subject to the merger operation, "according to the independent audit standards issued by the Federal Council of Accounting." Our understanding is that this statement does not meet the provisions of art. 5 of CVM Instruction No. 319/99, since the council's standards do not cover every and any circumstance that may characterize the existence of a conflict of interest. Therefore, the reports to be issued must contemplate whether there is or is not a conflict of interest, in accordance with CVM Instruction No. 308/99, which, in addition to establishing its own rules, endorses the standards of the Federal Council of Accounting.

Still on this subject, we must remind you that the care for independence is not the exclusive task of the auditor. If the CVM's understanding prevails in court, the administrators of the audited entities, by virtue of art. 27 of CVM Instruction No. 308/99, may also be held liable for hiring auditors who do not possess this independence.

III DISTRIBUTION OF RESULTS

Art. 25 of CVM Instruction No. 308/99 determines that the independent auditor must verify if the allocation of the audited company's result is in accordance with the provisions of corporate law, the standards issued by the CVM, and the company's bylaws. If any irregularity is found, the auditor must communicate the fact to the CVM within 20 (twenty) days, from its occurrence. Failure to communicate the fact to the CVM constitutes an offense of an objective nature, subject to the initiation of an Administrative Procedure of Summary Rite, as provided in art. 38 of the same Instruction.

IV REGISTRATION UPDATE

Last, but not least, it should be noted that independent auditors must keep their registration updated, informing any changes in registration data, in addition to sending, annually, until the last business day of April, the information required in Annex VI to CVM Instruction No. 308/99, under penalty of application of a daily coercive fine, provided for in art. 18 of the same Instruction. During this year, the number of fines resulting from the failure to update registration information and the presentation of periodic information was quite high, resulting in the use of human and financial resources that could be better allocated to other activities, if there were greater attention on the part of independent auditors.

Still regarding the update of registration data and communication with independent auditors, we inform that a project is being developed that will allow more agile contact with participants in the securities market. For the implementation of this project, the information of the electronic address, still little available by independent auditors, is necessary. Therefore, we request the immediate communication of the electronic address used, through an electronic message to:
gna@.cvm.gov.br.

6. The above information is being forwarded to you, to remind you that Law No. 6.385/76 grants the independent auditor a responsibility that is, moreover, of public order, and their performance within the securities market is of fundamental importance for the credibility of the information made available to the external public, and they may be held civilly liable for their acts.

7. In this sense, we emphasize that it is imperative that audit opinions and reports on limited review are always issued in accordance with the standards and procedures of audit endorsed in CVM Instruction No. 308, of 05/14/99, with observance of the Fundamental Accounting Principles and in accordance with the interests of the securities market.

Sincerely,

ANTONIO CARLOS DE SANTANA
Superintendent of Accounting Standards and Audit

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