Explanatory Note to CVM Instruction 204

Ref.: CVM Instruction No. 204, of December 7, 1993, which alters, consolidates and revokes CVM Instructions No. 04, of October 24, 1978, No. 38, of September 13, 1984 and No. 145, of May 10, 1991, which provides for the registration of independent auditors for the purposes set forth in Law No. 6.385, of December 7, 1976, defining their duties and responsibilities when exercising their activity within the scope of the Securities Market, as well as the cases in which registration may be refused, suspended or cancelled.

1. INTRODUCTION
   CVM Instruction No. 204, now approved, has as its main objective the consolidation of the rules for the registration and operation of independent auditors within the securities market. As it is opportune, some modifications that had become necessary due to the practical application of CVM Instructions No. 04/78, 38/84 and 145/91 over time are being introduced.

Considering that this is an update of existing rules, the concepts that underpinned the aforementioned Instructions are also being consolidated in this Explanatory Note.

Due to its relevance, an effectively independent audit constitutes an indispensable support for the good performance of the duties entrusted to the Securities and Exchange Commission (Comissão de Valores Mobiliários).

The Securities and Exchange Commission continues to understand that the figure of the independent auditor is still essential to the credibility of the market, representing an instrument of inestimable value in the protection of the investor, insofar as its function is to ensure the fidelity and reliability of the financial statements of publicly-held companies and entities that are part of the securities distribution and intermediation system.

The accuracy and clarity of these financial statements, the disclosure in explanatory notes of information essential for a view of the company's assets and liabilities and results, depend on an effective audit system and, primarily, on the independent auditor's awareness of their role.

Due to this relevance, it is extremely important that independent auditors become aware that the work they develop, within the scope of the Securities Market, is primarily directed towards the external users of accounting information. Therefore, the responsibility assumed by the independent auditor when issuing their audit opinion is a matter of public responsibility, which can be claimed, administratively or judicially, by any user who feels prejudiced by their work.

Thus, it is evident the need for the market to have highly qualified auditors who simultaneously enjoy a high degree of independence in the exercise of their activities.

By regulating the activities of the independent auditor, what the Securities and Exchange Commission seeks is precisely to fix the parameters that guide this performance, in the sense of effective professional independence and competence.

2. REGISTRATION OF INDEPENDENT AUDITOR, ITS CATEGORIES AND CONDITIONS FOR REGISTRATION
   Law No. 6.385, of December 7, 1976, which provides for the Securities Market and created the Securities and Exchange Commission, determines, in its article 26, that only accounting audit firms or independent accounting auditors registered with the Securities and Exchange Commission may audit the financial statements of publicly-held companies and institutions, societies or companies that are part of the securities distribution and intermediation system.

However, the registration of an Independent Auditor with the Securities and Exchange Commission does not constitute a new professional category. The activity of independent audit is the prerogative of the Accountant legally qualified, registered with the Regional Council of Accounting, an activity that may be exercised individually or in a partnership constituted, registered with the Regional Council of Accounting.

The rules now consolidated maintain the two categories of Independent Auditor registration – Individual (AIPF) and Legal Entity (AIPJ). In addition, the registry of Technical Managers of audit firms is being established (art. 3°, sole paragraph), which will allow better supervision of the work performed by these professionals in the audit firms they are part of.

Still regarding audit firms, two other modifications are being introduced. The first refers to the requirement that at least half of the partners of the Independent Auditor – Legal Entity be registered as a technical manager with this Commission, that is, that they possess the minimum required experience of 05 (five) years (art. 5°, VI). The second establishes the figure of the technical partner responsible for providing clarifications of any nature that the Commission may request (art. 5°, VIII).

3. GRANTING, REFUSAL, SUSPENSION OR CANCELLATION OF REGISTRATION
   The Securities and Exchange Commission regulates the activity of independent audit only within the strict limits conferred by law. On one hand, it establishes the conditions for registration and, on the other hand, it provides for the cases in which it may or must refuse, suspend or even cancel this registration.

The new Instruction maintains the framework of the previous rule for the granting and refusal of registration.

However, some important changes have been introduced, namely:

a) time of professional experience developed abroad by the legally qualified professional and time of work exercised in an audit firm before registration in the accountant category are being used for the purpose of counting the minimum required professional experience, when it is proven that during this period the interested party was attending the Faculty of Accounting Sciences (art. 6°, II and III).

b) professionals from countries that are part of Mercosur are allowed to use the work time developed in their respective countries to prove the minimum required professional experience, limited to up to 04 (four) years (art. 6°, sole paragraph).

c) a minimum experience of 02 (two) years in a leadership or supervision position in audit is required for those who acquired the minimum experience of 05 (five) years as an employee of an audit firm registered with this Commission (art. 14, § 2°).

d) a maximum deadline of 30 (thirty) days is determined for the granting or denial of the registration request by the CVM.

It is also worth noting that the Securities and Exchange Commission does not intend to restrict the exercise of a professional category, nor to supersede the specific competence area of other bodies.

However, inherent to its power to register is the power to temporarily suspend, cancel the registration or apply other sanctions, once the requirements that it is incumbent upon the Securities and Exchange Commission to administer are not met.

In this sense, a new figure being introduced by CVM Instruction No. 204 is that of automatic suspension and cancellation of registration (art. 17, I to III). The CVM understands that automatic suspension or cancellation, that is, without the need to open an administrative inquiry, is appropriate when it is evident that the independent auditor has failed to meet the conditions necessary to obtain registration. Examples include: submission of false or fraudulent documents, suspension or cancellation of registration with the CRC, subsequent admission of a partner without legal qualification to practice the profession, etc. It should be emphasized, however, that a deadline for regularization of the registration and for the presentation of a defense is assured, as well as the right to appeal to the Commission's Collegiate Body.

Suspension and exclusion mean the provisional or definitive disqualification for the exercise of the Independent Auditor activity, related to publicly-held companies and institutions that are part of the securities distribution and intermediation system. It is important to note that any sanction applied by the Securities and Exchange Commission, in theory, does not prevent the professional exercise of the Accountant or the audit activity outside the scope of the Securities and Exchange Commission's attribution. This will only occur if there is a decision by the proper body of the professional category to that effect.

4. CIVIL LIABILITY OF THE INDEPENDENT AUDITOR
   In accordance with paragraph 2 of article 26 of Law No. 6.385/76, accounting audit firms and independent accounting auditors will be civilly liable for damages caused to third parties due to fault or intent in the exercise of their functions.

Thus, the rules now consolidated maintain the requirement, for registration purposes, that societies be constituted in the form of a civil society (therefore, any form of commercial society, including limited liability companies, is prohibited) and that they incorporate into their respective articles of association or equivalent constitutive act, the clause of joint and unlimited liability.

Since it is a society typically of persons, in which there is civil liability for damages caused in the exercise of the professional activity, it is required that all partners be Accountants registered with the Regional Council of Accounting.

5. PERIODIC INFORMATION
   The information previously required from independent auditors registered with the CVM referred only to their client portfolio within the scope of the Securities Market. The new Instruction significantly expands the level of information required with the objective of having a better profile of independent auditors, both in terms of physical structure, human resources, continuing education policy, and in terms of their participation in the market. Thus, in addition to the list of clients, auditors must present, annually, in the month of April, information related to their revenue, working hours, staff, continuing education policy and affiliated companies (art. 21).

In addition, communication regarding the cancellation of audit contracts, which was made together with the annual list of clients, must be made within a period of 20 (twenty) days, from the date of its occurrence (art. 22).

It should be emphasized that the failure to present this information, as well as the lack of updating of the registration, by the auditor, will imply the imposition of a coercive fine of up to 69.20 (sixty-nine point twenty) UFIR per day of delay.

6. EXERCISE OF AUDIT ACTIVITY IN THE SECURITIES MARKET
   The elaboration and establishment, by the community to which independent auditors belong, of the rules that regulate their activities cause the acceptance of these rules to increase and the community to feel more responsible for their compliance, thus reducing the need for permanent intervention by the Securities and Exchange Commission, as a regulatory body.

Under these conditions, the CVM recognizes that it is up to the body responsible for regulating the professional exercise to establish the rules of audit related to the auditor's conduct, the exercise of their activity and the issuance of the audit opinion. However, it maintains the legal prerogative to, through its own act, restrict or complement them for application within the scope of the Securities Market, whenever it deems necessary.

Thus, it is entirely convenient that independent auditors registered with this Commission remain permanently informed regarding the rules emanating from the Federal Council of Accounting.

7. DUTIES AND RESPONSIBILITIES OF THE INDEPENDENT AUDITOR IN THE SECURITIES MARKET
   The Securities and Exchange Commission, as a regulatory body, retains specific competencies that allow it to avoid possible inconveniences of self-regulation, such as complacency regarding matters of public interest, the tendency of the regulated to self-protect, leniency in imposing sanctions, and tolerant attitudes resulting from the desire to avoid adverse publicity for businesses.

In the present case, the Securities and Exchange Commission establishes, within the competence attributed to it by law, the duties and responsibilities that must be assumed by the independent auditor in the exercise of their activities within the scope of the Securities Market, without prejudice to those duties established in the rules of the Federal Council of Accounting.

The CVM understands that the responsibility of the auditor operating in the Securities Market should not be limited to issuing an opinion on the fidelity or not of the audited financial statements. It must go further, encompassing other aspects that are also quite important in the information process and investor protection. Thus, the CVM requires that independent auditors verify the consistency of the information and analyses presented in the management report of the audited entity. In addition, it requires the preparation of detailed reports on deficiencies detected in internal controls, as well as the verification of the existence of acts practiced by administrators that are in disagreement with legal and regulatory provisions (art. 29).

Another relevant aspect to be highlighted is the need to highlight, when issuing an adverse or qualified opinion, all items that are being affected, such as: dividends, profit/loss per share and all accounts or subgroups of assets, liabilities, results and equity.

8. DUTIES AND RESPONSIBILITIES OF THE ADMINISTRATORS OF THE AUDITED ENTITIES IN RELATIONSHIP WITH INDEPENDENT AUDITORS
   The CVM understands that an audit, based on its concepts of professional independence and competence, should not be considered as just another burden for the audited entity, since the quality and fidelity of the accounting information made available to the public must be the main concerns of its administrators. In fact, the administrators of the audited companies are directly responsible for any failures and omissions detected in the financial statements.

Therefore, the Instruction, although primarily directed towards independent auditors, also establishes some duties and responsibilities that administrators of audited entities must have when contracting and in their relationship with their auditors (art. 30).

Administrators must exercise maximum diligence in hiring independent auditors, especially regarding the requirements related to technical qualification and organizational structure of the hired parties and their compatibility with the size and complexity of the operations of the hirers.

Administrators may also be held liable for the eventual hiring of auditors who do not meet the independence conditions required by the Instruction.

9. FINAL PROVISIONS
   The new Instruction ensures that independent auditors already registered have an adequate period to adapt to the new requirements made in article 5°, that is, to have at least 50% (fifty percent) of partners registered as technical managers and to choose a partner to provide clarifications to the CVM.

Original signed by
THOMAS TOSTA DE SÁ
President
D.O.U. published on 05/04/94
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