Explanatory Note to CVM Instruction No. 88

EXPLANATORY NOTE TO CVM INSTRUCTION NO. 88, OF NOVEMBER 3, 1988.
Ref.: CVM INSTRUCTION NO. 88, of November 3, 1988, which provides for secondary distributions of securities and sale of surplus shares not subscribed during the preference period in the private subscription of an open company.

The distribution of securities can be primary or secondary.
Primary distribution presupposes the creation of new titles, with the destination of the resources obtained for the issuing companies.
Secondary distribution presents two basic characteristics, namely:

• there is no destination of resources to the issuing company, as a way to integrate capital, because the batch of titles subject to this distribution was already issued in the past, at which time the company received the monetary counterpart, which was integrated into its capital;
• the securities are not in negotiation on the market, that is, it is a block that has remained in the hands of intermediaries, controlling shareholders, or investors.

Now, the reallocation of a significant quantity of securities to the market can affect the normal conditions of price formation and the continuity of that market because there is an intensive effort of sale carried out by the offerer, which does not usually occur in an ordinary negotiation. The stimulation and methods used cause strong selling pressure on potential investors, who are led to acquire the offered titles.

And even if they did not cause this strong impact on the regular intermediation system, potential investors need easy access to a set of information, both about the negotiation itself, and about the quantity involved and about the company that issued the titles (information already contained in the company's registration), in order to be able to decide on the convenience of investing.

These are the main reasons that guide the requirement for registration of certain secondary distributions, and, as the CVM's Information Disclosure Policies well emphasize, the purpose of this registration is "to provide potential investors with specific information about certain types of distributions of securities in the secondary market".

LAW NO. 6,385, in its article 19, determines that no public issuance of securities shall be distributed without prior registration with the CVM. It defines acts of distribution as sale, promise of sale, offer for sale, or subscription, as well as the acceptance of the request for sale or subscription of securities, when practiced by the issuing company, its founders, or persons equated to them (controlling shareholder and controlled persons by the company, the co-obligor in the titles, financial institutions and other companies whose purpose is to distribute issuance of securities - article 15 of the same Law - and whoever has subscribed to the issuance of securities or acquired them from the issuing company, with the aim of placing them on the market).

The law characterizes public issuance in § 3 of the aforementioned article 19 and establishes that it can only be placed through the system provided for in article 15, and the CVM may require the participation of a financial institution. It defines the competence of the CVM regarding the issuance of rules on the matter, highlighting among them: the faculty to define other situations that constitute public issuance for registration purposes or its waiver, considering the interest of the investing public, and the right to fix registration procedures and the specification of information that should accompany its request.

It is necessary to adequately explain the distinction between the special procedures provided for in CVM Instruction No. 35, of July 23, 1984, and negotiations subject to registration of secondary distribution.
That Instruction provides, for Stock Exchanges, a series of operations that require, for their realization, compliance with a differentiated treatment from that of an ordinary operation in the Exchange. On the other hand, the Instruction on secondary distribution provides for prior registration of certain operations that present the characteristics previously described, justifying, therefore, the protection of registration.

Thus, the CVM decided to issue INSTRUCTION NO. 88/88, from which the following aspects should be highlighted.

Of the hypotheses of secondary distribution subject to registration, item II of article 2 refers to operations with debentures, when the intention is to obtain the registration of an open company, with the distribution of these securities, whether by the company (treasury debentures) or by persons equated to it.

Item III applies to operations with debentures of an open company issued through private subscription.
An example would be the situation supported by old CMN Resolution No. 796/83 and CMN Resolution No. 1,455/88, which concern the subscription of debentures by commercial banks, using resources from compulsory deposits on demand deposits. The issuance of these titles was not subject to registration with the CVM.

Thus, if there is the intention to distribute them publicly, prior registration with this agency will be necessary.

Item IV encompasses operations on the exchange or over-the-counter, whose main characteristic is the existence of sales effort, using the distribution system, better remunerated intermediaries, special procedures, and advertising, with the aim of enabling the placement of the offered securities.

The auction of subscription preference rights belonging to the controlling shareholder or to persons equated to the issuing company, in a significant quantity, defined by the Instruction, must be preceded by registration, so that the transparency required in a capital increase process is achieved.

Article 3 of the Instruction establishes that the sale, on Stock Exchanges, of surplus shares resulting from the non-exercise of the preference right by the controlling shareholder in the private subscription of an open company, in a quantity greater than 5% (five percent) of the issuance and since it corresponds, at least, to 5% (five percent) of the shares of the same species or class in circulation in the market, is subject to the same requirements for registration of primary distribution of shares.

In article 4, item IV, the Instruction exemplifies situations that characterize sales effort, that is, that present the characteristics of a distribution, without prejudice to the existence of other hypotheses not presented there and which may, in the same way, characterize this effort.

Article 5, in obedience to LAW 6,385/76, merely reproduces the equating of various persons to the issuing company, for the purposes of distribution subject to registration. Item IV is what could leave doubts. However, the objective of the law was clear. Anyone can be equated to the issuing company, provided that their intention is to buy directly from the issuer and resell the titles to the public. It is not, therefore, about companies or financial institutions that perform the function of underwriter, since these are covered in the previous item.

Article 6 is justified by the need to have a time limit in the case of sale of fragmented lots. Since the secondary distribution period is three months, this necessarily had to be the limit.

Those responsible for the registration of the distribution with the CVM are the offerer itself and the institutions that intermediate the operation.

The Instruction provides that the secondary distribution be carried out by the distribution system, including in the over-the-counter market, even if it involves securities admitted to negotiation on a Stock Exchange.

However, the Instruction establishes the hypotheses in which the CVM may authorize this operation. It is necessary that it involves a significant quantity of securities, ensures access to the investing public, and aims for greater share dispersion. These conditions are cumulative, that is, it is essential that these three factors are present.

Articles 9 to 11 define the documentation to be presented with the registration request, which is requested by the offerer itself, through the lead distribution institution. This registration is simpler than the issuance registration (primary distribution). Only in the cases of seeking to open capital through secondary distribution or debentures originating from private subscription is a larger amount of information required.

The obligation to use a prospectus exists only in three hypotheses: the distribution of debentures concurrent with the registration of the company, the auction of subscription preference rights (art. 2, V), and distributions carried out in the over-the-counter market. Even so, the Instruction provides for the waiver of the prospectus, provided that a justified explanation is presented by the lead distribution institution.

The use of advertising material follows the same system as CVM INSTRUCTION NO. 13/80.
The analysis periods for the registration request are shorter than those of primary distribution, with the objective of meeting the greater speed of the process as a whole.

Article 17 of the Instruction provides that the registration of secondary distribution carried out by the controlling shareholder or by the company will only be approved if the registration of the open company is up to date. If any other person is the offerer, the circumstance of non-updating must be contained in the information provided to the public. In effect, to the company itself and the controlling shareholder, the delay of periodic information (annual, semi-annual, and quarterly) can be opposed. Regarding any other person, one can only require that the fact be disclosed, for the knowledge of possible interested parties in purchasing those securities.

The publication of a notice or announcement of the start of distribution was simplified in relation to the requirement made by CVM INSTRUCTION NO. 13/80, which deals with the registration of issuance.

The fixing of the three-month period for distribution is understood as satisfactory by the CVM, as secondary distributions carried out so far have demonstrated that the market absorbs securities in much shorter periods. However, the Instruction provides for the possibility of the CVM extending this period, for an equal period, if the non-placement of all securities is duly proven.

The primary responsibility for the information provided in the registration lies with the offerer of the distribution. The lead placement intermediary is co-responsible together with the offerer, as it is up to them to reanalyze the information being provided to the public, in order to verify if it is reliable and sufficient for a decision by potential investors.

Article 25 is the very philosophy of the registrations required by the CVM. The acceptance of the request by the agency does not imply a guarantee of the veracity of the information or the success of the undertaking.

It also provides, in the strict terms of Law 6,385/76, the hypothesis of suspension of distribution.

Finally, for the purposes of § 3 of article 11 of Law 6,385/76, the Instruction defines the hypotheses that characterize a serious offense.

The CVM believes that with INSTRUCTION NO. 88/88, a gap is being filled that required the establishment of precise rules regarding certain hypotheses that characterize a secondary distribution, in the constant search of this agency to protect holders of securities and market investors.

Signed originally by
ARNOLD WALD
President