By Walter Douglas Stuber
I – Introduction
The Brazilian Securities and Exchange Commission ("CVM") has finally edited the new general rules governing the formation, management, operation and disclosure of information of investment funds. Those rules apply also to funds of investment in quota funds ("Quota Funds"). This is governed by Instruction CVM nº 409, of August 18, 2004 (Instruction 409)1. The existing funds will have to adjust to the new rules by December 31, 2004. This article examines the relevant provisions in Instruction 409.
According to the Instruction, "investment fund" is the gathering of capital, in the form of a condominium, aimed at the investment in shares and stock and any other kind of instrument available in the financial and capital markets. The name of the fund will include the expression "Investment Fund", and reference to the class it falls under2. Instruction 409 divides the investment funds in different classes, based on the equity composition, as discussed in details ahead. Pursuant to this category, funds can be "short term", " backed", "fixed income", "shares", "FX" (foreign exchange), "foreign debt" and "multimarket."
As to the form, investment funds can be open-end or closed-end funds. In open-end funds, members may redeem their quotas at any time. In closed-end funds, quotas can only be redeemed at the expiration of the fund3. Quotas in open-end funds may not be assigned or transferred, save in the case of court ruling or succession. The quotas in closed-end funds may be transferred by way of assignment and transfer agreement, executed by the assignor and assignee, or on stock exchange or organized over-the-counter market where the quotas are listed, due respect being given to the formalities provided in the respective regulations4.
Investment funds may be managed by legal entities accredited by the CVM to legally discharge the portfolio management activity5. Certain acts are expressly forbidden to the fund administrator, including, but not limited, the administrator cannot, on behalf of the fund: accept current account deposits; borrow or lend, except as authorized by CVM; give guarantees, aval guarantees, accept or assume co-responsibility of any kind; sell the quotas on credit, without prejudice of the full payment, in installments, of the quotas subscribed; guarantee pre-fixed income; and trade shares outside the stock exchange or the organized over-the-counter market by entity accredited by CVM. It is however allowed to the administrator to participate, in the name of the fund, in public distributions, the exercise of the right of first refusal and conversion of debentures in shares, the exercise of the right to subscription warrants, as well as the situations expressly accredited by the CVM. Additionally, investment funds may use their assets to pledge guarantees in their own trading in stock exchanges, and loan and borrow shares and stock, so long as the loan transactions occur exclusively as authorized by CVM or the Central Bank of Brazil (Bacen).
Funds are registered automatically and electronically by the administrator, that is, via the Document Submission System available at the CVM web page, whereby documents and information are submitted electronically, including the internal regulation and prospectus6.
As to responsibility for the funds equity, as long as the investment policy and concentration thresholds set forth in the regulation have been met, the administrator and manager of the fund may not be held liable by the members, should the fund have a negative performance. Instruction 409 establishes that members shall be answerable for the fund’s net equity. The administrator or manager, if any, are liable to the members for failure to comply with relevant policy or the concentration thresholds provided in the internal regulation.
II – Issue, Redemption and Distribution of Quotas
Fund quotas7 will be issued at the quota value on the same or subsequent day8 the administrator or intermediary makes effectively available the resources invested, according to the internal regulation, except in the case of short term, backed and fixed income funds, which can use a different value to issue quotas on the same day as the date of financial availability of funds, as per the regulation. Full payment of the fund quotas must be made in national currency, except in the case of Qualified Investors Funds, which allows shares and stock to pay fully and redeem quotas, with establishment of detailed criteria for the use of procedures, and further, if any, the satisfaction of tax obligations.
The regulation must set the time to elapse from the redemption order to the date of quota conversion, which is the date the quota value is determined for payment of the redemption. Quota conversion will be at the quota value on the day of conversion, except in the situations provided for short-term, backed, and fixed income funds, as per the regulation. Except for funds intended solely for Qualified Investors (Qualified Investors Funds), payment of redemption will be made within the timing provided in the regulation, which may not exceed five business days of the date of conversion of quotas. The regulation may set a grace period for redemption, with or without income. In the event of delayed payment of the redeemed quotas, the fund administrator will pay the members 0.5% daily fine of the redemption value. Should the regulation provides for different dates of conversion and redemption, the payment for the redemption on a different date than the redemption order or grace period of redemption, such facts will be included in highlight on the prospectus cover and in all promotional material, clearly and conspicuously.
Exceptionally, lack of liquidity of the assets in the fund, including as a result of redemption orders that are incompatible with the existing liquidity, or that may change the tax treatment enjoyed by the fund or the members, to the detriment of the latter, the administrator may order the closing of the fund and proceed to the redemption. In this case, a Special Meeting will be called in no later than one day to deliberate, within 15 days of the date of closing, about the following possibilities: replacement of the administrator, the manager or both; reopen-end or keep the fund closed-end for redemption; possible payment of redemption in shares and stock; split-up; and dissolution of the fund.
Distribution of quotas in open-end funds is not subject to registration, but distribution of quotas in closed-end funds is conditioned on the prior registration with the CVM9. The administrator will forward electronically to CVM the list of subscribers of the closed-end fund, within two business days of the closing of quota subscription. No quota distribution is allowed prior to subscription of previous distribution.
Quota subscription in closed-end funds shall be completed within no later than 180 days of the initial date of distribution.10 The amounts received as full payment of quotas, during the distribution of quota in closed-end funds, must be deposited, in the name of the fund, at a commercial bank, multiservice bank with commercial portfolio or the Federal Savings Bank, being the amount immediately, and mandatorily invested in federal bonds or quotas in short-term funds.11
The fund may engage, in writing, intermediary institutions members of the securities distribution system to distribute quotas, and authorize them to proceed to the subscription or acquisition of quotas in the fund on account of and in the name of their respective customers, due respect being given to Instruction 409.12
The administrator and manager of the fund’s portfolio will be replaced in the case of: discreditation to manage the portfolio, as decided by CVM; waiver; or removal, as decided at Members’ Meeting.13 Should there be order for intervention, special temporary management, extrajudicial dissolution, insolvency or bankruptcy of the fund’s administrator, the liquidator, temporary administrator or intervening person may satisfy the provision in Instruction 409. In any case, the liquidator, the temporary administrator or the intervening person may, as the case may be, request that CVM designates a temporary administrator or calls a Members’ Meeting to discuss and deliberate about the transfer of the management to another financial institution or entity accredited by CVM or the dissolution of the fund.
III – Prospectus and Regulation
The main features of the fund will be disclosed to the public by way of a prospectus, which shall contain all the relevant information to the investor about the investment policy and the risks involved. In the case of Qualified Investors Funds, the prospectus is unnecessary. Prospectuses must inform the maximum number of quotas to be held by one single member. When describing the risk management policy, the Prospectus will include warning that the methods used by the administrator to manage the risks the fund is exposed to are not a guarantee against equity loss14. Changes in the risk management policy must be disclosed as material fact. When defining the information disclosure policy, the minimum frequency of disclosure of the fund’s portfolio composite; level of detailing; and place and means of request and disclosure of information must be specified.
The fund will be regulated by internal regulation, which will mandatorily provide about the qualification of the fund’s administrator, portfolio’s manager (if applicable) and the custodian15; kind of fund (open-end or closed-end); duration (determined or undetermined); investment policy (to classify the fund); management fee (fixed and denominated as annual percentual of the net equity –base 252 days); performance, entry and withdrawal fees; other expenses of the fund16; conditions for investing and redeeming quotas; distribution of profits; target audience; frequency of updating quota value (if applicable); the fund’s financial year17; information disclosure policy18; and policy about the exercise of the right to vote by the administrator or its legal representatives, at shareholders’ meetings of companies the fund holds ownership interest of. Provided that express authorization exists in the regulation, the administrator may distribute directly to the members the sums attributable to the fund as dividends, interest on capital or other income from portfolio assets.
The change to the regulation is conditioned on prior approval of a Members’ Meeting, and is effective as of the date fixed at the meeting19. In the following cases, changes are effective at least 30 days of the communication to the members of the meeting decisions: (i) increase or change in the calculation of management, performance, and entry or withdrawal fees; (ii) change in the investment policy; (iii) change in the redemption conditions; and (iv) merger, spin-off or consolidation involving closed-end funds, or resulting in the change, with respect to the members, of the conditions mentioned for the previous situations. The administrator will send CVM, via the Internet, within 15 days of the Members’ Meeting, a copy of the regulation, consolidating any changes made, and the updated Prospectus (if any).
Members’ Meeting will be called via mail sent to each member, and email is a valid way of calling meetings. The regulation must address the possibility of meetings deliberations being implemented by way of formal inquiry, without the members meet. The regulation may fix the qualified quorum for deliberations, including quorum for matters usually deliberated at Members’ Meeting only.20
IV – Management of the Fund
Management of funds means a set of services directly or indirectly related to the operation and maintenance of the fund that may be provided by the administrator itself or its contractors, on behalf of the fund. The administrator may engage, on behalf of the fund, the following services: management of the fund’s portfolio;21 investment consultancy; shares and stock related treasury, control and processing services, recordation of issue and redemption of quotas and custody of shares and stock and other financial assets;22 distribution of quotas, and independent auditors. It is up to the administrator to oversee the services provided by third parties to the fund.
As to managing the fund’s portfolio, shares and stock treasury, control and processing, recordation of issue23 and redemption of quotas and custody of shares and stock and other financial assets, agreements made must include clause spelling out the joint liability of the fund’s administrator and its contractors to the fund, in the event of loss caused to the members resulting from violation of laws, regulation and regulatory acts of the CVM.
Included in the obligations of the administrator is the transfer to the fund of any benefit or advantage it may gain as a result of its condition as administrator. Exceptionally, administrator of the investing quotas fund can be remunerated by the administrator of the invested fund.
Remuneration rate must be used by the administrator for payment of services provided by its contractors, on behalf of the fund, management of fund’s portfolio, investment consultancy; shares and stock related treasury, control and processing services, quota distribution, recordation of issue and redemption of quotas.
The internal regulation may provide that remuneration is be paid based on the fund’s performance (performance fee), except for the short-term, backed and fixed income funds, where such remuneration modality is forbidden. Charging the performance fee must be in accordance with the following criteria: fee is linked to a parameter compatible with the fund and securities effectively making the portfolio; the fee may no be lower than 100% of the parameter; fees must be collected semi-annually, at least; fees will be payable after discounting of all expenses, including the management fee; and fee may not collected if the quota value is lower than the value determined at the time of previous collection.24 Such requirements do not apply to Qualified Investors Funds, which may collect a performance fee based on their own regulation.
V – Composition of the Portfolio
The regulation may also establish how the fund will invest its equity. Such investments will be in shares and stock, financial assets and operating modalities available on the financial and capital markets.25 Open-end funds must adjust to the portfolio diversification requirements of the regulation within no later than 60 days of the first payment for the quotas. Closed-end funds will have up to 180 days of the date of closing of distribution to adjust to the requirements provided in the regulation.
Shares and stock and other financial assets in the fund’s portfolio will be kept by custodian, posted under specific deposit accounts opened in the name of the fund, with assets registration and financial settlement systems approved by Bacen or with institutions authorized by CVM to provide custodian services. Investments in quotas in investment funds and in the Mercosur are not subject to that requirement. Gold investments are allowed, so long as this is made via commodities and futures exchanges.
The total number of securities issued by or having co-obligation of one single legal entity, of its controller, of companies directly or indirectly controlled thereby and of affiliated or other companies under common control, as well as of one single state, city, or the individual will have to respect the threshold of 10% of the fund’s net worth. The total issue or co-obligation of one single financial institution, of its controller, of companies directly or indirectly controlled thereby and of affiliated or other companies under common control may exceed that 10% but never exceed 20% of the fund’s net worth. Investments in federal public bonds and committed transactions backed on these bonds are not subject to the 10% threshold. Said threshold needs to be satisfied on a daily basis, based on the fund’s net worth as of the immediately preceding business day. These thresholds do not apply to share funds.
Funds may not have over 20% of their net worth as securities or stock issued by the administrator, manager or connected companies.26 The acquisition by the fund of shares issued by the administrator is expressly forbidden. The 20% threshold does not apply to funds managed by institutions directly or indirectly controlled by the Federal Union, as far as investments in federal bonds is concerned only. The internal regulation must further fix the maximum percentage of investments in quotas in investment funds managed by their administrators, managers or connected company. Funds seeking to emulate the market rates may acquire shares issued by the administrator or companies connected thereto, where those shares are included in said indexes pro rata to their fraction in said indexes.
The administrator and manager are not subject to penalties applicable to failure to observe the limits of portfolio composition and diversification and concentration of risks set by current investment laws and regulations, if failure results from external factors beyond their will and cause unpredictable and significant changes in the net worth or capitals market conditions in general, so long as such situation does not continue for over 15 consecutive days and does not result in change of tax treatment enjoyed by the fund or its members. Otherwise, the administrator must communicate CVM immediately the occurrence of event of non-compliance and justifications, further informing the normalization of portfolio as it occurs.
If the non-compliance with the limits of portfolio composition and diversification and risk concentration exceeds the fixed 15 consecutive days, CVM may determine that the administrator, without prejudice of applicable penalties27, calls a Members’ Meeting to choose one of the following: (a) transfer of administration or management of the fund, or of both; (b) merger into another fund; or (c) dissolution of the fund.
The acquisition of quotas in other investment funds by funds regulated by Instruction 409 is allowed in the following circumstances: (i) quotas funds may acquire quotas in investment funds and other quotas funds, due respect being given to rules applicable quotas funds, to be listed ahead; (ii) the "fixed income" or "multimarket" investment funds and quotas funds may acquire quotas in real estate investment funds, credit rights investment funds and investment funds in quotas in credit rights investment funds, up to 10% of its net worth, so long as expressly provided in its internal regulation prospectus; and (iii) acquisition of quotas in investment funds regulated by Instruction 409, by invested fund is allowed up to 10% of the investing fund’s net worth, so long as provided in the respective internal regulation and prospectus of the investing fund. The fund acquiring quotas in other funds will prefix in its regulation that the management fee charged by the administrator includes the management fees of the investment funds it may invest in.
VI – Classes of Funds
Pursuant to Instruction 409, the funds are categorized, depending on the composition of its equity, as follows: (i) short term funds; (ii) backed funds; (iii) fixed income funds; (iv) shares funds; (v) FX funds; (vi) foreign debt funds; and (vii) multimarket funds.
Short-term funds will invest its capital solely in federal bonds, pre-fixed or indexed at the reference rate of the Special Settlement and Custody System – SELIC for federal bonds (SELIC rate), or instruments indexed at price indexes, for a maximum of 375 days, and medium-term of the fund’s portfolio less than 60 days, the use of derivatives only for hedging purposes and committed transactions backed on federal bonds being allowed.
Backed, fixed-income, FX, foreign debt and multimarket funds may be further categorized as "long-term", where the average term of their portfolios exceed 365 days and is made of private or federal public instruments, pre-fixed or indexed at the SELIC rate, price indexes or FX variance, or, even, committed transactions backed on said federal bonds.
Backed funds will include their names the performance rate,28 based on the structure of the financial assets in their portfolios, provided that, cumulatively, the following conditions are met: (i) 80%, at least, of the net worth represented, singly or cumulatively, by (a) instruments issued by the National Treasury and/or Bacen; and/or (b) fixed-income shares and stock, whose issuer’s risk rating is low or equivalent, with certification by rating agency located in the country;29 (ii) fixed 95%, at least, of its portfolio is made of financial assets so as to keep up, directly or indirectly, with the variance of the chosen benchmark; and (iii) limits the performance in derivative markets to transactions for hedging purposes.
The categories "fixed-income", "shares" and "FX" are defined based on the main risk factor associated to the fund’s portfolio. Main risk factor of a fund is the inflation rate, interest rate, shares index or price of assets whose variance may have an impact on the fund’s portfolio market value. In the case of fixed-income funds, it is the variance of domestic interest rates or inflation rate, or both. For share funds, the factor is the variation of price of shares listed in stock exchange or organized over-the-counter market entity. In the case of FX funds, the prevailing factor is the variance of foreign currency price. Fixed-income and FX funds must have at least 80% of their portfolios made of assets tied directly, or synthesized by way of derivatives, to the respective risk factor. The shares funds must have at least 67% of its portfolio made of shares listed in the stock exchange or organized over-the-counter market entity.
Foreign debt funds must invest at least 80% of their equity in instruments representing the foreign debt under the responsibility of the Union,30 the investment of up to 20% of the net worth in other credit instruments traded in the international market being allowed.31 After compliance with those requirements, any remaining capital can be used in transactions in the derivatives organized markets: (i) abroad, solely for hedging purposes with respect to instruments in the portfolio, or in deposit account in the name of the fund, abroad, due respect being given, in this case, to 10% of the respective net worth; or (ii) in Brazil, also exclusively for hedging purposes of securities in its portfolio and so long as they are backed on instruments representing the foreign debt under the responsibility of the Union, or to be kept in deposit account in the name of the fund, within the Brazilian territory, due respect being given, in this case, to 10% of the respective net worth. Thus, transactions in organized derivative markets may occur in those managed by commodities and futures exchanges, and on the over-the –counter market, in this case so long as registered with the Central of Custody and Financial Settlement of Securities – CETIP, and expenses effectively incurred in the posting of security margins for guarantees in cash, daily adjustments, premiums and operating costs, resulting from the maintenance of positions on the organized derivative markets in the country should be factored in. No maintenance or investment in Brazil of capital raised by the fund is allowed, save in the case of transactions carried out in organized derivative markets, instruments representing the foreign debt under the responsibility of the Union.
Multimarket funds should have investment policies in place that provide the various risk factors, without any required concentration on a given factor or different factors from the other fund classes.
It is incumbent on the administrator and manager to monitor on a daily basis the compliance with the limits fixed by Instruction 409 and the risk factor of the fund’s portfolio, so as to maintain the class indicated in the fund’s internal regulation and investment policy.
VII – Funds for Qualified Investors
The regulation also allows the formation of investment funds intended only for Qualified Investors (Qualified Investors Funds). Qualified Investors are the following: (i) financial institutions; (ii) insurance and capitalization companies; (iii) publicly- or privately-held complementary pension companies; (iv) individuals or legal entities with financial investments higher then R$ 300 thousand and that additionally, attest in writing to their condition as qualified investor;32 (v) investment funds aimed solely to qualified investors; and (vi) portfolio administrators and securities consultants accredited by CVM, with respect to their own capital. Employees and/or partners of management companies may be admitted as members of qualified funds, expressly authorized by the institution’s contact officer for CVM.
Additionally the exclusive funds, funds formed to receive investments exclusively from one single member, can be admitted. Only Qualified Investors may be members of exclusive funds.
VIII – Funds for investment in quotas of investment funds
Quota funds may keep no less than 95% of its investments in quotas of funds under the same class.33 The only exception to this rule is the quotas fund classified as "multimarket", which may invest in quotas of funds under different classes. The remaining 5% of the equity of the quotas fund may remain in deposit accounts or invested in federal bonds, fixed-income securities issued by the financial institution and committed transactions, pursuant to specific regulation of the National Monetary Council. Such percentages must be met daily, based on the fund’s net worth recorded on the immediately preceding day. The quotas fund’s name must include the expression "Fund of Investment in Quotas of Investment Funds", plus the class of the invested funds pursuant to specific regulation.
Fixed-income and multimarket funds may invest up to 10% of their net worth, in quotas of real estate investment funds, in credit rights investment funds and in funds for investment in quotas of credit rights investment funds, so long as provided in their internal regulation. Exclusive and multimarket quota funds, so long as intended solely for qualified investors, may acquire quotas in mutual funds for investment in emerging companies, real estate investment funds, funds for investment in shares and stock, credit rights investment funds and funds for investment in quotas of credit rights investment funds, up to the limits provided in their internal regulation and prospectuses, if any. No investment in quotas in funds that invest directly in the investing fund is allowed.
Quotas funds acquiring quotas in funds charging performance fee must meet the aforementioned requirements or be intended exclusively for qualified investors.
Prospectuses and internal regulations of quota funds must specify the maximum percentage of the equity to be invested in one single investment fund at any one occasion. Prospectuses must further contain provisions about the investment policy and management fee of funds where the specific fund intends to invest. If quota funds are to invest their capital in one single investment fund, their prospectuses must inform the summation of management rates charged by the investing and invested funds. The internal regulation of quota funds must establish that the management rate charged by the investor includes the management rate of all investment funds in which it invests, including of other quotas funds. Where the quotas fund invests in funds making trading in derivatives that may result in equity loss or negative net worth, a warning must be included to that effect in the prospectus’s cover and in all promotional material.34
IX – Reorganization
Merger and consolidation of funds are allowed where the funds have compatible investment policies. In this case, the transaction may occur immediately after the Members’ Meeting approving the merger or consolidation. If the funds have distinct investment policies, a merger or consolidation can only occur after amendment to the internal regulation, as approved by a Members’ Meeting.
In the event of slip-up, merger or consolidation involving closed-end funds, the administrator must arrange for the amendments to the internal regulation, as approved by a Members’ Meeting, and address the redemption of quotas from dissenting members. Such redemption of quotas will occur within no later than ten days of the request.
Upon prior approval of CVM, open-end funds may convert into closed-end funds. Investment clubs may also convert into open- or closed-end funds, after approval of CVM of the conversion. In order to obtain such approval, the fund’s administrator must submit to CVM, via Internet, the necessary documentation, within 15 days of the Members’ Meeting. After approval of CVM, the fund’s administrator will allow at least 30 days for the quotas to be redeemed by the dissenting members. The redemption will occur under the conditions prevailing prior to the Members’ Meeting approving the conversion of the open-end into closed-end fund, or of the investment club into fund.
In the case of split-up, merger, consolidation and conversion, the administrator will submit to CVM, via Internet, within 15 days of the date of implementation of actions approved at the respective Members’ Meetings, the new internal regulation, the updated prospectus (as the case may be) and proof of filing of application for cancellation of the registration with the National Directory of Legal Entities (CNPJ) of the funds closed for merger or consolidation. The fund’s administrator will keep available to CVM an auditor’s report about the split-up, merger or consolidation.
The accounting statements of each one of the funds involved in the split-up, merger, consolidation or conversion, ascertained on the transaction date, must be audited within no later than 60 days of the date of event, by independent auditors properly registered with CVM. The criteria used to equalize quotas among the funds must be described in the explanatory notes to those accounting statements. Under the terms of Instruction 409, the parameter used to convert the value of quotas in the funds, in the case of split-up, merger or consolidation, as well as the value of quotas in the funds resulting from those transactions must be described in the explanatory note.
X – Liquidation and Closing of Funds
After 90 days of the initial activities, open-end funds with, at any time, average daily net worth lower than R$ 300 thousand for 90 consecutive days will be immediately liquidated or incorporated by another fund.
If a fund is liquidated by deliberation of a Members’ Meeting, its administrator will distribute the assets among its members, pro rata to their quotas in the fund, within no later than 30 days of the date of the Members’ Meeting. The Members’ Meeting will deliberate how sums owing to members are to be paid, upon liquidation of the fund. The independent auditor will issue an opinion on the net worth activity statement for the period starting on the date of the latest audited accounting statements and the date the fund is effectively liquidated, voicing their opinion as to the activities recorded in this period. The explanatory note to the fund’s accounting statements will include analysis as to whether or not equitable conditions were present during the redemptions and whether or not those redemptions were made according to applicable regulations, as well as to the existence or not of debts, credits, assets or liabilities unaccounted for.
After payment to the members of all their quotas, including in the case of closing by redemption, the fund’s administrator shall forward to CVM, via Internet, within 15 days, the minutes of the Members’ Meeting deliberating about the liquidation of the fund, as the case may be, or termination instrument signed by the administrator, in the case of full redemption, and evidence of the filing of the CNPJ registration cancellation form. Those documents and the audit’s report about the liquidation statement will be kept by the administrator and available to CVM, for inspection purposes, after 90 days of the date of filing of documents with CVM.
XI – Tax considerations
Up to December 31, 2004, on the income from fixed- and variable-income investments Income Tax will be levied at 20%, irrespective of the time of investment. As of January 1, 2005, the taxation of financial and capital markets will change. The new system seeks to encourage the longer time of investment funds portfolios, and consequently of the investments in public bonds and private securities, and was established by the Provisional Measure nº 206 (MP 206), of August 6, 2004, which amends the taxation of financial and capital markets and creates the Tax System for Incentive of Modernization and Expansion of the Port Structure – REPORTO, as later amended by Provisional Measure nº 209 (MP 209), of August 26, 2004, which contains provisions about the taxation of benefit plans for social security purposes and complements MP 206 with respect to investments in investment funds.
Income earned from any fixed- or variable-income financial investments or transaction, and as of January 1, 2005, in investment funds whose securities portfolio have average terms of or less than 365 days, are taxed by the Income Tax withheld at source upon redemption, at the following rates: (i) 22.5%, for investments of up to 6 months; and (ii) 20%, for investments of over 6 months. On the income taxed semi-annually, the Income Tax withheld at source will levy at 20% and on the redemption of quotas an additional 2.5% will accrue, where redemption occurs within up to 6 months.
Included in the income is the predetermined income from conjugated transactions in the put and call options market on stock exchange, commodities and futures exchange (box), on the future market on the stock exchange, commodities and futures exchange, from transactions covered sale and without daily adjustments, and on the over-the-counter market.
A fund’s securities portfolio is made of private and federal public bonds, pre-fixed or indexed at interest rates, price indexes or FX variance, or committed transactions backed on said federal bonds and other securities and transactions with similar features, on the terms to be regulated by the Ministry of Finance.
For income from investment funds whose securities portfolio exceeds 365 days, the following rates apply: (i) 22.5%, for investments of up to 6 months; (ii) 20%, for investments for 6 months and one day up to 12 months; (iii) 17.5%, for investments for 12 months and one day up to 24 months; and (iv) 15%, for investments for over 24 months. In the case of these funds, income earned semi-annually will be taxed at 15%; and on the occasion of quotas redemption, an additional rate will be applied as provided in items (i) to (iv). Should the fund becomes non-compliant, that is, the average term of its securities portfolio is equal to or less than 365 days, the situation must be corrected within no later than 30 days and the fund may not become non-compliant again in the following 12 months.35
Thus, investors must know the average term of the portfolio of the fund they invest their money and therefore the fund administrator and portfolio manager have the responsibility to inform the time of investments in the portfolio. The longer the investment time, the lower the applicable Income Tax rate is (withheld at source). Consequently, for investors seeking to pay less tax will have to do more than simply investing for longer in the fund. They will have to make sure that they are investing in product with long-term securities.
Footnotes
1 The following funds, governed by specific regulation, have been excluded from Instruction 409: (i) funds for investment in shares and stock; (ii) funds for investment in funds for investment in shares and stock; (iii) investment funds with credit rights; (iv) credit rights funds under the Program for Incentive of Social-Interest Projects Implementation; (v) funds of investment funds in quotas of credit rights investment funds; (vi) funds for financing of the national movie industry; (vii) mutual privatization funds – FGTS; (viii) mutual privatization funds – FGTS – free portfolio; (ix) funds for investment funds in emerging companies; (x) index funds, with quotas tradable on stock exchanges or organized over-the-counter market; (xi) mutual funds of investment in emerging companies – foreign capital; (xii) conversion funds; (xiii) real estate investment funds; (xiv) privatization funds – foreign capital; (xv) mutual funds of shares deriving from tax incentives; and (xvi) cultural and artistic investment funds.
2 A fund’s name may not contain words or expressions conducive of misinterpretation about its goals, investment policy, or target audience. Words that indicate a specific tax treatment funds or their members enjoy are allowed.
3 Amortization of quotas in close and open funds is allowed by way of even payment to all members of the amount corresponding to their quotas worth, without reduction of the number of quotas issued, as per the regulation or deliberation of the Meeting of Members.
4 The transfer of ownership of the quotas in close funds is conditioned on the confirmation, by the administrator, that the formalities set forth in the internal regulation and Instruction 409 have been satisfied.
5 Pursuant to article 23 of Law nº 6385, of December 7, 1976, the professional management of securities portfolios is subject to prior authorization of CVM. Pursuant to definition in Instruction CVM nº 306, of May 5, 1999, the management of securities portfolios is the professional management of resources or securities, subject to CVM inspection, entrusted to the administrator, which is authorized to buy and sell shares and stock on behalf of the investor. The authorization for the management of securities portfolios is granted by CVM to legal entity domiciled in the country: (i) whose purpose is the management of securities portfolios; has been properly organized and registered with the National Directory of Legal entities (CNPJ); (ii) tasks a executive officer, delegate-manager or managing-partner accredited by CVM with the management of securities portfolios; and (iii) creates and keeps technical department specializing in analysis of securities and stocks or, if no such department exists, engages a third party accredited by CVM to provide those services.
6 The following information must be attached to the fund registration application: fund’s internal regulation, registration of internal regulation with proper public records office; prospectus; administrator certification that all service agreements for share and stock treasury, control and processing, quotas distribution, recordation of issue and redemption of quotas and custody of shares and stock and other financial assets, if applicable, have been made and that same agreements are available to CVM for review; name of independent auditor; fund’s CNPJ number; and standard application form containing the fund information.
7 The fund’s quotas are notional fractions of its equity and are book-entry and nominative. The fund’s quotas confer same rights and obligations to all members. Each quota has a vote. Members become members by signing their names on the fund’s members record. Only members registered on the members record as of the date of meeting call, their legal representatives or attorneys-in-fact properly appointed less than one year before can vote at General Meetings. Members may vote by way of written or electronic communication, provided that such communication is received by the administrator prior to the opening of the meeting and due respect being given to the fund’s internal regulation. Except where they are the sole members, or upon express approval of the majority of members, the fund’s administrator and the partners, executive officers and employees of the administrator; companies related to the administrator or its partners, executive officers and employees may not vote at General Meetings; and the fund service providers and its partners, executive officers and employees.
8 The day quota value obtainable by dividing the net worth by the number of quotas, both determined at end of the day. Closing of the day is the time markets where the fund operates close.
9 If not intended solely to Qualified Investors, quota distributions in close funds must be preceded by registration of public offer of distribution, under the terms of Instruction CVM nº 400, of December 19, 2003, which contains provisions on public offers for securities distribution on the primary or secondary markets. In the case of Qualified Investors Fund, the registration application for quota distribution will be forwarded to CVM via Internet, together with: (i) promotional material to be used for the quotas distribution; (ii) maximum and minimum number of quotas to be distributed, issue value and other relevant information about the distribution; (iii) initial and end date of distribution; (iv) statement by administrator certifying that a distribution agreement was made with the institution member of the distribution system and that said agreement is available to CVM for examination, if applicable; and (v) prospectus, if any. Registration will be automatically granted and of the date of respective receipt of mailing. For distributions subsequent to the initial distribution, members must receive communication of the initial date of distribution, at least ten days in advance, and of end the date of distribution, no later than ten days after the end thereof, with the results. The administrator shall keep in its possession, for five years, the proof of mailing of said communications, and available to CVM.
10 If, during the quotas distribution the administrator should decide to change any previously announced condition, the distribution will be suspended until all the subscribers agree with the new condition(s). Dissenting members will be assured by the right to have the amount paid returned plus income earned, pro rata, net of charges and taxes. Thereafter, and before the distribution process is resumed, the prospectus and documents and material will be corrected, then a new 180 day time will start counting for the placement of quotas.
11 During the distribution, the administrator shall forward to CVM, via Internet, monthly statement of the investments, within no later than 15 days of the end of the month. In the case of an operational fund, the amounts corresponding to the new quota distribution will be entered separately from the other investments in the fund, until the end of distribution. The Members’ Meeting deliberating about the distribution of new quotas in close funds, may fix the minimum number of quotas that need to be subscribed necessary for the maintenance of the distribution, treatment extendable in the case there is partial subscription of quotas. If the minimum number of quotas fails to be subscribed within 180 days of the date of registration approval, extendable for an additional 180 days, the amounts paid will be immediately returned, plus the income earned, pro rata, net of charges and taxes. If the total number of quotas cannot be distributed and deliberation of Members’ Meeting has no fixed minimum number of quotas to be subscribed, quotas subscribers may choose to remain in the fund or have the amount paid returned plus the plus income earned, pro rata, net of charges and taxes.
12 Therefore, both the administrator and a intermediary institution must establish, in writing, the requirement for the intermediary institution to create a complementary record of members for each fund where such subscription or acquisition of quotas exists so that: (i) the intermediary institution records the complementary ownership of members holding quotas in the name of investors, assigning each member a customer code and informing this number to the fund administrator; and (ii) the administrator, or institution engaged, records the quotas in a special manner in the fund’s member record, using, in the owner’s identification, the name of the intermediary institution, plus the customer code furnished by the intermediary institution, and which identifies the complementary record. Investments in or redemptions from investment funds by way of intermediary institutions acting on account of and in the name of customers will occur separately. Such separation is important so that assets and rights of each customer, and the income and earnings, are separated from the intermediary institution. Assets and rights of customers of intermediary institutions do not account, directly or indirectly, for any obligation of these institutions. No intermediary institution can create, for its own benefit, in rem guarantees or securities interest in favor of third parties on the fund’s quotas. Intermediary institutions performing on account of and in the name of customers will assume all the burden and responsibility related thereto, including with regards to the customer’s registration, identification and other procedures originally attributable to the administrator.
13 In the event of waiver or discreditation, the administrator will immediately call a General Meeting to elect a replacement, to be held no later than 15 days. Members holding at least 5% of the quotas issued may call General Meeting to elect a replacement for the administrator, in any case, or CVM, in the case of discreditation. In the case of waiver, the administrator shall remain in office until the replacement occurs. Such replacement must occur within no later than 30 days, subject to dissolution of the fund by the administrator. In the case of discreditation, CVM will designate a temporary administrator up to the election of the new administration.
14 Funds willing to transact in derivatives that may cause equity loss or, specially, cause negative equity, will have to include in highlight on the prospectus cover and in all promotional material, clearly and conspicuously, note to that effect. Requirements under Instruction 409, as the case may be, are the following: (i) "This fund uses strategies in derivatives as part of its investment policy. Such strategies, as they are used, may cause significant equity loss for its members;" or (ii) in addition to the wording provided in item (i), the text may include the following "and may also cause losses that exceed the invested capital and resulting responsibility of the member to make addition contribution."
15 If the administrator is not accredited by CVM as custody service provider of securities amounts, the fund shall engage with an accredited institution in order to have those services.
16 The following are the fund’s charges, directly debitable: (i) federal, state, local or quasi-governmental imposed fees, taxes or contributions, accruing or that may accrue on assets, rights and obligations of the fund; (ii) document registration, printing, editing and publishing of documents and reports provided in Instruction 409; (iii) mail expenses, communication to the members; (iv) independent auditors hours and expenses; (v) fees and commissions paid for transactions; (vi) attorney’s fees, court fees and expenses, to protect, in or out of court, the interests of the fund, including the sum award against the fund, if any; (vii) portion of losses uncovered by insurance policies and not resulting directly from negligence or malice of providers of management services in the discharge of their duties; (viii) expenses directly or indirectly associated with the exercise of the right to vote by the administrator or its legal representatives, at shareholders’ meetings of companies the fund holds ownership interest; (ix) expenses incurred with the custody and settlement of shares and stock and other financial assets trading; (x) expenses incurred with closing exchange, associated to its transactions or securities deposits certificates; (xi) in the case of close funds, the annual contribution payable to stock exchanges or to organized over-the-counter market entities where the fund’s quotas are listed; and (xii) management and performance fees, as provided in the regulation. Any expense regarded as charges of the fund, including promotional expenses and expenses incurred with the preparation of the prospectus, are hired and borne by the administrator.
17 The fund’s financial year must close every 12 months and the financial statements prepared for the previous year. The end of the financial year must coincide with the end of one of the civil year months.
18 The disclosure policy must be the same for all members, investment consultants, rating agencies and other stakeholders. Any change to that policy will be disclosed as material fact.
19 Whenever there is the sole need to satisfy express requirements of CVM, adjustment to legal or regulatory rules or even to have updated information of the administrator, manager or custodian of the fund, such as change to the name, address, telephone number, the internal regulation can amended regardless of Members’ Meeting. Changes must be informed to the members via mail within no later than 30 days, of the date they have been implemented.
20 It is exclusively up to the Members’ Meeting to deliberate about: accounting statements submitted by the administrator; replacement of the administrator, of the manager, or of the custodian; merger, consolidation, spin-off, conversion or dissolution of the fund; increase of management rate; amendment to the investment policy; issue of new quotas in close funds; amortization of quotas, if no express provision is found in the internal regulation; and amendment to the regulation.
21 Management of fund’s portfolio is managing professionally shares and stock of the members, by individual or legal entity accredited by CVM to perform the management of securities portfolios. The manager will have authority to trade, on behalf of the fund, said shares and stock.
22 The custody agreements must contain the following provisions: (i) custodians will accede to the orders from the administrator, manager or its legal representatives or proxies only; (ii) the custodian institution will only carried out orders directly linked to the fund’s affairs; and (iii) clear information as to the price of services. Purchase and sale orders for shares and stock and other available assets for the financial and capital markets should be given with precise identification of the investment fund in whose name they will be carried out.
23 Funds managed by financial institutions are not required to engage the services treasury, control and processing relating securities and stock and recordation of the issue and redemption of quotas where such services are rendered by administrators themselves. Financial institutions are authorized to provide this kind of services.
24 It is allowed the collection of remuneration on the individual performance of a member making contribution to fund after the date of last collection is allowed, if the value of quota acquired is lower than its value at the time of last collection of the performance fee.
25 Investments in warrants funds and products or goods purchase and sale or service agreements for future performance, as well as in securities or certificates representing those agreements must have a guarantee from the financial institution or insurer. If the guarantee is provided by insurance company, the transaction will be subject to regulation from the relevant body (Superintendência de Seguros Privados – SUSEP). Under the terms of Resolution nº 2801, of December 7, 2000, of the National Monetary Council, which contains provisions on certificates representing goods purchase and sale and service agreements, investment funds may invest capital in the acquisition of certificates that meet the following requirements: (i) registered with a registration, custody and financial settlement system accredited by either Bacen or CVM; and (ii) tradable on organized secondary market, on the floor or at system accredited by CVM and supported by the self-regulating entity. In the case of derivative markets, transactions can be carried out on those managed by stock exchanges or commodities and futures exchanges, an over-the counter. If over-the-counter, the transaction must be properly registered with the registration and de financial assets settlement system authorized by either Bacen or CVM.
26 Connected company is the company where the fund’s administrator or portfolio manager, their controllers, officers or respective spouses, partners or relative up to second degree, hold over 10% of the capital stock, directly or indirectly, singly or collectively, or where they hold a management position. However, the fund’s administrators may hold offices resulting from the exercise of rights associated to the securities in the portfolio managed thereby as administrators of third parties’ portfolios.
27 Gross violation is the failure to comply with the provisions in the fund’s internal regulation, including the limits of portfolio composition and diversification and concentration of risks, subjecting the fund administrator to the payment of daily fine of R$ 200,00 accruing on the first business day subsequent to the expiry date.
28 Performance benchmark must be expressly indicated in the fund’s name.
29 Such a requirement does not apply to funds indexed by share market rates.
30 The acquisition of securities representing the foreign debt under the responsibility of the Union is exclusively for foreign debt funds, as provided by the National Monetary Council. These securities must be kept overseas, in a custodian account in the name of the fund, in the System Euroclear or LuxClear – Central Securities Depositary of Luxembourg (CEDEL). Securities making the fund’s portfolio must be deposited in the custody of entities authorized to provide such services by the relevant local authority, directly in the name of the fund.
31 With respect to the credit instruments traded in the international market, total issue or co-obligation of one single legal entity, its controller, company(s) directly or indirectly controlled thereby and its affiliates under common control, may not exceed 10% of the foreign debt fund’s net worth.
32 A sample of that written certification is attached to the Instruction 409 as Exhibit I (Declaration of Qualified Investor). By signing the statement, the investor states that they are qualified investors and aware of the financial and capital markets adequacy so that legal rules related and protection granted to non-qualified investors will not apply, as well as attests to be fit to understand, judge and assume the financial risks associated with the investment of its capital in investment fund intended for Qualified Investors that, under the terms of current laws and regulations may, among other things: (a) admit the use of shares and stock to pay and redeem quotas; (b) waive the preparation of prospectuses; (c) charge the performance fee, as fixed by regulation; and (d) to establish time for ascertainment of quota value and for payment of redeemed quotas other than those provided in Instruction 409.
32 The following investments are forbidden: (i) funds for investment in shares and stock; (ii) funds for investment in funds for investment in shares and stock; (iii) investment funds with credit rights; (iv) credit rights funds under the Program for Incentive of Social-Interest Projects Implementation; (v) funds of investment funds in quotas of credit rights investment funds; (vi) funds for financing of the national movie industry; (vii) mutual privatization funds – FGTS; (viii) mutual privatization funds – FGTS – free portfolio; (ix) funds for investment funds in emerging companies; (x) index funds, with quotas tradable on stock exchanges or Organized over-the-counter market; (xi) mutual funds of investment in emerging companies – foreign capital; (xii) conversion funds; (xiii) real estate investment funds; (xiv) privatization funds – foreign capital; (xv) mutual funds of shares deriving from tax incentives; and (xvi) cultural and artistic investment funds.
34 The warning will be similar to that used by other investment funds. For more information, see footnote # 14.
35 The Internal Revenue Service will lay down regulation about the intervals and methodology to calculate the average time of an investment fund’s securities portfolio.
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