New Rules in Brazil Applicable to Financial Institutions

At meeting of November 28, 2002, the Brazilian Monetary Council approved the new regulation to govern the requirements and procedures related to the organization, permit to operate, transfer of equity shareholding and corporate reorganization, as well the revocation of permit to operate of financial institutions¹and other equivalent entities that need prior approval of the Brazilian Central Bank ("Bacen") to operate in the country. The regulation is a Schedule to Resolution nº 3040 of November 28, 2002².

Financial institutions or equivalent entities subject to that regulation and expressly indicated therein, are the following: multiple, commercial, development and investment banks; credit, finance and investment companies; savings and loan companies; mortgage companies; development agencies; leasing companies; securities brokers; securities dealers and exchange brokerage companies. Bacen will enforce the conditions required for the organization and authorize operation of all those institutions in Brazil.

The operation of financial institutions and equivalent entities will be conditioned on prior express approval of Bacen and assumes not only that the company was organized pursuant to applicable legal and regulatory rules, but also that it has a permit to operate.

The financial institution or equivalent company must inform Bacen the name of the technically qualified person overseeing the organization process and of the new company’s organization group.

Representatives of the future controlling group and future holders of qualifying interest must participate in the new institution’s organization group.

Controlling group is a concept deriving from the definition given to "controlling shareholder" by existing law governing corporations³. Thus, under the terms of corporation legislation, a controlling shareholder is "an individual or legal entity, or group of persons bound by a voting agreement, or under common control, that: (a) is the holder of partner’s rights that entitle the holder, on a permanent basis, majority of vote in decisions at shareholders’ meetings and authority to elect the majority of the company’s management members, and (b) effectively exercises the authority to conduct the business of the company and guide the corporate bodies."

For purposes of that regulation, qualifying interest is any individual or legal entity holding, directly or indirectly, either 5% or more of the shares or quotas representing the company’s total capital.

In order for a financial institution or equivalent entity to be organized, the interested parties must satisfy the following conditions:

1. Publication of a statement of purpose⁴, by the individuals or legal entities that are not yet participants in the financial institution’s or equivalent’s controlling group, under the terms and conditions established by Bacen. Bacen is charged with disseminating that statement of purpose by any means it may deem appropriate;
2. Submission of an economic-financial feasibility study and a business plan for the first three years of operation, as well as definition of the corporate governance procedures to be followed, including a detailed description of the incentive and salary policy structure;
3. List of the institution’s controlling group;
4. Evidence of an economic-financial capacity compatible with the size, kind and purpose of the engagement. At the discretion of Bacen, this condition may be satisfied either individually by controlling shareholder or by the controlling group;
5. Document prepared by the members of the controlling group and holders of qualifying interest expressly authorizing the Federal Revenue Department to furnish Bacen with copies of the income tax returns containing a list of property and rights and actual debts and liens for the preceding three fiscal years, to be used exclusively in the authorization process, and authorizing Bacen to access information related thereto contained in any public or private registration and information system; and
6. Nonexistence of limitations that might, to the best of Bacen’s knowledge, adversely affect the reputation of controlling members⁵.

The economic-financial feasibility study must contain at least the following information: (a) economic and financial analysis of the market segments in the region where the institution plans to perform and its projected share in these segments, including main competition in each segment; (b) anticipated profitability, including expected return in each of the market segments selected; and (c) financial projections showing the equity evolution for the period, including a list of sources of fund raising that render evolution possible.

The business plan, in turn, should include at least: (a) detailed information on the proposed organizational structure, with precise definition of duties attributed to the several levels in the institution; (b) internal control structure, showing mechanisms that ensure proper supervision by the management and effective use of internal and external audits as control tools; (c) setting of strategic goals; (d) definition of core products and services to be offered, including target public; (e) technologies to be used in placing products and extent of the service network; (f) setting of deadline to initial operation after Bacen authorizing it; and (g) description of the criteria used in the selection of and profile of management members, as well as identification thereof, upon request from Bacen.

Upon confirmation by Bacen that all conditions established in the regulation have been satisfied, it will forward communication to the interested parties which have ninety days, from the date of receipt of such communication, to make a formal application for permit to operate⁶. If properly justified, Bacen may grant an extension of up to nine days, upon whose expiration the organization process will be automatically cancelled if adequate measures have not been taken. Authorization to operate will be granted after Bacen’s approval of the organization documents, due respect being given to the legislation in force, with all members of the controlling group and holders of qualifying interest required to present sufficient evidence to Bacen as to the source of funds to be used. The institution will start operating within the time indicated on the business plan, but Bacen may exceptionally extend such time if properly justified by the members of the management⁷. Before the beginning of operations and after securing the authorization to operate, the institutions are required to present Bacen a certified statement of compliance of their infrastructures with the business plan previously presented, and in the case of financial institutions, adhesion to the mechanism of credit holders protection against financial institutions⁸. After the startup and for the first three fiscal years of operations, institutions must include proper evidence in the management report accompanying the financial statements that the transactions carried out are proper to the strategic goals established in the business plan. The independent auditors’ report must include a note regarding the financial statements, giving their opinion on the information contained in the management’s report. Upon determination in the three fiscal years of unsuitability of transactions with the strategic goals, the institution concerned must present reasonable justification thereof. This justification will be reviewed by Bacen, which may set additional conditions to be satisfied by the institution, fixing a deadline therefor.

Transfer of the company’s controlling shareholding and any direct or indirect change in the controlling group that may result in the effective management of the business, derived from: (a) shareholders’ or quotaholders’ agreement; (b) inheritance and acts of will , such as donation, acceleration of inheritance and creation of usufruct; (c) action by individual or legal entity, separately or collectively, or by group of persons representing common interest, is also conditioned on authorization by Bacen. However, the simple transfer of controlling shareholding to legal entity will not be conditioned on approval by Bacen to the extent that there is no admission of new individuals to the group of ultimate controlling members of the institution.

Reorganizations, including change of corporate purpose; creation or extinction of operating portfolio by multi-service bank; amalgamation, spin-off or merger are also conditioned on Bacen approval.

Additionally, the regulation lists other events that must be reported to Bacen within the times yet to be established by that body:

1. admission of shareholder or quotaholder, holding qualifying interest or rights resulting therefrom, arising out of legal acts performed, directly or indirectly, with other shareholders or quataholders of the institution;
2. increase of interest by shareholder or quotaholder by 5% or more of the company’s capital, whether cumulatively or not; and
3. party assuming the status of qualifying-interest-holder shareholder or quotaholder.

Direct interest that result in control of institutions organized as from November 29, 2002⁹, may only be held by individuals, financial institutions or equivalent or other legal entities whose sole corporate purpose is the corporate interest in financial institutions or equivalent entities¹⁰.

Revocation of the authorization to operate will be required upon the performance of actions that result in the extinction of company or change in its corporate purpose, which causes the institution to lose its status as a company member of the National Financial System. Extinction resulting from composition, full spin-off or merger, to the extent that the resulting or succeeding company is accredited by Bacen, does not imply cancellation. In addition to the indispensable requirements for the revocation of authorizations to operate, which requirements will be listed ahead, Bacen may condition said revocation to the liquidation of liabilities typical of the financial institution or equivalent entity. The following are the indispensable requirements for revocation:

1. publication of a statement of purpose, under the terms and conditions established by Bacen;
2. decision at a shareholders’ or quotaholders’ meeting, as the case may be; and
3. attachment of proper documentation to the respective cancellation application, under the terms and conditions set forth by Bacen.

After exhausting all applicable measures available thereto within its authority, Bacen may revoke the authorization for financial institutions or equivalent entities to operate upon determination, at any time, of one or more of the following situations: (a) operating inactivity, without acceptable justification; (b) institution cannot be found at the address furnished to Bacen; (c) unjustifiable discontinuation, in excess of four months, of provision to Bacen of financial statements required under legislation in force; and/or (d) failure to meet the deadline set on the business plan submitted to Bacen for initial operation. Prior to the cancellation for any of the above reasons, Bacen will announce, by any means it may deem appropriate, its intention to revoke the authorization to operate, so that it is possible for the general public to present objections within thirty days.

Bacen may or may not approve applications related to any of the issues dealt with in the regulation and, in the course of review of those issues, may also request presentment of additional documents and/or information it may deem necessary to make a reasoned decision. Additionally, an interview with the members of the controlling group, holders of qualifying interest and appointed officers may be requested by Bacen. Bacen may summarily disapprove applications in the case of irregular registration information if such irregularity remains uncured for time yet to be established by Bacen, and/or in the event of misinformation and/or misrepresentation.