Brazil: Short Selling In Connection With A Public Offering In Brazil

Last Updated: 22 November 2012
Article by Walter Stuber

Among its duties, the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) shall promote the expansion and the regular and efficient operation of the Brazilian stock market, and stimulate permanent investments in the capital stock of publicly-held corporations controlled by local private capital, as well as it shall avoid or prevent any kind of fraud or manipulation intended to create artificial conditions of supply, demand or price of the securities traded on the market.

Pricing integrity is essential to the capital raising process and CVM recently enacted specific rules of protection to the price formation process in the context of stock public offerings, by means of CVM Instruction No. 530, of November 22, 2012 (CVM Instr. 530/2012).

This Instruction brings security to the publicly-held corporations already registered and stimulates the realization of subsequent public offerings in the Brazilian capital markets. A significant increase of short sales in the period prior to the definition of price in subsequent public offerings after the initial public offering (follow on or repeat offer) is observed in the local and international markets, which leads to an artificial fall in the price of the offered shares.

These new rules are based on Regulation M and Rule 105 adopted by the Securities and Exchange Commission (SEC) of the United States to safeguard the integrity of the capital raising process and protect issuers from manipulative activity that can reduce issuer´s offering proceeds and dilute security holder value.

CVM Instr. 530/2012 prohibits the acquisition of shares in the context of stock public offerings by investors who have held short sales (vendas a descoberto) of the offered shares on the date the pricing is fixed and in the five trading sessions that precede such date. Under this Instruction, "short sale" means any transaction carried out by an investor who is not the holder of the offered shares, or whose ownership results from a loan or any other kind of contract that has an equivalent effect.

Operations of the same investor are deemed to be short sales and purchases of shares held in his/her/its own name or by means of any vehicle whose investment decision is subject to his/her/its influence. This means that an investor who buys shares in a public offering and is also a unit-holder (cotista) of a discretionary management investment fund, who/which held in the restricted period short sales with those shares, does not fall in the event of infringement to the provisions of CVM Inst. 530/2012.

Investment funds whose investment decisions are taken by the same manager will not be considered as a single investor for the purposes of CVM Instr. 530/2012, provided that the transactions are included in the respective investment policies of each fund.

The prohibition imposed by CVM Instr. 530/2012 does not apply to the following cases:

  1. operations carried out by legal entities in the exercise of the activity of market maker of the offered shares; and
  2. operations later covered by acquisition in the market of the total quantity of shares corresponding to the short position up to a maximum of two trading sessions before the date of fixing the offer price.

The disobedience to the rules introduced by CVM Instr. 530/2012 is defined by CVM as a serious breach for the purpose of paragraph 3 of article 11 of the Brazilian Securities Act.


1 These duties are expressly contemplated in article 4, items II and V, and article 8, item I of Law No. 6.385, of December 7, 1976 (the "Brazilian Securities Act"), which regulates the Brazilian securities market and creates CVM.

2 Since 1997 SEC adopts a set of anti-manipulation rules concerning securities offerings, known as Regulation M, whose fundamental goal is to protect the independent pricing mechanism of the securities market so that offering prices result form the natural forces of supply and demand unencumbered by artificial forces. Rule 105 of Regulation M governs short selling in connection with public offerings and concerns short sales that are made prior to pricing an offering. This rule is particularly concerned with short selling that can artificially depress market prices which can lead to lower than anticipated offering prices, thus causing an issuer´s offering proceeds to be reduced and it is intended to foster secondary and follow-on offering prices that are determined by independent market dynamics and not by potentially manipulative activity. These provisions apply irrespective of the short seller´s intent.

3 Article 11 of the Brazilian Securities Act regulates the penalties that may be imposed by CVM to the violators as follows:

Article 11. The Brazilian Securities and Exchange Commission may impose the following penalties on the violators of any provision of this law, the Corporation Law, or its resolutions, as well as any other legal provisions which that are the Brazilian Securities and Exchange Commission responsibility to enforce:

I - warning;

II - fine;

III - suspension from duties of a director administrator or member of the fiscal council statutory audit committee of a publicly-held corporation, from an entity taking part of the distribution system, or from other bodies which require authorization by, or registration with, the Brazilian Securities and Exchange Commission;

IV - temporary disqualification, up to a maximum period of 20 years, from occupying the posts mentioned in the previous item;

V - suspension of the authorization or registration for the execution of the activities covered by this law;

VI - cancellation of the registration or of the authorization to carry out the activities covered by this law;

VII - temporary prohibition, up to a maximum period of 20 years, from practicing certain activities or transactions, to the entities that compose the distribution system or other entities that depend on authorization by, or registration with, the Brazilian Securities and Exchange Commission;

VIII - temporary prohibition, for a maximum period of 10 years, to operate, directly or indirectly, in one or more types of transaction in the securities market.

Paragraph 1. The fine shall not exceed the larger of the following amounts:

I - R$ 500,000.00 (five hundred thousand Brazilian Reais);

II - 50 per cent of the amount of the securities issuing or of the irregular operation; or

III - three times the amount of the economic advantage gained or loss avoided due to the violation.

Paragraph 2. If the offense is repeated, the fines of the previous paragraph can be imposed and multiplied up to three times or, alternatively, the penalties provided for in items III to VIII of this article may be applied.

Paragraph 3. Except for the provisions of the previous paragraph, the penalties provided for in items III to VIII of the caput of this article will only apply when there has been a serious breach, as defined by the rules of the Brazilian Securities and Exchange Commission.

Paragraph 4.The penalties may only be imposed by observing the procedure provided for in paragraph 2 of Article 9, above, and the interested party may appeal to the Council of Appeals of the National Financial System.

Paragraph 5. The Brazilian Securities and Exchange Commission may, at its discretion, according to the public interest, suspend, at any moment, the administrative procedure opened in order to investigate illegal acts over the securities market legislation, if the defendant or accused signs a settlement instrument compromising to:

I - refrain from the activities or acts regarded as illicit by the Brazilian Securities and Exchange Commission , and;

II - amend the irregularities, including offering compensation for losses.

Paragraph 6. The instrument referred to in the previous paragraph does neither imply a confession of the matter or a recognition that the conduct was illicit.

Paragraph 7. The commitment letter shall be published in the Federal Official Gazette, describing the period assigned for compliance with the obligations that have been undertaken, and shall constitute an extrajudicial collection instrument.

Paragraph 8. If the obligations are not fulfilled in time, the Brazilian Securities and Exchange Commission shall reopen the suspended administrative procedure in order to apply the relevant penalties.

Paragraph 9. When applying the penalties provided for in this law, special consideration will be given to any person who voluntarily confesses an offense or provides relevant information concerning the commitment of an offense.

Paragraph 10. The Brazilian Securities and Exchange Commission shall regulate the observation of the provisions of paragraphs 5 to 9 of this article to the proceedings ruled by the Stock Exchanges, Futures Exchanges, entities of the organized over-the counter market and entities of clearing and settlement.

Paragraph 11. The fine imposed for not complying with an order of the Brazilian Securities and Exchange Commission under item II of article 9, and item IV of paragraph I of article 9, shall not exceed R$ 5,000.00 (five thousand Brazilian Reais) for each day of delay, and its imposition is independent of the administrative procedure provided for in item V of article 9, above.

Paragraph 12. The party may appeal to the Board of Commissioners, within 10 days from the decision to impose the fine provided for in the previous paragraph without suspensive effect."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Walter Stuber
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