On April 20, 2011, the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários - CVM) enacted CVM Instruction No. 494 (Instr. 494/2011), which amended and updated the existing regulation that governs the incorporation, administration, operation, information disclosure and distribution of units (cotas)1 of Brazilian Investment Clubs (Clubs)2, and CVM Instruction No. 495, dealing specifically with the preparation and disclosure of financial statements by the Clubs.

Besides giving new treatment to the Clubs´ regulation, lagged in recent years due to several factors, among which the largest refining of the rules applied to the investment funds, Instr. 494/2011 reconciles certain market demands with concerns about the use of Clubs for the purpose of "regulatory arbitrage". The Clubs were originally designed to encourage participation of small investors gathered in groups. However this concept was eventually misused in recent times. Some brokers have used this framework to offer open portfolios to investors who do not fall into such category (small investor) as a way to create investment funds "disguised" as Clubs, which caught the attention of the Brazilian regulator. And as in the Clubs the accuracy of the information was not so demanding, with structures simpler and cheaper, less subject to controls, many potential investment funds could be formed as Clubs. The new regulation prevents this "regulatory arbitrage" from happening.

The changes adopted now highlighted the role of the Clubs to introduce retail inexperienced investors who are not yet familiar with the Brazilian securities market (the target public) to such market at the same time that the current regulatory framework was updated, through increased transparency and higher level of participation of unitholders (cotistas) in those vehicles. There is a new content for the monthly information to be sent to the unitholders. CVM intention was to let the rules of the Clubs more similar to those applied to investment funds, without raising the costs, by demanding more transparency and greater security and resuming the educational purpose of this type of vehicle which aims to form new investors.

Under the current regulations, the Club is an open-end condominium formed by at least three and no more than 50 individuals in order to apply their resources in securities listed in the stock market and no unitholder can own more than 40% of the total units of the Club. The name of the Club must contain the expression in Portuguese "Clube de Investimento". The Club must be incorporated by means of a resolution of the administrator and its operation depends on the registry of the Club with the managing entity of the organized market, that must regulate and maintain reasonable controls over the activities of the registered Clubs. At the moment, the only entity that is authorized by CVM to act in such capacity and register Clubs is the Brazilian Exchange (BM&FBOVESPA S.A. – Bolsa de Valores, Mercadorias e Futuros - BVMF).

The Club must be administered by a brokerage company, a securities dealership company, an investment bank or a multiple bank with the investment portfolio (the administrator), which is responsible for all activities and services directly and indirectly related to the Club´s operation and maintenance. The management activity of the Club shall be under the direct supervision and responsibility of a statutory officer of the administrator, who may cumulate this obligation with other duties and responsibilities, provided there is no conflict between the activities.

The portfolio management of the Club may be exercised by: (i) the administrator, if previously authorized to engage in the activity of portfolio manager of securities by CVM and elected by the general assembly of unitholders, (ii) any individual or legal entity hired as administrator, if previously authorized to engage in the activity of portfolio manager of securities by CVM, and (iii) one or more unitholders elected by the general assembly of unitholders. In case management is attributed to a unitholder, it is forbidden for this unitholder to have more than one Club under his/her management and receive any kind of remuneration or direct or indirect benefit for services rendered to the Club. An autonomous agent investment cannot be designated as portfolio manager, even if he or she is a unitholder of the Club.

One of the main innovations introduced by Instr. 494/2011 is the reduction of the ceiling on the number of investors of the Clubs. From now on, the Club will have at least three and no more than 50 investors. The previous rule provided up to 150 unitholders.3 However, 90% of the Clubs today are composed of up to 50 applicants. This limitation has been imposed to stop the possibility of "regulatory arbitrage", which has already been discussed above.

Another important novelty is the requirement for the Club to compulsorily hold an annual general assembly of unitholders but the new regulation allows the adoption of electronic media and forms of non-face deliberation to hold such meetings.

The distribution of units of the Club is not subject to registration with CVM but must be made through the participants of the Brazilian securities distribution system. The indiscriminate advertising of the vehicles is not permitted. In this regard, the use of public communication such as press, radio, television and internet (website), as well as sending direct mailings, including through electronic messages, to seek unitholders is expressly prohibited. The managing entity of the organized market (BVMF) must regulate the content of the material used in the distribution of units of Clubs and practices related to such distribution, overseeing the implementation of such regulation through its self-regulation department.

Clubs can use their assets to provide guarantees to its own operations as well as they can borrow and lend securities, provided that such loans are routed only through a service authorized by the Central Bank of Brazil (Banco Central do Brasil - Bacen) or CVM.

Regarding the composition of its portfolio, the Club must have at least 67% of its equity invested in the following assets: (i) shares; (ii) subscription bonuses; (iii) debentures convertible into shares issued by publicly-held corporations; (iv) subscription receipts; (v) units of stock index funds traded on organized markets; and (vi) certificates of deposit of shares. This minimum percentage includes any assets transferred on loan and the guarantees deposited in excess. However, the assets that are deposited as security by the Club for its own operations shall be disregarded for the purpose of calculating this percentage. The balance may be invested in: (a) other securities issued by publicly-held corporations; (b) units of "Short Term", "Referenced" and "Fixed Income" investment funds; (c) federal government bonds; (d) negotiable instruments guaranteed by a financial institution; and (e) purchase options.

The possibilities for the use of derivatives were expanded, to enable a more efficient risk management, making it mandatory to impose limits on leverage and exposure of the Clubs by the use of such instruments, as well as the creation of mechanisms for controlling risks.

In addition to purchase options, the Club may perform other operations in the derivatives market subject to the regulation issued by the managing entity of the organized market in which the Club is registered. The managing entity of the organized market must: (i) establish the operational modalities allowed, as well as the exposure limits and leverage arising from transactions in the derivatives market, subject to certain criteria as outlined below; (ii) regulate the form and limits of use of the assets of the Club for the provision of guarantees in its own operations; (iii) define risk management procedures to be adopted by the administrator in case of use of derivatives; and (iv) define procedures and deadlines for adjusting the portfolio in case of noncompliance.

In the regulation, the managing entity of the organized market shall observe the following criteria: (i) in any case the main risk factor of the Club is the price fluctuation of the acquired assets, and the underlying asset of the derivatives transactions must be either shares or stock indexes; (ii) the Club can only perform operations with derivatives in stock markets; (iii) exposure limits and leverage in the derivatives market, as well as the possibility of using a particular operational mode, must be defined in order to protect the integrity of the equity of the Club; and (iv) it is prohibited to launch uncovered options.

The Club cannot: (i) effect transactions with securities outside of the organized markets; (ii) acquire securities issued by the administrator, the portfolio manager or any companies connected with them; and (iii) purchase units of investment funds administrated or managed by the administrator, the portfolio manager or any companies connected with them.

However, few exceptions to the above-mentioned limitations are expressly contemplated. The Club can purchase such securities: (i) in cases of public distribution, exercise of preemptive rights, conversion of debentures into shares and exercise of subscription bonuses, as well as in other cases where the managing entity of an organized market in which the Club is registered has granted prior written authorization for such acquisition under the regulation issued by it; (ii) in cases where securities are held in the market index which is linked to the investment policy of the Club, when they can be purchased in proportion to their participation in such index; and (iii) in cases of acquisition of shares issued by the company by a Club formed exclusively by the company´s employees.

The portfolio of the Club can only be formed by financial assets admitted to trading on organized markets or registered in a registry, custody or settlement system duly authorized by Bacen or CVM, in their respective areas of competence4. These financial assets should be kept in special deposit accounts, opened directly ne name of the Club, answering the administrator for the maintenance of such accounts, even when third-party custodians are hired to render this service.

In summary, Instr. 494/2011 also sought to enhance the regulatory activities of the managing entity of the organized market in which the Club is registered. This managing entity will be responsible for regulating, among other issues, operational modalities, the limits of exposure and leverage and the minimum procedures for risk management to be adopted by the Clubs and their administrators, in case of operations with derivatives. The same principle applies to enforcement and penalties for noncompliance, which must be determined by the self-regulatory department of the managing entity.


1 The units correspond to ideal fractions of the equity´s Club and they must be in book-entry form and registered and confer equal rights and obligations to the unitholders. The creation of different classes of units is forbidden. The quality of unitholder is evidenced by the entry of the name of the unitholder in the register of unitholders of the Club..

2 The amended rules were formerly contained in CVM Instruction No. 40, of November 7, 1984, and other related normative acts, which have been expressly revoked by Instr. 494/2011. Just to give an idea of the size of this type of investment, in 2000 there were 379 Clubs, with total assets of R$ 1.3 billion. In February 2011, there were more than 3,000 Clubs registered in the Brazilian Exchange, which gathered approximately 1,310 people and R$ 10.9 billion in assets under management. This corresponds to 5.73% from R$ 190.2 billion now invested in investment funds with stocks portfolio.

3 The Clubs already in operation with more than 50 investors will continue to exist but cannot receive new members. The previous rule also provided that the number of 150 unitholders might be higher in case of Clubs formed by officers, employees or contractors of the same entity, company or group. The new regulation no longer admits such possibility. From now on, the ceiling is 50 unitholders.

4 The area of competence of Bacen is limited to the federal. state and municipal government bonds and negotiable instruments guaranteed by a financial institution (other than debentures, that are classified as securities). The area of competence of CVM is broader and comprises all types of securities (including debentures).

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.