New Regulation of Investment Funds in Brazil

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 n 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...