Governance

"Corporate Governance is the system used to manage and monitor companies, and involves relationships among shareholders/members, the board of directors, board of executive officers, independent audits and fiscal councils. Good corporate governance practices seek to add value to companies, facilitate their access to capital and contribute to their sustainability."

History

During the first half of the 1990s, following a trend initiated mainly in the United States, shareholders became aware of the urgency of having new rules to protect them against the abuses of power practiced by executive officers, inefficient boards of directors and omissions in the conduction of external audits.

Conceptually, corporate governance was created to overcome "agency conflicts" arising from the separation of a business‘ ownership and management. In this situation, the owner (shareholders) delegates to specialized agents (executive officers) the power to make decisions concerning their ownership. However, management interests may not be aligned with ownership interests, resulting in an agency or agent-principal conflict.

Corporate governance's main concern is to create a set of efficient investment and monitoring mechanisms to ensure that the actions of executive officers are aligned with shareholders' interests.

Good corporate governance allows controllers (shareholders or members) to strategically manage companies and effectively monitor administrators. The main tools assuring the exercise of ownership control over management are the board of directors, the independent audit and the fiscal council.

Companies that choose to implement good corporate governance practices adopt transparency, accountability, equity and corporate responsibility as key vectors. For this, the board of directors, which represent shareholders, must exercise their role by establishing company strategies, electing and removing from office the chief executive officer, overseeing and assessing management performance and appointing the independent audit firm.

The lack of qualified board members and good corporate governance systems has led companies to fail because of:

- Abuses of power (by the controlling shareholder against minority shareholders, by executive boards against shareholders and by management against third parties);
- Strategic errors (due to excessive power concentrated in key executives);

- Fraud (use of privileged information for own benefit, and conflicts of interest).

In Brazil, the adoption of professional and independent directors arose in response to the trend of implementing good corporate governance practices and the need to restructure the senior management team at companies to make it more attractive to investors. Globalization, privatization and deregulation only accelerated this adoption, since these trends resulted in a more competitive corporate environment.

Oligopolies, which are companies controlled and managed exclusively by families characterized by high concentration of capital, passive minority shareholders and merely symbolic boards of directors, were substituted by more active institutional investors, greater dispersion of ownership and an increased focus on economic efficiency and management transparency.

Privatization led to the first experiences with jointly controlled companies in Brazil, which were formalized by shareholders' agreements. In these cases, the investors in the controlling block began to share control of the company, establishing contractual rules for the company's management.

Institutional investors, namely insurance companies, pension funds, investment funds, among others, took an active stance and began to attend shareholders' meetings, exercise voting rights involving their shares and monitoring more closely the companies they invested in.

The opening up and subsequent corporate restructuring of companies also occurred in the financial market. Foreign investment in the local capital markets increased, reaffirming the need for companies to adapt to international requirements and standards. In short, corporate governance practices became a priority and a source of pressure from investors.
Because of the need to adopt good corporate governance practices, in 1999 the first corporate governance code, drafted by the Brazilian Institute of Corporate Governance (IBGC), was published. In this initial version the code included information on boards of directors and what was expected of them. In subsequent versions, the four main principles of good corporate governance were described more thoroughly.

In 2001, Brazilian Corporation Law was reformulated and in 2002 the Securities and Exchange Commission of Brazil (CVM) published its guidelines on corporate governance. Focusing on managers, board members, controlling and minority shareholders and independent auditors, the guidelines provide orientation on issues affecting the relationships between these players.

Another contribution to the application of corporate governance practices came from the São Paulo Stock Exchange (Bovespa), with the creation of special listing segments for companies with higher standards of corporate governance. In addition to the traditional market, three new special corporate governance segments were created: Level 1, Level 2 and the Novo Mercado. According to the Bovespa‘s informative bulletin, the objective was to "promote interest by investors and increase the value of listed companies."
The Level 1 segment requires additional stock liquidity and disclosure practices, whereas the Level 2 segment requires additional practices involving shareholder rights and boards of directors. Lastly, the Novo Mercado differs from Level 2 in that it requires the issue of only shares with voting rights.

These latter two segments seek to reduce the uncertainties involved in assessment, investment and risk processes, increase the number of investors interested, and consequently strengthen the stock market, bringing benefits for shareholders, companies, the market and Brazil.

To foster and disseminate corporate governance best practices, between 2005 and 2006 the IBGC created three awards recognizing academic papers, news articles and corporate governance. The awards promote discussion among the academic, business and communication worlds, as well as recognize companies and individuals focused on corporate governance issues.

Despite this expanded discussion on corporate governance issues and greater pressure to adopt good corporate governance practices, Brazil is still characterized by highly concentrated stock ownership, inefficient boards of directors and substantial overlap of ownership and management. This situation shows there is considerable scope for learning, adopting and disseminating corporate governance concepts.

Special Corporate Governance Practices

In 2000, the São Paulo Stock Exchange (Bovespa) created three special stock listing segments, known as the Level 1, Level 2 and Novo Mercado Special Corporate Governance Practices. The objective was to create a secondary market for securities issued by publicly held companies that adopt corporate governance best practices. The listing segments were created for shares of companies that voluntarily commit to good corporate governance practices and to disclosure requirements beyond those required by Brazilian Corporation Law. In general, these standards increase shareholders' rights and improve the quality of information disclosed.

As a result of National Monetary Council Resolution 2,829 of March 30, 2001 ("CMN Resolution 2,829/01"), as amended (which established rules for investments made by closely held private pension companies), shares issued by companies that adopt special corporate governance practices, such as the Novo Mercado, Level 1 and Level 2 segments, as per Bovespa regulations, may have a higher share of these pension funds in their investment portfolios. Thus, following publication of CVM Resolution 2,829/01 and further amendments, shares issued by companies adopting special corporate governance practices became an important and attractive investment for closely held private pension companies, i.e., large investors in Brazil‘s capital markets. We believe this resolution may leverage the development of local capital markets, benefiting companies with stocks traded in these markets, including our bank.

Adherence to Level 1 and Adoption of Certain Novo Mercado Regulations

We plan to be listed on the Bovespa‘s Level 1 Special Corporate Governance Practices for companies committed to adopting corporate governance practices concerning the disclosure of information in addition to those required by Brazilian regulations. Additionally, although our bylaws were not analyzed by the Bovespa, as mentioned below, we have voluntarily adopted certain corporate governance practices required only of companies listed on the Novo Mercado.

All members of our board of directors and board of executive officers must subscribe to the Administrators‘ Term of Commitment referred to in the regulations of the Level 1 listing segment, with their installation dependent on the signing of this document. Through this instrument, our administrators take personal responsibility and comply with the Agreement of Adoption of Level 1 Special Corporate Governance Practices and the Regulations of the Level 1 Special Corporate Governance Practices.

Minimum Percentage of Free Float Shares following the Capital Increase

According to the Level 1 Regulations, in the event of a capital increase not fully subscribed to by shareholders with preference rights or with insufficient interest in a public offering, controlling shareholders fully or partially subscribing to said capital increase must take measures to return the free float to the minimum percentage of 25% (twenty-five percent) of the bank's capital stock within 6 (six) months of the subscription.

Trading in securities and derivatives by Administrators, Controlling Shareholders and Fiscal Council Members

In accordance with CVM Instruction 358 of January 3, 2002, the bank's administrators and members of the fiscal council must inform to the Securities and Exchange Commission of Brazil (CVM) and the São Paulo Stock Exchange (BOVESPA), on a monthly basis, the number and types of securities they hold directly or indirectly.
According to Level 1 Regulations, the controlling shareholder, immediately after assuming ownership control, must inform the Bovespa about (I) the number and types of securities, including derivatives, it holds directly or indirectly, and (II) the details of any transactions in securities and derivatives that come to be effected, including the price, within 10 days after the end of the month in which the trade was made.

Delisting of the Company

As provided for by the company's bylaws, the procedures for delisting the company must comply with the regulations and other requirements established by governing law, especially the corporate governance regulations published by the Securities and Exchange Commission of Brazil (CVM).

Adoption of Certain Novo Mercado Rules

As provided for by our Bylaws, we have voluntarily adopted the following rules observed by companies with stocks listed on the Novo Mercado segment: (I) of the members of the board of directors, at least 20% (twenty per cent) are independent members; (II) the obligation, under certain circumstances, to hold public offerings for the acquisition of stock; (III) tag-along rights for all shareholders in the event of the bank‘s sale; and (IV) the bank, its controlling shareholders, administrators and members of the fiscal council must comply with the Regulations of the Market Arbitration Chamber of the São Paulo Stock Exchange (Bovespa) to resolve potential conflicts related to the application, validity, effectiveness, interpretation, violation and related effects of the provisions of Brazilian Corporation Law, the bank's bylaws, the regulations issued by the National Monetary Council (CMN), the Central Bank of Brazil and the Securities and Exchange Commission of Brazil (CVM), as well as those of the Regulations of the Level 1 Special Corporate Governance Practices Segment, the Arbitration Regulations and the Agreement to Adopt Level 1 Special Corporate Governance Practices, which we aim to adopt in the event of a public offering through the signing of an agreement with the Bovespa.

Banestes shareholders are entitled to the following rights:

• Each common share grants its holder voting rights at shareholders' meetings. Preferred shareholders do not have voting rights.
  
  
• According to Brazilian Corporation Law, shares without voting rights or with limited voting rights will enjoy unlimited voting rights if the company stops paying, for three consecutive fiscal years, any fixed or minimum dividends granted to these shares until said distribution is made. Since the company's bylaws do not establish fixed or minimum dividends, Banestes preferred stock is not entitled to unlimited voting rights in the event dividends are not paid, as mentioned above;
  
  
• According to Brazilian Corporation Law, any changes in preferences or rights affecting the ownership interest of preferred shareholders or any creation of a class of shares with priority over preferred shares must be approved by common shareholders at a meeting of shareholders, and will only take effect if approved by the majority of preferred shareholders at an extraordinary shareholders' meeting. At these extraordinary meetings, preferred shareholders vote as a special class;
  
  
• Brazilian Corporation Law entitles holders of (I) preferred shares without voting rights (or with limited voting rights) representing at least 10% of the total voting capital; and (II) common shares not included in the controlling group, representing at least 15% of the total voting capital, the right to elect a member to Banestes' board of directors and his or her alternate member, to be appointed at an annual shareholders' meeting. If no preferred or common shareholders outside of the controlling group achieve the limits set above, equivalent to at least 10% of the capital stock, they may combine their shareholding interests to appoint a member or an alternate member to the board of directors. Said rights may only be exercised by those shareholders that prove they did not alter their combined shares for a period of at least three months before the annual shareholders' meeting;
  
  
• Shareholders are entitled to certain rights that cannot be altered by bylaws or annual shareholders' meetings, including (I) voting rights at general shareholders' meetings for holders of common shares; (II) the right to participate in the distribution of dividends and interest on equity and to share in Banestes' remaining assets in the event of the winding up of the company; (III) under certain circumstances, preference rights in the subscription of shares or securities convertible into shares; and (IV) withdrawal rights in certain cases. In addition to these rights, the company's bylaws and the majority of shareholders with voting rights may establish, as well as relinquish, additional rights.

Brazil‘s stock market is regulated by the Securities and Exchange Commission of Brazil (CVM), which oversees and issues the general rules that govern the administration of stock exchanges and financial institutions registered at the CVM and participants in Brazil‘s securities market. The market is also regulated by the National Monetary Council (CMN) and the Central Bank of Brazil (BACEN), which hold, among other powers, the power to authorize the constitution and the operation of brokerages and to regulate foreign investment and foreign exchange operations.

Brazil‘s stock market is regulated by Brazilian Securities Market Law, Brazilian Corporation Law and the regulations issued by the CVM, CMN and Central Bank. These laws and regulations determine information disclosure requirements, restrictions on stock trading using insider information and price rigging and the protection of minority shareholders. However, Brazil‘s stock market does not have the high level of regulations and supervision of the U.S. stock market.

According to Brazilian Corporation Law, a company is publicly held if its securities can be traded on the Brazilian stock market. If a company's securities cannot be publicly traded on said market, then it is a closely held company. All publicly held companies must be registered with the CVM and are subject to regulatory and information disclosure requirements.

A company registered with the CVM may trade its securities on the São Paulo Stock Exchange (Bovespa) or on the over-the-counter market, and if it seeks to be listed on the Bovespa it must register at the Bovespa and the CVM. Once listed on the Bovespa, its shares cannot be trade simultaneously on Brazil‘s over-the-counter market, although they may be traded in private transactions, subject to various restrictions.

The Brazilian over-the-counter market, which includes the organized and unorganized over-the-counter markets, consist of transactions between investors intermediated by financial institutions authorized to operate in Brazil‘s capital markets and registered with the CVM. No special requirements other than registration with the CVM are required to trade publicly held securities on the unorganized over-the-counter market. The CVM requires from the respective intermediaries information on all transactions carried out on the over-the-counter markets.

The trading of securities on the Bovespa may be suspended upon request of the company issuing the shares before it publishes a material fact notice. Trading may also be suspended by the Bovespa or the CVM based on or due to suspicions that the company has published inadequate information in a material fact or given inadequate responses to inquiries made by the CVM or Bovespa.

Information Disclosure and Use

CVM Instruction 358

CVM Instruction 358 regulates the disclosure and use of information concerning material facts or events involving publicly held companies, as follows:

• Establishes the concept of a material event or fact, which includes any decision by a controlling shareholder, any resolution by a meeting of shareholders or management body or any other fact or event of a political, administrative, technical, business, economic and financial nature occurring or related to the Company's business that may considerably influence (I) the market price of a security; (II) investor decisions to buy, sell or hold securities; and (III) investor decisions to exercise any rights that benefit the holders of a securities issued by a company;
• Provides examples of events or facts that are potentially material, which include agreements to transfer control, the inclusion or removal of a contracted partner or an operational, financial, technological or administrative partnership and the incorporation, merger or spin-off involving a company or its subsidiaries;
• Requires the Investor Relations Officer, controlling shareholders, executive officers, members of the fiscal council and any other technical or advisory agency to inform the CVM of any relevant material fact;
• Requires the simultaneous disclosure of a material fact in all markets where a company has shares listed for trading;
• Requires the controlling shareholder of a publicly held company to disclose material facts, including if they plan to delist the company within a year after its listing;
• Establishes rules for disclosure of the purchase or sale of relevant holdings in a publicly held company; and
• Limits the use of insider information.