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G-Men Swarm the Bovespa!

DATELINE: SAMBODIA — Yesterday’s Valor Econômico carried a special section on law enforcement cooperation and financial crimes investigation training provided by the SEC and FBI to Brazilian federal police and the native securities regulator, the CVM.

The key analysis is translated from an article by Jonathan Weil of Bloomberg, who excoriates the PCAOB as a do-nothing enforcer of accounting standards.

The coverage was neither substantial nor all that newsworthy, given that the previous federal government had worked out an accelerated cooperation program in the wake of a series of cases in which Brazilian and U.S. authorities cooperated in multijurisdictional cases, financial in nature and otherwise.

Today, Relatório Reservado — my beloved carioca tip sheet, which admittedly sometimes makes up for in eloquence what it lacks in substance — follows up. This, says the Relatório, is not necessarily a drill.

The shock troop of 150 agents dug in inside the CVM has other, less transparent, reasons for its visit. They are here to look into suspicions that are being treated as a matter of state policy by the U.S. government: the supposed promiscuity between the Brazilian government and some of the major listed companies on the Bovespa — The São Paulo State Stock Exchange — both in Brazil and in New York.

The matter is the subject of three SEC investigations — Nos. 676.5600.200, 207.648.894.3 and 323.950.536 — and one from NYSE’s regulatory arm, Case 676.590.196.

Let me see if I can find those documents. They do not exactly pop right out at you in a search of the SEC Web site, but then again, this is the SEC Web site we are talking about.

The FBI is also looking into the charges.

The North Americans have come to the conclusion that the Bovespa lacks transparency and reliability when it comes to regulatory disclosure by listed companies, and is not in compliance with international rules in these areas.

Hell, you need not be a forensic accountant to reach that conclusion. But the dance of converging accounting standards is a slow and complex one.

… statistics provided by the Americans show that nearly 90% of the M&A deals closed in the last decade involved at least one of the three largest pension funds for federak civil servants — Previ, Petros and Funcef — or else investment funds specializing in the shares of Banco do Brasil’s investment funds or BNDESPar, the investment arm of the state-owned BNDES. Taken altogether, these institutions manage some US$ 600 billion.

The higher profile of Brazilian ADRs on the NYSE-Euronext also drives concern about state interventionism in this big-ticket firms, according to our carioca friend.

Our reporter says our gringo feds are not happy about the active role taken in large, expansive companies like JBS Friboi, Embraer, Embratel, and Brasil Foods — all of them in fourth-gear deal-making mode with subsidies from BNDES or the more indirect action of CALPERS-sized trade-union pension funds with close ties to a trade-unionist government.

We gringos are said to be alarmed, for example, by the ousting of Roger Agnelli from Vale do Rio Doce, apparently as a result of political considerations.

In a word, according to our man in Rio, our G-men are said to suspect the Brazilian federal government of directly manipulating stocks held by U.S. investors. This sounds a bit more like a talking point for trade talks than a subject for a roundtable on finding and seizing Bolivian drug money, however. 

It is not exactly a secret that the Lula I and Lula II governments bankrolled the internationalization of firms in sectors in which it though Brazil could feasibly establish multinationals of its own, to even the playing field in trade talks and strengthen its bilateral hand. Except in the case of Brasil Telecom, these cases were not usually scandalous. There was an application process and BNDES and other institutional investors would say either yea or nay.

It happens to be true that the capital markets of Brasil remain shallow and dominated by a very small circle of blue-chip industrials, often BNDES-backed, and that overall, stock market returns remain inferior to fixed-income, commodities instruments and other modes of investment.

This is a fact that tend to slow the growth of these markets despite the merger of commodities, futures and equities trading engineered by the Chicago Mercantile Exchange, which owns 10% of the exchange and dreams up a lot of its innovation programs, it seems to me. Two cases of currency swaps mismanaged in the last couple of years — Aracruz and Votorantim — are still cited as what can happen when national firms get hooked on the firewater of the gringo as his exotic ABSes.

If, as the poet Carl Sandberg said of Chicago, Brazil has laid out a state policy to become “meatpacker to the world” through the acquisition of traditional U.S. firms like Swift & Co. — where my grandfather once worked, and long-time sponsor of Dodgers baseball! — it views this as a matter of building its own multinationals as a strategic hedge against the power wielded by multinationals in its own markets — much as it dreams of building its own booster rocket and launching its own satellites from Alcântara in Maranhão.

And so the note seems a little inflammatory to me. I doubt very much that U.S. diplomacy will treat Brazilian “economic growth acceleration” programs as the moral equivalent of the House of Rothschild cornering the market in blood and real estate.

U.S. and Brazilian feds do not lack for cases of common interest. The two countries bracket the Caribbean, after all — font of all innovations in quantum accounting according to the Fastow paradigm — and seem to have gotten past their beef wars.

Some Brazilians I know believe the country survived the recent crisis so well because it remains relatively free of the exotic derivatives that fueled it — although in compensation, we Yankees lack anything like the Brazilian “factoring” system and its homespun asset-backed securitization — and hope that the do-nothing CVM will mature into something a little stricter than the Christopher Cox-era SEC and PCAOB.

But big private Brazilian banks — almost all of them with a state subvention in their checkered pasts — are extremely powerful and tend to be on the self-regulation warpath at the moment. The Brazilian federal government would likely argue that firms in which it owns a large stake — 30% is the standard stake for BNDES — present higher standards of governance that their private-sector peers.

Most U.S. firms that list in São Paulo through what are called Brazilian Depositary Receipts are traded in the OTC –DRN — market, meanwhile.

To be honest, I can find little to say on the topic raised by my Rio rabble rousers in the time that can be spared for a blog post. In the past, Brazilian attorneys have argued forcefully against any attempt to impose U.s. regulations on firms incorporated in Brazil, as in this 2002 comment letter:

There are a number of companies organized under the laws of Brazil that are, or over the next several years may become, issuers within the meaning of proposed Part 205.2(g). Accordingly, the Commission’s rules, if implemented as proposed, would potentially apply to many attorneys practicing law in Brazil and to the relationship between those attorneys and their clients. As discussed below, we believe the Commission should not attempt to regulate the legal profession in countries other than the United States. In addition, we are concerned that application of the proposed rules to attorneys practicing law in Brazil would be unnecessarily disruptive to the relationship between them and their clients without significantly enhancing the protection of investors. It would also be unfair, given the fact that non-U.S. attorneys most likely will not be conversant with U.S. securities laws.

In a 2008 speech to Brazilian lawyers, SEC commissioner Paul Atkins sought to “avoid the erecting of any unnecessary barriers between our markets” with a series of proposed concessions.

Meanwhile, the SEC is considering whether to permit U.S. companies to file using IFRS. If IFRS is good enough for non-U.S. companies, then why not for American companies as well? Making this change would leave the choice between U.S. GAAP and IFRS to the markets. If investors prefer one set of accounting standards over another, they may well reward with premium pricing those issuers who use the preferred set. You can easily see the utility of IFRS for multi-national U.S. companies that access international capital markets and have non-U.S.-based competitors.

Brazil has not adopted IFRS as far as I know. Its companies still produce quarterly reports marked with the sign of that hypohethical beast, “Brazilian GAAP,” which does not narrow things down a whole hell of a lot.

IFRS, of course, is still a work in progress, and there are areas in which IFRS has no applicable standards. The U.S. Financial Accounting Standards Board (FASB) and the IASB have much still to do in converging U.S. GAAP and IFRS, but both are committed to this work. Other issues that remain concern the funding and governance of the IASB, supporting the further development and consistent implementation of IFRS, encouraging education of accountants in IFRS, and working towards continued convergence.

Has not happened here, although Portugal has apparently adopted IFRS.

A third step that the SEC took to enhance the attractiveness of its capital markets was an overhaul of the rules that govern when a foreign private issuer can deregister, or leave the U.S. markets. We made an important decision — we would make it easier for companies to leave in order to make it more likely that they would come to the U.S. in the first place. The SEC’s former deregistration rules required a nearly impossible count of U.S. investors to determine if the company had fewer than 300 U.S. investors. The new approach, a much more flexible, realistic, and forward-looking one, measures trading volume instead of the number of U.S. investors. Essentially, if an SEC-registered foreign company has less than five percent of its worldwide trading volume in the U.S., it can leave. Measuring U.S. trading volume to determine if registration is required simply makes sense because it focuses on domestic U.S. investor interest in an issuer.

Well, that exhausts my time, although certainly not the complexity of the subject matter. I do not doubt that there are U.S. politicians of the neo-Austrian faith who regard the weight thrown around by the Brazilian government and ideologically attuned institutional investors a crime against nature.