Amec / President Letter No. 05/2017. São Paulo, April 28, 2017

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1 Amec / President Letter No. 05/2017 São Paulo, April 28, 2017 To José Carlos Bezerra da Silva Superintendent of Accounting Standards Brazilian Securities and Exchange Commission CVM Rua Sete de Setembro, º andar Rio de Janeiro, RJ audpublicasnc0117@cvm.gov.br Subject: SNC Public Hearing 01/17 Dear Superintendent, The Association of Capital Market Investors Amec seeks to systematically contribute to the proposals presented by the CVM to support the evolution of the Brazilian regulatory environment. The public hearings promoted by CVM s Offices of Superintendents are a great opportunity to collaborate by sharing the investors view about relevant topics that impact on the capital market. With that in mind, our members analyzed the aforementioned public hearing and would like to present suggestions and comments to the Office of the Superintendent of Accounting Standards about the draft of the Instruction submitted to public hearing. First of all, we would like to point out that Amec considers the role of independent auditors crucial to build the credibility of our capital market. Accordingly, we support the work conducted by the Office of the Superintendent to update specific points of the main instruction dealing with the topic the CVM Instruction 308/99, so important for our market but currently outdated considering it was published 18 years ago. Additionally, we think it s also important to review the remaining standards for audit activities, such as the CVM Instruction 381/03 and the CVM Instruction 480/09, and their respective amendments. Please find below our considerations about the aforementioned public hearing:

2 1. About the convenience of a limited reform of the standards for independent audit activities The notice of the public hearing highlights the evolution of accounting practices and technological capabilities during the applicability period of the CVM Instruction 308/99 primarily the implementation of the IFRS in Brazil during that period. Based on the rationale described below, we understand that the new accounting standards should include considerations about the relationship among accounting professionals that, in turn, should guide their update. It s based on this broader view that we came to the first conclusion we would like to share with the SNC. Notwithstanding the merits of the proposals presented, we think they can prove insufficient as to the objective of strengthening and ratifying the reliability and quality of the independent auditors registered at the CVM. We believe there s a large gap today as to the expectations of market participants about the nature of the work performed by auditors and the actual work delivered. The market may get frustrated if this problem is not addressed as part of the standards update, bringing consequences that can be contrary to those intended by the CVM. It s important to highlight that, in our conversations with other associations, we noticed that the users of the financial statements have not participated in the debates about the update of the CVM Instruction 308/99. We see that as a problem. We consulted several entities, among which Anbima (the Brazilian Financial and Capital Market Association), IBGC (the Brazilian Institute of Corporate Governance), Apimec (the Association of Capital Markets Analysts and Investment Professionals) and the CFA Institute, and they informed us they have not analyzed the public hearing in details. Amec itself would like to have participated more in the debates, but it was not possible. Accordingly, our first and maybe the most important suggestion is that the CVM carefully analyzes whether an update of the standards for independent audit activities exclusively focused on the points listed in the draft is sufficient without a greater interaction with the users of the financial statements and an analysis about the broader changes that are necessary considering the new technological, accounting and market environment. We believe that such reform should be preceded by events with market agents to drive the debate and help identify the problems regarding the accounting activity. Amec would be very pleased to participate in the process and help the regulator in the debate. 2. About the Governance of Accounting Practices During Amec s internal debates, we have been noticing a constant concern among our members about the quality of the financial statements. One of the most common discussions is related to the unexpected consequences of the implementation of the IFRS, with impacts for all those responsible for preparing and monitoring the financial statements.

3 Our members understand that the IFRS, along with all the merits in terms of international convergence and the fact that the essence is prioritized over the form, brings with it a very important characteristic that, if misused, can negatively impact on the quality of the financial statements instead of improving them: the management s discretionary power. Several accounting statements in our system are based on the judgments of management, with significant consequences for the financial statements. There s nothing intrinsically wrong about that, provided the IFRS Principles and its Conceptual Framework, under the terms of the CPC 00 (CVM Decision 675/11) are strictly observed. For that, two important elements are necessary: (1) the proper qualification of the accounting professionals, mainly as to the principles involved; and (2) a system of checks and balances to ensure that the principles are being duly implemented, and not operated to their limit so that the discretionary power is used in a way that does not represent a true and fair view of the company s economic and financial reality. As to the above mentioned, we understand that the draft of the Instruction properly addresses the item (1). Yet item (2) requires an additional analysis. System of checks and balances is the classic definition of governance. With that in mind, here follows our view about the governance of accounting. As an example, we can mention the power given to a company s accountant as to the judgments he/she needs to make when preparing the financial statements. The fact is that the chief accountant often reports to the CFO. If this latter, who can be less concerned with the Accounting Principles, demands his/her reportee to push when making this or that judgment, there is no guarantee that the professional will not give in to the pressure of his/her superior. The independence requirement on the judgments made by the accountant are, therefore, subject to corporate and market pressures from superior officers, such as the CFO. At the same time, the independent auditors should adopt a different approach. They must be the guardians not only of the PROCESSES, but also of the CHOICES a company makes. Based on the wording of the (new) auditors opinions, we have been told that independent auditors not always know whether the judgments made by the boards actually reflect the companies economic and financial reality. Worse than that, the scope of their activity is usually so limited that they explicitly refrain from judging such judgments. Consequently, the users of the financial statements are subject to subjective documents produced without the proper checks and balances. Based on the aforementioned, we suggest a debate about the governance of accounting as the cornerstone of a review of the regulatory apparatus on the independent audit activity. Once again, unlike what s happening today, it s very important that the users of financial statements participate in this process.

4 Notwithstanding the comments about the possibility of implementing a broader review, we would like to make specific suggestions to the SNC as to the Instructions that are part of the agenda: 3. CVM Instruction 308, Article 25, Section II We suggest that the when requested expression is replaced by when installed. With that, the wording of the provision would be: II develop and submit, to the board of directors and, when installed, to the Conselho Fiscal, a detailed report including the results of the analyses on the internal controls and accounting procedures of the audited company The objective of such change is to reinforce the role of the Conselho Fiscal in monitoring the companies. We do not consider appropriate that the internal control reports are not submitted to the Conselho Fiscal. It s an essential tool for the performance of its legal activities. The fact is that the scope of duties performed by the Conselho Fiscal is so broad that sometimes it eventually becomes ineffective. The compulsory submission of the internal control reports to the Conselho Fiscal can add an important routine to the body s work, assigning more responsibility to its members with respect to the supervision of the companies businesses. 4. CVM Instruction 308, Article 25, Section IV We understand that the reference of the Generally Accepted Accounting Principles in the aforementioned instruction has become outdated due to the implementation of the IFRS in Brazil. More specifically, the principles that are actually relevant and should be considered are those found in IFRS s Conceptual Framework, under the CPC 00, included in CVM s regulation through the CVM Resolution 675/11. Additionally, we have been witnessing situations in which the professionals responsible for preparing the financial statements and/or auditors have not been following the CPC 00 principles, based on the interpretation that they are not an accounting standard. In our opinion, such practice is contrary to the essence intended by the IFRS, and represents a risk to its integrity. Finally, we would like to point out that the Generally Accepted Accounting Principles expression was replaced by Accounting Principles through the CFC Resolution 1.282/2010. We consider that the current update of the CVM Instruction 308/99 is an excellent opportunity to update the reference. Accordingly, we suggest the following wording: IV clearly indicate, also to which amount, the asset, liability, result and shareholder s equity accounts or subgroups that are being affected by the adoption of accounting procedures that

5 conflict with the Accounting Principles and the Conceptual Framework for Financial Reporting, as well as the effects on the compulsory dividend and on the earning or loss per share, as the case may be, whenever a special review report of quarterly statements or an adverse or qualified report is issued; 5. CVM Instruction 308, Article 28 Our members do not understand why companies are allowed to communicate the replacement of independent auditors within 20 days after that the fact occurs. As it happens with the disclosure of the summary of the board of directors decisions, we recommend that companies immediately communicate such replacement. Here follows our suggestion on the wording of the item: Article 28. The board of the audited company should immediately communicate within 20 days the replacement of the auditor to the CVM and the market, regardless of whether the contract for the audit services is rescinded or not, and justify the replacement, including the consent of the auditor being replaced. 6. CVM Instruction 308, Articles 31 and 31-A Amec endorses the innovation introduced by the CVM Instruction 509/11 to create and define the Statutory Audit Committee (CAE). However, we understand that the mandatory rotation of independent auditors should not be bound to the installation of the CAE because it generates a mistaken incentive for its creation. The CAE should exist for its merits and not as a tool to enable longer rotation terms. At the same time, Amec endorses CVM s pioneering and bold initiative of establishing the rotation of independent auditors in 1999, when it suffered strong criticism by the auditors themselves. Time has shown that the CVM was right and that the rotation is an important tool to control the auditors independence. Several countries followed the Brazilian example and the trend was confirmed with the implementation of the new European legislation in 2016, which establishes the mandatory rotation of audit firms. Notwithstanding that, as CVM itself seems to recognize through the CVM Instruction 509/11, the rotation term of 5 years is too short. This is particularly true considering the limited number of audit firms duly qualified to audit the most complex Brazilian companies. Accordingly, we think that the regulator should analyze a potential change to the maximum term for the mandatory rotation, possibly to 10 years, inspired by the European and other jurisdictions regulations, irrespective of the installation of the CAE. With that in mind, we suggest the respective

6 amendment to the Article 31 of the CVM Instruction 308/99 and, consequently, the adjustment of the Article 31-A of that same document according to the amendment. Also with regard to the Article 31 and 31-A, we would like to say that Amec agrees that the Audit Committee should be exclusively comprised of board members and coordinated by an independent member. Such understanding is in line with both the Code of Best Practice of Corporate Governance published by the Brazilian Institute of Corporate Governance (IBCG) and the best international practices. There s no doubt that the fact that the committee is formed only by board members with voting rights does not eliminate the suitability of having permanent external guests. However, we understand that such reflection goes beyond the objectives of this public hearing and, therefore, we are at the disposal of the CVM to debate the topic in the future. 7. CVM Instruction 381/03 Finally, in addition to the above-mentioned contributions, we would like to suggest that the review of audit firms standards also include a review of the CVM Instruction 381/03, which deals with a related topic, namely, the disclosure of audit information by the audited party. We would like to make two specific suggestions: a. To reconsider the document in which the information required by the Instruction is disclosed as today it is apart from its objective and published in the Management Report (both in the annual and quarterly financial statements, according to the Article 2, paragraph 1 of the CVM Instruction 381/03). We suggest that such information is included in an explanatory note or in the Reference Form. b. Establish that the fees received by independent auditors for the services provided to other companies of the same economic group (i.e., under common control) are to be disclosed to avoid a possible loss of independence. 8. CVM Instruction 480, Article 25, Paragraph 1, Subsections V and VI Unfortunately, we have been experiencing situations (many of them in administrative or sanctioning processes under analysis by the CVM) in which board members evade responsibility by claiming ignorance about the financial statements. We understand that the board of directors should participate in the approval of financial statements and effectively engage in the discussion about its preparing although the management board certainly has access to more details and more responsibility in the process.

7 There are also a number of situations in which the boards do not receive the financial statements submitted to the Shareholders Meeting or receive them during the meeting, what means there is no time for any objective discussion about the topic. Accordingly, we suggest that the aforementioned provisions begin to include the board of directors members of the referred statements, detailing their responsibility for the financial statements: Art. 25. The Company shall submit the financial statements to the CVM on the date they are made available to the public. 1º The following documents shall be submitted together with the financial statements: (...) V statement signed by the directors and the members of the board of directors stating they revised, debated and agree with the opinions expressed in the independent auditors report, informing of the reasons in the event of disagreement with the opinions; VI statement signed by the directors and the members of the board of directors stating they revised, debated and agree with the financial statements; Very truly yours, MAURO RODRIGUES DA CUNHA CEO