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Shareholder rights

It was labeled the "deal of the century." Senior executives of Enersis, a huge Chilean electricity holding firm, had negotiated to sell a large stake in the company to a Spanish concern. The $1.5 billion transaction was supposed to enrich shareholders and set the stage for new expansion.

There was only one problem. As the terms of the deal gradually became public last September, a committee of Enersis minority shareholders concluded that a handful of top executives who own a preferred class of Enersis stock were set to receive hundreds of times more per share than holders of the company's common class shares.

The outraged shareholders' committee took Enersis managers to court just as a government regulatory entity, the Superintendency of Securities and Insurance (SVS), announced that it was investigating a number of irregularities in the deal.

Although the matter is far from resolved, both the chairman and the general manager of Enersis have since resigned under pressure from the company's board. The svs has issued millions of dollars in fines to executives who brokered the deal, citing conflicts of interest that violate Chilean securities law. The merger with the Spanish concern is being renegotiated, this time under intense scrutiny by minority shareholders and the managers of several private pension funds that are heavily invested in Enersis.

Speaking at an IDB conference on securities markets (see page 4) Manuel Marfán, Chile's under secretary of finance, called the Enersis situation a "test case" that will probably strengthen the rule of law and underscore the importance of regulations designed to protect the rights of shareholders.

Rights for investors?

In the past, the words "shareholder" and "rights" rarely appeared together in Latin America, where ownership of stocks was largely limited to elites. But over the last decade, privatization policies have turned millions of middle- and even working class Latin Americans into shareholders. The sale of state-owned industries has usually included provisions granting shares to employees. Moreover, social security privatization schemes in half a dozen Latin American countries have linked the retirement income of workers to the performance of private pension funds that invest in securities.

As a result, workers who never paid much attention to corporate management are turning to the business section when they read the morning paper. They are wondering how much information they can expect to get from the managers of their pension funds and the directors of companies they partially own. As the Enersis case illustrates, they are even beginning to organize and seek redress when they believe a company is failing to act in their best interests.

This represents a striking change in Latin America, where most large companies are still run behind closed doors by close-knit families and associates. Businesses tend to be selective about what they disclose, making it difficult for investors to determine how much a company's assets are worth, how much it owes, and how much it is earning--in short, whether it is a sound investment.

But once a company decides to raise capital by placing stocks or bonds on the market, it automatically invites greater scrutiny. Investors across Latin America are consequently displaying a keen interest in laws and regulations designed to ensure that companies provide timely and accurate information to their shareholders.

In addition to making it possible for small investors to evaluate a company, these laws prevent a company's owners and executives (along with "majority" shareholders who own large blocks of stock) from using privileged "insider" information to arrange transactions that enrich them at the expense of minority shareholders. As the "insider trading" scandals on Wall Street in the 1980s famously illustrated, even the world's most sophisticated securities markets are prone to such abuses.

Virtually all of Latin America's major stock exchanges have adopted laws and regulations that address these issues, according to Jesse Wright, an IDB specialist in securities market development. Nearly all of them have opted for a two-tiered regulatory approach similar to that used in the United States. An independent regulatory entity, typically known as the Comisión Nacional de Valores (National Securities Commission), enforces laws that govern securities and exchanges, while delegating most of the day-to-day enforcement work to self-regulating member organizations that run particular stock exchanges. Like the National Association of Securities Dealers in the U.S., these entities enforce a wide range of rules, from verifying that companies are reporting accurate information to ensuring that stock brokers don't mislead their customers.

Safeguards for the little guy

Are Latin America's securities regulators doing a good job of protecting the interests of small shareholders? The evidence is mixed. "Regulators at the largest exchanges are extremely professional and serious about compliance," said the IDB's Wright. The situation is less encouraging in some of the smaller and newer exchanges. In some cases inadequate legislation and a dearth of qualified regulatory professionals create the potential--if not the reality--for serious abuse.

Speaking at the IDB conference, Gerard Carpio, manager of the World Bank's Financial Sector Research Group, warned of inadequate enforcement of adequate rules. "A lot of countries have posted listing requirements , but in some cases regulators haven't delisted companies that are known to be publishing bad information," he said.

The consequences of poor enforcement can extend far beyond the losses that can befall individual investors. According to Ross Levine, a professor at the University of Virginia in the U.S., recent research shows that the quality of securities laws and regulations is directly linked to the growth potential of security markets, and indirectly to economic growth as a whole.

The reason, Levine explained at the IDB conference, is that securities markets are based on trust. Buying shares is similar to signing a contract: investors will tend to do it only if they have reasonable assurances that the managers of a company will work to increase the value of those shares and report honestly on their progress.

If minority shareholders suspect that they are going to be taken advantage of," asked Levine, "why would they invest in stocks?"

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