Panamanian Securities Legislation: the Road to Transparency and Accountability
Panama’s economy is closely linked with its geographic location, being service-based and heavily weighted towards banking and commerce. In the last decade, banking, financial services and trade through the Colon Free Zone have continued to expand, while the industrial and agricultural sectors of the country have experienced little growth or investment. With over eighty international banks in Panama City, many would like to see Panama’s banking centre become a financial centre for Latin America.
Panama’s trade centre dates back to 1567, with the Nombre de Dios and Portobelo trade fairs. These fairs were the central hub of exchange between Spain and the Americas. Europe was in an expansionist stage, suffering a dearth of precious metals, while in the Americas there was newly discovered gold and silver. With the discovery of the silver ore in Peru and the formation of the Callao-Sevilla route through Panama, merchandise from Europe was sold into Latin America from the Nombre de Dios fairs, while silver was shipped back to Europe from here. According to historical sources, sixty percent of all gold and silver sent to Spain from the Americas passed through the Isthmus of Panama. It is possible that in the 1660s the Portobelo fair was the largest in the world. Following the destruction of Portobelo and San Lorenzo in 1739 by Admiral Edward Vernon of the British Armada, the fairs were permanently ended. Panama’s trading centre was re-established in the early 1900s when it gained independence from Colombia through the intervention of the United States. The construction of the Panama Canal was essential to the renaissance of international trade through the Isthmus.
For the most part, trade in Panama has been carried out on a “cash” basis. During the years of the Nombre de Dios and Portobelo fairs, silver and gold were used as forms of payment, rather than negotiable instruments, derivatives or securities. Although paper would have been much easier to transport, the trade was effected in powder and bars with payment upon delivery of the goods. Now, the Free Trade Zone is heavily dependent on the banking centre of paymets. Nevertheless, neither trade in negotiable instrumets, nor the use of derivatives and securitisation has developed to a great extent in Panama.
Panama’s legal system is based on the Napoleonic system adopted by Spain and introduced into Latin America during the colonial period. Panama’s financial system thus mirrors the Spanish financial system, where financing for enterprise is raised through a credit market rather than through equities. The need for financing and trading though a stock exchange, although generally provided for in legislation was not developed until recently.
The Commercial Code, adopted in 1916, introduced the first legislative concepts of “exchanges”, providing for the creation of commercial trade houses and sites. This included not only financial exchanges, but also markets, fairs and warehouses. The Code covered all exchanges until 1970, when Cabinet Decree 247 created a National Securities Commission, under the auspices of the Ministry of Commerce and Industry. This law responded to the unrestrained sale of mutual funds in and from Panama, which required urgent regulation. It was intended to impede the sale of unregistered securities, thus protecting local and foreign investors from fraudulent dealings being undertaken through Panama. It was not conceived, however, in a proactive manner for the development of a securities market in Panama, but rather was adopted to ensure that the sale of unregistered securities did not continue to tarnish Panama’s reputation internationally.
In the 1970s, following the introduction of Cabinet Decree No. 247, a group of independent brokers attempted to form a securities exchange, but due to the zenith banking sector, this was unsuccessful. Between 1971 and 1983, the National Securities Commission attempted various times to organise a securities exchange, but the lack of a developed secondary market, and hence a lack of liquidity, hampered this founding. During 1984 and 1985 the Ministry of Commerce initiated various studies into the establishment of the exchange, but the recommendations set forth in these reports were never put into effect. It was not until 1990 that a group of businessmen established the “Bolsa de Valores de Panamá, S.A.”, an independent stock exchange.
These failures by both private enterprise and the public sector to establish an operating securities exchange in the Panamanian financial sector can be contrasted with the prominent successes of exchanges in the United States of America or United Kingdom. In part, that may be due to the lack of an industrial and manufacturing sector in Panama. As a result, financing on a large scale is not required here. Nevertheless, the existence of a strong securities exchange would offer possibilities for the development of enterprises in Panama, in areas that local businessmen do not have the capital to venture. It offers rapid financing for business expansion, without high interest rates. With a thriving services sector, which is not dependent on large initial capital injection for start-up ventures, Panamanian business people seem to be complacent about the lack of a manufacturing or agricultural base which could offer further employment and growth.
In addition to the reasons mentioned above, we consider that the following three factors have been influential in the Panamanian market: a) the banking sector has provided exclusive financing for the economic necessities of the country; b) Panamanian businesses are still, to a large extent, family enterprises; and c) the state has only recently participated extensively in the securities market and the direction of the economy to stimulate its growth. Given the nature of family business and the control which is maintained by the family, rather than raise capital from independent equity holders, bank finance has been a satisfactory means of obtaining capital. This trend has obviously hampered the growth of the financial market.
Since 1990, and the birth of the Bolsa de Valores de Panama, there has been a drive to convert Panama into an international financial centre for foreign investment in Latin America, not simply as a banking centre, but rather as a true financial centre. If Panama were successful at this, it would compete with the United States for capital and issuers in Latin America. Through the introduction of new legislation in 1999, the Panamanian government has attempted to promote the creation of a securities market in Panama. Nevertheless, it is questionable whether the simple introduction of a law will create and shape the market, or whether its involvement is limited to creating a framework in which the securities market can emerge on its own, through the efforts of private enterprise. Previously in Panama, the law’s failure to protect minority shareholders and ensure transparency and accountability have contributed to the lack of growth of the securities exchange, but with changes made to address these inadequacies, Panama continues to strive to position itself for growth in the financial services sector.
The scope of this article does not allow us to consider the entire securities market and the diverse issues which arise in regulating a securities market. As a result, we have limited our study and comparison to examining transparency and accountability of issuers in the securities market and the role of disclosure, financial reporting and corporate governance rules with respect to the primary and secondary securities markets.
In part I of this article, we will examine the structure for disclosure and transparency in the Panamanian market, with a view to comparing the legal framework which promotes disclosure by market participants versus the applicable rules in other jurisdictions. This section will look at who is subject to disclosure requirements, what information should be disclosed, and how the information is to be disclosed. It will also consider how transparency in the market can be achieved through these disclosure rules. It is not our intention to discuss the theoretical bases for disclosure rules, such as public choice theory, market failure theory, and efficient market hypothesis. For the purposes of this article, we have assumed that our audience is conversant with the theories and the unpinning necessity for disclosure.
In part II, titled “Financial Reporting”, we will explore the new regulations adopted in Panama to ensure proper reporting of financial statements which are disclosed. These regulations arise from reporting fiascos in the Panamanian market, similar to cases seen in international markets. The relationship between law and accounting in the securities market will be discussed briefly.
This will be followed, in part III with an examination of the Corporate Governance rules which are currently being considered by the Panamanian National Securities Commission. We will compare the proposed rules with international corporate governance standards, as well as consider the cultural aspects of corporate governance in Panama.
It is our intention to offer through this paper an introduction to the steps being taken in Panama to develop a stronger financial services sector. The primary focus of this analysis is to provide a comparison of the measures taken in Panama to ensure transparency and accountability of the players in the securities market against those measures adopted in other jurisdictions. It is through this comparison that we hope to provide a benchmark for the future growth and investment in the Panamanian market.
Part I. Disclosure & Transparency
The regulation of company disclosure has vital importance for the securities market, as it defines the relationship of the company, its directors and administrators with the shareholders. The purpose of regulating disclosure in the securities market is to guarantee public confidence in the market, with a view to stimulating investment of savings into the future growth of the country. Disclosure requirements delineate the communication between the company and its shareholders, as well as the capacity of the administration to produce relevant information. The financial statements and reports published by issuers are available to the investing public for investors to analyse where their investments are best placed. These rules should include those requirements applicable to public offers, the content and distribution of the prospectus and other offering documents, regulation of the supplementary documents, information regarding the control of a company or those who have a substantial interest in a company, information about persons who seek to gain control of a company, and information which is essential in determining the price or value of a security. The purpose of disclosure rules is to ensure the sufficiency and the certainty of the information provided.
In this section we will consider various aspects of disclosure and transparency, such as the audience to whom disclosure is aimed, the form and content of disclosure, and the resulting liability for disclosure of false or misleading information.
Section seventy-three of the Securities Act (1999) in regulating disclosure establishes that the National Securities Commission (NSC) can only request information which is relevant to the investing public, and must refrain from requesting information and documents which would cause too great a burden on the issuer. We can therefore conclude that in Panama the information disclosed is aimed at investors, and not at their investment advisors. It is interesting to note, however, that this section also specifies that the Commission may establish different disclosure requirements and documents in light of the type of issuer or security or the type of investor that the issuance is targeted to.
The investing public is comprised of the shareholders, future investors, analysts, and other interested parties. Nevertheless, it seems appropriate at this point to pause and consider the importance that the investing public gives to the disclosed information and the manner in which this information is actually interpreted. In 1981 Hines studied the question of who utilises a prospectus and what information these users actually required, in order to understand whether investors use the annual reports in their decision making. Hines considered that the majority of investors read the narrative of the report carefully, giving greater importance to the financial statements such as the Balance Sheet and Income Statement. However, he also noted that only those versed in accounting considered that they understood the financial statements.
These conclusions appear to be confirmed by research undertaken in 1987 by SRI International in the United States of America. This research confirmed that professionals concentrated their attention on the financial statements, discarding the narratives as partisan or overly optimistic. Professionals preferred to receive greater financial data from which they could draw their own conclusions and projections. If the prospectus is aimed at the investment advisor, rather than the investor himself, the information can be provided in greater detail and with more technical information. The relevancy and reliability of the information may be affected by the degree of detail provided.
Individuals, on the other hand, felt greater confidence with the financial statements and projections provided by the issuers, acknowledging however their lack of understanding of the financials. If we conclude that every investor has the opportunity to consult with an advisor regarding the information provided, we can only conclude that issuers must provide full financial details which can be analysed by professionals.
The form and content of disclosure:
The form and content of disclosure is dealt with superficially in the Securities Act (1999), and in greater depth in the NSC regulations. We will consider three aspects of the disclosure: a) disclosure of information in the prospectus, at the moment of registration; b) disclosure in periodic reports (such as annual or quarterly reports), through perspectives or projections; and c) disclosure of material facts as and when they arise.
The basic rule in all disclosure is set forth in section seventy-two of the Securities Act, which states that reports may not contain false information or declarations regarding material facts, nor omit information regarding material facts which should be disclosed, or which should be disclosed so that the declarations made are not misleading or deceptive in the light in which they were made. It is readily obvious from the wording used throughout the Act that the Panamanian Securities Act was modelled on the Securities Act (1933) and the Securities Exchange Act (1934) of the United States of America, and their regulations.
The Securities Act (1999) in section seventy-three establishes that registration applications and reports should contain the information and documentation about the issuer, its operations, business and securities as prescribed by the NSC. As mentioned previously, the NSC can only request information which is relevant to the investing public. Section seventy-four of the Securities Act (1999) empowers the NSC to adopt forms and formats for registration and disclosure purposes, to ensure homogeneity, simplification and efficiency in the registration process.
The NSC has established regulations, adopting forms and formats for disclosure. The most important of theses is Regulation 6-00, which adopts the procedures for the presentation of registration applications and the termination of registration. This regulation indicates that the prospectus must be presented in clear, concise, and understandable language, without using unnecessary technical jargon or omitting relevant information. The prospectus should set forth the risks of the investment, a general description of the securities offered, general company and administrative information (including the corporate governance rules), financial reports, and the details of all principals involved in the management of the company. It should also address any tax issues which may relate to withholdings on dividends payable to shareholders. Nevertheless, Regulation 6-00 provides also for the reservation or confidentiality of certain information, which the issuer may request through the NSC. A special form is provided by the NSC for requesting the reservation of information, due to its sensitive commercial nature. Upon receipt of the documentation, the NSC may reject an issuer’s registration where the information provided: a) is incomplete or fails to meet the requirements; b) contains a false statement regarding an material fact; or c) omits a material fact which should be disclosed so that the statements made are not misleading in the light of the circumstances in which they were made.
With respect to disclosure in annual or quarterly reports, issuers may include not only information about their performance in the last quarter or financial period, but may also provide forecasts for the oncoming period. “Perspectives” or “future projections” refers to the disclosure by issuers of future estimated earnings, based on a company’s financial performance and the company management’s projections for the next period. Although this matter may be contemplated in legislation in other countries, the possibility of issuing projections regarding future earnings is not actually taken into account in our legislation. In Regulation 6-00 analysis of perspectives is mentioned in the analysis of financial and operational results, but not projections of future earnings. This regulation indicates that the issuer should make reference to the known facts or trends which may affect the company’s operations or financial situation in the industry sector. Therefore, the issuer may refer to possible future events or circumstances, but must clearly distinguish those events which are reasonably foreseeable and those whose possibility are simply anticipated or which have little impact on the company’s operations.
The importance of future earnings depends to a great extent to the importance with the investing public gives to those statements by issuers as to their anticipated future earnings. It is also important to question the responsibility of the issuer, having provided anticipated future earnings, to update the information in the event of a change in circumstances. If we consider that the purpose of the provisions of the law regarding disclosure of information is to ensure that the investing public and analysts have available all relevant information, we must consider the importance of the administrator’s projections.
Although Panama’s legislation does not require it, we consider that the legislation should require that where projections regarding future earnings are given, strong disclaimers should also be provided. The value of a company’s stock is clearly affected by the potential dividends which shares may earn as a result of greater income. The administrators of a company, as holders of critical company information, are best positioned to calculate such projections as well as to balance external factors on the company’s performance.
Of equal importance in disclosure are material facts or events which may occur during a given period. Section seventy-seven of the Securities Act (1999) obliges an issuer to release public notices when a material fact occurs which may significantly effect the value of a security. In section one of the Securities Act (1999) we find the following definition of “material” with respect to the requirement of disclosure of information:
“material is limited to that information which the holder, buyer or seller of a security, or the person to whom such information is directed, would give importance to at the moment of taking a decision. To determine whether future and uncertain acts are material the magnitude of such acts must be considered as well as the probability whether they will occur.”
Panama’s legislation and regulation does not provide examples of “material” facts, and since the legal system is based on Roman Law as opposed to Common Law, courts will need to consider comparative law for guidance regarding what might be considered a material fact. If we examine, for example, form 8-K in the US, we will note that a material fact includes a) change in control; b) acquisition or transfer of a significant quantity of assets; c) bankruptcy or receivership; or d) change in the financial reporting year. A change in directors or auditors is also considered to be material. Unlike the United States we do not expect Panama to build a case law which practitioners can refer to, due to the nature of our court system and the fundamental difference between a common law system and those based on Roman law. Unless cases are taken to the Supreme Court, they will not have binding authority on the lower courts. Previous cases will only be deemed persuasive authority, rather than binding. As a result, it is still unclear what specific material facts or events will need to be disclosed in Panama.
What is clear is that where information, which has been previously disclosed, ceases to be true or complete, the disclosed information must be updated immediately if circumstances change making the statements made false or misleading. Title XII of the Securities Act (1999) prohibits false or misleading declarations by issuers or offerors, as well as false or misleading declarations regarding any material matter. This results in civil liability for such false or misleading statements. Nevertheless, most of the control of disclosure is found in the regulations issued by National Securities Commission (NSC), rather than in the Securities Act (1999) itself.
Responsibility for False or Misleading Information
The Securities Act (1999) does not assign responsibility to any specific person(s) for errors or false declarations made about an offering, but does establish in sections 197 and 198 that the issuers and offerors shall not issue any false or misleading information. Section 204 attaches civil liability to any person who knowingly or negligently contravenes the above sections.
Until earlier this year, there was no criminal liability for publication of false or misleading information. Law 45 (2003) adds a new chapter to the Criminal Code, introducing previously non-existent financial crimes. Section 393-B of the Criminal Code provides that whoever destroys, occults, or falsifies accounting journals, other accounting registers, financial statements or other financial information of a natural or legal person, for the purpose of obtaining, maintaining or extending a credit or capitalisation facility from a banking entity, financial enterprise or any other enterprise which captures or brokers public financial resources or to whom these have been entrusted, which is detrimental to another person, shall be imprisoned from four to seven years. Where the person who promotes or facilitates the above described conduct is a director, manager, officer, administrator, legal representative, attorney-in-fact or employee of the natural or legal person who received the credit facility or capitalisation, the prison term increases to five to seven years. This new section of the Criminal Code now ensures that all persons responsible for preparing financial statements will have criminal liability where knowingly misleading statements are made for financial gain.
Furthermore, section 393-F of the Criminal Code provides that the director, officer, manager, administrator, legal representative, or employee of a banking entity, financial or other enterprise, which captures or brokers public financial resources, who omits or refuses to provide information or provides false information to the supervisory and oversight bodies, for the purpose of concealing a permanent situation of illiquidity or insolvency shall be sanctioned with five to seven years of imprisonment.
With this recent introduction of criminal liability, it is hoped that company officers and auditors will take their responsibilities more seriously regarding disclosure of information to the investing public and preparation of financial statements. As we will see in the next section, Panama has also introduced more stringent rules regarding which officers of a company must participate in the preparation and presentation of financial statements and the format in which they must be produced. Nevertheless, the cynics among us might still believe that “issuers who are going to commit fraud still will make fraudulent disclosures – they will simply use the approved form to do so”.
Part II. Financial Reporting
Financial reporting is an integral part of disclosure and helps investor to identify investment opportunities. The principal purpose of financial statements is to provide information regarding the financial position of the company, its operational results, cash flow, and any changes of control in the company. For disclosure to be effective, financial statements should be complete, consistent, relevant, trustworthy and comparable. The rules regarding financial statements ensure that the fundamental information regarding the company’s operations are clearly stated, as well as provided in a timely manner. Rules require quality and uniformity, so that investors can compare companies with similar operations, and so choose the more rewarding investment. Adequate financial information is essential for measuring the effectiveness of the company management, and the inherent value of a corporation.
In the same way that lawyers may argue both sides of a case, accountants are able to construct and defend different aspects of the economic situation of a company. As a result, without rules regarding the preparation of financial statements, variations may arise between one form of presentation of the financial situation of a company and another. These accounting variations thwart the objective of protecting investors through the compulsory disclosure of information in a timely manner. Accounting rules are intended to standardise practices, particularly those dealing with valuations and the frequency of reporting. It is also necessary to have rules about the reporting formats, specifying the information which must be provided, as well as the order and format it should take, thus providing uniformity in financial reporting, so that a Company’s performance is easily compared against another.
Even where accounting rule are followed, variations may still arise as accounting rules and practices vary between jurisdictions. International investors, who wish to invest in more than one market, may find reporting standards are incompatible, and that it is difficult to compare the performance of a company in one jurisdiction with a similar enterprise in another. Panama, to develop as an international financial centre for the Americas with foreign companies quoted on the stock exchange, must confront these issues of accounting systems and preparation of financial statements.
In October of 2002, the National Securities Commission (NSC) adopted Regulation 7-2002, following a year and a quarter of public debate and scrutiny of the accounting rules following several accounting fiascos locally and internationally. It is helpful to trace the origins of this regulation. In February of 2000, the NSC adopted Regulation 2-2000 which set forth the general accounting principles to be followed. This established that the Panamanian NSC would accept either the International Accounting Standards (IAS) of the International Accounting Standards Board or the Generally Accepted Accounting Principles (GAAP) in the United States of America issued by the Financial Accounting Standards Board. It also provided that in the case of foreign issuers of “acceptable jurisdictions” whose shares were traded on the Panamanian market, it would accept that the generally accepted accounting standards of that country be used.
Regulation 2-2000 was followed in May 2000, with the adoption of Regulation 6-00, which governs the disclosure of information in the prospectus, particularly the financial reports. The analysis of the financial and operational results must at least include the following areas: liquidity, capital resources, and operational results. Liquidity, in this sense, refers to any known trends or any demand, commitment or event which may result in the increased or decreased liquidity of the issuer. Where there is an important drop, the information provided in the application for registration should indicate the measures taken or to be taken by the issuer to remedy the deficiency. Internal and external liquidity factors should be address. Operation results must cover any unusual transaction or event which results in a significant economic change in the income reported by the company, and the level to which the income is affected. The financial statements as provided in the prospectus should be audited financial statements.
Regulation 8-00 of 2000, whereby rules applicable to the form and content of the financial statements and other financial information to be presented periodically to the Commission by persons registered or subject to reporting according to Law Decree 1 of 1999 are adopted, is to be applied as a supplement to Regulation 2-00. This regulation defines financial statements, audited financial statements and interim financial statements. It requires that the auditor be independent, and established the rules regarding the opinion letter provided by the company’s auditors. Regulation 8-00 is modified considerably by Regulation 7-2002. Finally Regulation 18-00, of 11 October 2000, highlights the necessity of issuers to prepare financial statements regularly, providing for annual and quarterly reports.
The need for greater clarity and rules about financial reports was highlighted by a problem in ADELAG, a local company with bonds offered on the Panamanian Stock Exchange. In February 2001, the NSC formally announced that the financial statements presented by ADELAG were unacceptable. Apparently, in the financial statement provided, ADELAG indicated that the auditors Ernst & Young had recommended that adjustments be made in the financial statements and that these had not been made. Further, in later reports, ADELAG referred to the previous financial statements prepared by Arthur Anderson, and indicated that these financials did not reflect the financial reality of the company. The financial statements, signed by a shareholder of the Company, for the period ending 30 September 2000, presented “adjustments” of 51-million US dollars. The information provided conflicted with information previously provided by the group to their Credit Committee. ADELAG eventually ended up in bankruptcy proceedings, and investors lost around 60-million US dollars. This case precipitated the need for more adequate regulation of financial statements.
The need for greater regulation was also encouraged by events in the United States of America, from which Panama had modelled its securities legislation. The international financial crisis which resulted from cases such as Enron, Worldcom and XEROX merely served as a catalyst to force Panama to stiffen the legislation concerning preparation of financial statements. The NSC established a committee in October 2001 to examine Regulation 8-00 and make recommendations regarding its possible reform. The parameters and issues to consider included: consolidation rules, disclaimers, letters of representation, and rotation of the auditors. Furthermore the same committee reviewed the need to establish corporate governance rules, although these were later addressed in a separate report and recommendations.
Regulation 7-2002 introduces the following amendments to Regulation 8-00:
The Certified Public Accountant acting as auditor will not be considered to be independent if at any time during the period in question the accountant or his firm have been: the internal auditor, the promoter, agent, or trustee of the securities; a family member of any officer, director or shareholder; a person with a financial interest of any nature in the issuer; a person having a loan from the issuer or any executive, director, or principal shareholder thereof; or where the accountant or his firm has entered into discussions or negotiations to become any of the above. The accountant will also be considered to have a conflict of interest where their remuneration is dependent upon the outcome of a transaction of the company, except where the transaction is tax-related or where the decision is dependent on the authorities and not on the accountant.
Where an issuer’s auditor or accountant has resigned or left as happened with ADELAG, it is necessary for the issuer and the outgoing auditor or accountant to provide a joint statement (or separate explanations) about the reason for the rupture. This statement must:
These rules regarding the independence of the auditor are intended to ensure the credibility of the audited financial statements, by making certain that an auditor does not have any dependence on the issuer, as well as answering any concerns about the termination of the relationship. As we mentioned before when discussing disclosure, our criminal code has now been amended to typify white collar crimes which may affect the transparency of the stock market. It is hoped that both the company’s officers as well as independent auditors will be induced by these new rules to ensure that the necessary controls are in place to prepare adequate and proper financial statements.
Before finalising our discussion of financial reporting, we would like to re-examine the problems which may arise when different accounting standards or principals of accounting are used in the preparation of financial statements. As noted above, the Securities Act (1999) provides that foreign issuers from a “recognised” jurisdiction may choose to present financial statements which are prepared in accordance with the generally accepted accounting principals of their jurisdictions. This has the potential to result in inconsistent financial statements, when compared to financial statements prepared under a different set of guidelines, such as IAS or GAAP standards. Nevertheless, we should highlight the importance of this clause for the development of Panama as an international financial centre in Latin America. With the globalisation of financial markets, regulation should take into account not only the protection of investors, but also the creation of a certain level of flexibility which may allow the creation of new financial products, encourage foreign investment and more importantly encourage foreign issuers to seek capital through the Panamanian stock exchange.
It is this last objective which has resulted in Panama’s legislation accepting the preparation of financial statements according to the rules of another state. This means that issuers will not be required to prepare financial statements in their country of origin under one set of rules and then prepare financial statements in Panama under different guidelines. This will result in less cost and difficulty for the issuer, ideally inducing them to consider offerings on the Panamanian stock exchange. However, the notes accompanying the financial statements must adequately state what differences may result from the rules used rather than IAS or GAAP standards. Irrespective of which rules are used for the preparation of the financials, the disclosure rules require that the information be provided in a certain order. Uniformity is at least achieved in this respect.
Given the diversity of the accounting standards which may be used, a broad knowledge of each jurisdiction’s rules is necessary in order to compare the results of one company against another. We can only conclude that Panama’s legislation visualises the analysis of financial statements by trained professionals rather than by the investing public directly, if these intricacies are to be fully appreciated.
Part III. Corporate Governance
One of the issues to be addressed by corporate governance rules and closely related to transparency, is that shareholders must be provided with adequate information regarding the share interests which administrators or directors have in the company. We consider that three groups of people are principally interested in the governance of a company: namely, shareholders, directors and officers of the company. In Panama, many businesses continue to be run as family enterprises. The Board of Directors is composed mainly of family members, who are also the principal shareholders. Officers of a company are often also members of the Board of Directors. A separation between control and investment has not yet occurred, and even where capital is raised through the market, there has still been a tendency to manage the corporation as a family business. This also has implications for the independence of the auditors and legal counsel of the company, who may be related or close friends of the company’s management. The separation of control and economic investment creates new problems for what have been typically family enterprises.
For foreign investors, the rules of corporate governance will be essential to ensuring the credibility of Panama’s stock market. Investor confidence can be assured where their financing is protected from abuse or improper use by the administrators, directors or majority shareholders. Disclosure rules only go so far in ensuring that investors are protected. Corporate governance rules are intended to ensure that the disclosure produces true information as well as having adequate checks and balances within the company’s management, thus protecting shareholder’s rights from mismanagement by officers and directors or through pressure exerted by a majority shareholder.
It is imperative to consider the rights of shareholders, whether minority shareholders or otherwise, against the rights of the administrators. These rights include the right to clearly identify any participation by others, the liberty to transfer interests in a company, the timely provision of material information, participation in shareholder meetings for the election of new directors, and participation in profits of the company. It is for this reason that the rules of corporate governance are closely tied with transparency and disclosure of information, since the framework of corporate governance must include the timely notification of material matters to the company to shareholders, whether the company be a private or public company.
To date, Panama has not adopted corporate governance rules. As we mentioned in the previous part of this article, the National Securities Commission (NSC) appointed a panel to review the financial disclosure rules in 2001. This panel initially was tasked at the same time with reviewing corporate governance, but published its recommendations separately from the report regarding financial reporting. We consider that this was the correct path to take, since these matters should be approached from separate angles.
If we look at the corporate law which is in place in Panama, we will see that articles twenty to thirty-nine deal with the shares and capital of the company, articles forty to forty-eight consider the rights and duties of a general shareholder assembly, while articles forty-nine to sixty-four deal with the directors of a company. However, the law only has three articles regarding the officers of a company, and yet officers play an integral role in the day-to-day management of corporations in this day and age. The Commercial Code has only one section which mentions the liability of the directors of a company to third parties, such as creditors, for ensuring that the paid in capital has actually been paid in, that dividends were declared only when appropriate, and for properly maintaining the accounts and records of the company, in accordance with the laws, articles of incorporation and bylaws of the company. No mention is made in any of these rules about the responsibilities of officers in the management of the affairs of the company, nor any fiduciary responsibility of directors as exists in common law jurisdictions. The development of adequate corporate governance rules, together with a duty of care, is essential for the international development of Panama as a financial centre. These rules should apply not only for the companies which are traded on the stock exchange, but are appropriate for all corporate enterprise.
At the same time, however, we must consider that the adoption of corporate governance rules requires a cultural change, and not simply a check list of to-do items. This means that function and effectiveness take precedence over simple form. The independence of directors should not mean simply that an outsider is appointed to the board of directors, especially if that person does not have applicable knowledge of the company’s business sector. The corporate culture of the country needs to change, to avoid systemic problems of interlocking directorships and private interests taking preference over the shareholder’s and company’s long term interest.
The draft regulations for corporate governance adopted by the NSC are based in a large part on the Organisation for Economic Co-operation and Development’s (OECD) Principles of Corporate Governance. These principles are summarised in five areas: I) the rights of shareholders; II) the equitable treatment of shareholders; III) the role of stakeholders; IV) disclosure and transparency; and V) the responsibilities of the board. It is noticeable that even these principles do not address the concerns mentioned above regarding the responsibility of officers in the day-today management of a company. The draft regulations also took into account the recommendations and conclusions prepared by the Center for International Private Enterprise, issued in the document “Instituting Corporate Governance in Developing, Emerging and Transitional Economies”.
According to the draft regulation, corporate governance is the distribution of rights and responsibilities among the various participants of a corporate entity, such as the board of directors, shareholders, among others. It is the set of norms which define the rules and procedures to be observed in making decisions in corporate affairs, which provides a structure under which the company’s objectives may be established, as well as the mechanisms to reach the established objectives and the correct supervision of the fulfilment of these objectives.
An independent director is defined in the draft regulation in a negative manner, as the definition states that for the purposes of this regulation, a person shall not be considered to be an independent director if:
The definitions also define a principal executive, as a person who has primary responsibility in the business, administration, operations, accounting, finance or the accountability of the operations or the employees. The introduction of this definition is important, as it expands the responsibility from simply the directors of the company to include also officers or other executives which are involved in the day-to-day management of the company. Other interesting concepts defined in this section of the regulations are “information policies”, “rules of ethics”, and “control mechanisms”.
Unlike the Securities Act (1999), these draft regulations actually set out the objectives for which they are being adopted. Although the Presidential Committee which adopted the Securities Act (1999) had among its objectives the protection of national and international investors against damaging and misleading practices, the Act itself does not provide any principles upon which it is based. On the other hand, the draft regulations which we have obtained from the NSC state that their principal objective is to recommend to issuers that they incorporate into their organisation principles which are consistent with good corporate governance, such as:
Measures which procure the equilibrium, transparency and proper representation of all shareholders in the direction, control and management of the corporation, as well as the disclosure of important information to all groups of shareholders;
Clear assignment of responsibility, under the principal of autonomy, for the purpose of achieving efficiency, flexibility, responsibility, credibility and transparency in companies;
Establishment of basic structures of efficient governance, which is apt to confront the inherent risks of divergence of interest between the property and control of the administration which affects shareholders, directors, officers, and the investing public;
The responsibilities and procedures which should be fulfilled by the various bodies of the company to ensure transparency in decision making and company strategies, as well as disclosure of information; and
Establishment of internal controls.
Much like the principles of the OECD, the principles highlighted in these rules outline the rights of shareholders, whether to participate in decision making or to be properly informed on decisions concerning fundamental corporate affairs. This ensures the equitable treatment of shareholders, as well as the right to effective redress in the event of violation of their rights.
These rules proposed by the NSC will require that every public company disclose in their initial public offering, as well as in their periodic reports, the extent to which corporate governance rules and principles have been adopted and implemented by their management.
The second heading of the proposal addresses directors and shareholders, while heading three addresses support committees, such as audit committees or compliance and risk management committees. We feel it is appropriate to study some parts of these draft regulations to provide an outline of what the corporate governance rules would cover for Panama’s public companies. The draft establishes fourteen parameters which the NSC considers a good corporate governance system should contain. These include: the establishment of precise criteria of independence for directors, based on detachment from management and controlling shareholders; formulation of rules which ensure that control is not held by a small group of employees or directors; the real and effective creation of commissions, which undertake their responsibilities on a permanent basis and report to the Board of Directors; the adoption of procedures and measures which are necessary for the provision of reliable, transparent and timely information to all interest parties in the company (whether they be shareholders, suppliers, employees, clients or regulators); and the recognition of the right of every officer and director to investigate and obtain any information and advice necessary to fulfil their supervisory responsibilities. The parameters also include the need for procedures which permit the rapid, precise and reliable disclosure of information, and the essential nature of a business plan which addresses the inherent corporate risks which a company may have.
Among the responsibilities which the board of directors would have are:
These rules encompass more than those outlined in the OECD Principles on Corporate Governance. According to this draft, the majority of the directors should be individuals who do not participate in the daily administration of the company and whose participation does not present any material ethical conflicts or conflicts of interest. This is meant to ensure that the board is able to exercise objective judgement on corporate affairs, independently from management. Therefore, the general manager, operations manager and chief financial officer would form a minority on the board of directors and none of these individuals should, in any case, act as chairperson of the board. Accordingly, the NSC recommends that for every five members of a board of directors, at least one of these should be independent, as defined previously.
With respect to the shareholders, the proposed rules guarantee the free and equitable exercise of the shareholder rights, through:
Perhaps the greatest development introduced by the corporate governance rules proposed by the NSC is the principles introduced regarding support committees. These are the committees which are designed to provide support and information to the board of directors in the exercise of corporate governance. Where a board of directors has more than five members, the NSC also suggests the appointment of a committee for the evaluation and postulation of independent directors and key executives. Otherwise, the support committees would simply consist of an audit committee and a compliance and risk management committee.
According to the draft regulations, an audit committee would be established for the purpose of evaluating the accounting verification system of the company. This committee would have at least two board of director’s members who do not participate in the daily management of the company, and at least one of these members must be “independent” as previously defined. An obvious member of this committee would also be the company’s treasurer or chief financial officer, who would chair this committee. The audit committee would need to have its own guidelines or bylaws, establishing the procedures for fulfilling the commissions responsibilities. Among the attributions and responsibilities of this committee we find that it should be:
This committee would also be responsible for reviewing the annual and interim financial statements of the company, before their publication or release, as well as the important press releases associated with financial results. It would review the information to be provided to the shareholders, regulatory authorities and investing public, to ensure that the information is transparent, reliable and timely.
In addition to the Audit Committee, the NSC recommends that all companies have a Compliance and Risk Management Committee, which would be responsible for identifying the corporate risks and establish policies and procedures for managing these risks. This committee would report any irregularities found in the operation of the company as well as in its development in the market place, as and when events occur. This committee would need to adopt its own bylaws regarding the format in which meetings are to be held, and the mechanisms which it will use for its role in supervision of corporate governance in the company.
A noticeable effect of these draft provisions introducing corporate governance into Panamanian corporate law is the concept of accountability and checks and balances in companies. If investors consider that they should avoid jurisdictions that do not have strong rules regarding corporate governance, Panama has taken a step towards acceptance in this area. Capital flows into Panama may increase as a result of the improvements which these regulations introduce. Accountability in companies has been sorely lacking in Panamanian legislation, particularly with respect to oversight of the information which is produced for presentation to the public or shareholders. Although the adoption and implementation of these corporate governance measures is strictly voluntary, many companies will introduce such measures in an effort to improve their credit ratings. Although this may not ensure a stable relationship between transparent board practices and good returns for investors, it will be the first step towards changing customary practices in corporate circles.
For Panama to upgrade from a simple banking centre to a financial centre, it must attract foreign investment, by protecting investors with protections equal or better than those offered in their jurisdiction. Foreign investment is fostered where investors have a better return on capital, as investors migrate to those jurisdictions which offer greater returns while not substantially increasing the risk factor. Investors will always seek efficiency in the market, with little concern for the actual geographical or physical location of their funds. This means that they search for markets where securities are listed at their true value. The success of a financial market in attracting foreign investment will depend on its sophistication, transparency and technology. This requires the same level of regulation that is offered internationally, and adequate enforcement of those rules.
We have briefly outlined in this article how Panama’s securities legislation and regulations are developing to integrate the international concerns regarding financial reporting and corporate governance into its regulatory structure. With respect to disclosure and transparency, we have provided a basic outline of what an issuer must provide at the time of registration of securities, as well as what should be provided periodically or upon the occurrence of a material fact. Nevertheless, investors will no doubt be concerned about the lack of case law development which they are accustomed to in common law systems. In Panama, this void will need to be filled by the NSC, through the adoption of adequate regulation and guidelines. To date, the NSC has shown itself to be proactive and responsive to these needs.
While common law systems have a well-developed area of corporate law, with the underlying philosophies of fiduciary duty, good faith and loyalty, these concepts are alien to Panama’s legal system. Absent actual bad faith or damages to creditors, directors may be exculpated for failures to adhere to their standard of duty of care when it affects the investing public. As part of the change in corproate governance and financial reporting, cultural changes will be necessary with respect to the indepdence of participants in traditional family enterprises.
Although the NSC has some teeth to enforce its regulations, particularly with respect to violations for financial reporting, we consider that the introduction of criminal responsibility will have a greater impact on the officers, directors and auditors who prepare financial statements than the rules of corporate governance or independence may have. Furthermore, the requirement that President, Treasurer, General Manager and CFO or controller of the company certify to the NSC and the investing public that the financial statements do not include any false statements or information regarding material facts, nor do they omit any information regarding material facts is of considerable importance. As these officers are now required to certify that they have internal controls in place which are designed to guarantee the reliability of the information and that these controls have been reviewed within the 90 days preceding the publication of the financial statements, we consider that the corporate governance rules regarding audit committees and risk management may be effective in resulting in more transparent financial statements. Where in the ADELAG case a shareholder signed off on the financial statements, the new rules introduced by the NSC will ensure that various members of a company’s management team are held accountable for the information provided to the public.
Nevertheless, these are but small steps along the road to becoming a financial centre for the Americas. As we have shown briefly, Panama’s Securities Act (1999) was drafted to take into account the international nature of the securities market. It provides for international issuers to offer securities from Panama, while being businesses set up in Panama. With the financial reporting requirements adopted, they may prepare their financial statements in accordance with the generally accepted accounting principles of their jurisdiction, as long as these are presented in the format and order required for uniformity in the reports.
Panama has many issues to confront which affect capital flows from and to other Latin American countries. Panama is currently black-listed by various countries as a “tax haven”, resulting in withholdings being made on any funds being sent to Panama from those countries. This reduces the amount of investment that Panama is able to capture from those Latin American countries, and will inhibit its ability to become a financial centre for the Americas until this matter is addressed. Nevertheless, factors which make Panama attractive to foreign investors include the absence of any currency restrictions, the free circulation of the US dollar as a legal tender, the free international movement of capital (from Panama), and the lack of a central bank in charge of currency issuance. Panama has an advantage over other countries in Latin America, as it does not suffer from high inflation making it an attractive place for residence.
Technologically, it is possible to have Central and South American countries connected through the digital stock exchange, in which securities from the various countries can be listed, bought and sold throughout the region. Distance is no longer the problem that it posed previously. It would be appropriate to conclude by stating that the financial centre is still evolving.
Nevertheless, unlike London, Tokyo or New York, Panama does not yet offer a deep and liquid market. The development of a liquid market requires “market makers”, which Panama has not attracted so far. The development of Latin Clear as an international clearing and custodial facility for Latin America seems still to be many years away.
While Panama may be in the process of adopting the laws which are necessary to promote a modern infrastructures, through electronic trading, with a central international custody of shares and with international standards, nevertheless, if Panama fails to attract the capital investment which it requires to develop, the laws which it has adopted will be for nought. The development of the financial centre requires substantial investment by venture capitalist and institutional investors, before a investors will have the security of a liquid market.
Prepared November 2003, Beth Anne Gray J.
Last modified 08-May-2009 12:09 -0400
 Castillero Calvo, Alfredo Economía Terciaria y Sociedad: Panamá Siglos XVI y XVII [Impresora de la Nación: Panama, 1979], p. 9.
 Castillero Calvo, Alfredo Economía Terciaria y Sociedad: Panamá Siglos XVI y XVII [Impresora de la Nación: Panama, 1979], p.11.
 Zunzunegui, Fernando Derecho del Mercado Financiero [Marical Pons, Ediciones Jurídicas y Sociales, S.A.: Madrid, Spain, 1997], p. 35.
 Código de Comercio, 7th Ed. [Editorial Mizrachi & Pujol, S.A.: Panama, 1999].
 Brown Villalobos, Irlena La Bolsa de Valores en Panamá [University of Panama: Faculty of Law and Political Science: Panama, 1983], p. 19.
 The lack of a prominent manufacturing and agricultural base is noticable, for example, in the area of patent law, where a dearth of scientific and industrial patents exist.
 Law Decree 1, 8 July 1999 (Decreto Ley 1 de 8 de julio de 1999). “Whereby the National Securities Commission is created and the securities market is regulated in the Republic of Panama”
 Among other things.
 Hines, R. “Are Annual Reports Used by Shareholders?” The Chartered Accountant in Australia (March 1981), pp. 48-52.
 McKenzie, Robert “Jumping the Gun: an Examination of the Law Relating to Pre-Prospectus Advertising of Securities Issues in Australia” (Working Paper) http://www.murdoch.edu.au/elaw/issues/v1n1/mckenzie.html, p. 4.
 Regulation 6-00, of 19 May 2000.
 Section 9 (IV)(D.)
 Being silent on this matter.
 Section seventy-seven, in subsection two, provides, however, that the information may be withheld, where it is considered that the disclosure would materially affect the interests of the issuer and that the persons who have access to the information which is not publicly available have not and will not trade the shares which they have. This means that the issuer will not be required to disclose where it deems that the information will not be used by insiders with access to delicate information.
 Section ninety of the Securities Act (1999).
 Law 45 of 4 June 4 2003 “Whereby Chapter VII, denominated “Financial Crimes” is added to Title XII
of the Second Book of the Criminal Code, sections of the Criminal and Judicial Codes and Law Decree 1 of 1999 are modified and other provisions are adopted”
 Bainbridge, Stephen M. “A Behavioural Economic Analysis of Mandatory Disclosure: a Thought Experiment Turned Cautionary Tale” http://papers2.ssrn.com/paper.taf?abstract_id=204110.
 Regulation No. 7-2002 of 15 October 2002, “Which modifies Regulation 8-2000 of 22 May 2000, whereby rules applicable to the form and content of the Financial Statements and other financial information which should be presented periodically to the Commission by registered persons or subjected which report according to Law Decree 1 of 1999 are adopted”.
 Regulation No. 2-2000 of 28 February 2000.
 This mirrors closely Item 303 under Regulation S-K (Securities Act Release 33-6332 (1982)) of the United States of America.
 Adopted 22 May 2000.
 Castillero Duarte, Edith “CNV exige informe a ADELAG” La Prensa – Negocios (13/02/2001).
 Law 32 of 26 February 1927, “Corporations”.
 Código de Comercio, 7th Ed. [Editorial Mizrachi & Pujol, S.A.: Panama, 1999].
 Poschmann, Finn “Good (for nothing) corporate governance: Independent boards have not delivered better returns for investors” (20 November 2003) National Post (http://www.nationalpost.com/)
 Prepared by the Directorate for Financial, Fiscal and Enterprise Affairs – Ad Hoc Task Force on Corporate Governance (1999).
 Published March 2002.
 Article 2 “Definitions”.
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