Funds and financial institutions: a matter of identity
Natasha do Lago , Eduardo Salomão Neto

I am Justinian, and Caesar was then;
that, by the will of the God I cherish,
removed the superfluous from  the law, and the vain.
(Divine Comedy, Paradise, Canto VI)


The separation between financial and capital markets has always been clear. In the first, financial institutions operate by collecting funds to discretionally transfer them, or by using their network to trade fixed income securities. In the capital market, on the other hand, securities are traded.

These markets are not watertight, as banks, particularly investment banks, participate actively in the capital markets. And capital market institutions, such as brokers and dealerships, may be subject to regulation by the Brazilian Central Bank.

The difference was, however, disregarded by a 2019 decision of the Superior Court of Justice which held that investment funds operate in the capital market section of financial market, including raising and keeping in custody  popular savings, by subscribing securities. Therefore, investment funds conform to the legal definition of a financial institution, even being managed by one.

In the judgment, it was discussed whether a fund for investment in credit rights (FIDC) could receive and keep financial (higher) interest on credits that left the financial system upon their acquisition by the fund. The decision, well intentioned, tried to preserve the agreement between the parties and avoid the debtor’s unjust enrichment, which would occur if interest rates were reduced by a random event such as the change of the creditor.

But the grounds for the decision are unnecessary and incorrect.

They are unnecessary because the principles of respect for contracts and the prohibition of unjust enrichment, reinforced by the recent Law on Economic Freedom, would be enough to maintain the interest rates. Strictly speaking, it is also inaccurate to sustain the existence of “interest” after the acquisition of credits by a specialized fund: the entity acquires an asset, and obtains capital gain in its realization by achieving a higher value than that of acquisition. In the fund’s activity, no monies are “placed with a debtor in exchange for creditor rights”, which is a typical feature of the concept of credit.

The decision is furthermore incorrect, because the financial institution and its private activity are dealt with in the Banking Reform Act of 1964. Such law had imprecise and expansive language, typical of the 1964 military movement and its impetus for legislative reorganization. It defined the activity of a financial institution as involving the collection, intermediation or application of financial resources owned by the financial institution itself or by third parties.

But this rule was too wide. If literally construed, most if not all individuals or legal entities woud be considered financial institutions.  This is so because everybody (or almost everybody) invests resources in financial products, or eventually borrows money. That is the reason why the jurisprudence eventually determined that the collection and application of resources should take the form of a  loan and be cumulative, performed repeatedly and  with intention of profit.

What jurisprudence does jurisprudence changes, one could argue to uphold the decision of the Superior Court. But not here, because the decision has the deleterious effect of causing the broadening of the incidence of criminal law.Brazilian Financial White Collar Crimes Law reproduces the broad definition of a financial institution in the Banking Reform Law of 1964, adding to the definition institutions responsible for the custody, issuance, distribution, negotiation, intermediation or administration of securities.

Such latter law punishes, for example, the crime of reckless management of a financial institution. If the new definition of the Superior Court prevails, this could lead to the prosecution of fund managers and administrators whose very reason of existence is to place monies in risky investment, aiming at greater profits at the expense of greater losses, with the full knowledge of investors. Examples of which are the multimarket investment funds and the certain credit rights funds, defined by their high degree of risk.

The flaw in this rationale is that funds, unlike financial institutions, are not subject to a minimum safety parameter for their investments. Unlike financial institutions, they owe nothing to third parties, and their investors share a common equity, which is invested according to what the shareholders determine in the fund regulation.

Decisions like the one mentioned above blur this reality and, if applied broadly, may create criminal liability without justifiable cause. This leads to the violation of individual rights and guarantees enshrined in Braziliam Federal Constitution, such as the right to freedom, both personal and of work.

Just as Justinian, the Byzantine emperor and legislator of the 5th century, was able to ascend to paradise by making precise rules to the necessary extent, we can descend into hell for complicating them without reason. Our hope is that this article will help in the right direction, as Dante Alighieri will not be around to bring us back to Paradise.