Decline and Fall of the Rio de Janeiro Exchange : Prior to 1971, the Rio de Janeiro Stock Exchange still had a chance of keeping its crown as the leading Brazilian stock exchange.

Generally, a stock exchange that has the largest trading volume can maintain its leadership position indefinitely, unless it fails to keep up with the needs of the market.

Prior to 1964, all Brazilian stock exchanges were controlled by a small number of official brokers who had passed on exclusive privileges from father to son since the days of the Empire.

However, the Revolution of 1964 broke this oligarchy and introduced reforms to the securities markets.

Immediately after the Revolution of 1964, the Rio de Janeiro Stock Exchange had the following advantages:

• The most powerful economic leaders in government, Octávio Gouvêia de Bulhões, Dênio Nogueira, and José Garrido Torres, were from the Fundação Getúlio Vargas and had a natural bias towards maintaining the position of the Rio de Janeiro market.
• The Minister of Finance had asked the Rio Exchange to contract a modernization plan so that it could maintain its position of leadership. A workable plan was submitted that might have accomplished this, incorporating concepts in 1965 that would still be considered modern in 1995, such as book entry settlement at a central depository and computerized order matching.
• Although most issuers were headquartered in other states, many early promoters of capital market development were located in Rio de Janeiro.
• The new government bond market came to life in Rio de Janeiro, where the most sophisticated trading techniques and technical support developed.

The challenges that the Rio Exchange faced were as follows:

• Following the completion of Brasilia, the capital of the country was scheduled to be moved from Rio to the new Federal District, 900 kilometers inland. Until the early 1970s, most ministries still operated from Rio offices, but change was inevitable.
The removal of the seat of government to Brasilia was a blow from which Rio de Janeiro never recovered.
• The new Capital Market Law licensed 'bancos de investimentos' which were really finance companies authorized to perform investment banking functions. Because of the high capital requirements set for investment banks, most stock brokers were not able to set up these institutions that were at the apex of the government's concept of the institutional hierarchy in the market. The new 'investment banks' were usually owned by commercial banks, often with large branch networks.
• Decree-Law 157 established special mutual funds funded by tax dollars. When a taxpayer checked off the option to invest in such funds on his tax return, it was necessary to indicate a specific fund. The large commercial banks had set up 'investment banks' that managed 157 funds and easily persuaded bank depositors to choose funds associated with commerical banks where the maintained their checking accounts.
• As a result, most 157 money ended up in the hands of commercial bankers, who then, using their licenses to do underwritings, easily dominated the underwriting market by subscribing to new issues with money accumulated in the 157 funds. This put unaffiliated broker-dealers at a tremendous disadvantage in competing for underwriting business.
• Because the largest commercial banks were located in São Paulo, the Paulista capital gained a competitive advantage over Rio de Janeiro, with respect to underwriting activity. Not only dominating the underwriting market, São Paulo banks could also channel trades for their 157 funds to the São Paulo Stock Exchange through their brokerage subsidiaries.

Nevertheless, the Rio Exchange still had a chance in 1965 if they could modernize fast enough and use their position to continue to dominate the secondary market. The modernization plan of 1965 called upon brokers to work together and set up centralized back-office and communications facilities that would allow them to compete effectively with the largest banks.

As it turned out, the São Paulo Exchange was slow to modernize, giving the Rio Exchange time to consolidate its position as leader in trading volume.

If the Rio brokers had acted while Octávio Bulhões, Dénio Nogueira, and Garrido Torres were still in power, it is probable that the Rio Exchange could have obtained financing for modernization from the National Economic Development Bank.

Unfortunately for the future of the Rio Exchange, its management was not up to the task and by 1967, when Delfim Netto became minister of finance, the São Paulo banking interests held the winning cards.

• The President of the Rio Exchange who received the 1965 modernization plan, Ney Souza Ribeiro de Carvalho, was a affable man who lacked the management skills and vision needed to undertake a major reform of the system.
• Even with new brokers joining the Exchange as the result of capital market reforms, the old official brokers still controlled a voting block that could oppose modernization. Some official brokers bragged of never having visited the trading floor. Most had small offices with less than a dozen employees. Many were resentful of market reforms that had removed their privileges and some even hoped that the monopoly might be restored, as it had after the "encilhamento" at the end of the 19th century.
• M. Marcello Leite Barbosa became president of the Rio Exchange after Ney Carvalho and aggressively fought the entrance of new members under the reform law. Instead of welcoming new ideas and progress, he opposed new members who brought valuable skills, know-how, and capital.
• In this, he went to extremes.

In the case of S-N Investimentos, a new broker under the reform law and closely associated with the modernization plan, M. Marcello Leite Barbosa invited the entire sales force of this company to a party at his home and informed them that S-N Investimentos would never be allowed to become a member of the exchange.

He then offered the salesmen double what they were earning at S-N Investimentos and promised each a private office and secretary if they joined his firm. He was successful in hiring away the new company's sales force. S-N Investimentos was forced to recruit and train a new salesforce.

It took direct intervention from the Minister of Finance Bulhões to stop Marcelo Leite's schemes.

• When in the early 1970s, the Rio Exchange finally got around to considering modernization, progress was impeded by fighting among factions that, it was said at the time, were seeking kickbacks from vendors of competing systems.

In any event, in 1972 São Paulo became the first Brazilian exchange to install electronic systems.

The decade-long decline in stock prices following the boom of 1971 was a set-back for Rio brokers who were dependent upon individual investors and who were not associated with the new 'investment banks'.

In 1990, following the example of Taiwan, Bangkok, and other emerging markets, the São Paulo Bolsa installed the CATS electronic trading system donated by the Toronto Stock Exchange.

By the last decade of the century, the Rio Exchange had fallen so far behind São Paulo that recovery was no longer possible.

Having failed to modernize and establish sound back office procedures, the Rio Exchange became increasingly vulnerable to a failure of its clearing house as the market expanded with the entry of foreign investors.

By the 1980s, the São Paulo Exchange dominated the Brazilian market.

In 1989, a wealthly speculator, Naji Nahas, presented a bad check for over $10 million in settlement of a trade on the Rio Exchange. Due to sloppy internal controls and lack of credit discipline, the Rio de Janeiro clearing house failed, with repercussions that wiped out the capital of member firms.

Descendants of some of the same official brokers who had refused to modernize in 1965, were caught up in the criminal proceedings that followed.

The political and financial scandal was of such magnitude the Rio de Janeiro Stock Exchange never recovered and was forced to close its doors, merging its meager assets with the now dominant São Paulo Exchange.

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