Contact Bates Today

Bates Group is with you every step of the way. Contact us today for more information on how our End-to-End Solutions can help your firm.

Get My Solution Started

Bates Group Logo

We’re looking for talent! Interested in a career at Bates Group? Visit our Careers page.

Bates Research  |  07-17-15

Spotlight on Brazil

Interview with Esdras Vera, Bates Compliance Solutions Global Practice Leader.

 

Alex Russell: Last week, we blogged about the current situation in China's equity markets and about the ongoing negotiations in Greece, but we haven't really talked about Brazil.

Esdras Vera: Since the latter part of last year, some economists continue to have doubts on Brazil’s economic growth forecast.  Although President Dilma Rousseff ran her campaign on a platform of economic improvement, the truth is that the Latin American powerhouse has had little to no growth at all.  Inflation is over 8%, the unemployment rate is at a 5-year high at almost 7% and the economy is contracting. The BRICS meeting just took place in Russia. Each country is dealing with their own issues right now, and Brazil is no exception, particularly in the political front.

AR: How is Brazil weathering these economic conditions relative to other countries?

EV: The BRICs concept it still in its adolescent stage, so it’s hard to say how they will work together in the long term to get a bigger voice at the global policy table. Opinions vary widely as to when or even if they will become a truly unified economic and political force.

There is no lack of volatility in Brazil; it just seems a bit calmer now following the massive spike in volatility after President Rousseff’s election last year. EWA (Brazilian ETF) volatility spiked above 70 at that time. Currently, Brazil is not facing the same market volatility that some of the other BRIC countries are, and this is in part due to Brazil’s large and well-diversified private sector and other institutions that can withstand some of the pressure other BRICs cannot. Unlike Russia, for example, Brazil is not subject to international sanctions, nor is it strictly dependent on energy exports like oil and gas.

In 2010, The Bovespa Index was at a high of 73000.  So far in 2015, the Bovespa has seen a high near 58000, but currently sits at 53000.  It started the year near 50000, and the uptick from March through the beginning of May 2015 was surprising given the general economic downturn.  News regarding the corruption scandal at Petrobras has not helped either.

AR: Let's dive into that. What is currently happening with Petrobras?

EV: Brazil began investigating Petrobras back in March of 2014, and this week investigators with Brazil's Finance Ministry announced that they had identified nearly $17 billion in suspicious activity. The scandal is very political as it involves bribes and kickbacks being paid to many highly-connected government officials and other company CEOs.

Reports have also surfaced of the oil giant’s executives manipulating the value of public contracts.  The excess money from the values ended up in the pockets of corrupt executives and construction companies contracted to do work for Petrobras, robbing billions of dollars from taxpayers.  One of Brazil’s richest men, Marcelo Odebrecht, was just arrested in June.

To make things worse, Petrobras has taken additional hits from the crash in oil prices last year.  Moody’s has downgraded the firm within two steps of junk -- S&P and Fitch have rated the company at the lowest possible investment grade.  Price of Petrobras stock has decreased over 40% year-to-date.

Amazingly though, Petrobras went to the international debt markets with a $2.5 billion offer and was met with a surprising demand with order in excess of $13 Billion.

AR: They're being pressed in the United States as well, aren't they?

EV: At the end of 2014, Petrobras ADR owners here in the US filed a class action suit in the Southern District of New York. Although some issues related to debt issuance in 2012 were dismissed, Petrobras' motion to dismiss was not granted this week, so the case is still very much alive. They are claiming that bid-rigging, money laundering and bribery caused $98 billion in securities it sold in the US to be overvalued, and that the company filed false and misleading financial statements (and offering documents) during the class period. The SEC and DOJ have also been investigating since late 2014.

It will be interesting to see how this all plays out. Russia’s appropriation of assets from Yukos in 2002 also caused similar investor lawsuits. The hard part will be getting the judgment enforced.

AR: What do these allegations mean for anyone looking to do business in or with a Brazilian company?

EV: Well, that depends on the industry.  Certain activities in the infrastructure or other government-controlled areas may be prone to corruption.  There are usually multiple layers of individuals, brokers or agents that add complexity to the system, which tends to deflect attention away from corrupt government officials searching for some kind of payoff.  Due diligence is critical and approaching any relationship with a Brazilian firm should be done with a measured system of checks and balances, as in other emerging markets.

Brazil made a major shift after President Cardoso’s term ended in 2003. The people elected President Lula da Silva and with him the Workers’ Party. Lula privatized state companies, broke monopolies and, among other things, instituted the Lei de Responsabilidade Fiscal (Fiscal Responsbility Law).   In 2008, the Workers’ Party massively increased public expenditure, directed credit and has demonstrated a tolerance for high inflation. Typically, governments do not spend well, and Brazil is no exception. Its Central Bank is not independent, which inevitably means that it is used for long-term sustainability of the party and not necessarily operated in the best interest of the country. So, how they issue debt is tied to the inflation index.

AR: Should we take it as an encouraging sign that the Petrobras scandal was uncovered domestically by Brazil first, as part of Operation Car Wash? It seems like an encouraging sign that there is political will for this kind of behavior to be stopped.

EV: When Operation Car Wash first came to light in May 2014, it caused Petrobras to delay its financials, forcing them to explain why in local newspaper ads.  Not only did it implicate a former high-ranking executive, but it attempted to create a possible link to Presidents da Silva and Rousseff as well.   It is an encouraging sign that effort is being made, but there is still much more work to do.  The question in this case is does Brazil have the resources to carry this investigation fully and as far back as it needs to?  How deep is Brazil willing to dig to analyze the root causes?

Compliance culture must start at the top with politicians and government officials creating an atmosphere that sets a certain tone.  Cross-border compliance has an effect not just on that country’s financial outlook, but it has the potential of benefitting stakeholders at all levels. 

AR: From a compliance perspective, what went wrong? Is it a cultural issue, an oversight issue, an enforcement issue? What happened here?

EV: In this case, there are so many individuals, firms and insiders involved, and the oversight was overlooked at all levels. The Corruptions Perceptions Index from Transparency International’s 2010 Annual Report gives transparency scores to 178 countries.  The scores, on a scale of 10 - 0, are a measure of the degree to which public sector corruption is perceived, where 10 is very free of corruption and 0 is highly corrupt.  Brazil scored 3.7, which ranked it at 69 of 178 countries.  (The U.S scored 7.1, Sweden 9.2, and India 3.3).  As I said, compliance starts at the top, and adherence to the FCPA and the UK Bribery Act is a first step for Brazil and other countries in the region.  In 2008, the Securities and Exchange Commission and Brazil’s CVM signed an MOU for joint cooperation between the two regulatory bodies, but it takes a stronger resolution internally to mitigate these risks and find a clear path to corporate compliance.

AR: What can firms operating in Brazil do to keep themselves out of situations like this?

EV: Due diligence is critically important. Even better is to involve local respected firms that can do the appropriate background and due diligence on who you are doing business with.  Prior hands-on experience in a country is invaluable. The learning curve in a country like Brazil is far too steep for a company with a good product or service to sell to understand how to comply with tax, regulatory and local legal compliance procedures. Never mind doing it in Portuguese on top of all that!! Complexities in procedures, tax, etc. can be manipulated by local bad actors.

Partnering with experts who have boots on the ground with tax, legal and compliance experience is a must to succeed in Brazil.

AR: Thanks for walking us through this, any concluding thoughts?

EV: Regardless of all the attempts to curtail corruption, it will continue to exist at different levels.  It is critical that, as firms do business across borders, they realize exactly how much they stand to lose if they do not have a robust internal compliance culture. When contemplating doing any part of your business in emerging markets, be sure that the firm you partner with truly has local experience and expertise -- it will be absolutely critical. Your story can then be a tale of success instead of a lesson in failure.