Welcome to Brazil. The weather’s beautiful.
People are friendly. Business is corrupt.
Corrupt?
Sure. At least, that’s the gist of ongoing media coverage out of the South American nation: bribery, kickbacks, and price-fixing among the country’s corporations, governments, and political parties.
But that’s not the full story. In fact, many say it’s far from accurate.
Yes, Brazil has uncovered corruption involving large state-run businesses and high-ranking politicians. But legal experts say the country is poised to tackle corruption with sharp new legislation and detailed regulations.
And they’re not just for locals. The anticorruption measures apply to any and all businesses in the country, including Canadian organizations with Brazilian operations.
Corruption scrub
Operation Car Wash: That’s where this situation begins. It has little to do with tri-colour detergent and a spot-free rinse. It’s an investigation by a Brazilian police agency into corruption — a case of fraud that led all the way into the executive offices of Petrobras, Brazil’s country-owned oil company and one of the nation’s largest enterprises.
Police kicked off Car Wash in 2014, chasing a crime ring that used a currency exchange service at a gas station to launder money. Agents soon linked the criminals to a former Petrobras director. Then police discovered that a number of companies that had won construction contracts for a Petrobras oil refinery had bribed Petrobras officials. As the situation unfolded, officers investigated nine construction firms, arrested 57 people — including federal politicians accused of taking money and facilitating the fraud — and charged 46. An estimated R$2.1 billion had allegedly been misappropriated.
The fallout has been wide. Last April, Petrobras said the value of its assets was some R$17 billion lower than stated due to graft. This, at a time of sinking oil prices, set the firm back a step or four. By January 2016, the company had slashed its growth projections, greatly contributing to the trend of rising unemployment and economic recession underway across Brazil.
That’s bad. What’s worse: Petrobras isn’t the country’s only large-scale scandal. Another involves kickbacks at Eletrobras, Brazil’s largest power utility. Yet another has to do with allegations that companies involved in a passenger rail project in São Paulo colluded to fix prices.
It’s easy to see how some might think Brazil is rife with corruption, a country in which business and bribery walk hand in hand. Others go even further in their criticism. The New York Times said in a story last year that corruption in Brazil was fuelling a serious national “identity crisis . . . Much of Brazil’s recently acquired cachet looks as if it was the product of fraud.” The political system is unstable, the economy is in recession, and unemployment is rising, all thanks in part to corruption, the paper said.
But not everyone agrees that Brazil is in an especially precarious collective state of mind. And people who know the situation in the country say the idea that Brazil’s business culture is inherently corrupt is ridiculous. “It’s more nuanced than that,” says Milos Barutciski, Toronto-based international trade and investment lawyer at Bennett Jones LLP. Corruption is a problem, he says, but it isn’t endemic.
Growing pains
Bear in mind that Brazil has evolved substantially since 1985, when it began to transition away from rule under the authoritarian military junta and started down the path toward democracy, support for civil rights, and economic freedom. Since then, the country has developed more sophisticated and effective business and legal frameworks.
But progress can be messy. “As in many emerging economies, large fortunes were made very quickly, relationships were established that spilled over into areas they maybe shouldn’t have, and certain things went off the rails,” says Barutciski.
Corruption in the oil and gas sector was peculiar. “What happened at Petrobras was a perfect storm. You had a combination of three red flags.”
The first concern is the resource sector itself. It’s inherently risky, Barutciski says. Organizations make sizable upfront capital investments long before they see a penny of cash flow. “Large pools of money — we’re talking billions here in most instances —
attract bad people like honey attracts flies.”
The second potential problem: the public-private interface. “You have a state enterprise that is controlling the oil and gas sector,” Barutciski says. “It’s a meeting of worlds that don’t necessarily mix well.” Success in the public sector is measured according to contributions to the public good. Success in the private sector has more to do with profits. Meeting both goals can be complicated.
“This problem isn’t unique to Brazil; look at Canada,” Barutciski says. “Remember eHealth Ontario?” The provincial agency came under fire after an investigation revealed that it had improperly approved nearly $5 billion in contracts. “How about construction in Quebec?” The Charbonneau Commission’s investigation into Quebec’s construction industry and its relationship with the province uncovered widespread corruption.
And the third red flag: As in many emerging economies, Brazil’s rule of law is a work in progress.
Successive governments have yet to fill gaps in the legal and political framework.
Like Barutciski, Glenn Faass acknowledges the fact that Brazil’s corruption problem is big international business news. “But you never know whether something’s more prevalent or whether it’s being policed better,” says the Rio de Janeiro-based senior partner and co-head of corporate merger and acquisition and securities, Latin America at Norton Rose Fulbright LLP. “Sometimes, more news coverage is evidence of better policing and improving transparency because cases are brought to light.”
Faass doesn’t buy the idea that Brazil is experiencing an identity crisis linked to corruption. From his perspective, the country knows what it has going for it in the long term: abundant natural resources, political stability, an educated population, a growing middle class, and an expanding domestic market.
Brazil also recognizes its current challenges: historically low commodity prices, which undermine the country’s resource-focused exports; and a currency that has depreciated compared to the U.S. dollar, making it difficult for Brazil and Brazilian businesses to service their debts.
“Those external difficulties have had a more profound effect on the economy than any single scandal, no matter how large,” Faass says. “As commodity prices improve and currencies strengthen, I think you will see the economies in Latin America getting better, whether or not corruption scandals are resolved satisfactorily.”
Brazil’s strong attempt to curtail corruption indicates that some parts of the nation’s political class see the need for improvement. “I think people in Brazil, including legislators and the society in general, aren’t given credit for that,” Faass says.
The Clean Company Act
In January 2014, the Brazilian government brought into effect the Clean Company Act. It covers all companies that operate in Brazil, including foreign organizations.
The law provides for proceedings to hold businesses and legal entities accountable for acts against the Brazilian or foreign governments. Harmful acts include: offering an undue advantage to a public official; defrauding through collusion the competitiveness of public bid processes; and manipulating the financial aspects of public contracts.
Penalties include potential fines of between 0.1 and 20 per cent of the accountable organization’s annual revenues, or, if the entity’s revenue is unknown, a fine between R$6,000 and R$60 million, depending on — among other things — the seriousness of the infraction and whether the organization has internal integrity mechanisms designed to prevent corrupt practices.
An organization could face judicial as well as administrative penalties. The country, states, and municipalities may seize property and money, prohibit the company from receiving loans or subsidies from public financial institutions for up to five years, or even dissolve the business.
That’s the law. Next, the regulations: In March 2015, the government enacted Decree 8,420, which explains how the government and its agents should conduct anticorruption proceedings. Note that according to these regulations, the government will consider reducing fines by one to four per cent if the liable company has and applies an integrity program, including procedures to encourage people to report corruption and an auditing system to ensure that the program is actually working.
All of the above matters to Canadian businesses operating in Brazil. Barutciski says they may need special support. His advice: “Make sure you have somebody on board either at the senior-management level or in an advisory role who really understands the business, the culture, and the environment. That might mean hiring an accounting firm, a law firm, or a new senior executive with deep hands-on experience. You need to understand what you’re getting into. Otherwise, it’s hard to avoid the pitfalls.”
Engaging local Brazilian consultancies and law firms is a different prospect today than it was in the 1990s, when Barutciski first started doing business in the country. Back then, local service providers “were relatively small general practitioners, people who did litigation and some corporate and commercial. Now you see a high degree of specialization, much as you have here in Canada.”
Experts indicate that Brazil’s new law and regulations are no common measures. Decree 8,420 is notably specific, says Faass. It spells out fines and lays out how companies can argue to have fines reduced. And the act is unusually firm, says John Boscariol, a McCarthy Tetrault LLP partner specializing in international trade. “To Brazil’s credit, the provisions in the Clean Company Act are probably the most strict I’ve seen around the world.” He points to the firm line on liability. Unlike in other jurisdictions, in Brazil, a company is still liable even if it can prove that it took steps to prevent corruption.
Local pain, international gain
Mariana Mota Prado is an associate dean of graduate studies at the University of Toronto Faculty of Law and a Brazilian national who collaborates with other scholars on institutional reform. She says the new law and regulations could work well alongside extra Brazilian anticorruption legislation. Consider the U.S. Foreign Corrupt Practices Act and Canada’s equivalent, the Corruption of Foreign Public Officials Act. Both pieces of legislation stipulate that if an official working for a Canadian or U.S. company abroad bribes a representative of that country, then a Canadian or U.S. court can prosecute and sentence the official to jail time and fines. Coupled with Brazil’s anticorruption steps, these laws could help reduce corruption across the board, Mota Prado says.
But at the same time, corruption control measures could prove risky for Brazil’s economy. As Mota Prado says, following the Petrobras scandal, many Brazilian construction companies are prohibited from entering into government contracts. So, when the government wants to start construction projects, it has fewer Brazilian companies to call on.
Now, if those companies reorganize and do away with corrupt practices, they’ll likely be allowed to participate in government projects in the future. “That’s the story for SNC Lavalin here in Canada,” Mota Prado says. Until then, though, she says, “We’re going to go through a downturn. It will take time for these businesses to learn to do things in a different way.”
The positives likely outweigh the negatives. “All the losses in the Brazilian economy that were due to corruption would be recouped,” Mota Prado says. “It’s estimated that five to 15 per cent of our GDP is consumed by corruption — meaning the Brazilian economy could be growing much faster if there were no corruption.”
Measuring the effects of corruption is tough. Many investors and regulators rely on Transparency International’s annual Corruption Perceptions Index, which tracks people’s points of view on various nations’ apparent levels of corruption, drawing on a variety of polls and other corruption-related data. For 2014, Transparency International ranked Brazil 69th out of 175 countries in terms of corruption perception. For the record, Canada ranked 10th. (Transparency International was scheduled to produce the 2015 numbers just as this article went to print.)
Will Brazil’s new strict anticorruption systems help the country improve its position in the index? Mota Prado is hopeful that they will. “Transparency International in many of its reports has said Brazil’s problem was a lack of punishment. We caught corruption in the past and there were massive scandals, but we rarely managed to punish anybody. This new law changes the dynamic.”
Petrobras’ ongoing saga
Perhaps not surprising given the sheer extent of the situation, the Petrobras story continues to unfold. In December 2015, The Associated Press reported that the Brazilian government was investigating 21 companies and 59 Petrobras executives for alleged involvement in a cartel to fix the terms and prices for contracts between the company and contractors. Other reports say it’s one of the world’s largest corruption cases, involving companies not only in Brazil but also Norway, Italy, and other nations.
Don’t forget: Petrobras isn’t the only scandal underway. Look at what happened in São Paulo with its passenger rail project. According to the Financial Times, in December 2014, Brazilian police indicted 33 people and seized R$600 million in assets from six companies including German engineering firm Siemens and French train maker Alstom following an investigation into collusion to win contracts to build the rail system. Like Petrobras, this problem involved politicians accused of co-operating with the construction cartel.
Bombardier Inc. was implicated, too. According to The Globe and Mail in March 2014, Brazilian prosecutors charged executives from the transportation arm of that Canadian company with participating in the collusion. At the time, a spokesman said Bombardier operates ethically and that the four employees named in the charge no longer work for the organization.
These crackdowns may expose Brazil to unwanted international scrutiny, but the results could be positive.
As Barutciski says: “You now have senior politicians and administrators who were appointed politically and who got into the game of extracting personal wealth — and they’re being flushed out. That will have a sobering effect on those who are tasked with taking their places. The next generation says, ‘We don’t want to go down that road.’”
Indeed, these corruption cases could count as the latest in a number of steps toward a fair and reasonably competitive marketplace. But the question remains: Is Brazil doing enough to create a positive foreign-investment environment? Boscariol points out that the country has no foreign-investment protection and promotion agreement in place with Canada. FIPAs bind a country to protect investors from another nation. Under a Brazil-Canada FIPA, if a Canadian company invested in Brazil, and Brazil expropriated that investment or discriminated against the investment, the company would have the right to sue Brazil.
FIPAs are common, Boscariol says. “We have them in place with more than 20 countries around the world including many in Latin America, but Brazil has been reluctant to ratify these agreements.” He explains why: Brazil saw what happened to Argentina. In the late 1990s, that country ran into significant economic trouble — and since then, it has been subject to a number of investor-state claims under FIPAs, largely lawsuits from organizations that saw the value of their investments in Argentina devalued as the country enacted measures to manage an economic depression. Brazil doesn’t want investors to be able to make the same sorts of claims.
All that said, Brazil is taking a new, perhaps more mature approach to investment protection. The government has started to enter into co-operation and facilitation investment agreements with other nations, signing with Mexico in 2015, and with Angola and Mozambique in 2014. CFIAs include provisions on non-discrimination, expropriation, corporate-social responsibility, and other matters. But these agreements don’t allow investors to sue the government. Brazil still seems reluctant to provide for financial recovery through the courts, Boscariol says. Yet the country apparently recognizes “that they have to create a stable investment environment, and part of that is entering into these agreements to assure investor protection.”
Brazil’s corruption crackdown also follows similar action in other states. “It’s what we’ve seen in the last few years with China, now Brazil, and even with Cuba: Countries are stepping up enforcement of their own domestic corruption laws,” Boscariol says. “The message we’re giving clients now is: It’s not just the Canadian, the U.S., and the U.K. laws you have to worry about. You need to understand the requirements of local law, too. And even if you perceive a local practice of engaging in corrupt activity, you have to make sure you comply with the law, not the custom.”
Next steps for Canadians in Brazil
In that Brazil’s anticorruption law requires companies to run anticorruption systems, Boscariol is worried.
“Many Canadian companies that do business internationally don’t have real, effective anticorruption systems in place. That is a real problem. They need to put in those controls and they need evidence that those controls are being implemented.”
Plenty of advice is available to organizations that seek to implement anticorruption compliance programs.
Experts at law firm CMS Cameron McKenna LLP, for instance, say an effective system involves:
• Commitment from the company’s
senior management to the program
• Implementation of ethics and
conduct codes
• Periodic employee and third-party
training
• Program auditing and monitoring
• Procedures to prevent fraud in
bidding and performance on
government contracts
As for the ongoing corruption investigations, the world waits to find out if Brazil’s new laws and regulations are effective. “We have to see some follow-through on these cases,” Boscariol says. “We’ve heard about all sorts of investigations, but we haven’t seen those come to completion.”
Faass, for one, believes that the outcomes of those investigations could affect Brazil’s business mindset.
“Whether there’s a change in the way business is done here for the better will really ultimately depend on the perception that corrupt conduct has been punished regardless of who committed it,” he says.
Canadian companies with Brazilian operations seem to be waiting to see what happens next, too.
Meanwhile, they aren’t saying much. None of the in-house lawyers we contacted for this article would participate in an interview.
That Brazil’s anticorruption systems are more sophisticated than previous measures gives legal experts hope for the country’s future. Mota Prado makes the point that the new legislation allows the government to hold companies accountable, whereas previous laws only targeted individuals. Knowing that an entire organization could be held responsible for the underhanded activities of even a few bad apples makes companies less tolerant of fraud, she says.
Barutciski says Brazil still has a lot to recommend it, despite headlines fraught with fraud and the challenging global financial environment. Oil prices are low, which may well hamper the nation’s economy for many years to come, but the populace is smart, ambitious, and apparently unafraid to face up to challenges such as wide-reaching corruption among the business and political elite.
“It’s going through a very tough patch right now, no question,” Barutciski says of the country’s current state of affairs. “But on the whole, I’m still optimistic for Brazil.”
