FCPAméricas Blog

Considering Reputational Risks in Brazil: A Growing Spotlight

Author: Gavin Parrish

Guest Blog Post Today FCPAméricas features author Gavin Parrish, a Practice Leader for Compliance and Fraud at Control Risks. He was previously an attorney in New York and São Paulo. Mr. Parrish can be reached at gavin.parrish@control-risks.com.

In previous posts, Matt has eloquently summarized some of the key operating and compliance challenges in Brazil, here and here. He has graciously invited me to share some additional thoughts on the reputational challenges that surface for our clients operating in Brazil.

Within the community of Brazilian lawyers involved in international transactions, the disclosure last month by Embraer was a long time coming: a full-blown FCPA investigation involving a Brazilian international conglomerate. To be sure, there were previous FCPA enforcement actions that implicated Brazil, but they generally involved small, ancillary players (e.g., Nature’s Sunshine) or the Brazil piece of the alleged activity was part of a larger regional or international corruption scheme (e.g., Panalpina). The disclosure that Embraer is conducting an internal investigation into possible violations of the FCPA is neither, and may signal the long-anticipated arrival of a wave of increased compliance scrutiny on Brazil – both towards Brazilian companies as well as those international entities operating in Brazil.

Brazil presents significant operating and reputational challenges, generally reflected in its sub-par ranking in the Transparency International Corruption Perceptions Index. However, some of the most difficult challenges our clients struggle with are more granular in nature: day-to-day operational bribes to keep the business running. To take just one minor example, anyone operating in Brazil that has ever navigated Brazilian bureaucracy has almost certainly relied on a so-called despachante, a profession that exclusively exists to wind through the maze of seemingly endless permits, licenses and operating regulations. The country’s fascination with documentation means that even simple tasks necessitate multiple written approvals, often from a wide range of public agencies. Achieving full compliance with this regulatory web requires significant time and effort, as well as creative strategies to ensure adherence to legal norms and a company’s own ethics and compliance policies.

This legacy of bureaucratic hurdles in Brazil poses serious challenges, particularly when combined with the global spotlight on the country due to the 2014 World Cup, 2016 Olympic Games, massive foreign investment, particularly into infrastructure and the energy sector, and a burgeoning middle class that consumer products and services companies are angling to attract. While corruption concerns hardly represent a new phenomenon, I believe that the compliance threats are particularly toxic right now. Here are a number of specific reasons why:

Private Equity. The wave of Brazilian issuers that tapped the international capital markets and listed shares abroad or on the São Paulo Stock Exchange over the last five years was unprecedented in Brazilian history, jumping from 6 in 2005 to 28 and 63 in 2006 and 2007, respectively, prior to temporarily stalling due to the international financial crisis. As a result, private equity investors taking equity positions in privately-held Brazilian companies are now being forced to analyze a different set of opportunities. As in-house counsel at a large investment bank in Brazil told me, “the gold standard Brazilian companies have installed professional management and listed, so we’re dealing with smaller, regional companies with nonexistent or extremely weak compliance and corporate governance programs. We simply don’t know the quality of the companies we’re dealing with.” As a result, the compliance risks are qualitatively different and should be given greater priority when PE firms are fashioning investment strategies and professionalizing a portfolio company’s management.

M&A. The M&A market in Brazil jumped from $11.4 billion in transactions in 2005 to $153.5 billion in 2010, according to Dealogic. During 2011, various Brazilian lawyers noted to me that FCPA representations and warranties in purchase agreements have caused some significant negotiating heartburn. Not surprisingly, U.S. and other foreign investors acquiring Brazilian companies demand FCPA-related contractual protections, including ongoing indemnification for FCPA violations arising from pre-acquisition activity. Brazilian companies, on the other hand, may be completely unfamiliar with, and not subject to, the FCPA. Why, they ask, should I make any representation involving the violation of a foreign law that I’m not familiar with and doesn’t even apply to my operations? It’s not an unreasonable negotiating position and one that, at least anecdotally, may be hardening since Brazilian companies have local suitors flush with cash (see IPO activity above) and some international suitors not subject to the long arm of US enforcement authorities.

Energy. With the liberalization of Brazil’s energy sector over the past two decades and the discovery of the offshore pre-salt hydrocarbons, foreign investment into Brazil’s energy sector has exploded – both via direct investment and indirectly through the capital markets. In 2008, Eike Batista’s E&P company OGX completed a $4.1 billion IPO that was the then largest IPO in Brazilian history. In 2010, the two largest IPOs by Brazilian issuers were HRT, a brand new E&P company that raised $1.5 billion, and OSX, an oil and gas services company involved in shipbuilding and offshore rig construction that raised $1.4 billion. Of course, Petrobras also completed a $70 billion equity offering in 2010 to secure offshore exploration areas from the Brazilian government and partially fund its anticipated exploration activities. International and domestic investment into the energy sector is expected to continue booming. However, the energy sector has been plagued by FCPA enforcement issues, in part because of the nature of the business, the jurisdictions involved, a heavy reliance on agents and the ubiquitous touch points with local government officials. A recent study by Ernst & Young concluded that the oil and gas sector is also likely to suffer the greatest impact under the UK Bribery Act. In short, the energy sector remains extremely vulnerable to enforcement actions since authorities will continue to allocate resources where the impact is likely to be greatest. The Brazilian energy sector looks like a prime target.

Corruption has deep historical roots in Brazil. The recent flurry of Brazilian government ministers to resign is just the latest manifestation of a longstanding problem. While companies operating in Brazil require dealmaking boldness to secure attractive returns, such boldness must be tempered (but not obstructed) by compliance humility. It is admittedly not an easy balance to sell internally at many corporations. But getting it right and adhering to a comprehensive and effective compliance program provides companies that most elusive of comforts: relative peace of mind in an uncertain and extremely complicated world.

The FCPAméricas blog is not intended to provide legal advice to its readers. The blog entries and posts include only the thoughts, ideas, and impressions of its authors and contributors, and should be considered general information only about the Americas, anti-corruption laws including the U.S. Foreign Corrupt Practices Act, issues related to anti-corruption compliance, and any other matters addressed. Nothing in this publication should be interpreted to constitute legal advice or services of any kind. Furthermore, information found on this blog should not be used as the basis for decisions or actions that may affect your business; instead, companies and businesspeople should seek legal counsel from qualified lawyers regarding anti-corruption laws or any other legal issue. The Editor and the contributors to this blog shall not be responsible for any losses incurred by a reader or a company as a result of information provided in this publication. For more information, please contact Info@MattesonEllisLaw.com.

The author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author.

© 2011 Matteson Ellis Law, PLLC

Post authored by Gavin Parrish, FCPAméricas Author

Categories: Anti-Corruption Compliance, Brazil, Due Diligence, Energy Sector, FCPA, M&A

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