Home > Brazil, corruption and the commercial fallout

Brazil, corruption and the commercial fallout

27th July 2017

Introduction

There has been a lot going on in Brazil in the last few years. And when I say that, I mean more than the World Cup, Olympics and Zika. Unfortunately, this is about as much news as we get on this side of the Atlantic. The fact that even the Netflix television series, House of Cards, tweeted “Hard to compete” about Brazil’s own real life political drama, shows that there plenty to talk about in Brazilian politics. To understand what has been happening in Brazil it is necessary to understand a little more about the country and culture.

Brazil was discovered by the Portuguese in 1500. In 1809, when Napoleon’s armies began moving to the west of Europe, the Portuguese royal family fled to Brazil, making a deal with the English for safe passage across the Atlantic in exchange for trade with Brazil. Rio became the centre of the Kingdom Portugal, Brazil and the Algarve.

In 1822, Brazil gained its independence from Portugal. In 1889, the monarchy were overthrown, following a military coup d’état. The military would take over again in its most recent history, between 1964 and 1984. The current constitution was written in 1988, following the introduction of democracy. It is now a federal democratic republic with a bicameral parliament and presidential system. There are some 30 political parties, of which 20-25 have representatives in either house. The legislature and the executive deal with the running of the country, including its large public sector. There are currently 522 ongoing public sector projects and a further 54 infrastructure projects were announced by the new president, Michel Temer.

The legal system is Roman-German, civil law. The Supreme Federal Tribunal (STF) is the court of last instance for all matters of constitutional relevance and the Superior Court of Justice (STJ) rules, finally, on all other matters of law. Brazil boasts the largest fused legal profession with compulsory registration. The Brazilian Bar Association (OAB) registered over one million lawyers in 2016.

Brazil is the fifth largest country in the world in terms of size and population. It has the ninth largest GDP, although it did rank sixth, overtaking the UK just a few years ago. It is the largest economy in the Latin American region. It exports aircraft, automobiles, electrical systems and a series of commodities such as coffee, sugar, oranges, beef, soya, ethanol, cotton, oil, iron ore and steel.

Cast

You must also become acquainted with the cast, particularly in Operation Jet-Wash (Operação Lava-Jato). It is not possible to cover all the important characters in the story, but I will highlight the protagonists.

Michel Temer (PMDB) – president (2016 – present)

Dilma Rouseff (PT) – impeached president (2011-16)

Luiz Inácio “Lula” da Silva (PT) – former president (2003-10)

Renan Calheiros (PMDB) – former leader of the senate (2013-17)

Eduardo Cunha (PMDB) – former leader of the lower house (2015-16)

Sérgio Moro – federal judge in Curitiba, PR, supervising the case

Luiz Edson Fachim – supreme tribunal minister, supervising the case

Deltan Dallagnol – lead prosecutor

Operation Jet-Wash

Operation Jet-Wash is the largest corruption case in Brazil, involving its largest companies, Petrobras, money men and politicians. Its name comes from a petrol station, in Brasilia, the capital city of Brazil. Police investigating a suspected money laundering operation, unravelled the largest corruption scandal in Brazil, if not the world. Its name in Portuguese is “Operação Lava-Jato” and it means – jet-wash, not car-wash. All prosecutions are being heard in two instances.

In the first instance, the Federal Court in Curitiba (PR), since it was issued in March 2014 as it has seized jurisdiction. In the Federal Court, there have been 1,765 cases filed, 844 search and seizure orders, 97 pre-conviction detention orders, 104 temporary detentions, 279 requests for international mutual assistance, 158 plea bargains, 10 leniency agreements, 64 charges against 281 individuals, 32 convictions and sentences totalling 1,563 years, 7 months and 5 days of imprisonment. The crimes involve some R$10.4 billion (£2.53 billion) of which R$3.2 billion (£780 million) are subject to freezing orders.

In the second instance, in the STF and STJ, 28 petitions were filed against politicians who were involved in the nomination of directors of Petrobras, the national oil and gas company. In Brasilia, the case has led to 450 investigations, 178 interviews, 180 search and seizures orders, 28 assets and 5 sums of money sequestered, 24 complaints, 66 individuals charged, 5 prosecutions, 159 plea bargains and R$79 million (£19.22 million) repatriated so far.

The Scheme

Petrobras awarded contracts by competitive tenders. They varied in value some in the millions of reais. Several construction companies formed a cartel to win the tenders and create a façade of true competition. Representatives held secret meetings to determine in advance (a) who would win the contract, (b) the price and (c) the level of inflation of stated cost.

Petrobras staff were also involved, ensuring cartel members were invited to submit tenders. The cartel bribed staff members in charge of executing the tenders. In turn, staff favoured the cartel members by (a) taking part in direct negotiations with cartel members, (b) adding unnecessary work and excessive rates to tenders by non-cartel members (c) waiving or suppressing certain phases in favour of cartel members; and (d) leaking relevant confidential information to the cartel.

With all the money flowing, there were also “Dollar Men”. In Brazil, illusive figures lurking in the shadows have always been known to the general population by the name of “Doleiros” or Dollar-men. They are used as an illegal foreign exchange. Given the high political office of some of the assailants, these Dollar-Men were employed to move and lauder money for the payment of bribes. They collected money from the companies by way of cash, foreign transfers or payments under fraudulent contracts. The three known Dollar-Men were Alberto Youssef, Fernando Baiano e João Vacari Neto. Payments to beneficiaries were also made by way of cash, foreign transfers or the transfer of assets.

In March 2015, 28 petitions were presented to the STF for the investigation of 55 individuals 49 of which were serving in office. They belonged to various political parties, responsible for nominating and appointing the directors of Petrobras. Each politician or political party was responsible for a division of Petrobras and nominated a director. Their names and roles in the scheme were obtained in exchange for plea bargains with suspects.

Paulo Roberto Costa was director of the supply division between 2004 and 2012. He was appointed by members of the PP and later support of members of the PMDB, among those members was the Dollar-Man Alberto Youssef. Renato Duque was the director of the services division between 2003 and 2012, appointed by the members of the PT. The party’s treasurer, João Vaccari, was responsible for the distribution of the illegal funds. Nestor Cerveró was the director of the international operations division between 2003 and 2008, nominated by members of the PMDB, he used the Dollar-Man Fernando Baiano.

How did we get here?

In my opinion, Operation Jet-Wash would not have been possible, or at least as effective, convicting and sentencing such powerful figures, including president Lula himself, who was convicted by Judge Moro just this month to a nine-and-a-half-year sentence for passive corruption and money laundering, were it not for what came before it.

For over 500 years, Brazil has suffered endemic corruption. A culture of systemic exploitation and impunity has been the norm. This has been a problem not only in Brazil, but in the entire Latin American region. Plagued with domestic issues, it is no wonder that there has been an absence of continental conflict, as seen in Europe. That said, since Jim O’Neil coined the phrase “BRIC economies”, changes had begun to take place in Brazil. The large-scale protests that occurred during the World Cup and Olympics campaigns are a manifestation of that.

Mensalão

One of the first precursors of Operation Jet-Wash, was the “mensalão” or the “big monthly” case. In 2005, during Lula’s government, a lower house parliamentarian, Roberto Jefferson, told a São Paulo newspaper that the PT had been paying several lower house parliamentarians R$30,000 a month to vote in favour of legislation proposed by them. Payments were made from the advertising budgets of public sector companies, syphoned into companies owned by Marcos Valério.

The investigation by a parliamentary commission resulted in 18 members of the lower house being accused of corruption and many others resigning together with Lula’s key advisors. The investigation also led to the implication not only of PT members but PSDB, PMDB and DEM party members. In 2007, the STF accepted petitions relating to 40 individuals. Following the televised STF trial in 2012, 37 people, including Marcos Valério were convicted and sentenced and 3 were acquitted. The president of the STF at the time, Joaquim Barbosa, took the public by surprise by demonstrating impartiality to the government who had appointed him as a supreme court judge. This, in Brazil, in 2007, was a refreshingly novel concept. In the same year, Marcos Valério stated in an interview with a magazine that Lula was the mastermind behind the plan.

Following, and despite the case, Lula was re-elected for a second mandate and then succeeded by Dilma Rouseff. The PT continues to be a very popular party in Brazil as it took several measures to relieve extreme poverty in the country, especially in the remote rural regions in the north and northeast. However, the mensalão case and the unsustainable public spending compounded by investments on the World Cup and Olympics, which yielded poor returns for the country, led to a certain level of disenchantment by the Brazilian population, especially the squeezed middle classes. The country became and has since remained somewhat divided.

This was probably the main reason that led to the impeachment of president Dilma Rouseff. Even though direct evidence of corruption was never found against her, public opinion against PT, and specifically Dilma, was so high by mid-2016 that her removal was almost inevitable. There was also a game of cat-and-mouse between the authorities and Lula, who in 2016 was temporarily appointed by Dilma as chief-of-staff, to gain immunity from prosecution. In the end, she was removed on a technicality. She was accused of what we would term false accounting. She delayed repayments of loans, so that budgets of public departments were artificially inflated. In August 2016, Dilma was officially removed from office by a 61-20 vote in the senate.

Eduardo Cunha

Eduardo Cunha the former leader of the lower house, who led the impeachment against Dilma, is currently serving a fifteen-and-a-half-year sentence for corruption, money laundering and tax evasion. Until his expulsion from the PMDB in September 2016, he was one of the most powerful politicians in Brazil. His lies about funds discovered in Switzerland were unravelled following a request for information with the country’s authorities. I remember reading this particular storyline unfold, over a few weeks on my mobile phone, on the way to chambers each morning. This led to an investigation by the ethics committee of the Brazilian parliament, which, in turn, led to his demise. Operation Jet-Wash revealed Cunha received bribes of £1.2 million for his role in an oil exploration contract Petrobras won in Benin.

Renan Calheiros

Renan Calheiros, the leader of the Senate, was by November 2016 the subject of twelve STF investigations, eight related to Operation Jet-Wash. Another former senator accused Calheiros of receiving $10 million in bribes over 10 years. A former Petrobras director accused of being paid $1.7 million through a Petrobras lobbyist in a case related to drill ship contracts. He also has a historical corruption charge related to illegal payments to an illegitimate daughter. In December 2016, he was suspended by the STF from his role as leader of the senate, for being under investigation. He ignored that suspension until it was overturned. This month, he gave a speech supporting Lula in the senate, following the latter’s conviction.

Michel Temer

Michel Temer, the then vice-president, now standing president was recently investigated himself. First, for information obtained through plea bargains with high level employees of Odebrecht, a company whose role I shall explain in a moment. Secondly, and more recently, for the information given by Joesley Batista, owner of the JBS group of companies that he had ordered the payment of “hush money” to keep Eduardo Cunha quiet, while he was detained. The information obtained, suggests that the president was himself involved with the uncovered scheme. The saga continues.

In a country with a polarised class system, seeing politicians getting away with corruption never bodes well. Seeing impunity undone before your very eyes, revives hope. As the STF cases are televised (including deliberation by the “ministers” (judges)), these spectacles become very popular viewing indeed. New heroes have emerged in the form of former minister and chief justice of the STF Joaquim Barbosa and current federal judge Sergio Moro. The villains are of course the convicted criminals. Like all good Brazilian soap operas, there are many twists and turns as the plot thickens.

Brazilian Oil & Gas Sector

Petróleo Brasileiro SA, or Petrobras as it is known, was created in 1953 by the government of Getúlio Vargas. In 1997, with the introduction of law 9.478 Petrobras monopoly over exploration and production ended. At the same time the National Petroleum Agency (ANP) was created to regulate and supervise the petroleum sector. In 2000, it floated its stocks in NYSE a couple of years later in the European markets. Petrobras really came into being in 2007, following the discovery of pre-salt reserves in the Campos Basin. In 2010, law 12.351 was introduced in respect of the operation of exploration and production in pre-salt fields. Petrobras went from a company that produced 2,700 barrels of oil equivalent per day to a staggering 2.144 million, today. Despite everything it has been through, the Brazilian state continues to hold approximately 53% of the capital.

Following the changes in the law in 1997 and 2010, the ANP allows two systems of exploration and production. First, the concession regime, where “concessionaires” are liable for 4 payments upon successful bidding. Those payments are (a) signature bonus, (b) retention fee (c) 10% royalties on production and (d) special participation fee where high yields occur. ANP is currently in its 14th bidding round. Secondly, Production Sharing Agreement (PSA) regime for pre-salt fields. For PSAs, Petrobras must be the operator and hold at least 30% share capital of the PSA vehicle. ANP is currently in offering 2nd & 3rd bidding rounds.

Two of the other players in the Brazilian market are OGX and Odebrecht. It would be unfair to tell the story of Operation Jet-Wash without mentioning them.

OGX is part of the EBX group of companies, belonging to Eike Batista (once Brazil’s richest man with a net worth estimated at £27 billion). It was founded in 2007, as a private sector alternative in Brazil’s oil and gas exploration sector. In 2013, it filed for insolvency protection, failing to agree a settlement plan with institutional investors. The EBX group collapsed with the downturn of commodities. Batista himself, was being detained in prison on corruption charges, until he was released on house arrest in April of this year. The collapse of the EBX group, notably OGX and OSX, the sister company providing ships and ports infrastructure to OGX, signaled the demise of domestic, private sector competition for Petrobras. Batista and an associate are accused of paying $16.5 million in bribes to former Rio Governor Sergio Cabral via offshore accounts. The US and Cayman Islands are also investigating him.

Odebrecht is a large Brazilian conglomerate with two arms: construction and petrochemicals. It was founded in 1944 by Noberto Odebrecht. Its petrochemical arm, via the company Braskem, is the fifth largest petrochemical company in the world and operates internationally. Its construction arm is the largest in Latin America. In June 2015, Marcelo Odebrecht, grandson of the founder was arrested, accused of paying $30 million in bribes as one of the cartel companies in Operation Jet-Wash. He was convicted in March of 2016. The group has since admitted to paying £2.1 billion in bribes as part of its leniency agreements with US and Swiss authorities. Odebrecht’s reach over Latin America is also a cause of concern over the entire region. Its actions have implicated bribery all the way to the top. In Peru, President Alejandro Toledo is implicated. In Colombia, President Juan Manuel Santos. In the Dominican Republic, several officials were arrested. This is without counting the projects in Angola, Argentina, Ecuador, Guatemala, Mexico, Mozambique, Panama, Peru, Venezuela and even in the UK.

There have been number of large Brazilian and foreign entities implicated in Operation Jet-Wash, such as OAS, Camargo Corrêa, Andrade Gutierrez, Queiroz Galvão, Mossack Fonseca, Rolls Royce and Sete Brasil. The list continues to grow.

The Commercial Fallout

The news of Operation Jet-Wash and the current state of the oil market has led to various claims being brought by and against Petrobras and its suppliers. I have picked out three to give a flavor of the extent and variety.

PIMCO -v- Petrobras

On 16th October 2015, in the Southern District of New York, Pacific Investment Management Co (PIMCO) and several other parties and institutional investors, filed a 140-page class action against Petrobras and others, for damages in respect of breaches of the Exchange Act, Securities Act, misrepresentation and fraud, further to Operation Jet-Wash. The cases involve claims brought starting in late 2014 by a variety of investors against Petrobras, its US arm and executives, along with PWC and Petrobras’ debt underwriters. They are accused of helping conceal billions of dollars in bribes and kickbacks through a decade long scheme.

In its response, Petrobras alleged that any dispute arising from the acquisition of shares was subject to arbitration in Brazil, in accordance to its articles of association. The preliminary dispute as to whether the arbitration clause was valid and the claim should be stayed was decided on the basis that shares purchased via the NYSE, were subject to the federal acts and a separate, non-contractual cause of action arose. Shares purchased in Brazil, via BOVESPA, were subject to arbitration.

Petrobras subsequently settled four individual actions in which some of its largest investors outside of the Brazilian government, including PIMCO, sought to recover losses they blame on the corruption scandal. Petrobras set aside at least $353 million to handle those and other claims.

Sete -v- Petrobras

Sete Brasil Participações SA was formed in 2010 to supply and operate oil rigs (FPSOs) to Petrobras. The project would involve the purchase of 28 FPSOs, for use by Petrobras. To give this context, there are around 226 FPSOs operating in the world and 29 of them are operated by Petrobras. Each FPSO costs around $500 million (for Brazilian pre-salt exploration and production). As Operation Jet-Wash broke and oil prices dropped, Petrobras reduced its commitment to some 10 FPSOs. Sete had orders with various shipbuilders in Singapore and was delayed in payments due. The smaller order would not be sufficient to repay the R$8.25 billion shareholders invested in Sete.

Petrobras is a party to arbitration proceedings in Brazil initiated by investors in Sete, related to its participation in Projeto Sondas (“Rigs Project”), as well as proceedings in the Federal Court in Washington, DC. Sete filed for bankruptcy protection in April 2016, is in talks with Singapore’s Jurong and Keppel shipyards, negotiating an option to complete the FPSOs, take delivery and pay them off when the company starts generating money. Meanwhile, Sembcorp Marine, another Singapore-based drilling rig builder, has launched an arbitration against Sete.

As recently as last month, Petrobras has resumed negotiations with Sete with a view to reaching a settlement.

Ensco & Vantage -v- Petrobras

Petrobras chartered the DS-5 drilling rig in 2008, when it was owned by Pride International, a company purchased by London-based Ensco in 2011. In 2015, Brazilian prosecutors announced a plan to file criminal charges stemming from the lease. In January 2016, Petrobras cancelled its contract with Ensco for the drillship DS-5, alleging the contract was won by corruption. Petrobras asserted the DS-5 contract was void due its subsidiary, Pride, having knowledge of and being assisted by a former third-party marketing consultant that procured and received improper payments from Samsung Heavy Industries, the shipbuilder of Ensco DS-5 drilling rig, subsequently paid to employees of Petrobras.

Ensco’s audit committee appointed independent counsel to lead an investigation into the alleged irregularities. The audit committee neither found evidence that Pride or Ensco were aware of or involved in any corruption, nor evidence linking Ensco or Pride to any illegal acts committed by the company’s former marketing consultant. Ensco issued arbitration proceedings against Petrobras and the South Korean shipbuilder Samsung Heavy, in 2016.

The allegations of bribery came from the plea bargains reached with Jorge Zelada a former director of Petrobras, in charge of drilling rig contracts.

Zelada also alleges that bribes were paid in respect of the Titanium Explorer. The Titanium Explorer is a self-propelled, dynamically positioned drilling rig for drilling in remote locations. In December 2012, Petrobras entered a $1.6 billion a year, 8-year contract for its use with Vantage Drilling. In 2016, Petrobras terminated the contract, alleging that Vantage had breached its obligations under the contract for the Titanium Explorer. Vantage filed for arbitration challenging the assertions made in the notice of termination and advance a claim on the basis that Petrobras’ action is a wrongful attempt to terminate the contract.

Conclusion

As can be seen, there is a lot going on. Much of it is ongoing. When you speak to anyone who truly knows Brazil, they will be familiar with the concept of Brazil being the “country of tomorrow”. There has for as long as I can remember, been a feeling that Brazil has all the ingredients necessary to be the world’s greatest superpower. The problem is the governance. There have been many times in Brazil’s history that it has shown signs of tomorrow coming. Unfortunately, it has not yet quite turned that corner. Some people feel that with every year that goes by, every arrest that takes place, we are edging slightly closer. Others are more cynical about the situation. In either case, it is my view that Brazil is currently going through a transformation, which is permanent. I cannot predict whether it will be for the better or worse, but I for one am hopeful for what tomorrow may bring.

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Sally Wollaston
Sally Wollaston
Business Development and Marketing Director
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