BRAZIL INVESTMENTS
Be Careful What You Wish For
July 2011 | Vander Giordano & Eduardo Gomide, Sao Paulo
Foreign firms bidding on infrastructure projects or buying up local companies in Brazil
are understandably keen to get in on the country's economic boom. But two projects
gone awry provide a cautionary tale of the considerable risks that accompany potential
rewards in Brazil.
In November 2009, The Economist noted that “Brazil has been democratic before, it has had economic growth before, and it has had low inflation before. But it has never before sustained all three at the same time. If current trends hold (which is a big if), Brazil, with a population of 192 million and growing fast, could be one of the world’s five biggest economies by the middle of this century, along with China, America, India and Japan.”
Predictably, Brazilians have embraced the optimistic scenario. They have concluded that it is Brazil’s time to shine. The media has reported extensively on how Brazil is finally tapping into opportunities in a changing world economy and fulfilling all the potential of its large population, fertile lands, vast mineral resources, and now huge deepwater oil reserves discovered in the last decade.
However, economic growth and prosperity – Brazil’s GDP grew 7.5% in 2010 – also bring the risks associated with excessive optimism and a gold-rush mentality. On top of the “big if” listed above, investors and companies need to pay careful attention to details when it comes to where they put their money. A consideration of just two areas – the potential pitfalls of Brazil’s rapidly growing infrastructure sector and compliance issues arising from new environmental legislation – show that a lack of such care can be costly.
Playing the game cleanly
Brazil is about to host two major international sporting events. In 2014, the World Cup will be played in Rio de Janeiro and 12 other major cities. Two years later, Rio will welcome the Olympic Games. Analysts are predicting an enormous impact on the economy, with infrastructure investment as the driving force. A study by Brazil’s Sports Ministry estimates the potential economic impact from the World Cup to be nearly $100 billion between 2010 and 2014 and cites an expected $5.1 billion in incremental tourism, $9.2 billion in tax collection and the creation of 330,000 permanent jobs.
The vast opportunities related to the rebuilding and expansion of Brazilian infrastructure are attracting foreign investors. Some estimates put the likely cost of the planning and construction of Olympic sports venues at $15 billion. The building of new stadiums and the refurbishing of existing ones for the World Cup, along with improvements to ports, upgrading of public transport and roads, and the expansion of airports necessary for both events will involve at least another $18 billion. These figures may even be underestimated.
Taking part in the infrastructure boom in Brazil will almost always involve a public bid. The major infrastructure projects, such as hydroelectric plants and enhanced power grids, as well as new ports, highways, and airports are largely backed by agencies with full or partial government ownership, including BNDES, Brazil’s National Development Bank. The second phase of the national Growth Acceleration Program (PAC), the largest public sector investment program of the past 20 years, will open up US$220 billion in opportunities for foreign investment in Brazil from 2011 to 2014. The federal government has also established the Olympic Public Authority to coordinate the construction projects for the Olympic and Paralympic Games. Companies must be aware of the risk of getting caught up in bribery or corruption schemes in violation of Brazil’s own laws, as well as the US Foreign Corrupt Practices Act and the UK Bribery Act.
One cautionary tale involves a European company, which came under scrutiny by both European and Brazilian authorities in 2009. The company had subcontracted a European engineering firm for its infrastructure projects. Authorities began to suspect that a $6.8 million expense the subcontractor had on its books was, in fact, a payment made to local public officials in order to win a $45 million subway project in Brazil.
Further investigation revealed that this same company made close to $200 million in suspicious payments in connection with a hydroelectric project in Brazil. The scheme allegedly involved a consultancy contract with a Panamanian company. The consultant was hired to provide information to help in the bidding process for the hydroelectric power plant. But both Brazilian and European investigators are convinced that the Panamanian company never provided any consulting services and that its sole purpose was to act as a go-between to deliver bribes to secure the contract. Meanwhile, the European engineering firm is prohibited from participating in contract bids in Brazil until the investigation concludes, effectively barring it from the infrastructure boom.
An investment nearly gone to waste
Another cautionary tale involves a foreign company getting embroiled in legal action related to government regulation of waste treatment.
Brazil produces 150,000 tons of garbage annually. Its comprehensive National Policy on Solid Waste, passed into law last July, is the culmination of a long line of policies strongly emphasizing the use of recycled materials. Nevertheless, despite the efforts of the national government, states, municipalities, agencies, and industry organizations, up to 43% of waste collected in Brazil may not be adequately treated.
Compliance with the new law’s regulations will require many companies to invest in new technology and procedures, as well as spend considerable amounts on monitoring and auditing activity. For international investors looking to purchase Brazilian companies, due diligence should now go beyond assessing the background, reputation and integrity of these businesses to include compliance with the new waste management regulations. Otherwise, buyers risk inheriting liabilities that might eventually jeopardize their entire investments.
Recently, a foreign group acquired a Brazilian petrochemical company. Eight months later, the firm’s legal department received a subpoena from the State District Attorney. The company, along with others which outsourced waste management to a particular garbage treatment and disposal business, was being included in a civil action. The waste treatment company was not compliant with the new law: waste was being discarded without treatment. This left the petrochemical company also in violation of the law and subject to heavy fines.
Kroll was hired to investigate the matter and found that the risk could have been managed during the due diligence process had the auditors at the time done a more thorough review and spent more time looking at the waste disposal company’s record. Evidence already existed about its failings as did complaints about operational activities. Kroll’s evaluation of waste disposal documentation also found large discrepancies in weight and outright falsifications. In some cases, the waste management truck did not even enter company premises, although the contractor had a record of trash removal. Similarly, field interviews indicated that some of the waste was simply thrown in the city’s public dump.
Kroll’s reports supported efforts by the foreign acquirer’s lawyers to prove that the new shareholders of the petrochemical company had acted in good faith. The responsibility for the violations of the waste law was therefore assigned to the former owners.
Brazil’s economy provides substantial opportunities for foreign investors. To fully profit from them, however, companies need to study and gauge the underlying risks.
The Authors: Vander Giordano ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it ), a managing director in Kroll’s São Paulo office, has extensive experience in investigative and business intelligence matters, including fraud investigations, asset searches and competitive intelligence. He is a member of the Brazilian and International Bar Associations. Eduardo Gomide ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it ), a managing director in São Paulo, has more than 10 years of financial and risk consulting experience. Eduardo has managed a wide variety of complex assignments with special emphasis on financial investigations and forensic auditing.
An earlier version of this article appeared in the May 2011 edition of Kroll's Global Fraud Report. Click on icons below to download a copy of English and Spanish-language editions of the Global Fraud Report.
