The fallout continues from the ongoing investigation of corruption at Petrobras, Brazil’s giant state-owned oil company. (See New York Times coverage here, and helpful timelines of the scandal here and here.) In March of 2014, Brazilian prosecutors alleged that Petrobras leadership colluded with a cartel of construction companies in order to overcharge Petrobras for everything from building pipelines to servicing oil rigs. Senior Petrobras executives who facilitated the price-fixing rewarded themselves, the cartel, and public officials with kickbacks, and concealed the scheme through false financial reporting and money laundering. The scandal has exacted a significant human toll: workers and local economies that relied on Petrobras contracts have watched business collapse: several major construction projects are suspended, and over 200 companies have lost their lines of credit. One economist predicted unemployment may rise 1.5% as a direct result of the scandal.
The enormous scale of the corruption scheme reaches into Brazil’s political and business elite. The CEO of Petrobras has resigned. As of last August, “117 indictments have been issued, five politicians have been arrested, and criminal cases have been brought against 13 companies.” In recent months, the national Congress has initiated impeachment proceedings against President Dilma Rousseff, who was chairwoman of Petrobras for part of the time the price-fixing was allegedly underway. And last month, federal investigators even received approval from the Brazilian Supreme Court to detain former President Luiz Inácio Lula da Silva for questioning. (Lula was President from 2003 to 2010—during the same period of time that Ms. Rousseff was chairwoman of Petrobras.) Meanwhile, the House Speaker leading calls for President Rousseff’s impeachment has himself been charged with accepting up to $40 million in bribes.
As Brazilian prosecutors continue their own investigations, another enforcement process is underway in the United States. Shareholders who hold Petrobras stock are beginning to file “derivative suits,” through which shareholders can sue a company’s directors and officers for breaching their fiduciary duties to that company. Thus far, hundreds of Petrobras investors have filed suits. In one of the most prominent examples, In Re Petrobras Securities Litigation, a group of shareholders allege that Petrobras issued “materially false and misleading” financial statements, as well as “false and misleading statements regarding the integrity of its management and the effectiveness of its financial controls.” (For example, before the scandal broke, Petrobras publicly praised its Code of Ethics and corruption prevention program.) The claimants allege that as a result of the price-fixing and cover-up, the price of Petrobras common stock fell by approximately 80%. In another case, WGI Emerging Markets Fund, LLC et al v. Petroleo, the investment fund managing the Bill & Melinda Gates Foundation has alleged that the failure of Petrobras to adhere to U.S. federal securities law resulted in misleading shareholders and overstating the value of the company by $17 billion. As a result, the plaintiffs claim they “lost tens of millions on their Petrobras investments.”
Thus, in addition to any civil or criminal charges brought by public prosecutors, private derivative suits offer a way for ordinary shareholders to hold company leadership accountable for its misconduct. In these derivative suits, any damages would be paid back to the company as compensation for mismanagement; the main purpose of the suits is not to secure a payout for shareholders, but to protect the company from bad leadership. The Petrobras cases illustrate how derivative suits can offer a valuable mechanism for anticorruption enforcement, but they also face a number of practical challenges.
The Petrobras cases highlight three potential advantages of private shareholder derivative suits as an anticorruption tool:
- First, as noted above, shareholder suits complement the usual enforcement by government prosecutors. Even where government enforcement is active and effective, shareholders suffer financial and other economic harms that may not be vindicated by criminal charges or a civil fine. Indeed, government enforcement sometimes harms shareholders, because the shareholders bear the costs when a company is fined. Derivative suits can help focus the blame and some of the consequences on the company leadership that actually caused the misconduct.
- Second, derivative suits hold companies accountable for their public claims. When Petrobras attracted shareholders by promoting its Code of Ethics and anticorruption policy, those were legally enforceable promises. In this way, the threat of derivative suits can encourage companies to treat their ethics policies as more than window dressing.
- Third, derivative suits can also be used to hold auditing companies accountable for enabling or even aiding corruption. The Gates Foundation suit alleges that Petrobras’s principal auditor, PriceWaterhouseCoopers, breached its duties to the company by “failing to detect the 20% price inflation in over 1/3 of Petrobras’s contracts, totaling over $80 billion, falsely booked as ‘assets.’” Derivative suits enable shareholders to bring claims against company executives and the professional experts that enabled them, all in one suit.
Yet despite this potential, shareholder derivative suits in corruption cases have not always fared well in U.S. courts, for two reasons:
- First, it can be very difficult for shareholder plaintiffs to meet the burden of proof required to bring a derivative suit in U.S. federal court. In a similar case arising from Wal-Mart’s corruption scandal in Mexico, the judge dismissed the claim for “lack of particularity”—which essentially means that the shareholders could not assemble enough evidence to convince the court that it was “plausible” that Wal-Mart’s conduct toward its shareholders was illegal. Assembling complex evidence to prove a case against a global company is difficult, and attributing misconduct to particular management decisions or senior officers is especially difficult, even when the pattern of corruption is widely established (see the New York Times article that broke the story, and previous discussion on this blog here and here). This is a common challenge for class actions, and anticorruption advocates will need to make strategic litigation choices to bring cases that meet the federal pleading standard.
- Second, many district judges are not experts in international anti-bribery standards or foreign investment. (Indeed, Professor Mike Koehler noted that the judge who dismissed the Wal-Mart suit referred to the FCPA as the “Federal” Corrupt Practices Act.) Human rights advocates have faced similar challenges in bringing alien tort claims before judges who are unfamiliar with customary international law. The solution to this challenge is unclear. Lawyers bringing shareholder derivative suits would probably benefit from structuring their arguments to build familiarity with lesser-known international legal rules.
Thus far, the Petrobras cases have avoided these risks. The In Re Petrobras Securities Litigation survived a motion to dismiss, and a trial is scheduled for September. This suggests that the facts in the Petrobras case may be more favorable for shareholders, as compared to the Wal-Mart case. Moreover, the judge assigned to the case—Judge Jed Rakoff—is exceptionally experienced in complex international commercial disputes, having previously served as Chief of the Business and Securities Fraud Prosecutions Unit with the United States Attorney for the Southern District of New York, and as head of criminal defense at two top law firms. Moreover, he is publicly committed to fighting corruption. (Judge Rakoff is also the presiding judge in the WGI Emerging Markets Fund case, which is in an early stage of proceedings.)
These suits against Petrobras have potential to be some of the most successful and high-profile derivative suits ever filed in a corruption case. Their outcome will likely shape prospects and strategies for derivative cases in the future. As more and more shareholders see the opportunity — and as noted, Petrobras is facing hundreds of claims — derivative suits are likely to become a more common response to corporate corruption.