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.
Very useful summary of the issues involved when shareholders sue for damages resulting from the payment of bribes. But the way you refer to shareholder suits is a bit confusing. Shareholder actions against companies charged with violating the FCPA are of two kinds: one against the company and its officers for securities fraud and a second against the officers and directors only for failing to prevent the company from paying bribes. The former are termed “securities fraud” actions and only the latter are called “shareholder derivative suits.” Until recently, derivative suits were the most common type of action but as you point out, these are very hard cases to maintain, and as a result, securities fraud actions are now the preferred vehicle for recovering damages. Columbia Law School Professor John Coffee’s new book, Entrepreneurial Litigation: Its Rise, Fall and Future, provides a first-rate discussion of the differences and why the one has supplanted the other.
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Fascinating post. In the event derivative suits are filed against Petrobras directors and officers, It would be interesting to know how Brazil’s corporate law compares with corporate law in states such as Delaware with respect to indemnification provisions for individuals found liable and/or insurance for directors and officers. From one perspective, a derivative suit is a means of holding individuals accountable, but if the corporation is required/permitted to reimburse individuals found liable for any damages they owe, then the economic impact of a successful suit may not restore Petrobras to its pre-scandal state (or even its pre-scandal condition absent the price-fixing that took place).
More generally, given your points about the difficult of winning shareholder suits, how much value do you see in the publicity that might come along with a shareholder suit regardless its success on the merits (if it even reaches the merits, that is)? I am not sure where I come down on this question. On the one hand, even an unsuccessful derivative suit might result in so much bad publicity for individual bad actors that the form can be an effective deterrent going forward. However, a derivative suit is most likely a follow on to other actions, such as public revelations of fraud that have the same publicity and potential future deterrent effect, so if there is director indemnification or insurance, I am not entirely convinced of a derivative suit’s publicity value.
So interesting–and what a complex question. Just briefly reading Judge Rakoff’s opinion from this stage, it’s clear this is a hugely complex case, one that I am certainly struggling to understand. While I certainly won’t claim to see all the pieces and how they fit together in the class action, two things were interesting to me. First, the opinion says the securities claims were brought because Petrobras had American Depository Shares that were listed on the NYSE. I had to look that up, but apparently depository shares are basically a way to list equity in a foreign company on the U.S. stock markets. That seems relevant because of the obligations that attach when listed on a U.S. exchange–the internet (always trustworthy) tells me that when these depository shares are listed on a major exchange, the company is subject to the same reporting requirements and securities regulation that U.S. firms would face. But I wonder how that works out in a case like this. One of the differences of a derivative suite would be seeing the recovery put back into the company (because the shareholders are suing the directors on behalf of the corporation), where a class action like this would see relief given directly to the shareholders themselves. If there are more possibilities for shareholder recovery and/or obligations under U.S. law, should the depository shareholders have more recovery than Brazilian investors?
Second, at least one of the parties is a state retirement fund; I would suspect that at least a couple other class members are investment management entities as well. These types of investors in particular might tend to be relatively hands-off and highly diversified. I wonder how perceptions of corruption, given that these are depository shares, can or should impact a securities fraud claims, particularly Rule 10b-5 claims (one of the claims here, which involves misrepresentation–page 16-17 of Judge Rakoff’s opinion), particularly in the case of hands-off investors. Is the standard of fraud/misrepresentation changed in the case of depository shares if there is some expectation of a high(er) possibility of corruption being allowed in the company’s home country? Or, conversely, are investors allowed to hold companies in high-corruption-risk countries to the full securities fraud misrepresentation standards of U.S. law if they list on U.S. exchanges?
The advantages are well explained in the blog-post. But I am concerned about shareholder’s incentives to act in a proactive manner against corporate wrongdoing.
Take the example of corruption: If you own shares in a company that is corrupt and the company does not get caught for it, you have a good return on your investment. If the company you invested in is corrupt and gets caught for, you can sue them, and still make a return on your investment.
In other words, there are no downside to investing in corrupt companies. Isn’t this problematic?
If you want to know more about the massive Petrobras corruption scandal, visit petrobribes.wordpress.com
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