Brazil’s Pension Scandal?

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Anthony Boadle of Reuters reports, Brazil’s new government buffeted by pension fund scandal (h/t, Suzanne Bishopric):

The government of Brazil’s new President Michel Temer scrambled on Tuesday to distance itself from a multibillion-dollar corruption scandal that broke less than a week after he took office, involving fraud in the country’s largest pension funds.

With the country already reeling from a sprawling bribery and kickback scandal at state oil company Petrobras, the new corruption case could hamper the conservative Temer’s efforts to restore credibility and turn the page on the leftist government of impeached President Dilma Rousseff.

Police on Monday arrested five people linked to fraudulent investments made by four huge pension funds of state-run companies. The investigation snared dozens of businessmen and fund managers suspected of involvement in a fraud scheme valued at around 8 billion reais ($2.5 billion), including the chief executive of the world’s biggest beef exporter.

The coveted appointments of directors to the funds’ boards were made by political parties and the probe is expected to spread to Brazil’s political establishment, where some 50 politicians are already under investigation in the Petrobras scandal.

Temer’s office said the appointments were made during the 13 years of Workers Party rule that ended with Rousseff’s removal from office last week, and the “irregularities” uncovered by the police had nothing to do with the current administration.

“The Workers Party appointed the pension fund directors from the moment it took office in 2003 and they were closely linked to the unions,” said a Temer aide who asked not to be named.

“The Workers Party was responsible for the big loss suffered, ironically, by the workers of the state companies who were saving for their retirement,” the aide said. “This has not even scratched the image of the new government.”

Temer’s government will press for a thorough investigation as it pushes through proposed legislation that will depoliticize the appointment to directors of state companies, he said.

The investigation focuses on investments in overpriced assets, including private equity funds with artificially inflated share prices, according to the federal police.

The Workers Party declined to comment on the investigation but its president, Rui Falcao, denounced as “arbitrary” a raid and seizure of documents at the home of the party’s former treasurer Joao Vaccari, jailed a year ago in the Petrobras scandal.

POLITICAL INTERFERENCE

Political observers in Brasilia doubt that Temer’s Brazilian Democratic Movement Party will emerge unscathed from the new scandal, since it shared power with the Workers Party during the years the fraud allegedly took place. The party has also been deeply implicated in the Petrobras scandal.

The state-company pension funds, flush with cash, have long been vulnerable to political interference and dogged by suspicions of fraud, said political risk consultant Andre Cesar.

“The 8 billion reais is just the tip of the iceberg. They have opened a Pandora’s Box and names of politicians will inevitably appear sooner or later,” Cesar said.

Even if nobody in Temer’s government is implicated, the new scandal underscores some of the unsavory ties between business and political interests in Brazil that have undermined confidence in Latin America’s largest economy.

“What are voters going to think? We just got rid of one government and corruption continues just the same in the new one,” Cesar said.

The pension funds caught up in the investigation are those of state-run banks Banco do Brasil and Caixa Economica Federal, the postal service Correios and oil company Petrobras, or Petroleo Brasileiro SA. The funds have said they are cooperating with the investigation.

The funds, which controlled 280 billion reais in assets last year, have been an important source of investment in Brazil’s credit-starved economy, now in its second year of recession.

I just finished writing a comment on the global pension crunch, going over China and Chile’s pension woes, and the hits just keep on coming.

The latest pension scandal coming out of Brazil shouldn’t surprise us. Brazil and other Latin American countries are fraught with political corruption, and it’s no different in other emerging markets. These scandals typically come to the surface after a big boom turns into a big bust.

I discussed my thoughts on this recently when I went over Ontario Teachers’ Brazilian blunders:

Investing in emerging markets isn’t easy. You need to find the right partners and make sure they’ve got the right alignment of interests and aren’t con artists. I don’t trust many fund managers in Brazil and think there are a lot of blowhards there selling snake oil. Then again, Brazil is home of 3G Capital, arguably the best private equity fund in the world (at least Warren Buffet thinks so).

And while there’s no denying Brazil has huge potential, it’s currently experiencing a lot of political and economic turmoil, highlighted by the fact that the 2016 Rio Olympic Games are in dire straits.

The lesson for Canada’s large pension funds? Choose your investment partners very carefully in emerging markets like Brazil, Russia, China and India but no matter how well you vet them, be prepared for headline risk if things go awfully wrong.

Now, I don’t want to beat up on emerging markets like Brazil because the truth is scandals happen everywhere, including the United States and even boring old Canada (we just don’t hear about them every time because they are swept under the rug).

The key difference — and I keep harping on this — is that Canada’ radical pensions have adopted world class governance standards precisely to avoid undue political interference and corruption in their day-to-day operations.

Importantly, Canada’s large public pensions have an independent, qualified investment board overseeing their operations but not responsible for taking investment decisions or other decisions that are the responsibility of senior pension managers who get compensated extremely well if they deliver outstanding long term results.

Is it perfect? Of course not. No governance system is perfect and even in Canada, I can tell you there are shady things going on at large public pensions to varying degrees. It can be as “innocent” as a new CEO coming into power and placing all his people in key positions (basically, shoving them through the front and back door) on to more serious stuff like pension fund managers accepting bribes from external managers or third party vendors, service providers and brokers (to be fair, this is extremely rare but shady things do occur at large Canadian funds too).

Still, even though the governance at Canada’s large pensions is far from perfect, I would take our governance model over that of any other country, including the United States where public pensions are crumbling and many are facing disaster.

So the next time you hear of Brazil’s pension scandal or that of another country, just remember the root cause is poor governance which allows for public pensions to be easily corrupted or influenced by politicians who don’t have the pension’s stakeholders best interests at heart.

Of course, there’s outright corruption and then there’s what I call “systemic and legal corruption” like in the US where poor governance allows for undue political interference at public pensions, basically ensuring external fund managers can rake them on fees. This symbiotic and perverse relationship has been going on for years but now that the pension Titanic is sinking, the chicken has come home to roost, threatening the very foundations that Wall Street was built on.

I know, I sound like a hopelessly arrogant, cynical and critical Greek-Canadian jerk who needs to give everyone the benefit of the doubt when it comes to pensions but I’m not here to coddle people in power and you’re not reading me for the sanitized version of pensions and investments.