Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.
Theresa Tedesco of the National Post reports, Buyer beware: How the Ontario Teachers’ Pension Plan got caught in the fallout of Brazil’s biggest scandal:
An investigation into money laundering at gas stations and laundromats that began two years ago in southern Brazil has since mushroomed into a wide sweeping corruption scandal, creating a national soap opera that has enthralled Brazilians as it reaches into the upper echelons of the country’s political and corporate elites.
Operation Lava Jato (Car Wash), launched by Brazil’s federal police, has ensnared top executives at Brazil’s powerful state-controlled oil giant Petroleo Brasileiro SA (Petrobras) who are alleged to have accepted bribes from a cartel of companies to enrich themselves while also channelling funds to politicians.
The fallout has included the recent impeachment of President Dilma Rousseff and the arrest of dozens of senior politicians and business leaders. But also caught up in the tumult are hundreds of millions of dollars managed by some of the world’s biggest investors, including Ontario Teachers’ Pension Plan, one of Canada’s biggest and most respected publicly funded pension funds.
Teachers’ is among a group of major global investors who own an 18.6-per-cent stake in Grupo BTG Pactual SA, the largest independent investment bank in Latin America, whose billionaire founder, chairman and chief executive, Andre Santos Esteves, was arrested last November for allegedly attempting to obstruct the corruption probe.
The charismatic 47-year-old, with an estimated net worth of US$2.2 billion according to Forbes Magazine, is the highest-profile business executive implicated in the widening corruption dragnet and was held under house arrest for almost four months until he was released in late April.
The current criminal charges against Esteves are still pending and he has vehemently and repeatedly denied any wrongdoing. Yet he was forced to resign from his executive roles at BTG Pactual, although he remains the controlling shareholder.
Shares of BTG Pactual, which are listed on the BM&F Bovespa and NYSE Euronext, have collapsed, losing more than 50 per cent of their value before recovering some ground although they are still down 42 per cent. The investment bank’s bonds have been downgraded to junk status by credit rating agencies Moody’s Investor Services Inc., Fitch Ratings and Standard & Poor’s.
BTG Pactual in May was also listed among nine financial institutions placed under “special surveillance” by Brazil’s central bank, which is closely monitoring the liquidity and stability of their operations, according to a report by Reuters.
The firm, which Esteves steered through an aggressive global expansion, has sold more than US$3.5 billion in assets, including loan books and its Swiss private-banking unit BSI, slashed dividend payments and cut costs at its operations in Brazil, Europe and Hong Kong.
Teachers’ original $206-million private-placement investment made in December 2010 is now worth less than $150 million.
Teachers’, which has a reputation for promoting good governance and principled investing, declined repeated requests to answer questions about its investment in the Brazilian investment bank and association with Esteves, who along with other business associates have a track record of being on the wrong side of securities laws.
“We very rarely discuss the mechanics of our decisions and rationale for specific investments in companies or assets,” Deborah Allan, vice-president of media relations, said in an email. “We’re a global and well diversified long term investor, and we operate with the principles of investment risk.”
There’s no doubt the pursuit of higher returns is increasingly propelling major Canadian pension funds to invest in emerging markets such as Brazil, said Malcolm Hamilton, an actuary and former partner at Mercer with 40 years’ experience in the pension industry.
“The pressure has just been getting worse and worse, especially as interest rates continue to decline, for public funds to try to get the returns they used to get,” he said. “They want to invest where they can achieve the best return for the risk they take, and this means looking beyond Canada and North America to opportunities elsewhere in the world.”
Those opportunities also bring heightened risk.
“Sometimes it’s hard to perform tough due diligence in developing countries, especially when people will always present you with the best possible picture,” said a senior pension expert who asked not to be named. “Sometimes you make mistakes and you’ve got to keep it even when it’s tricky.”
Added Keith Ambachtsheer, director emeritus at the Rotman International Centre for Pension Management at the University of Toronto: “When you’re in this type of situation, maybe the right way to go is to try to save the investment, clean up the situation and drive on.”
• • •
Andre Santos Esteves, also known as the golden boy of Brazilian banking, and his partners pulled off a major coup when they persuaded an impressive group of nine major global investors — mostly sovereign-wealth funds and rich families — to purchase an 18.65-per-cent interest in BTG Pactual for US$1.8 billion in December 2010.
But it seems Teachers’ held a special place in Esteves’ heart. During the annual Foreign Policy Association’s Financial Services Dinner at the Pierre hotel in midtown Manhattan for 400 well-heeled guests on Feb. 29, 2012, he introduced the evening’s guest of honour, James Leech, then the chief executive of Teachers’ as “one of the most sophisticated investors in the world.”
In his heavily accented English, the billionaire that Forbes ranked 13th richest in his country, declared that his bank has “a very special relationship with Ontario Teachers’,” adding that when BTG Pactual organized the largest private placement in Latin America, “Ontario Teachers’ was one of the cornerstone investors.”
Each of those investors — China Investment Corp., Singapore’s Government Investment Corp. Pte Ltd., Abu Dhabi Investment Council, J.C. Flowers & Co., RIT Capital Partners PLC, Colombia’s Santo Domingo Group, Exor, Inversiones Bahia and Teachers’ — invested anywhere from $25 million to $300 million.
In return, the investment consortium received three seats on the Sao Paulo-based bank’s board, one of which was given to Teachers’ (which has appointed people to the post, although it is been vacated since Esteves’ arrest). More importantly, the investors were guaranteed handsome returns down the line when BTG Pactual eventually went to the public markets.
A 2011 analyst report for Exor noted the investment company controlled by Italy’s Agnelli family was given “a guaranteed minimum IRR (internal rate of return) of 20 per cent for its commitment to the IPO.”
But two months before the private-placement deal was inked, central bank investigators and securities regulators in Brazil threatened to derail it.
In October 2010, a probe inside Brazil’s central bank recommended that Esteves be banned from banking in the South American country for six years due to “serious infractions” of banking rules between 2002 and 2004, according to a report by Reuters.
The investigation focused on US$3.8-billion worth of trades between Banco Pactual SA and a limited liability corporation known as Romanche Investment Corp. LLC in Delaware.
Brazil’s central bank director Sidnei Correa Marques ruled against the ban in early 2011, apparently because of the importance of BTG Pactual, the precursor to Banco Pactual, to the economy and the perception of disciplining the head of Brazil’s largest investment bank.
“When a bank is important systemically, important to the country, among the 10 largest, I have to be careful about getting rid of essential management at that financial institution,” the central bank director was quoted by Reuters.
However, Brazil’s securities market authority — the Comissao de Valores Mobilianos (CVM) — was less forgiving. In a separate case, the market watchdog concluded that Banco Pactual had illegally transferred profits to foreign funds to disguise gains and avoid taxes. In 2007, the CVM fined Pactual and Esteves about US$4 million although there was no admission of guilt or wrongdoing.
By the time the two decisions were rendered, Esteves had already persuaded Teachers’ and eight other well-heeled investors to give him the all-important credibility to eventually take his bank to market.
• • •
BTG Pactual’s initial public offering, the first for an investment bank in Brazil and the most high-profile and lucrative pubic offering that Brazilian capital markets had seen in almost a year, occurred April 26, 2012. The stock was priced at 31.25 reals and the IPO raised about US$1.96 billion.
That same year, Esteves was honoured as “Person of the Year” by the Brazilian-American Chamber of Commerce and one of the 10 most influential bankers in the world by Bloomberg Magazine, alongside Wall Street icons Jamie Dimon of JP Morgan Chase and Lloyd Blankfein of Goldman Sachs, as well as Gerald McCaughey, then chief executive of Canadian Imperial Bank of Commerce.
Behind the scenes, however, Esteves’s past brushes with securities regulators began to emerge.
A month before BTG Pactual’s private-placement deal was signed in December 2010, Italian market regulators had notified Esteves that he was the target of an insider trading probe dating back to 2007, when he was head of fixed income at UBS.
The Commissione Nazionale per le Societa e La Borsa alleged that Esteves used a private account to purchase shares in Italian meat producer Cremonini SpA after he heard about an upcoming joint venture with a Brazilian company.
Esteves denied and fought the allegations, but apparently did not inform his investors of the ongoing probe when they participated in the 2010 private placement. Nor was the probe disclosed to potential investors in BTG Pactual’s initial IPO prospectus in April 2012.
On April 4, 2012 — three weeks before BTG Pactual’s IPO — Italy’s capital markets authority fined Esteves 350,000 euros for alleged insider trading.
The findings and penalties against the Brazilian banking executive were “administrative,” however he was suspended nine months from serving as a director or executive officer of a company regulated by the Italian securities commission. As well, he was forced to return his alleged profits of US$5.4 million.
A day before the Italian regulator released its decision, BTG Pactual amended its IPO prospectus and issued a statement that read “our controlling shareholder is a subject of an ongoing civil, non-criminal investigation in Europe in connection with certain trades in the securities of a European market issuer made by him in his personal capacity in 2007.”
Notably absent is any mention of Esteves directly or that the controlling shareholder was also the chief executive and chairman of the board of BTG Pactual. (Esteves would file an “administrative appeal,” later withdrawn despite his protestations of innocence, citing costs and a loss of time as his reasons.)
Even so, Brazil’s securities regulator CVM issued a receipt blessing the IPO.
“Under those circumstances, why was the IPO even allowed to proceed?” asked a senior Canadian regulator who spoke on the condition of anonymity. “At a minimum, the Brazilian securities regulator should have demanded disclosure of Esteves’s role in the company. Any commission in Canada and the SEC [the U.S. Securities and Exchange Commission] certainly would have insisted.”
Sources say the private-placement shareholder group was broadsided by the revelations of Esteves’s track record of securities violations.
In the days following the Italian probe, principal investors were given the opportunity to back out of the deal and some took the opportunity.
For example, the Agnelli family, which invested US$25 million, sold 87 per cent of its 0.26-per-cent interest less than a month after learning of Esteves’ insider trading conviction, according to a 2011 filing. U.S. investment firm J.C. Flowers began slowly divesting some of its stake, as did RIT Capital Partners and China Investment Corp.
What they didn’t know at the time was that Charles Rosier, a partner at BTG Pactual in charge of client relations in Europe, had also been in the crosshairs of securities regulators while Esteves was gathering the consortium of investors back in 2010.
France’s market regulator was probing insider trading during the French state railway’s takeover of a logistics company called Geodis in March 2008, while Rosier was a managing director at UBS, which had advised on the deal.
The result was that the Autorite des Marches Financiers in October 2013 levied the largest fine in its history by penalizing Rosier 400,000 euros for tipping insider information to his cousin prior to the deal.
The investigation of Rosier and his subsequent conviction have not been disclosed in any of BTG Pactual’s corporate filings. Calls to a number of the consortium investors and BTG Pactual were not returned.
Since the revelations of Esteves’ insider trading convictions in 2012 and the bribery and corruption charges against him in 2015, sources familiar with the Brazilian investment bank say six of the nine principal investors have sold their interests.
The three remaining “cornerstone” investors are Singapore’s sovereign fund, Colombia’s Santo Domingo Group, which among other holdings held the second-largest stake in SABMiller PLC, the world’s second-largest beer company, and Teachers’.
At the end of 2012, Teachers’, which manages $171.4 billion in net assets, had $206 million invested and that exposure remained the same at end of 2013. The following year in 2014, it was down to $203.4 million and by Dec. 31, 2015, the value plunged below $150 million, mostly due to the fallout of Esteves’ arrest.
“We remain an investor,” Teachers’ spokesperson Allan confirmed in an email, adding, “it remains part of our relationship investing portfolio, in our public equities asset class.”
Ultimately, Teachers’ main function is to create value for plan participants and it has certainly done that. In the four years since BTG Pactual’s IPO, the pension fund has enjoyed annual returns of 13 per cent in 2012, 10.9 per cent in 2013, 11.8 per cent in 2014 and 13 per cent in 2015.
Teachers’ investment in BTG Pactual is relatively small, but it raises questions about its ability to properly vet investments far from home, and its troubles in Brazil are far from over. A multi-million-dollar lawsuit launched by a former executive against BTG Pactual in Hong Kong also threatens to drag the investment bank’s principal partners, including Teachers’, into another potentially unseemly mess.
So what is this all about? Basically André Santos Esteves, the golden boy of Brazilian banking, was able to schmooze Ontario Teachers and large sovereign wealth funds into buying a 19% stake of BTG Pactual through a private placement and now it turns out he might be another Brazilian con artist.
Remember Eike Batista, Brazil’s rags to riches (back to rags) billionaire boy wonder? He too burned Ontario Teachers but at least they invested early on with him and made money in those investments before Batista’s massive empire crumbled (a former colleague of mine who met Batista told me “he was an unbelievable salesman”).
I’m sure Teachers made some money off BTG Pactual too. When I was working at the Caisse, we had invested in BTG Pactual’s multi-strategy hedge fund and everything was kosher and it performed exceptionally well (don’t think the Caisse is invested in it any longer; its hedge fund program has been slashed). BTG Pactual is a Latin American powerhouse when it comes to banking.
More importantly, this deal represents a small investment in Teachers’ huge portfolio, so it will be able to absorb any losses and it won’t make a dent in the overall performance which has been stellar in the last ten years.
Having said this, even if it’s a small deal, the last thing Ontario Teachers or any big Canadian pension fund needs is headline risk.
Don’t forget, back in February, news broke out that Teachers stepped on a German land mine, so the last thing Teachers needs is more negative press highlighting its supposedly weak due diligence.
The truth is Ontario Teachers has a great due diligence team but my sources tell me it might be stretched thin, covering everything from hedge funds, to private equity funds, private placements and PIPE deals. If this is true, OTPP’s board and senior management need to rectify it.
I sent this article to Ron Mock, Ontario Teachers’ CEO, and Jim Leech, the former CEO. Not surprisingly, they didn’t reply but I already know what their reply would be: “Sometimes you find gems of deals and sometimes you get burned badly, it’s the nature of taking risks in emerging markets and elsewhere.”
That’s true but Ive been very skeptical about Brazil’s boom for a long time and think many Canadian pension funds were too quick to pull the trigger, even if these are long-term investments.
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.
As for Ontario Teachers, I have no doubt that Wayne Kozun and his team know what they’re doing and while the article above raises a lot of red flags, you need to take everything you read with a grain of salt. I’m sure it’s not all terrible or else Teachers would have dumped this investment a long time ago. Also, keep in mind, the media reports only bad news, not the investments that went well in Brazil.