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Brazil: Avoiding the Potholes of Fraud

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The opportunities for foreign suppliers, contractors and investors are considerable. So, too, are the risks of fraud.

BY VANDER GIORDANO
AND ALLIE NICHOLS

SAO PAULO -- Traveling by air, land or sea in Brazil can be a feat of epic proportions. The Federation of International Football Association’s (FIFA) Secretary General told the country’s authorities that airport facilities and connections between host cities are the Federation’s greatest concerns for the 2014 World Cup. The apprehension is well-founded:  although the World Economic Forum’s Travel & Tourism Competitiveness Report 2009 ranked Brazil 45th out of 133 countries overall, its airport infrastructure was rated 101st.

The country is also home to some of the world’s worst automobile traffic: São Paulo, the largest city, regularly endures traffic jams of over 100 miles long – the longest was 165 miles. The city puts the annual cost of the traffic at $2.3 billion. The ports are choked with lines of ships, as well. Bloomberg News reports that trucks delivering sugar wait up to 40 hours to unload their cargo onto vessels.

Brazil must address these problems in order to sustain current levels of economic growth. Of more immediate urgency, however, is the need to be ready for the inundation of tourists expected for the World Cup in 2014 and the Olympics in 2016.  In its application to host the latter, for example, Brazil committed to spend $1.1 billion on upgrades to Rio de Janeiro’s suburban railway, $1.5 billion on projects to expand and connect pre-existing bus rapid transit systems, and $1.2 billion for metro line extensions.  In addition, $80 million is earmarked for airport upgrades to renew and add terminals and runways, and to expand parking facilities in order to accommodate 25 million passengers annually by 2014.

Whatever its immediate cause, such infrastructure investment will clearly provide long-term benefits for the country’s population and significant opportunities for investors and companies alike. Investors and project planners, however, must take into account the prevalence and history of fraud that has long tainted this industry in Brazil. The latest Global Fraud Survey, produced by the Economist Intelligence Unit for Kroll, suggests this trend continues, having found that 83% of Brazilian companies believe that their exposure to fraud has increased over the last 12 months. The survey also revealed that 27% of Brazilian companies indicated that they had been the victim of vendor, supplier, or procurement fraud during that time. In the coming wave of investment, the planning, organization, and management of these projects will be critical to determining whether they will be successes or costly failures beset by fraud.

TWO CAUTIONARY TALES

For years, transportation infrastructure projects in Brazil have been rife with fraud and the problem shows no sign of abating. As recently as August 5, 2010, arrest warrants were executed for 28 individuals accused of rigging bids and diverting funds related to several transportation infrastructure projects in Brazil. Losses are estimated to be nearly $2.9 million and the accused range from government administrators and officials to owners and employees of the companies contracted to perform the work. They face a wide range of charges, from corruption, embezzlement, and money laundering to forgery, conspiracy, and other criminal violations of Brazilian bidding laws.

Another recent example of fraud in the sector came to light in September 2009 when a whole host of individuals, companies and other entities that provide or manage services related to the air travel industry were investigated for allegedly rigging online auctions and forming a cartel that served to exclude potential competitors from the market. Of the 305 companies authorized to participate in bids, only 16 actually registered. The fraud, estimated to have reached more than $286 million, was one of the largest of its kind in recent Brazilian history.

The ways in which fraud in the industry has been perpetrated are seemingly endless: overbilling, overpayments, use of ghost employees, use of materials of inferior quality, attesting to work that has not actually been completed, forewarnings about upcoming audits, altering or concealing documents. Given the widespread presence of fraud, the risks inherent in participating in infrastructure projects can outweigh the benefits. In most cases, these projects involve government officials or entities in some capacity. Consequently, if your company has any significant link to the United States or the United Kingdom, the far-reaching provisions of the Foreign Corrupt Practices Act (FCPA) or UK Bribery Act could lead to crippling costs, including penalties, disgorgement of profits, and mandatory monitoring. Moreover, Brazilian authorities can separately impose their own hefty fines and initiate criminal and civil litigation. Finally, conviction for fraud, or even investigation, can result in reputational damage which, while difficult to quantify, will certainly leave a long-lasting scar on any company or individual involved.

BE PREPARED

For companies seeking to exploit upcoming investment opportunities there are several ways to build up a layer of protection against fraud. The first step is to evaluate the transparency and fairness of the bidding process carefully. Some of the key questions that should be asked include: Have the details of the process been clearly communicated? Is an independent committee or person presiding over the process? What criteria will be used to qualify or disqualify bidders?  Are these criteria fair or tailored to disqualify all but a select few companies?  Are they reasonably related to the necessities of the present project?  What factors will be considered in selecting the winner? All of these questions should be answered to the company’s satisfaction before it submits a bid.

The second step for a business is to conduct background checks on its own employees and on those companies which it will engage. This is especially important when subcontracting local workers and businesses. A thorough background check can provide clearer details of their qualifications and prior experience, how they are perceived by their competitors and clients, and whether they have previously been involved in fraudulent projects or have otherwise been the subject of a fraud investigation.

Competitive market intelligence is an additional weapon in the investor’s arsenal. Fundamental questions to consider in this analysis include: Are competitors able to sell their services and products at abnormally low prices?  If yes, is there a legitimate reason or is the real explanation that fraudulent methods are being employed, such as the use of substandard or counterfeit materials and products?  Is there a cartel or similar organization in place that is preventing other companies from entering the market in general or a particular bidding process?  Is it possible other relationships exist between competitors that would constitute unfair competition?

Safeguards against possible fraud and exposure to corruption during the project’s execution are equally important.  It is essential that corporate executives be aware of local and international laws, regulations, and industry standards, particularly when doing business in new jurisdictions. These must therefore be researched and resultant actions and policies clearly communicated and enforced through appropriate training and periodic monitoring of the work underway. Additionally, audits of, for example, purchase orders, invoices and payroll information will provide information that can raise red flags.

Brazil’s need for transportation infrastructure is great, and the government’s commitment to investment and to the industry is clear.  Those wishing to take advantage of this tremendous opportunity, however, need to put in place protection against high levels of fraud.

Vander Giordano is a managing director based in Kroll’s São Paulo office and specializes in business development for Latin America. He is a member of the Brazilian and International Bar Associations.  Allie Nichols is a compliance associate based in Kroll’s New York office.  She is an attorney with business experience in Brazil and has published several articles in leading Brazilian publications. This article is republished with permission from Kroll Tendencias, Kroll’s monthly newsletter.

 

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