Auditors evaluating a recent transaction for a Brazilian energy firm held up the deal for more than six months. The delay wasn't the result of malice, ineptitude or efforts to bill more hours. Rather, the investigation into the company's operations—an effort to root out potential corruption—was so thorough, it merited more time.

“They were working hard to get to the bottom of corruption issues—that can be time-consuming,” recalls Steven Sandretto, a corporate law partner in Paul Hastings' São Paulo office with knowledge of the deal.

More than five years have passed since Brazil unveiled Operation Car Wash—a probe into the operations of the construction firm Odebrecht that signaled a willingness and ability to crack down on corruption. The investigation uncovered Odebrecht's illicit payments to government officials, who in turn awarded lucrative contracts to the company. The investigation ultimately had a ripple effect throughout Latin America, even taking down former presidents.

It has also had a profound impact on business. Lawyers say that due diligence to uncover potential corruption consumes many more hours now for the legal representatives, bankers, accountants and company executives working on any given deal. The goal is to search for practices that would violate the U.S. Foreign Corruption Practices Act, either to flag them to authorities or walk away from the transaction.

Michael Fitzgerald, head of the Latin America practice at Paul Hastings, calculates that extra due diligence has added hundreds of millions of dollars in legal and accounting expenses to deals in the region over the past five years. “It's pretty much baked into the process now of raising capital in Latin America,” he says. 

Paul Hastings has a separate practice area focused entirely on due diligence, and the firm has staffed up to meet growing demand. This sort of homework is important because it helps investors accurately value targets, identify violations of in-country law and identify issues that could delay closing deals should clients push forward.

The Car Wash investigation took on people previously thought untouchable in Brazil: Top businessmen and politicians. Then, its revelations unmasked high-level corruption in Colombia, Mexico, Peru and Venezuela—with varying degrees of impact.

Odebrecht admitted in 2016 that it had paid millions of dollars in bribes to officials in a dozen countries to secure public works contracts going back more than a decade.

The fines have been substantial: Odebrecht paid around $3.5 billion in settlements in the U.S., Brazil and Switzerland in the wake of the scandal, while one of its clients, Brazilian state-run oil firm Petroleo Brasileiro agreed to pay $2.95 billion to settle a U.S. class-action lawsuit. Shareholders will often argue in litigation that companies condoned corruption.

The sizable fines and threat of lawsuits have made a difference. The Car Wash investigation has led to heightened compliance efforts in Brazil.

“The culture of compliance in Brazil—which was practically nonexistent in 2013—has now taken off to a level of professionalism never imagined,” says Rafael Ribeiro, a partner with Hogan Lovells in Miami who has handled numerous internal investigations and cross-border investor disputes in Latin America.

Brazil's Clean Companies Act, implemented in 2014, established potential fines of as much as 20% of a company's prior year gross income if employees are proven to have engaged in graft. 

But in Brazil, Ribeiro says the impression was that this law was “great on the books”—essentially just for show to the international community. That impression changed with Lava Jato, as the Brazilian investigation into Odebrecht is known in Portuguese; people started going to jail and prosecutions became real.

“There's an important need for preacquisition due diligence—you'd better kick the tires first,” Ribeiro says.

Sandretto describes the Car Wash investigation as a “game-changer” in Brazil. Previously, he says, there was “a check-list mentality” for mergers, acquisitions and other corporate transactions.

More Due Diligence

Lawyers, bankers and accountants now spend many hours focusing on due diligence for deals, poring over documents. Before Lava Jato, they spent perhaps an hour doing such work. Companies are asked to furnish copies of internal policies, procedures and payment receipts. Questionnaires are detailed, consisting of five or more pages versus perhaps two questions previously.

Some of the most significant questions relate to better understanding relationships with third parties, such as shell companies, since that's where much of the risk lies. These parties may be customs brokers, accountants, lawyers, consultants, sales agents, distributors or lobbyists who have close relationships with government officials or unions that influence business decisions.

More broadly, the first step in assessing risk for any acquisition is to consider country risk. A purchase in Venezuela would be held to higher scrutiny than one in Chile, for instance.

In Transparency International's 2019 Corruption Perceptions Index, where a lower score indicates a higher level of corruption, Venezuela scored 18 out of 100 points. That puts it on par with Iraq and among the dozen “dirtiest” in the survey of 180 countries. Chile scored 67 points, just four points less than the U.S. 

Next, compliance officers look at how many touchpoints the business has with government officials—contracts, building permits, customs—that present opportunities for bribes. Companies with government contracts are a minefield.

Forensic accountants with KPMG recommend going back at least two years to search for shell companies that may have hidden suspicious payments, fake invoices or contracts won at below-market prices. For companies accused of corruption, they suggest safeguarding all digital and physical evidence so as to reconstruct the internal network that allowed slippery dealings to flourish.

The burden on companies is sizable—with some paying the same amount of time and attention to examine a $10,000 transaction as they would a $1 billion transaction. Most global law firms recommend self-reporting when companies find something amiss in the books.

The anti-corruption drive has translated into rising demand for legal services to address compliance issues across Latin America. 

“It's been huge,” said Hastings' Fitzgerald. “It has certainly increased the cost of doing business in the region.”