petrobrasIn an interesting opinion addressing several of the critical issues in the U.S. securities lawsuit arising out of Petrobras bribery scandal, on July 30, 2015, Southern District of New York Judge Jed Rakoff denied in part and grated in part the defendants’ motions to dismiss. Among other things, Judge Rakoff rejected the company’s “adverse interest” argument, in which the company had tried to argue that the complicit corporate executives’ knowledge of the bribery scheme and consequent awareness of the misrepresentations of the company’s financial condition could not be attributed to the company. However, Judge Rakoff dismissed the claims asserted under Brazilian law on behalf of shareholders who purchased their Petrobras shares on the Bovespa, the São Paulo Stock exchange, ruling that these shareholders’ claims were subject to the mandatory arbitration clause in the company’s bylaws. A copy of Judge Rakoff’s opinion can be found here.



Petróleo Brasileiro S.A. (Petrobras) is a multinational energy company headquartered in Brazil. The Brazilian government is the company’s majority shareholder. The company’s shares trade on the Bovespa, and its sponsored American Depository Shares (ADS) trade on the NYSE. The company has been caught up on a massive investigation of rampant corruption involving the company’s contracts for the construction of production facilities. The corruption allegedly involves a scheme in which several large construction companies formed a cartel to circumvent Petrobras’s competitive bidding process. Executives at the company received kickbacks to facilitate the scheme. A system of political patronage resulted in the diversion of funds to various political parties in Brazil as well. As a result of the scheme, the company massively overpaid for several refineries.


The corruption scheme was ultimately revealed as part of an investigation by the Brazilian Federal Police known as Operação Lava Jato (“car wash”). Following the public revelation of the details of the scheme, the company’s shares price fell by over 80% and the price of its ADSs fell by 78%. As discussed here, in December 2014, investors who had purchased the company’s ADSs on the New York Stock Exchange filed a securities class action lawsuit in the Southern District of New York against the company; certain of its directors and officers; its auditor; and its offering underwriters. The ADS investors asserted claims under both the Securities Exchange Act of 1934 and the Securities Act of 1933. An amended complaint added claims alleging violations of Brazilian securities laws asserted on behalf of investors who had purchased Petrobras securities on the Bovespa.


The plaintiffs assert that in various public statements and regulatory filings, the company had made misrepresentation of two types: with respect to the company’s financial condition and about the state of its business and management. With respect to the company’s financial condition, the plaintiffs essentially allege that the company improperly capitalized the costs associated with the payments to the cartel members. With respect to the company’s business and management, the plaintiffs, among other things, alleged that the company had misrepresented its financial controls and its ethical practices.


The defendants filed motions to dismiss the plaintiffs’ claims. On July 9, 2015, Judge Rakoff entered an order (here) stating with respect to the defendants’ motions to dismiss that he was granting the motions in part and denying them in part, for reasons that he would detail in a forthcoming memorandum opinion. On July 30, 2015, Judge Rakoff released the memorandum opinion in which provided the reasons for his rulings.


The July 30 Opinion 

In his July 30 Opinion, Judge Rakoff made three rulings: first, he denied the defendants’ motions to dismiss the plaintiffs’ claims under the ’34 Act; second, he granted in part and denied in part the motions to dismiss the plaintiffs’ claims under the ’33 Act; and third, he granted the defendants’ motions to dismiss the claims asserted under Brazilian law on behalf of investors who purchased their Petrobras shares on the Bovespa.


The ’34 Act Claims: With respect to the plaintiffs’ ’34 Act claims, Judge Rakoff held that the amended complaint adequately alleged that the company’s alleged misrepresentations were both material and false. Although in ruling that the alleged misrepresentations were material Judge Rakoff considered the quantitative magnitude of the alleged financial misrepresentations, he noted that “here, the qualitative factors strongly favor a finding of materiality,” noting that the errors in the company’s financial statements were “directly related to its concealment of the unlawful bribery scheme.”


Judge Rakoff also rejected the argument that the allegedly misleading statements about the company’s business and management were mere “opinion” or “puffery,” stating that “where (as here alleged) the statements were made repeatedly in an effort to reassure the investing public about the Company’s integrity, a reasonable investor could rely on them as reflective of the true state of affairs at the company.”


With respect to the issue of scienter, the defendants conceded that the amended complaint adequately alleged scienter with respect to the four individual defendants who carried out the bribery scheme; however, with respect to the company itself, the defendants relied on the “adverse interest” exception to the general rule that a corporate executive’s scienter is attributable to the corporation. The exception applies where an officer acts entirely in his own interests and adversely to the interests of the corporation.


Judge Rakoff rejected the defendants’ effort to rely on the adverse interest exception, holding that the company’s financial misrepresentations operated as a fraud on the investors, not on the company itself, and that the corrupt executives’ failure to correct the various statements about the company’s integrity and its compliance with law “clearly benefitted the company, which was able to continue to attract investment and to complete its large-scale expansion plans.” Because he found that the amended complaint’s allegations did not establish that the company received no benefit from the alleged misrepresentations, Judge Rakoff concluded that the adverse interest exception did not apply, and that the plaintiffs had adequately alleged scienter.


’33 Act Claims: With respect the plaintiffs’ ’33 Act claims, in which the plaintiffs alleged that the defendants had made various misrepresentations in connection with several Notes offerings during the class period, Judge Rakoff rejected several of the defendants’ arguments that the plaintiffs lacked standing to assert the claims. However, Judge Rakoff granted the defendants’ motions to dismiss with respect to the plaintiffs’ claims based on the 2012 Notes Offering as barred by the ’33 Act’s three-year statute of repose. Judge Rakoff also dismissed plaintiffs’ Section 11 claims based on Notes purchased after various revelatory public statements had been released.


Brazilian Law Claims: In their motions to dismiss, the defendants argued with respect to the Brazilian securities law claims asserted on behalf of investors who purchased their Petrobras securities on the Bovespa that the claims were subject to mandatory arbitration pursuant to the company’s bylaws.


Article 58 of the company’s bylaws provide that “disputes involving the Corporation, its shareholders, managers and members of the Audit Board” regarding “the rules issued by the [Brazilian Securities and Exchange Commission] as well as in all further rules applicable to the operation of the capital markets in general” shall be “resolved according to the rules of the Market Arbitration Chamber.” The Market Arbitration Chamber was created by the Bovespa to serve as a specialized forum for resolution of disputes related to corporate and securities laws.


Judge Rakoff, applying Brazilian law, held that the company’s arbitration clause is “valid and enforceable against purchasers of Petrobras securities on the Bovespa,” holding specifically that Article 58, “by its plain terms, encompasses the Brazilian law claims” asserted in the amended complaint. However, Judge Rakoff rejected the defendants’ arguments with respect to the subclass of investors who purchased securities on both the NYSE and the Bovespa that those investors had to arbitrate all of their claims, even those asserted under U.S. law with respect to the shares purchased on the NYSE, ruling that the arbitration clause, and the investors inferred consent to the clause, did not extend to these investors’ claims under U.S. law.



Among the more interesting parts of Judge Rakoff’s opinion is his rejection of what has become of the messages that Petrobras has tried to communicate about the scandal, which is that the company itself is one of the scheme’s victims. Judge Rakoff was having none of that, highlighting the fact that the company benefitted greatly from the scheme for years, until the scheme finally came to light.


Judge Rakoff’s ruling that the company’s bylaw arbitration clause was valid and enforceable is interesting as well. In recent years, there has been an active movement in the the form of litigation reform bylaws (relating, for example to issues such as forum selection and fee-shifting). Among the litigation reform bylaw proposals has been the inclusion in bylaws of mandatory arbitration clauses. As discussed here, a series of court decisions upheld the validity under Maryland law of the arbitration clause in the bylaws of Commonwealth REIT. However, those decisions, unlike this case, did not involve the application of the bylaws to a claim under the federal securities laws.


While litigation reformers might take heart from Judge Rakoff’s determination here that the Petrobras mandatory arbitration bylaw is valid and enforceable, it is important to note not only that his rulings were made under Brazilian law, but also that the Petrobras arbitration bylaw was adopted pursuant to a formal scheme organized by the Brazilian stock exchange. It seems unlikely that Judge Rakoff’s ruling under Brazilian law would have much bearing on the questions of the validity and enforceability of a mandatory arbitration clause under U.S. corporate law to a claim asserted under U.S. securities laws.


Some readers, reading about the claims asserted on behalf of the investors who purchased their Petrobras shares on the Bovespa, may have vaguely wondered why those claims were not barred by the U.S. Supreme Court’s decision in Morrison v. National Australia Bank, since the claims did not involve domestic U.S. securities transactions. The key is that the Bovespa purchasers’ claims were asserted under Brazilian securities laws, not the U.S. securities laws. Because they purported to assert claims under Brazilian law, Morrison is irrelevant. Morrison determined only the U.S securities laws’ reach, not the reach of U.S. courts.


There is actually some precedent for this type of approach. As discussed here, in a September 2014 ruling, a federal judge ruled that the Deepwater Horizon disaster-related lawsuit brought against BP by investors who purchased their BP shares on the London Stock Exchange and who were asserting claims based on English law could proceed in U.S. court. Although there were factors unique to the Deepwater Horizon disaster that affected the court’s determination in that case, it is an example of a case where investors who purchased their shares on a non-U.S. exchange were permitted to pursue a lawsuit in a U.S. court without running afoul of Morrison. However, in this case, Judge Rakoff concluded that the Bovespa investors attempt to pursue their Brazilian law claims in U.S. court were barred by the company’s mandatory arbitration clause, so he never reached the issue of whether or not the investors could otherwise pursue their claims in U.S. court.


The Petrobras bribery scandal has swept up a number other companies, including two of the country’s largest construction companies and their executives (refer here). The scandal has also resulted in two other U.S. securities class action lawsuits, one involving the Brazilian chemical company, Braskem (about which refer here), and Eletrobras (refer here, third item), as well as this securities lawsuit involving Petrobras itself. The massive scandal continues to unfold.


During my recent trip to Brazil, I learned that the unfolding Petrobras scandal has roiled the D&O insurance marketplace there, not only because of the magnitude of the claims that have emerged already but also because of the uncertainty about what other companies could become swept up in the scandal investigation. The local and locally active carriers are tightening terms and conditions and seeking pricing increases. Even more difficult than the more restrictive marketplace conditions is the overall uncertainty. There are general concerns about what might be next. The resulting uncertainty creates very challenging conditions for the local D&O insurance professionals and the companies they must advise.


Whether the expanding Petrobras investigation will result in other Brazilian companies being sued remains to be seen. But whether or not the Petrobras scandal itself results in further claims, it is clear that there will be more lawsuits in the future following-on in the wake of bribery and anticorruption investigations. As I detailed in my post about the Braskem lawsuit to which I linked above, over the last several years there has been a growing number of U.S. securities lawsuit involving non-U.S. companies that are the targets of corruption investigations in their home countries.


Brazil is not the only country cracking down on corruption. China, Australia, Canada, Italy, Romania, South Korea and numerous other countries have stepped up their corruption enforcement. Increasingly, enforcement authorities are cooperating and collaborating cross-border as well. These activities create operational uncertainty for companies in these jurisdictions. They also create challenges for the local D&O insurance professionals as well.


Special thanks to a loyal reader for providing me with a copy of the Judge Rakoff’s Petrobras opinion.


The Future of Securities Class Action Litigation?: In an interesting July 31, 2015 post on his D&O Discourse blog (here), Doug Greene shares his thoughts about the future of securities class action litigation in the U.S.  Among other things, he notes how, starting with the Chinese reverse merger securities suits in 2010, there has a pronounced shift in the securities lawsuits that are being filed, toward suits against smaller companies, filed by smaller plaintiffs’ law firms. As Greene notes, this trend has implications for the way that securities suits are going to have to be defended, and implications for D&O insurers as well.


Supreme Court Review of Insider Trading Issues?: You may have heard that the U.S. Department of Justice has asked the U.S. Supreme Court to review the Second Circuit’s decision in the United States v. Newman case, in which the appellate court overturned the insider trading convictions of two hedge fund managers who had traded in shares of Dell and Nvidia based on nonpublic information they had received from sources. It remains to be seen whether the Supreme Court will take up the case, but there is a long history and trading of the high court taking up cases proposed by the government, so it is possible we could see the consideration of insider trading standards by the Supreme Court. To see a good review of the issues that the case presents, please see UCLA Law Professor Stephen Bainbridge’s thorough July 31, 2015 post on his eponymous blog, here.


ABA Top 100 Law Blogs List: Once again, it is time for nominations to the American Bar Association’s annual list of the Top 100 Law Blogs. I certainly am going to nominate my favorite law blogs for inclusion in the list. I would be very grateful to any reader who would be willing to nominate The D&O Diary for inclusion in the ABA’s annual list. You can nominate your favorite law blogs on the ABA website, here. When you make your nominations be sure to provide the reasons why you like the blogs you are nominating. Nominations are due no later than 11:59 p.m. CT on Friday, Aug. 16, 2015. Thank you for your support.