In mid-2013, Brazilian federal police investigator Erika Mialik Marena noticed something strange.
Alberto Youssef, suspected of running an illicit black-market bank for the rich, had paid 250,000 reais (about $125,000 at the time) for a Land Rover. The black Evoque SUV ended up as a gift for Paulo Roberto Costa, formerly a division manager at Brazil’s national oil company, Petrobras. “We were investigating a money-laundering case, and Petrobras wasn’t our target at all,” says Marena. “Paulo was just another client of his. So we started to ask, ‘Why is he getting an expensive car from a money launderer? Who is that guy?’”
Marena had spent the previous decade building cases against money launderers, and Youssef had been a perennial target. He’d been arrested at least nine times for using private jets, armored cars, clandestine pickups by bagmen, and a web of front companies to move illicit cash. But Youssef had been spared serious jail time by testifying repeatedly against other doleiros, Brazilian slang for specialists in laundering unreported cash.
The Petrobras connection suggested Youssef was into something bigger. Marena and her partner, investigator Márcio Anselmo, dug into Costa from offices in the modern glass-and-concrete federal police headquarters in the city of Curitiba, 400 kilometers (250 miles) south of São Paulo. A dozen more investigators and prosecutors joined, and the case grew so big that Brazil’s attorney general set up a task force in temporary office space across town.
By March 2014, federal judge Sérgio Moro had begun rounding up dozens of suspects. (In Brazil’s justice system, a judge formally charges a defendant, approves major steps in the investigation by police and prosecutors, hears the evidence, and then decides whether the defendant is guilty or innocent.) They were accused in Moro’s court of participating in a bid-rigging scheme of astounding proportions. For years, prosecutors have alleged in Moro’s court, a cartel of Brazil’s biggest and richest builders fixed a vast swath of the world’s seventh-biggest economy, subverting competition in the oil industry and, possibly, the huge public works programs that drive growth and employment.
Brazilians are riveted by the scandal, nicknamed Operation Carwash because some funds were laundered through a service station. Moro has ordered more than a dozen dragnets so far, and the arrests of executives, bankers, politicians, and bagmen, marching some to jail past a phalanx of television cameras. One suspect took his private jet to Curitiba to turn himself in. Another spent his last hours of freedom in a hotel suite on Rio de Janeiro’s fabled Ipanema beach to avoid being taken from his home handcuffed. The arrested shared four holding cells in Curitiba police headquarters with unenclosed communal toilets. Some slept on mattresses strewn on the bare floor. A dozen have confessed to making or accepting payoffs and rigging contracts, some in videotaped testimony that is posted online.
One former Petrobras manager, Pedro Barusco, described taking almost $100 million in bribes; he’s since returned most of the money in a bid for leniency.
Since March 2014, prosecutors have accused more than 110 people of corruption, money laundering, and other financial crimes. Six construction and engineering firms have been accused of illegal enrichment in what is known as a noncriminal misconduct action. On April 22, Moro delivered the first convictions. He found Costa and Youssef guilty of money laundering, including the Land Rover purchase. Moro gave both men reduced sentences—two years’ house arrest for Costa and three years in prison for Youssef—for cooperating with prosecutors.
All of that is something of a preview of the big show: Prosecutors say they may accuse some of Brazil’s largest builders with running an illegal cartel. “It’s been clearly proven in this case that there was a criminal scheme inside Petrobras that involved a cartel, bid rigging, bribes to government officials and politicians, and money laundering,” Moro wrote in sentencing Costa and Youssef. “There will be a cartel indictment,” says Carlos Lima, a lead prosecutor in the case. “I don’t like to get ahead of myself and say this will happen, but it will. It’s just a matter of time.”
In filings in Judge Moro’s court, prosecutors have named 16 companies that allegedly formed a cartel to fix Petrobras contracts between 2006 and 2014. The list includes some of Brazil’s largest construction and engineering firms, including Camargo Correa, OAS, UTC Engenharia, and the biggest of them all, Construtora Norberto Odebrecht. All of these companies deny being part of a cartel, except Camargo Correa, which declined to comment.
Petrobras says it knew nothing about the bid rigging and is “collaborating” with authorities in the investigation. As to whether it was the victim of a cartel, “the company is certain,” Mario Jorge Silva, Petrobras’s executive manager for performance, said at an April 22 news conference. In financial filings, Petrobras says 199.6 billion reais’ worth of contracts were rigged by the alleged cartel.
For years, a co-owner of the engineering firm UTC called members to meetings at his offices in São Paulo via text messages, according to testimony and documents submitted in Moro’s court. The participants were greeted by an assistant, who handed out name tags. At the meetings, executives took copious notes detailing how the alleged cartel would divvy up Petrobras contracts, at inflated prices. One builder put together a 2½-page encoded guide for group members that describes contract bidding as a soccer tournament, with leagues and teams. Another document drawn up by a group member lists the chosen winners of upcoming bidding for 14 contracts for a refinery, with the title Fluminense Final Bingo Proposal, using a nickname for the state of Rio de Janeiro.
Prosecutors say the builders got away with it by paying kickbacks, usually 3 percent, on every contract. Petrobras estimates that the graft added up to at least 6.2 billion reais, much of which, prosecutors say, was funneled into the war chests of the parties that backed Luiz Inácio Lula da Silva, president of the country from 2003 to 2010, and his handpicked successor, Dilma Rousseff. Lula and Rousseff haven’t been charged with wrongdoing, but special prosecutors have opened criminal investigations into more than 50 members of congress and other politicians implicated in the corruption scheme.
It’s not just the drama of the snowballing scandal that holds Brazilians’ attention. There is a growing resignation—and anger—that Brazil, a country that seemed so close to joining the ranks of the world’s developed nations, isn’t going to pull it off. Lula inspired the country with promises of a “new Brazil” that would leave behind five centuries of poverty and corruption. Brazilians now understand that behind Lula’s message was a rigged, corrupt game that enriched a few and hobbled the country’s ability to compete.
A corruption scandal is the last thing Brazil’s economy needs: It’s already mired in the worst four-year slump in a quarter century. Finance Minister Joaquim Levy is trying to close deficits to avert a catastrophic downgrade of Brazil’s credit rating to junk. He proposes to cut social programs that serve millions of people.
Perhaps more serious, the scandal has corroded Brazil’s democracy, weakening Rousseff’s government so much it doesn’t have the clout to get major legislation through congress. Rousseff’s approval ratings slid to 9 percent in April, the worst for a Brazilian president ever. On March 15 and again on April 12, throngs of people poured onto the streets of Brazil’s large cities, demanding an end to corruption and the impeachment of Rousseff. The spoiled fortunes have revived, with a new bitterness, an old, popular refrain: “Brazil is the country of the future and always will be.”
One muggy February morning, Antônio Delfim Netto sits in his office in an old stone house in São Paulo, incredulous over the reach of the Petrobras scandal. But perhaps the 87-year-old economist shouldn’t be surprised. In a way, Netto laid the foundation for Brazil’s intertwined world of politics, business, and finance.
In 1969, at the height of the military dictatorship that took power after a coup in 1964 and ruled Brazil until March 1985, Netto, as finance minister, designed a policy called market reserve. It gave Brazilian builders a lock on government contracts by shutting out most foreign competitors. Tax breaks and subsidized credit followed. The military commanders had plans for huge public works to tie together the vast, uninhabited expanses of Brazil, and a few family-owned builders got the big contracts. “We needed the builders to be strong and completely loyal to Brazil,” says Netto, his broad torso dwarfed by his big wooden desk. Two-dozen framed caricatures of Netto by Brazil’s most famous cartoonists cover the walls, and some of his tens of thousands of economics books fill a shelf.
As Netto engineered protectionist policies, the builders cultivated ties to the dictators, according to the National Truth Commission, which issued a report in December about abuses during the military dictatorship. Camargo Correa, implicated in the current scandal, was among the companies that won favor by helping fund Operation Bandeirantes, a campaign to hunt down and torture suspected insurgents in the 1970s, the commission concluded. One of the operation’s victims was Rousseff, who was then a young member of an armed leftist opposition group. She was arrested and tortured. (Netto said in a Truth Commission hearing last year that he had no knowledge of any torture.)
Construtora Norberto Odebrecht, the largest builder in Latin America by revenue, is perhaps the most adept of all Brazil’s builders at intertwining business with politics. That has been the case since 1944, when Norberto Odebrecht, then a soft-spoken 24-year-old engineer, convinced a state bank to bail out his father’s bankrupt construction company, Emílio Odebrecht & Cia., in the city of Salvador in northeastern Brazil. Norberto then created the company that bears his name, which absorbed the operations of his father’s business. The construction company is now part of Odebrecht SA, a conglomerate with 15 divisions spread across 21 countries.
Petrobras was critical to Odebrecht’s growth in the 1950s and 1960s. The company won a slew of Petrobras contracts to build pipelines, canals, power plants, and oil wells across Brazil’s northeast. One of Odebrecht’s first big jobs outside the northeast was Petrobras’s 27-story headquarters in Rio de Janeiro, completed in 1971. The imposing concrete monolith is across the street from the sloping dark-glass headquarters of the state development bank, BNDES, which Odebrecht also built.
The military dictatorship continued to steer contracts to Odebrecht, including those for Rio’s international airport and the Angra Nuclear Power Plant. Odebrecht also worked political ties to win business outside Brazil, starting with contracts to build a hydroelectric plant in Peru and reroute a river in dictator Augusto Pinochet’s Chile. In 1981, four Odebrecht executives flew to Moscow on a trade mission with Netto, who was planning minister at the time. Odebrecht wanted the government’s help swaying the Soviets to persuade allies to give it business, Netto says. The trip helped produce major contracts in Brazil and Peru and Odebrecht’s first project in Angola. “There’s nothing strange about any of that; it’s what governments do for their companies all the time,” says Netto.
Norberto’s son, Emílio, became CEO of the company in 1991. Shortly after that, São Paulo’s state governor, Mário Covas, introduced Emílio to a leader who’d been jailed 90 days by the military regime: Luiz Inácio Lula da Silva.
Marcelo Odebrecht, who succeeded his father, Emílio, in 2008, tells the story in an interview at Odebrecht’s São Paulo headquarters. “He said, ‘Emílio, this is one of the politicians with the brightest future in Brazil. It’s worth knowing him,’” Marcelo says. “Since then, we have always had interaction with Lula.”
Odebrecht poured money into political campaigns, including Lula’s, mirroring a practice by all the major builders. The builders being investigated in the Petrobras scandal legally contributed 344 million reais to political parties in 2014, an election year. About half went to the three parties implicated in the scandal, according to Brazilian election records. The share of Odebrecht and its subsidiaries was 88 million reais, most to the three parties.
Marcelo Odebrecht says his company has contributed to about 150 members of congress. “If you believe in a guy who’s going to be important and can support you in congress, you have to support him,” he says. “If you are someone who contributes to someone, at the least he’s going to give you a meeting and listen.’’
After Lula won the presidency in 2002, in the biggest landslide ever in Brazil, Odebrecht grew rapidly. Lula and his Workers’ Party promised a revolution that would take Brazil to the next level, with bold public works projects at the center of his plans. Odebrecht was awarded some of the biggest contracts.
Early on, Lula introduced Marcelo to Rousseff, who was then energy minister. “We interacted with her a lot,” Marcelo says. “We’ve always had a relationship of trust.”
Lula had foreign policy goals as well; he talked of transforming Brazil into a sort of superpower for the developing world. That meant new business for Brazilian construction companies in places such as Cuba and Ecuador, funded with subsidized financing from BNDES. Under Lula and then Rousseff, Odebrecht projects outside Brazil were showered with 5.5 billion reais of BNDES financing from 2009 to 2014, more than any other Brazilian company except for the aircraft maker Embraer.
Odebrecht has not been charged in connection with Operation Carwash; neither has any individual employed by the company. “Odebrecht never participated in cartels, whether in contracts with Petrobras or any other government or private client,” the company said in a statement to Bloomberg. Nevertheless, the company is being investigated, with other builders, in at least three criminal and regulatory probes. In November, Moro ordered federal agents to search the homes and offices of two Odebrecht executives. The searches did not result in charges being filed.
One of those executives was Márcio Faria. According to sworn testimony in Moro’s court by Youssef, the convicted money launderer, Faria negotiated with Costa a 20-million-real payoff for 4.5 billion reais in Petrobras refinery contracts the company won in December 2009. Youssef said the bribe was funneled to politicians.
Faria, now a director of an Odebrecht industrial engineering division, referred questions to Odebrecht. Faria didn’t do anything illegal in business dealings with Petrobras, Odebrecht said in a written statement. “Odebrecht denies making any payments or deposits into supposed accounts of any executive or ex-executive,” the company said, referring to Petrobras.
Since Lula left office, on Jan. 1, 2011, Odebrecht has flown the former president outside Brazil as a paid speaker at events for clients and business groups. “We are trying to strengthen the country’s image,” Marcelo says. “I see that everywhere in the world.”
Federal prosecutors have opened a preliminary influence-peddling inquiry into whether Lula used his connections to persuade BNDES to provide subsidized financing for Odebrecht projects. Lula, Odebrecht, and BNDES each denied any wrongdoing.
Netto, the economist, has advised every president save one in the past three decades. He understands how power is wielded in Brazil. Still, he says, he’s astounded by the cartel that is alleged to have penetrated Petrobras. “What’s shocking is how a cartel colluded with the state in Brazil’s most important company,” says Netto, shaking his head in disbelief. “But I don’t have any regrets for what I did. Those companies built modern Brazil.”
In early September 2007, Lula trudged through a driving rain at the construction site at Petrobras’s Abreu e Lima refinery in northeastern Brazil’s Pernambuco state. Wearing white work gloves and a Petrobras hard hat, he climbed onto a backhoe and helped steer the machine’s steel bucket into the red earth, breaking ground on the project. Petrobras would build Abreu e Lima with financing from then–Venezuelan President Hugo Chávez, a socialist like Lula, to turn that country’s tarlike crude into fuel for Brazilians. (Venezuela later backed out of the agreement.) Every real would be spent wisely by Petrobras, Lula said, and Rousseff, then Lula’s chief of staff and chairman of Petrobras, would make sure of it. “They used to say that Petrobras didn’t have to justify spending to anyone,” Lula said. “But today I will put Dilma Rousseff on top of it.”
In the months after Lula’s visit, prosecutors say, the cartel made plans for Abreu e Lima. In April or May 2008, Rogerio Araújo, then a director of Odebrecht’s industrial engineering division, handed Barusco, executive manager of Petrobras’s engineering division, a list of cartel members to invite to bid on the refinery contracts, Barusco said intestimony in the criminal case in Moro’s court. Araújo, now an executive in Odebrecht’s industrial engineering division, denied through a company-issued statement being part of a cartel or committing any wrongdoing. “Odebrecht vehemently denies allegations made by a confessed criminal,” the company said.
Within two months, Barusco signed a plan to seek bids on 12 packages of contracts, which were later awarded to the companies in the alleged cartel. Central to the scheme were the alleged cartel’s partners inside Petrobras. They charged builders kickbacks of up to 3 percent for the right to fix a contract, Costa and other witnesses testified. The graft, they said, was divided among three political parties and the executives themselves, via payments funneled through Alberto Youssef and other intermediaries.
Soon, government auditors began warning that contractors were vastly overcharging for Abreu e Lima. That brought the matter to Homero de Souza’s tiny cubicle in the Consultancy, congress’s in-house auditing arm in the labyrinthine legislative annex in Brasília. Souza, a senior Consultancy auditor, recommended that congress block funding for the project. “It was so obvious, this pattern of theft,” says Souza. “I’d never seen anything on the scale of Abreu e Lima.” Congress’s Irregular Works Committee recommended excising the refinery from the 2010 federal budget, effectively halting work, and congress voted to approve. Lula vetoed the recommendation, assuring Petrobras the funding it needed to pay the builders to forge ahead.
The refinery rose at a time when Brazil seemed to have no limits. Record prices for oil, iron ore, soy, and other commodities exports; a roaring currency that made consumer goods more affordable for the growing middle class; and plummeting interest rates were fueling a boom that almost tripled the size of the economy during the Lula years. A wildly successful welfare program pulled 40 million people out of poverty.
By the time Lula turned over power to Rousseff, Brazil’s giddy boom had fizzled, revealing a foundation built on good fortune (those high commodities prices), corruption (including a vote-buying scandal that reached up to Lula’s top political lieutenants), and a near-doubling of the national debt, to $1.2 trillion. When Rousseff traveled north to inaugurate Abreu e Lima, in December 2013, there was little to celebrate. The refinery had cost Petrobras $18.5 billion, eight times the original budget. Instead of policing the project, Rousseff failed to disrupt what might be one of Brazil’s biggest single cases of corruption ever.
Rousseff says she knew nothing about the alleged cartel scheme. “This isn’t an issue of management, pure and simple. The Petrobras board was comprised of very qualified businesspeople,” Rousseff told Bloomberg in April in a one-hour interview at Planalto, the presidential palace in Brasília. “None of us even saw a sign. Everything points to a cartel and the corruption of some employees.”
Maria das Gracas Foster, an old friend of Rousseff’s who became CEO of Petrobras in 2012, has also said she didn’t know what was going on. Late last year, Foster launched a massive investigation. She also temporarily banned more than 20 companies being probed in the scandal from doing business with the company; that led directly to three big builders—Galvão Engenharia, Grupo Schahin, and OAS—filing for bankruptcy. In February, Rousseff forced out Foster, along with all of her top management.
Under its new CEO, Aldemir Bendine, Petrobras is seeking reimbursement for damages from the companies in the alleged cartel. It is also, it says, establishing a new compliance, governance, and risk division. “We are embarrassed,” Bendine said on April 23. “We are cleaning up mistakes.”
The scandal has all but crippled the company. In February, Moody’s Investors Service chopped its credit rating to junk. In April, Petrobras took charges of 44.6 billion reais, most for overpriced and unfinished refineries that were the target of the alleged builders’ cartel. The writedown caused a 21.6-billion-real loss for 2014. Bendine is trying to sell $13.7 billion of assets to raise cash. It’s a stunning change of fortune from the Lula heyday, in 2010, when Petrobras raised a whopping $70 billion by selling stock to investors.
Everyone in Brazil knows the Portuguese term for the inefficiencies that hold back the economy: custo Brasil, or Brazil cost. When it comes to the ease of starting a business, Brazil fell seven spots this year to 167th in the world, behind Uganda, according to theWorld Bank. Corruption will cost the economy as much as 120 billion reais this year, says José Ricardo Roriz Coelho, competitiveness director at Fiesp, the country’s biggest industrial association.
An increasingly independent judicial branch may finally stop the alleged Petrobras cartel from driving up costs and siphoning funds from the investments the country sorely needs to compete, but the damage it caused won’t be undone quickly. And the problem goes beyond Petrobras. Last year, the Brazilian antitrust regulator fined cement makers 3.1 billion reais for operating a cartel for years. Recently, the regulator launched investigations into cartels that may have rigged the market for school supplies and medicine. The custo Brasil is growing harder and harder to bear.
This story appears in the June 2015 issue of Bloomberg Markets. With assistance from Anna Edgerton in Brasilia; David Biller, Yasmine Batista, and Peter Millard in Rio de Janeiro; and Francisco Marcelino in São Paulo.