The Risk Advisory Group, which, as its name implies, consults with organizations to manage risk, recently released the 2019 edition of its Corruption Challenges Index. The Index is designed to identify the “most and least challenging places for foreign investors in relation to corruption levels.”
How was the Index created? First, experts graded each country on the likelihood of i) investors confronting corruption when “seeking a significant government contract, license or permit,” and ii) local businesses facing “small scale official corruption” when operating day-to-day. A “regime stability score” was then added in order to generate a “Corruption Threat” rating (“T”). T was then subtracted by “O”, an “opacity” score reflecting the “comprehensiveness and reliability of public information [e.g., the accessibility of public records], media openness, [and] the freedom of human sources to converse and particular linguistic barriers.” This produced an overall “Corruption Challenge Index,” or “C.” Or, more bluntly: C = T – O. What this means is that the most challenging jurisdictions will “have a high risk of both petty and grand corruption, less stable regimes and low availability of public information and business intelligence.”
The Index’s use of a hybrid corruption/opacity methodology generated some interesting results. India, which has significant corruption issues, is nonetheless “one of the more transparent countries…to work in.” By contrast, several European countries, while reflecting traditionally low corruption levels, are subject to an increasingly stringent privacy regime under the EU’s General Data Protection Regulation (“GDPR”) which will likely pose difficulties in “both retrieving and communicating information.”
Aside from grading each country, the Index includes brief regional summaries, and also identifies the industries most exposed to corruption.
While Risk Advisory’s target audience is likely corporate management seeking to navigate complex transnational business arrangements, investors in publicly traded companies that do business in countries with a high risk of fraud or corruption should also take note of the group’s findings. Notably, revelations of a company’s corruption scandal can cause significant damage to its stock price, injuring investors who owned stock. In Morrison v. National Australia Bank Ltd., the U.S. Supreme Court ruled that the antifraud provisions of the Securities Exchange Act of 1934 apply only “in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” Therefore, if you purchase a security that trades on a foreign exchange and you suffer losses due to fraud, you likely cannot use the U.S. securities laws to recover damages.
A recent famous example of this situation is the Brazilian Lava Jato money laundering investigation (in English: “Operation Car Wash”), which, among many bombshell revelations, uncovered that high-level officers at Petrobras, a massive semi-public Brazilian energy company, had been accepting bribes in connection with the awarding of valuable contracts. Aside from leading to the convictions of Petrobras executives (as well as the removal from office of prominent politicians throughout Latin America), the exposed fraud caused Petrobras’s stock to plummet. Ultimately, a class action on behalf of U.S. investors against Petrobras, its underwriters, and its auditor, settled for $3 billion [full disclosure: Wolf Popper filed the initial complaint in this litigation]. However, the settlement class included only those persons who purchased Petrobras securities in transactions “to which the United States securities law apply” (e.g., purchases of Petrobras securities listed for trading on the New York Stock Exchange). All other Petrobras investors, including American investors, who purchased securities listed on a foreign exchange could not participate in the recovery.
We all know that investing involves risk, and some investments are riskier than others. If you are investing in foreign companies, or companies that do significant business in foreign countries and want to ensure that you are protected by U.S. securities laws, consider whether the security is listed on a U.S. exchange, or if the company has American Depository Receipts (ADRs) listed in the U.S. If you purchase a foreign listed security and a fraud comes to light, you may have to rely on foreign securities laws, or be subject to foreign arbitration, neither of which are likely to be as favorable to investors as the laws in the U.S.