PETROLEO BRASILEIRO S.A. (PETROBRAS)
BOVESPA:  PETR3        Annual Meeting: 4/29/2015       Special Meeting: 5/25/2015

The much-awaited audited financial statements for the third quarter and annual financials for 2014 were finally released on April 22, 2015, a week before the deadline that would have triggered early repayment clauses for Petrobras’ debt arrangements. In its report signing off on the financial statements, PricewaterhouseCoopers, Petrobras’ independent auditor, makes note of the US$2.53 billion write-off resulting from the criminal investigations under Operation “Carwash.” The Company also addressed, in the notes to the financial statements, the investigation’s impact and the implementation of remedies. The total write-off amounted to over $17 billion, which also includes $14.7 billion written off regarding the valuation of its main petrochemical complex and a large refinery. Shareholders will be asked to approve these financial statements at a special meeting scheduled for May 25, 2015.

Everyone following the developments of Petrobras and the ongoing investigation by the Brazilian federal police named Operation “Carwash,” has been eagerly awaiting the disclosure of the final write-off amount which stemmed from the largest scandal in Brazilian history.  The establishment of this amount, which cost Maria Foster her job as CEO earlier this year, was based on the testimony of former executives, employees, and contractors of the Company which have been arrested for their involvement in the overinflated construction contracts. By all accounts, the write-off amount is only an approximation based on facts revealed so far. Even the Company’s new CFO, Ivan Monteiro, did not seem overly confident as to what else will be uncovered in this investigation and how it will affect the write-off amount during his interview by CNBC on July 23, 2015. Nevertheless, in its financial statements, the Company does not believe additional revelations would be of material significance.

In the notes to the financial statements, the Company also lists changes it implemented to curb future misappropriations and to improve its corporate governance structure. These include hiring two large law firms to conduct internal investigations, establishing committees to into sanctioning contractors and suppliers, appointing a Governance, Risk and Compliance Officer, and a special committee to act as a liaison between the board of directors and the law firms conducting the internal investigations. Additionally, the Company mentioned it has implement additional improvements regarding corporate governance, risk management and control which are documented in the minutes of the management meetings. Unfortunately, for most everyone, these minutes are not made public by the Company.

While these remedial steps seem significant in the Company’s desire to turn its fortunes around, they should probably be taken with a grain of salt. Investors should question the value in adding additional working committees, when, according to retiring independent director Mauro Rodrigues da Cunha in a Glass Lewis Proxy Talk, that the current board committees only existed on paper and never met. This includes the nominations committee, which should have been involved with searching for suitable candidates replacing the retiring directors and those that have already retired, and including the CEO position that was unilaterally filled by the Brazilian government with no outside vetting.

It should also be noted that there has not been a “mea culpa” issued by the Company or the ever-present government in this affair. On the contrary, in Note 3 of the 2014 annual financial statements, the Company disavowing having made illegal payments linked to Operation “Car Wash,” arguing instead that it was a scheme colluded by only a handful of Petrobras employees, which have since left the Company, and a “cartel” of contractors. For such a scheme to go on for almost a decade, it seems to indicate that the Company’s internal controls broke down. Glass Lewis generally holds the chairman of the board responsible for such governance and oversight failures. Although, no evidence links her to this scandal, it should be noted that Brazil’s President Rousseff was the board’s chairman between 2003 and 2010, which falls within the period the fraudulent changes were tracked to. The reputational risk to the Company due to the strong link with the government, as evidenced with the market’s negative reaction to appoint of Aldemir Bendine as CEO, is still a shareholder concern, even after the release of the 2014 audited financial statements.

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