Stocks, lies, and conference calls: the scandal of reinsurance firm IRB Brasil

</p> <p>It all started when private equity firm Squadra Investimentos questioned how profitable the company actually was, a spark that evolved into a public accounting battle. Things went really sour after IRB&#8217;s management confirmed rumors that Warren Buffett&#8217;s conglomerate Berkshire Hathaway had become a shareholder—a lie that led to changes in the firm&#8217;s corporate governance and a series of questions from Brazil&#8217;s Securities Commission.</p> <div class="flourish-embed flourish-chart" data-src="visualisation/1522607"><script src="https://public.flourish.studio/resources/embed.js"></script></div> <h2>Is IRB Brasil the new Enron?</h2> <p>Nearly 20 years ago, U.S. energy group Enron went bankrupt after a series of accounting frauds became public. The company&#8217;s stock crashed, employees lost their pension funds, U.S. markets acted to install measures to provide better governance.&nbsp;</p> <p>IRB shareholder Renoir Vieira sees the Brazilian reinsurer&#8217;s woes as more of a market manipulation case than Enron-level accounting fraud. “We did not find any problems [in the balance sheets] (&#8230;) The company needs to regain the market&#8217;s confidence and the only way to do that is replacing its management, increasing transparency and the involvement of minority shareholders,” he told <strong>The Brazilian Report</strong>. Despite the crisis, Mr. Vieira has increased his stake in IRB and shares in the company now make up 11 percent of his family&#8217;s investing portfolio.</p> <p>Levante Investimentos stocks analyst Eduardo Guimarães echoes this view. “I don’t think it is similar to (&#8230;) Enron. IRB is a company that has a competitive edge in a good business. The <a href="https://brazilian.report/business/2019/10/31/bull-market-next-stock-market-crash-brazil/">awful governance</a> is what is questionable,” he said.&nbsp;</p> <p>The analyst says he dropped IRB Brasil from his dividend portfolio as soon as the first doubts arose in early February. He now recommends investors stay away from the company. But the struggle is not over for everyone.</p> <p>Mr. Vieira is part of a group of roughly 30 investors who have a combined one-percent stake in the company. They are currently demanding the replacement of the company&#8217;s management, as well as an extraordinary shareholder&#8217;s meeting to decide on a divestment plan of non-operational assets, executives’ compensation, and the shares’ buyback program.&nbsp;</p> <div class="flourish-embed flourish-chart" data-src="visualisation/1523062"><script src="https://public.flourish.studio/resources/embed.js"></script></div> <p>“I guess there’s a chance we may be heard, mostly because our demands are in line with the investors’ best interests,” said Mr. Vieira.</p> <p>IRB Brasil is currently a corporation, which means there is no single controlling stakeholder. According to the reinsurer&#8217;s website, its three leading shareholders are the insurance divisions of banks Bradesco and Itaú Unibanco, and BlackRock, the world’s largest independent asset management firm. Approached by <strong>The Brazilian Report</strong>, representatives of Itaú Unibanco and Bradesco declined to comment on the case; BlackRock had not answered our interview request by the time of publishing.&nbsp;</p> <p>Regardless of the next steps to be taken by new management, shareholders, or the Brazilian authorities, “what happened to IRB will become one of the largest messes in Brazilian stock markets ever,” wrote Nord Research analyst Renato Breia.  </p> <h2>Numbers don’t lie?&nbsp;</h2> <p>On February 2, private equity firm Squadra Investimentos disclosed a <a href="http://www.squadrainvestimentos.com/pdf/relatorio-2019.pdf">154-page report</a> with an in-depth analysis of IRB Brasil RE&#8217;s accounting and operational data. Squadra was struggling with traders speculating on the decline of IRB&#8217;s stock price and went public to explain its investment strategy.</p> <p>In Squadra&#8217;s view, there were discrepancies in accounting profit and normalized earnings. While the company had reported BRL 1.39 billion in normalized profit before tax, Squadra believed the actual result was a BRL 112 million loss over the first nine months of 2019.&nbsp;</p> <p>This difference was the result of one-off items, such as the sale of a shopping mall, and Squadra cast doubt over whether IRB was creating as much value as its share price suggested. It is important to note, however, that the private equity form did not accuse IRB of manipulating their accounts.&nbsp;</p> <p>This evaluation came as a shock. Until then, IRB Brasil was seen as a success in the Brazilian market, a recommended &#8220;buy&#8221; in many portfolios. As a former state-owned company that became a corporation, IRB delivered good operational results and enjoyed a leading market position, with a <a href="https://valor.globo.com/financas/noticia/2019/11/26/irb-amplia-fatia-de-mercado-e-ve-espaco-para-crescer-em-negocios-digitais.ghtml">37-percent market share in 2019</a>.</p> <h2>A failed strategy</h2> <p>IRB categorically denied the existence of any problems with its accounts, claiming that the reports were reviewed by its board of directors and financial board, and then independently audited by PwC. Without naming Squadra, IRB also said it would pursue legal action, “as the issuer of the letter has an economic interest that is in conflict with the interests of the company.”&nbsp;</p> <p>IRB focused on privately answering individual questions until organizing a conference call with analysts on February 10. To calm the market, management announced it would hire consulting firm EY to audit the reports and provide more detailed information on the aspects questioned by Squadra. The call, which interrupted the usually quiet period before the publication of fourth-quarter earnings reports, “was among the worst I&#8217;ve ever seen,&#8221; according to Mr. Vieira.</p> <p>Expectations rose and IRB posted strong earnings for the last quarter of 2019: net profit increased 44.7 percent over the year to BRL 1.76 billion. In the earnings conference call, they also announced a shares repurchase amounting to 5 percent of the company’s shares. That seemed to help, as stocks rebounded 1 percent on February 19.&nbsp;</p> <h2>Not so fast</h2> <p>On the afternoon of February 26, newspaper <a href="https://economia.estadao.com.br/blogs/coluna-do-broad/berkshire-hathaway-aumenta-investimento-em-irb-brasil/"><em>Estadão</em></a> published a story saying Warren Buffett&#8217;s conglomerate Berkshire Hathaway had tripled its stake in IRB, following the fall in share prices. The newspaper went on to say it had been shown a list of shareholders&#8217; list showing that not only Berkshire, but other important funds had increased their stakes in IRB—the information was confidential, as noted by Mr. Breia in his report.&nbsp;</p> <p>The market&#8217;s reaction was immediate and IRB&#8217;s shares rose 6.6 percent on February 27. But this rally wouldn&#8217;t last long.</p> <p>On the same day, newspaper <em>Valor</em> broke the news that chairman Ivan Monteiro had resigned from IRB’s board due to feeling “uncomfortable” with the company’s management. IRB quickly denied the information in the morning, only to confirm it later in the day, claiming that it was informed of Mr. Monteiro’s decision that afternoon. The company claimed his departure was due to health reasons and announced that fellow board member Pedro Guimarães would step in as chairman.&nbsp;&nbsp;</p> <h2>The downfall</h2> <p>It seemed that IRB’s reputation could not get any lower. However, on the morning of March 2, IRB&#8217;s management participated in another conference call in which <a href="https://economia.estadao.com.br/blogs/coluna-do-broad/eleven-participou-de-teleconferencia-em-que-irb-confirmou-investimentos-do-berkshire-hathaway/">analysts affirm they were told </a>Berkshire Hathaway was an IRB shareholder and would appoint a member to the company&#8217;s board.</p> <p>The story was blown wide open the following day, when <a href="https://www.berkshirehathaway.com/news/mar0420.pdf">Berkshire Hathaway declared</a> it “is not currently a shareholder of IRB, it has never been a shareholder of IRB and it has no intention of becoming a shareholder of IRB.&#8221;</p> <p>The news rocked the markets and IRB shares dropped 40 percent during the day, only to recover slightly for a single-day devaluation of 31 percent—the largest in IRB&#8217;s history.</p> <p>The fallout in Brazil&#8217;s financial community was enormous. From fund managers to scholars and retail investors, everyone was stunned by the revelation. “It feels like market manipulation because they lied on a conference call,&#8221; said Mr. Guimarães. &#8220;I’ve never seen anything like it in 20 years working on the market.”</p> <p>In his view, even before involving Berkshire Hathaway in the case, IRB adopted the wrong strategy by opting to answer public manifestations in private conference calls and taking too long to provide details. The governance issues investing in the company too risky, he says.&nbsp;&nbsp;&nbsp;</p> <p>Analysts have been removing their recommendations to buy IRB stocks. Guide Investimentos removed the firm from its “Top Picks” and dividends portfolios. According to <a href="https://www.infomoney.com.br/mercados/irb-quais-as-recomendacoes-de-analistas-para-as-acoes-apos-polemicas-com-balanco-e-buffett/">InfoMoney</a>, Bank of America, Safra and XP Investimentos were also reassessing their recommendations. Eleven Financial chopped its target price from BRL 54 to BRL 38 per share, but maintained its buy recommendation.&nbsp;</p> <p>Mr. Guimarães sees the impact of the case affecting more than just IRB, being a blow to the confidence in the governance of Brazilian companies.&nbsp;</p> <p>“This is terrible from a foreign investor’s point of view. If they were already scared of joining Brazilian markets, this does not help at all. It shows a large risk perception of Brazilian companies,” he said.&nbsp;