GTECH's Dicey Situation

It pays to read earnings announcements closely. Take GTECH Holdings' (NYSE:GTK) fiscal year 2004 earnings announcement, released roughly one month ago. Buried in the depths of the announcement, sandwiched between the good news and the boilerplate paragraphs about "forward looking statements," was a note of real danger. Danger that manifested itself over the past week, as the company's share price plunged from $60 a share to $50 a share, rising only after the really bad news finally broke.

To summarize, back in March, Brazil's Public Ministry recommended indicting nine individuals on bribery-related charges stemming from a contract extension between GTECH and Brazil's lottery operator, Caixa Economica Federal. The defendants would include the president and marketing director of GTECH's Brazilian subsidiary, as well as a former senior vice president of GTECH Holdings itself.

GTECH clarified in its 10-K, released last week, that while its officials may soon be under criminal indictment, the company itself is safe on that score. Unlike the U.S., Brazil's criminal laws do not permit the criminal indictment of legal entities.

That's pretty much the end of the "good" news for GTECH, such as it is. The bad news, released last week, came in two parts. First, Brazil has launched a civil prosecution of the company. Second, the SEC has launched its own informal inquiry into the situation.

Fools who have been following the other recent cases of (alleged) corporate bribery -- Lucent Technologies (NYSE:LU), IBM (NYSE:IBM), and Lockheed Martin (NYSE:LMT) acquisition target Titan (NYSE:TTN) are all under investigation -- will recall that U.S. prosecutions of bribery cases fall under the Foreign Corrupt Practices Act, and come in two flavors. The SEC handles civil enforcement, and focuses on whether a U.S. public company can account for where its money is going (hopefully, not into the pockets of foreign bureaucrats). The Department of Justice usually joins in the investigation once it is pretty clear that the company has done something wrong, and prosecutes the bribery allegations under criminal law.

If the U.S. investigations do develop into prosecutions, the company's share price will likely continue to suffer. That could spur shareholder class action lawsuits, prompting further stock price declines. Meanwhile, down south, Brazilian prosecutors will be busily trying to confiscate up to $650 million worth of GTECH's revenues from its contracts with Caixa.

Bad news indeed, for GTECH and its shareholders.

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Foolish lawyer and contributor Rich Smith advises companies on complying with the Foreign Corrupt Practices Act as part of his day job. His advice generally boils down to "you better do it." He owns no shares in any of the companies mentioned in this article.