By Anthony Boadle

BRASILIA (Reuters) - The government of Brazil's new President Michel Temer scrambled on Tuesday to distance itself from a multibillion-dollar corruption scandal that broke less than a week after he took office, involving fraud in the country's largest pension funds.

With the country already reeling from a sprawling bribery and kickback scandal at state oil company Petrobras, the new corruption case could hamper the conservative Temer's efforts to restore credibility and turn the page on the leftist government of impeached President Dilma Rousseff.

Police on Monday arrested five people linked to fraudulent investments made by four huge pension funds of state-run companies. The investigation snared dozens of businessmen and fund managers suspected of involvement in a fraud scheme valued at around 8 billion reais ($2.5 billion), including the chief executive of the world's biggest beef exporter.

The coveted appointments of directors to the funds' boards were made by political parties and the probe is expected to spread to Brazil's political establishment, where some 50 politicians are already under investigation in the Petrobras scandal.

Temer's office said the appointments were made during the 13 years of Workers Party rule that ended with Rousseff's removal from office last week, and the "irregularities" uncovered by the police had nothing to do with the current administration.

"The Workers Party appointed the pension fund directors from the moment it took office in 2003 and they were closely linked to the unions," said a Temer aide who asked not to be named.

"The Workers Party was responsible for the big loss suffered, ironically, by the workers of the state companies who were saving for their retirement," the aide said. "This has not even scratched the image of the new government."

Temer's government will press for a thorough investigation as it pushes through proposed legislation that will depoliticize the appointment to directors of state companies, he said.

The investigation focuses on investments in overpriced assets, including private equity funds with artificially inflated share prices, according to the federal police.

The Workers Party declined to comment on the investigation but its president, Rui Falcao, denounced as "arbitrary" a raid and seizure of documents at the home of the party's former treasurer Joao Vaccari, jailed a year ago in the Petrobras scandal.


Political observers in Brasilia doubt that Temer's Brazilian Democratic Movement Party will emerge unscathed from the new scandal, since it shared power with the Workers Party during the years the fraud allegedly took place. The party has also been deeply implicated in the Petrobras scandal.

The state-company pension funds, flush with cash, have long been vulnerable to political interference and dogged by suspicions of fraud, said political risk consultant Andre Cesar.

"The 8 billion reais is just the tip of the iceberg. They have opened a Pandora's Box and names of politicians will inevitably appear sooner or later," Cesar said.

Even if nobody in Temer's government is implicated, the new scandal underscores some of the unsavory ties between business and political interests in Brazil that have undermined confidence in Latin America's largest economy.

"What are voters going to think? We just got rid of one government and corruption continues just the same in the new one," Cesar said.

The pension funds caught up in the investigation are those of state-run banks Banco do Brasil and Caixa Economica Federal [CEF.UL], the postal service Correios and oil company Petrobras, or Petroleo Brasileiro SA. The funds have said they are cooperating with the investigation.

The funds, which controlled 280 billion reais in assets last year, have been an important source of investment in Brazil's credit-starved economy, now in its second year of recession.

($1 = 3.2183 Brazilian reais)

(Additional reporting by Alonso Soto; Editing by Tom Brown)