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« The 2011 Watch List | Main | Alcatel-Lucent Settles Bribery Case »
Tuesday
Dec282010

Moscow Activist Questions International Auditors

A correspondent sent word from Russia about Alexey Navalny -- a lawyer, political activist, and popular blogger who campaigns against corruption inside Russian state-controlled companies.

He invests in the companies, attends their shareholder meetings, and never follows the script. A profile in Time magazine earlier this year described Navalny's appearance two years ago at Surgutneftegas' annual meeting in the Siberian city of Surgut:

In front of some 300 stunned shareholders, Navalny, who owned about $2,000 worth of stock in the company, grilled senior management for several minutes about the company's minuscule dividends and opaque ownership. When he finished, there was a brief silence and then an unexpected burst of applause from a small group of shareholders in the back of the hall. The company directors were visibly flustered . . . .

Now Navalny, 33, has fixed his sights on Transneft. The mainly state-owned giant owns the largest oil pipeline system in the world, stretching 31,000 miles and transporting 93% of the oil produced in Russia.

Navalny alleges large-scale fraud at Transneft -- up to $4 billion -- and says it couldn't have happened without outside help. In an extraordinary public letter to the company's auditor, PricewaterhouseCoopers Russia, he urges an investigation into both Transneft and those responsible for its audit.

A few days ago, the Russian press agency Itar-Tass reported a police search of Transneft's offices in Moscow "as part of the probe into the embezzlement of funds during the construction of the Eastern Siberia – Pacific Ocean (ESPO) pipeline." Transneft built ESPO at a cost of around $13 billion to transport oil to China and the Pacific Rim.

The Itar-Tass story had no further details about the raids or where other searches may have taken place.

Whatever happens with Transneft and its auditor, activist Navalny isn't likely to run out of targets soon. Russia ranks near the bottom of the Corruption Perception Index, tied at 154 with Cambodia, the Central African Republic, Comoros, Congo-Brazzaville, Guinea-Bissau, Kenya, Laos, Papua New Guinea, and Tajikistan.

"How can a country claiming to be a world leader be in such a position?" Yelena Panfilova, director of the Moscow office of Transparency International, told the Washington Post in October. "It's a situation of national shame."

___________________________

Here's the full text of Alexey Navalny's public letter to PwC Russia:

December 10, 2010

Peter Gerendasi
Managing Partner
PricewaterhouseCoopers Russia

Dear Mr. Gerendasi,

In this letter I would like to draw your attention to the recent widely publicized disclosure of certain information related to the construction of ESPO (East Siberia-Pacific Ocean) pipeline by OAO Transneft, the state controlled Russian pipeline monopoly, and the implications of this disclosure for PricewaterhouseCoopers (PwC) as Transneft’s auditor.

The ESPO pipeline has been one of the most prominent investment projects undertaken by the Russian state over the last few years. The construction cost of the pipeline is estimated to exceed USD 13 billion and its completion would allow Russia to diversify the export routes for country’s Eastern Siberia oil. Throughout the course of the project the market was filled with rumors of widespread graft and corruption within Transneft resulting in huge misappropriations from its capital expenditure budget.

As a minority shareholder of Transneft and a concerned citizen of the Russian Federation, I have been investigating this issue for several months. On November 16, 2010 I made publicly available a copy of the report provided in 2008 by Transneft management to the Audit Chamber of the Russian Federation, outlining numerous instances of violations of normal business practices. It is estimated that the total amount siphoned from the company through various mechanisms and schemes reaches up to USD 4 billion. I understand that the Audit Chamber has decided against the publication of the report and its findings. However, so far neither the Audit Chamber nor Transneft have questioned the existence and authenticity of this report. 

Given high professional standards of PwC and the scale of fraud, I find it hard to believe that the PwC Transneft audit team has not seen signs of the irregularities related to the pipeline construction during annual audit procedures.  One would have expected PwC to request and review the aforementioned report during the test of internal controls given the fact that information about the Audit Chamber enquiry was publicly available. 

If facts stipulated in the report are correct, it is very likely that the financial statements of the company are materially misstated at least in relation to the cost of fixed assets and construction in progress, capital expenditure cash outflows, cost items classification and non-disclosure of transactions with affiliated parties. In addition, the auditing standards stipulate that the discovery of major facts of fraud and graft in the course of the audit process should be disclosed in the auditor’s opinion, which was not done. The auditor also has a duty to examine the negative information regarding the company, such as the described report, and if confirmed, reflect the findings in its independent opinion.

The fact that Transneft has enjoyed unqualified audit opinions in previous years raises the question about the quality of audit and potential non-compliance with the International Standards on Auditing (ISAs) and International Standard on Quality Control (ISQC). The unprecedented size and relative simplicity of fraud schemes developed and applied by Transneft  management over many years may also  serve as an indicator of potential violations of the Code of Conduct by PwC auditors and low professional ethic standards.

The likely audit shortcomings and inaccurate financial statements may have misled holders of securities issued by Transneft, including myself, as well as the general investing public.  PwC sign-off on the accounts with such serious "misappropriations" poses a direct threat to integrity and reputation of your firm. I strongly encourage you to be open and transparent with various stakeholders about this regretful situation and undertake the following steps:

1.  Internal investigation into the authenticity of the report and the facts therein, as well as into the quality of the Transneft audit engagement. The results of the investigation should be made public.

2.  Should the findings of the report be confirmed, modification of prior independent auditor's opinions would be the logical step. It can be done irrespective of any further actions likely to be required in conjunction with release of 2010 financial statements by Transneft.

3.  Self-disclosure with the U.S. Department of Justice with respect to potential violations of the Foreign Corrupt Practices Act in connection with the Transneft case. If report findings are confirmed, it is very likely that PwC employees have helped Transneft management (which would fall under “foreign government officials”) to gain illegal profits, an offense punishable under FCPA.

Failure to do this expediently will expose PwC to the risk of litigation on behalf of various users of Transneft financial statements, and may also trigger independent inquiries by professional bodies responsible for maintaining auditing standards. Ultimately, as exemplified by the WikiLeaks events unfolding over the last weeks, the truth will be known.

I encourage you and your colleagues not to view this situation as a case specific to Russia and its state-owned companies, which are notorious for their murkiness and dubious business practices, but consider global implications of this case, which may pave the way to a “de facto” relaxation of PwC standards in various countries. It is understandable, moreover, inevitable that some individuals within such global organization like PwC would be inclined to bend to the client’s pressure and take a relaxed view of the auditing standards, especially in countries like Russia which consistently find themselves near the bottom of the international rankings of transparency and corruption. However, the financial world and the investing public rely on the integrity of the major audit firms and require uncompromising attitude to such cases, including honest public disclosure of internal failings. Similar circumstances led to a number of scandals, including unraveling of some of your competitors over the last decade. It would be a shame if the reputation of audit professionals and PwC in particular would be undermined by its non-transparent treatment of the Transneft case.

I would be grateful for your prompt response. Should you have any questions and/or concerns regarding this matter, please do not hesitate to contact me at your convenience.

Sincerely yours,

Alexey Navalny

Copy to: Pierre Coll
             Global Leader for Risk and Quality
             Javier H. Rubinstein
             Global General Counsel
             PricewaterhouseCoopers

Reader Comments (6)

Top auditing companies should be addicted to anticorruption activity not only in their own countries but everywhere where they are working and not consider the other countries as the place just to make quick and big money disregard of their origin. They should be responsible for supporting corruption anywhere they are working. Only with such an attitude at least some progress can be achieved in these countries.
December 30, 2010 | Unregistered CommenterOleg
yo
December 30, 2010 | Unregistered Commenteranon
Very formal approach is applied in regards to auditors. Senior auditors, managers etc could see and have some analytics to suspect suppliers (related to corrupted management) of an audited company as related parties, but there is no budget and audit objectives to investigate and confirm this cases. All is done is sign off of the statement that this parties are not related to the management of the company.

Problem that there is no side in management or shareholders who would pay for an extended forensic audit of the Company.
December 30, 2010 | Unregistered CommenterKonstantin
There was Big 5, now big 4 ... when we end up with Big 1 someone will wake up and scrutinize all of those guys ...
it's time to get rid of all too big to fail
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