Audit in Politics: Russia vs Yukos vs PwC

There have been two events in recent days which triggered me to write post on this subject. First, last week The Economist published the article about auditing in China. Second, the recent decision of European Court of Human Rights (ECHR) regarding the Yukos vs. Russia case.

The article in The Economist considers the issue which happened between Deloitte and Longtop, a Chinese company once listed in NYSE. Here is remarkable abstract:

     “… After signing off Longtop’s financial statements for several years, the firm smelled trouble during its audit for the financial year that ended in March. Its subsequent questions did not go down well at Longtop, which seized some of Deloitte’s papers and threatened to keep Deloitte staff from leaving company premises. Deloitte quit as auditor, and Longtop’s shares ended up being delisted from the New York Stock Exchange in August.”

Subsequently, SEC issued subpoena for Deloitte’s audit working papers in relation to Longtop. After Deloiite’s refusal to cooperate the PCAOB threatened to decertify its Chinese division.

Medvedev and Putin

Several features of the above case look like Yukos-PwC affair which I would like analyse in several following articles. Yukos-PwC matter is perfect case for audit, accounting, tax and business ethics studies. It is rather complicated and requires accurate consideration of all facts. I am going to cover audit related professional and ethical issues. In this post I will give brief overview of the issue.

Essence of Issue

Yukos was one of the largest Russian oil companies with successful growth strategy and was listed on the LSE. However the company eventually had to file for bankruptcy (2006) after the Russian Ministry of Taxation proved in court (in 2003) that Yukos’ tax evasion amounted around $28 billion. The hypotheses standing behind this case are as follows:

1.      Tax evasion. This is obvious: company tried to pay less taxes using illegal schemes;

2.  Politically motivated expropriation of the company. The major shareholders and top-managers of Yukos, Mr. Khodorkovsky and Mr. Lebedev, were arrested in 2003 with criminal charges including tax evasion, fraud, forgery and embezzlement of assets. Meanwhile it is believed that Khodorkovsky and Lebedev had political ambitions and tried to influence state parliament by financing both left-wing and right-wing parties. Eventually, Mr. Putin being the president of Russia (now prime minister) decided to punish these independent oligarchs.

Khodorkovsky and Lebedev

The issue is that both hypotheses might be truthful partially. The fact is that similar tax evasion models were used at those time (and now used also) by almost all oil and gas companies in Russia and the only company which carried its part of punishment was Yukos. Nevertheless, I do not want to focus on this dispute, I am interested in the role of auditors in all this mess and here they come…  

Involvement of the Russian PwC firm

Unfortunately, PwC was an auditor of Yukos, acted as advisor on tax strategy, worked closely with Kodorkovsky on financial and accounting issues. After years of cooperation with client, PwC decided to withdraw its audit opinions in 2007 issued in respect of Yukos consolidated financial statements for 10 years from 1995 to 2004!

The Russian PwC office claimed that during tax investigation the prosecutors revealed new facts, which managers of Yukos misrepresented during previous audits. So what facts were revealed? The level of cooperation with client on tax issues was so close that there are significant doubts about this?

The other peculiar matter is that PwC-Cyprus has not withdrawn its audit opinions in respect of Yukos Cuprus subsidiaries.

Third, there are beliefs that Russian PwC was a coerced into opinion revocation by the Russian authorities.

Questions

Finally, based on the above overview I would like to raise following questions in my further blog posts:

·      What were the audit evidences, which had dramatic impact on PwC’s opinion?

·      Could Yukos case raise the same concerns of PCAOB about reliability of the Russian PwC audit working papers as in case Deloitte-Longtop affair?

·      Might the significant share of audit fees incoming from state owned giant company, Gazprom, somehow impact PwC’s decision?

·      What are ethical stances behind PwC deed?

The specialists, blogers who would like to contribute to the discussion of this issue and probably post their own article in “Audit is Cool” blog are welcomed (please send me message) or you can just leave your comment.

PS: Funny Reality

Here is the real phrase from Russian court ruling on the second case against Khodorkovsky and Lebedev (p. 613):

“… Khodorkovsky and Lebedev kept two sets of financial accounts (reporting per Russian Accounting Principles and US GAAP) and concealed from shareholders consolidated financial reports, by publishing them only in English language…”

This funny words were noticed by my friend in Livejournal, tema57 J

Sources:

The Economist. 2011. Auditing in China.September 17

The Wall Street Journal.2010. Oil Tycoon Says PWC Caved to Pressure. September 7

Financial Times.2010. Russia:Chain retraction. September 6.

Khodorkovky and Lebedev Communication Center:

·       http://www.khodorkovskycenter.com

·       http://www.khodorkovsky.ru/

Q&A from the defense team on the PwC investigation - A Q&A with the defense team inrelation to PwC's withdrawal of 10 years of its YUKOS audits

ECHR. 2011. Case of OAO neftyanaya kompaniya Yukos v. Russia. Applicationno. 14902/04

Second Case Ruling Khodorkovsky and Lebedev.2010

Ethical Auditor: Independence vs Rotation

Rotation

My previous post on ethics was rather popular, which gives me reasons to suggest that people are interested in auditors’ behavior and their place in business culture. Last week The Economist published interesting article about independence of auditors. Here are very appealing facts in the article:

    “… 1896 was also the year that Barclays, a British bank, chose an ancestor of PwC as its auditor, a relationship unbroken to this day. Fidelity is the norm in auditing. GE, Procter & Gamble and Dow Chemical have also clocked up centuries with their auditors. The average tenure for an auditor of a British FTSE 100 company is 48 years. Two-thirds of Germany’s DAX 30 have had their auditors for over 20 years.”

There are several opinions presented in article, one of which suggests that to address the issue it necessary to impose audit firm rotation. After reading I decided to discuss independence, because it is quite disputable area.

Current Situation: Partner Rotation

The literature on audit states that there is familiarity threat, which could arise between staff of audit firm and client. The risk is that auditor would lose professional scepticism because of too close relations with client. To address this issue official documents like SOX (in USA) and accounting codes like ACCA Code of Ethics and Conduct set specific requirements on audit partners rotation in case of dealing with listed (or public interest) clients. The requirements are as follows:

1.  Engagement partner should be rotated after 5 years;

2.    Other key audit partners should be rotated after 7 years;

3.    Partner responsible for quality control should be rotated after 7 years

However, current talks about rotation of firm suggest that above measures are not enough to provide independent audit opinion.

Who to Decide

Now we are coming to the point of appointing auditors on top management level. As known auditors, which expected to be appointed have to be approved by shareholders on annual general meetings. If shareholders did it for 100 years as in above case with Barclays then it all right. They bear all risks of such appointment and they should have understood it. 

However, in current stakeholder theory – shareholders are not the only persons who are affected by activity of listed Company. If it is “public interest entity” then the potential effect on other members of public gives right to public to interfere in the process of auditor appointment. I wrote about it in previous post considering proposals of European Commission on extra audit regulations.

The appointment of auditor becomes especially significant in case of financial institutions in our days as panic on market related with bankruptcies might jeopardize whole economy.

More Regulation – Better Results?

The above article gives example of number of studies which founded that rotations do not necessary results increase of audit quality. On the contrary, because of lack of client knowledge the quality might deteriorate. On the other hand, then it would be necessary to establish special rules for information transfer between auditors to provide better client understanding. The third point is that all these regulation might become too huge for auditors and add much more to existing bureaucracy in our profession.

What are your ideas in this issue, please share your thoughts in comments.