People often write to me saying: enough about dachas and offshore companies—write something smart and serious for a change. Nikita Kulachenkov from ACF’s investigations department, whom you may remember from his excellent explainer on sanctions against Russia (part 1, part 2), decided to make up for the shortage of serious writing and has written an important article about the ethical problems facing auditors, using the recent high-profile arbitration ruling on Yukos as an example.
The international arbitration tribunal in The Hague has ruled on the claim brought by former Yukos shareholders and ordered the Russian Federation to pay them $50 billion. Impressive, isn’t it? There is now a debate over whether Russia should pay, and whether it will do so at all, but I would like to raise a different question.
The Hague arbitration ruling contains “a few” words—more than 20 pages, in fact—about how PricewaterhouseCoopers (PwC) withdrew its audit opinions on Yukos’s financial statements. Why was this so important to the tribunal? Because when an auditor signs off on financial statements, it means there are no material misstatements in them and no significant legal violations in the company’s operations. That sat poorly with the Prosecutor General’s Office’s claims that Mikhail Khodorkovsky had spent years evading billions of dollars in taxes and, absurdly, stealing oil from himself. Former Yukos shareholders and managers, for their part, relied on the auditor-certified financial statements, and this was one of the key arguments in their defense in court proceedings.
After the audit opinions on the 1995–2004 financial statements were withdrawn on the basis of “new information” that had allegedly come to the auditor’s attention, that fact was widely used by representatives of the Russian Federation both in Russian courts and in the arbitration proceedings in The Hague. I imagine it sounded something like this in The Hague: “See? Even your bourgeois auditors admitted there were violations! So why do you keep going on about political persecution and the seizure of a business...?” Former Yukos shareholders, meanwhile, argued that PwC withdrew its opinions not because of any “new information,” but because it was under enormous pressure from various Russian state bodies. In that view, the real justification for withdrawing the opinions may have been that Yukos no longer existed, and that this was the only decision that could remove serious business risks for PwC and personal risks for the audit firm’s employees.
If there really were solid grounds for withdrawing the opinions, then the withdrawal significantly strengthened Russia’s position in the arbitration in The Hague. But if there were no such grounds, then the withdrawal significantly strengthened the position of Yukos’s shareholders. Either way, however, the withdrawal dealt a devastating blow to PwC’s reputation. The tribunal specifically notes that its ruling does not contain an ethical or professional assessment of PwC’s conduct, and before I pose my question, let us look at the chronology of events.
PwC had worked with Yukos since 1997, providing not only audit services but also consulting services (including tax advice) and training, and it also played a key role in setting up the company’s financial reporting processes. One of the claimants’ witnesses said that PwC had been given unrestricted access to the group’s entire documentation, and that the auditor had a complete picture of the financial position and procedures of Yukos and its subsidiaries. The auditors never once raised the issue of any restrictions on access to information or personnel.
In 2003, when Platon Lebedev was arrested on tax-related charges, a PwC partner told Yukos’s Board of Directors that “there are no problems, and Yukos, together with its tax optimization scheme, complies with the requirements of Russian law.” What happened to PwC afterward strongly suggests that the auditor was subjected to substantial pressure from the Russian authorities. That pressure included:
On June 27, 2007, PwC withdrew ALL of its audit opinions on Yukos’s financial statements for every year it had audited the company during their relationship. This was a unique case in global practice—never before had auditors withdrawn opinions for every year they had audited. The stated justification for the withdrawal was that, based on “new information” from the Russian Prosecutor General’s Office, the auditors had lost confidence in Yukos’s management. It was as if the auditors were saying: “Yukos management and the people under their control deceived us brutally all these years, and we naively believed them. Our eyes have now been opened, and we consider our opinions to have been mistaken.”
However, several important points described in the Hague arbitration ruling should be noted.
It seems to me that about ten years ago I heard from one of PwC’s employees how, at Yukos, “with the push of a button, accounting entries are created reflecting the resale of oil through all the intermediary legal entities for tax optimization purposes.” It is entirely possible that this text is now being read by people who took part in reviewing those Yukos tax schemes and signing off on the relevant items in the financial statements. So now, several years after the withdrawal of the opinions, and on the basis of this “new information” from The Hague, what answers should we give to the following questions:
I agree that these questions are largely rhetorical, but at present auditors and consultants from international firms may face yet another ethical and business dilemma. It is logical to assume that, in light of the state’s confrontation with the rest of the world, our government will not want a group of foreign “enemies” right next door who have access to information about the operations, cash flows, and business practices of a huge number of companies, including state corporations. Do you really think auditors do not know how Rosneft or Russian Railways operate?
To preserve their business in today’s new reality, auditors and consultants may have to comply with whatever conditions the state sets for them. At the same time, pressuring foreign auditors would also be risky for the state. On the one hand, the state wants to get rid of foreigners who have access to important information; on the other hand, if it pushes them out, there is a chance they may disclose information about abuses that they have long known about but had not previously revealed.
Thus, foreign audit firms may now find themselves facing questions that simultaneously involve ethics, safety, and professional duty. And I hope that, in dealing with these questions, they will not use PwC’s tactic of “trying not to give broad publicity to the difficulties that had befallen the company.”
P.S. Incidentally, some of the information set out in the arbitration ruling comes from WikiLeaks publications—specifically, from the diplomatic correspondence of the U.S. Embassy in Moscow. It is amusing that the results of WikiLeaks’ work keep surfacing in the most unexpected places, and I was quite surprised that the Hague tribunal considered information from such a source.
P.P.S. The Hague tribunal uses information hosted on some “unknown servers in San Francisco.” Meanwhile, our very own Russian court refuses to consider a video recording that clearly shows the offense on which it is supposed to rule. The court ignores the video but accepts oral testimony that contradicts it. Whose oral testimony do you think is deemed more reliable than the video? Hint: people who wear uniforms at work and are supposed to enforce the law.
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