Slowly but surely, we are carrying out the work plan for the "Transneft case." Reporting on item 4: "Pressure on the auditors."
We managed to put together a small but highly professional group of auditors. All very sharp guys. Most are former or current employees of the "Big Four" firms. I’m extremely pleased about this, because my own knowledge of the finer points of how audit firms work is roughly at the following level: **- mmmmmm... auditors probably use calculators a lot, since they deal with numbers all the time... ** But now, thanks to the help of some kind-hearted volunteers, we’re ready to cheerfully poke PricewaterhouseCoopers (aka "the Prices") with a sharp stick. The Prices are obviously accountable for their work to Transneft itself, its shareholders, and its bondholders. It is very hard for all of us to believe that they were unaware of theft on this scale, the subsequent massive internal investigation at Transneft, and the inspection by the Audit Chamber (Russia’s state audit body). The position of "sitting there, blinking innocently, and pretending nothing is happening" is no longer acceptable to anyone. Reputation is the main asset of an audit firm. In the Transneft situation, Pricewaterhouse is taking a very serious risk of losing it. We will do everything possible to make sure everyone knows about the Prices’ questionable actions. Let me remind you that they already made a mess of things with Yukos. They had to withdraw an audit report. Transneft won’t come free either. Below is the first result of this collective effort. An official appeal to PwC’s Russian and international offices: December 10, 2010 Peter Gerendasi Managing Partner PricewaterhouseCoopers Russia Copy to: Pierre Coll Global Leader for Risk and Quality Javier H. Rubinstein Global General Counsel PricewaterhouseCoopers 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: 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. 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. Self-disclosure with the US 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, Alexei Navalny If anyone needs the text in Word format, you can download it here. Please feel free to circulate this text among friends and colleagues connected to the exciting world of auditing. It would be especially welcome if it were circulated among employees and shareholders of companies that engage PwC as their auditor. To everyone who contributed to the letter: rays of gratitude, warm regards, and a huge thank-you.