Hermitage Capital Management, an international
investment firm owned by HSBC London, is suing PwC
(PricewaterhouseCoopers), the biggest among the big four
accounting firms (Andersen, the fifth, is being
cannibalized by its competitors).
Hermitage also demands to have PwC's license suspended
in Russia. All this fuss over allegedly shoddy audits of
Gazprom, the Russian energy behemoth with over $20
billion in annual sales and the world's largest reserves of
natural gas. Hermitage runs a $600 million Russia fund
which is invested in the shares of the allegedly misaudited
giant.
The accusations are serious. According to infuriated
Hermitage, PwC falsified and distorted the 2000-1 audits
by misrepresenting the sale of Gazprom's subsidiary,
Purgaz, to Itera, a conveniently obscure entity. Other loss
spinning transactions were also creatively tackled.
Stoitransgaz - partly owned by former Gazprom managers
and their relatives - landed more than $1 billion in
lucrative Gazprom contracts.
These shenanigans resulted in billions of dollars of losses
and a depressed share price. AFP quotes William
Browder, Hermitage's disgruntled CEO, as saying: "This
is Russia's Enron". PwC threatened to counter-sue
Hermitage over its "completely unfounded" allegations.
But Browder's charges are supported by Boris Fyodorov,
a former Russian minister of finance and a current
Gazprom independent director. Fyodorov manages his
own investment boutique, United Financial Group.
Browder is a former Solomon Brothers investment
banker. Other investment banks and brokerage firms -
foreign and Russian - are supportive of his allegations.
They won't and can't be fobbed.
Fyodorov speculates that PwC turned a blind eye to many
of Gazprom's shadier deals in order to keep the account.
Gazprom shareholders will decide in June whether to
retain it as an auditor or not. Browder is initiating a class
action lawsuit in New York of Gazprom ADR holders
against PwC.
Even Russia's president concurs. A year ago, he muttered
ominously about "enormous amounts of misspent money
(in Gazprom)". He replaced Rem Vyakhirev, the oligarch
that ran Gazprom, with his own protégé. Russia owns 38
percent of the company.
Gazprom is just the latest in an inordinately long stream
of companies with dubious methods. Avto VAZ bled itself
white - under PwC's nose - shipping cars to dealers,
without guarantees or advance payments. The penumbral
dealers then vanished without a trace. Avto VAZ wrote
off more than $1 billion in "uncollected bills" by late
1995. PwC did make a mild comment in the 1997 audit.
But the first real warning appeared only three years later
in the audit for the year 2000.
Andrei Sharonov, deputy minister in the federal Ministry
of Economics said, in an interview he granted "Business
Week" last February: "Auditors have been working on
behalf of management rather than shareholders." In a
series of outlandish ads, published in Russian business
dailies in late February, senior partners in the PwC
Moscow office made this incredible statement: "(Audit)
does not represent a review of each transaction, or a
qualitative assessment of a company's performance".
The New York Times quotes a former employee of
Ernst&Young in Moscow as saying: "A big client is god.
You do what they want and tell you to do. You can play
straight-laced and try to be upright and protect your
reputation with minor clients, but you can't do it with the
big guys. If you lose that account, no matter how justified
you are, that's the end of a career".
PwC should know. When it mentioned suspicious heavily
discounted sales of oil to Rosneft in a 1998 audit report,
its client, Purneftegaz, replaced it with Arthur Andersen.
The dubious deals dutifully vanished from the audit
reports, though they continue apace. Andersen claims
such transactions do not require disclosure under Russian
law.
How times change! Throughout the 1990's, Russia and its
nascent private sector were subjected to self-righteous
harangues from visiting Big Five accountants. The
hectoring targeted the lack of good governance among
Russia's corporations and public administration alike.
Hordes of pampered speakers and consultants espoused
transparent accounting, minority shareholders' rights,
management accessibility and accountability and other
noble goals.
That was before Enron. The tables have turned. The Big
Five - from disintegrating Andersen to KPMG - are being
chastised and fined for negligent practices, flagrant
conflicts of interests, misrepresentation, questionable
ethics and worse. Their worldwide clout, moral authority,
and professional standing have been considerably dented.
America's GAAP (Generally Accepted Accounting
Practices) - once considered the undisputable benchmark
of rectitude and disclosure - are now thought in need of
urgent revision. The American issuer of accounting
standards - FASB (Financial Accounting Standards
Board) - is widely perceived to be an incestuous
arrangement between the clubby members of a rapacious
and unscrupulous profession. Many American scholars
even suggest to adopt the hitherto much-derided
alternative - the International Accounting Standards (IAS)
recently implemented through much of central and eastern
Europe.
Russia's Federal Commission for the Securities Market
(FCSM) convened a conclave of Western and domestic
auditing firms. The theme was how to spot and neutralize
bad auditors. With barely concealed and gleeful
schadenfreude, the Russians said that the Enron scandal
undermined their confidence in Western accountants and
the GAAP.
The Institute of Corporate Law and Corporate Governance
(ICLG), having studied the statements of a few major
Russian firms, concluded that there are indications of
financial problems, "not mentioned by (mostly Western)
auditors". They may have a point. Most of the banks that
collapsed ignominiously in 1998 received glowing audits
signed by Western auditors, often one of the Big Five.
The Russian Investor Protection Association (IPA) and
Institute of Professional Auditors (IPAR) embarked on a
survey of Russian investors, enterprises, auditors, and
state officials - and what they think about the quality of
the audit services they are getting.
Many Russian managers - as avaricious and venal as ever
- now can justify hiring malleable and puny local auditors
instead of big international or domestic ones.
Surgutneftegaz - with $2 billion net profit last year and
on-going dispute with its shareholders about dividends -
wants to sack "Rosexperitza", a respectable Russian
accountancy, and hire "Aval", a little known accounting
outfit. Aval does not even make it to the list of 200 largest
accounting firms in Russia, according to Renaissance
Capital, an investment bank.
Other Russian managers are genuinely alarmed by the
vertiginous decline in the reputation of the global
accounting firms and by the inherent conflict of interest
between consulting and audit jobs performed by the same
entity. Sviazinvest, a holding and telecom company, hired
Accenture on top of - some say instead of - Andersen
Consulting.
A decade of achievements in fostering transparency,
better corporate governance, and more realistic accounting
in central and eastern Europe - may well evaporate in the
wake of Enron and other scandals. The forces of reaction
and corruption in these nether lands - greedy managers,
venal bureaucrats, and anti-reformists - all seized the
opportunity to reverse what was hitherto considered an
irreversible trend towards Western standards. This, in
turn, is likely to deter investors and retard the progress
towards a more efficient market economy.
The Big Six accounting firms were among the first to
establish a presence in Russia. Together with major league
consultancies, such as Baker-McKinsey, they coached
Russian entrepreneurs and managers in the ways of the
West. They introduced investors to Russia when it was
still considered a frontier land. They promoted Russian
enterprises abroad and nursed the first, precarious, joint
ventures between paranoid Russians and disdainful
Westerners.
Companies like Ernst&Young are at the forefront of the
fight to include independent directors in the boards of
Russian firms, invariably stuffed with relatives and
cronies. Together with IPA, Ernst&Young recently
established the National Association of Independent
Directors (NAID). It is intended to "assist Russian
companies to increase their efficiency through
introduction of best independent directors' practices".
But even these - often missionary - pioneers were blinded
by the spoils of a "free for all", "winner takes all", and
"might is right" environment. They geared the accounts of
their clients - by minimizing their profits - towards tax
avoidance and the abolition of dividends. Quoting
unnamed former employees of the audit firms, "The New
York Times" described how "... the auditors often chose
to play by Russian rules, and in doing so sacrificed the
transparency that investors were counting on them to
ensure".