PwC and Yukos - Additional validity for the Russian prosecutors or not?

In an unprecedented move for worldwide assurance practice PricewaterhoueCoopers (PwC) withdrew 10 years worth of audit opinions regarding the now bankrupt Yukos oil company. PwC said yesterday it suspects that former Yukos management may have provided inaccurate information to its auditors, and thus Yukos's financial reports certified by PwC for the years 1995-2004 should no longer be relied upon.

The reason for the withdrawal of opinion according to PwC was the existence of intercompany and arm's length transactions between Yukos and its subsidiaries which were never properly classified and which were an inseparable component of its money-laundering scheme. As the Financial Times reports:

“Company management many times declared to us that [the companies]… were not related parties,” the letter says, a copy of which was first obtained by Russian newspaper Vedomosti. During a criminal investigation by prosecutors into the company “we received information that showed [these companies] were controlled by the shareholders of Group Menatep Limited and were used to their advantage,”it says. Baltic Petroleum, South Petroleum and Behles traded Yukos oil from 1995 to 1999. Group Menatep is Yukos’s majority shareholder.

PwC also said management failed to provide enough information on whether Russian entities later used by Yukos were arm’s length transactions or not, and also failed to disclose enough information on “significant payments” the company paid to entities owned by the shareholders of Menatep Bank, which went bust in the August 1998 financial crisis.

PwC previously said it stood by its audits of Yukos and its internal trading structures, which the letter appears to refer to.

Such an issue has a multitude of repercussions both for the future of the Yukos affair and for the future of PwC. Withdrawing 10 years worth of audit work has not been done in the case of billion dollar corporations. Even the infamous Arthur Andersen did not withdraw its audit work for Enron, despite being indicted then for intentional participation in creating fraudulent schemes for the US energy giant. PwC's actions inadvertently claim that the auditor either knowingly participated in the Yukos schemes or it was too dumb to find out about it (in 10 years worth of audits). Both scenarios are extremely negative for the respected auditor.

Mikhail Khodrokovsky's (the former CEO of Yukos, now in jail for fraud) lawyer Mr. Amsterdam, told the Financial Times that PwC worked with Yukos on constructing most of these trading structures and on making sure they were compliant with both Russian and international accounting standards. If this event is in fact true, it proves that PwC was providing consulting work for Yukos and must have been aware of any and all transactions of the now bankrupt oil company.

Another implication that stems from PwC's actions is the international validity given to the Russian prosecution which has successfully pursued its case against Yukos in Russia, resulting in a $27bln unpaid tax bill, and ultimately leading the company into bankruptcy. The Russian government thus has also cleared itself of any possible lawsuits from international shareholders for intentional and wrongful actions against Yukos. PwC's actions, although suspicious, give assurance that Yukos was indeed a hotbed for fraud schemes. Such was the claim made by Russian daily Kommersant.

All would be fine if not for one fact. The Russian government is pursuing its own investigation into PwC'a involvement in the Yukos affair. The investigation could result in a suspension of its license to do business in Russia, where it has a significant financial interest. PwC is the biggest auditor in Russia and audits the state's two biggest energy companies - Gazprom and Rosneft. PwC has already paid to settle some charges last year, but has lost in court on further charges, which it is set to appeal in July. Some see PwC's statements as a surrender to the forceful actions of the Russian government and an attempt to indirectly settle the dispute through friendly actions.

Such a theory has ample evidence. The fact that Gazprom and Rosneft have reinstated PwC as their auditor is strange. Since the audit teams in a particular industry are closely related, this would mean that the partners that have been involved in auditing Yukos are most likely involved in the Gazprom and Rosneft audits and share employees on those jobs. Gazprom and Rosneft are thus denying potential problems or wrongful actions that PwC may have committed in the Yukos audits and confirming the auditor's best reputation. In other words, they deny that PwC may harm their reputation. Would any US energy company hire Arthur Andersen to perform an audit in 2001 or 2002, shortly after the bankruptcy of Enron? I would guess not.

The issue will see further developments in July, when PwC's appeal will he heard in court. If the Russian government is in fact attempting to give validity to its actions, the proper course to take would be at least to suspend auditing licenses from any and all partners involved in the Yukos audits (if that has not already been done) or ban PwC from auditing the oil and gas sector. In any case Gazprom and Rosneft should reconsider having PwC as an auditor, unless they openly believe that it is being bullied by the Russian government.