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. Last Updated: 07/27/2016

Bending Rules to Play Russian Auditing Game

The big U.S. accounting firms were among the first foreign companies to arrive in Russia after the fall of communism. They opened offices here and in other former Soviet republics and rapidly landed many of the largest companies as clients.

But in their competitive rush for a foothold, the Big Six (now Big Five) auditors lent their reputations to practices that in the West would be regarded as unethical if not illegal, current and former employees of the firms said in recent interviews.

The employees of the auditing firms -- Arthur Andersen, Deloitte Touche Tohmatsu, Ernst & Young, KPMG International and PricewaterhouseCoopers -- are bound by agreements guaranteeing confidentiality to their clients, and they spoke on condition that they, and in some cases the firms they were associated with, not be identified.

As auditing firms have come under increased scrutiny since Enron Corp.'s collapse, most attention in Russia has focused not on Andersen, Enron's auditor, but on PricewaterhouseCoopers, which has been accused by minority shareholders and regulators of failing to look critically at a pattern of vanishing assets at Gazprom, the giant gas monopoly.

In the chaotic early years of new Russian capitalism, accounting standards here were poorly suited to market economics. They were built around reporting to tax authorities, not gauging a company's financial health for investors. Oversight was all but nonexistent, and the legal system was undeveloped, leaving room for manipulation and theft.

In many cases, Russian managers actively tried to conceal their companies' true financial condition, as Enron managers have been accused of doing. But instead of disguising losses, the Russian managers wanted to disguise profits, both from tax inspectors and from shareholders.

In this environment, Western auditing firms could have and should have held their Russian clients to higher standards of behavior, investors in Russian companies are now saying. But instead, according to the current and former auditing employees, as well as analysts and government officials interviewed for this article, the auditors often chose to play by Russian rules and in doing so sacrificed the transparency that investors were counting on them to ensure.

In Russia, auditors "check that the paperwork was done correctly, but look right past the deeply corrupt heart of the matter," said Pyotr Karpov, the former head of the government's financial accounts commission, which investigated companies with large tax arrears. "They interpret their mission very narrowly," Karpov said. "In a society with morals and functioning societal controls, that approach can work. But not in Russia."

Consider AvtoVAZ, Russia's biggest car company. Auditors and tax consultants from Price Waterhouse, now part of PricewaterhouseCoopers, began examining the company's books in 1993.

The audits did not give AvtoVAZ a completely clean bill of health. For example, in its 1997 Russian audit, Price Waterhouse warned that AvtoVAZ was accounting for domestic and foreign sales differently and that it could not say how much the inconsistency affected reported sales revenue.

But this red flag hardly conveyed what was actually going on at the company. "They shipped the cars to all these wonderful dealers, and the dealers disappeared after six months with huge debts that were written off," said a former Price Waterhouse employee who worked on the audit. "'What's going on?'" the former employee recalled thinking. "'You aren't getting paid -- no guarantees, no nothing. Are you stupid?' It was clear to me that it was part of an organized robbery."

Karpov, who went through the auto company's books in late 1995, said he saw a similar problem, with nearly $1 billion in uncollected bills for shipped cars.

By 2000, PricewaterhouseCoopers' warnings about AvtoVAZ had become much sharper, expressing doubts that the company could pay its debts over the next year.

AvtoVAZ did not respond to requests for comment.

In a written statement, PricewaterhouseCoopers said that it stood by its audits of AvtoVAZ, that there were no material errors in its 1997 financial statements and that the accounting firm could not respond to general and unsubstantiated claims by the former employee.

Even so, principals of PricewaterhouseCoopers' Moscow office are clearly concerned about mounting criticism of the firm as misdoings at clients such as Gazprom come to light. The principals took out full-page advertisements in two of Russia's business dailies in late February to argue that an audit "does not represent a review of each transaction or a qualitative assessment of a company's performance."

Hold on, say investors -- if not the auditor, who will give the public an accurate picture of a company's finances?

William Browder, manager of the $600 million Hermitage Fund in Moscow, said: "If the auditors were doing their job properly, they would say, 'Why did you do business with that particular oil trading firm?' Or: 'Why did you sell assets to that person? Is that a relative? If so, we'll have to disclose it in the audit.' Then we'd have a clearer picture."

Sales at far below market prices to companies owned by managers or their families are another common abuse here. A team from a Big Five auditor found evidence that something like that might have been going on at a factory in the Urals.

A member of the team said in an interview that a colleague was able to get sales data from a low-level employee in the factory's computer center that showed much of its output being sold extremely cheaply to obscure offshore companies. The accountant who obtained the data informed the auditing firm's Moscow partners, his colleague said, but the partners refused to mention the suspicious sales in the audit. The accountant who obtained the data later resigned.

Fierce competition for clients may account for some laxness by auditors. The biggest, most lucrative clients were also the most complex, and at times auditing employees said they felt pressure to sign off on questionable practices by such clients to avoid alienating them.

"A big client is god," said one former employee of Ernst & Young in Moscow. "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."

Gazprom is held up by critics of the auditors as a case in point. Of PricewaterhouseCoopers' 800 employees in Moscow, 50 work on Gazprom alone, according to a former employee assigned to the account.

A spokesman for the auditing firm declined to say how much of its business Gazprom represents. In a statement last month, the firm dismissed as "absurd" the accusation that it compromises its standards to retain big clients.

Some investors are not persuaded. "The only related party transactions PricewaterhouseCoopers eventually disclosed were those that found their way into the public domain," said Charles Ryan, chairman of United Financial Group, an investment bank that has Gazprom shareholders as customers. "If you believe their assessment, you would conclude we found 100 percent of the related-party deals. I doubt that is true."

Russian business -- and auditing -- has changed markedly since the mid-1990s. Managers of some Russian companies now try hard to please minority shareholders. AvtoVAZ, which began a joint venture with General Motors last year, now posts two years of financial data on its web site. And changes in several laws since 1998 have modernized some Russian accounting practices and, more recently, made auditors more responsible for the integrity of the figures they sign.

"There has been quite an evolution of financial statements over the years," said Stanley Root, a partner at PricewaterhouseCoopers in Moscow. "The accountancy profession started from scratch. Companies have come a long way since then. We are here to help our clients improve their level of disclosure."