Not long ago, I was researching several stories about the fiscal health of the Russian economy. For three months, I interviewed government economists, bankers, corporation presidents, accountants, lawyers, and the heads of "ratings firms" like Moodys and Dun & Bradstreet.
One morning, halfway through a remarkably candid conversation with the man who ran the Moscow office an international rating firm, I was politely asked to press the "pause" button on my tape recorder. When I complied, the man leaned closer and admitted, "Frankly, the conclusions we reach are based on data supplied to us by accountants. We assume they’re telling us the truth, but most of the time we know they’re lying. It’s a guessing game."
Ironically, Russia — once one of the most corrupt and least transparent of all global economies — is taking steps to ensure accountants are truthful in their dealings.
The reforms are inspired by fraudulent practices by Arthur Andersen accountants that enabled multinational clients such as Enron, Global Crossing and Waste Management, Inc. to hide huge losses while enabling their managers to pilfer millions of dollars.
The reforms Russia is imposing on international accounting firms operating within its borders are considered long overdue by financial experts, and could serve as a model for other countries seeking to rid their economies of corruption.
"Congress is seeking to finally impose some kind of control on an [accounting] industry that has never been adequately regulated," says a Washington lobbyist hired recently to defend the interests of a "Big Five" accounting firm. "Arthur Andersen may be the sacrificial lamb in all this, but the death of Arthur Andersen may be the only way the accounting industry will recognize that it should work for the interests of the entire company — which includes employees and shareholders — not just company management."
The effort to police auditors in Russia is being pushed by the Federal Securities Commission (FSC). Last month, leaders from the FSC met with key auditing companies and their clients to explore ways of implementing transparency and restoring the damaged reputation of their financial reports.
"Though cases similar to Enron are very unlikely today on the Russian market, partly due to its grossly undervalued nature, it’s necessary to take measures to prevent their probable occurrences in the future," FSC director Igor Kostikov told the representatives of the auditing community, which included the Big Five — Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers.
The commission and its guests were briefed on examples of "cooked" bookkeeping and how to spot the kind of dishonest accounting practices that prompted the US Department of Justice to indict Arthur Anderson for criminally preventing investigators from looking into Enron’s bankruptcy.
"The Enron debacle shook the whole international equities market to its very foundations and, consequently, triggered almost a complete loss of trust in the integrity of the auditors’ financial reports on corporations," says Vladimir Milovidov, FSC’s first deputy director.
There are many examples aside from Enron’s case, where Arthur Andersen auditors reportedly doctored the company’s financial reports and engaged in other manipulative accounting practices. For instance, on the eve of the historic Russian 1998 financial meltdown, financial reports prepared by some auditing firms listed local companies in general, and the banking sector in particular, as healthy, making the sudden collapse all the more painful and damaging the reputations of auditing firms, who forecast a rosy future. Last year, Boris Fyodorov, a minority-shareholder representative on the Gazprom board, urged shareholders of Gazprom, a huge Russian natural gas concern, to look into the "objectivity" of a company audit performed by PricewaterhouseCoopers.
Fyodorov’s concern was precipitated by PricewaterhouseCoopers’ failure to bring to light the true nature of the relationship with the then-insignificant Itera Corporation, which grew from obscurity in the mid-’90s to the world’s fourth-largest gas producer. According to Fyodorov, this formerly insignificant company was able to rise through the ranks of the Russian energy sector thanks to its connections to the partially state-owned Gazprom — something PricewaterhouseCoopers entirely missed in its audit. With Gazprom about to be audited — once more, by PricewaterhouseCoopers —Fyodorov protested, noting in a statement carried by Interfax, a Russian news agency, that publicly-held companies like Gazprom should change auditing firms every five or six years to avoid a high level of dependence developing between auditor and client.
Duma deputies and other state agencies, including the Audit Chamber — headed by Sergei Stepashin, a St. Petersburg appointee of Russian President Vladimir Putin — have also weighed in on the issue by expressing concerns over financial reports on government monopolies — Unified Energy Systems, Gazprom and the Railways Ministry — prepared by supposedly independent auditors.
For instance, the Audit Chamber has promised to review Gazprom’s past audited reports, while a similar inspection of the Railways Ministry’s finances last year led to the indictment of top managers, including former Railways Minister Nikolai Aksyonenko, for financial mismanagement.
All these unclear financial profiles have led to a situation where auditors’ reports no longer have credibility and most investors and shareholders have totally lost faith in their contents, the FSC’s Milovidov says. This stems from a conflict of interest between companies and auditors, who, by definition, are hired to scrutinize a company’s finances — meaning that these companies are paying salaries to the very people hired to look for fiscal irregularities.
"It’s extremely difficult, if not impossible, to maintain independence and objectivity in such situations," Milovidov adds.
One of the ways to resolve this dilemma is to set up a consultative organ with members drawn from the industry, which will work out a mechanism to raise the auditors’ role and accountability for the contents of their reports, he said. This is very important because the government has not worked out an effective mechanism to enforce a law that makes auditors legally responsible for the authenticity of audited companies’ financial reports, Milovidov notes.
But the auditors refused to be made scapegoats for the professional shortcomings of the companies they audit, arguing that measures to redress the declining trust in financial-audit reports should be directed at enhancing corporate transparency and upgrading companies’ auditing standards.
"Though auditors are in charge of auditing companies and verifying their results, the quality of the audited reports and the authenticity of their content, however, depend on the type of information presented by the companies," Vadim Sorokin, a partner with Deloitte & Touche, tells reporters. Consequently, the companies’ chief economic officers, and not the auditors, should bear the responsibility for the authenticity (or otherwise) of the information contained in reports on them, Sorokin says.
PricewaterhouseCoopers partner Leonid Shneidman also offered the same view: "Auditors can only increase the level of trust in information contained in financial reports. And it’s totally incorrect to hold only auditors responsible for the authenticity of their content."
KPMG managing partner Richard Mannings supported the idea of forming an expert consultative organ, such as auditing committees within companies, which would oversee their auditing procedures.
The unenviable task of trying to convince the US government to abandon — or, at the very least, moderate — its pursuit of Arthur Andersen falls to the Alpine Group, a Washington-based lobbying firm.
Rick White, the Alpine partner handling the Arthur Andersen case, tells Strategic Policy that US control of Andersen’s activities in foreign countries "is not my concern" He explains that Alpine is focused solely "on lobbying on Arthur Andersen’s behalf regarding its domestic activities. Our job," he adds, "is to deal with people on Capitol Hill." Send questions or comments to: [email protected]