8.8
OAO CASE GAZPROM
Synopsis
In 2001, PricewaterhouseCoopers (PwC) became entangled in what business journalists
referred to as Russias Enron. One of PwCs largest audit clients at the time was OAO
Gazprom, the largest publicly owned company in Russia and the company that had long
dominated that countrys natural gas industry. Over the past several years, critics had charged
top Gazprom officials with engaging in a wide range of asset-stripping practices. Allegedly,
these executives funneled billions of dollars of Gazproms assets into a network of privately
owned companies that they and their family members controlled.
Gazprom became an audit client of PwC in 1995. In 2001, Gazproms minority
shareholders, who were predominantly U.S. investors, sued PwC for deliberate malpractice. The
Gazprom lawsuitsmultiple lawsuits were actually filed against PwCwere noteworthy
because they were the first such lawsuits filed against a major international accounting firm in
Russia. The principal allegation in these lawsuits was that PwC failed to take any measures to
encourage Gazproms management to disclose in the companys annual financial reports the true
nature of its complex and clandestine related party transactions.
This case examines the controversy surrounding PwC and its Gazprom audits. Also
discussed in the case are several international accounting, auditing, and financial reporting issues
that are central to the PwC-Gazprom debacle.
81 Case 8.8 OAO Gazprom
OAO GazpromKey Facts
1. Gazprom is a huge Russian company that dominates that nations important natural gas
industry.
2. Similar to most major Russian companies, Gazprom was a product of Russias
privatization programme of the early 1990s that was intended to convert the country from a
communistic to a capitalistic economic system.
3. PwC was selected as Gazproms audit firm in 1995 at the first meeting of the companys
stockholders.
4. Viktor Chernomyrdin, who became the Russian prime minister in 1992, and his close friend
and protg, Rem Vyakhirev, are two former Gazprom executives who had a significant impact
on the company and its corporate culture over the past few decades.
5. The Russian press accused Chernomyrdin, Vyakhirev, and their colleagues of diverting a
huge amount of Gazproms assets into related party entities that they or their family members
controlled.
6. A reform movement begun by new Russian president Vladimir Putin shortly after he took
office in 2000 forced large numbers of so-called red directors to resign their positions with
large Russian companies.
7. To improve the credibility of Russian corporate financial statements, Putin and other
reformers took measures to strengthen Russias financial reporting system, including the
adoption of Western-style accounting principles and auditing practices.
8. Allegations that Gazprom executives were diverting corporate assets to a related entity,
Itera, prompted the companys board to retain PwC to perform a special audit of the GazpromItera transactions.
9. Critics claimed that PwC lacked the objectivity to carry out the special Itera audit since the
firm had implicitly approved the suspicious Gazprom-Itera transactions during prior audits.
10. PwCs special audit failed to uncover any direct evidence of fraud involving Gazproms
business dealings with Itera.
11. Gazproms minority stockholders filed several lawsuits against PwC that charged the firm
with defective audits of the company; these were the first such lawsuits filed against a major
accounting firm in Russia.
12. Russian courts dismissed the minority stockholders lawsuits, ruling that there was not a
valid basis for those lawsuits under existing Russian laws.
Case 8.8 OAO Gazprom
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Instructional Objectives
1. To illustrate the central importance of a reliable accounting and financial reporting
infrastructure and rigorous independent audit function for a free market economy.
2. To demonstrate that auditors in other countries face many of the same criticisms that
auditors in this country have dealt with for decades.
3. To demonstrate that differences in cultural, political, and legal norms across countries can
pose unique ethical challenges and business risks for auditors.
4. To introduce students to different accounting and auditing philosophies applied across the
globe.
5. To provide students with a historical overview of the emerging accounting and auditing
profession in Russia.
Suggestions for Use
This case provides an opportunity for instructors to discuss several key auditing issues as
well as lend an assist to any of their students concurrently enrolled in Russian History 101. In
fact, the recent history of Russia is very relevant to this case. This case tracks the history of
Russias largest and most important company, OAO Gazprom, through the turbulent 1990s and
beyond when that nation effectively converted from a controlled to a free market economy.
More than any other case, the Gazprom case hopefully demonstrates the central and critical role
that a reliable financial reporting system and credible independent audit function play in a
capitalistic society. You might ask students if there are any parallels between the development
of the independent audit function in the United States and Russia. I believe that you can
compare the past decade in Russia to the years following the stock market crash of 1929 in the
United States. Following the stock market crash, the importance and need for independent
audits was firmly established in the minds of business and political leaders in this country. The
widespread corruption in Russia in recent years has convinced many of that countrys leaders
that a strong independent audit function is a necessary ingredient for the development of a
vigorous private enterprise system.
Probably most importantly, this case provides students with an opportunity to discuss the
overarching ethical responsibilities of independent auditors and independent audit firms. The
key events in the Gazprom case occurred in an environment in which there were very few formal
rules, regulations, or legal constraints on auditors and accountants. It is in such an environment
that the ethical mettle of professional auditors and accountants is most thoroughly tested. I hope
that students realize that even in the absence of any explicit requirements for doing so, true
professionals should act with honor and integrity and, as Spike Lee says, do the right thing.
As a prelude to discussing this case, consider having a group of students present a brief
report on the most recent developments relevant to this live case. Ask the group to provide a
five- to ten-minute oral report on the current status of Russias independent audit function, the
83 Case 8.8 OAO Gazprom
status of that nations effort to embrace IFRS, and key political developments that may have
major implications for the nations economy and thus its financial reporting and auditing
domains.
Suggested Solutions to Case Questions
1. Listed next are examples of key challenges that an accounting firm may face when it
decides to establish its first practice office in a foreign country.
Need to become familiar with the laws and other regulations that govern business
operations in that country.
Need to become familiar with unusual or nonstandard professional rules or practices
in that country.
Need to become familiar with unique and/or important cultural norms in that country
that influence business relationships.
Need to develop a network of business contacts for client development purposes.
Financing will likely be needed to fund the new offices operations before it
becomes self-sustaining.
Staffing needs for the new office will likely require some firm partners and
employees to agree to relocate to that office.
For most firms, economics dictate whether a practice office should be established in a
new market. After considering the items just listed and a slew of other relevant variables, an
accounting firms management must decide whether it makes economic sense to open the new
office, that is, will the new office contribute to the economic well-being of the firm? Among the
other relevant variables the firm must consider in reaching this decision are the prospects for
economic growth in the new country or market, the level of competition that the firm will face
from domestic accounting firms and other international firms in the potential new market, and
any complimentary effects that the new office might have for the firms existing practicefor
example, the new office may help the firm better serve the needs of domestic clients that have
operations in the given country. Intangible variables, such as enhancing a firms reputation as a
worldwide player in the accounting, auditing, and consulting disciplines, are also relevant
variables in deciding whether to open a practice office in a new market. (Granted, intangible
variables also have economic consequences, consequences that are difficult to quantify in most
cases.)
Similar to any proposed or potential business venture, an accounting firm that is
considering opening a practice office in a new market should develop a comprehensive business
plan for that venture. An indispensable feature of this business plan is a set of detailed budgets
and forecasts that cover each of the three major time horizons for the proposed venture (nearterm, intermediate term, and long-term).
2. In my view, this is a difficult but important question for students to address. Practically
every multinational company or organization struggles with this issue at some point in time. I
believe that one important point that instructors and students alike should realize is that no one
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84
country, including ours, has cornered the market on business ethics. That is, there is room for
improvement in this regard across the globe. In this same vein, there are honest and often sharp
differences of opinion across countries in exactly what practices are considered ethical (and
legal). For example, the following article summarized the results of a study that investigated
business practices that are considered ethical or unethical in Russia and the United States: S.M.
Puffer and D.J. McCarthy, Finding the Common Ground in Russian and American Business
Ethics, California Management Review, Winter 1995. This study found that Russian
businesspeople generally have no problem with price-fixing, while American businesspeople
believe price-fixing is unethical. Grease payments were also considered ethical by the Russian
participants in the study but unethical by their U.S. counterparts. On the other hand, whistleblowing and large differences between executives and subordinates salaries were perceived as
ethical business practices in the United States but unethical practices in Russia.
In my view, the best strategy for coping with situations similar to the one posed by this
question is to simply rely on the bedrock ethical principles that have been embraced by the
public accounting profession in the United States. In auditing classes, we often spend
considerable time studying and dissecting the specific rules, rulings, and interpretations included
in the AICPA Code of Professional Conduct. However, we might better serve our students by
spending more time on the six principles that underlie those more specific components of the
Code. The Preamble to the Code (ET 51.02) notes that, The Principles call for an unswerving
commitment to honorable behavior, even at the sacrifice of personal advantage. I particularly
enjoy discussing the third principle, Integrity, with my students. Here is an excerpt from the
Code that focuses on the meaning of integrity.
Integrity is measured in terms of what is just. In the absence of specific rules, standards, or
guidance, or in the face of conflicting opinions, a member should test decisions and deeds
by asking: Am I doing what a person of integrity would do? Have retained I my
integrity? Integrity requires a member to observe both the form and the spirit of technical
and ethical standards, circumvention of those standards constitutes subordination of
judgment. (ET 54.03)
In the final analysis, I would suggest that the ultimate moral or ethical obligation imposed
on an accounting firm or individual auditor by the circumstances described in this case question
may simply be to respond to the two questions presented in the prior excerpt and then to act
accordingly. In my view, individuals and professional organizations all too often make ethical
dilemmas too complex, too multidimensional, too muddy. In many, if not most cases, the
proper decision in such dilemmas is very obviousas are the costs of making that choice.
3. Recognize that we do not have access to the engagement letter that PwC signed for the
Gazprom engagementwhich is an important caveat to raise for your students in addressing this
question. So, we do not know what specific commitments that PwC made to Gazprom officials.
Likewise, recognize that Russian laws and common law precedents relevant to independent
auditors are, as indicated in the case, scanty at best, which means that it is difficult, if not
impossible, to pinpoint PwCs specific legal responsibilities to the various parties relying on the
firms Gazprom audits.
With those disclaimers out of the way, I would suggest that PwC certainly had multiple
responsibilities to Gazproms minority investors. For example, since the minority investors
85 Case 8.8 OAO Gazprom
were part owners of Gazprom, PwC had a responsibility to those investors to live up the
contractual commitments the firm had made in agreeing to complete the annual Gazprom audits.
The key question in this context is whether PwC had a responsibility to alert the minority
investors to the apparently questionable business transactions that Gazprom officials were
engaging in with various related parties. Before answering that question, we have to make an
assumption regarding whether or not PwC was aware of those transactions and their true nature
and intent. If, in fact, PwC was aware that Gazprom executives were diverting assets to related
entities, I would argue that PwC officials certainly had a responsibility as professionals to take
appropriate measures to alert those parties that were being harmed by those transactions,
including the companys minority investors. In determining an audit firms responsibilities in
such contexts, again, I would suggest that we should always refer to the professions bedrock
ethical responsibilities. As noted in the suggested solution to Question 2, when an auditor faces
situations in which his or her professional, moral, or ethical responsibilities are unclear, an
appropriate strategy for dealing with those situations is to answer the following simple
questions: Am I doing what a person of integrity would do? Have I retained my integrity?
4. This is a good discussion question for an auditing class but another question that does not
have a clear-cut answer. In the final analysis, the PwC personnel making the decision of
whether or not to perform the Itera special audit had to consider a number of variables, including
their perception of whether or not they could objectively complete that engagement. A key
variable those personnel should have, and may have, weighed heavily in this decision was the
opinion of other PwC executives regarding the propriety of accepting the Itera engagement. I
would suggest that this latter input should have been a very important, if not determining, factor
to consider in making that decision. Why? Because PwC partners unrelated to the Gazprom
engagement would have been able to analyze more objectively the propriety of completing the
special Itera audit. In fact, PwC officials might have considered obtaining input from other
parties, including outside legal counsel and trusted associates with other firms, before reaching a
decision regarding the Itera engagement. (Note: As pointed out in the case, even some PwC
partners in the firms Moscow office apparently disagreed with the decision to accept the Itera
engagement.)
Listed next are examples of specific ethical issues or challenges that the Itera special audit
engagement posed for PwCs Moscow practice office:
Could the PwC auditors be objective in reviewing major transactions that they likely had
already considered in arriving at clean opinions on Gazproms previous financial statements?
How would the PwC auditors react to any explicit or implicit pressure imposed on them by
Gazprom management during the course of the special audit? (Clearly, Gazprom officials had a
vested interest in a clean report from that audit. The large audit fee that PwC received for the
annual Gazprom audit provided those officials with some economic leverage on the audit
firm.)
If the PwC auditors found that the Gazprom-Itera transactions in question were improper in
some sense, would the auditors have the courage to include such findings in their report for the
special audit?
If the PwC auditors found that the Gazprom-Itera transactions in question were improper in
some sense, would the auditors have the courage to retract their prior audit opinions?
Could the decision of whether or not to perform the special audit impact the credibility and
reputation of the PwC firm in Russia, throughout Europe, and worldwide?
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5. The relevant section of the professional standards in this context is AU 334.07,
Determining the Existence of Related Parties. This section points out that certain related
parties are clearly evident. For example, each subsidiary of a conglomerate or holding
company qualifies as a related party. Auditors have an affirmative responsibility to search for
related parties that may not be evident. AU 334.07 lists eight specific audit procedures that
auditors may apply to identify related parties of an audit client. Listed next are four of those
procedures.
Request from management the names of all related parties.
Review stockholder listings of closely held companies to identify principal stockholders.
Review the clients filings with the SEC and other regulatory authorities for the names of
related parties.
Review material investment transactions of the audit client to determine whether those
transactions created related parties.
6. You can find numerous articles in recent years that have documented, described, and
debated the differences between the audit philosophy applied in the United States versus that
applied in the United Kingdom. Although a little dated at this point, the following article
provides a comprehensive and insightful analysis of those differences: C.A. Frost and K.P.
Ramin, International Auditing Differences: The Implications for Investors and Other Financial
Statement Users, Journal of Accountancy, April 1996. [Note: This article actually compares
and contrasts auditing practices in the United States, the United Kingdom, and Germany.] Here
is an opening punchline from this article. International differences in audit objectives,
standards and practice . . . result in differing levels of audit assurance. Financial statement users
and accountants whose clients demand expertise in all phases of financial reporting matters
domestic and internationalneed to be aware of these differences. Another even older J of A
article provides additional insights on the true and fair audit philosophy. See, A.B. Creamer,
Auditing Beyond the U.S. Shores: What the U.S. CPA Should Know, Journal of
Accountancy, November 1987.
Frost and Ramin suggest that the audit philosophies applied in the United Kingdom and the
United States are more similar than they are different, which is to be expected since the
independent audit function in this country was effectively imported from the United Kingdom
during the late 19th and early 20th centuries. Nevertheless, there is one readily apparent
philosophical difference between U.K. and U.S. auditing standards. Frost and Ramin report that
U.S. auditing standards tend to be highly specific and comprehensive, while U.K. auditing
standards are more principle-based. Because of this difference, U.K. auditors tend to have more
flexibility or leeway in designing audit plans for their clients than U.S. auditors. This difference
in U.S. and U.K. auditing standards has prompted some degree of tension between professional
organizations in the two countries. Of course, U.K. auditors tend to prefer the U.K. approach,
while U.S. auditors have an affection for the U.S. audit model. (There are a number of other
differences between U.K. and U.S. auditing standards that tend to be more technical, or less
philosophical, in a nature. For example, a U.K. audit report indicates whether or not a given
public companys financial statements are in compliance with federal securities laws, while a
U.S. audit report contains no such indication.)
87 Case 8.8 OAO Gazprom
Which of the two philosophies is better or more defensible? The jury is still out on this
question. [Granted, the U.K.s true and fair philosophy is more widely invoked worldwide.]
You might point out to your students that the major U.S. audit firms have debated a closely
related issue for decades, namely, how much structure should be incorporated into a firms
basic audit strategy. Structured firms tend to rely heavily on canned audit programs,
statistical sampling applications, and related audit tools, while unstructured or judgmental
firms are more inclined to allow each audit engagement team to use its discretion in developing
an appropriate audit plan for a given client. Again, this debate is ongoing, although empirical
evidence seems to suggest that structured audit strategies have become more prevalent in recent
years.
7. This question is closely related to Question #6. The IASB believes that accounting
standards should be principle-based as opposed to being highly specific and comprehensive.
Throughout the final quarter of the 20th century, IASB spokespeople subtly, and sometimes
bluntly, criticized accounting rule-makers in the United States for promulgating standards that
were allegedly too detailed and often highly contextual. The IASB believes that the role of a
rule-making body for the accounting profession should be to lay down broad guidelines or
principles that individual accountants can then interpret and apply to specific situations.
Members and representatives of the FASB have typically responded to the implicit or explicit
criticism of the IASB by insisting that U.S. accounting standards are both contextual and
principle-based. One individual that made the latter point very definitively was Edmund
Jenkins, who served for several years as the chairman of the FASB. Principled versus detailed
accounting standards is a misnomer. I think FASB standards are principle-based, beginning with
the concept statements, but we dont stop there. Our standards are principles and details. The
issue is where to draw the line. (G. Cheney, As Parting Plea, Jenkins Calls for Broad Changes
in U.S. Accounting, Accounting Today, July 8-21, 2002, 14.)
There have been numerous articles appearing in British publications during the past few
years that suggest the Enron scandal was a direct consequence of the pinpoint nature of U.S.
accounting standards. These articles typically maintain that overly-detailed or specific
accounting rules provide creative accountants, bankers, and lawyers with an opportunity to
develop highly stylized transactions that can undercut the intent of those rules. Allegedly, such
creative ruses are less feasible in Great Britain given the overriding need for financial statements
to present a true and fair view of a given entitys financial affairs.
[Note: In responding to this question, you will no doubt want to summarize, or ask your
students to summarize, the current status of the ongoing effort to harmonize IFRS and U.S.
GAAP.