In February 2002, a lengthy Business Week article examined a major financial scandal swirling around one of the large international accounting firms. Key features of the scandal included the accounting firm allegedly “overlooking wildly improper deals” in its audits of a huge client that ranked among the “country’s biggest energy firms,” a company that had become a symbol “for the evils of crony capitalism.”1 The opening prologue for the article went on to note that the scandal involved “billions and billions” of dollars of losses as well as “leaked documents, infuriated shareholders, and threatened lawsuits.” Several major political figures had been caught up in the scandal, including the president. No, the article was not dissecting the sudden collapse of Enron Corporation in December 2001. Instead, the article focused on the international controversy sparked by the relationship between the largest energy producer in Russia, OAO Gazprom, and that company’s independent audit firm, PricewaterhouseCoopers (PwC). 

The commotion surrounding PwC’s audits of Gazprom was ignited by the accounting firm’s alleged failure to report candidly on a series of huge transactions involving that company and several smaller firms owned or controlled by Gazprom executives or their family members. Principal among these entities was Itera, a secretive company with U.S. connections. Criticism of PwC’s audits of Gazprom became so intense that the prominent accounting firm was forced to purchase full-page ads in the major Moscow newspapers to defend itself. Throughout the 1990s, the dominant international accounting firms pursued strategic initiatives to expand their worldwide operations. Many of these initiatives targeted Russia and the cluster of smaller countries carved out of the former Soviet Union when it suddenly disintegrated in 1991. The New York Times reported that the major accounting firms were among the first foreign firms to establish significant operations in Russia following the collapse of the Soviet Union. In their “competitive rush” to establish an economic beachhead in Russia, these firms may have underestimated the many risks posed by that country’s rapidly evolving business environment.

The massive reorganization of Russia’s political, social, and economic infrastructure in the 1990s produced widespread chaos within the suddenly “new” country that had a proud history that was centuries old. Russia’s political leaders wanted to quickly embrace capitalism. To accomplish this objective, Russia’s new democratic government implemented a “privatization programme” intended to convert the country from communism to capitalism in a span of a few years. The first and most important phase of this enormous project gave Russian citizens the right to acquire ownership interests in thousands of Russian firms at a nominal cost by using state issued “privatization vouchers.” These Russian firms were formerly state-owned companies or agencies that had established corporate governance structures equivalent to boards of directors to oversee their operations. From 1992 through 1999, more than 75 percent of Russian companies were handed over to the private sector, although the federal government retained a sizable minority ownership interest in the nation’s largest and most important companies. The privatization program succeeded in quickly converting Russia’s controlled economy into a free market economy. However, the project was flawed in many respects. For example, more than one-half of the newly created companies were technically insolvent and able to survive only with subsidies and other economic support from the federal government. Complicating everyday life for these new firms and their managers was the rampant inflation in the Russian economy that exceeded 2000 percent annually. Arguably the most pervasive weakness of the privatization program was that it allowed thousands of the individuals who had overseen the formerly state-owned businesses to acquire top management positions in the newly organized companies.

The Russian press commonly referred to these individuals as “red directors,” since most of them had been Communist Party “apparatchiks” or operatives. Not surprisingly, few of these corporate managers shared or even understood the capitalistic principles they were being asked to embrace. As Business Week noted, these individuals “cling to the view that the enterprise is an engine to generate wealth for themselves.”4 This pervasive attitude among the newly minted corporate executives spawned a rough-and-tumble version of capitalism in Russia that sparked widespread violence—including hundreds of murders and contract killings, kickbacks, bribes, and “organized robbery.”5 Critics of the privatization program often pointed to OAO Gazprom, a huge Russian company, as a prime example of this “rogue” capitalism. Gazprom, a term that means “gas industry,” was initially a privately owned company created by officials of the Soviet Union to assume control of the country’s natural gas industry. The company’s most important assets are enormous natural gas reserves discovered in Siberia following World War II. Gazprom was one of the first publicly owned firms created by Russia’s privatization program. Fifteen percent of Gazprom’s common stock was given to employees and 28 percent to customers, while the federal government retained a 40 percent ownership interest in the company. Most of Gazprom’s remaining common stock was sold to foreign investors. To ensure that domestic investors maintained control of major Russian companies, foreign investors were permitted to buy only a small fraction of a Russian company’s stock. Gazprom’s initial stockholders’ meeting was held in 1995. At that meeting, the stockholders endorsed the board of directors’ selection of PwC as the company’s audit firm. Rem Vyakhirev, Gazprom’s top executive at the time, reported that the world’s largest audit firm had been chosen to enhance the credibility of his company’s financial statements and financial disclosures...... 

Questions 

1. List the challenges that a major accounting firm faces when it establishes its first practice office in a foreign country. Identify the key factors that accounting firms should consider when deciding whether to establish a practice office in a new market.

2. Suppose that a U.S.-based accounting firm has a major audit client in a foreign country that routinely engages in business practices that are considered legal in that country but that would qualify as both illegal and unethical in the United States. What specific moral or ethical obligations, if any, would these circumstances impose on this accounting firm Explain.

3. What responsibilities, if any, do you believe PwC had to Gazprom’s minority investors?

4. In your opinion, should PwC have agreed to perform the “special audit” of the Itera transactions? Defend your answer. In your answer, identify the specific ethical issues or challenges that the engagement posed for PwC.

5. In the United States, what responsibility do auditors have to determine whether or not “related parties” exist for a given audit client? Explain.

6. Explain how the British “true and fair” audit approach or strategy differs from the audit philosophy applied in the United States. In your opinion, which of the two audit approaches is better or, at least, more defensible?

7. In recent years, there has been an ongoing debate in the accounting profession focusing on the quality of the accounting standards issued by the International Accounting Standards Board versus those issued by the Financial Accounting Standards Board. Research and briefly explain the key philosophical difference between those two important rule-making bodies that significantly affects the nature of the accounting standards promulgated by each.