Gazprom

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? Based on this, what responsibilities, if any, do you believe PwC had to Gazprom?s minority investors?

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Advanced Auditing Summer 2017 OAO Gazprom Lecture Notes NOTE: When answering the questions in the test on OAO Gazprom, the information contained in the readings that have been assigned for OAO Gazprom control; that is, if anything I say during this lecture or anything contained in these lecture notes conflicts with what you encounter in the readings assigned for this case, you should rely on the readings when answering the test questions. (The reason for this statement is simple: For the lecture, I will sometimes draw on sources that are not listed in the reading list for this topic; I have found that dates, names, and dollar amounts can vary among media sources. Therefore, to increase the likelihood that you do well on the tests, I will confine answers to those found in the reading material, including the text, assigned for this case.) I. Background Gazprom was created in 1965 as the Soviet Gas Ministry, when the Communist Party decided to aggressively develop the national gas industry (the Soviet Gas Ministry and later, Gazprom, traces its roots to 1943 when Glavgazprom was set up to build a pipeline from Saratov to Moscow). Note that at that time, the Soviet Gas Ministry was a part of the government. In 1989, during the \"perestroika\"1 era, the goals of the state changed because the inefficient planning economy desperately needed reform. At that time, President Mikhail Gorbachev created Gazprom as a state unit responsible for gas production, distribution, and sales. Following the breakup of the Soviet Union in 1991, the Russian federal government gained jurisdiction over the major oil fields in Russia along with control over the transport and export of oil and gas resources. But oil exports were constrained by the capacity limitations of the old Soviet pipeline system and by a lack of investment. The Russian oil sector of the 1990s urgently needed investment and restructuring. Reformers of the newly democratized Russia saw only one way to do it - through privatization. The first stage of privatization was set in motion via a presidential decree on November 17, 1992 titled \"On Privatization and Transformation of State-Owned Enterprises, Production and Research Associations of Petroleum, Oil Refining Industries and Petroleum Product Supply Agencies into Joint Stock Companies.\" The decree produced companies such as Lukoil, Yukos, and Rossneft from preexisting oil producing enterprises and refineries, and turned them into open-stock 1 \"Perestroika\" means restructuring; Russia was restructuring the country both politically and economically. 1 companies.2 Russia's biggest companies were sold first through voucher auctions, with ownership limited to workers and Russian citizens. In 1995, the Russian government implemented the second stage of privatization, a shares-for-loans program in which large blocks of government shares in certain joint stock companies (including five of Russia's oil giants) were auctioned to a group of Russian commercial banks for cash. The successful bidders were required to hold the shares in trust for a maximum of three years in return for providing loans to the government to reduce its budget deficit. At any time, the government could buy back its shares. In a series of auctions, stakes in the companies were transferred into trust accounts and then sold to insider banks for a fraction of their market value. Stakes often went to the very companies organizing the loan tenders for the government, and through the shares-for-loans scheme, assets estimated at more than $25 billion were privatized and sold for just $1.2 billion. Only the first stage of the privatization scheme was applied to the gas industry. As a joint-stock company, Gazprom was established in February 1993 in accordance with the 1992 presidential decree and a \"Resolution of the Council of Ministers of 17 February 1993\". As with the oil industry, shares were divided among Gazprom employees and other domestic investors, while 40% of shares were left in government hands for at least three years. Nine percent of Gazprom's stock was set aside for foreign ownership. Gazprom didn't go through the shares-for-loans stage, for several reasons. First, Chernomyrdin (Gazprom chairman and former Russian Prime Minister) and associates didn't want to lose control over the gas sector or introduce new competition that might weaken government control.3 Second, the internal gas prices were too low and the sector considered too important to the economy to introduce market dynamics. Even after the 1998 crises, when the Russian government was looking for more cash, Russian President Yeltsin approved the sale of only a further 5% stake in Gazprom. Although foreign ownership of Gazprom stock was allowed to 2 In accordance with the Civil Code, joint stock companies fall into two categories: \"closed\" and \"open.\" The difference between an open and closed Russian stock company is that in an open company, shares may be freely sold to third parties, while in a closed company, share transfers are subject to the preemptive rights of other shareholders. Open stock companies have to comply with a number of requirements of the Russian securities authorities, and for this reason closed stock companies are generally preferred. 3 In 2000, the government owned 38% of Gazprom and the managers' official stake was around 35%, leaving about 20% in other, hidden hands. At least some of the hidden shares were likely also held by Gazprom insiders, and former Gazprom chairman and former Russian Prime Minister Viktor Chernomyrdin is rumored to have been a major owner. 2 increase from its former limit of 9% to 14%, only a 2.5% stake was actually sold to Ruhrgas for $660 million (the goal of this action was to establish a close liaison with the German company). For most of the 1990s, Russia's new oil barons and their private money restructured oil operations to become more efficient than their state company equivalents. Part of their efficiency, however, was in significantly reducing tax revenues to the Russian state and moving large amounts of capital offshore. Gazprom during the 1990s existed as a state within the state. The government was loyal to the gas monopoly, though there were a few attempts to change the situation. For example, in 1992, the government tried to open the gas industry to competition; however, Gazprom was smarter than the government and powerful: After an audit by the government was finished, Viktor Chernomyrdin became responsible for the oil and energy complex and was given the rank of vice-premier. Under Chernomyrdin, Gazprom was given exclusive rights to supply gas on the state's foreign contracts, and the company could keep 45% of the earnings from these contracts. These operations were made tax exempt. Gazprom became even more powerful when Chernomyrdin became prime minister at the end of 1992. In 1993 Boris Yeltsin signed a decree establishing a special stabilization fund for Gazprom. The company was allowed to divert up to one-third of the income it derived from the value added tax on gas sales to consumers into the fund (needless to say, the money directed to the fund was exempt from taxation). In 1997, Boris Nemtsov became the first deputy prime minister and promised to split up Gazprom. There was some restructuring, but mostly to Gazprom's liking. All drilling enterprises within Gazprom were to be united under a specialized company, Burgaz, and production and transport companies were to delegate their sales functions to a limited liability company, Mezhregiongaz. One more attempt to take control from Gazprom took place in April 1997. Anatoly Chubais and Boris Nemtsov convinced President Yeltsin to terminate the trust agreement with Rem Vyakhirev4, who managed the 35% state stake in Gazprom. Boris Yeltsin signed the decree while Prime Minister Viktor Chernomyrdin was on a two-day holiday. Once back from holiday, the prime minister promptly blocked the decree. Russian oil and gas companies from the 1990s through 2004 could be classified as private, private with regional government influence, private with federal government influence, fully state-controlled companies, and Gazprom. Gazprom appeared to be a 4 This is the correct spelling of Rem Vyakhirev's name. The text uses two different spellings of his last name. If, for any reason, you encounter two different spelling of this last name in the quiz, you are to assume that I mean \"Vyakhirev\