Everything old is new again: When accountants bail out loudly

Mazars resigns and disavows ten years of Trump Org financials. Nearly 15 years ago PwC did the same to Russian oil company Yukos.

A little more than a year ago, on February 9th, 2021, the U.S. general counsel for global public accounting firm Mazars wrote to Trump Organization EVP and Chief Legal Officer Alan Garten that the firm was advising that its Statement of Financial Condition for Donald J. Trump for the years ending June 30, 2011 through June 30, 2020 “should no longer be relied upon” and that Trump Organization should inform anyone who received those documents and may be relying on them to no longer do so.

Mazars wrote that although the firm had not “as a whole” found material discrepancies between the information the Trump Organization provided and the actual value of Mr. Trump’s assets, “the totality of circumstances” that include Mazars’ own investigation required it to now notify anyone who had received the statements that they should no longer rely on them.

The “non-reliance” letter and evidence of Mazars’ resignation as a service provider to the Trump Organization and Donald Trump, personally, were revealed in a filing by Letitia James, the Attorney General of the State of New York in the Supreme Court of the State of New York on January 18, 2022. (The filing was made public in open court on Feb. 14.)

The filing in the Attorney General’s case against The Trump Organization, DJT Holdings LLC, DJT Holdings Managing Member LLC, his golf course Seven Springs LLC, Trump as an individual, a couple of Trump organization outside counsels, and a law firm, Trump’s children Donald Jr., Eric, and Ivanka, and the accounting firm Mazars USA also reveals that Mazars ceased work on the financial statements after the one reflecting Mr. Trump’s financial condition as of June 30, 2020. Another firm, Whitley Penn LLP, compiled the June 30, 2021 statement and the Trumps are also looking for a new firm to finish its tax returns for 2021.

Key in the letter from Mazars to the Trump Organization was a statement that the firm would cease doing any more work for the Trumps and the Trump Organization because, “We have also reached the point such that there is a non-waivable conflict of interest with the Trump Organization.”

That means Mazars believes it is now in a position that is adverse to its client, perhaps as a result of being sued along with its client and acting as a cooperating witness against its client.

The Trump organization is a private company not a public one, so its accounting firm and the services it provides are governed by AICPA standards, not PCAOB standards. However, when auditing a public company, auditor independence may be compromised when the audit firm and its client or its management “are in threatened or actual positions of material adverse interests by reason of threatened or actual litigation.”

Mazars is a defendant in the NYAG case, and reportedly a cooperating witness in a criminal case the New York District Attorney is pursuing against Trump’s long-serving chief financial officer, Allen H. Weisselberg and the Trump Organization, who were indicted last summer. Weisselberg and the Trump Organization are accused of perpetrating a 15-year scheme to enable tax avoidance by executives and their families on compensation and perquisites provided by Trump. Weisselberg and the Trump Organization have pleaded not guilty and the case is expected to go to trial this summer.

The New York Attorney General alleges that the Trump Organization financial statements contain exaggerated estimates of Mr. Trump’s property values. The financial statements are compilations of financial information provided by management, a special kind of “non-attest” engagement. As such, the documents are not opinions based on a full financial statement audit, and include a number of disclaimers, including Mazars had not audited or verified any valuations that were incorporated in the numbers.

Nothing Trump Said Was True | Private companies such as the Trump Organization operate under very lax accounting rules, by David Dayen in The Atlantic in 2019:

Trump’s accountants at Mazars freely admitted in legal proceedings quoted in the Post story that all they did was write down numbers Trump supplied. “In the compilation process, it is not the role of the accountant to assess the values,” said one accountant in a deposition. “The value per se does not have to be logical.”

Mazars wrote in its letter to the Trump Organization that did “not express an opinion or provide any assurance about” the statements and that while compiling the information the firm had even “become aware of departures from accounting principles generally accepted in the United States of America.” I was quoted in Forbes on this:

“They were doing their own risk management,” says Francine McKenna, an accountant and former Forbes contributor.

Many people have been surprised that major banks like Deutsche Bank and other lenders seemingly lend hundreds of millions of dollars to Trump over and over again over the years without audited financial statements. It’s not that unusual.

Donald Trump has had no trouble getting big loans at competitive rates, June 23, 2017, MarketWatch, Francine McKenna

The idea that banks won’t lend to Trump because of his bankruptcy history is the equivalent of fake news: MarketWatch analysis

A spokesman for Ladder Capital declined to comment on its business relationship with Trump, citing client confidentiality requirements.

Ladder Capital no longer holds the loans, according to a person familiar with the transactions. That person also said all of the credits are non-recourse — meaning the lender or investors in the collateralized mortgage debt securities, or CMBS, can pursue the collateral, in this case the properties, but not the borrower in case of default — and have been securitized. The CMBS that includes the Trump Tower note was rated triple-A.

Said Thesman: “It’s the collateral, and the underlying economics of the deals, not the character of the borrower, that ultimately drives the deal terms.”

And there are always the tax returns, a sensitive topic for Donald Trump who may have provided those instead of audited financials to lenders and others. We don’t know because the public never saw any tax returns during his administration and Trump has been fighting the public’s access to any that have been turned over in any of these lawsuits or criminal cases or Congressional investigations. Although the New York Times obtained 17 years worth of returns, we had to take their word for what they said. The actual documents were not made public and any documents obtained by prosecutors have not been made public, either.

How Can You Monitor a Borrower without Financial Statements?

Banks don’t always request financial statements from a borrower—whether they do depends on their relationship with a borrower and a borrower’s credit risk.

Chicago Booth Review, June 20, 2014, Francine McKenna

After a bank loans money to a private company, one that isn't required by regulation to produce financial statements, how does the bank keep tabs on the company's finances? About half the time, a bank monitors a small private company by requesting financial statements, and in other cases it asks for tax returns or proof of creditworthiness. But often the bank doesn't require any financial reporting—faith and collateral are sufficient.

I received a lot of questions about the number of years — ten — of financial statements that Mazars withdrew. How common is that?

Not that common.

When public companies receive an auditor opinion with a material weakness in internal control over financial reporting as a result of material errors or fraud that lead to a “Big R” restatement, you will see non-reliance statements by the company. A few quarters or at most a prior year’s worth of financial statements should not be relied on because they will be restated. When an auditor resigns because of an independence violation, perhaps, you may see a non-reliance statement on the auditor’s opinion, because the new auditor has to do the audit again.

However, I was reminded as a result of the horrific events of this past week of the invasion of Ukraine by Putin, that nearly 15 years ago, something similar did happen. It was more serious because the situation back then was related to ten years of audits of a listed global company. But the scenario of an auditor resigning because of worries about its own liability based on alleged prosecutorial pressure is eerily similar.

PwC withdraws Yukos audits (This FT story is not available online anymore but a similar one at Reuters is available here.)

“PwC has withdrawn its entire set of audit reports over 10 years for the bankrupt Yukos oil group, in a move that marks a significant climbdown by the global audit firm following months of Russian government pressure.

PwC said on Sunday it was withdrawing all its audit reports of Yukos from the years ending 1995 to 2004 because Russian prosecutors had unearthed new information that led it to believe statements provided by Yukos management in the past “may not have been accurate”. The sudden about-turn comes after a government pressure campaign that included police raids in March on PwC’s Moscow office and an ongoing criminal investigation into alleged underpayment of taxes by PwC.

A court in Moscow had declared Yukos bankrupt in August 2006 and ordered its assets to be sold. The court upheld a vote by creditors to liquidate Yukos, once headed by the oligarch Mikhail Khodorkovsky, who served eight years in a Siberian prison on charges of fraud and tax evasion.

Pretty soon after PwC announced it was disavowing its audits, PwC started saying that Yukos executives had lied to them, they had been “duped”.

(Mazars statement was more subtle: “While we have not concluded that the various financial statements, as a whole, contain material discrepancies, based upon the totality of the circumstances, we believe our advice to you to no longer rely upon those financial statements is appropriate.”)  

Yukos chiefs lied to us, claims PwC, FT, June 25, 2007

Mr Amsterdam [Khodorkovsky’s attorney] said PwC’s decision to pull the audits was unique. “This has nothing to do with standard practice,” he said. “We’re talking about a situation where an auditor has files seized at gunpoint and then suddenly decided, after its licence is threatened, to withdraw 10 years of audits.” Former Yukos vice-president Alexander Temerko said PwC had caved in to Kremlin pressure. “This is the worst thing PwC could have done for its reputation,” he said. “Its audits are worth next to nothing if it is going to withdraw them under pressure.”

After PwC withdrew the audits, it found itself out of the crosshairs of the Russian prosecutors, who had not only been going after the firm over Yukos, but had raided PwC’s Moscow offices for tax avoidance allegations of the firm itself and threatened to cancel its business license.

Boost to PwC over Yukos audits (No longer available on line at the FT but my discussion of the story is at my legacy blog. )

Russian prosecutors have cleared PwC in Russia of any wrongdoing in auditing Yukos, the bankrupt Russian oil group, PwC said on Wednesday, in an apparent boost to the audit firm nearly four weeks after it said it was withdrawing a decade of Yukos audits.

PwC said on Wednesday it had received a letter from the prosecutors office saying they had found no wrongdoing in PwC’s audits of Yukos. “We are pleased … the general prosecutor … has decided not to take any action against PwC Russia, its partners or employees,” it said.

The letter, which it produced as evidence during court hearings in a law suit filed by the tax service, is likely to help the audit firm in its defence against claims it colluded with Yukos in producing false accounts between 2002 and 2004 – a potential threat to its licence. The prosecutors’ office declined to comment. The tax service is continuing to pursue the case. PwC’s decision to withdraw all its Yukos audits from 1995 to 2004 came after months of government pressure including the tax service case, a police raid on its Moscow office and a criminal investigation into suspected tax evasion by the audit firm itself.

Its decision, over what it says was Yukos’s failure to disclose a number of related party transactions, will probably strengthen a new case against Mikhail Khodorkovsky, former Yukos chief executive, who has been jailed in a Siberian prison camp but now faces charges of embezzling more than $32bn in oil sales from Yukos.

The apparent show of support by prosecutors comes a week after Russia’s Higher Arbitration court overturned an earlier ruling that found PwC had itself underpaid Rbs243m ($9.6m) in taxes and sent the case back to a lower court.

PwC on Wednesday said the audit firm’s apparent reversal of fortune had nothing to do with its withdrawal of the audits. PwC has also said its decision to pull the audits had nothing to do with any attempt to reduce the legal pressure.
But Yukos’s majority shareholder GML says there may be a connection.

“We have not seen any credible reason for withdrawing the audits,” said Tim Osborne, managing director of GML, formerly known as Menatep. “It seems to me they have some sort of deal with the prosecutors that will allow them to avoid the tax bill and keep their licence.”

PwC said in a letter to Yukos’s liquidator, Eduard Rebgun, it was withdrawing the audits because it received new information showing Yukos management misled the audit firm when it declared a number of oil trading firms, including Baltic Petroleum, South Petroleum and Behles, were not related parties. Mr Osborne and Yukos’s former management have denied this.

“They had complete and full disclosure with regard to these companies when they conducted the audits,” Mr Osborne said.

The next hearing in the tax service case is scheduled for August 1.”

PwC went back to work in Moscow after a few more hearings, but the issue of whether the firm had caved to Russian prosecutors came up again when Khodorkovsky and his business partner Platon Lebedev were subject to a new trial brought by prosecutors intent on preventing their scheduled release from prison in 2011.  Khodorkovsky and Lebedev have decided to target PwC in their defense. I wrote about it:

The Wall Street Journal makes a double vodka, straight-up, no chaser assessment of PwC’s problem:

PWC’s entanglement in the legal travails of Mr. Khodorkovsky highlights the ethical and legal dilemmas that can face auditors in emerging markets where corporate governance and judicial systems are weak, industry observers say.

It got quite messy for the PwC men on ground in Moscow.

Russia: Chain retraction | PwC’s withdrawal of Yukos audits moves to centre of trial | FT, Catherine Belton, September 6, 2010

As the defence lawyers make a final stand, they are also taking their case to international courts. They filed a subpoena in the southern district court of New York in July seeking documents that might shed light on any role PwC’s headquarters in Manhattan played in the decision to withdraw the audits. PwC insists the decision was made by its Russia office alone. Its New York arm has declined to comment on the subpoena.

The defence lawyers argue that PwC may have violated US accounting rules. Also in July, they quietly filed a complaint with the California Board of Accountancy against Douglas Miller, one of the lead PwC partners on Yukos, who has since left Russia for California. It claims that Mr Miller, who played a main role in recommending that the audits should be withdrawn, did so fraudulently…

By March 2007, law enforcers were raiding the office, seizing documents and announcing a probe into whether PwC itself had evaded taxes. PwC partners were dragged in for questioning and in April, three state-linked companies said they were not renewing their audit contracts with PwC.

Throughout it all, Michael Kubena, then head of its Moscow office, had insisted the firm stood by its Yukos audits. But after six interrogations by prosecutors, Mr Miller told them he was recommending that the audits should be withdrawn. That was based on new information he said he had received from the prosecutors, which in his view showed that Yukos management, led by Mr Khodorkovsky, had lied to it on four significant transactions.

One day after PwC announced it was pulling the audits, Mr Kubena received a letter from Salavat Karimov, the senior prosecutor on the Yukos case. No criminal investigation would be launched into whether PwC employees had knowingly produced false audit opinions, he said – because it was clear they had been misled…

Whatever PwC may have known or not known about the transactions, many auditors believe there is no doubt that the broader embezzlement case against Mr Khodorkovsky and Mr Lebedev, the wily former Soviet official who co-founded Menatep, is political. But few have dared to testify at the trial.

Only one former PwC tax director, Stephen Wilson, who later took a full-time post at Yukos, took the witness stand to counter prosecutors’ assertions that Mr Khodorkovsky had stolen Yukos’s oil. But he fled Russia after being presented with a summons by prosecutors to appear for questioning. In an environment such as that, defence lawyers say, it is little wonder PwC withdrew the audits. As one person close to the defence team puts it: “We don’t hold anything against them: they had a gun to their heads.”

© Francine McKenna, The Digging Company LLC, 2022