Rio Tinto and ex-CEO and ex-CFO face accounting fraud charges on $3.7 billion coal calamity

Rio Tinto Group’s calamitous $3.7 billion coal deal in Mozambique keeps coming back to haunt the world’s second-biggest miner, three years after it unloaded the mine.

U.S. authorities filed fraud charges against London-based Rio, former Chief Executive Officer Tom Albanese and ex-Chief Financial Officer Guy Elliott, claiming they inflated the value of the coal assets acquired in 2011. The unit was sold for $50 million in 2014 following impairments of about $2.9 billion in 2013 and $470 million a year later.

Rio concealed setbacks at the project and Albanese publicly reinforced a “false positive outlook” for the asset, according to a Securities and Exchange Commission complaint filed in federal court in New York. Executives told Albanese and Elliott by May 2012 that the Mozambique unit was likely worth negative $680 million, the SEC said.

“Rio Tinto intends to vigorously defend itself against these allegations,” the company said in an emailed statement on the SEC charges. Albanese, Rio’s CEO between 2007 and 2013, said in a separate statement that “there is no truth in any of these charges.” Elliott, who retired in 2013, also refuted the allegations in a statement issued on his behalf. He stood down as a non-executive director of Royal Dutch Shell Plc, the company said Wednesday in a statement.

Rio has also agreed to pay a 27.4 million pound ($36 million) fine for a breach of disclosure rules concerning the Mozambique assets, the U.K. Financial Conduct Authority said in a separate statement. The Australian Securities and Investments Commission is also reviewing the issue, the company said.

There’s an onus on Chairman Jan du Plessis and the board to explain the issues around the SEC charges, Peter O’Connor, a Sydney-based analyst with Shaw and Partners Ltd., said in an email Wednesday.

Rio’s shares declined 2.3 percent by 3:30 p.m. in London, while rival BHP Billiton Ltd. fell 1 percent.

The charges come as Rio assists authorities in three countries over a separate case related to the $20 billion Simandou iron ore project in Guinea. Rio said in November it had alerted authorities including the U.S. Department of Justice and the U.K.’s Serious Fraud Office to a $10.5 million payment to an external consultant made in 2011.

Rio’s 2011 acquisition of Riversdale Mining Ltd., holder of the Mozambique assets, came as the producer sought access to coking coal in the Moatize basin at a time the African nation was seeking to become a major supplier of the steelmaking raw material.

The plans unraveled as the government refused to allow Rio to barge coal down the Zambezi and amid prohibitive costs of accessing or building rail lines to a port. Estimates of recoverable coking coal held by the assets were also downgraded, Rio said in 2013.

Rio, Albanese—who stepped down in August as CEO of Vedanta Resources Plc—and Elliott, “allegedly breached their disclosure obligations and corporate duties by hiding from their board, auditor, and investors the crucial fact that a multi-billion dollar transaction was a failure,” Stephanie Avakian, co-director of the SEC’s enforcement division said Wednesday in the statement. Shell declined to comment on charges against Elliott.

Rio raised $5.5 billion from U.S. debt investors, including $3 billion after May 2012, the SEC said.

Concerns over the carrying value of the coal assets were raised in January 2013 by an executive in Rio’s Technology and Innovation Group, allegedly triggering an internal review, the SEC said in its statement. Shortly after, Rio announced Albanese’s departure and the major writedown, the SEC said.

The SEC charges that having already booked major writedowns following a takeover of Alcan Inc., Albanese and Elliott knew that disclosing a second failure would “call into question their ability to pursue the core of Rio Tinto’s business model to identify and develop long-term, low-cost, and highly-profitable mining assets,” according to the statement. Rio recorded more than $29 billion of charges after paying $38 billion in 2007 for aluminum producer Alcan, company filings show.

The U.K.’s FCA said Rio agreed to settle a breach of disclosure rules at an early stage and received a 30 percent reduction on its penalty. “The FCA made no findings of fraud, or of any systemic or widespread failure by Rio Tinto,” Rio said in a Wednesday filing.

Source: Accounting Today

Anti-Fraud Collaboration issues case study

The Anti-Fraud Collaboration between the Center for Audit Quality, Financial Executives International, the Institute of Internal Auditors and the National Association of Corporate Directors has released the fourth in a series of case studies highlighting ways to deter financial fraud.

The new case study focuses on LDC Cloud Systems, a fictitious global technology company whose board is dealing with bribery accusations and accounting shenanigans. The case study offers a timeline of management and board decisions after potential problems are uncovered. It demonstrates how complex accounting practices typical in a fast-changing business environment can make a company prone to fraud. The hypothetical scenario shows how fraud situations can develop and be addressed, such as through strong board oversight. For classroom use, the Anti-Fraud Collaboration has developed a video series to bring scenes from the case study to life. The videos are available at the Anti-Fraud Collaboration website.

“The Anti-Fraud Collaboration is pleased to present the latest case study in our series designed to raise awareness of financial reporting fraud,” said Center for Audit Quality executive director Cindy Fornelli in a statement. “These case studies have proven to be valuable educational tools for all members of the financial reporting supply chain, as well as students.”

The Anti-Fraud Collaboration’s case studies take participants through a hypothetical scenario about a fictional company dealing with fraud. Guided by an instructor, participants can then discuss what could have been done to address or avoid the situation. Each case study offers a companion discussion guide for instructors, available on request.

LDC Cloud Systems is the Collaboration’s fourth case study. Others include:

• Hollate Manufacturing focuses on the conditions that can lead to fraud and misrepresentation in financial reporting.

• Carolina Wilderness Outfitters aims to facilitate a discussion about how to perform an internal investigation when fraud is suspected in a company.

• Kendallville Bank focuses on the need for professional skepticism in the financial reporting process.

“New technologies can make for a disruptive business environment, and can create new challenges on existing business practices,” said FEI president and CEO Andrej Suskavcevic in a statement. “Resources like this case study provide a practical tool to help financial executives explore and deter financial reporting fraud.” 

Source: Accounting Today

Internal control weaknesses correlate with financial fraud

Former Sen. Paul Sarbanes (D-Md), co-author of the Sarbanes-Oxley Act.

Bloomberg

The audits of companies’ internal controls mandated by the Sarbanes-Oxley Act are good predictors of financial fraud, according to a new study.

The study, by professors Matthew Ege of Texas A&M University and Dain C. Donelson and John M. McInnis of the University of Texas at Austin, found the incidence of fraud disclosures at companies previously found by auditors to have material weaknesses in their internal controls is approximately 80 to 90 percent greater than companies on average, depending on how it was measured. Of the 127 fraud cases identified by the study, 36 of them, or nearly 30 percent, occurred after auditor reports of material weakness in internal controls. The study appears in the August/October issue of Auditing: A Journal of Practice & Theory, a quarterly published by the American Accounting Association.

The researchers collected 14,000 internal-control opinions from auditors for large and midsized corporations, examining the relationship between reports of material weaknesses and reports of corporate fraud within the following three years.

“Although material-weakness reports mostly reflect accounting errors and portend revelations of fraud only infrequently, the fact that they precede almost 30 percent of the instances where fraud does, in fact, come to light should lead investors, regulators and legislators to take notice,” Ege said in a statement.

The study provides ammunition for defenders of the Sarbanes-Oxley Act of 2002, particularly Section 404(b), which mandates outside audits of public companies’ internal controls. The legislation was passed in the aftermath of the wave of accounting scandals of the early 2000s at companies such as Enron and WorldCom. However, Congress later relaxed the requirement for so-called “emerging growth companies” in the JOBS Act of 2012, in an effort to spur the development of startup businesses with less than $1 billion in annual revenues that want to go public. The Financial Choice Act that the House passed in June would lower the threshold further to $50 million.

“SOX Section 404(b) provides a potential benefit of an early warning system for future fraud revelation,” said the study. “Given the criticism of SOX and discussion in favor of its repeal or curtailment, this benefit is an important consideration alongside the costs of internal control reporting.”

Source: Accounting Today

Congressmen concerned about misuse of .cpa domain

A group of four lawmakers has sent a letter to an internet governing body expressing concern about how the proposed .cpa domain extension might be exploited by fraudsters pretending to be CPAs.

The American Institute of CPAs has been working to secure a .cpa domain string, in partnership with the Australian accounting body CPA Australia, since 2014. The two groups have pending bids for what is technically known as a “generic Top-Level Domain string,” or gLTDs, before the Internet Corporation for Assigned Names and Numbers, also known as ICANN, the global nonprofit that oversees internet namespaces.

Rep. Steve Pearce, R-N.M., Michael Conaway, R-Texas, Steve King, R-Ind., and Ruben Kihuen, D-Nev., are asking ICANN to develop and promulgate verification regulations for gTLDs that are at the most risk of fraud and abuse, including “.cpa.” Conaway is a CPA who is a member of Congress’s CPA Caucus.

In a letter last month, the lawmakers pointed out that a 2013 communique by ICANN's Governmental Advisory Committee identified several domain extensions connected to regulated or professional sectors, including the accounting profession. “The GAC recognized that ‘these [gTLDs] are likely to invoke a level of implied trust from consumers, and carry higher levels of risk associated with consumer harm,’” they wrote. “Further, the communique highlighted that gTLDs such as ‘.cpa’ could be used to deceive consumers of CPA services in the United States and around the world if granted to those outside the global CPA community.”

“Ultimately,” the lawmakers added, “the communique recommended ICAAN ‘[e]stablish a working relationship with the relevant regulatory, or industry self-regulatory, bodies, including developing a strategy to mitigate as much as possible the risks of fraudulent, and other illegal, activities,’ and specifically cited ‘.cpa’ as requiring "Category 1" safeguards.”

“Unfortunately, to date, ICANN has not fully implemented this recommendation,” they noted. “While it has taken steps in the right direction, gTLDs, such as ‘.cpa,’ are still not regulated in a way to prevent fraud and abuse. For a gTLD that has a strong connection to a regulated industry, such as ‘.cpa,’ the protection of the public against fraud or other illegal activities should be of paramount concern to ICANN. Strong, reliable verification procedures are essential to protect the public interest. The importance of the public trust to the CPA profession around the world cannot be overstated, and the potential harm to the public of fraudulent or illegal use of a ".cpa" domain is immense.”

The lawmakers are encouraging ICANN to come up with verification procedures for websites that try to claim .cpa domain names. “ICANN cannot combat fraud by simply requiring applicants to make a representation, without any verification,” they wrote. “We recognize that although such verification is not a simple task, but it is an essential one.”

Source: Accounting Today