Hulley v. Russia 2014

of GAAP standards).1594 PwC had looked at the issue itself and expressed doubts, but concluded that even if they were related, the transactions with the BBS Companies were done under fair market conditions, and were so immaterial that they could have no impact on the financial statements and thus did not need to be disclosed.1595 Then, in 2007, while being interrogated, Mr. Miller found out “new information,” in the form of the record of an interrogation of a Mr. Anilionis, who described how the BBS Companies were set up in a structure that would enable Messrs. Khodorkovsky and Lebedev to “keep [them] under control but on the surface the structure should not belong to ‘Yukos.’”1596 A trade office was set up in Geneva, prices were coordinated with Mr. Lebedev, and Yukos’ employees were responsible for oil trading activities. The discovery of this “lie”, even though relating to an immaterial matter from a financial reporting standpoint, is said to have shattered PwC’s confidence in the statements of Yukos’ management and thus caused PwC to withdraw its audit opinions.1597 Claimants say it is simply not credible for PwC to have invoked the BBS Companies issue as an excuse to withdraw its audit opinions.1598 They also question the reliability of the source of “new information,” the interrogation of Mr. Anilionis.1599

1228. When Mr. Kosciusko-Morizet was shown documents indicating that PwC had raised concerns in the past about Yukos’ relationship with the BBS Companies, he emphasized that PwC had approved Yukos’ G.A.A.P. accounts and thus “ any problem they might have had was solved.”1600 Mr. Misamore also confirmed the view that the BBS Companies were not related parties vis-à-vis Yukos, that the issue had been on PwC’s radar, and that PwC could have caused Yukos to identify the BBS Companies as related if it were essential, but did not.1601

1229. Mr. Misamore denied that PwC had repeatedly recommended that Yukos disclose the ownership structure of the BBS Companies and that Yukos had refused such disclosure. He explained that PwC had conducted a study in 2002 and that it had not been able to “reach a

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conclusion as to whether or not [information about Yukos’ relationship with the BBS Companies] should be disclosed.”1602 Further, he noted that PwC signed Yukos’ audited financial statements without that information. Upon being shown an internal PwC document, “Matters for Partner Attention”, for year 2000, wherein PwC stated that “[t]he absence of disclosure, while not desirable, does not constitute a material omission,”1603 Mr. Misamore said that this document too supports his view that disclosure was not so desirable as to warrant PwC insisting on its inclusion in Yukos’ F-1 document.1604

1230. Nevertheless, the Tribunal is unconvinced by the claims that the BBS Companies, apparently the, or certainly, a, principal exporter of the oil produced by Yukos, were not controlled by or related to Yukos. PwC’s contention that it was misled in this regard may have been true.

ii.Did Yukos Management Lie to PwC about Yukos’ Control over the Trading Companies?

1231. The second category of alleged misinformation identified in PwC’s Withdrawal Letter was the following:

Now we have information demonstrating that the management of certain Russian legal entities affiliated with the Company did not control the activities of these entities, rather these legal entities were fully controlled directly by the Company’s management. Since the management of these affiliated entities were not in control of these entities’ activities, the court found that these activities were fictitious. Consecutively, the courts found that the profit earned by these legal entities affiliated with the Company was a profit of the Company, and therefore the Company should have accrued and paid taxes on this profit. Nevertheless, in the course of the audits, the Company’s management told us that key issues of the activities of these affiliated legal entities were under supervision and control of their own management.1605

1232. This is an issue that was traversed at length in Chapters VIII.A and B of the present Award.

1233. Claimants argued that PwC was fully aware of the structures of the trading companies, and that in the context of the preparation of Yukos’ U.S. GAAP financial statements, PwC had given specific and detailed advice to Yukos on how to demonstrate control over affiliated companies

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so that they could be included within the consolidation umbrella.1606 Respondent accuses Claimants of conflating concepts of accounting (control relationships amongst various Yukos entities for consolidation purposes under the U.S. GAAP), which PwC did understand, with questions of tax (how much actual control Yukos exerted at an operational level over the trading shells from Moscow while maintaining the fiction of management in the low-tax region to avoid tax under Russian tax law), which PwC certainly did not appreciate, because it never audited the trading companies.1607 Respondent does not actually refer to any “new” information PwC learned which would have caused them concern about this in June 2007; it simply points to a series of negatives (PwC did not design the trading company scheme, PwC did not audit the trading companies).

1234. At the hearing, Respondent referred to the August 2007 interrogation of Mr. Kubena’s predecessor as PwC tax advisor in Russia, Mr. Klubnichkin, to show PwC never audited the trading companies.1608 While PwC was fully aware of Yukos’ use of the tax optimization scheme, Mr. Klubnichkin said, it was not aware of any abusive elements. Mr. Klubnichkin said that as Yukos’ auditor, PwC had “never been aware of the fictitious nature of these ‘operational’ companies . . . . The deceit lies in the fact that a corporation creates false appearance of normal activity, of a serious business, with respect to a fictitious business . . . .

We could only learn about such nature of these companies in case of a full audit of these companies themselves, which would include our visits to their operational premises.”1609 The Tribunal notes that Mr. Klubnichkin’s interrogation took place in August 2007, after the PwC withdrawal.

1235. Respondent submits that PwC did not know about the Lesnoy assessments. Respondent thus disputes that PwC was ever aware that the trading companies were sham entities directly controlled by Yukos from Moscow, and disputes that Yukos’ tax scheme was adopted on PwC’s advice or recommendation.1610

1236. Claimants’ response is two-fold. Firstly, they refer to oral and documentary evidence in the

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record confirming PwC’s participation in the Yukos tax scheme in the regions.1611 They point to a contemporaneous internal memo from PwC Cyprus to PwC Moscow, which discloses that PwC was familiar with the details of the group structure and the relationships of the trading companies.1612 In addition, Claimants underline the closeness of Yukos’ relationship with PwC as shown by PwC’s attendance at an “international symposium” held by Yukos in early 2002, at which tax issues, group structure, international accounting standards and related party disclosure requirements were discussed.1613

1237. Finally, Claimants point to a timing problem that in their view undermines the credibility of PwC’s statement that it obtained “new information” only in May 2007. The Tribunal finds much force in Claimants’ submission that PwC was on notice of the Russian Federation’s alleged concerns about Yukos’ tax optimization structure at least as early as January 2004, when it issued its opinion on the 2000 Audit Report. As Yukos’ auditor since 1997, PwC obviously had a strong incentive in ensuring that its previous audit reports were accurate, and if there was anything new or worrying in what it had seen, it would have raised it at the time. PwC did not withdraw the audits in 2004, 2005, or 2006 when the issues were being aired through the Russian courts and in the public domain. Rather it waited three and a half years, and then suddenly decided that there was “new information” on the basis of which the audits should be withdrawn.

iii.Did Yukos’ Management Lie to PwC about Transactions with Bank Menatep?

1238. The third category of alleged misinformation identified in PwC’s Withdrawal Letter was the following:

In the course of the Investigation, we were shown documents demonstrating that the Company had made significant payments to meet liabilities of the companies effectively

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owned and controlled by Group Menatep before AKB Menatep Bank. Complete

information about the nature of these transactions and relations was not disclosed to us in the course of the audits.1614

1239. This “new information” concerned transactions going back to the late 1990s, when Yukos purchased what Respondent calls “worthless claims” against Bank Menatep, which was in bankruptcy at the time.1615 The principal shareholders of Bank Menatep were the same as the principal shareholders of Yukos. PwC was concerned that the purchase of claims against a bankrupt bank was undertaken to further the interests of the companies’ common shareholders, using Yukos’ funds and at the expense of Yukos’ minority shareholders. By May 2000, Yukos had accumulated USD 500 million in claims against Bank Menatep, but had at most USD 220 million in guarantees.

1240. During one of the 2007 interrogations, Mr. Miller was shown minutes of a May 2000 meeting, in which Yukos’ managers stated that “it would be not be desirable to disclose this information since those shares were bought out from the borrowers.”1616 The minutes then state that “[i]t is necessary to immediately demonstrate to the Company’s auditors the intention to sell the excess of the purchased assets―with a book profit―to unrelated third parties. . . .” Although Mr. Miller could not in fact remember if he worked on this issue or if the information was disclosed to PwC, he was outraged what he described as the “unacceptable manipulation of information” revealed by the minutes and by Yukos’ plan to lie to the auditors about its worthless claims against Bank Menatep.1617

1241. Claimants assert that PwC was always fully aware of the substance of the transactions concerning the assumption of Bank Menatep’s debt, and that the transactions were accounted for in Yukos’ financial statements and draft F-1 forms.1618

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iv.Did Yukos’ Management Lie to PwC about its Compensation Payments to Certain VPL Managers?

1242. The fourth category of alleged misinformation identified in PwC’s Withdrawal Letter was the following:

The Company failed to timely disclose to us information about certain payments made by the shareholders of Group Menatep in favor of certain individuals, who were leading executives of the Company at the time of its privatization. In the course of the Investigation, some information disclosed to us ran counter to the explanations given to us by the management and shareholders of the Company in the course of our audits with regard to the exact nature of those payments.1619

1243. This allegation concerned the extraordinarily generous compensation plan that had been put in place for certain persons who had been managers of Yukos at the time of its privatization. PwC suspected that the immense sums paid to those persons could not have been for services rendered to Yukos itself. Respondent alleges that Yukos had misrepresented to PwC the purpose of the compensation plan. PwC’s long-held suspicion about the nature of the payments was only confirmed when the Prosecutor General showed Mr. Miller statements signed by the beneficiaries of the payments to the effect that they had been made to them “not for services provided to Yukos but were . . . connected to Group Menatep’s acquisition of Yukos.”1620 Mr. Miller expressed “indignation” at the “lie” and alleged that Mr. Khodorkovsky had told him he would go to jail if forced to disclose the real reason for the payments.1621 This category of so-called “lies” was seen as important to PwC not in terms of material effect on the audited reports, but insofar as they undermined the credibility of Yukos’ management’s statements.1622

1244. Claimants affirm that Mr. Miller had always been familiar with the payment arrangements. How the payments are identified in the accounts is only an accounting issue (as opined by Clifford Chance and Cleary Gottlieb at the time).1623 When PwC signed off on the Yukos financial statements, they were aware of the issue. Even Mr. Miller acknowledged that the

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“reliability of the financial statements is not affected.”1624 Claimants were prepared to disclose the existence and purpose of the compensation fund to the public for the ADR listing.1625

(c)Concluding Observations

1245. The Tribunal observes that there are some notable timing problems concerning the date of PwC’s withdrawal following the revelation of “new” information. For example, the fact that PwC did not audit the trading shells would have been known to Mr. Miller before June 2007. PwC would have known about alleged “sham” or “abusive” elements of the Yukos tax optimization scheme at least as early as January 2004 when it was shown the 2000 Audit Report. It is not understandable that PwC would wait until June 2007 before determining that its audits were unreliable. Respondent itself notes that “[a] question can be raised as to whether PwC waited too long to withdraw its audit opinions.”1626

1246. In addition, PwC said that its withdrawal letter was drafted on the basis of “new” information that Mr. Miller learned in the course of his interrogations in May 2007. However, it appears that a draft withdrawal letter was prepared as early as March of that year.1627

1247. PwC was clearly pressed by the Russian authorities to find grounds for withdrawing its audits of Yukos. Bearing in mind the complexity of the Yukos structure, the business environment at the time it was set up, and the grey areas of Russian tax law at the time, it is not surprising that PwC could identify elements of evidence with respect to some aspects of Yukos’ business practice that it affirms gave rise to credibility issues. As far as the Tribunal can judge, Yukos may not have been candid in its representations to PwC about control of the BBS Companies and about the reasons for the immense payments Yukos undertook to make, and did make, to individuals who were involved in its privatization.

1248. However, the Tribunal cannot accept that the four issues identified in PwC’s Withdrawal Letter were in fact “new” for PwC. In addition, even if the information was new, it was not unequivocal, and could have been tested with Yukos when it was still operational. In this

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regard, the Tribunal notes that PwC did not give former Yukos senior officials an opportunity to comment on the new information before signing the withdrawal letter. At the Hearing, Mr. Misamore testified that he stood by the following statement he made in 2009 in relation to the PwC withdrawal:

PWC never said anything to me or, as far as I know, anyone else at Yukos, to my knowledge, about a lack of information or the refusal to provide information, other than the instance concerning the ownership interests in [the] BBS [Companies]. If PWC had asked me to intervene―and I did intervene with the BBS inquiry―I would have gone to Group Menatep shareholders or their lawyers, and would have urged the release of the requested information.1628

1249. According to Respondent’s accounting expert, Mr. Ellison, who was not cross-examined, the U.S. Statement of Auditing Standards No. 1 sets the following standard for the “Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report”:

When the auditor becomes aware of information which relates to financial statements previously reported on by him, but which was not known to him at the date of his report, and which is of such a nature and from such a source that he would have investigated it had it come to his attention during the course of his audit, he should, as soon as practicable, undertake to determine whether the information is reliable and whether the facts existed at the date of his report. In this connection, the auditor should discuss the matter with his client at whatever management levels he deems appropriate, including the board of directors, and request cooperation in whatever investigation may be necessary.1629

[emphasis added]

1250. Similar steps are expected to be taken under international and Russian auditing standards.1630 Mr. Ellison notes that PwC’s Withdrawal Letter stated that “due to the company undergoing bankruptcy and the former company executives no longer working for the company, PwC was unable to access the information required that could lead to revision of the financial statements and was also unable to discuss the matter with management, as recommended by [the audit standards].” Mr. Ellison concludes that under those circumstances “PwC had no option but to withdraw its audit reports.”1631

1251. Mr. Ellison observes that when a reputable international firm withdraws an audit opinion it is an “unusual and serious” event.1632 In light of the seriousness of the decision to withdraw the

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audit opinions, and the industry standard of consulting with the audited company before taking any action, it is noteworthy that PwC made no effort to reach out to Yukos’ management or exmanagement to discuss the “new” information.

1252. PwC’s senior executives confided to the U.S. Embassy that the withdrawal decision was a “difficult” call.1633 At stake for PwC on the one hand was its reputation and loyalty to a “dead” client, and on the other hand its continued viability in the Russian market. As the cables reveal, Russia mattered to PwC.1634 PwC’s senior executives met with the Russian Government to resolve PwC’s problems. And, as noted earlier, after PwC made its decision, criminal charges were dropped, and PwC prevailed in two lawsuits, received a refund of its fines, maintained its license and retained important Russian clients such as Gazprom. As observed by Mr. Kosciusko-Morizet, “PwC undoubtedly opted in the end for the most pragmatic approach so as to maintain its office in Russia and protect its employees from being sued.”1635

1253. As the Tribunal stated at the outset of this chapter, PwC is not on trial before this Tribunal, which draws no conclusion in the present Award about PwC’s professional conduct. However, the pressure mounted by the Russian authorities against Yukos’ auditors, which led to PwC’s eventual withdrawal of its audits and even to a PwC auditor testifying against Messrs. Khodorkovsky and Lebedev at their second trial, informs the Tribunal’s view that Yukos was the object of a series of politically-motivated attacks by the Russian authorities that eventually led to its destruction, as alleged by Claimants.

IX. PRELIMINARY OBJECTIONS

1254. Before turning to the central question of Respondent’s liability under the ECT on the basis of the extensive factual record canvassed in the preceding Part VIII, the Tribunal addresses in this Part IX three preliminary objections made by Respondent, including two that were not finally resolved in the Tribunal’s Interim Awards.

1255. The Tribunal considers, in this order, Respondent’s preliminary objections related to: (a) the ECT’s “fork-in-the-road” provision―Article 26(3)(b)(i); (b) Claimants’ allegedly “unclean

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hands”; and (c) the relevance of Article 21 of the ECT.

A.ARE ALL OR SOME OF THE CLAIMS BARRED BY THE “FORK-IN-THE-ROAD” PROVISION OF THE ECT?

1. Introduction

1256. Article 26(3)(b)(i) of the ECT contains the ECT’s “fork-in-the-road” provision. It must be read together with the preceding paragraphs of Article 26:

Article 26

SETTLEMENT OF DISPUTES BETWEEN AN INVESTOR AND A CONTRACTING PARTY

(1)Disputes between a Contracting Party and an Investor of another Contracting Party relating to an Investment of the latter in the Area of the former, which concern an alleged breach of an obligation of the former under Part III shall, if possible, be settled amicably.

(2)If such disputes can not be settled according to the provisions of paragraph (1) within a period of three months from the date on which either party to the dispute requested amicable settlement, the Investor party to the dispute may choose to submit it for resolution:

(a)to the courts or administrative tribunals of the Contracting Party party to the dispute;

(b)in accordance with any applicable, previously agreed dispute settlement procedure; or

(c)in accordance with the following paragraphs of this Article.

(3)(a) Subject only to subparagraphs (b) and (c), each Contracting Party hereby

gives its unconditional consent to the submission of a dispute to international arbitration or conciliation in accordance with the provisions of this Article.

(b)(i) The Contracting Parties listed in Annex ID do not give such unconditional consent where the Investor has previously submitted the dispute under subparagraph (2)(a) or (b);

(ii)For the sake of transparency, each Contracting Party that is listed in Annex ID shall provide a written statement of its policies, practices and conditions in this regard to the Secretariat no later than the date of the deposit of its instrument of ratification, acceptance or approval in accordance with Article 39 or the deposit of its instrument of accession in accordance with Article 41.

[. . .]

1257. Before turning to the Parties’ submissions, the Tribunal recalls its dismissal in the Interim Awards of Respondent’s identical Article 26(3)(b)(i) objection to jurisdiction and/or admissibility:

The Tribunal finds that Respondent’s arguments are unconvincing. Indeed, in its written submissions, Respondent did appear to concede that, as a general matter, there is ample

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