Editor’s note: This story has been updated to include additional expert commentary.
When PrivatBank was found to have billions in unpaid insider loans, one question hung over Ukraine: How did this go undetected?
The country’s largest commercial lender was able to transfer cash into its Cyprus branch without triggering any oversight.
Meanwhile, a 2015 audit of PrivatBank by global auditing firm PricewaterhouseCoopers, or PwC, underestimated the scale of a fraud that stripped $5.5 billion from the bank’s balance sheet over a decade, according to the National Bank of Ukraine, or NBU.
According to the central bank, most of the corporate loan book was comprised of credit issued to related parties of PrivatBank’s former owners, the billionaire oligarchs Ihor Kolomoisky and Gennadiy Boholyubov. A subsequent audit by international auditor Ernst & Young did not fully confirm this assertion.
It took a forensic audit by U.S. risk management firm Kroll to confirm the scale of the fraud and identify its mechanism. While Kroll’s report was not made public, its findings were likely used in PrivatBank’s lawsuit against Kolomoisky, Boholyubov and their business partners in the U.S. A copy of the report also made its way to the Organized Crime and Corruption Reporting Project.
The Delaware complaint and the OCCRP confirmed the most important findings: the presence of a “Shadow Bank” within PrivatBank, the Ponzi-like structure of its corporate loans and the money laundering scheme through Cypriot companies and PrivatBank’s foreign affiliates.
“The lack of a collateral assessment function… has led to the possibility of issuing loans against significantly overvalued or non-existent collateral,” PrivatBank wrote in an email. “The result is known — a hopeless problem portfolio.”
The NBU accused PwC of helping PrivatBank conceal this scheme and subsequently excluded the firm from auditing banks. In May 2019, a Kyiv court lifted that ban. The NBU stated that it was still in force and would appeal the court ruling.
Meanwhile, PrivatBank launched a $3 billion lawsuit against the firm in Cyprus, which is still ongoing.
PwC did not respond to requests for comment by press time but the auditor has consistently defended its work in public statements over the past few years. In July 2017, the firm wrote “PwC performed its audit of PrivatBank’s 2015 financial statements in accordance with international auditing standards… The audit opinion on these financial statements included a qualification in respect of related party transactions.”
Experts told the Kyiv Post that it is hard to say whether the auditor was guilty of wrongdoing. However, they identified several warning signs about PrivatBank that could have warranted a closer look.
Widespread rumors
Financial analyst Ruslan Cherniy told the Kyiv Post that even before PwC’s audit, PrivatBank had a suspicious reputation. Many people in the banking sector knew that something was not quite right at PrivatBank, from information which came from the bank’s former employees.
According to PrivatBank’s lawsuit against Kolomoisky and Boholyubov in Delaware, dozens of senior-level managers and other PrivatBank employees worked for the so-called “Shadow Bank.” These employees were likely the source of that information.
“No one could prove it with documents but everyone knew about it,” said Cherniy. “So the auditors had to pay attention to this information and check the documents more thoroughly.”
Cherniy is the chief editor of Financial Club, which produces an annual ranking of the top 50 banks in Ukraine. He said that when PrivatBank was nominated to be the number one bank in the 2012 ranking, it raised an outcry from a high-level central bank executive involved in the ranking. “PrivatBank is not a bank but a pyramid,” Cherniy said of the reaction.
Several experts told the Kyiv Post that if an auditor perceives a large reputational risk, the firm is likely to either decline to conduct the audit or make a note of this risk as part of the auditing process.
But Illia Neskhodovsky, a tax expert with the Reanimation Package of Reforms, a coalition of reformist NGOs in Ukraine, told the Kyiv Post that it would be difficult for an auditor to make that call just because of rumors from former employees. “That’s why auditors don’t pay attention to these kinds of findings,” he said. “Formally, PrivatBank filed everything correctly.”
Anastasia Tuyukova, a senior analyst at Dragon Capital, told the Kyiv Post that the suspicion could have come from the bank’s reporting statements over the years. These reports appeared to greatly understate the proportion of related party loans, given the industries with which the bank was involved.
Oligarchs Ihor Kolomoisky (R) and Gennady Boholyubov (second from left) participate in the grand opening of a Ukrainian museum of Jewish history in Dnipro in October 2012. The business partners used to be the major shareholders of PrivatBank until its 2016 nationalization. (UNIAN)
Coincidence?
Alexander Paraschiy, research director at Concorde Capital, told the Kyiv Post that PrivatBank’s documents broke down which companies it credited by sectors of the economy. An auditor should have noticed that these sectors coincided with the areas in which Kolomoisky was invested, including ferroalloys, hydrocarbons, hotels, football clubs and airlines.
“This right away begs the conclusion: did PrivatBank credit Kolomoisky’s competitors, which is hard to believe,” said Paraschiy. “Or it credited Kolomoisky’s businesses. At least, this could lead to questions.”
Tuyukova agreed. She said the bank’s reporting would have “looked strange,” given how many loans it issued to companies in industries controlled by PrivatBank’s main shareholders. “The auditor clearly saw this too and should have been asking questions,” she added.
Paraschiy added that since PwC had done work for the bank in the past, it should have had a strong understanding of how the bank worked, which would have made attempts to conceal fraudulent activities more difficult.
“It’s very hard to believe that an auditor that worked for more than a year with the bank did not notice anything,” said Paraschiy.
PwC probably committed no violations, he added, even though it’s possible that they missed something very important.
Experts said that the final piece of the puzzle fell in place when the PrivatBank’s owners took assets from the bank’s borrowers and added them to the bank’s balance.
“It’s impossible to take assets from the borrowers if he doesn’t control them,” said Tuyukova.
EY audit
In 2017, EY, another member of the Big Four global audit firms, conducted another audit of PrivatBank, which was by that point under government control following its 2016 nationalization. EY’s due diligence analysis found that the bank needed the government to inject another $1.5 billion to meet capital adequacy standards, which the government implemented.
Andrii Ianitskyi, a journalist who co-wrote the book “Privat Story” about the bank’s travails, said that the NBU was hoping that the EY audit would confirm the existence of large-scale related party loans. However, EY stopped short of making that declaration, said Ianitskyi, who called its report “rather toothless.”
“The auditor did not take that kind of responsibility upon itself, to directly accuse the former shareholders,” he said.
Standards vs. obligation
Auditors mostly review the documents they are presented and rarely go on site to examine the physical companies or collateral, said Ianitskyi.
“As far as I know… there were some comments in the [PwC] auditing report,” he said. “They did not write that the bank is ideal.”
However, by the time PwC made these comments, it was too little, too late. The bank would be found insolvent and nationalized a year later.
Accountancy expert James Peterson, who is based in Chicago, told the Kyiv Post that, in his international experience, mere compliance with standards hasn’t helped companies get out of cases where they failed to identify large-scale fraud.
“The profession tried to wrap itself in the defense that we did everything correctly,” he said. “The trouble with that is lawyers, judges and the public don’t believe that and in fact that is not the case in the legal systems that I know best in the US and the UK.”
Peterson added that the size of the case and the $3 billion lawsuit against PwC poses a serious threat to the international stability of the company. In recent years, the auditor was banned from auditing companies in India for two years after it failed to spot a $1.7 billion fraud at former Satyam Computer Services company. It also had to pay $335 million to the U. S. Federal Deposit Insurance Corporation over failed audits of Alabama Colonial Bank.
However, it is unclear how the case against PwC will be settled in Cyprus — and Ukraine. Ianitskyi said that it is a very politicized case, whose resolution will be affected by changes in the government.
Several experts, including Neskhodovsky, said that it was good that PwC was punished by being banned from auditing banks, because it sends a clear signal.
“The entire big four was very frightened by this decision and their approach, as far as I know, became a lot tougher,” said Cherniy.
Foreign branches
Auditing firms are not the only ones to have dropped the ball. According to former NBU head Yakiv Smolii’s statements to the OCCRP, Ukrainian authorities did nothing to regulate the huge sums being funnelled from PrivatBank in Ukraine into its Cyprus branch.
Ukraine treated the Cyprus branch of PrivatBank the same as any domestic branches, which meant that the cash being transferred to Cyprus went undetected for a decade, until it was too late.
The Delaware complaint said that PrivatBank’s corporate loans were “cycled through dozens of… affiliated bank accounts at PrivatBank’s Cyprus branch,” before being funneled into external companies in other jurisdictions.
The Central Bank of Cyprus only conducted investigations in 2015, after which it alerted Ukrainian authorities. In 2016, as the nationalization of PrivatBank loomed, billions of dollars from PrivatBank’s Cyprus branch were rapidly shuttled to other European jurisdictions where the Ukrainian authorities could not get at them.
“The 2016 financial statements also show that the events which took place after we signed the 2015 accounts may have had a significant impact on PrivatBank’s financial status,” PwC wrote in 2017.
