The Securities and Exchange Commission (SEC) has charged Rio Tinto, its former CEO Thomas Albanese and former CFO Guy Elliott with accounting fraud and it’s a doozy.

Rio Tinto is a London-based minerals company that is quoted in London, New York and Australia. Because the company is listed in New York it has to comply with Sarbanes-Oxley and false certifications under that law are a criminal offense.

Albanese became CEO in May 2007 and two months later acquired Alcan for $38 billion. Between 2009 and 2013, the valuation of that business was written down on four separate occasions. Eventually the whole investment was written off.

In 2010, the CEO decided to buy Riversdale, an Australian company that owned large coal mines in Mozambique. He decided that Rio Tinto could rapidly increase production to 30 million tons of coal a year, primarily by getting a permit from the government to barge most of the coal down the Zambezi river. That would justify the purchase price of $3.6 billion. The deal was finally closed in April 2011.

The SEC allege that the in-house due diligence team identified that there was a major risk that the permit would not be granted but the CEO withheld this information from the board when they signed off on the acquisition.

Within 7 months of the deal, Rio Tinto received a double blow. In October its VP of Logistics had determined that the maximum barging capacity was only 10 million tons, not 30. In any case, the following month the Mozambique government declined to issue a permit to barge. The company also over-estimated rail capacity in the country. As a result, the maximum coal production capacity was only 2 million tons, rendering the investment as basically worthless. Because of the debacle with the Alcan acquisition, the SEC allege that the CEO and CFO decided to withheld these facts from the auditors (PwC) conducting the audit for the 2011 report.

By May 2012, just over one year after the acquisition, the Rio Tinto executives in Mozambique had determined that the value of the business was a negative $680 million.

In March 2012, days after issuing the false audit report, the company issued four bonds totaling $2.5 billion. In August 2012, days after the half-yearly results were issued, they raised another $3 billion through three bonds.

In late 2012 the CEO and CFO began concealing information from the audit committee that was looking at possible impairment issues for the 2012 annual report.  Finally in December 2012, a senior executive found out about the withholding of the information and went directly to the Chairman with his concerns on the over-valuation.

The CEO was fired (technically stepping down ‘by mutual agreement’) in January 2013 and the investment was written down to $600 million. The CFO left in April 2013 and the Mozambique business was sold for $50 million in October 2014. The CEO and CFO didn’t get any cash bonuses in that period (because of the Alcan write-downs) but did receive long-term stock incentives.

Albanese, the CEO, receives an annual pension from Rio Tinto worth $738,000 a year. Elliott, the CFO, is a director of Shell and has a role on the UK’s Takeover Panel! (UPDATE: Elliott has resigned as a non-exec director of Shell)

It should be noted that, both the company and the CEO deny the allegations. In a separate statement the UK Financial Conduct Authority said that Rio Tinto will pay a fine of $36 million for breach of disclosure rules by failing to carry out an impairment test.

My take

• Easy to make profits on a spreadsheet!
• Don’t let a CEO ego get in the way of due diligence concerns!
• The executives at the very top can often override system-wide internal controls and procedures. Companies should mitigate this risk.
• I suspect that many senior executives kept quiet about their concerns on the over-valuations.
• Hard to deny the allegations in the USA when you have just paid a fine in the UK!

https://www.sec.gov/news/press-release/2017-196