As the world moves to reduce carbon emissions, experts are increasingly warning about the potential of significant asset impairments (sudden reductions in asset value) in the coal industry. Unable to compete with other renewable energies in the face of increasing regulatory risk, thermal coal mines in particular may become stranded assets. As the industry faces greater financial pressure, in an already unpredictable business, these conditions may increase the pressure on mining companies executives to prove to investors that coal assets are still valuable. To do so, some executives could be tempted to delay disclosing negative developments and impairments from investors.
To ensure accurate financial reporting by publicly-traded companies, the U.S. Securities and Exchange Commission (SEC) requires U.S. companies to comply with U.S. generally accepted accounting principles (U.S. GAAP) when preparing and filing annual and interim financial reports. For foreign private issuers, such as Rio Tinto, the SEC requires compliance with either U.S. GAAP or other accepted accounting standards, such as the International Accounting Standards Board. Pursuant to International Accounting Standards 34 and 36, companies are required evaluate whether an asset is impaired at the end of each reporting period. When the asset is worth less than the amount listed on the company’s financial statements, companies are required to disclose an impairment in interim financial reports.
Without inside information, however, it can be difficult to determine whether companies are accurately reporting impairments when they identify them. To encourage those with inside information to step forward, the Dodd-Frank SEC Whistleblower program allows whistleblowers, including non-U.S. citizens, to confidentially report companies who are fraudulently delaying the disclosure of impairments, and whistleblowers who provide original information that leads to successful SEC prosecution can receive between 10% and 30% of monetary sanctions.
As the coal industry faces increasing regulatory hurdles, oversight of company’s impairments and the potential for fraud may be more important than ever. A previous fraud case, involving Rio Tinto’s inflation of Mozambique coal assets, shows how executives under pressure could be tempted to commit fraud by failing to disclose asset impairments – and how internal whistleblowers can reveal the truth.
Rio Tinto Coal Mozambique
In 2011, executives at Rio Tinto were facing significant pressure to prove that the company could rebound from the high-profile failure of a recent acquisition. Four years prior, at the peak of the aluminum cycle, CEO Thomas Albanese had led the company in acquiring Alcan, a Canadian aluminum company, for the hefty price of $38 million. When aluminum prices dropped shortly after, Rio Tinto was forced to announce a series of dramatic impairments that slashed the acquisition’s value.
In April 2011, still reeling from the Alcan impairments, Rio Tinto acquired Riversdale Mining Ltd and its Zambezi coal project in Mozambique. According to a later investigation by the SEC, CEO Thomas Albanese and CFO Guy Elliot hoped that the company could restore its reputation through the acquisition of this new “world class” coal asset which would enable the company to rapidly expand into the energy industry.
The $3.7 billion acquisition was based on the assumption that the company could transport and sell 40 million tons of coal per year. Rio Tinto’s pre-acquisition due diligence assessment estimated that the coal deposits contained 7 billion tons of coal, including both thermal coal and a significant amount of coking coal, a valuable form of coal used in steel production. Rio Tinto planned to barge the majority of the coal down the Zambezi River to the coast and transport the rest on the Mozambique railway.
The pre-acquisition due diligence assessment had also identified substantial risks associated with the project, but Albanese and Elliot failed to disclose these to the Board of Directors and proceeded with the acquisition. Shortly after this acquisition of the project, which was renamed Rio Tinto Coal Mozambique (RTCM), these risks materialized as serious negative developments.
The proposal to barge coal down the Zambezi River, upon which the majority of project depended, was rejected in December 2011 by the Mozambique government, who cited the river’s limited size and the potential for ecological damage. The Mozambique railway, the only remaining transportation option, turned out to be “severely limited” and could transport only 5% of the coal assumed in the initial evaluation.
To compound these problems, new estimates showed that the deposits only contained an estimated 3 billion tons of coal, less than half of Rio Tinto’s original estimate. High-value coking coal also represented a significantly smaller portion of this new estimate. Based on this new information, an internal model reduced the value of the project from $3.7 billion to between negative $3.45 billion and negative $9 billion. RTCM executives advised Albanese and Elliot in early 2012 that, in the best-case scenario, the project was worth negative $668 million.
Under International Accounting Standards, negative developments of this magnitude should have triggered an impairment test. If the impairment test determined that RTCM was worth less than the estimate reflected on financial statements, Rio Tinto would have had to list an impairment loss on the value of the assets in financial statements. However, while Albanese and Elliot knew by this point that the RTCM was “close to worthless,” they continued to carry RTCM with a value of $3 billion for the remainder of the year. Through the end of 2012, they misled the Board of Directors, the Audit Committee, independent auditors, and the market, allowing the company to raise $5.5 billion in U.S. debt offerings that contained materially misleading statements and omissions.
The deception might have continued even longer if not for an employee who stepped outside the chain of command. According to the SEC investigation, in August 2012, Preston Chiaro, Rio Tinto’s head of technology and innovation, informed Elliot that experts in the innovation and technology division had determined that RTCM had a negative valuation. After several months passed without Elliot informing the audit committee or board of directors several months, Chiaro reported the information directly to the Chairman of the Board. The Chairman ordered an investigation and impairment process that led to an announcement that Rio Tinto was impairing RTCM by $3 billion, as well as Albanese’s and Elliot’s departures. The company would reduce RTCM’s value a second time; in 2014, RTCM, once valued at $3.7 billion, sold for $50 million.
The rapid drop in valuation prompted a joint investigation by the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and the Australian Securities and Investments Commission. Rio Tinto is an Anglo-Australian company, but its listing on the New York Stock Exchange allowed the SEC to investigate. In October 2017, the U.K. Financial Conduct Authority fined Rio Tinto $45.7 million dollars for breaching disclosure and transparency rules, the authority’s largest ever such award. On the same day, the U.S. Securities and Exchange Commission filed a lawsuit, which is currently ongoing, in U.S. federal court in Manhattan, alleging that Rio Tinto plc, Rio Tinto Limited, Albanese, and Elliott violated the antifraud, reporting, books and records and internal controls provisions of the federal securities laws. Rio Tinto also faces a similar lawsuit from the Australian Securities and Investments Commission.
The Rio Tinto case demonstrates the shaky foundations that energy expansion in the mining industry may rest on. While Rio Tinto had planned to make an expansion into coal the bedrock of its business, the revelations of fraud at the center of its coal division put a short end to that plan. The same year that Rio Tinto sold RTCM, it began to sell its other major coal assets and stopped approving new ones, effectively ending its bid to move into the energy industry.
The case also demonstrates the impact that employees can have when they report concerns about fraud – a lesson that Rio Tinto may not have learned. In March 2020, a whistleblower from within Rio Tinto said that he had referred to regulators in the US, the UK, Australia, and Mongolia that Rio Tinto had failed to disclose to investors negative developments concerning a copper mine in Mongolia.
As the entire coal industry faces increasing financial pressure, executives could be tempted to hide negative developments. What the case of Rio Tinto shows is that, when faced with this pressure, some executives may see financial fraud as a solution – and whistleblowers could be the key to proving them wrong.