SEC charges Rio Tinto with fraud

The U.S. Securities and Exchange Commission (SEC) has charged Rio Tinto (NYSE: RIO; LON: RIO) and two of its former executives with fraud for inflating the value of coal assets the company acquired in Mozambique for US$3.7 billion in 2011 and sold for US$50 million in 2014.

The SEC’s complaint alleges that Rio Tinto, its former CEO Thomas Albanese and its former chief operating officer Guy Elliott did not follow accounting standards and company policies to accurately value and record its assets.

“Instead, as the project began to suffer one setback after another resulting in the rapid decline of the value of the coal assets, they sought to hide or delay disclosure of the nature and extent of the adverse developments,” the SEC noted in its Oct. 17 press release.

“Rio Tinto’s top executives allegedly breached their disclosure obligations and corporate duties by hiding from their board, auditor and investors the crucial fact that a multibillion-dollar transaction was a failure,” Stephanie Avakian, co-director of SEC’s Enforcement Division, said in a statement.

Avakian’s co-director, Steven Peikin, added that “Rio Tinto and its top executives allegedly failed to come clean about an unsuccessful deal that was made under their watch. They tried to save their own careers at the expense of investors by hiding the truth.”

The mining company swiftly came to its own defence.

“Rio Tinto believes that the SEC case is unwarranted and that, when all the facts are considered by the court, or if necessary by a jury, the SEC’s claims will be rejected.”

Separately, but in the same press release, Rio Tinto confirmed that it had reached a settlement with the U.K.’s Financial Conduct Authority in relation to the timing of the impairment of the coal company in question — Rio Tinto Coal Mozambique (RTCM).

The FCA concluded that Rio Tinto should have carried out an impairment review in relation to RTCM for its 2012 interim results, and, if it had done so, those results published in August 2012 would have reflected the impairment it recorded six months later. In its ruling the FCA said the company had breached the agency’s disclosure and transparency rules, and fined Rio Tinto US$36.4 million.

“The FCA made no findings of fraud, or of any systemic or widespread failure by Rio Tinto,” the company pointed out in the news release, adding that the case with FCA is now closed but that the Australian Securities and Investments Commission is also reviewing the RTCM impairment.

In the complaint filed in the United States District Court in the southern district of New York, the SEC noted that Rio Tinto’s acquisition in April 2011 of RTCM was Rio Tinto’s second large-scale acquisition under Albanese’s leadership, and the company “had already experienced dramatic setbacks with Albanese’s first large-scale acquisition, Alcan Incorporated.

“The Mozambique acquisition was expected to restore the market’s confidence in Albanese’s deal-making acumen, but on-the-ground realities in Mozambique quickly undermined the narrative,” the claim stated.

Rio Tinto acquired the coal business in April 2011 based on the notion that it could mine, transport and sell more than 40 million tonnes of coal a year by barging the majority of it down the Zambezi River to a port on the Indian Ocean, the claim stated. But by November of the same year, the company discovered that their initial assumption was unrealistic. In December, the government of Mozambique rejected Rio Tinto’s proposal to barge the coal down the river. At the same time, the company also found out that rail capacity was limited.

Workers at Riversdale Mining’s Benga coal project in Mozambique in 2011, before Rio Tinto bought the company for $3.7 billion. Credit: Riversdale Mining.

“By the end of 2011, Rio Tinto knew that it could transport and sell only about 5% of the amount of coal it had originally assumed,” the SEC’s claim states. “Rio Tinto also learned that there was significantly less and lower-quality coal than it had assumed at acquisition.”

The claim alleges that the “nature and extent” of the adverse developments were then concealed from the company’s board of directors, audit committee, independent auditors and the market. If they had been disclosed, the SEC charges, it would have triggered an impairment analysis of RTCM.

“By the time problems with RTCM emerged, Rio Tinto had already impaired Alcan twice,” the claim states.

“Defendants knew that impairing RTCM or publicly disclosing its rapidly declining value would call into question Albanese’s and Elliot’s ability to pursue the core of Rio Tinto’s business model — identifying and developing long-term, low-cost and highly profitable mining assets.”

According to the claim, in May 2012, RTCM executives advised Albanese and Elliott that the valuation of the coal company and its assets was negative US$680 million, and yet, “Rio Tinto continued to carry RTCM on its books at a value of more than US$3 billion and [the] defendants continued to promote RTCM’s prospects to the market.

“Their misconduct paid off,” the claim continues. “Rio Tinto raised a total of US$5.5 billion in U.S. debt offerings that incorporated materially misleading statements and omissions concerning RTCM’s valuation. Of that amount, Rio Tinto raised approximately US$3 billion in an offering initiated soon after Albanese and Elliott learned of RTCM’s negative US$680-million valuation. Each of the debt offerings took place only days after Rio Tinto released misleading financial information to the market. Publicly, Rio Tinto continued to value RTCM at more than US$3 billion for the relevant period.”

The claim states that the two executives “misrepresented and inflated” RTCM’s value until December 2012, at which point an employee of the company “outside the normal financial control function” discovered that “the true nature and effect of adverse RTCM developments was being hidden from the Board of Directors and that RTCM was being carried at an inflated value on Rio Tinto’s financial statements.”

The employee went around Albanese and Elliott, taking his findings directly to the chairman of the board, which triggered an internal review and impairment process for the asset. The chairman asked the board to dismiss Albanese as CEO.

By January 2013, the company had announced it was impairing RTCM’s carrying value by more than US$3 billion — more than 80% of RTCM’s value less than two years after it was purchased. Elliott stepped down as chief financial officer in April 2013.

After a second writedown of RTCM in 2014, Rio Tinto sold it for just US$50 million — less than 2% of the original US$3.7-billion acquisition price.