Exclusive: Flying blind - Marubeni's Gavilon ignored Brazilian red flags

By Ana Mano

SAO PAULO (Reuters) - When Japanese conglomerate Marubeni <8002.T> booked a loss of 3.9 billion yen ($35 million) at its U.S. grain trader Gavilon in November, it blamed adjustments for "inappropriate transactions" with Italy and Spain.

While Marubeni didn't give further details, the issues that led to the loss stretched back years and had been overlooked by Gavilon's U.S. managers despite repeated warnings from accountants and some company executives in Brazil, according to audits, emails and four people familiar with the matter.

Brazilian risk controllers at Gavilon do Brasil raised red flags as early as June 2016 about lax accounting that ultimately let the company book inaccurate estimates for freight costs, boosting its profits and masking losses, according to three sources and documents about Gavilon's risk mitigation efforts.

That same month, an Ernst & Young audit flagged to Gavilon do Brasil managers that its processes left room for fraud. In 2017, EY said in another audit seen by Reuters that there was a "significant deficiency" in the way freight costs were booked.

Yet it was only in 2019 when Gavilon adopted a new accounting methodology that major discrepancies were revealed between actual shipping costs and the freight costs recorded in Gavilon's books, leading to an internal investigation.

A person familiar with the enquiry said it revealed a shortfall of about $25 million related to accounting issues with freight expenses for Brazilian corn destined for Italy and Spain and about $10 million from other misvalued positions - leading to the declared loss.

A Gavilon representative said the company did not comment on internal financial matters.

A Marubeni spokesman declined to respond to Reuters' questions about Gavilon or its losses.

EY declined to comment citing confidentiality issues.

During the internal investigation, Gavilon dismissed several executives at its U.S. headquarters but did not explain publicly the reason for their sudden departure.

Reuters was unable to reach them for comment and could not verify that the dismissals were connected to the investigation.

FLYING BLIND

Gavilon do Brasil's former chief financial officer Paulo Silva spoke out in 2017, warning U.S. executives that accounting issues in Brazil could snowball if they weren't tackled.

He said it was not uncommon for new firms to operate without major issues during the first couple of years but the risks at Gavilon had increased significantly as the volume of grain traded had risen sharply.

"Without proper flight controls the situation can develop into a blind flight all of a sudden," Silva wrote in an email, seen by Reuters, to Gavilon executives in the United States in August 2017. He left the company about two months later.

Silva declined to be interviewed.

Before the $35 million hit, Gavilon's Brazilian operation had been driving breakneck growth at the agribusiness firm, which Marubeni bought for $3.6 billion in 2012, nearly doubling its grain trading volumes overnight.

In its 2018 fiscal year, Gavilon do Brasil's revenue surged to more than 10 billion reais ($2.2 billion) - six times sales just three years earlier, according to public filings.

Gavilon's soybean sales from Brazil to China, the world's top exporter and top importer respectively, jumped more than 20-fold in four years to 4.5 million tonnes in 2019, making it the fifth-largest player in the business, shipping data show.

But when Brazilian executives raised concerns with their U.S. bosses about accounting shortcomings, senior management deferred to the fast-growing trading division, rather than dig into issues that could draw unwanted attention from Marubeni, three sources familiar with the matter said.

Brazilian risk officers said in a June 2016 presentation that after years of aggressive growth, Gavilon "now lacks controls and higher levels of governance to manage its business", according to emails and documents about the presentation seen by Reuters.

EY's audit report that month flagged to managers at Gavilon do Brasil that there were unwarranted manual entries in the books compiled without proper approval or documentation, which created "opportunities for errors or fraudulent activities".

Management replied that changes proposed by auditors were impossible due to software limitations and it proposed a parallel system for documentation, the audit report showed.

'UNCONTROLLABLE SNOWBALL'

In its 2017 audit, EY flagged similar issues again. It also warned of another risky practice: Gavilon was regularly using freight suppliers to give short-term, or "spot", rates - without entering into a formal contract nor providing evidence of any bidding process between shipping firms to get the business.

EY called this a "significant deficiency" which left it with no way to know if actual shipping costs were reflected in the books. "To improve the company's internal controls, the spot method should only be used for specific operations on an urgent basis," the EY audit said.

In July 2017, Gavilon missed its profit estimate by $5 million due to accounting issues in Brazil, catching U.S. bosses by surprise, according to an email from Gavilon's former global controller Jeremy Koeppe.

"Our environment is not as controlled as it needs to be nor is it as controlled as I thought it was," wrote Koeppe, who could not be reached for comment.

Reuters could not determine the exact accounting issues that led to the profit miss.

Silva had complained about "lots of last minute (by month end) changes in the freight tables", which made it harder to prepare profit and loss reports. He said the logistics unit often updated freight estimates after accountants had told traders the value of their positions based on market prices.

Internal messages seen by Reuters showed that Silva had made repeated calls for tighter controls to avoid, "a horrible uncontrollable snowball".

Two other people familiar with accounting practices at Gavilon do Brasil echoed Silva's concerns, with both saying traders could easily adjust freight prices recorded in the books to offset market swings affecting their positions.

"(This) leads us to think that they might be trying to 'manage' their results and freight prices," Silva wrote.

(Reporting by Ana Mano in São Paulo; Additional reporting by Aaron Sheldrick in Tokyo; Editing by Brad Haynes, Simon Webb and David Clarke)