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Chinese Affiliates of Big Four Fined $2 Million

The SEC fined each of the Chinese affiliates of the Big Four auditing firms $500,000 for failing to hand over work papers related to investigations into suspected accounting fraud. The settlement also sets a framework that requires the firms to comply with future document requests or face a ban on working for clients listed on U.S. markets.

The SEC on February 6, 2015, sanctioned the Chinese affiliates of the Big Four accounting firms for “willfully” refusing to hand over work papers in suspected accounting fraud cases of Chinese company clients whose stocks traded in U.S. markets.

The four firms are Deloitte Touche Tohmatsu CPAs Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen, and PricewaterhouseCoopers Zhong Tian CPAs Ltd. As part of the settlement, each firm agreed to pay $500,000 and admit that they didn’t produce the documents before the proceedings were first brought against them in December 2012.

The settlement was announced in Accounting and Auditing Enforcement (AAER) Release No. 3627.

Section 106 of the Sarbanes-Oxley Act requires foreign public accounting firms to provide the work papers to the SEC upon request.

During the proceedings, the firms said they showed good faith but had no control over a Chinese policy that bars them from handing over papers directly to the SEC. China fears state secrets may be revealed.

The SEC’s Enforcement Division said the firms violated U.S. laws while choosing to comply with Chinese laws, and an administrative judge agreed in January 2014, ruling against the firms. The judge said the firms should have shown a good faith effort to obey all laws, not just the laws they wish to follow.

The settlement ends the risk the firms faced of a six-month ban from auditing U.S.-listed companies. The administrative law judge imposed the ban, pending a full SEC review of the ruling. The settlement extends the stay unless a firm fails to hand over documents in a future investigation. The SEC could also bring new proceedings against a firm or resume the current proceeding against all Big Four firms.

“As we repeatedly have stated throughout this litigation, obtaining an audit firm’s work papers is critical to enforcement staff’s ability adequately to protect investors from the dangers of accounting fraud,” said Andrew Ceresney, the Enforcement Division director. “This settlement recognizes the SEC’s substantial recent progress in obtaining those documents from registered firms in China. The settlement also holds four of the firms accountable for previously violating U.S. rules, and makes clear that should production of documents cease, the SEC can restart the administrative proceeding.”

The SEC negotiated with the China Securities Regulatory Commission (CSRC) to obtain the documents but had little success until 2013.

In May 2013, the CSRC signed a memorandum of understanding with the PCAOB to cooperate on enforcement matters. Shortly after the July 2013 Strategic and Economic Dialogue in Washington, an annual round of bilateral meetings between senior U.S. and Chinese officials, the CSRC handed documents to the SEC in a separate case involving a subpoena against Deloitte’s Shanghai affiliate. Since then, the CSRC has been providing papers to the SEC on enforcement matters.

“We are pleased to have reached a settlement with the U.S. SEC in the proceeding related to the production of Chinese audit work papers to the U.S. SEC,” the firms said in a joint statement. “The firms’ ability to continue to serve all their respective clients is not affected by this settlement.”

EY separately added that it “is pleased this matter has been resolved, given the potential for significant harm to investors and the global capital markets of further proceedings. We look forward to continued progress by the U.S. and Chinese regulators on all matters related to cross border cooperation.”

“It was fourth and long, and the SEC elected to punt,” said Paul Gillis, a professor of accounting at Peking University. He called the deal a major loss for investors.

“What was needed here is an agreement to allow the SEC access to all documents necessary to enforce U.S. securities laws against Chinese companies that list in America,” he said. “This settlement falls far short of that.”

A proceeding against a fifth firm, Dahua CPA Co. Ltd., continues separately because it had exited the U.S. market. The firm was called BDO China Dahua CPA Co. Ltd. until April 2013 when it dropped its affiliation with BDO International Ltd.

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