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Chinese Audit Documents Remain out of Reach

Sep 26, 2013

After years of U.S. effort, it seemed like a breakthrough was achieved when Chinese regulators in July 2013 handed over to the SEC 20 boxes of documents related to a China-based company that was listed on a U.S. stock exchange and suspected of accounting fraud.

The SEC has yet to receive paperwork for other companies from the China Securities Regulatory Commission as of September 25. In the view of the U.S. market regulator’s enforcement officials, “the CSRC does not (at least yet) appear to be a ‘viable gateway’ for obtaining audit workpapers from China; certainly it is not a dependable gateway for such documents.”

The assertion in a courtroom brief submitted to an SEC administrative judge is the latest salvo in a legal battle pitting U.S. regulators against their Chinese counterparts. The fight has targeted the Chinese affiliates of the largest audit firms for punishment that could ban them from work for U.S. companies.

In recent years, the SEC and PCAOB have grown alarmed at the rise of accounting misconduct at Chinese companies listed on U.S. markets.

China barred direct production of audit papers needed for investigation to the U.S. regulators out of fears that the papers contain state secrets.

The SEC has been negotiating to get the papers from the CSRC under international agreement with no success.

In September 2011, the SEC brought a subpoena action against Deloitte Touche Tohmatsu CPA LLP of Shanghai, the former auditor of Longtop Financial Technologies Ltd., as part of an investigation into the company’s accounting.

The CSRC recently initiated a process of providing papers to foreign regulators, and in July produced the 20 boxes of Longtop documents.

In the meantime, the SEC in December 2012 brought a separate administrative proceeding against the Chinese affiliates of five large audit firms for refusing to hand over documents to agency investigators.

The SEC wants to bar the Big Four’s Chinese affiliates and BDO China Dahua Co. Ltd. for “willfully” flouting U.S. laws by not producing the audit papers. The firms said they have no control over a Chinese government policy that bars them from handing over papers directly to the SEC.

And the firms have pointed to CSRC’s work to produce documents of some of their clients as a “viable gateway” that should render the SEC actions against the firms moot.

“The ability to obtain requested documents through an alternative means substantially undermines the enforceability of document demands that would require the violation of foreign law,” the five firms’ brief said. “There is no doubt that the requested documents can be obtained through the CSRC, and the Section 106 requests therefore cannot be enforced under well-settled principles of internal comity.” Firms are required to hand over documents under Section 106 of the Sarbanes-Oxley Act of 2002.

The audit firms said the SEC recognized the importance of the delivery of the Longtop paperwork. Moreover, they said that the SEC’s Division of Enforcement along with the Office of International Affairs has “repeatedly contended that this proceeding would be rendered altogether unnecessary if such developments occurred.”

The SEC “cannot now punish [the firms] for the failure to produce documents that are available through the CSRC,” the firms wrote.

David Mendel, the SEC’s lead attorney in the case, disagreed.

“In short, audit workpapers are not ‘now flowing’ from the CSRC, as described by the firms,” wrote Mendel in his brief. “Other recent events involving the CSRC do not change this assessment. Although the SEC has received audit workpapers relating to the Longtop investigation, the CSRC only sent these documents as the hearing in these proceedings commenced in 2013, 11 months after the SEC sent a request for assistance.”

Further, Mendel said the CSRC gave the documents only after the federal court in the Longtop case backed up the SEC’s subpoena.

“The CSRC’s sudden willingness to produce documents with one of its major regulated domestic entities under imminent threat of a U.S. court order should not, by itself, be taken to signal sustained, long-term cooperation by the CSRC in other SEC investigations requiring audit workpapers,” Mendel wrote.

Similarly, even if the CSRC provided the papers of other companies, the action—coming against the backdrop of possible sanctions against the audit firms—would not demonstrate that the CSRC is an acceptable alternative means of obtaining audit papers from China, he said.

He cited the three years which the CSRC has held paperwork for a company labeled Client A and the seven months since the CSRC instituted new procedures.

The SEC also said that the five audit firms are still liable for their actions because “any present-day thaw in the CSRC’s historical intransigence is wholly irrelevant to [the firms’] liability under Section 106(e).”