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US Securities and Exchange Commission

SEC Fines Deloitte China for Audit Failures

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

The U.S. Securities and Exchange Commission on Sept. 29, 2022, charged Deloitte Touche Tohmatsu Certified Public Accountants LLP in China for violating U.S. audit requirements. The U.S. regulator alleged that Deloitte China failed to perform even certain basic audit tasks.

“We find that Deloitte-China fell woefully short of professional auditing requirements in numerous component audits of Chinese operations of U.S. issuers and audits of Chinese companies listed on U.S. exchanges,” said SEC Chair Gary Gensler in a statement. “These basic, foundational auditing requirements are necessary to instill trust in our capital markets. It’s a privilege for issuers to access our markets — the largest, deepest, most liquid markets in the world. Investors in U.S. markets should be protected — and have trust in a company’s financial numbers — regardless of whether an issuer is foreign or domestic.”

The Shanghai-based audit firm is settling the charges by paying a $20 million fine and agreed to takes steps to fix the problems and institute procedures to help prevent future violations.

The commission alleged that Deloitte China audit personnel asked their clients to select their own samples for testing and to prepare audit documentation to show that the audit firm itself had gotten and evaluated the supporting evidence for certain clients’ accounting entries.

“This created the appearance that Deloitte-China had conducted the required testing of clients’ financial statements and internal controls when there was no evidence in the audit file that it had in fact done so,” the SEC said.

In particular, auditors must assess the support for entries in companies’ general ledgers to make sure that the transactions were appropriately recorded. Without doing this work, an auditor cannot credibly provide an opinion about whether its clients’ financial statements are fairly presented and whether their internal control over financial reporting (ICFR) is effective.

The SEC’s investigations found that the misconduct involved both junior and senior auditors, reflecting a lack of supervision by audit partners. The commission noted that Deloitte China did not follow numerous PCAOB auditing standards, including due professional care of audit evidence, sampling, documentation, ICFR, audit supervision and quality control. For example, Deloitte U.S. instructed its affiliate in China to test certain account balances at a U.S. public company’s China business for fiscal 2018 audit.

Deloitte U.S. also instructed Deloitte China to test this company’s ICFR in China, asking the Chinese firm to follow PCAOB standards. Deloitte China agreed to do so, according to Accounting and Auditing Enforcement Release (AAER) No. 4342.

However, Deloitte China personnel asked the client employees on at least 21 occasions to complete audit procedures that the auditors were required to perform. This involved 18 different accounts: testing for sales; cash and cash equivalents; accounts receivables, inventory; accounts payable; cost of sales; and selling, general and administrative expenses, according to AAER 4342.

“While the SEC’s action today does not implicate a violation of the Holding Foreign Companies Accountable Act, the action does underscore the need for the Public Company Accounting Oversight Board (PCAOB) to be able to inspect Chinese audit firms,” Chair Gensler added. “A fundamental goal of the PCAOB’s inspection regime is to identify weaknesses in the firms’ quality control processes — the very weaknesses at issue in this case.”

PCAOB inspectors are currently inspecting Chinese audits of companies listed on U.S. stock exchanges under an agreement signed in August.

“This action involves audit failures at the most basic level. Across multiple years and audit engagements, Deloitte-China auditors failed to meet professional standards, exercise independence and fulfill their essential role as gatekeepers,” SEC Enforcement Director Gurbir Grewal said in a statement. “Auditors are vital to the success of our financial markets and the standards they must abide by are neither optional, nor are they aspirational best practices. Rather, they’re foundational to audit quality and investor protection, and every audit firm that conducts audits for issuers with securities trading on U.S. exchanges must meet them. Here, Deloitte-China audit professionals fell woefully short.”

In addition to paying the $20 million fine, Deloitte China was ordered to get a review and assessment of its policies and procedures by an independent consultant and undergo remedial efforts.

For the next 36 months, each Deloitte China personnel that audits U.S. public companies must complete a minimum of 16 training hours annually in topics related to U.S. professional standards in addition to any required continuing professional education credits.

“Deloitte Hua Yong has agreed to a settlement with the U.S. SEC, including the payment of a settlement sum, bringing closure to a self-reported matter relating to certain deficient procedures identified in 12 PCAOB audits (nine component audits and three foreign private issuer audits),” Deloitte China said in an emailed statement. “In reaching this settlement, the SEC has acknowledged the Firm’s cooperation and remedial efforts.”

Former SEC chief accountant Lynn Turner criticized Big Four firms.

“All of the Big 4 have had serious unethical and unprofessional lapses. In recent comments to the PCAOB, they and the Chamber of Commerce have argued the PCAOB does not have a basis for stepping up enforcement. In light of their behavior, stricter enforcement is definitely warranted.”

For example, the U.S. Chamber said that it is concerned by the elevation of enforcement by the new leadership at the board. The group claimed that the PCAOB was organized and operated under a supervisory model for oversight of audit firms, citing the board’s initial five-year strategic plan.

 

This article originally appeared in the September 30, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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