8 Min Read
* SEC seeks to enforce subpoena
* Wants documents for Longtop Financial probe
* Deloitte says case a matter for U.S. and China regulators
* Deloitte at risk of losing PCAOB registration - expert
(Adds comment from Deloitte China)
By Andrea Shalal-Esa and Sarah N. Lynch
WASHINGTON/SINGAPORE Sept 9 (Reuters) - The Securities and Exchange Commission (SEC) has asked a U.S. federal court to force a Chinese unit of accounting giant Deloitte & Touche to produce records related to possible accounting fraud at Longtop Financial Technologies Ltd .
The effort by the U.S. regulator to enforce a subpoena against Shanghai-based Deloitte Touche Tohmatsu CPA Ltd underscores the difficulties American regulators face in probing U.S.-listed Chinese companies.
The SEC and the Federal Bureau of Investigation have been probing U.S.-listed Chinese companies and their auditors amid a rash of accounting scandals.
Deloitte's China unit said it wished to co-operate with the SEC but that it is unable to give them the requested documents without approval from the Chinese regulatory authorities.
"We have passed on the SEC's requests to the regulators in China, as we are required to, but so far the China regulators have not given us permission to provide papers to the SEC," said Hong Kong-based company spokesman Wilfred Lee in an emailed statement.
"This is essentially a matter between regulators in China and the United States; Deloitte China is happy to comply with any outcome that is agreed between them," he added.
The Deloitte unit abruptly resigned in May after uncovering "numerous improprieties" during its audit of the Chinese software company for the year ended March 31.
The case could mark a major escalation in the diplomatic battle between the two countries to allow American regulators access to U.S.-listed Chinese firms, accounting experts said.
"This is the biggest thing that has happened in the transnational regulation of accounting in history," said Paul Gillis, visiting professor of accounting at the Guanghua School of Management, Peking University.
A failure by Deloitte to comply with the SEC order may lead to the loss of its registration with the U.S. Public Company Accounting Oversight Board (PCAOB), Gillis said, a move that would have serious implications for U.S.-listed Chinese firms as other auditors might stop working for them.
"The nightmare scenario for a lot of people would be that the court directs the PCAOB to revoke Deloitte's registration," said Gillis.
"A lot of these U.S.-listed stocks have just become riskier because the listings of these companies may be in jeopardy if all these accounting firms have to bail out."
The SEC said Deloitte had argued it should not be required to produce documents that pre-date the 2010 Dodd-Frank Wall Street oversight law, and that producing any documents could subject it to sanctions under Chinese law.
"This is a culture clash that the SEC is throwing to the courts to resolve," said Jacob S. Frenkel, a former senior counsel in the SEC's enforcement division and now a partner at Shulman Rogers Gandal Pordy & Ecker.
The subpoena enforcement filed in the U.S. District Court in Washington D.C. marks the boldest move yet by the agency against a big accounting firm in its crackdown on fraud at Chinese companies that list on U.S. exchanges.
Next month, U.S. and Chinese accounting watchdogs are due to meet in Washington for a second round of talks on joint inspections of auditing firms in China.
The chairman of the U.S. PCAOB recently chided big accounting companies, saying they had a responsibility for the quality of audits conducted by their units in other countries.
Jake Zamansky, an attorney who pursued investment banks after the dotcom crash on behalf of investors, predicted Deloitte would ultimately comply with the subpoena.
"Ultimately the SEC and PCAOB can take their license away. As long as it has the name Deloitte on it, they have a responsibility to adhere to U.S. laws," said Zamansky.
That move though could be fraught with risks for Deloitte's standing with the Chinese authorities if it fails to win their blessing to hand over the documents before doing so.
"Deloitte really are between a rock and hard place here, If they don't comply it's a possibility they may lose their rights to do U.S. audits, if they do it's possible they will lose their right to do all audits (in China)," said Peking University's Gillis.
The SEC is seeking evidence to support its investigation into what it described as "an apparently massive fraud on the domestic securities markets" by Longtop, a Cayman Islands corporation with principal offices in China and Hong Kong.
It said Deloitte had failed "in every respect" to comply with its subpoena.
"Compliance with an SEC subpoena is not an option, it is a legal obligation," said Robert Khuzami, the director of the SEC's Division of Enforcement.
"Subpoena recipients who refuse to comply should expect serious legal consequences."
Subpoena enforcements by the SEC are relatively rare, with the agency filing just 31 similar actions in the past five years.
Prominent previous recipients of SEC subpoena enforcements have included Enron's former chief financial officer Andrew Fastow and tobacco company RJ Reynolds.
The SEC said the Deloitte documents may reveal how any fraud schemes were able to continue undetected for years at Longtop.
It said the date of the Dodd-Frank law was irrelevant, and its interest in obtaining Deloitte's documents "far outweigh China's secrecy interests."
Perrie Weiner, the international co-chair of the securities litigation practice at DLA Piper in Los Angeles, said the SEC is wading into untested territory as it tries to compel non-U.S. based companies to hand over documents.
"I think it's going to be a significant uphill battle to enforce subpoenas issued by U.S. courts in China," said Weiner. "We have yet to see how this will play out."
Longtop's U.S. depositary shares began trading on the New York Stock Exchange after an initial public offering in 2007.
In May, the NYSE halted trading in Longtop and delisted the company last month. At the time its shares were halted, Longtop had a market capitalization of $1.09 billion.
Its shares now trade on the pink sheets and closed 17.7 percent lower at 28 cents on Thursday.
Late last month, Longtop disclosed it had received a Wells notice from the SEC indicating it may face civil charges for accounting problems.
U.S. officials are hoping China will agree to joint inspections of auditors, although they do not expect an agreement until sometime in 2012.
"This is a battle that I think is going to be fought in the headlines and with diplomacy and it's not going to be a battle that's going to turn on neat legal points in the courtroom," said James Cox, a securities law professor at Duke University. (Additional reporting by Dena Aubin in NEW YORK; Lynnley Browning in Fairfield, Connecticut; Nanette Byrnes in Chapel Hill, North Carolina and Rachel Armstrong in SINGAPORE; Editing by Muralikumar Anantharaman)