US SEC stumbles in Deloitte's Chinese audit case

WASHINGTON, March 13 (Reuters) - U.S. securities regulators faltered at times in federal court on Wednesday as they sought to convince a judge to force a Chinese unit of audit firm Deloitte to hand over documents in connection with a fraud investigation.

It is unclear whether the Securities and Exchange Commission’s halting performance in U.S. district court could hurt its efforts to pursue fraud investigations into Chinese companies listed on U.S. stock exchanges.

But it raises questions about the agency’s ability to handle the complex and delicate legal matters when it comes to China.

During oral arguments in a U.S. district court, SEC attorney David Mendel was unprepared to answer several questions from Magistrate Judge Deborah Robinson about which federal rules the SEC relied on when it served Deloitte China’s U.S.-based attorney with a subpoena in May 2011.

“I am going to suggest you review the rules so you can answer my questions more specifically,” Judge Robinson told Mendel.

An SEC colleague in the court room then ran out with a cell phone and a notepad, before returning to consult with Mendel. After about ten minutes had passed, Robinson called a brief time-out. Later on, however, Mendel had to pause yet again to answer additional follow-up questions.

The SEC is seeking to force Deloitte Touche Tohmatsu CPA Ltd to hand over audit work it did for Longtop Financial Technologies Ltd, a Chinese technology company suspected of fraud.

The SEC sued Longtop in 2011, saying the company failed to file current and accurate financial reports. It contends it needs Deloitte’s work to properly conduct a fraud investigation into the company.

But Deloitte argues it cannot give the SEC the documents because it would violate strict Chinese secrecy laws. Instead, Deloitte believes the SEC needs to resolve the dispute through a diplomatic solution with Chinese regulators.

“It would violate Chinese law and it would expose Deloitte Touche Tohmatsu Cpa to severe sanctions, including the possible imprisonment of its partners,” Latham & Watkins attorney Miles Ruthberg argued on Wednesday in Deloitte’s defense.

Accounting scandals have plagued China-based companies listed on U.S. stock exchanges over the past few years.

The SEC has been investigating companies and their auditors, but have faced difficulties in pursuing legal cases against them. Many of the companies have had their auditors resign, and U.S. exchanges have also moved to de-list companies plagued by accounting woes.

The SEC has tried to reach a diplomatic solution with Chinese regulators, and at one point even agreed to put its federal court action against Deloitte on hold. But the SEC says those talks have since broken down.

Separately, the SEC also has an action pending against the Big 4 audit firms and a fifth firm in its administrative court also for refusing to turn over documents in connection with nine Chinese companies suspected of wrongdoing.

“They’re on the hook to provide the documents requested,” Mendel told the judge. “If they don’t comply with the rules, they’re subject to sanctions.”

At Wednesday’s hearing, many of Robinson’s questions focused on technicalities in the case, including whether the SEC followed the correct process in serving the subpoena to Deloitte.

Although the documents are located abroad, the SEC served the company through a U.S. counsel whom the agency claims agreed to accept the subpoena on Deloitte’s behalf.

Ruthberg told Robinson that the SEC was overreaching in its authority by serving the U.S.-based attorney of a foreign firm, and added that the agency must instead rely on the Hague convention to get the documents.

Mendel countered that the SEC has legal authority under federal securities laws, and followed the proper protocol.

“It wasn’t just any lawyer. It was their lawyer,” Mendel said.