January 23, 2014 / 12:36 AM / 6 years ago

SEC judge bars "Big Four" China units for six months over audits

WASHINGTON (Reuters) - Chinese units of the global “Big Four” accounting firms should be suspended from auditing U.S.-listed companies for six months, a judge in the United States ruled, in an escalation in a long-running dispute over regulators’ access to documents.

The logo of the Ernst & Young accounting and consulting firm is seen on a building in Warsaw August 30, 2013. REUTERS/Kacper Pempel

In a harshly worded 112-page ruling, Securities and Exchange Commission Administrative Law Judge Cameron Elliot censured the Chinese affiliates of KPMG, Deloitte & Touche, PricewaterhouseCoopers and Ernst and Young.

The four firms said that they intended to appeal against the ruling. “In the meantime the firms can and will continue to serve all their clients without interruption,” the four said in a joint statement.

Elliot, an SEC judge who operates independently, sided with the SEC and said the companies “willfully” failed to give U.S. regulators the audit work papers of certain Chinese companies under investigation for accounting fraud.

Auditors have refused to turn over such papers for fear of violating Chinese secrecy laws. They argue that it is up to Washington and Beijing to resolve the dispute.

They’re putting pressure on us because they think we can influence the regulators in China, which is absolutely not correct,” said Paul Winkelmann, the partner in charge of risk and compliance for PwC in Greater China.

“They keep putting pressure on us when in fact the whole thing can only be resolved by government-to-government or regulator-to-regulator discussions - and those discussions are taking place so we’re just piggy in the middle.”

Elliot also censured a fifth firm, Dahua, previously a member of the BDO international network, but did not impose a six-month suspension.

The decision is not expected to be disruptive to U.S.-listed Chinese companies relying on these firms to review their 2013 books as the ruling does not go into immediate effect.

However, if the firms are unsuccessful in their appeal, which could last years, then companies would need to find a new auditor during the suspension period or else be unable to file accounts, a move likely to see their shares suspended.

“If the Big Four can’t sign these audits, all these companies are in a hell of a pickle,” said Paul Gillis, an accounting professor at Peking University.

The ruling may also impact on a wave of Chinese listings in the United States that were expected to return this year.

Last year’s U.S. market rally, in particular the jump in tech shares, re-ignited a push by China-based companies to seek stock offerings on U.S. exchanges.

“We don’t think there will be an immediate impediment for the accounting firms to practice,” said Shuang Zhao, a partner at law firm Shearman & Sterling LLP in Hong Kong.

“The immediate impact will be that in many IPO prospectuses you will see this as one of the risk factors. The IPO market is very active. The momentum is very strong now.”


U.S. multinationals with significant Chinese operations such as fast food group Yum Brands Inc, tech firm Qualcomm Inc and construction equipment maker Caterpillar Inc will also be watching the developments closely.

Some companies have been concerned that they could be drawn into the dispute if they use the local units of the Big Four firms to look at their operations in China.

Under rules set by the Public Company Accounting Oversight Board (PCAOB), the U.S. audit industry watchdog, an audit firm needs to be registered with the watchdog if it looks over more than 20 percent of a company’s consolidated assets or revenue. Lawyers and accountants said they were still uncertain what the SEC’s ruling would mean for those audits.

“It’s not clear at this stage and I understand guidance is being sought,” said a senior partner at one of the firms in Hong Kong, who asked not to be named given the sensitivity of the issue.

Just last July, U.S. Treasury Secretary Jack Lew announced that an agreement had been reached whereby Chinese regulators would hand over some audit documents of U.S-listed Chinese companies to the SEC.

However, the judgment sheet shows that while some audit papers had been produced, not all the ones the SEC demanded were handed over.

As the auditors ready their appeal, experts said the spat may only be settled at the highest diplomatic levels, given China’s expected reluctance to budge further on its secrecy act.

“This decision appears to be punishment by proxy, with the real target being the Chinese regulators,” said James Zimmerman, managing partner of law firm Sheppard Mullin Richter & Hampton in Beijing and former chairman of the American Chamber of Commerce China.

“What is actually an ongoing diplomatic impasse continues to negatively impact the services sector that supports US capital markets.”

In an expert witness testimony in the SEC judgment, former SEC Commissioner Paul Atkins said that the issue may have to be dealt with by the U.S. President and the Chinese premier.

“He did not think the Commission would obtain the materials any sooner through this administrative proceeding than by some other means,” a write up of his testimony read.


The judge’s decision marks a major victory for the SEC, which for years tried with limited success to gain access to audit work conducted by Chinese accounting firms for Chinese companies that list in U.S. markets.

Several companies that have listed on U.S. stock exchanges have been caught up in accounting scandals.

The SEC has tried to delist or de-register some troubled companies, but has said investigations into possible fraud were stymied by the firms’ failure to turn over audit work papers.

The accounting firms have repeatedly declined to share their audits, saying Chinese secrecy laws forbid it. They urged the SEC to pursue a diplomatic solution with China instead.

After years of often strained negotiations with Chinese regulators, the SEC decided in late 2012 to pursue sanctions against the firms.

The judge declined to impose a permanent bar as the SEC requested, but said a six-month bar was in the public interest, and said he had “little sympathy” for the firms.

“Respondents operated large accounting businesses for years, knowing that, if called upon to cooperate in a Commission investigation into their business, they must necessarily fail to fully cooperate and might thereby violate the law,” he said.

“Such behavior does not demonstrate good faith, indeed, quite the opposite - it demonstrates gall.”

The SEC said it was gratified by the decision, which upholds its authority.

“These records are critical to our ability to investigate potential securities law violations and protect investors,” said Matthew Solomon, the chief litigation counsel in the SEC’s Enforcement Division.

Recognizing the risk that the ruling could strain diplomatic ties, Elliot said he decided to seal large portions of his decision that delve into Chinese-SEC relations.

“I am hopeful that the commission and the (China Securities Regulatory Commission) will continue to constructively engage one another,” he wrote.

A PCAOB spokeswoman declined to comment on Wednesday’s ruling.

Additional reporting by Douwe Miedema in Washington, D.C.; Dena Aubin in New York and Rachel Armstrong in Singapore; Editing by Karey Van Hall, Andre Grenon, Eric Walsh and Alex Richardson

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