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23 Jan 2014 10:40am

SEC issues ban on Big Four over China audits

The row over global audit firms in China has taken a new turn, after a Securities and Exchange Commission judge issued a ban on Big Four Chinese joint ventures working for any US-listed Chinese companies

The US regulator has ruled that Ernst & Young Hua Ming, KPMG Huazhen, Deloitte Touche Tohmatsu, and PwC Zhong Tian had violated the Sarbanes-Oxley Act, and said they should be barred from practising in the US for six months.

SEC administrative trial judge Cameron Elliot made the ruling yesterday evening. The decision, issued in a 112-page document, said the decision “censures and denies” the Big Four JVs and “censures” BDO China Dahua, although that firm has not received a ban.

The US Sarbanes-Oxley Act was introduced to allow public companies to maintain quality auditing practices and avoid unnecessary additional costs that ultimately are passed on to investors and consumers, setting new or enhanced standards for all US public company boards, management and public accounting firms.

The Big Four firms have said they will appeal the decision. “It is regrettable that the SEC’s administrative law judge has recommended sanctions against the big four firms in China for failing to produce work papers to the SEC in circumstances where such production would have violated Chinese law and regulations,” the firms said.

“However, the firms note that the decision is neither final nor legally effective unless and until reviewed and approved by the full US SEC Commission. The firms intend to appeal and thereby initiate that review without delay.”

The ban does not come into effect immediately, but if finalised by the SEC all four joint ventures would be unable to audit the accounts of more than 100 Chinese companies listed in the US. These companies will be forced to hire new accounting firms in China. And it could force multinationals with significant operations in China to have to bring in new firms to check those units.

This SEC ruling is the latest twist in a long-running battle between US and Chinese regulators over access to company documents of Chinese companies listed in New York.

The Chinese practices of a number of firms have found themselves in a catch-22 situation over demands from the SEC and the Public Company Accounting Oversight Board (PCAOB) for access to their working papers where their US listed Chinese clients have collapsed.

The controversy came to a head in 2012 over a fraud investigation into Chinese company Longtop Financial Technologies, which was audited by Deloitte Touche Tohmatsu. The SEC filed proceedings against Deloitte and the other Chinese subsidiaries over nine of their US-listed clients currently under investigation for fraud. The firms were charged with administrative violations for refusing to provide audit papers.

However, the firms argued that, under Chinese accounting law, they were not allowed to produce documents directly to any foreign regulator without Chinese government approval. Deloitte has said that to comply with the SEC’s demands would place the firm and its personnel at “substantial risk of prosecution” under Chinese criminal law.

The tension seemed to have eased, however, after the Public Company Accounting Oversight Board (PCAOB) signed a memorandum of understanding with the China Securities regulatory Commission and the Chinese Ministry of Finance, enabling the firms to co-operate with the SEC up to a certain point.

The SEC has already banned some smaller US accounting firms for performing audit work for “botched” audits on a number of US-listed Chinese companies.

Accounting expert Professor Paul Gillis noted that parts of the judgment were redacted because they reported interactions between the SEC and China Securities Regulatory Commission “more candidly than is customary in diplomatic circles”.

“This has significantly upped the ante in the regulatory battle between the US and China,” Gillis wrote on his China accounting blog. “The SEC appears to be signalling to Chinese regulators that it is willing to deploy the ‘nuclear option’, for six months anyway.”

Helen Roxburgh

 

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