Recently, Cameron Eliot, Security and Exchange Commission (SEC) administrative trial judge, ruled that the four global auditing firms (with Chinese affiliates), Ernst & Young Hua Ming, KPMG Huazhen, Deloitte Touche Tohmatsu, and PricewaterhouseCoopers Zhong Tian, violated the Sarbanes-Oxley Act for refusal to release the audit documents of companies investigated for accounting fraud.
Barred from “appearing or practicing” before the SEC for six months, the “Big Four” accounting firms announced their intention to appeal. In a joint statement, they declared: ”the firms note that the decision is neither final nor legally effective unless and until reviewed and approved by the full U.S. SEC Commission. The firms intend to appeal and thereby initiate that review without delay.” In the meantime, the firms can and will continue to serve all of their clients without interruption.
The alleged violation stemmed from auditors’ attempts to comply with both U.S. and Chinese laws regarding securities. The Big Four accounting firms refused to turn over documents to the SEC in several fraud investigations, claiming that would run afoul of Chinese law. Alternatively, the accounting firms sent their documents directly to Chinese regulators who would pass them on to the SEC, slowing down the process. In response, the SEC sought a ruling to obtain access to these documents. “The Division is gratified by the decision which upholds the commission’s authority to obtain essential records from audit firms registered in the U.S. even when they are located overseas,” said Mathew Solomon, the SEC’s Chief Litigation Counsel in the Division of Enforcement. These records are critical to investigate potential securities law violations and protect investors.
The ruling is the latest twist in the longstanding diplomatic battle between U.S. and Chinese regulators over access to the accounting papers of Chinese companies listed in the New York Stock Exchange, with over 100 companies in total. Last May, the U.S. Public Company Accounting Oversight Board (PCAOB), the China Securities Regulatory Commission (CSRC), and the Chinese Ministry of Finance agreed to co-operate on the exchange of documents related to investigations in either country. The Memorandum of Understanding they signed included not only a mechanism to request documents through the other, but also allowed one party to decline the other’s request. The recent ruling seems to indicate the failure of this mechanism and many unsettled issues. “The SEC appears to be signaling to Chinese regulators that it is willing to deploy the ‘nuclear option,’ for six months anyway,” accounting expert Professor Paul Gillis expressed in his recent blog post.
The six-month ban could be a double–edged sword for companies in both the U.S. and China. Virtually all publicly traded Chinese companies in the U.S. choose one of the Big Four to work on their audits and will now find it difficult to publish their 2013 results on schedule with other auditors. While public Chinese companies are directly impacted, the side effects also extend to U.S. companies who operate business in China. The quasi-governmental regulator created under the Sarbanes-Oxley Act, PCAOB, requires an audit firm to be registered and declared on a firm’s financial statement if it handles more than 20% of a company’s assets or revenue. Preventing the Chinese affiliates of U.S. firms from using the Big Four will make it difficult for companies to find accountants for their Chinese business arms. The auditors say the market value of companies caught in the dispute could reach as high as $870 billion, $464 billion of which is U.S.-listed.
In addition to the adverse impact on multinational companies, the ruling also provides incentives for Chinese companies to list elsewhere, and investors could lose a lot of valuable information. U.S. stockholders deserve assurance of reliable audit documents, but they are caught in the middle of a conflict between the U.S. and China beating their chests over whose laws will take precedence.