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 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."
MULTINATIONALS POSITION UNCLEAR
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.
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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.
LITTLE SYMPATHY
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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