Chinese affiliates of the four largest accounting firms were barred for six months from leading audits of U.S.-listed companies after failing to comply with Securities and Exchange Commission orders for documents at the heart of a series of accounting fraud probes.
The decision by U.S. Administrative Law Judge Cameron Elliot, if finalized, would force more than 200 Chinese companies traded in the U.S. to find new auditors, while multinationals with significant operations in China, like General Motors Co., would also have to bring in new firms to check those units, said Jason Flemmons, a former SEC accountant who is now a senior managing director at FTI Consulting Inc.
“This is a big deal,” said Lynn Turner, a former SEC chief accountant. “For those companies that have an audit report to be done, finding another auditor in China might be a bit difficult.”
The firms receiving the bans -- Deloitte Touche Tohmatsu CPA Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen and PricewaterhouseCoopers Zhong Tian CPAs Ltd -- said in an e-mailed statement that they will appeal the decision.
The SEC filed an action against the auditors in 2012 after struggling for years to obtain information for dozens of accounting fraud probes at China-based companies. After an agreement in May between the two countries allowed some information to be shared, the accounting firms argued, unsuccessfully, that the SEC was getting what it needed and that the case jeopardized the listings of hundreds of Chinese companies trading in the U.S.
The auditors’ “actions involved the flouting of the commission’s regulatory authority, which may not be as egregious as, say, accounting fraud, but is still egregious enough that it weighs against leniency,” the judge said in the decision. The firms “acted willfully and with a lack of good faith.”
The audit firms that were barred called the judge’s decision “regrettable,” according to a joint e-mailed statement. “In the meantime the firms can and will continue to serve all their clients without interruption,” they said.
BDO China Dahua Co., Ltd. -- now called Dahua CPA -- was only censured since it had already withdrawn from the U.S. market. Deborah Meshulam, a lawyer for Dahua, declined to comment.
The Bloomberg China-US Index of the most-traded Chinese stocks was down 3.7 percent at 3:50 p.m. Web-book retailer E-Commerce China Dangdang Inc. had fallen 11 percent and Baidu Inc., China’s largest web search engine, had declined 6.7 percent. Both companies are audited by Ernst & Young Hua Ming.
The impact on the audit firms may extend far beyond the six-month time frame because many companies would be unwilling to bring in a new auditor for such a short period, according to Flemmons. The decision could push firms to make a “long-term switch” to new auditors, he said.
“We’re monitoring the situation and will plan accordingly,” said Jonathan Blum, a spokesman for Yum! Brands Inc., which owns the KFC, Pizza Hut and Taco Bell brands and gets about about half of its revenue from China. Yum is audited by KPMG. Tom Henderson, a spokesman General Motors, declined to comment. The carmaker is audited by Deloitte & Touche.
There are 45 China-based accounting firms registered with the Public Company Accounting Oversight Board, which regulates the industry. Companies that could perform audits if the decision does take effect include the Chinese affiliates of Grant Thornton LLP and Crowe Horwath LLP, the PCAOB list shows.
The accounting firms have 21 days to file a so-called petition for review with the SEC before the judge’s decision would become final and go into effect. If the five-member commission were to uphold the judge’s decision, the firms could then take it to the U.S. Court of Appeals in Washington.
“This could be hung up easily for five years in the courts before it ever takes effect,” Turner said. “I wouldn’t be surprised to see the firms do that.”
The SEC enforcement division was “gratified” by the decision, chief litigation counsel Matthew Solomon said in an e-mailed statement. “These records are critical to our ability to investigate potential securities law violations and protect investors.”
‘Vulnerable on Appeal’
The auditors are caught between U.S. law, which requires them to turn over all documents requested by regulators, and Chinese law, which prohibits transferring data to foreign parties that might contain state secrets.
“The decision imposes a draconian sanction, which is vulnerable on appeal,” said Bradley Bondi, a securities lawyer at law firm Cadwalader, Wickersham & Taft, LLP. “Under a conflicts of law analysis, the more-stringent Chinese law, which would subject these firms to criminal exposure for complying with the SEC’s subpoenas, takes priority over the U.S. government’s interests in obtaining this information.”
While the May accord between the two countries opened the door for some cooperation, it didn’t allow for inspections, a key requirement for audit firms doing work for U.S.-listed companies.
“To the extent respondents found themselves between a rock and a hard place, it is because they wanted to be there,” Elliot said in the decision. “A good faith effort to obey the law means a good faith effort to obey all law, not just the law that one wishes to follow.”