Chinese affiliates of the four largest accounting firms plan to file an appeal to U.S. regulators as soon as today to reverse an administrative judge’s decision to bar them for six months after they stymied investigations of possible accounting fraud.
The Securities and Exchange Commission will have to weigh the punishment just as U.S. and Chinese regulators make strides in overcoming some of the legal conflicts that the auditors say prevented them from cooperating with probes of China-based companies listed on U.S. exchanges. China has signaled that the diplomatic progress could be derailed if the SEC upholds the judge’s Jan. 22 decision. The firms said that day they will submit an appeal, which must be filed by Feb. 12.
The SEC filed an administrative action against the auditors in 2012 after struggling for years to obtain information for dozens of accounting fraud probes at China-based companies. Once a petition for review is filed by the four auditors that received the bar -- Deloitte Touche Tohmatsu CPA Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen and PricewaterhouseCoopers Zhong Tian CPAs Ltd. -- the judge’s ruling is held from going into force until the SEC makes a decision.
The five-member commission approved the enforcement action before it was filed, which would make it awkward to now reverse the favorable ruling, said Daniel O’Connor, a partner at Ropes & Gray in Boston who has followed the case.
“Everyone recognizes there’s a need for a practical solution” O’Connor said. “Whether that means they back off from the administrative law judge’s decision or not remains up for grabs.”
The SEC has the latitude to confirm the bar, reverse the judge’s decision or do anything in between. Under commission rules, the SEC has seven months to consider the matter and can extend that indefinitely if there are “extraordinary facts and circumstances.”
Stephen Crimmins, a former SEC attorney who is now a partner at law firm K&L Gates LLP, said the SEC may hold off on making a decision until the two countries reach an agreement or discussions break down.
“This is a matter that deals with the regulatory standards of two independent countries with two different economic and political systems, and accounting firms are caught in-between,” Crimmins said. “We haven’t seen this in the 80-year history of the SEC and it warrants one-off handling.”
The China-based auditors have argued they are caught between U.S. law, which requires them to turn over all documents requested by regulators, and Chinese law, which prohibits transferring data that might contain state secrets to foreign parties. A compromise could be struck by giving the Public Company Accounting Oversight Board access to work papers or allowing it to meet with auditors outside China, Chairman James Doty said last week.
An agreement in May between the two countries allowed some cooperation, and U.S. regulators have received documents on at least four companies, the China Securities Regulatory Commission said last month. That agreement didn’t allow for the PCAOB to inspect audit firms in China.
“It could be they would allow PCAOB inspectors into country, either with Chinese counterparts or alone,” said Joseph Carcello, an accounting professor at the University of Tennessee. “But in an enforcement case, in order for the SEC to be able to meaningfully investigate and prosecute a case, they would need the papers in the U.S.”
‘The Big Picture’
The bar, if enforced, would force more than 200 Chinese companies traded in the U.S. to find new auditors, while multinationals with significant operations in China would also have to bring in new firms to check those units. If the SEC upholds the judge’s decision, the firms could ask the U.S. Court of Appeals in Washington to overturn the bar.
Following the judge’s ruling to bar the firms, the CSRC said the SEC should “take into consideration the big picture of China-U.S. regulatory cooperation” and “make the right judgment” in the matter. “The SEC should bear all responsibility to possible consequences arising from the decision,” the CSRC said.
More Chinese companies are showing interest in listing on U.S. stock exchanges. Eight Chinese companies had initial public offerings in the U.S. last year, up from three in 2012. Alibaba Group Holding Ltd., China’s largest e-commerce company, said in November that it’s deciding whether to sell shares in the U.S. or Hong Kong.
The uncertainty over the audit firms’ status has hurt shares of China-based companies that trade in the U.S. The Bloomberg China-US Equity Index of the most-traded Chinese stocks in the U.S. is down 6.9 percent since the judge’s initial decision, compared with 1.7 percent increase in the Shanghai Composite Index and a 2.4 percent drop in the S&P 500.