Securities and Exchange Commission (“SEC”) Charges Chinese Affiliates of Five Large Accounting Firms for Failing to Produce Work Papers

This post was also written by Terence Healy.

Yesterday, the SEC instituted administrative proceedings against the Chinese affiliates of the “Big Four” accounting firms and BDO related to audits they conducted at nine Chinese companies. At issue is the accounting firms’ “willful refusal” to provide audit work papers and other materials the Commission seeks in its investigations into potential accounting irregularities at several China-based companies whose securities are publicly traded in the United States. The administrative order can be found here.

This administrative action is the latest step in an ongoing standoff between U.S. and Chinese regulators regarding the obligations of Chinese accounting firms that certify the financial statements of China-based companies listed on U.S. exchanges. While auditing firms are normally required to produce their work papers to the SEC and Public Company Accounting Oversight Board (“PCAOB”) on demand, China’s “State Secrets” and archives laws could carry severe civil or criminal penalties for sending these materials outside the country. This inability to obtain work papers has frustrated the efforts of U.S. regulators to ensure the integrity of the capital markets. Earlier this week, Commissioner Luis Aguilar said the SEC’s investigations into accounting irregularities at dozens of China-based companies “have been hampered by the lack of access to relevant documents.”

The accounting firms in China have been willing to produce their work papers to the Chinese Securities Regulatory Commission (“CSRC”) and Ministry of Finance (“MOF”) with the understanding that U.S. regulators could then seek those materials from their foreign counterparts. But while the SEC and CSRC signed a memorandum in 2006 to improve “the exchange of information in cross-border securities enforcement matters,” U.S. regulators have had difficulty obtaining materials through the CSRC, resulting in the current standoff.

Without a diplomatic solution, the impasse between U.S. and Chinese regulators could lead to the delisting from American markets of some Chinese companies, and even to some major Chinese accounting firms from being barred from appearing before the SEC – an outcome that could complicate the efforts of many multinational companies operating in China.