SEC hoes in to dubious China auditors

The agency, which has been investigating Chinese companies that have gone public in the US, said it had been trying for months to obtain paperwork from the firms. But the government said the auditors "refused to co-operate", citing prohibitions in local law.

"Only with access to work papers of foreign public accounting firms can the SEC test the quality of the underlying audits and protect investors from the danger of accounting fraud," said SEC enforcement director Robert Khuzami. "Firms that conduct audits knowing they cannot comply with laws requiring access to these work papers face serious sanctions."

The accounting firms cited by the SEC are the Chinese affiliates of Deloitte, Ernst & Young, KPMG and PwC - the big four - and BDO. The agency did not name the firms' Chinese clients.

Most of the accounting firms said they were co-operating, but noted the difficulties of navigating the conflicting laws of the US and China.

"The fact that the action is being taken collectively against all of the four largest audit firms and one other firm demonstrates that this is a profession-wide issue, not unique to one firm," PwC said in a statement.

As part of the administrative proceedings, the accounting firms could face sanctions. The government could prohibit them from practising before the SEC temporarily or permanently. In essence, that means their audits of publicly traded companies would not satisfy securities laws.

The actions stem from a broader inquiry into Chinese companies listed on US exchanges. In recent years, dozens of Chinese businesses have raised money in the US through "reverse mergers". Such backdoor listings allow companies to go public without the high costs and regulatory scrutiny of traditional offerings. Investors, looking to capitalise on the growth in China, rushed to buy the stocks.

Investors have lost billions of dollars and the companies have been the subject of increased scrutiny. The SEC has deregistered the securities of nearly 50 Chinese companies and has filed 40 related fraud cases. Increasingly, regulators are focused on the auditors.

In May, the SEC announced an enforcement action against a Deloitte affiliate, Deloitte Touche Tohmatsu, over failure to produce documents related to an SEC investigation of one of its China-based clients.

Ernst & Young also faces legal challenges in Canada. The Ontario Securities Commission charged the firm's Canadian affiliate with failing to perform a full audit in its work on the financial statements of Sino-Forest, a Chinese forestry company.

In June 2011, an independent analyst posted a report online claiming Sino-Forest was a fraud, prompting its shares to plummet. An independent committee appointed by the company later investigated and could not locate the 800,000 hectares of forest plantations the company said it managed in rural China. Sino-Forest filed for bankruptcy in March.