THE US Securities and Exchange Commission has charged the Chinese affiliates of five big accounting firms with violating securities laws, claiming they failed to produce documents from their audits of several China-based companies under investigation for fraud.
The agency, which has been investigating Chinese companies that have gone public in the US, said it had been trying for months to obtain certain paperwork from the accounting 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 the commission's enforcement director, Robert Khuzami, pictured. "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 PricewaterhouseCoopers - 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," PricewaterhouseCoopers said.
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-based businesses have raised money in the US through "reverse mergers". Such backdoor listings allowed 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.
Such companies have been the subject of increased scrutiny, and investors have lost billions of dollars. The SEC has deregistered the securities of nearly 50 Chinese-based 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 China-based 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's board 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.
Frequently Asked Questions about this Article…
What did the SEC charge the Chinese affiliates of accounting firms with over Chinese audits?
The US Securities and Exchange Commission charged the Chinese affiliates of five accounting firms with violating securities laws after they failed to produce audit work papers for several China-based companies under investigation for fraud.
Which accounting firms’ Chinese affiliates were named in the SEC action?
The SEC identified the Chinese affiliates of the Big Four — Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers — and the firm BDO as the accounting firms cited in the enforcement action.
Why does the SEC want access to auditors’ work papers on Chinese-listed companies?
The SEC says access to foreign public accounting firms’ work papers is necessary to test the quality of audits and to protect investors from accounting fraud — without those papers the commission cannot fully investigate potential problems.
What penalties could the accounting firms face if the SEC’s proceedings go against them?
As part of administrative proceedings, the firms could face sanctions, including temporary or permanent prohibition from practising before the SEC — which would mean their audits of US-traded companies might no longer satisfy securities law requirements.
How does this enforcement action fit into the wider scrutiny of Chinese companies on US exchanges?
The SEC’s action is part of a broader inquiry into China-based companies listed in the US, many of which used 'reverse mergers' to list. Regulators have deregistered nearly 50 Chinese-based companies’ securities and filed about 40 related fraud cases, prompting increased focus on auditors.
Have any firms already faced related investigations tied to Chinese clients?
Yes. In May the SEC announced an enforcement action against a Deloitte affiliate for failing to produce documents for an SEC probe, and Ernst & Young’s Canadian affiliate was charged by the Ontario Securities Commission over audit work on Sino-Forest.
What happened in the Sino-Forest case mentioned in the article?
In June 2011 an independent analyst alleged Sino-Forest was a fraud, its share price plunged, and an independent committee later could not locate the roughly 800,000 hectares of plantations the company claimed to manage; Sino-Forest filed for bankruptcy in March.
As an everyday investor, what should I watch for regarding Chinese-listed companies and their auditors?
Keep an eye on SEC enforcement actions, whether auditors are able to produce work papers, any deregistration notices or fraud cases, and public reports about a company’s auditors — these signals have been tied to significant investor losses in recent cases involving China-based listings.
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