As discussed in the February 2014 Update, on January 22, 2014, an SEC Administrative Law Judge issued an initial decision suspending the Chinese affiliates of the Big Four accounting firms from practicing before the SEC for a period of six months. While the suspensions did not immediately take effect and the firms appeal the ALJ’s decision to the full Commission, the decision raised the possibility that the audits of some U.S.-listed Chinese companies, and of some U.S.-based public companies with operations in China, would be disrupted. On February 6, 2015, the SEC announced that it had issued an order settling the cases. The terms of the settlement do not include the proposed suspensions.
These cases arose from requests that the SEC enforcement staff made to the four China-based accounting firms for work papers related to audits of certain companies with operations in China that are under SEC investigation. Section 106 of the Sarbanes-Oxley Act requires foreign accounting firms that issue audit reports filed with the SEC, or that
perform work on which a U.S. accounting firm relies, to provide their work papers to the SEC when requested to do so. The Chinese Big Four affiliates declined to comply with the SEC’s Section 106 requests for their work papers on the ground that doing so would violate Chinese law. In 2012, the SEC commenced administrative actions against the four firms alleging that they were in violation of Section 106. The ALJ held that the firms’ conduct constituted a willful violation of the Act, notwithstanding legal limitations in China on work paper disclosure. The ALJ found that the firms chose to perform audit work for U.S. issuers “knowing that a failure to directly produce documents pursuant to Sarbanes-Oxley 106 might be a violation of Sarbanes-Oxley.” In the judge’s view, “to the extent [the Chinese Big Four firms] found themselves between a rock and a hard place, it is because they wanted to be there.”
Under the terms of the settlement reached this month, the Commission censured the firms and each agreed to make a $500,000 payment to the Commission. The firms admitted that they did not produce documents before the proceedings were instituted against them in 2012, but otherwise did not admit or deny the findings in the Commission’s order.
The SEC’s order also contains a framework for dealing with future requests for work papers with respect to audit work performed in China by the four firms. The SEC Enforcement Division agreed that it will “in the first instance” issue a request for assistance to the China Securities Regulatory Commission (CSRC) under “international sharing mechanisms” such as the Multilateral Memorandum of Understanding to which the SEC and the CSRC are parties. The firms agreed to produce documents that are responsive to such a request to the CSRC and to “use all reasonable efforts to facilitate the SEC’s receipt of all responsive documents” from the CSRC in “as expeditious a manner as possible.” If a firm does not perform its obligations under the arrangement, the SEC will have the right to reopen the enforcement proceeding against that firm and to impose sanctions, including a partial bar from practice.
Comment: While the settlement is a victory for the SEC in the sense that it results in findings that the four firms violated the law and imposes sanctions against them, as a practical matter, the settlement seems to vindicate the firms’ position. In the future, a firm’s obligation in the event of an SEC work paper request will be to provide the work papers to the Chinese authorities, who will then make the final decision as to what should be provided to the SEC. This approach seems to acknowledge that the firms need not violate Chinese law in order to comply with Section 106, just as the firms had argued.
From a public company audit committee perspective, the significance of the settlement is that it removes the risk that the Big Four might be unable, for some period of time, to perform audit work in China, thus complicating the ability of SEC-registered companies with operations in China to complete their audits. However, the settlement leaves unresolved the issue of PCAOB inspections of China-based accounting firms. Unless and until the Chinese government consents to PCAOB inspections in China, the risk remains that the China firms will be de-registered by the PCAOB and that audits of U.S. public companies with operations in China will be disrupted.