On May 24, 2013, the Public Company Accounting Oversight Board (PCAOB) announced a breakthrough in its years' long log-jam with Chinese regulators over access to audit firms' documents located in China.1 The long-term impact of the agreement is unclear, but it represents a small step towards more consistent and collaborative assistance between the United States and China with respect to securities enforcement.
U.S. Regulators Have Been Frustrated In Their Attempts To Obtain Documents From China
In recent years, and in the wake of the large number of alleged accounting irregularities and fraud at China-based U.S-listed companies, the PCAOB and the U.S. Securities and Exchange Commission (SEC) have aggressively sought to obtain financial records and audit papers from those companies and their auditors. Although the documents sought by the PCAOB and the SEC from China are similar to those they routinely obtain from domestic and other foreign companies, Chinese data secrecy laws have proven an obstacle to U.S. regulators' requests. Many Chinese companies have reportedly refused to provide documents to U.S. regulators on the basis that doing so might violate Chinese data secrecy provisions.2 Likewise, and on the same grounds, Chinese affiliates of U.S.-based auditing firms have resisted investigative subpoenas from the SEC and have refused to hand over audit work papers for PCAOB inspections. Chinese regulators have appeared unwilling to assist U.S. regulators in obtaining access to requested materials.3 The PCAOB has therefore been unable adequately to inspect the work of auditors signing off on the books of many U.S.-listed companies. Because the integrity of the U.S. securities markets, and the PCAOB's and SEC's ability to effectively monitor those markets and market participants is at stake, the SEC has made concerted legal efforts to obtain the information requested from Chinese audit firms. For example, in one instance, the SEC filed a motion to compel compliance with a subpoena issued to the Chinese affiliate of Deloitte, and has also brought administrative enforcement actions against the Chinese affiliates of Deloitte, Ernst & Young, PricewaterhouseCoopers, KPMG and BDO.4
MoU Between PCAOB and Chinese Regulators Provides Increased Access
Although only recently made public, in early May the PCAOB and China's primary securities regulators - the China Securities Regulatory Commission, and the Ministry of Finance of China - executed a Memorandum of Understanding on Enforcement Cooperation (MoU). As summarized below, while relatively narrow, the MoU signals that discussions among the two sets of regulators are moving toward greater accessibility.
- Generally. The MoU provides that Chinese regulators and the PCAOB will assist each other in obtaining materials related to investigations of auditors.5
- Only covers audit firms. The MoU applies only to documents held by audit firms. It does not reach requests for documents in the possession of U.S.-listed public companies, or other entities or persons.6 Further, the requests only apply to investigations regarding acts, practices or omissions by a public accounting firm or its associated persons.
- Authorities can still deny requests. Notwithstanding the commitment to assist each other, the MoU makes clear that the regulators do not intend to ignore their own domestic laws, and have reserved their rights to deny requests for assistance. In particular, the MoU states that requests for assistance "may be denied... where the request would require the Requested Party to act in a manner that would violate domestic law... [or] on grounds of public interest or essential national interest."
- Information will be shared with the SEC and other U.S. regulators. The MoU explicitly authorizes the PCAOB to share information obtained through the MoU with other U.S. authorities, as permitted under Sarbanes-Oxley Section 105(b)(5)(B) (15 U.S.C. § 7215). That provision allows the PCAOB to make documents available to the SEC, the U.S. Attorney General, federal regulators, any State regulatory authority or attorney general, and any self-regulatory organization, on a confidential basis.
- Chinese authorities will receive advance notice of any information sharing or PCAOB sanctions. Chinese regulators will receive advance notice of the PCAOB's intention to share any information obtained through an MoU request, and will also receive advance notice of any sanctions imposed on an auditor or audit firm within China.
- No legal obligation or private rights are created. Consistent with other international cooperation agreements, the MoU explicitly asserts that it creates no legal obligations, and that no person other than the PCAOB and the Chinese regulators have any rights under the MoU.
Immediate and Potential Impact
With the MoU in place, the PCAOB's investigation of Chinese auditors of U.S.-listed companies will presumably promptly increase, commensurate with PCAOB's increased access to Chinese-based audit papers. The PCAOB and Chinese authorities also continue to discuss an agreement on cross-border inspections of auditors, which could provide further regulatory monitoring of Chinese auditors of U.S-listed companies.7
Chinese authorities described the MoU as paving the way for "cross-border enforcement assistance" between the U.S. and China.8 Chinese authorities also acknowledged their continuing discussions with the PCAOB, which they claim are focused on finding a "mutually recognized way of regulating Chinese accounting firms that provide auditing service to companies trading on U.S. exchanges." It is unclear, however, how Chinese authorities will react if the new access to audit work papers results in PCAOB or SEC sanctions against Chinese firms. It is entirely possible that such adverse actions may dampen China's desire to cooperate with U.S. regulators.9
The MoU may render moot the pending SEC actions against Chinese-based audit firms. The MoU may present a path through which the PCAOB and the SEC can obtain the documents they requested, without placing the audit firms at risk of violating Chinese law. At the very least, this new development should merit a stay in the SEC proceedings against the Chinese audit firms. Subpoena enforcement litigation could resume, however, if the Chinese authorities do not allow the PCAOB access to the full scope of requested documents. Should that occur, the U.S. authorities' request for assistance under the MoU will likely bolster the PCAOB and the SEC's litigation stance, as the U.S. regulators will be able to argue that they have exhausted all other avenues to obtain the requested documents.
Regardless of the immediate impact on Chinese audit firms, other companies subject to both Chinese and SEC/DOJ jurisdiction still face the proverbial immovable object (Chinese data privacy restrictions) against the irresistible force (SEC and DOJ subpoena power). U.S. courts typically enforce U.S. subpoenas despite conflicting foreign laws, and companies that do not comply with such subpoenas face potentially harsh consequences.10 The current MoU, however, may be an indication of broader relief to come. It may signal China's willingness to adopt agreements that would cover a broader scope of documents relating to companies in China with jurisdictional ties to the United States. Time will tell; until then, companies subject to both jurisdictions must continue to be wary of potentially conflicting obligations.
Tom Kuczajda and Colleen Kukowski .