A long-running dispute between US and Chinese Regulators over providing audit documents of US-listed Chinese companies has taken new turns. The dispute shows that multinational companies doing business in China must be aware of the potentially conflicting authority of regulators.

The dispute between the SEC and its Chinese counterparts dates back several years. The SEC wants to obtain information in order to investigate possible accounting fraud at dozens of Chinese companies listed on US stock exchanges. But China-based auditors have refused on the grounds that compliance could violate China’s Law on Guarding State Secrets and result in severe criminal sanctions.

In December 2012, the SEC started to increase its pressure on China-based auditors by bringing additional administrative charges against the Chinese affiliates of the Big Four accounting firms. Some smaller US accounting firms have already been banned by the SEC from performing audit work for a number of US-listed Chinese companies.

As of July 2013, following the signing of a memorandum of understanding between the regulators, the China Securities Regulatory Commission has been handing over audit documents from US-listed Chinese companies, obtained from accounting firms, to the SEC and the Public Company Accounting Oversight Board. However, the SEC did not obtain all the information it was seeking.

On 22 January 2014, an SEC administrative judge ruled that the Chinese affiliates of the Big Four violated the Sarbanes-Oxley Act by refusing to turn over documents of companies investigated for accounting fraud, and that these firms will be banned from appearing or practising before the SEC for six months.

In a joint statement, the Big Four announced that they will appeal against the ruling, and that “in the meantime the firms can and will continue to serve all their clients without interruption”.

Although the ruling will not go into effect until the case is resolved, the Big Four risk losing their clients in China, as they will not be able to file audited financial statements. Without audited financial statements, a company cannot stay listed on US exchanges. More than 100 Chinese companies listed in the US would therefore have to find a new auditor. Moreover, the ruling potentially affects US companies active in China as well, as a number of them use services from the Chinese affiliates of the Big Four. At the time of this writing, the effect of the ruling on these companies was yet to be clarified.

The dispute over the exchange of information shows that multinational companies must be aware of the potentially conflicting authority of regulators, especially when doing business in China. We advise companies active in China to take precautions by identifying information that may be considered sensitive under China’s Law on Guarding State Secrets, and to implement internal compliance procedures to prevent becoming subject to potentially severe administrative and criminal liability.