Audit firms are smack in the middle of the tension between U.S. and Chinese regulators with respect to allegations of accounting fraud at Chinese companies traded on U.S. exchanges. At present, a Chinese affiliate of Deloitte is in the uncomfortable limelight for its work auditing Longtop Financial Technologies. The affiliate resigned from the post earlier this year citing difficulty in verifying the company’s financial statements, but is facing continually mounting pressure relating to the audit relationship on both domestic and foreign fronts. In sum:
- the SEC is attempting to obtain a court order to enforce a subpoena that would compel the affiliate to deliver materials regarding the Longtop audits; but
- Chinese law prohibits the disclosure of state secrets, which are broadly interpreted to include work papers in connection with the audit of Chinese companies, even when these companies are traded in the United States.
In China, violation of secrecy laws can result in a prison term. In the United States, Deloitte’s continued refusal to turn over the records could cause the firm to be held in contempt of court and face suspension or revocation of its auditing firm registration by the Public Company Accounting Oversight Board (“PCAOB”). The PCAOB has already identified quality control issues relating to Deloitte’s oversight of the firm’s foreign affiliates (PDF) and is seeking broad measures to prospectively improve the quality and credibility of Chinese audits by a proposed rule that would require an audit report to name the person “responsible for the engagement and…performance” of an audit – not just the name of the audit firm.
The New York Times summarized the issue well: “Deloitte’s Chinese affiliate finds itself between the proverbial rock and a hard place because the S.E.C. is unlikely to back away from a case in which American investors suffered losses based on what appears to be a rather brazen accounting fraud. And the Chinese government is unlikely to accede to allowing the auditors to respond to a subpoena that would create a precedent for other firms being compelled to disclose their work papers. What began as a fairly routine accounting fraud investigation threatens to become a much more contentious issue between the United States and China.”
OUR TAKE: Doing business on an international stage poses interesting and often difficult challenges for audit firms seeking to comply with the laws of the countries in which they operate. U.S. regulators are working hard to see that the work of audit firms with Chinese companies traded in the United States is not immune from U.S. law – an issue that we will continue to monitor.
If you would like to catch up on our series tracking developments related to allegations of accounting fraud at Chinese companies, please see our prior posts available at the following links: