Banking & Finance

Counting the days

SEC directive could lead to audit nightmare


Held to account by US regulator

“To the extent [the Big Four] found themselves between a rock and a hard place, it is because they wanted to be there. A good faith effort to obey the law means a good faith effort to obey all law, not just the law that one wishes to follow.”

Stern words from Cameron Elliot, a judge at the Securities and Exchange Commission, on ordering a six-month ban on the Chinese affiliates of accounting firms KPMG, Deloitte & Touche, PwC and E&Y.

The ruling is that they should be punished for failing to provide details on Chinese companies suspected of accounting fraud. The crisis began three years ago with the collapse of a series of Chinese companies on US stock markets. Regulators suspected financial irregularities and demanded full financials from the auditors concerned. But the request was refused on the basis that the audit firms might face prosecution under Chinese law for providing data without approval.

The Americans then agreed an information-sharing deal with the Chinese securities regulator (the CSRC) but still didn’t get access to the information they were seeking.

“In short, the CSRC remains unwilling or unable to provide the SEC with meaningful assistance in its enforcement investigations,” claimed papers in the case pursued against the audit firms.

At heart this is a disagreement over jurisdiction. While American law allows the SEC to demand audit information from non-US accounting firms, Chinese legislation can deem such information a state secret that should not be provided.

The accounting firms say they are being forced into an impossible position. “They’re putting pressure on us because they think we can influence the regulators in China, which is absolutely not correct,” Paul Winkelmann, the senior partner for risk and compliance at PwC in China, told Reuters. Winkelmann says the audit firms are “just piggy-in-the-middle” in a dispute that needs to be solved between the two regulators.

True to form, the Chinese media supported the refusal to yield to American pressure. Then again, there was little discussion about why revealing the financials of internet gamers or online travel agencies should be a matter of concern on state secrecy grounds.

But the Chinese press wasn’t so supportive of the accountancy profession itself. Some even admitted that there might be lessons in the case. “We should learn more from US regulators in monitoring the accountants,” China Business Times suggested. “If firms file fake reports, let them lose everything. Only then will we get a clean market.”

The official response from the CSRC to the SEC judgement was a terse one. “The ruling ignores the efforts and progress made by China on providing audit documents and in cross-border law enforcement,” a spokesman complained. “The SEC should bear full responsibility for the possible consequences of the ban.”

The immediate impact of the announcement was that share prices at US-listed companies like Baidu, Sina and Ctrip fell as investors absorbed news of the censure. In fact, the accounting firms are appealing against the decision, which could delay its implementation for some time. But if the verdict is finalised, each firm will be prevented from auditing Chinese clients listed on US markets. Because their second-tier peers may be unable (or unwilling) to take up the slack, the clients may struggle to find acceptable alternatives. Paul Gillis, a professor at Peking University’s Guanghua School of Management is warning of potential chaos. More than 160 Chinese firms risk being kicked off American exchanges for failing to file their accounts on time.

There are other implications. New IPOs will be delayed until the uncertainty clears, while multinationals with operations in China will be feeling nervous. Under US rules, an auditor needs to be registered with the Public Company Accounting Oversight Board if it has oversight of more than 20% of its client’s assets or revenues. So a formal suspension of the Chinese accounting units of the Big Four would create huge headaches, possibly rendering their Chinese audits invalid. Companies like Yum Brands – with China revenues well in excess of the hurdle – will be watching closely.

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