SEC Increases Pressure on Accounting Firms to Produce Work Papers From China
On Dec. 3, 2012, the Securities and Exchange Commission ramped up its efforts to obtain documents from five Chinese affiliates of major U.S. accounting firms. The SEC has been seeking documents from the firms in connection with its investigation of PRC-based issuers traded on U.S. exchanges. The five firms are the Chinese affiliates of PricewaterhouseCoopers, KPMG, Deloitte, Ernst & Young, and BDO. Each of the accounting firms has refused to produce documents to the SEC based on the PRC’s state secrets law, which defines state secrets as “matters which, if divulged, would harm national security and interests in the areas of politics, economics, national defense, and diplomacy.” Accounting work papers created in the course of audit work could clearly fall within this definition. The SEC maintains that, notwithstanding the PRC law, the accounting firms must produce the documents pursuant to section 106 of the Sarbanes-Oxley Act, which the SEC claims requires auditors of U.S.-listed companies based abroad to provide audit work papers and other documents to the SEC. The SEC’s Dec. 3 action is in the form of an administrative order instituting proceedings to bar the Chinese affiliates of the major U.S. accounting firms from performing audits or otherwise practicing or appearing before the SEC based on the alleged failure of the firms to comply with section 106.
It is unclear how this conflict between U.S. and PRC law will be resolved. There are reports that the SEC is negotiating with Chinese securities regulators. It is unlikely that the accounting firms will comply with the SEC’s demand for documents because of the risk of severe sanctions under Chinese law. An outcome where the firms are barred from performing audit work for China-based issuers threatens to undermine the ability of Chinese companies to trade in the U.S. Under the SEC’s rules of practice, an initial decision from an SEC Administrative Law Judge is required by September 2013.