The Dispute Over Work Papers for PRC Based Issuers May be About to End

The resolution of a long standing dispute between the SEC, the PCAOB and the China Securities Regulatory Commission or CSRC over the availability of audit work papers which has spawned three pending actions may be about to end. While the Sarbanes-Oxley Act requires auditors registered with the Board to turn over audit work papers on request from the Commission or the PCAOB, audit firms based in China have declined based on the position of the CSRC. Now, according to a report from Thomsonreuters, the work papers are being produced under a recent agreement between the CSRC and the PCAOB. Soyoung Ho, “Chinese Are Prepared to Hand Over More Auditor Papers,” Thomsonreuters (Aug. 2, 2013). This could signal an end to the dispute and the litigation.

Presently, the SEC is litigating three actions against five PRC based audit firms centered on their failure to produce audit work papers. The most recent was filed in December 2012 against the affiliates of five major accounting firms based in the Peoples Republic of China. In the Matter of BDO China Dahua CPA Co., Ltd., Adm. Proc. File No. 3-15116 (Dec. 3, 2012). The Order names as Respondents: BDO China, Ernst & Young Hau Ming LLP, KPMG Huazhen (Special General Partnership), Deloitte Touche Tohmatsu Certified Public Accountants Ltd. and PricewaterhouseCoopers Zhong Tian CPAs Ltd.

The proceeding is based on Rule 102(e)(1)(iii) which permits the Commission to sanction any person found to have willfully violated or aided and abetted the violation of the Federal securities laws. The Order alleges that the provision was violated by each Respondent since it failed to comply with Section 106 of the Sarbanes-Oxley Act of 2002, as amended by the Dodd-Frank Act, which requires PCAOB registered firms to produce audit work papers pursuant to a Board or SEC request.

A similar proceeding had been instituted against the Deloitte PRC affiliate earlier. In the Matter of Deloitte Touche Tohmatsu Certified Public Accountants Ltd., Adm. Proc. File No. 3-14872 (May 9, 2012). That same firm is also a defendant in a subpoena enforcement action brought by the Commission on essentially the same basis. SEC v. Deloitte Touche Tohmatsu CPA, Ltd., File No. 1:11-MC-00512 (D.D.C. Filed Sept. 8, 2011).

Last month a resolution of these actions appeared eminent. The PCAOB, the China Securities Regulatory Commission and the Ministry of Finance in China executed a Memorandum of Understanding on Enforcement Cooperation. The agreement provides for the exchange of certain materials on request to assist in the enforcement matters. In the MOU the parties pledged the “fullest assistance permissible to secure compliance with the respective Laws and Regulations of the Authorities.” Under the MOU audit work papers are to be made available.

Recently, the work papers for Longtop, the Deloitte Touche Tohmatsu client in the subpoena enforcement action, were furnished to the Commission staff under the agreement. Other work papers are about to be produced, according to the Thomsonreuters report. Nevertheless, the Enforcement Division has continued to litigate the actions. Indeed, the hearing in the proceeding against the five firms was recently completed. Apparently the record in that action has been held open to furnish the Judge with information future developments however.

The production of the work papers in the subpoena enforcement action would effectively moot that proceeding. While the production of the work papers may not cure the violations in the two administrative proceedings, it should certainly have a significant impact on the resolution of those matters. Indeed, if the agreement between the PCAOB and the CSRC is effective, it would not seem to be in the interest of the SEC to bar the affiliates of the five largest international accounting firms from practicing before the agency if the goal is to ensure quality audits of PRC based companies. Accordingly, the long running dispute over audit work papers for PRC based issuers may well be about to come to an end.