SEC Judge Sanctions Chinese Affiliates of the Big Four Accounting Firms


On January 22, 2014, an administrative law judge for the U.S. Securities and Exchange Commission (the “SEC”) ruled that the Chinese firms affiliated with the Big Four accounting firms, which are PwC, Deloitte, KPMG and Ernst & Young, should be denied the privilege of practicing or appearing before the SEC for a period of six months, which means that a company could not use an audit report by these firms to satisfy their SEC filing obligations. The decision is under appeal and it will not take effect until the decision is finalized; so, there will not be an immediate impact. If the decision stands, companies that rely on these auditors to satisfy their SEC filing obligations will need to either switch auditors or withdraw from U.S. markets.

This decision is the result of a struggle between the SEC, which demanded that these firms provide certain working papers pursuant to an order under Sarbanes-Oxley, and Chinese privacy law, which has very strict rules regarding the sending of this information. In essence, if the audit firms in China complied with the SEC’s disclosure order, the individuals responsible for sending the information could be sent to jail in China. In other words, the fact that you may be sent to a Chinese prison is not a good enough reason to ignore an order from the SEC. The judge found that even if sending such information violates Chinese law, those firms knew that when they engaged in auditing companies listed in the U.S.

The initial impact of this decision on multination firms with significant operations in China is unclear. The Public Company Accounting Oversight Board, which governs the auditors of companies listed in the U.S., requires that a firm must register with it if it “plays a substantial roll in the preparation or furnishing of an audit report with respect to an issuer” listed in the U.S., which includes “performing the majority of the audit procedures with respect to a subsidiary or component of any issuer the assets or revenues of which constitute 20% or more of the consolidated assets or revenues of such issuer necessary for the principal accountant to issue an audit report on the issuer.” If a company listed in the U.S. has a Chinese subsidiary or operations in China that trip this 20% threshold, it may have difficulty obtaining an audit report in the future.

Last year, the U.S. and Chinese governments reached an agreement and the Chinese government started providing some of the documents requested by the SEC. Like most political negotiations, progress has been slow. This decision may force the U.S. and Chinese governments to find a solution quickly or it may simply drive Chinese companies from U.S. markets.

If you have questions about this ruling, contact Clark Wilson’s Corporate Finance & Securities Group.