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.
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