Chinese Affiliates of Big Four Accounting Firms Ordered Barred from Practicing Before the SEC for Six Months; Suspension Stayed Pending Appeal: Administrative Law Judge Finds that the Firms “Willfully Refused” to Comply with SEC Requests for Audit Work Papers for Issuers Under Investigation for Accounting Fraud

Sullivan & Cromwell LLP - January 29, 2014
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On January 22, 2014, a Securities and Exchange Commission (“SEC”) administrative law judge issued a decision that is of substantial importance to China-based issuers of securities that are registered in the United States, to multinational corporations with significant operations in China and, more generally, to any party seeking to navigate conflicts between U.S. enforcement actions and local data-privacy and bank-secrecy laws. In a 112-page initial decision, Judge Cameron Elliot held that the Chinese affiliates of Ernst & Young, KPMG, Deloitte Touche Tohmatsu and PricewaterhouseCoopers had willfully refused to comply with SEC requests for the production of audit work papers of certain China-based companies that the SEC was investigating for possible accounting fraud. As a sanction for this violation of Section 106 of the Sarbanes-Oxley Act, Judge Elliot censured the accounting firms and further barred them from practicing before the SEC for six months.

The administrative law judge’s ruling, which the accounting firms have indicated that they intend to appeal, does not take immediate effect. As a result, the decision is not expected to be immediately disruptive to U.S.-listed China-based companies relying on these firms to audit their 2013 financial statements. If, however, the accounting firms are ultimately unsuccessful in their appeal, then companies may need to find different auditors during the six-month suspension period or else be unable to file financial statements, which could have a variety of serious consequences. Due to the significant number of issuers in China that use these auditors, the decision has the potential to cause serious disruption to many companies and their investors, particularly in light of uncertainty over what substitute auditing arrangements are feasible. The decision also focuses attention on a long-running dispute over access to information between the SEC and its Chinese counterpart, which, in this case, forbade the accounting firms from providing audit work papers directly to the SEC.