The Securities and Exchange Commission is taking a different approach than back in September 2011 when the agency first sought to compel Deloitte’s Shanghai affiliate to produce subpoenaed work papers related to audit client Longtop Financial Technologies Ltd.

 Deloitte responded that the China Securities Regulatory Commission refused to authorize the document production and that to do so would be a criminal violation of Chinese law. 

In May 2012 the SEC filed an unprecedented Sarbanes–Oxley Act Section 106 administrative suit against Deloitte, the first action of its kind in the ten years since the statute was enacted.  Section 106 applies to foreign audit firms that prepare or furnish audit reports, making those firms accountable to the same laws as U.S. firms.  In August 2012 in the U.S. District Court for the District of Columbia granted the SEC’s request to lift the stay while there was hope of diplomatic resolution with the Chinese regulators.

After months with little or no progress, a frustrated SEC in December 2012 returned to the court to ask for the stay to be lifted and to compel Deloitte to produce audit work papers and that same day filed a consolidated omnibus administrative action against the China–based affiliates of five major U.S. audit and accounting firms:  In re BDO China Dahua CPA Co. Ltd., SEC, Admin. Proc. File No. 3-15116, 12/3/12), specifically  BDO China Dahua Co. Ltd., Deloitte Touche Tohmatsu Certified Public Accountants Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen (Special General Partnership), and PricewaterhouseCoopers Zhong Tian CPAs Ltd.

The SEC’s decision to bring this consolidated administrative proceeding under the SEC’s Rules of Practice is an interesting strategy but one that does not resolve the impasse of the conflict in sovereign laws. An administrative law judge has the power to prohibit the accounting firms from continuing to practice before the SEC. In other words, this carries far greater penalties, with serious ramifications for Chinese companies doing business within the United States than a subpoena enforcement action in federal court.  The administrative law judge, however, must find there was a willful failure to produce the documents. And the case will turn on whether a failure to produce documents can be considered “willful” if it would run afoul of another country’s laws.  

 On Jan. 29, Magistrate Judge Deborah Robinson of the U.S. District Court for the District of Columbia temporarily extended the stay on the subpoena action by the SEC against Deloitte which requested that the stay be extended until resolution of the consolidated administrative action against the five Chinese affiliates. DTTC’s counsel, Miles Ruthberg, returned to the pivotal conflict of laws question, arguing that in the case of the China based auditors, there has been no willful refusal because “no reasonable person in China would take on the risks “ of Chinese criminal sanctions solutions in China. 

A similar case has been brought Aug. 27, by the Hong Kong’s securities regulator against Ernst &Young’s Hong Kong affiliate, for failing to produce audit records based on their firm’s work as accountant and auditor for Standard Water Limited, a Beijing-based company that provides wastewater treatment producing the documents. That hearing is scheduled for March.

Laura Salisbury, Accounting Policy and Practice Legal Editor