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Thursday, April 26, 2012

DTTC Caught in the Impasse Between the Securities and Exchange Commission and the China Securities Regulatory Commission

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 In an April 11 statement over DTTC‘s - the Shanghai affiliate of Deloitte Touche Tohmatsu - refusal to produce subpoenaed workpapers related to audit client Longtop Financial Technologies Ltd., DTTC’s counsel objected that DTTC had been placed in an untenable position.

“China regulators would be authorized to dissolve the firm entirely and to seek prison sentences of up to life in prison for any DTTC partners and employees who participated in the violation.”

The Securities and Exchange Commission began investigating Longtop Financial Industries of China, a foreign private issuer, for accounting fraud early in 2011 after DTTC resigned as auditor because of “very serious defects” in its financial statement. DTTC had served as Longtop’s auditor since the company went public in the U.S. in 2007 through an initial public offering, listing its shares on the New York Stock Exchange under the symbol LFT.

Longtop sold more than $300 million in shares in the U.S. and November 2010 had a market value of $2.4 billion before its stock price collapsed with disclosure of DTTC’s resignation. On August 29, 2011, the NYSE delisted LFT. The SEC’s case will investigate whether anyone at DTTC participated with management in the accounting problems that led to DTTC’s resignation as auditor and consider if the firm was diligent enough in verifying the financial statements in the years from 2007 to 2011.

On May 27, 2011, the SEC issued a subpoena for records related to DTTC’s Shanghai audit client Longtop and when they were not produced, filed a show cause with the U.S. District Court for the District of Columbia. DTTC’s counsel pointed out that the issue is really between the SEC and CSRC and that international diplomacy will be the only way to resolve the impasse. Chinese law considers these workpapers a “state secret” as they include information about the “national economy and social development.”

The case involves more than just conflicting international jurisdictional issues, of whether the SEC may properly exercise subpoena authority over documents located in China by means of the federal rules of civil procedure or whether the proper method of service of process is through the Hague Convention. The subtext is the impasse in negotiations, over six years now, between Chinese regulatory authorities and the Public Company Accounting Oversight Board (PCAOB) over inspection of audits of U.S. companies doing business in China. Moreover, since the international scandal and billions of lost dollars due to reverse mergers, Senator Charles Schumer (D.N.Y.) last year increased the pressure, calling on PCAOB to deregister Chinese audit firms that refuse to allow inspections.

DTTC's counsel argues that respect for China’s sovereignty and judicial principles of international comity bar enforcement of the subpoena, the SEC argues that forcing service of process by means of a cumbersome international treaty will prevent access to information crucial to protecting public investors. The hearing is set for May 4th in the U.S. District Court for the District of Columbia.

Laura Salisbury
Legal Editor
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