China: SEC's Charges Against China-Based Accounting Firms Have Broad Implications

As part of its effort to investigate potential accounting fraud at unnamed China-based companies that are publicly traded in the United States, on December 3, 2012 the U.S. Securities and Exchange Commission (the "SEC") charged the Chinese affiliates of the "Big Four" accounting firms – Ernst & Young, Deloitte, KPMG and PricewaterhouseCoopers – and BDO with violating the Securities Exchange Act and the Sarbanes-Oxley Act. The SEC says that it has sought to obtain audit documents and work papers from each of these firms in connection with its investigation of their publicly traded China-based clients and that each has willfully refused to produce such documents in violation of their legal obligations as foreign public accounting firms. The firms, however, claim that they are not at liberty to produce the documents because doing so could violate China's Law on Guarding State Secrets and result in severe criminal sanctions for their auditors. This apparent conflict between U.S. and Chinese law, which U.S. and Chinese regulators have been unable to resolve, may pose significant problems for any China-based, U.S.-listed companies, as well as multinational corporations which may need to rely on the Chinese affiliates of these auditing firms for purposes of completing their consolidated audit.

The SEC's action stems from its difficulty obtaining the documents necessary to conduct its investigations of China-based companies. As SEC Commissioner Luis Aguilar recently noted, these investigations have been "hampered by the lack of access to relevant documents, many of which are overseas." Specific to the charges against these firms, Robert Khuzami, Director of the SEC's Division of Enforcement, stated that "[o]nly with access to work papers of foreign public accounting firms can the SEC test the quality of the underlying audits and protect investors from the danger of accounting fraud," and "[f]irms that conduct audits knowing they cannot comply with laws requiring access to these work papers face serious sanctions." In fact, if an administrative law judge were to find in favor of the SEC, the Chinese affiliates of these firms could potentially be prohibited from practicing before the SEC, meaning their audit reports could not be included in required filings with the SEC.

This action is not the first of its kind, but it comes at a crucial time as it appears that negotiations between U.S. and Chinese regulators to reach a resolution regarding their conflicting laws have fallen apart. In September 2011, the SEC brought a similar action against Deloitte's Chinese affiliate demanding audit documents related to the SEC's investigation of one of its former China-based clients. In July 2012, however, the SEC sought (and the court later granted) a six month stay in the proceedings so that it could continue to negotiate with Chinese regulators regarding cross-border enforcement cooperation and obtaining access to the requested audit documents. While the SEC engaged in discussions with its counterpart, the China Securities Regulatory Commission (the "CSRC"), in hopes of reaching a resolution, on the same day that the SEC brought charges against the Big Four, it also filed a motion to lift the stay in the Deloitte proceedings stating that these efforts "ended unsuccessfully" and that the CSRC remains "unable or unwilling" to produce the requested documents.

It seems, therefore, that the SEC may be using this current action as a means to put pressure on both the firms and Chinese regulators in light of the failed negotiations. However, while some of the firms have expressed the desire to comply with the requests of the SEC, with severe criminal sanctions under the Chinese laws looming, these firms are left in a near impossible situation without an agreement in place between U.S. and Chinese regulators. In the court documents recently filed by the SEC in the Deloitte matter, Deloitte's counsel stated, and the CSRC confirmed, that in relation to one investigation, Deloitte provided its working papers to the CSRC and the CSRC refused to provide the papers to the SEC because it could not come to terms with the SEC over restrictions related to the use of the documents. This shows a willingness on the part of the firm to turn over documents when doing so is legal and permissible. Yet, these firms feel that they cannot risk turning the type of documents over to the SEC that the CSRC itself is not willing to provide.

The SEC is not alone in its stalemate with Chinese regulators and fight for documents from Chinese affiliates of U.S.-based accounting firms. In August 2012, Hong Kong's Securities and Futures Commission (the "SFC") brought a similar action against an Ernst & Young affiliate for its failure to produce accounting records related to a former China-based client.

The failure to reach an agreement between the U.S. and Chinese authorities, and the outcome of these ongoing actions, have the potential to negatively impact not only the Chinese affiliates of these big U.S. accounting firms, but also the several hundred China-based, U.S-listed companies who rely on their audits to satisfy their SEC reporting obligations and are essentially caught in the middle of this dispute. In fact, the potential severity of the situation and lack of clear solutions for issuers were not lost on investors and directly contributed to an immediate decline in the share prices of many such companies. These include market leaders, such as certain large cap China-based companies that saw their share prices decline in excess of 5% following the SEC's announcement, who had arguably been largely immune thus far from the so-called "China discount" being applied to some Chinese issuers due to a perceived lack of transparency in their businesses and/or questions about their corporate structures. Moreover, there remains a sizeable pipeline of China-based companies seeking to list in the U.S., particularly internet and social media companies including one which listed on NASDAQ last week, and this situation would appear to present a huge obstacle to those companies and any private equity investors backing them in achieving a listing for the foreseeable future. In addition, the audits of multinational corporations could also be affected because the Chinese affiliates of their auditors are not able to reply to SEC requests or provide reasonable assurance as to the adequacy of their work.

Although a long-term solution will require an agreement between the U.S. and Chinese governments, it seems that the SEC will remain steadfast in its efforts to investigate China-based companies as well as other foreign U.S. issuers. Over the past year, the SEC has increased these efforts particularly because of concerns arising from such companies entering the market through reverse mergers which were popular among Chinese businesses for a number of years. In connection with its increased enforcement efforts, the SEC has deregistered nearly 50 companies and filed fraud cases against over 40 foreign issuers and executives, including numerous China-based companies. Conversely, while the CSRC has not publicly evidenced a willingness to accede to what it views as extraterritorial demands of the SEC, many of the China-based, U.S.-listed companies such as those listed above are considered national champions and crippling their U.S. listings may entail some very real and undesirable reputational harm to the Chinese government. The outcome of these competing interests is difficult to predict.

Pending any long-term political solution, the interim path forward for those companies caught in the middle – and their investors – remains murky at best. We are aware that some investors in China-based, U.S.-listed companies have already been raising the question whether the companies could quickly migrate their listing to Hong Kong, thereby eliminating the problem. While delisting from the U.S. markets and deregistering from the SEC's reporting requirements has been a notable trend among China-based companies in the last two years, that requires significant time and financing to achieve and does not represent an obvious quick fix solution. And in light of the unprecedented action recently brought against Ernst & Young's Hong Kong affiliate by the SFC, there is no guarantee that after putting in substantial effort and resources to move to the Hong Kong market, China-based companies and their auditors would not find themselves in the same predicament with the SFC. Likewise, engaging the Hong Kong or other non-Mainland Chinese affiliate of an auditor would not by itself eliminate the need for audit work to be performed within China and the possible production of documents related to that work to the SEC.

We will continue to monitor developments in this area.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions