Securities Regulation Daily Wrap Up, ACCOUNTING AND AUDITING—SEC ALJ censures and suspends Chinese units of Big Four audit firms, (Jan 23, 2014)

By Jim Hamilton, J.D., LL.M.

A SEC administrative law judge (ALJ) ruled that the Chinese units of the Big Four audit firms willfully refused to comply with Sarbanes-Oxley Sec. 106 requests for audit work papers, that the disallowance of the production of audit work papers by alternate means was appropriate, and that no affirmative defense had been established. To the defense that producing the audit work papers requested by U.S. authorities could trigger draconian sanctions under Chinese law, the ALJ said that to the extent the auditors found themselves between a rock and a hard place, it is because they wanted to be there. Thus, the ALJ censured the audit units and denied them the privilege of appearing or practicing before the SEC for a period of six months. Although the audit units may have acted willfully and with a lack of good faith, noted the ALJ in a 112-page opinion, they did not act with scienter. They had no intent to defraud, nor were they reckless, in the sense that their conduct was an extreme departure from the standards of care. Their state of mind at the time of their respective violations was driven by their concerns over potentially draconian Chinese law. (In the Matter of BDO CHINA Dahua CPA, Co Ltd; Ernst & Young Hua Ming LLP, KPMG Huazhen; Deloitte Touche Tohmatsu CPAs Ltd, and Pricewaterhouse Coopers, Zhong Tian CPAs Ltd, January 22, 2014).

But, the flouting of the Commission's regulatory authority, which may not be as egregious as accounting fraud, was still egregious enough that it weighed against leniency. Also, the Chinese units of the Big Four audit firms failed to recognize the wrongful nature of their conduct, and because they are all registered with the PCAOB as public accounting firms, their occupation presented opportunities for future violations. In addition, the degree of harm to investors and the marketplace varied, but was clearly present in at least some instances.

The units registered with the PCAOB knowing that they might be required to provide audit work papers to the Board. Thereafter, the Board notified each unit that it was subject to all applicable U.S. laws. Yet each unit performed audit work for U.S. issuers, hopeful, but not certain, that the regulators would iron out any potential problems. They knew that a failure to directly produce documents pursuant to Sarbanes-Oxley Act Sec. 106 might violate the act. The Dodd-Frank Act amended Sec. 106 to require that any registered audit firm that either relies on the work of a foreign audit firm in issuing an audit report or performing audit work must produce the foreign audit firm’s audit work papers in response to the PCAOB’s request for production.

Auditors. The audit units operated large accounting businesses for years, knowing that if called upon to cooperate in a SEC investigation into their business, they must cooperate fully or violate the law. Then, when actually called upon to cooperate fully, they complained that they should be relieved from that duty because, among other things, they invested money and effort in building up their accounting businesses. Such behavior does not demonstrate good faith, said the ALJ; indeed, quite the opposite, it demonstrates gall. Each audit unit made the affirmative decision, no later than the time it filed its Sarbanes-Oxley Sec. 106 designation of agent, to conduct its auditing business "at risk." That alternate production means that the possible availability of Sec. 106(f) changed nothing, in the ALJ’s view, because the auditors had no control over the applicability of Sec. 106(f).

Attorneys: David Mendel for the SEC. Deborah R. Meshulam (DLA Piper LLP) for BDO China Dahua CPA Co., Ltd. Justin P. Bagdady (Orrick, Herrington & Sutcliffe LLP) for Ernst & Young Hua Ming LLP. Neal E. Sullivan (Sidley Austin LLP) for KPMG Huazhen. Miles N. Ruthberg (Latham & Watkins LLP) for Deloitte Touche Tohmatsu Certified Public Accountants Ltd. Gina Caruso (Davis Polk & Wardwell LLP) for PricewaterhouseCoopers Zhong Tian CP.

Companies: BDO China Dahua CPA Co., Ltd.; Ernst & Young Hua Ming LLP; KPMG Huazhen; Deloitte Touche Tohmatsu Certified Public Accountants Ltd.; PricewaterhouseCoopers Zhong Tian CP

RegulatoryActivity: AccountingAuditing InternationalNews Enforcement SarbanesOxleyAct DoddFrankAct