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UPDATE 2-U.S. SEC judge suspends 'Big Four' China units over audits

Sarah N. Lynch
Wednesday, 22 Jan 2014 | 8:49 PM ET

WASHINGTON, Jan 22 (Reuters) - A U.S. judge has ruled that the Chinese units of the "Big Four" accounting firms should be suspended from practicing in the United States for six months, an escalation in a long-running dispute between U.S. and Chinese regulators over access to audit documents.

In a harshly worded 112-page ruling, Securities and Exchange Commission Administrative Law Judge Cameron Elliot censured the Chinese units of KPMG, Deloitte & Touche, PricewaterhouseCoopers and Ernst and Young.

Elliot censured a fifth firm, Dahua, previously a member of the BDO international network, but did not impose a six-month suspension.

Elliot, an SEC judge who operates independently, sided with the agency and said the companies "willfully" failed to give U.S. regulators the audit work papers of certain Chinese companies under investigation for accounting fraud.

Wednesday's ruling does not go into effect immediately, and the firms might appeal. That process would take time because it must first be made to the five-member commission before it can be heard in a U.S. federal appeals court.

The decision is not expected to be immediately disruptive to the U.S.-listed Chinese companies relying on these firms to review their 2013 books.

But if the decision ultimately stands, it could have a major impact on the estimated 200 Chinese companies that rely on the Big Four to audit their books.

"This decision will be a huge shock in Beijing. The SEC has pushed a lot of chips out on the table," said Paul Gillis, an accounting professor at Peking University in Beijing.

Gillis noted that some of the Big Four's smaller competitors, like Grant Thornton and RSM, do not have the capacity to handle the workload. "Everybody is just starting their annual audits. If the Big 4 can't sign these audits, all these companies are in a hell of a pickle," he added.

Representatives for the Big Four in the United States did not have immediate comments. A spokesman for the U.S.-based unit of BDO referred all questions to China.

"I think the decision came totally unexpected to the firms," said Jason Flemmons, a senior managing director at FTI Consulting who helped bring the case against the firms when he worked in the SEC's Enforcement Division.

"That said, this will undoubtedly be appealed, which will significantly delay the institution of the six-month bars."

LITTLE SYMPATHY

The judge's decision marks a major victory for the SEC, which for years tried with limited success to gain access to audit work conducted by Chinese accounting firms for Chinese companies that list in U.S. markets.

Several companies that have listed on U.S. stock exchanges have been plagued with accounting scandals.

The SEC has tried to delist or de-register some troubled companies, but has said investigations into possible fraud were stymied by the firms' failure to turn over audit work papers.

The accounting firms have repeatedly declined to share their audits, saying Chinese secrecy laws forbid it. They urged the SEC to pursue a diplomatic solution with China instead.

After years of often strained negotiations with Chinese regulators, the SEC decided in late 2012 to pursue sanctions against the firms.

The judge declined to impose a permanent bar as the SEC requested. But he said a six-month bar was in the public interest, and said he had "little sympathy" for the firms.

"Respondents operated large accounting businesses for years, knowing that, if called upon to cooperate in a Commission investigation into their business, they must necessarily fail to fully cooperate and might thereby violate the law," he said.

"Such behavior does not demonstrate good faith, indeed, quite the opposite - it demonstrates gall."

The SEC said it was gratified by the decision, which upholds its authority.

"These records are critical to our ability to investigate potential securities law violations and protect investors," said Matthew Solomon, the chief litigation counsel in the SEC's Enforcement Division.

It is not clear what impact the decision could have on major U.S. firms that had become concerned that they could be drawn into the international dispute in a way that could compromise their ability to produce audited accounts.

U.S. firms with major Chinese businesses include fast food group Yum Brands Inc, tech firm Qualcomm and construction equipment maker Caterpillar.

Bradley J. Bondi, the head of the SEC enforcement practice at Cadwalader, Wickersham & Taft LLP and a former SEC attorney, said he was skeptical the "draconian" ruling would stand if appealed.

"Under a conflicts of law analysis, the more-stringent Chinese law, which would subject these firms to criminal exposure for complying with the SEC's subpoenas, takes priority over the U.S. government's interests in obtaining this information," he said.

DIPLOMATIC EFFORTS IN JEOPARDY?

It remains to be seen whether Wednesday's ruling could hinder the SEC's diplomatic bid to convince China to provide greater access to audit work papers, an effort that has led to improved ties since the summer.

During testimony in this case, the SEC revealed that China had agreed to send 20 boxes of audit work for Longtop Financial Technologies, one of the companies under investigation for fraud. In addition, the Public Company Accounting Oversight Board, which registers, inspects and disciplines auditors, has been pursuing a diplomatic solution for gaining access to the work papers.

In May, the PCAOB reached a deal with China that has allowed it to get some audit documents in connection with investigations. The board is still hoping for cross-border cooperation so its inspectors can also examine China-based audit firms.

Recognizing the risk that the ruling could strain diplomatic ties, Elliot said he decided to seal large portions of his decision that delve into Chinese-SEC relations.

"I am hopeful that the commission and the (China Securities Regulatory Commission) will continue to constructively engage one another," he wrote.

A PCAOB spokeswoman declined to comment on Wednesday's ruling.