» Biz Commentary
Scars of sparring over audit access
THE ongoing quarrel between China and the US over access to the auditing documents of US-listed Chinese companies under regulatory investigation hit the headlines again recently.
Deloitte filed a notice earlier this month in a US federal court, rejecting a request by the US Securities and Exchange Commission (SEC) to reopen a case requiring the firm to hand over documents protected under Chinese secrecy laws. The SEC had ordered Deloitte to hand over documents related to Longtop Financial Technologies Ltd, which was accused of fraud and delisted from the New York Stock Exchange in 2011.
In December, the SEC initiated administrative proceedings against the Chinese units of five of the world's biggest accounting firms: Deloitte Touche Tohmatsu, BDO International, Ernst &Young, KPMG and PricewaterhouseCoopers.
The commission accused the firms of failing to provide requested audit papers for US-listed companies under investigation. The standoff between China and the US over information access has been going on since 2007.
William McGovern, a partner with the Hong Kong office of international law firm Kobre & Kim LLP, sat down with Shanghai Daily to discuss the nature and impact of the dispute. McGovern is a former enforcement attorney with the SEC and now represents investors and firms in financial disputes, including those under investigation by the SEC.
Q: Why has the deadlock persisted so long?
It's surprising to me that the SEC did not resolve these issues with the China Securities Regulatory Commission several years ago, before Chinese companies rushed to the US capital markets. Given where we are now, the only solution I see is a diplomatic one.
There has to be a restart of negotiations and search for a compromise. The US and China will both have to give a little ground to get to a resolution.
The fact that the SEC filed the (recent) lawsuits signals that they may not be interested in a negotiated resolution. The message the litigation sends is that US will insist on full recognition and acceptance of its position. I'm not sure if that is the right answer in the current environment. Similar issues of conflicting sovereign laws have arisen between the US and other countries. The relationship between the US and China is more complex than others and this standoff indicates that China may be more willing and more capable of opposing the US.
Q: What sorts of compromises could be made?
On the Chinese side, the CSRC could provide greater clarity to audit firms around the definition of "sensitive documents" under the state secret law. Perhaps not every document that makes up the audit works papers is truly a threat to China state secrets. On the US side, maybe the SEC could move off its position that it needs a complete document production in order to meet its oversight and enforcement objectives.
Thinking back on the records I looked at in accounting fraud cases when working at SEC, a lot of records lead to really essential information. In some of the cases, the CSRC is worried that the audit work papers will reveal sensitive information about state-owned banks, such as debt or bad loans, passed on to foreign governments. There may be a way to carve out those legitimately sensitive documents while still providing the SEC with adequate visibility. But getting to a solution like that requires two willing negotiators, sitting across the table and going through the problems.
Q: How do these auditing disputes affect Chinese companies you represent?
We have represented both US and Chinese companies in connection with SEC investigations. Typically, US-based companies more readily understand the SEC's enforcement powers and are more conditioned to cooperate in an investigation. Counseling Chinese companies in similar circumstances involves more discussion about the role of the SEC and the reach of its powers. Chinese companies often ask: "What happens if I don't cooperate?"
The answer is that the SEC can take steps to delist the company. Individual officers and directors may also be barred from acting in those roles and could be fined by the SEC. On the other hand, there can be challenges for the SEC to enforce judgments in China and, as we are seeing with the audit firms, to enforce its subpoenas.
So some companies that deny fraud allegations and defend the accuracy of their financial statements will vigorously engage in dialogue with the SEC. Others will weigh out risks and make decisions based on different circumstances. In some cases, companies are delisted. In others, the SEC has stopped its investigations. It seems the SEC now has channeled public attention, energy and resources to the auditing issue.
Q: So where does all of this lead?
The biggest problem I think is the uncertainty created in the marketplace. Chinese entrepreneurs who are trying to raise capital probably need to think carefully about US capital markets. Some of my contacts in private equity or venture capital sectors say their clients have lost interest in US listings because of all the regulations. It similarly hurts US investors who want the opportunity to invest in Chinese companies to capture some of the growth out here.
Q: Do you think the root of the problem is a basic dishonesty in Chinese business?
There are fraudulent companies in any market, including the US, and the responsibilities are upon people who are supposed to monitor, oversee, regulate and enforce the laws. Analysts like Muddy Waters put a lot of pressure on the SEC to take action, and that brings more public attention to the issue. But I don't see that there are more problems with Chinese companies than with US ones. The point is that you need to have the two countries on the same page on how to regulate Chinese companies listed in the US.
Q: Does the Chinese regulator have something to learn from the US?
The US regulator is more experienced in dealing with companies doing business across borders. But the US model is not the only model, and China may develop its own cross border regulatory structure. It's not a matter of whether or not to learn from the US, but rather of watching an evolution unfold. The Chinese regulatory model may not ultimately look like the US system. I think it may be difficult for the US government to accept that there may be an equally valid and effective system for helping companies grow, enforcing securities laws and overseeing investor risk.
China has proposed to have an international board for multinational companies to trade stocks, and it may some day face the same challenges as the US regulator has now. China will need to find ways to cooperate with regulators in other countries. The current disputes may be good for that evolution.
Q: What's it like working in the SEC?
Most SEC attorneys join the agency at a pretty early stage of their careers, when they are between 28 and 38 years old. They are new attorneys who want to do interesting and important work. The way to advance at the SEC is by bringing big cases, which involve big money, big issues, big penalties and novel issues.
In the current environment, enforcement cases involving Chinese companies are important to the SEC mission of protecting US investors.
These cases help the SEC demonstrate that its enforcement powers can reach across borders to protect investors.