In an unusual step, the US Securities and Exchange
Commission on Thursday asked a federal court to force Shanghai-based Deloitte
Touche Tohmatsu CPA Ltd. to hand over its audit records on Longtop Financial
Technologies Ltd., which is under investigation for possible fraud.
The move puts Deloitte in the middle of a conflict
between US and Chinese regulators, who must consent before Deloitte can release
documents.
At another level, the case pits the transparency prized
by US investors against the more closed world of finance in China.
"If Deloitte were to comply (with the SEC) it runs
the risk of China saying it violated Chinese rules and yanking their
license," said Paul Gillis, visiting professor of accounting at Peking
University. If Deloitte does not comply with the SEC, it risks sanctions in the
United States, he said.
The SEC's action could ultimately escalate frictions
between US and China regulators and prompt auditors to stop working on Chinese
companies that list in the United States, Gillis and other legal and accounting
experts said.
The problem could even extend beyond Chinese firms. Big
multinational companies that do business in China, such as Microsoft, could get
caught up in the problem if the SEC ever wanted to see audit work papers for
their Chinese operations, Gillis said.
Moreover, it could be just a matter of time before other
Big Four auditors are ensnared in similar problems, he said.
Although it is a Chinese firm, Deloitte's Shanghai office
is registered with the US Public Company Accounting Oversight Board (PCAOB),
which regulates auditors, so that the firm can audit US-listed Chinese
companies such as Longtop.
The firm is one of several affiliates of the Big Four
auditors — Deloitte, KPMG, Ernst & Young and PwC — that have encountered
accounting problems at China-based clients listing shares in the United States.
Ernst & Young has been named in at least two class
action lawsuits over its work on Sino-Forest, a Toronto-listed company accused
by short-seller Muddy Waters of accounting fraud.
KPMG in January said it had found possible irregularities
in the books of China Forestry, and online business services firm Subaye
announced in April that PwC Hong Kong resigned as its auditor amid concerns
about its accounting.
KPMG, PwC and Ernst & Young declined comment.
All of the Big Four have been counting on growth in
emerging markets such as China to boost revenues as the audit business in
mature markets like the United States levels off.
However, escalating scrutiny by US regulators has
underscored the risks of emerging markets auditing.
"An action like this could not only chill, but could
make cryogenic, literally freeze the willingness of any auditor to conduct an
audit of a China-based business or operation if those audit results may appear
in a US SEC filing," said Jacob S. Frenkel, a partner at Shulman Rogers
and former senior counsel in the Division of Enforcement at the SEC.
Chinese companies listing in the United States have
fallen through a regulatory loophole, partly because US audit inspectors have
not been allowed inside China where the audits are done. Auditors have also
resisted handing over records for fear of violating China's state secrets law.
"The issue that's been brewing for some time has
been the absolute invasion by Chinese companies of the US capital markets without
complying with US reporting requirements," said Duke University securities
law professor James Cox.
The SEC and the PCAOB have been talking with Chinese
officials to get access for inspections, but the SEC's latest action could
complicate those negotiations, Gillis said.
"I think China is going to become more wary of doing
a deal," he said. "They'll worry about setting a precedent until they
sort out the whole issue."
China-based software company Longtop is one of the
largest US-listed companies involved in a rash of accounting scandals. Deloitte
resigned as its auditor in May, saying it found falsified financial records.
Deloitte said Chinese law prohibits its Chinese affiliate
from turning over its records directly to a foreign regulator, and violations
can result in severe sanctions, including criminal penalties.
"Deloitte China is caught in the middle of
conflicting demands by two government regulators,"
