Many people have asked me if the Big Four could circumvent the SEC ban by having the U.S. or Hong Kong firms sign the audit opinions. The short answer is no, and for several reasons.
In order for a U.S. or Hong Kong firm to serve as the principal auditor who is allowed to sign the report, the firm:
...must decide whether his own participation is sufficient to enable him to serve as the principal auditor and to report as such on the financial statements. In deciding this question, the auditor should consider, among other things, the materiality of the portion of the financial statements he has audited in com-parison with the portion audited by other auditors, the extent of his knowledge of the overall financial statements, and the importance of the components he audited in relation to the enterprise as a whole (AU 543).
In plain English, that means that in order to sign, you actually have to do the audit, or most of it. The firms cannot just sign the report in the U.S. or Hong Kong; the U.S. or Hong Kong firms must actually do the audit.
Predictably, the Big Four firms are wailing about the SEC decision against them yesterday. One firm has complained that “this is a profession-wide issue, and not one of the profession’s own making”. The judge disagreed; finding that “to the extent the firms find themselves between a rock and a hard place, it is be-cause they wanted to be there”. The China Big Four partners would have prob-ably understood this better if the judge had used a Cantonese idiom: 食得鹹魚抵得渴 (Those who eat salty fish must put up with the thirst). The firms did not have to get into the business of serving U.S. listed Chinese companies.
As much as the firms are feeling sorry for themselves, it is their clients and the investors in those clients who will be hurt if the firms are banned from practice. A ban could lead to the companies being kicked off of U.S. stock exchanges for failing to produce audited financial statements. IPOs would have to be post-poned until the bans were over. Financings would be delayed. Fortunately appeals are likely to delay this for a long time.
Cameron Eliot, Administrative Trial Judge of the SEC, threw the book at the China Big Four today, suspending them from practicing before the SEC for six months in a 112-page opinion, parts of which were redacted because they reported interactions between the SEC and CSRC “more candidly than is customary in diplomatic circles”. While he may have been kind to the CSRC, he took the hide off of the Big Four. The firms, especially PwC, were probably feeling a little raw already from the blistering they received in the ICIJ report yesterday on how they aided Chinese elites to get money offshore.
BDO DaHua was censured by not banned. Dahua has pulled out of BDO and I do not believe it has any U.S. listed clients anymore.
The suspension will not begin until the Commission enters an order of finality. The firms can request review within 21 days or the Commission can decide to review it anyway. If the commission goes ahead and finalizes the decision, the Big Four could appeal to federal Circuit Court of Appeals and ask for a stay of the decision. That could delay the problem for a long time, but that may not be the best outcome for the firms or their clients.
The SEC brought administrative charges against the Big Four and BDO’s then China affiliate on December 3, 2012 for failure to turn over audit working papers to the SEC. Separate charges against Deloitte had been brought on May 9, 2012. At risk is the right of these firms to practice before the SEC. If this right is revoked, U.S. listed Chinese firms may find themselves without an auditor and consequentially be kicked off of U.S. exchanges. Under SEC rules, the presiding administrative law judge is to issue a decision within 300 days. On March 8, 2013, the SEC approved a delay in the case against Deloitte and put the Deloitte case on the same timetable as the rest of the firms – October 11, 2013.
A hearing was held in Washington between July 8 and July 31, 2013.
The CSRC reached an agreement with the PCAOB to release working papers in connection with investigations in May 2013, but continued to block the PCAOB from doing inspections of accounting firms. The CSRC began to release the working papers that the SEC had requested. The firms asked the judge for a summary disposition of the case because the SEC had found another way to get the working papers. The judge dismissed this request on December 6.