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 suspension will have significant effect. The Big Four cannot audit U.S. listed companies during the suspension. The worst possible time for the suspension to begin would be in the next month or two. Most of the calendar year companies file an annual report on Form 20F that requires an audit opinion. That report is due on April 30. If the firms are suspended, they cannot issue audit reports, so the clients cannot file Form 20-F. Under exchange rules, this should lead to the companies being suspended from trading since investors do not have the data they need to be able to trade. Any company planning to do an IPO using a Big Four firm as auditor is out of luck if the auditors are suspended.
Companies could switch to non-Big Four firms and avoid any consequences. There are almost 50 Chinese CPA firms registered with the PCAOB, but few, if any, have the scale and skills to audit the Big Four’s clients. I do expect that some of the second-tier firms like Grant Thornton, BDO, and Crowe Horwath/RSM are going to pick up a number of IPOs given the uncertainty surrounding the Big Four.
The U.S. member firms of the Big Four are unlikely to step in to fill the void. Coming to China to do audits would require them to obtain a temporary practice certificate, which would require them to follow Chinese law, which prohibits them from turning over working papers to the SEC. None of those firms are going to be willing to risk their practice rights in the U.S. to help out in China.
Possibly the best option for the Big Four if it has to face the suspension is to negotiate to have it start on May 1. That would allow them to complete the 2013 audits. Fiscal year companies would still have a problem, as would any companies that need to raise additional capital or do an IPO. But the firms could return November 1 in time to do the 2014 audits.
This has significantly upped the ante in the regulatory battle between the U.S. and China. Many investors had thought that this battle was settled last summer when the PCAOB signed a Memorandum of Understanding to share papers in connection with investigations and the working papers starting flowing. But the issues really never were settled – the PCAOB cannot do inspections and the SEC wants unfettered access to U.S. listed Chinese companies. The SEC appears to be signaling to Chinese regulators that it is willing to deploy the “nuclear option”, for six months anyway. I think this decision may empower the PCAOB to begin revoking the registrations of firms it cannot inspect, which would make the six month ban permanent. Ultimately, the only way this gets settled is if China agrees that companies that list in the U.S. are subject to all U.S. securities laws. For those companies that are too sensitive for that, like some large SOEs, China should pull their U.S. listings.