State secrets and the Big Four | China Accounting Blog | Paul Gillis

State secrets and the Big Four

Reuters is out with news that that the Big Four and two other CPA firms were summoned last week to meet with CSRC and MOF officials. The topic apparently related to whether these firms had disclosed any information from their China audits to overseas regulators or their overseas offices.  

One of Reuter's sources indicated that the Chinese regulators emphasized the need to maintain the confidentiality of audit information. Firms have been told to do a self examination of whether they have disclosed any information to foreign regulators or their overseas offices. The self examination is to be done this week.  

China has recently focused on keeping state secrets. The State Council directed that Chinese companies in critical industries should consider the protection of state secrets when selecting accounting firms, suggesting that some firms are better than others at doing this (presumably those without foreign partners). Recently Deloitte was subpoenaed by the SEC for its working papers on Longtop and advised the SEC that it was unable to comply because Chinese regulators would not give it permission to do so. 

The process of self examination and rectification is a popular technique for Chinese regulators. The accounting profession went through a series of these in the late 1990s. The attitude of regulators was to be lenient with past transgressions but unforgiving with future violations. The objective is to change future behavior and forgive all but the most egregious of prior sins.  

I expect that the firms will be spending some time in the confessional. Each of the Big Four firms require U.S. head office consultation and signoff on the audits of U.S. listed clients. Sometimes the partners who do that work are located in China, but often they are in the U.S. Any memoranda on complex accounting issues are going to be routinely shared between the audit teams in China and the reviewing partners in the U.S. 

It is also possible that the firms have shared some parts of their working papers - likely the same kind of technical memoranda - with the SEC. Over the past year most U.S. listed Chinese companies have received comment letters from the SEC. Comment letters arise from a desk review of the SEC filings and often raise questions about the company's accounting policies and treatments. The auditors are always intimately involved in the response.  

It is highly unlikely that these memoranda include any state secrets - even less likely than the remote possibility that the audit working papers contain this kind of information in the first place. This type of sharing is absolutely necessary to maintain audit quality, and I hope China does not shut it down. Instead, I hope that Chinese regulators use this data to develop a coherent policy on how audit information can be shared outside of China. This latest exercise has the potential for either settling the conflicts between Chinese and American regulators, or escalating them out of control. 

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