Professor Paul Gillis, who writes the essential (and highly readable) China Accounting Blog, just came out with a bombshell of a post. Or rather, his post explains the bombshell that landed Wednesday in the form of a 112-page opinion from Cameron Eliot, Administrative Law Judge at the US Securities and Exchange Commission (SEC). Judge Eliot’s opinion prohibits the Big Four accounting firms’ China entities (i.e., Ernst & Young Hua Ming, KPMG Huazhen, Deloitte Touche Tohmatsu, and PricewaterhouseCoopers Zhong Tian) from practicing or appearing before the SEC for six months.
I highly recommend reading Gillis’ post in its entirety, but the short version is that the Big Four’s Chinese entities were found to have violated the Sarbanes-Oxley Act by refusing to turn over documents of US-listed Chinese companies under investigation for accounting fraud. Good ol’ Sarbanes-Oxley. As someone who did a judicial clerkship in Houston not long after the collapse of Enron, it’s oddly comforting to hear echoes of that scandal still reverberating.
The Big Four’s basic defense was quite succinct: Chinese law prevented them from turning over the requested documents. Judge Eliot’s response was equally succinct: then don’t represent US listed companies. In one of many tartly worded sentences, Judge Eliot observed that “to the extent Respondents [i.e., the Big Four’s Chinese entities] found themselves between a rock and a hard place, it is because they wanted to be there.” As Paul Gillis sums up: “Ultimately, the only way this gets settled is if China agrees that companies that list in the US are subject to all US securities laws.”
Judge Eliot’s decision can be appealed, and it appears it will be, but there’s no positive spin on this for the Big Four’s Chinese entities. They defied the SEC, and they got hammered. Although they are allowed to continue practicing before the SEC during the pendency of the appeal, it’s unclear how many of their clients will wait for the other shoe to drop. Would you risk your firm being delisted out of loyalty to an accounting firm that is banned from appearing before the SEC?
It’s this consequence of Judge Eliot’s decision which may have the greatest ripple effect. Once again, Paul Gillis: “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 Big Four, it should be noted, have a near-monopoly on the auditing of public companies in China.
Many of our clients use either the Big Four or second-tier firms to do their accounting work in China. These clients are primarily non-Chinese companies that have WFOEs or joint ventures in China. But if their second-tier accounting firm suddenly acquires a dozen big new clients with upcoming audits or IPOs, what happens to all the regular accounting work for the old clients? The status quo cannot hold, but what will come is anyone’s guess.