8 August, 2017
On July 25, 2017, the United States Public Company Accounting Oversight Board (“PCAOB”) issued a settled disciplinary order censuring the registered public accounting firm Crowe Horwath (HK) CPA Limited (“Crowe Horwath (HK)”), a partnership located in the Hong Kong Special Administrative Region of the People’s Republic of China, and revoking its registration with the PCAOB. Crowe Horwath (HK) had, according to the PCAOB, failed to cooperate with an investigation by refusing to produce documents, including audit workpapers, on the grounds that the PRC Ministry of Finance had directed it not to produce those documents absent a direction from the Ministry of Finance. This is the second time the PCAOB has taken enforcement action against a Hong Kong-based accounting firm for non-cooperation with an investigation. In January 2016, it revoked PKF’s HK affiliate’s registration after the firm refused to make an associated person available for testimony.
The PCAOB’s order is the latest in a long-standing battle of wills between US and Chinese regulatory authorities. US regulators, such as the Securities and Exchange Commission (“SEC”) and the PCAOB, seek documents or other information from non-US-based accounting firms that are registered with the PCAOB and provide audit services to US issuers. Those efforts are then thwarted when the Chinese regulator either expressly prohibits or declines to permit their disclosure. Accounting firms and the clients for whom they work are caught in the middle.
Under the Sarbanes-Oxley Act of 2002, any non-US public accounting firm that prepares or furnishes audit reports, or plays a substantial role in the preparation of audit reports, regarding any issuer of US securities must register with the PCAOB and subject itself to the US securities laws and the rules of the PCAOB and SEC. Such firms are ordinarily subject to periodic inspection by the PCAOB, as well as formal and informal investigations. A registered firm’s failure to cooperate with PCAOB requests for documents can subject the firm to disciplinary sanctions, including monetary penalties and revocation of the firm’s registration.
Due to restrictions asserted by Chinese regulators, however, the PCAOB has been unable to conduct inspections in China or to inspect or investigate the Mainland China-related work of any registered accounting firm in Hong Kong. The restrictions derive from statutes and regulations bearing on state secrecy and national sovereignty, and the penalties for their violation can be severe. Accounting firms violating these laws could be suspended from practice, have their licenses revoked, or face dissolution; individual violators face imprisonment or the loss of their ability to practice their profession.
This clash between US and Chinese regulators was brought to a head as early as 2011, when the SEC served subpoenas on Chinese affiliates of the US’s largest accounting firms (Deloitte, EY, KPMG, PricewaterhouseCoopers, and BDO), in order to investigate alleged financial improprieties at several US-listed Chinese companies audited by these firms. The firms declined to produce documents in response to the subpoenas, on the grounds that production directly to the SEC would violate the law of China and the express directives of the China Securities Regulatory Commission (“CSRC”). The SEC brought action against each of the firms, contending that Chinese laws and directives did not justify noncompliance with its subpoenas.
While this dispute was ongoing, the PCAOB in May 2013 entered into a nonbinding Memorandum of Understanding (“MOU”) with the Ministry of Finance of China and the CSRC that was to enable the three signatories to ask for production and exchange of audit documents relevant to formal investigations in both countries’ jurisdictions. The MOU established a cooperative framework between the regulators for the production and exchange of audit documents relevant to investigations in both countries’ respective jurisdictions and provided a mechanism for the regulators to request and receive from each other assistance in obtaining documents and information in furtherance of their investigative duties. In the ongoing litigation between the SEC and the US’s national accounting firms, the CSRC gradually approved the requested documents to be produced to the SEC, and the accounting firms reached a settlement with the SEC in February 2015 which lays out the process that the firms must follow for future record requests and also details the consequences that they may face if they fail to follow it.
Against this backdrop are the two more recent disciplinary actions by the PCAOB against Hong Kong-based accounting firms, which indicate that the MOU has not resolved the conflict between US and Chinese regulators. PKF (Hong Kong) was disciplined in January 2016 for failing to comply with a PCAOB demand requiring an associated person of the firm to provide testimony to the PCAOB on behalf of the firm. Crowe Horwath (HK) was disciplined this month for failing to comply with a demand for audit workpapers and other documents related its audits of a company referred to only as “Issuer A,” a PRC-based issuer.
In each instance, the accounting firm explained that it could not comply with the PCAOB’s demand because under the MOU, the PCAOB was required to request the assistance of the CSRC and Ministry of Finance in order to obtain the requested documents or testimony, and that without such a request or the approval of the CSRC or Ministry of Finance, the firm could not make the requested disclosures.
In each instance, the PCAOB rejected this explanation, saying, “Respondent’s reliance on the MOU was not a valid justification for refusing to provide [documents or testimony] in a Board investigation.” Both orders went on to state the following:
The 2013 MOU “sets forth the [parties’] intent with regard to mutual assistance and the exchange of information for the purpose of enforcing and securing compliance with the respective Laws and [r]egulations of [the parties’] jurisdictions ….” At the same time, the MOU states that it is “not intended to create legally binding obligations or … supersede domestic laws” of the parties. By its unequivocal terms the MOU affords Respondent no legal rights.
The order regarding Crowe Horwath (HK) concluded, “Rather, the 2013 MOU is strictly a non-binding agreement between the signing parties.”
It is unclear from the orders whether the PCAOB in fact requested assistance from the CSRC or Ministry of Finance under the MOU and was rebuffed.
These orders highlight the dilemma facing Hong Kong-based accounting firms that are registered with the PCAOB. Charles Chan, managing director of Crowe Horwath (HK), stated, “In such a very complicated scenario, we are trapped between two big concrete walls – one is the PCAOB, and the other is MOF.” Claudius B. Modesti, Director of PCAOB Enforcement and Investigations, stated, “Regardless of their location, the PCAOB is prepared to bring disciplinary proceedings against registered audit firms that fail to comply with their obligations under U.S. law to provide information requested by the PCAOB. These firms are gatekeepers to protect investors in U.S. capital markets.”
As this battle of wills continues without a government-to-government resolution, additional accounting firms could be caught in the cross-hairs, creating issues for companies with Chinese business interests that wish to trade their stock on US exchanges.
Veronique Marquis, Partner, Eversheds Sutherland
veroniquemarquis@eversheds.com
