Precedent, sop or isolated case: whichever way you look at it, the resolution of a dispute between the SEC and Deloitte’s Chinese unit over its refusal to hand over documents relating to Longtop Financial Technologies, a mainland company under investigation for fraud, is a big moment.
The US regulator had issued a subpoena to force the local affiliate of the Big Four accounting firm to produce audit work papers and other documents relating to a possible fraud at the Chinese company.
However, on Monday the SEC and Deloitte Touche Tohmatsu CPA (DTTC) filed a joint motion to have the lawsuit, more than two years old, dismissed by the US district court for the District of Columbia.
The subpoena was issued because DTTC had insisted it was prohibited under Chinese law from providing the material, which is located in the country. The idea behind this is that such material could be deemed to contain state secrets or at least be considered state property.
So in essence something had to give and something gave. The SEC told the court that the China Securities Regulatory Commission had handed over many of the documents requested.
“It appears that the central problem of producing audit work papers from China may have been largely resolved with the SEC's acknowledgement of the CSRC's and Deloitte's cooperation as a basis to drop the SEC's action against Deloitte," said Paul Boltz a partner at law firm Ropes & Gray, which advises Chinese and HK companies listed in the US.
"This could provide a mechanism that may satisfy the SEC. [I am sure] the mechanism is not yet perfected but we view this as good news for investors,” he told FinanceAsia.
Sentiment towards such companies has been dented following a raft of negative publicity, including claims of fraud by short sellers, plunging valuations and the delisting of certain mainland Chinese companies from US markets. The reluctance of local auditors to provide US regulators with the relevant information hardly helped the situation.
On top of the specific action against Longtop, a judge in the US last week banned the Big Four’s local units from practising in the US for six months.
The judge ruled that the local units of KPMG, Deloitte, PwC and Ernst & Young had failed to comply with SEC document requests in connection with nine Chinese companies. If upheld, the four will no longer be able to audit the accounts of the Chinese companies listed in the US, meaning those groups will have to appoint new auditors in China – a costly hit to confidence for the groups and for investors.
Although the ban will not be implemented until an appeals process is worked through – all four units are appealing - the move has been seen as something of a provocative act, which begs the question whether the latest SEC decision is an olive branch.
“Sop is not a bad way to look at it. However, [the Longtop case] dealt with enforcing a subpoena and does not have any real bearing on the other administrative ruling and the 6-month ban,” Robert Woll, a partner at Deacons, a HK-based law firm that advises companies on HK capital markets and financial transactions, told FinanceAsia.
That may be so but will the Longtop decision have a positive or negative effect on such listings in the US going forward?
On the one hand it could be argued that investors will feel more heartened that the SEC is satisfied and has had some success in dealing with its Chinese counterpart. On the other hand, there is a train of thought that such companies may hold back from pursuing such listings now that they know their confidential documents may no longer be protected from scrutiny in the event of trouble.
“It shouldn’t affect the number of such listings. In the current market environment we don't see that these recent developments have deterred Chinese-based companies from listing in the US as there has been a recent resurgence of interest, particularly among internet-related companies, and investors appear to be taking the risk in stride,” said Boltz. “But we haven't seen the final chapter.”
The six-month suspension, according to Woll, threatens a more dampening effect on sentiment because of its broad scope, whereas the Longtop action is a one-off.
"There still appears to be a political problem between the SEC and the CSRC that needs resolving. There is still a fundamental problem with how these Chinese auditors deliver work papers that the SEC wants to look at when they think there is fraud at a company,” Boltz said.
Longtop might be a one-off but you have to start somewhere. With the broad case ongoing and threatening to drag on, a peace offering – whether deliberate or coincidental – is to be welcomed.
"It does set a precedent. Given that the CSRC must have let more audit work papers come out, this could imply that the [regulator] is taking a more realistic view of the state secrets and state-owned archives aspects of such cases. Maybe they have parsed the archives regulation and decided that if there are no state secrets involved, the papers can be produced to the SEC. That is a good development," said Woll.
Meanwhile, Boltz said he is hopeful a turning point has been reached in the long-running dispute between the US and Chinese regulators.
Although the CSRC has not commented, DTTC confirmed the conciliatory moves by the regulator.
“The Chinese regulators have provided the SEC with the Longtop working papers. That solution is the result of considerable work on the part of the China regulatory authorities,” it said in a statement.
Although the two cases are different in scope – Longtop involved a specific subpoena while the action against the local units of the Big Four is an attempt at punishment – the apparent soothing in relations is surely a good thing.
“At least there is consultation going on. Consultation, not confrontation, is good,” said Woll.
Quite so. It is good for markets, good for companies and good for investors.