The PCAOB and the PRC Take An Initial Step

 There may be a beginning to the end of the battle between U.S. and Chinese regulators over audit work papers relating to People's Republic of China (PRC)-based firms. The Public Accounting Oversight Board (PCAOB) announced a memorandum of understanding ( MOU) with its Chinese counterparts which promises to make audit work papers available on request.

The PCAOB and the China Securities Regulatory Commission or CSRC and the Ministry of Finance in China or MoF executed a Memorandum of Understanding on Enforcement Cooperation. Essentially, the agreement provides for the exchange of certain materials on request to assist in the enforcement of the laws of the parties to the agreement. In the MOU the parties pledge the "fullest assistance permissible to secure compliance with the respective Laws and Regulations of the Authorities."

The assistance available under the MOU is defined to include furnishing "information and documents held in the files of the Requesting Party." It also includes the exchange of documents which relate to:

Professional services - those "documents sufficient to identify all audit review or other professional services related to . . . " the request;

Work papers - "audit working papers or other documents held by audit firms . . . "

Systems - "documents sufficient to identify firms' quality control systems including organizational structures, policies adopted and procedures established to provide assurance of compliance with professional standards."

The request may be denied where it would require the "Requested Party to act in a manner that would violate law . . . " or on grounds of "public interest or essential national interest . . . " The agreement does not provide for inspections as called for by the Sarbanes-Oxley Act. That is a point of continuing discussion.

The MOU comes at a critical point. The SEC has three pending actions focused on the question. One is a subpoena enforcement action against the PRC affiliate of Deloitte. It seeks the production of audit work papers relating to a Chinese issuer. SEC v. Deloitte Touche Tohmasu CPA, Ltd., Case No. 11-mc-512 (D.D.C.). The second is a proceeding against the same firm relating to a different audit. The proceeding is based on SEC Rule of Practice 102(e). It seeks an order which would preclude the firm from appearing and practicing before the Commission. Such an order it would effectively bar the firm from auditing a U.S. public company. In the Matter of Deloitte Touche Tohmatsu Certified Public Accountants, Ltd., Adm. Proc. File No. 3-14872 (Filed May 9, 2012). Finally, there is the so-called "industry wide" proceeding against the PRC based affiliates of five international accounting firms. In the Matter of BDO China Dahua CPA Co., Ltd., Adm. Proc. File No. 3-15116 (Filed Dec. 3, 2012). It is also based on Rule 102(e) and seeks the same relief as the proceeding against the Deloitte affiliate.

If effective, the agreement provides a framework for the production of audit work papers. The production of those papers would permit firms to comply with their obligations under Sarbanes-Oxley which requires that PCAOB registered audit firms produce audit work papers on request. Accordingly, the MOU has the potential to resolve the pending actions. While the agreement offers this promise, and the prospect of a future arrangement on inspections, implementation is critical. Ultimately the MOU may also hold the key to the world capital markets for PRC based enterprises - the kind of transparency sought by the agreement is critical to such access. For now, however, the MOU is a step in the right direction.

ABA Seminar: Fifth Annual FCPA Update: Protecting Your Business in the Future: Lessons from the New DOJ-SEC FCPA Guide, June 19, 2013 from 1:00 -2:30 p.m. EST. The discussion will focus on building effective compliance systems and conducting M&A due diligence. Co-moderators: Thomas Gorman and Frank Razzano. Panel: John Buretta, Principal Deputy to the Assistant AG, DOJ; Charles Cain, Assistant Director, FCPA Unit, SEC Division of Enforcement; Catherine Razzano, Assistant General Counsel, General Dynamics Corporation; Steve Siegal, Senior Counsel, Northrop Grumman Corporation; Ryan Ong, President, U.S. China Business Counsel. Live in Washington, D.C at 600 14th St. N.W., Penthouse (no charge for ASECA members attending live in Washington who pre-register by sending an e-mail to cvitko.diane@dorsey.com). Webcast Nationally by the ABA. For further information please click here.

For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

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