SEC’s Action Seeking PRC Audit Papers Moves Forward

SEC’s Action Seeking PRC Audit Papers Moves Forward

The SEC's action seeking to compel the production of documents from the Chinese affiliate of Deloitte and Touche is moving toward resolution. The Court rejected a request by the audit firm for a stay pending the resolution of a Commission administrative proceeding which is based on similar issues. SEC v. Deloitte Touche Tohmasu CPA, Ltd., Civil Action No. 11-mc-512 (D.D.C. Ruling dated April 22, 2013 ("subpoena enforcement action").

The subpoena enforcement action: The subpoena enforcement action seeks an order requiring the production of PRC based audit work papers held by Deloitte Touche Tohmasu relating the audit of a Chinese issuer. Although the firm is registered with the PCAOB and the Sarbanes Oxley Act requires the production of work papers by registrants on request, the audit firm has refused to produce the material citing Chinese law which generally precludes such production absent consent.

The SEC secured a stay early in the proceeding because of a possible negotiated resolution, the agency later sought and obtained an end to that order when the discussions collapsed. Subsequently, the audit firm requested a stay based on related administrative proceedings in which similar but not identical issues are being considered. Initially the firm requested a stay until motions to dismiss were resolved. Later that request was modified and a stay was sought until the conclusion of the proceeding.

Related proceedings: There are two related administrative proceedings. The first was also brought against the Deloitte PRC based affiliated under Rule 102(e) of the Commission's Rules of Practice. That proceeding is predicated on the refusal of the audit firm to produce work papers from a different audit. The relief sought is sanctions. In the Matter of Deloitte Touche Tohmatsu Certified Public Accountants, Ltd., Adm. Proc. File No. 3-14872 (May 9, 2012)("D&T proceeding").

The second, filed during the term of the stay in the subpoena enforcement action, is a so-called "industry wide" administrative proceeding brought 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 (Dec. 3, 2012)("industry wide action"). That action is essentially the same as the D&T proceeding. It is based on alleged violations of Rule 102(e) of the Rules of Practice and the failure of the Respondents, all PCAOB registered audit firms, to produce requested audit work papers as required by the Sarbanes Oxley Act. Sanctions are sought. In this case the Respondents claim service is improper.

Rejecting the stay request: The Court denied the request of Deloitte Touche Tohmatsu for two reasons. First, there is no real hardship for the audit firm to litigate both cases simultaneously, contrary to its claim. There is little overlap in the actions. Each seeks a different remedy. In the subpoena enforcement action only the production of the work papers is sought. In the industry wide action, in contrast, sanctions are being requested not the production of work papers. Thus, not only is there minimal overlap, but there is also little potential for inconsistent adjudications since any appeals would go to the same court of appeals.

Second, balancing the interests of the parties counsels in favor of proceeding and against delay. Here the SEC has an interest in moving forward expeditiously. This proceeding is part of an on-going law enforcement investigation. The agency has an obligation to proceed with its inquiry.

In contrast, any delay until the conclusion of the industry wide administrative proceeding could be lengthy. Although that case is to be completed within 300 days under the Commission's Order, since jurisdictional issues are being raised it is possible that service would have to be effected through the Hague Convention which can be a lengthy process. Likewise, the final resolution of the proceeding may not take place until the conclusion of appeals. Such a delay could be harmful to the Commission's investigation thus arguing against a stay. Accordingly, after considering the interests of each party the Court concluded that the proceeding should move forward.

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

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