In January, an administrative law judge (ALJ) for the Securities and Exchange Commission (SEC) sanctioned five Chinese affiliates of major U.S. accounting firms for their failure to produce work papers related to audits of ten China based U.S. issuers who were under investigation by the SEC.
The accounting firms’ defense, essentially was — China says that if we cooperate with the SEC, we’ll violate the China state secrets law. So, we can’t cooperate.
The Administrative Law Judge who heard the case was not sympathetic to this defense.
“Respondents operated large accounting businesses for years, knowing that, if called upon to cooperate in a Commission investigation into their business, they must necessarily fail to fully cooperate and might thereby violate the law,” the judge wrote. “Then, when actually called upon to fully cooperate, respondents complained that they should be relieved from that duty because, among other things, they invested money and effort in building up their accounting businesses. Such behavior does not demonstrate good faith, indeed, quite the opposite – it demonstrates gall. Each Respondent made the affirmative decision, no later than the time it filed its Sarbanes-Oxley 106 designation of agent, to conduct its auditing business ‘at risk.’”
Were these firms betting that it would be easier to go against the SEC than against the Chinese authorities?
“They certainly understood that on the SEC side, there are civil and professional level sanctions for a public company accounting firm,” Bret Campbell, a partner at Cadwalader in Washington, D.C. told Corporate Crime Reporter in an interview last week. “There is the potential of a censure from the ALJ and a practice bar, which means you are not allowed to practice in front of the SEC. That means you couldn’t audit a public company. That is balanced on the other side with real criminal prosecution in China – detention and subsequent prosecution of your employees and the destruction of your organization with a bit less due process than you would expect over here. They were apparently more willing to push the SEC than flout the Chinese regulators.”
Campbell is author of an article titled Caught Between a Great Wall and a Hard Place: Issues for U.S. Public Companies in Responding to Regulatory Requests for Chinese Data.
“One of the arguments the firms made was — we have invested a tremendous amount of time and money building these practices, we have performed audits for all sorts of companies, we are very important to the smooth functioning of the securities markets because we provide accounting services which cannot be performed by smaller accounting firms,” Campbell said.
“When we registered to perform this kind of work with the Public Company Accounting Oversight Board, we said back then we were going to have this problem and wouldn’t be able to produce these documents. For all of these reasons, you should not sanction us.”
“The ALJ focused on the commercial side of that argument. He said — you saw profits, you were chasing the money, you decided you wanted to avail yourselves of this client base. You knew full well this could happen. So, if you are having a problem now, you shouldn’t complain about it, because you were chasing the dollars that put you in that place. The ALJ didn’t have a lot sympathy for the argument of the accounting firms.”
What exactly are the state secrets — what are the Chinese concerned about?
“That’s the crux of the problem for the review team in China and for Chinese regulators,” Campbell said. “You see that in the ALJ’s opinion — the Chinese regulators would not tell them what were state secrets. It can be a catch all for misconduct. And there could be political overtones to it. It’s opaque.”
“The Chinese government released what was supposed to be a clarification on state secrets law. And although it provides discretion to officials in determining what is a state secret, it cautions officials that any official who releases state secrets will be dealt with according to law.”
“What’s nice about the ALJ opinion is that it tells us what the accounting firms were finding and what they thought were state secrets.”
“The two examples that they gave were technology know how and non-public Chinese governance policy — presumably communications with regulators, advice from regulators on treatment of transactions — the kind of thing where it would be a discussion with the regulator, rather than something that was publicly issued by the agency.”
“Those are two examples of state secrets. And then the ALJ gives examples of the type of documents where they did not find state secrets. That’s also helpful.”
“Generally they did not find state secrets in bank records, supplier records, customer records, financial books and records, and the auditor’s findings.”
Is the judge saying that these companies, knowing the conflict, should not have operated in China?
“The SEC and the judge wouldn’t take that position,” Campbell said. “What they are saying is — you were aware of this risk when you chased your profit into China. You understood there was a risk of this happening. And now that you are facing this risk, you need to address it. And I’m not going to tell you how to do it. The SEC Enforcement Division isn’t going to tell you how to do it. But you need to fix this problem and comply with regulations here in the United States.”
But there might not be a way to fix it?
“That could be one outcome. In this case, there could be a middle way — cooperation and sharing agreements with the SEC and in China. Those are slowly becoming unstuck. And it looks as if production materials can occur.”
“Companies face conflicting cross-border regulator demands. And there’s not a perfect fix for it.”
[For the complete transcript of the Interview with Bret Campbell, see 28 Corporate Crime Reporter 9(12), March 4, 2014, print edition only.]