The Fraud Examiner

Auditing U.S. Companies in China: Symptomatic of Bigger Accounting Fraud Problems?
 

December 2012

By Peter Goldmann, CFE

  

The Security and Exchange Commission’s (SEC) Dec. 3, 2012 lawsuit against the Big Four accounting firms and BDO (a “second-tier” firm) got a few brief headlines, but not the kind of attention that should have been attracted by a move that could result in serious penalties for the defendant firms.

 

Though not explicitly stated in the SEC complaint, the key issue in question appears to be potential accounting irregularities among Chinese companies that are clients of the Big Four China affiliates.

 

The immediate problem is that Chinese law forbids the release of audit workpapers to U.S. regulatory agencies, referring to what The Wall Street Journal calls “state secrets.”

 

But there are bigger problems in the mix. U.S. multinational companies doing business in China have, for the most part, hired large U.S. accounting firms as their auditors. If Chinese law prohibits disclosure of audit papers, it could make it difficult for auditors to sign off on their audits of China-based clients, which in turn could have a negative impact on share prices and efforts by China-based foreign multinationals to raise capital.

 

Moreover, the very fact of having been sued by the SEC raises questions among investors. The SEC’s latest lawsuit against the Big Four and BDO reveals that:

 

“The [SEC] Division of Enforcement has ongoing fraud investigations concerning Clients A, B, C, D, E, F, G, H, and I, each of which is a U.S. issuer whose securities were registered with the Commission and whose principal operations were based in the People’s Republic of China.

 

“...This action stems from Respondents’ willful refusal, in response to Commission requests, to provide the Commission with audit workpapers and other materials prepared in connection with audit work or interim reviews performed for Clients A, B, C, D, E, F, G, H, and I, in contravention of their legal obligations as foreign public accounting firms.”

 

Obviously it is hard to know which companies are designated as “A” through “I,” however it is probably safe to assume that, since the SEC is investigating them, they are clients with financial records of questionable accuracy. The assumption is based in part on a substantial history of Chinese companies listing in the U.S. — often through what is known as reverse mergers — and then proving to have falsified or otherwise substandard financial records which in turn causes their share prices to tank.

 

An administrative law judge must review the claim and rule on its merits. According to The Wall Street Journal, “If the judge decides against the firms, they could be suspended from seeking new U.S.-traded clients, or even blocked entirely from auditing U.S.-traded companies.”




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