Call it a crack in the Great Wall. The Securities & Exchange Commission has long been investigating scores of U.S.-listed Chinese companies embroiled in accounting scandals. The agency has been hamstrung, however, in its efforts to compel the Chinese units of the major accounting firms that advised those companies to provide a paper trail. Again and again, the audit firms have successfully parried the requests, arguing that to do so would compel them to violate Chinese sovereignty and Chinese laws regarding state secrets.
Now, for the first time, China's securities regulator has agreed to turn over audit documents related to an ongoing SEC investigation of a U.S.-listed Chinese company. And more may be to come.
The news was first reported earlier in the week in the Chinese press, and later confirmed by the SEC on Wednesday in a subpoena enforcement action against the Chinese unit of Deloitte Touche. The SEC said in a one-paragraph notice that it had received assurances from the China Securities Regulatory Commission that the regulator would turn over audit papers related to Deloitte's work for Longtop Financial Technologies Ltd., a now-defunct U.S.-listed Chinese software company.
The SEC's court filing, lodged in the U.S. district court for the District of Columbia, noted that the extent of the document production remains unclear. But according to a Reuters report, the SEC could receive as many as 20 boxes of audit documents by Monday. (Reuters cited as a source a person present at a related SEC proceeding, an administrative trial against all five Chinese units of the five largest audit firms; an additional source confirmed the details to the Litigation Daily.)
On Friday, according to a person present at the SEC's administrative trial, an official in the SEC's international affairs office, Alberto Arevalo, testified upon cross-examination that the document sharing, if successful, would be the first production of work papers by the Chinese securities regulator to the SEC.
Also still unclear is whether the unprecedented move by the Chinese authorities is a watershed moment in cross-border sharing or just a one-off agreement. According to The Wall Street Journal, more than 100 Chinese companies traded in the U.S. have faced questions about their bookkeeping and disclosures. On Thursday, U.S. Treasury Secretary Jacob Lew praised the step towards cooperation on the investigatory front as part of his discussion of several joint Chinese-U.S. trade cooperation developments announced this week.
Longtop went public in 2007 with the help not just of Deloitte, but also Goldman Sachs and Deutsche Bank, which served as Longtop's underwriters. Over the next four years Longtop's profits far exceeded those of its competitors and investors jumped on the bandwagon. But in April 2011, a short-seller declared that Longtop's success story was a complete fraud. Those warnings didn't shake investor confidence, but did seem to make Deloitte inspect Longtop more closely. Deloitte says that, despite efforts by Longtop to stymie its investigation, it eventually discovered hidden debts and wildly inflated cash deposits. The auditing firm very publicly resigned in May 2011, sending Longtop's stock price down to zip. The New York Stock Exchange delisted Longtop in August, and the SEC revoked the company's registration in March 2012.
The subpoena enforcement action against Deloitte began the fall of 2011, when the SEC, frustrated at Deloitte's unwillingness to share the information about its former client, asked the court in D.C. to order the auditor to comply. Deloitte tapped Miles Ruthberg at Latham & Watkins, as well as Michael Warden at Sidley Austin, to defend it in that action and in the parallel administrative proceeding before the SEC.
Deloitte argued in April 2012 that China's secrecy laws prevented it from turning over the documents. It also argued that the SEC had other, lawful ways of acquiring the information—namely, a direct appeal to Chinese regulators. U.S. District Judge Gladys Kessler has been fully briefed on the issues but hasn't indicated when she'll decide the subpoena issue. If the documents are obtained via the SEC's agreement with the regulatory agency, it could moot or undercut the SEC's case. The SEC noted in Wedesday's court filing, however, that it has no idea whether it will receive all the records it requested or how their use may be restricted.
In the administrative trial, the SEC is seeking to sanction the audit firms' Chinese units for failure to cooperate in its investigations. Deloitte Touche Tohmatsu is represented by Sidley Austin and Latham & Watkins; the Chinese affiliate of BDO, China Dahua CPA Co. has tapped DLA Piper; Ernst & Young Hua Ming LLP is relying on Orrick; PriceWaterhouseCoopers Zhong Tian CPAs Limited is represented by Davis Polk & Wardwell; and KPMG Huazhen has Sidley Austin.
Meanwhile, there were other developments this week in the Longtop saga in the Southern District of New York. On Thursday, in a securities fraud case in which Longtop has yet to make an appearance, U.S. District Court judge Shira Scheindlin certified a class of Longtop shareholders and appointed Kessler Topaz Meltzer & Check as lead class counsel; Grant & Eisenhofer was appointed as local counsel. The certification motion, filed only last month, was unopposed.
Deloitte's Chinese arm, however, no longer faces civil liability in the class action. Plaintiffs counsel had alleged in an amended complaint filed last December that the audit firm helped cover up the massive accounting scandal at Longtop. But Deloitte's lawyers at Sidley Autin persuaded U.S. District Judge Shira Scheindlin that the auditor was likely a victim, not a perpetrator, in Longtop's alleged fraud, and in April she dismissed the company as a defendant.
We reached out to Grant & Eisenhofer's Daniel Berger and Kimberly Justice at Kessler Topaz. Neither responded at press time.
This article originally appeared in The Am Law Litigation Daily.
