On January 22, 2014, an administrative law judge handed down his decision in connection with the SEC's on-going efforts to obtain audit working papers from the Big Four accounting firms1. The requests arose in connection with several on-going SEC investigations. Significant portions of the decision were redacted. Much of the recent commentary is critical of the decision. Moreover, the international effect of the decision may be troublesome, particularly since in the months before the decision, progress was being made towards the ultimate goal of sharing working papers under the May 2013 Memorandum of Understanding among the CSRC, the MOF and the SEC (the "MOU"). See Sharing Audit Papers Across Borders - Incremental Progress. Just days after the decision, however, on January 27, the SEC, together with DTTC, filed a joint motion to dismiss a lawsuit that the SEC filed against DTTC in 2011, also in connection with the auditing firm's failure to produce requested auditing documents. The move comes after the SEC received a substantial number of the documents it sought from the CSRC. Then, on February 5, the PCAOB announced that it is close to reaching an agreement with the CSRC, under which the SEC would be able to inspect Chinese subsidiaries of accounting firms. Most recently, the Big Four have as expected appealed the administrative law decision. This Haiwen Alert sheds light on the possible implications of these latest developments.

In the latter part of 2013, there appeared to be incremental progress towards cooperation among the SEC, the CSRC and the MOF. From 2010 to 2012, the SEC sought audit documents from the Big Four and the CSRC a number of times. The SEC and the PCAOB are empowered to request audit working papers from PCAOB registered auditors who audit publicly traded companies in the US. Prior requests were rejected on the grounds that Chinese law did not permit the auditors to share these documents with foreign regulators. In 2012, the CSRC offered to produce audit documents sought by the SEC subject to conditions that the SEC was not prepared to accept. Cooperation between the Chinese and US regulators then gathered pace, and they executed the MOU in May 2013. A protocol for sharing audit papers followed on June 4, 2013. Reportedly, the protocol obligates accounting firms to hire Chinese legal counsel to certify that the protocol is followed when documents are produced, and to determine what, if any, content of the working papers require redaction as a matter of Chinese secrecy laws. Against this background, when the CSRC produced certain documents requested by the SEC in July 2013, many hoped there had been a significant breakthrough.

This January 22 decision, however, appeared to be another hiccup in the steadily improving relationship among the Chinese and US regulators. Technically, it was an administrative court decision pursued by the US regulators. As a result, it was likely to be perceived in China as an act of the US government itself2, a view that was evident in some of the Chinese media coverage of the decision. Consequently, it appeared that the implications of the decision would extend beyond the legal arena and into diplomatic channels. High-level diplomacy was considered to be the most effective channel for a timely and acceptable resolution of this perceived impasse.

This decision addressed only a few legal issues, including whether the auditors violated section 106 of the Sarbanes-Oxley Act by willfully refusing to comply with SEC requests. However, the decision also mentioned it may undermine the regulators attempts to reach a diplomatic solution to the existing conflict of national laws. It was for this reason, together with a need to keep expert opinions concerning sanctions confidential, that large passages of the decision containing sensitive information were redacted. The decision was criticized by the CSRC for disregarding China's increasingly accommodating stance towards the SEC's requests, jeopardizing future opportunities for improved cooperation, and ignoring its potential real-world consequences. While the experts appearing on record were all highly qualified, only one was a Chinese legal academic. Going forward, it may be beneficial to widen the pool of experts to include Chinese capital markets practitioners familiar with the workings of the international securities markets and CSRC and MOF practices.

On February 12, the Big Four appealed the administrative law decision to a five-member panel of the SEC. The SEC's decision to take legal action in the first place was a bold move in diplomatic terms, and the January 22 decision was widely expected to sour the relation between the SEC and the CSRC. However, it was hoped that the SEC's latest motion to dismiss its previous 2011 action against DTTC may reinvigorate diplomatic efforts between regulators in Beijing and Washington. This appears to be the case as latest reports suggest that the regulators are looking to finalize an agreement sooner rather than later, though the exact details are still unknown. It can only be hoped that this latest dialogue between the regulators reaches fruition and delivers the long term solution necessary for greater transparency and certainty, and that the appeal process will not further hamper these efforts.


1 The "Big Four" were the Chinese licensed operations of KPMG, Deloitte, PricewaterhouseCoopers and Ernst & Young. Dahua was also part of the decision, but has since almost completely withdrawn from the US market. The judge imposed only a censure on Dahua, not a six-month bar. The others received both a censure and a six-month bar.

2 This view will be bolstered if the SEC upholds the six-month bar or imposes another similar sanction on appeal.

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