PCAOB and Two Chinese Regulators Enter into Memorandum of Understanding on Enforcement Cooperation

 美国公众公司会计监察委员会与中国两家监管机关签署执法合作谅解备忘录

On May 7 the China Securities Regulatory Commission (“CSRC”), China’s Ministry of Finance (“MOF”) and the U.S. Public Company Accounting Oversight Board (“PCAOB”) executed a Memorandum of Understanding on Enforcement Cooperation¹  (the “MOU”).

According to a short announcement published on the websites of the CSRC and MOF on May 24, (i) the MOU serves as a framework pursuant to which China and the United States will provide to and exchange with each other audit documents held within their respective countries, and (ii) the CSRC, MOF and PCAOB will continue to negotiate and explore mutually acceptable procedures through which day-to-day supervision will be permitted in respect of PRC accounting firms providing audit services to U.S.-listed companies.

According to the MOU, subject to certain limitations and conditions, each of the CSRC and the MOF (on the one hand) and the PCAOB (on the other hand) (each, an “MOU Party”) will cooperate to provide the requesting MOU Party (i) information and documents held in the files of the requested MOU Party regarding the matters set forth in the request for assistance and (ii) other information and documents regarding the matters set forth in the request for assistance, including (a) documents sufficient to identify all audit review and other services performed by and quality control systems of audit firms, such as their engagement letters and quality control policies, and (b) audit work papers and other documents held by audit firms relating to audit work that is subject to the regulatory jurisdiction of the requesting MOU Party. Assistance and cooperation provided by either Party under the MOU is subject to the relevant domestic laws of such Party. This means that the CSRC and the MOF will need to comply with the PRC Laws on Protecting State Secrets, the PRC Archives Law, etc.

Although the MOU permits an MOU Party to share information obtained from the other MOU Party with other law enforcement and regulatory authorities within its jurisdiction, the MOU does not freely extend the assistance and cooperation mechanism to such other regulators. The MOU includes confidentiality provisions, one of which expressly requires that an MOU Party receiving non-public information from the other MOU Party must seek the providing MOU Party’s prior written consent if it intends to transfer such information to other authorities within its jurisdiction, except, however, that the PCAOB may share such information with the U.S. SEC without prior written consent so long as the PCAOB notifies the CSRC and MOF in advance.

The MOU primarily focuses on the provision and exchange of information for the purpose of law enforcement and compliance. It does not address the other contentious cross border regulatory issues related to audit oversight — namely, on-site audit supervision and on-site investigation.

Background:

• Under the Sarbanes-Oxley Act adopted by the U.S. in 2002, any audit firm, whether domestic or foreign, must register with and be subject to periodic inspections by the PCAOB if it (a) prepares or issues any audit report with respect to any U.S.-listed issuer; or (b) plays a substantial role in the preparation or furnishing of an audit report with respect to any U.S.-listed issuer.²
• PCAOB registrants currently include more than 900 non-U.S. auditing firms³ from 87 jurisdictions,⁴ including China (47)⁵ and Hong Kong (49).⁶ Starting in the fall of 2010, in response to disputes with China, among others, about the right of the PCAOB to inspect the files of non-U.S. auditing firms, the PCAOB required individual accounting firms from certain jurisdictions seeking to register with the PCAOB to state the firm’s understanding of whether a PCAOB inspection of the firm would be allowed by local law or local authorities, and, if the response was that the inspection would be allowed, to supply written confirmation from the appropriate local regulatory authority. Since that time, no China or Hong Kong-based firms have been registered with the PCAOB while as of May 23, 2013, eight applications from China and six applications from Hong Kong were pending.⁷ The PCAOB declared China and Hong Kong as jurisdictions where “PCAOB inspections are currently prevented because of the position taken by local authorities” and expressly requested China or Hong Kong-based applicants to provide certain additional information because of this circumstance.⁸
• In connection with SEC investigations of alleged financial misreporting by a number of Chinese U.S.-listed companies, the SEC has sought to examine the work papers of the Chinese accounting firms that audited the subject financial statements. In December 2012, the SEC initiated an administrative proceeding against the Chinese affiliates of five global accounting firms for failing to produce documents sought in connection with fraud investigations of Chinese issuers.⁹ The accounting firms in turn indicated they were unable to supply those documents on the basis that to do so would or could violate China’s state secrets law, thereby exposing them to criminal sanctions.
• China has long resisted such cross-border investigations. In May 2006, the CSRC and the SEC announced a new relationship to increase cooperation and collaboration through an enhanced bilateral dialogue mechanism between the two agencies. In 2006 SEC Chairman Christopher Cox (currently a Bingham partner) presented terms of reference and discussion subjects, which included issues related to public company auditing standards and convergence of national accounting standards.¹⁰
• Negotiation on a Sino-US Cross-Border Audit and Oversight Treaty has been on-going for some six years (measured from the PCAOB’s initiative in 2007, but was formally launched during the 3rd annual Sino-US Strategic and Economy Dialogues in May 2011).¹¹
• The SEC and PCAOB had been pushing hard for a resolution of this standoff by the end of 2012.

Conclusion:

While the U.S. regulators have not announced how they will proceed in pending registration, inspection or enforcement matters in light of the new MOU, it is likely that how they will proceed will depend in substantial part on how the MOU is applied in practice and whether both sides can make real progress toward a more comprehensive cooperative oversight agreement.

The execution of the MOU is an encouraging indication that the CSRC, MOF and PCAOB may be on their way towards resolving the remaining practical issues.

¹Link to the English version of the MOU: http://pcaobus.org/International/Documents/MOU_China.pdf
The Chinese version of the MOU is not yet publically available.

²Sarbanes-Oxley Act § 102(a), § 104 (a) & (b), 15 U.S.C. 7212, 7214 (2002); Bylaws and Rules of the PCAOB, Section 2, Rule 2100, as of August 25, 2011.

³http://pcaobus.org/International/Pages/default.aspx

⁴http://pcaobus.org/Registration/Firms/Pages/default.aspx

⁵http://pcaobus.org/Registration/Firms/Pages/RegisteredFirms.aspx

⁶See note 5

⁷http://pcaobus.org/Registration/Firms/Documents/Applicants.pdf

⁸http://pcaobus.org/Registration/Information/Pages/Non_US_Registration_FAQ.aspx

⁹http://www.sec.gov/news/press/2012/2012-249.htm

¹⁰http://www.sec.gov/news/press/2006/2006-63.htm

¹¹http://stock.jrj.com.cn/2012/07/04075013677800.shtml (Chinese source)