Accountants as whistleblowers | China Accounting Blog | Paul Gillis

Accountants as whistleblowers

Section 10A of the Securities and Exchange Act of 1934 requires reporting by auditors to the Securities and Exchange Commission (SEC) when, during the course of a financial audit, an auditor detects likely illegal acts that have a material impact on the financial statements and appropriate remedial action is not being taken by management or the board of directors.

Big Four watchdog Francine McKenna has an extensive post on her re: The Auditors blog where she mostly discusses her frustration in trying to find out how many Section 10A filings were done by Chinese auditors in connection with the rash of accounting frauds uncovered in the past year or so. She tried to get this information out of the SEC through a freedom of information act (FOIA) request. Her unsuccessful efforts are chronicled in a post that is both a testament to bureaucracy and a guide on the worst ways to write a FOIA request. 

I am betting the answer is zero, and I believe she thinks that too. Most Chinese auditors are probably not even aware of the requirement. Section 10A filings are rare for U.S. companies, since the board usually takes the appropriate remedial action. In many of the Chinese fraud situations, the board or management never did take appropriate action. Although the companies were delisted, it appears that Section 10A filings should have been made. 

Section 10A sets up a hypothetical situation that would be an absolute nightmare to a Chinese auditor. Suppose the auditor discovered an illegal act with a material impact on a major SOE. The illegal act might not even be illegal under Chinese law. Reporting it to the SEC would most certainly be considered to be a violation of China’s state secrets laws. Not reporting it would be a clear violation of U.S. laws. I am glad I am not in practice anymore. 

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