Aruna Viswanatha of Reuters has an interesting article this week about how the SEC is testing customized punishments. George Canellos, the SEC’s acting enforcement director is quoted as saying: “We want to use all the tools available to us to specifically discourage repeat misconduct and go beyond the injunctions we traditionally obtain”.
This new approach could be appropriate when the SEC decides on how to punish the Chinese accounting firms should it win its case against them.
In their testimony last week before the U.S.-China Security and Economic Commission both the Center for Audit Quality’s Cindy Fornelli and the U.S. Chamber of Commerce’s Tom Quaadman both warned of the risk of a blanket ban against Chinese accounting firms by the SEC. Such a ban could mean that U.S. multinational corporations (MNCs) like General Motors could not be audited since they have significant Chinese operations.
I pointed out in my testimony, as I have before, that it is unlikely that any action by the PCAOB will threaten the audits of U.S. MNCs because under PCAOB rules the auditor must play a substantial role in the audit before it must be registered with the PCAOB. The way substantial role is defined under PCAOB rules makes it highly unlikely in my view that the audit of any U.S. MNC operating in China trips the wire.
But Fornelli and Quaadman are right; the SEC could seek a blanket ban that would forbid the Big Four firms from doing any work on U.S. listed clients, even when it does not sign the audit opinion.
Banning the China firms from working on MNC clients would be a disaster for the U.S. capital markets. Borrowing from just war theory (readers may not know that I attended seminary and my first academic publication was about jus post bellum), I believe that for the SEC to seek such a harsh penalty would violate the principle of proportionality. The “civilian injuries” would be excessive in relation to the “military advantage” anticipated.
The time may come to decide what penalty to impose. In my view the harshest penalty that should be considered is to ban the firms from signing audit opinions on U.S. listed companies and from undertaking a substantial role (as defined by the PCAOB) in audit of those companies. That penalty would be quite severe, since it would likely lead to the delisting of all of their U.S. listed Chinese clients. But it would not disturb the audits of U.S. MNCs.
The SEC stumbled badly in court this week against Deloitte, so perhaps it will not come to that.