The judge has lifted his stay in the SEC case against Deloitte over the Longtop working papers. This slowly moves the ball forward. Now there will be a hearing on March 13 to hear the merits of the case.
Eventually, I expect the judge will rule that Deloitte must turn over the Longtop working papers to the SEC. Deloitte will certainly refuse citing Chinese laws that criminalize doing so. The judge will likely find Deloitte in contempt of court and punish them, possibly fining the firm, ordering the arrest of its partners should they show up at the San Francisco airport, or banning them from practice before the SEC. The latter could cost Deloitte China all of its U.S. listed clients. But I expect Deloitte appeals and the issue is tied up in courts forever.
Unless the Chinese come around to making a deal with U.S. regulators, I expect that the SEC proceedings will be subsumed into a PCAOB process to deregister all of the firms. China’s new government could make a deal soon, but I think it is now more likely that the PCAOB begins the process of deregistration.
It seems to me that that process could take two forms. First, the PCAOB could take disciplinary action against each registered firm. If the firm is unable or unwilling to subject itself to inspection, the PCAOB would go after the firm’s registration. The problem with this approach is that PCAOB enforcement actions must be kept confidential. No investor will know the status of the enforcement actions against the firm until they are resolved. When they are resolved, investors would suddenly learn that an accounting firm had been deregistered, and the clients would scramble to find new auditors or face delisting. It is unlikely that all disciplinary proceedings would conclude at the same time, meaning a firm might prosper through delaying tactics that allowed it to keep taking new clients until appeals are complete. This approach would be unfair to everyone. Congress could change the rules that prevent the PCAOB from disclosing disciplinary actions prior to their completion. We learn of SEC investigations on a timely basis, and that helps investors manage risk. There is no justification for the present rules that prohibit the PCAOB from disclosing pending enforcement actions.
A better approach would be for the PCAOB to propose a rule change that would deregister any firms it cannot inspect. This action would be subject to the normal rule making processes of the PCAOB, which require full transparency. Public comments would be sought, the PCAOB could conduct public hearings, and an effective date for the rule could be set in a manner to minimize disruption to the markets. Any action that takes place through rule making would apply to all firms at the same time, and would be much more fair.
Thursday, March 7 there will be hearings before the U.S.-China Security and Economic Commission on Chinese auditing problems. I will be testifying and my testimony is here.