Is the SEC suing the wrong audit firm? | China Accounting Blog | Paul Gillis

Is the SEC suing the wrong audit firm?

Deloitte has filed papers with Federal District Court arguing against the SEC’s motion to lift the stay. The judge had agreed to stay the case while the SEC tried to negotiate with the CSRC to obtain access to the working papers sought from Deloitte in the Longtop case. The SEC threw in the towel on negotiations, and asked the judge to lift the stay and proceed to rule on whether Deloitte must produce the working papers. 

Basically, Deloitte argues it would be mean to Deloitte to continue this case, since it might result in them getting punished ahead of the other firms that have since been charged with similar misconduct. I recall using a similar argument when I was in the third grade to defer punishment, and my appeal was denied. I expect that Deloitte gets the same treatment from the judge that I got from my third grade teacher.

There is a statement in the filing that appears incorrect to me, and it raises some significant issues. 

The filing says: Effective January 1, 2013, DTTC changed its name to “Deloitte Touche Tohmatsu CPA LLP (LLP). I don’t think that is what happened. Like all of the Big Four firms, Deloitte is required to move its audit practice into a new entity. It used to practice in Deloitte Touche Tohmatsu CPA Ltd. (LTD). LTD is a Sino-foreign joint venture.  That joint venture passed the end of its 20-year life. Deloitte, like the other Big Four firms, was required to establish a new firm in the form of a special general partnership.  The special general partnership is essentially the same as a limited liability partnership in other countries, and Deloitte appears to have adopted the LLP term in the name of its new China entity. 

Yet these are different entities. The SEC cases are against LTD, not LLP. The entities do not even have the same owners; Chinese law requires that locally qualified partners own at least 60% of LLP. LTD probably does not even exist anymore, since its 20-year life came to an end. 

That raises an interesting question. Suppose the SEC wins the cases against Deloitte. Suppose the judges decide to revoke LTD’s right to practice before the SEC. LTD no longer exists; Deloitte’s China audit practice is now in LLP, a different firm owned by different people. So can Deloitte just accept the SEC penalty and continue to audit U.S. listed companies because LLP has not been banned? Certainly the SEC cannot arbitrarily assign the penalty to LLP, especially since it is a new legal entity and has different owners.  

Deloitte filed Form 4 with the PCAOB on January 1 to report that LLP would succeed to the PCAOB registration of LTD. I have questioned whether LLP is allowed to succeed to the PCAOB registration of LTD. James Doty, Chairman of the PCAOB was asked whether the Big Four should have been allowed to transfer their registration to the new firms, and Doty suggested that the PCAOB review was not complete. This development may make that review more important, since the PCAOB has the power to revoke the registrations of the new firms, a power the judge in the SEC cases may lack. 

I am surprised that Deloitte’s lawyers made such a potentially misleading statement in the filing. The SEC and the judge ought to be figuring out the significance of this change in the entity that operates the Big Four firms in China. 

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