Today, the Securities and Exchange Commission (“SEC” or “Commission”) announced the terms of a settlement with four of the Respondents in In the Matter of BDO China Dhaua CPA Co., Ltd. The four Respondents are the China affiliates of the “Big Four” international accounting firms —Deloitte Touche Tohmatsu Certified Public Accountants Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen (Special General Partnership), and PricewaterhouseCoopers Zhong Tian CPAs Limited. The settlement resolves an administrative proceeding brought by the Commission against Respondents pursuant to Rule 102(e) of the SEC’s Rules of Practice over requests made by the SEC for the production of audit work papers located in China.
The SEC’s Division of Enforcement (“the Division”) requested audit work papers and related documents from each of the four Respondents pursuant to Section 106 of the Sarbanes-Oxley Act of 2002. In each instance, the requested documents were located in China and related to work done for a China-based company that was, at some point, listed on a U.S. stock exchange. In response to the requests, each of the four Respondents engaged in a lengthy series of correspondence with the Division to explain that, under Chinese law and pursuant to explicit instructions from Chinese regulators, the requested documents could not be produced directly to the SEC. The Respondents urged the Division to seek the documents through the Chinese regulator, pursuant to existing agreements between the two agencies.
Instead, in December of 2012 the Commission initiated this administrative proceeding pursuant to Rule 102(e)(1)(iii), citing to the Division’s allegations that each of the firms “willfully refused” to provide their audit work papers and other documents to the Commission, as required by Section 106. Under Rule 102(e), the Respondents faced censure or even a bar from appearing or practicing before the Commission for not producing requested materials. In practical terms, being barred from appearing before the Commission would effectively end Respondents’ work for any company listed on a U.S. stock exchange.
During the course of the proceeding, Respondents argued that they did not “willfully refuse” to produce the relevant documents to the SEC—a standard, they argued, which requires proof of an intentional violation—but were directly prohibited from doing so by Chinese law and regulators.
After a July 2013 hearing, Administrative Law Judge Cameron Elliot agreed with the Division and held that under Section 106, “‘willful refusal to comply’ means ‘choosing not to act after receiving notice that action was requested,’ without regard to good faith.” According to Judge Elliot, under this definition “the motive for the choice is irrelevant, so long as the Respondent knew of the request and made a choice not to comply with it” and, as such, “bad faith need not be demonstrated, and good faith is not a defense.” Accordingly, under Judge Elliot’s interpretation of Section 106, any restriction placed upon the Respondents by Chinese law or by Chinese regulators was deemed irrelevant to the “willful refusal” analysis. Judge Elliot censured each of the Respondents and barred them from appearing or practicing before the Commission for six months.
Both the Division and the Respondents appealed Judge Elliot’s ruling to the Commission. During the pendency of that appeal, the parties reached this settlement, thereby terminating the appeal and resolving the case. The terms of the publicly disclosed settlement provide for firm censures, payment of $500,000 by each Respondent, a stay of the proceeding, which will be dismissed if not restarted within four years, and undertakings for new procedures designed to control future requests for work papers and other documents located in China. Each Respondent also admitted to a series of facts regarding the matter and consented to entry of the Order, which contains a finding by the Commission that Respondents willfully violated Section 106.
Under the new procedures for SEC document requests covered by Section 106, for a period of four years from the date of the issuance of the Order, any Division request for audit work papers (and related documents) held in China will be made to the China Securities Regulatory Commission (“CSRC”) pursuant to existing international sharing mechanisms, such as the IOSCO Memorandum of Understanding. At the same time, the Division will also either issue a Section 106 request for the same information to the relevant firm’s designated U.S. counterpart, or, provide the firm with notice of the SEC’s request to the CSRC.
Within 90 days of a request to the CSRC by the SEC, or within 45 days after the CSRC receives notice of the Division’s request, whichever is later, the firm will provide an initial declaration to the Division explaining that the responsive documents have been provided to the CSRC for production to the SEC. The declaration also will identify whether documents have been withheld based on U.S. privilege or Chinese law. Firms are also required to notify the CSRC in writing when they are ready to provide responsive documents to the CSRC, and to facilitate the SEC’s receipt of those documents as expeditiously as possible. Then, within ten days of receiving notice from the SEC that the SEC has received the documents, the firm will provide a certification of completeness to the SEC that all responsive documents were provided to the CSRC except those withheld for US privilege or under China law. The firm must also include with the certification all requests made by the CSRC to the firm for the documents, together with English translations, and include in the certification a description of the search conducted for responsive documents and the “process” employed to determine whether information should be withheld.
Importantly, the settlement also provides the SEC with alternative forms of relief if it is dissatisfied with Respondents’ document production. First, the Order provides that if the Division believes that two or more of its requests made “collectively” to the firms are not met with “a materially complete production and/or an adequate privilege log, withholding log, initial declaration, and/or certification of completeness,” then the Division may recommend that the stay of the underlying action be terminated and the proceedings reinstated. In addition, the Division may also recommend that the stay be terminated if, with respect to two or more requests, “a substantial number of documents” have been withheld without justification, or if, in the Division’s view, “its receipt of a production has been substantially delayed.”
In addition to restarting the proceeding, as described above, the Commission may also institute summary proceedings against a Respondent for deficient productions. Under this procedure, the Division must give the relevant Respondent 20 days to cure the alleged deficiency. If, in the Division’s view, the deficiency has not been cured, then the Commission may institute a summary proceeding for the purpose of determining whether the Respondent’s response to the Division’s request was “inadequate,” whether “U.S. privilege justifies the withholding of any responsive information,” or whether a production made to the CSRC was “otherwise materially complete.” These summary proceedings will be adjudicated by an Administrative Law Judge within 180 days and, if decided against the Respondent, could result in a partial or complete bar on appearing or practicing before the Commission, a censure, and/or “a monetary penalty up to U.S. $750,000 per offense.”
Finally, the settlement also provides for the imposition of an automatic six-month practice bar if a firm does not provide the initial declaration or the certification of completeness as required under the new procedures. This circumstance also requires the Commission to first allow for a 20 day cure period, but if the deficiency has not been cured then the Commission can determine that the Respondent has not complied with its obligations under the Order, and will enter an order that partially denies the Respondent the privilege of practicing or appearing before the Commission for a period of six months. This six-month bar would prevent the firm from issuing an audit report, serving as a principal auditor, and “playing a 50% or greater role in the preparation or furnishing of an audit report for any issuer.”
Orrick represents Ernst & Young Hua Ming LLP in the case.