Auditing’s Snafu: Foreign Secrecy and Impaired Audits
Many US companies maintain substantial global operations, with increasing volumes of business done in China; many foreign companies are listed on US securities exchanges. This cross-border expansion makes the reliability of financial reports created in foreign locales increasingly important. Yet, in tandem with this cross-border expansion, there have been increasing assertions abroad, including in China, that local secrecy laws restrict access to the work papers of auditors, frustrating the ability of US federal authorities to enforce US securities laws designed to promote financial reporting integrity.
The snafu was joined this week in a case where the SEC is seeking access to audit work papers of a Deloitte affiliate in Shagnhai but the firm refuses. The firm’s lawyers cite Morrison v. National Australia Bank, the 2010 SCOTUS ruling that, absent explicit language, federal statutes are seen as intended to apply within the US, not be extraterritorial. It said that the federal securities laws lacked such explication.
Furthermore, for Deloitte to comply with the SEC’s requests, the lawyers said, would risk committing a serious crime under Chinese law, one punishable by imprisonment. Deloitte’s lawyers say that the combination of Morrison and Chinese secrecy laws puts the records beyond the SEC’s reach.
Lawyers for the SEC object that these points cannot possibly be seen to limit the SEC’s administrative subpoena power under which it has demanded the Deloitte documents. But, during oral argument, the SEC’s lawyers did not acquit themselves well, according to one report, as they could not readily cite the precise legal authority supporting their position.
Deloitte says there isn’t one and that the appropriate procedure to handle such cross-border securities matters is by diplomacy not enforcement. In this view, the SEC is wrong to proceed against Deloitte in court but must dispatch appropriate US officials to broker a resolution with Chinese regulatory counterparts.
The stakes are high for both sides in the case, of course, and for investors and students of auditing. After all, audits endow financial statements with credibility. Shareholders are willing to pay for audits in exchange for that credence value. But if an auditor’s work papers are top secret, inaccessible even to a regulatory overseer, how much of an audit’s credence value is lost? Is it still rational for shareholders to condone paying the auditor’s fee?
When the credibility of financial statements are in doubt, investors should shun their issuer and sell the stock. A critical mass of shareholders of companies affected by this snafu might do well to follow that old-fashioned Wall Street Rule. If they did, then, along with such companies, the need to resort to either a diplomatic or enforcement solution would disappear.
Hat Tip: Lynn Turner
Case: SEC v. Deloitte Touche Tohmatsu CPA Ltd., D.D.C., No. 1:11-mc-00512, 3/13/13
Lawyers: Miles Ruthberg, Latham & Watkins LLP, New York & SEC Assistant Chief Litigation Counsel David Mendel