U.S. regulators have charged the Chinese arms of the world's five top accounting firms with securities violations, raising tensions in a regulatory standoff which experts say could kill off U.S. listings for Chinese firms if not resolved.
Monday's move indicated China was refusing to yield in talks with the United States over access to Chinese audit papers, trying to keep foreign regulators off what it sees as its turf.
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The Securities and Exchange Commission (SEC) wants the firms to supply documents relating to audits of U.S.-listed companies suspected of possible wrongdoing, but the audit firms say they are prevented from doing so by Chinese state secrecy laws.
"I think China has determined that it does not want to cooperate in this way. It believes this is an impingement on China's national sovereignty, and it's just too far for them to go," said Paul Gillis, a professor at Peking University and author of the China Accounting Blog
"They want the U.S. regulators to rely on the work of Chinese regulators, and that has been their position and apparently continues to be their position," said Gillis.
The SEC began proceedings against the Chinese affiliates of Deloitte, KPMG, PricewaterhouseCoopers (PwC), BDO and Ernst & Young. The agency on Monday also moved to pursue a case they had put on hold against Deloitte.
It was the SEC's widest enforcement effort yet to procure documents in connection with probes of possible accounting fraud of U.S.-listed Chinese companies, however lawyers voiced doubts over whether it would help them make a breakthrough.
"Simply swinging the hammer of enforcement, while effective at garnering headlines, will likely not be enough to achieve the SEC's goal," said William McGovern, a partner at Kobre & Kim in Hong Kong and a former SEC attorney.
The SEC, which is seeking documents in investigating possible wrongdoing at nine China-based companies, said an administrative law judge would schedule a hearing to determine potential sanctions against the accounting firms' Chinese arms.
It was unclear whether the SEC's move would result in financial penalties and discourage the firms from working with certain Chinese companies, or it was designed to force a breakthrough in the larger negotiations.
Peking University's Gillis said if no diplomatic solution could be found, the SEC might ultimately suspend the Chinese firms' right to practice - a sanction that could in turn mean that their U.S.-listed client companies would have to de-list.
"That would mean they cannot audit U.S.-listed public companies," he said.
The SEC said in July it was in talks with Chinese regulators on cross-border cooperation, including access to documents, but Monday's action suggested it was unhappy with progress.
U.S. accounting regulator the Public Company Accounting Oversight Board (PCAOB) has now reached agreements with almost every major economy aside from China on being allowed to inspect foreign auditors of U.S.-listed companies.
"Firms that conduct audits knowing they cannot comply with laws requiring access to these work papers face serious sanctions," SEC enforcement director Robert Khuzami said in a statement announcing the action.
The accounting firms called for regulators to negotiate a solution, noting that U.S. and Chinese laws were in conflict.
"This action involves an issue that needs to be resolved between the U.S. and China," PwC China said in a statement.
Deloitte said it was unfortunate the two sides could not find common ground but "we remain hopeful that a diplomatic agreement can be reached".
China affiliates Ernst & Young Hua Ming and KPMG Huazhen said they too still hoped for an agreement. BDO did not immediately respond to a request for comment.
Top accounting firms operate as global networks of legally separate member firms in each country, so all member firms are not jointly liable for auditing work done in any one country.
Lawyers say there is still a queue of Chinese companies eager to tap U.S. capital markets, despite the problems faced by many of their peers that went before them.
"I would estimate that there are probably 30 to 40 China-based companies in some stage of pursuing a U.S. listing at this time," said Alan Seem, a partner at law firm Shearman & Sterling in Beijing.
Separately, Canada's securities regulator said it believed Ernst & Young had breached the Ontario Securities Act in its audits of Sino-Forest Corp, a China-focused forestry company which collapsed after being accused of accounting fraud.
Ernst & Young Canada said in a statement it was confident its work "met all professional standards".
Last year, the SEC took Deloitte to federal court to try to force it to turn over documents in connection with an investigation into China's Longtop Financial Technologies Ltd. In July, it sought a six-month delay in that legal battle, citing negotiations with Chinese regulators.
On Monday, the SEC said those talks had failed and it filed a motion to proceed with the case. It also renewed efforts to obtain the documents related to the Longtop audit.
The PCAOB, the U.S. accounting watchdog, recently completed observations of Chinese inspections of auditors and expressed optimism about talks over access to audit documents.
In a statement, PCAOB Chairman James Doty said his agency's negotiations were proceeding on a separate track from the SEC.
If the agency's efforts do not lead to an agreement, "then we will need to consider other alternatives", Doty said.
(Additional reporting by Dena Aubin in NEW YORK and Aileen Wang in BEIJING; Editing by Mark Bendeich)