A Case of Regulatory Capture: And Why The SEC Won’t Push Deloitte To The Limit

Given the SEC’s recent actions against Deloitte Shanghai regarding the firm’s unwillingness to provide audit workpapers for their former client Longtop, I thought it would be helpful to make sure you saw the column below, originally published at Forbes.com on August 22, 2011.

A few things need to be cleared up regarding the SEC’s actions against Deloitte Shanghai, in particular because of inaccurate reporting at Reuters and superficial reporting at the other major media outlets.

  • Having ‘Deloitte’ ‘KPMG’ PwC’ ‘EY’ in your name will not generate additional liability or obligation for a non-US audit firm beyond reputational risk.
  • The SEC/PCAOB will not pull the registration of a major non-US member firm because of inability to inspect or lack of cooperation with subpoenas. The SEC/PCAOB left reckless Price Waterhouse India of Satyam fame open. Crippled, but still pumping out audits. Fortune 500 multinationals are too dependent on the auditors to use their member firms to get full scope audit coverage even if it’s a sham. As the story below demonstrates, the regulators are at risk of capture by the Big Four audit firms.
  • There is no scenario where the SEC asks ‘Microsoft’ for their Chinese audit workpapers, as described by the Chinese academic source that Reuters quoted. The companies don’t have them. The SEC could tell “Microsoft” that their audit opinion is invalid, however, if they believe that a material consolidated portion of the company has been audited by a sham firm and the US firm does not adequately supervise, review, re-test or otherwise make up for this weakness. No valid audit means no exchange listing and the company also violates securities laws.
  • Nor is there a scenario where auditors voluntarily give up doing Chinese audits. The business and its potential, like in India, is too lucrative.

To understand the level of regulatory capture in Deloitte’s case, you have to understand how close all the audit firms, but especially Deloitte right now, are to the SEC. I talked about it in my column: “File Under Regulatory Capture: Deloitte’s Fireside Chats”. Deloitte sponsors a program at the SEC Historical Society where they can launder their image and pretend they had nothing to do with the crisis-era crash of Bear Stearns, Washington Mutual, Merrill Lynch, Fannie Mae, Taylor Bean and Whitaker, and Royal Bank of Scotland, to name only the big ones.

On the way to looking for something else – a list of all the S.E.C. Chairmen, Chief Accountants, and Directors of Enforcement since 2000 – I found this. It’s a calendar entry for a program this fall at the U.S. Securities and Exchange Commission (S.E.C.) Historical Society:

Someone will say, “But that’s history. They’re not talking about the day-to-day management of the agency.”


According to the S.E.C. Historical Society website, “the Society is a 501(c)(3) non-profit organization, independent of the U.S. Securities and Exchange Commission.”

The S.E.C. Historical Society website has a page describing the Deloitte series. It includes the Deloitte logo and a link to their website.

Deloitte Fireside Chats are interactive programs on current issues in financial regulation of interest to the accounting and auditing professions. The audience for each Fireside Chat is invited to submit questions for the program prior to broadcast.

The SEC Historical Society collaborates with Deloitte to broadcast the Fireside Chats. The Society is responsible for the selection of the academic moderator for each Chat; the Society and Deloitte work together to determine the topics and presenters for each program.

Previous topics in the series include:

  • Responsibility for Preventing and Detecting Financial Reporting Fraud
  • Regulation in the Audit Profession: Yesterday, Today and Tomorrow
  • Exploring Principles vs. Rules-Based Accounting and Auditing Standards
  • The Role of Professional Judgment in Accounting and Auditing

For more about how Deloitte, as a firm, views these topics on a day-to-day basis, all over the world, you can read:

No Audit At All: Deloitte And Bear Stearns

Chinese Reverse Mergers: The Auditor Angle (Recent Chinese alleged frauds China Media Express and Longtop were both audited by Deloitte.)

Two Wildly Different Stories About Deloitte: Or Are They?

Slippery People: Corporate Governance At Berkshire Hathaway(Deloitte is the relatively inexpensive auditor for Berkshire Hathway. When a Deloitte Vice Chairman was sanctioned for trading in several Fortune 500 audit clients’ shares, including Berkshire stock, while serving as a client relationship partner to the companies’ audit committees, Berkshire cleared Deloitte of independence violations and kept them on anyway. Better the devil you know…)

Deloitte’s Troubles Bubble To The Surface (Deloitte lost big clients during the financial crisis – Bear Stearns, Merrill Lynch, Washington Mutual, and American Home, to name a few – and is responding to significant litigation as a result of their audit opinions. They’ve kept a few clients too, like Morgan Stanley, Fannie Mae and Royal Bank of Scotland, where some say they shouldn’t have.)

Auditors And Consulting: Claims of No Conflict Strain Credibility

Deloitte, Delphi, and GM: Duped or Duplicitious

Deloitte: Good Corporate Citizen, Good Soldier

11 replies
  1. William Ross
    William Ross says:

    I think you are wrong about the SEC and Deloitte. Microsoft in China is audited by Deloitte, and if the SEC chose to see those working papers they could subpoena them, just as it did in the Longtop case. If Deloitte China were to lose its PCAOB registration it would also lose its ability to audit Microsoft in China.

  2. Francine
    Francine says:

    @Willima Ross

    The person quoted by Reuters said that the SEC could ask “Microsoft” for the audit workpapers. The company does not have them. The SEC could ask Deloitte for the workpapers, though. They may have better luck. Since Microsoft is based in the US, the US engagement team should be supervising the work of the audit teams in China to audit a portion of Microsoft. Deloitte China is doing work as a Deloitte US vendor, on an arms length basis. (Deloitte could have PwC China or KPMG China do the work if there were no Deloitte China.) Deloitte China is a separate legal entity, self-governed, working under the Deloitte name like a franchisee. They finish the work, send an invoice to Deloitte US and US sends a wire transfer to Deloitte China. (May be different to send money to China but you get the idea.)

    The complete “Microsoft” workpapers should be sitting electronically on a server that is accessible to all the “need to know” people all over the world but in particular in the United States because they are ultimately responsible for the audit and the issuer. Different case completely. (But the same in that people in the US have access to the Longtop workpapers on a global server or US server because they had to review them as a US issuer.)

    Yes, If Deloitte China were to lose its registration in China – a very unlikely situation – they could not support US as a vendor and audit the China portion of Microsoft. But someone else could. Like PwC China or KPMG China. Or, assuming the Chinese government would allow it – which they most likely would not – US could send US folks, Japanese folks, UK folks, to do the work in China. It happens all the time. Just because a global firm has a member fim in the country, does not mean the local firm gets to do all the work on behalf of multinationals. It’s a business arrangement and sometimes they are not the best choice. Some countries prohibit this and require locally registered firms to do audit work, but it’s very common on the advisory side.

    The SEC/PCAOB can not de-register Deloitte China for refusing to honor the subpoena without also de-registering all the registered firms there. All the firms in China have said they would not comply with such a request. And none of the firms are able to be inspected. It’s not a situation unique to Deloitte. Deloitte is the unlucky one to have it come up now.

  3. William Ross
    William Ross says:

    So you admit that the SEC could subpoena Deloitte’s work papers on Microsoft, which was clearly the point of the Reuter’s article, even if poorly expressed.

    And you don’t deny that the SEC could bar Deloitte from practice and the PCAOB could deregister for this and for the inability to inspect. They would not be required to do this to the other Big Four, although I agree they likely would.

    In the end, you are saying that you don’t believe that the SEC/PCAOB will use the nuclear option on the Big Four in China to force the issues of enforcement/cooperation/inspections. That is a fair opinion. I am not sure you need to attack those who point out that the nuclear option does appear to be on the table right now.

  4. Francine
    Francine says:

    The point of the Reuters article, I think, should have been to explain that the SEC can subpoena a Chinese audit firm’s work papers but that trying to do so doesn’t make it happen. (The article implied that the commentator thinks the client company has the audit work papers. That’s just wrong.) It’s a totally different situation when the SEC and PCAOB is dealing with the U.S. audit firm. That’s the point. Can the SEC’s arms reach to China to protect investors? Clearly in the US they can if they choose to extend themselves. But the SEC and PCAOB have gotten themselves into a pickle by allowing the audit firms to operate under these willful denials of the SEC and PCAOB’s authority over them.

    Inexperienced journalists and those who lack the interest and aptitude to understand the industry like hearing about “nuclear options”. Sometimes people like to be quoted making provocative statements. But that’s not helpful to understanding what’s likely to happen or what’s best for investors. That’s why I criticize Reuters, not the commentators. Except for Jake Zamansky. He knows better.

  5. William Ross
    William Ross says:

    On that we agree. The real question here is whether Chinese companies should be permitted to list in the U.S. when it is impossible to enforce securities laws against them. I think the SEC is trying to up the stakes here, but this is really a bigger issue than just the PCAOB and the SEC. They both have the ability to kick these companies out of the U.S. by going after the auditors like this. The lack of inspections is enough for the PCAOB to deregister these firms should they choose to do so. But do they have the political will do it? There are plenty of powerful people who make a lot of money off these listings – investment banks, accounting firms, lawyers etc.

    The Deloitte Longtop case is significant because the SEC does appear to have its finger on the nuclear bomb.

  6. Francine
    Francine says:

    @Willimam Ross

    I agree it’s the listing that matters first. That’s the first mistake they made. Longtop was not a reverse merger so it’s an even worse embarrassment, but the reverse mergers were a loophole that must be closed. Every last one of them should be forced to go through the regular listing procedure.

    No, they do not have political will to use nuclear option. Everyone I have spoken to, including some in very influential positions, says this will be solved one situation at a time. Longtop has received so much press and there’s so much exposure to China they had to do something.

  7. Independent Accountant
    Independent Accountant says:

    The PCAOB is a scam in my opinion. Its inspections are a farce. Why do you believe PCAOB inspectors are any more competent than Big 87654 CPAs? I don’t. If the SEC wants to do something useful it could prohibit the Big 87654 from “leasing” their names to firms for which they assume no legal liability.
    Why is the SEC interested in such a small portion of America’s capital markets anyway? I estimate the various Chinese “reverse merger” companies total market cap is less than $20 billion, or about .0015 of the value of all SEC registrants. Why does the SEC look at this? I have said before, the PCAOB is a scam when four firms audit 98.8% of SEC regitrants by market cap, three other firms audit 0.8% and 1,790 firms audit 0.4%. Who cares what they do? How can the PCAOB find time to look at these small firms?
    The PCAOB-SEC is diverting attention from the failures of the Big 87654 to audit TBTF financial institutions, among other failures.
    I disagree with you about closing the “reverse merger” loophole. The SEC’s listing processn adds nothing to investor protections. What do you know about the economics of reverse mergers anyway? They raise no money in the US. Think about it. The Chinese company owners get stock which is potentailly tradable in the US after the expriation of the Rule 144 period. No new money gets raised. The Barron’s article of August 2010 “Beware this Chinese Export” was a piece of economically illiterate garbage.

  8. Independent Accountant
    Independent Accountant says:

    Benjamin Lawsky was just appointed head of New York State’s Financial Services Department. He once worked for Mary Jo White, the “ping pong ball Fed” at Debevoise & Plimpton. Regulatory capture is everywhere.

Trackbacks & Pingbacks

  1. […] rather than an investor advocate for an upcoming open spot on the PCAOB Board. I also reported on the relationship between Deloitte and the SEC and the SEC’s Historical Society that allows that firm, the one responsible for Bear Stearns, Royal Bank of Scotland, Washington […]

  2. […] rather than an investor advocate for an upcoming open spot on the PCAOB Board. I also reported on the relationship between Deloitte and the SEC and the SEC’s Historical Society that allows that firm, the one responsible for Bear Stearns, Royal Bank of Scotland, Washington […]

  3. […] PCAOB member, Tom Ray, went back to a big job at KPMG in 2009. It’s not a stretch to say the SEC has been captured by the audit […]

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