The Securities and Exchange Commission is rattling a dull sabre again towards Shanghai-based Deloitte Touche Tohmatsu CPA Ltd. for its refusal to provide the agency with audit work papers related to another China-based company under investigation for potential accounting fraud against U.S. investors. The regulator filed an “enforcement action” instituting an “administrative proceeding” yesterday.
This has been going on now for two years and seems to have escalated into the kind of fight men have when trying to prove who’s bigger and tougher. It looks to me like it’s personal rather than productive. The SEC has access to as much as they need to review the work of the Deloitte China firm’s audit of Longtop – or any other Chinese fraud for a US listed company – assuming the US Deloitte firm had as much as they needed to sign off on the companies’ filings with the SEC over the years.
The SEC admits in their latest complaint against Deloitte Shanghai that they asked Deloitte US for the information the firm has right here in the US on Longtop and other US listed foreign based audits. The firm’s first answer was to deny any involvement in the audit.
4. On April 9, 2010, staff served Deloitte LLP, the U.S. member firm of the Global Firm with a subpoena requesting audit work papers relating to the Global Firm’s audit of Client A’s financial statements for the period January 1, 2008 through April 9, 2010.
5. Between April 13, 2010 and May 18, 2010, staff had several communications with U.S. based counsels for both Deloitte LLP and the Global Firm.
6. Counsel for Deloitte LLP initially informed the staff that Deloitte LLP did not perform any audit work for Client A, that all audit work was conducted by Respondent, and that Deloitte LLP did not have possession, custody, or control of the documents called for by the subpoena.
7. Counsel for Deloitte LLP subsequently informed the staff that Deloitte LLP performed some review work of Client A’s periodic reports and produced certain documents relating to this review to the staff.
Deloitte did eventually produce some documents related to the audit that are, and always have been, available in the US. If the Deloitte US reviews were sufficient, that should be enough for the SEC to see the quality of work performed by the Deloitte Shanghai unit.
So why is SEC continuing to fight this inane fight when, in reality, they should have all the information they need to investigate the Longtop or any other fraud? I suspect that the SEC attorneys are super annoyed with Deloitte’s lawyers and have decided to use their unlimited budget and intimidating administrative powers to annoy them back. Unfortunately, this just puts more money in the pocket of the super expensive Sidley & Austin outside counsel representing Deloitte Shanghai.
(Coincidentally, it was also a Sidley & Austin lawyer for KPMG that recently so annoyed a judge in a class action overtime case against the firm the judge ordered the firm to preserve the hardrives of all laptops for past, present and future class members. Note to Sidley & Austin: Scorched earth tactics not working.)
US-based GAAP and SEC reporting experts in the global audit firms review the workpapers behind the filings for every non-US based audit client that is listed on a US stock exchange, all over the world, before any filing with the SEC. That’s one of the quality control procedures all the firms who audit foreign-based, US listed multinationals have in place, not only because it is expected by regulators but because it’s good business.
The SEC/GAAP reporting team or Reg S-X review team – it may be drawn from and called something different in each firm – is the last stop before a foreign-based US issuer can file its quarterly and annual reports, as well as any filings for additional stock or debt offerings, with the SEC. Sometimes the team consists of experts from the firm’s financial advisory consulting group or capital markets group – the professionals who help companies prepare for IPOs, especially foreign companies who want a stock exchange listing in the US. The team may also call on additional expertise from the firm’s national office – a kind of one-stop shop for getting questions answered on arcane technical matters or standards for specific industries. Professionals may play double duty as consultants to some companies and remote members of an audit team for others. That way they can pick up billable hours reviewing filings when there are no deals to be done.
When a US-based listed company is a multinational, the US audit firm will use its member firm network extensively to do the audit work necessary all over the world to support the overall audit opinion. In this case, a US audit firm is expected to closely supervise and control the work of foreign affiliates who contribute to its audit.
From Part 2 of the PCAOB’s inspection report – the private quality control review of US firms.
Review of Processes Related to the Firm’s Use of Audit Work that the Firm’s Foreign Affiliates Perform on the Foreign Operations of the Firm’s U.S. Issuer Audit Clients
The inspection team performed procedures in this area with respect to the processes the Firm uses to ensure that the audit work that its foreign affiliates perform on the foreign operations of U.S. issuers is effective and in accordance with applicable standards performed by the Firm’s foreign affiliates on the foreign operations of U.S. issuer clients.
Some non-US audit member firms have more SEC reporting and GAAP experts on-site than others. I suspect the largest firms in Canada and the UK have their own SEC and GAAP reporting quality assurance review team for this purpose, but many countries do not.
PwC, for example, has the Global Capital Markets Group, a team of professionals dedicated to providing technical, strategic and project management advisory services to non-US companies actively interested in raising capital and/or listing their securities in the US securities markets. GCMG has partners and hundreds of professionals in more than 20 countries around the world.
GCMG assists companies in meeting ongoing SEC reporting requirements (e.g., review the company’s annual filing on Form 20-F and assist the company in responding to any SEC review comments). They are qualified to review management’s evaluation of the accounting treatment under U.S. GAAP and/or IFRS of new, complex or unusual transactions, such as a new type of financial instrument or a business combination. (Henri Steenkamp, a native of South Africa and a PwC alumni, is one of these accounting technical experts who helped companies prepare for IPOs for PwC before he helped Man Financial spin off MF Global and went on to become CFO of that PwC audit client.)
Take India, for example. According to the First Amended Complaint for the class action lawsuit brought by Satyam shareholders against Price Waterhouse India, PricewaterhouseCoopers US and PwC international as well as various executives and directors of Satyam, Price Waterhouse India created a multi-country, multi-disciplinary audit team for Satyam that included professionals with expert knowledge of US GAAP and SEC reporting requirements. Doing so satisfied PCAOB audit standards – which applied to Satyam because its shares (actually ADSs) were listed on the New York Stock Exchange. PW India had to assure the PCAOB, the SEC and investors worldwide that Satyam’s filings on Forms 20-F and 6-K, for example, were fully audited and reviewed in accordance with US auditing standards and were prepared using US GAAP.
The professionals PwC US brought to the global Satyam audit “client service” team are people like Suresh Persaud. Persaud was “the designated reviewer  with respect to Satyam,” according to emails to PW India partner Gopalakrishnan and Peter Ferraro of the PwC Global Capital Markets Group that were described in the class action Complaint. Persuad was based in PwC US’s Florham Park, New Jersey office and a director in SEC-FPI (i.e., Foreign Private Issuer) Services in US National Risk & Quality with PwC US. The SEC-FPI is based in the United States. That group provides technical support to PwC GCMG on complex or unusual issues regarding US GAAP, US SEC reporting and other related matters.
PwC US GCMG provided both consulting work to Satyam and support for the audit. GCMG was paid by PW India by invoicing the Indian firm for their services. The Indian firm, in turn, billed Satyam for these hours both as part of the audit and as additional consulting services. GCMG’s review and “sign off” on PW India’s audit was required per PwC Global policy before it could be considered final. However, the PW India partners had the last word on the Satyam audit. PW India “owned” Satyam as a client. In the case of Satyam, it seems the PW India partners either got bad advice, no advice, or ignored the advice of the US quality babysitters.
For example, the Complaint describes an exchange between Melissa Bledsoe, a manager at PwC GCMG and the India team where she explains the importance of PwC GCMG’s review of Satyam filings and gives them a timeline for the review:
“We will need to have a minimum of FIVE full days to review the Form 20-F. When we receive critical matters, we expect all significant current year issues to [be] well documented and the conclusions appropriately researched and concluded.”
The Designated Reviewer Program for Satyam included 22 procedures to be completed by the reviewer prior to the submission of any filings with the SEC. The procedures focused primarily on ensuring that the Satyam audits were performed in accordance with PCAOB audit requirements. In the “Scope of Designated Reviewer Support” section, the program specifies:
“It was agreed with the engagement partner that a review of the document is required by GCMG international office as done in the previous years.”
The Designated Reviewer Program also set forth the procedure for resolving conflicts between the designated reviewer and the engagement partner.
All the forms used to complete routine audit procedures for Satyam come from PwC US according to the Complaint. The forms used in the Satyam audits included:
- MyClient US GAAS Supplement
- MyClient US Master Data Program
- PwC Audit US 3110-3180
- PwC US Template Manager
- PwC Audit Guide – US via the PwC Audit – US Lotus Notes database
- US template manager for the SUD (Summary of Unadjusted Differences)
PW India had to consult PwC US on critical issues including significant accounting, auditing and financial reporting matters and all reviews of unaudited interim information were performed as required under PwC US audit policy.
The first Amended Consolidated Class Action Complaint goes on to say that PwC US regularly reviewed and approved US GAAP accounting issues on behalf of Satyam, including for:
- Each of Satyam’s financial statements filed on Form 20-F with the SEC during the Class Period
- Acquisition of Citisoft (e.g., discussed in a July 14, 2005 email, among others)
- Sale of a subsidiary, SIFY (e.g., discussed in a January 24, 2005 email, among others)
- Put option and reversal (e.g., discussed in a February 9, 2005 email, among others)
- Preference shares (e.g., discussed in a December 31, 2004 email, among others)
- Variable interest entities (e.g., discussed in a July 14, 2005 email, among others)
- Summary of unadjusted differences (e.g., discussed in an April 19, 2006 email, among others)
- Goodwill impairment (e.g., discussed in a December 31, 2004 email, among others), and
- Potential restatements (e.g., discussed in August 14, 2004, March 28, 2005 and May 2, 2008 emails, among others)
“Final clearance” by PwC GCMG was a necessary prerequisite for Satyam’s SEC filings. For example, in an April 22, 2005 email to Peter Ferraro of PwC GCMG, Khazat Kotwal requested expedited turnaround of an amended F-3:
“Satyam want’s [sic] PwC’s final clearance to file the F-3 on APRIL 25, 2005. Kindly call me immediately if you have any concerns to meet this deadline. I do not want to be in an embarassing [sic] position once more in front of the client. Also, note that there is a lot at stake for the client so even if we all have to stretch ourselves we should do that. Looking forward to a positive response from you.”
PwC GCMG acceded to the artificial deadline imposed by Satyam, according to the Complaint, and allowed the amended F-3 to be filed shortly thereafter with little further review.
In spite of so much involvement of the US firm in the Satyam audit, including critical quality reviews as safeguards for US investors before reports were filed with the SEC, the SEC and the PCAOB sanctioned and fined only the Pricewaterhouse India firm for the negligent audit that missed a $1 billion fraud.
The Public Company Auditing Oversight Board (PCAOB) has not been prohibited from inspecting Indian firms like they have been in China and the EU. The PCAOB inspected the PW India audit firm for the first time in the spring of 2008. We did not see a copy of that inspection report until three years later, in April of 2011, when the SEC and PCAOB jointly issued sanctions and a $7.5 million fine against the PW India firm.
It revealed a type-two error:
“Following the performance of the inspection procedures, a significant issue came to light that had not been identified in the inspection review.”
And that’s pretty much all the public section of the PCAOB inspection report says. It does describe, briefly, the subsequent events that forced the regulator to throw out any conclusions they had come to during the inspection.
The class action settlement, a private civil matter in New York federal courts, did however hold the US and the International PricewaterhouseCoopers firms liable for the Satyam fraud in addition to the India firm. PW India, PricewaterhouseCoopers US and PricewaterhouseCoopers International Ltd settled with investors for a total of $25.5 million. It’s not clear how much each contributed but there have been recent reports out of India that the local firm received funds from the International firm which could not be traced to payment for services. It’s against the law in India for a local audit firm to be subsidized by a foreign one.
By over and over again singling out only a single country practice for sanctions and disciplinary action, the SEC and PCAOB imply that the work of an audit of a US-listed, foreign, multinational company is performed in isolation.
It is not.
From the First Amended Complaint:
Notably, Satyam’s audited and unaudited financial statements prepared under Indian GAAP for the quarter and half year ended September 30, 2004, filed as exhibits to the October 25, 2004 6-K, were signed on behalf of the Board of Directors and by Price Waterhouse, by Gopalakrishnan, in “Santa Clara [California], USA.” Santa Clara, California is a location of Satyam’s US operations.
PwC International has also paid for the legal counsel to both PW India partners, Gopalakrishnan and Talluri, who are on trial in India.
It’s common for the global audit firms to want it both ways. When they promote themselves and their services to clients, regulators, legislators, and the media, they invoke the brand image of a “seamless global network of firms operating.
This is the bold title and introduction to Deloitte’s most recent Global Annual Review:
A Borderless Network
We all dream of the best future there can be.
For the clients and people of the Deloitte member firm network, it is one marked by excellence in client service, quality, accountability, distinctive talent development, innovation, and best-in-class practices. It is a future shaped by the unique capabilities and confidence of a global leader in professional services. And it is driven by the resources and commitments of a powerful, borderless network.
It’s sexier for the SEC to pick a fight with China to make political points about investor protection than to admit that the SEC and the PCAOB have not been monitoring the role the US firms play in audits of non-US based issuers audited by foreign member firms very well. The SEC also missed the boat on Longtop, in particular, and can’t blame the reverse merger loophole for letting a possible fraudster sell securities in the US. Longtop was a traditional listing. US regulators are making a habit of picking on the foreign member firms even when the issue is always integrity of the financial of US-listed companies. The regulators are giving the US firm, Deloitte US, a pass. That’s just like they did in the Satyam case. They did not hold the US audit firm accountable. They choose to ignore the charade of the global network concept.
There was ample evidence of significant involvement of PwC US in the negligent “no audit at all” at Satyam. The process of reviewing filings of foreign private issuers is the same at all large audit firms – the typically US-based and US-controlled GAAP and SEC reporting experts have to review everything – yet SEC will not push back on the US firm or hold them accountable for the quality of audits for US issuers.
The SEC’s pursuit of “paperwork” from Deloitte Shanghai is an exercise in futility. (All the records are electronic, anyway, and available in the firm’s global “cloud”.) The rules are changing in China and the audit firms there will be even more untouchable once they are Chinese owned and operated. That’s set to happen completely by 2017 as previous joint venture agreements with non-Chinese partners will soon expire and the Chinese government is taking advantage of the opportunity to become even more nationalistic – if that’s even possible – and expand the Chinese professional class rather than depending on foreigners to support its growth.
US regulators are criticizing professional services quality in China and the systemic corruption implied by frauds that include Chinese banks helping their corporate customers to falsify bank statements and account balance confirmations requested by auditors. At the same time, The Wall Street Journal is reporting “a landmark” decision by the Federal Reserve to allow three state-backed Chinese banks to expand in the US. Industrial & Commercial Bank of China Ltd., one of the world’s largest banking companies, will make the first acquisition of a U.S. retail-banking network by a state-owned Chinese lender when it buys 80% of the U.S. subsidiary of Bank of East Asia, a Hong Kong company with 13 branches in New York and California. The Fed also approved two Beijing-based banks, Agricultural Bank of China Ltd. and Bank of China Ltd., to build branches in New York City and Chicago, respectively.
The Fed better make sure they can walk into Chinese banks on US soil and inspect them.