China's financial regulators have asked the world's biggest audit firms to urgently review their work on U.S.-listed Chinese companies and give details on information they may have provided to overseas regulators, two sources told Reuters.
The unprecedented move, following a string of accounting scandals at U.S.-listed Chinese companies, could ratchet up tensions between U.S. and Chinese financial regulators.
It could also throw another wrench into Chinese expansion efforts by the Big Four auditors -- Deloitte, KPMG, PricewaterhouseCoopers and Ernst & Young -- which were already concerned about hits to their reputation from accounting problems at China-based companies.
Everyone knew a day of reckoning would come later, and in this case the day of reckoning is now, said Lynn Turner, former U.S. Securities and Exchange Commission chief accountant.
China has been one of the fastest-growing markets in the world for accounting firms, expanding by nearly 20 percent in 2010 and accounting for an estimated $1.5 billion in revenue for the Big Four firms last year, according to data from the International Accounting Bulletin.
China's request for information, sources said, is seen as a direct response to a move by U.S. regulators to get audit work papers on Longtop Financial Technologies Ltd, and an effort to assure that auditors do not hand over documents to authorities outside of China.
Last month, the SEC asked a U.S. court to force Deloitte Touche Tohmatsu's China practice to hand over documents from its audit of Chinese software company Longtop.
U.S. investors have lost billions of dollars on China-based companies listed on U.S. exchanges after questions were raised about their accounting, prompting a broad probe by the SEC.
CHINA MEETS WITH FIRMS
Two sources from the audit industry told Reuters that the Ministry of Finance and the China Securities Regulatory Commission (CSRC) met last week with the Big Four's Chinese member firms, along with two smaller auditors.
BDO, the largest auditor in China outside the Big Four, was one of the firms present, another source briefed on the meeting said.
The firms were asked by the government to conduct an urgent review of all audits they had done on U.S.-listed Chinese firms in 2010, along with work on U.S. initial public offerings by Chinese companies, the two industry sources said.
They were asked to report back by the end of this week on whether audit work papers or other client information were given to overseas regulators or any of their overseas practices.
One source, who asked not to be named due to the sensitive nature of the meeting, said the Chinese authorities emphasized to the firms their rules on confidentiality.
The request may indicate that the Chinese have drawn a line in the sand over releasing documents, said James Cox, a securities law professor at Duke University.
An easy thing for the Chinese to have done was to just let things sort of slip across the border and take some of the heat out of the process, he said.
China's Ministry of Finance has been working to build up domestic Chinese audit firms to compete with the Big Four in China, and this move may be part of that strategy, he said.
It puts global firms in a very precarious position, said Arvind Hickman, editor of the International Accounting Bulletin. All the global firms are investing huge amounts of money into building their Chinese affiliates.
CAUGHT IN THE MIDDLE
The request is likely to heap more pressure on auditors caught in the middle of competing demands from the U.S. and Chinese regulators.
I would guess they (auditors) are terrified, said Paul Gillis, a former partner for PWC and visiting professor of accounting at Peking University. This is not a pleasant time for them and I think they would like to find a resolution to these problems as quickly as possible.
Gillis added that auditors may well have provided some information to the U.S. SEC in response to questions on listed Chinese companies, while the exchange of information with their overseas offices happens frequently.
They (Chinese regulators) are going to learn, if the firms are honest about what they are doing, that they have shared a lot of information from China with foreigners, he said.
The CSRC and China's Ministry of Finance ministry had no immediate response. PWC, KPMG, Deloitte and Ernst & Young declined to comment.
Gillis said it was unlikely the big audit firms will face major sanctions for disclosing that they passed on information to their overseas offices or foreign regulators but will likely be told such behavior will not be tolerated in future.
U.S. accountancy watchdog Public Company Accounting Oversight Board (PCAOB) has been negotiating with the Chinese authorities to be allowed to inspect Chinese firms that audit Chinese companies listed in America.
However, the momentum of the talks appears to have been slowing in recent weeks, with no date set for the next round of discussions.
(Additional reporting by Nanette Byrnes in Chapel Hill, North Carolina, and Don Durfee in Beijing. Editing by Muralikumar Anantharaman)