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Gary DeWaal's Bridging the Week: January 20 to 24, and 27, 2014 (Accounting Firms under Attack; Enhanced CTA/CPO Customer Protection Necessary?)

Bridging the Week    My View   
Published Date: January 27, 2014

Accounting firms received the brunt of a US regulator's attention this past week when one major US accounting firm was challenged for not being "independent," while China-based affiliates of four top US accounting firms were barred by an administrative law judge for the regulator from auditing China-based companies listed on US exchanges for six months for not complying with requests for documents. The firms had alleged that complying would cause them to violate China laws, including privacy rules.

As a result, all the following matters are covered on this week's Gary DeWaal's Bridging the Week:

Video Version:

Article Version:

KPMG Agrees to Pay More Than US $8.2 Million to Settle SEC Claim of Independence Violation; SEC Issues Guidance Regarding Impact of Audit Firm Loan of Employees to Audit Clients

The US Securities and Exchange Commission alleged that KPMG violated its rules related to auditor independence by providing non-audit services to affiliates of three public companies it was auditing from 2007 through the end of 2011. The services included bookkeeping, payroll and expert services. Some KPMG personnel also owned stock in one of the relevant public companies, and an affiliate of another.

In connection with one affiliate, KPMG also hired a retired former senior employee, and then loaned the individual back to the entity to perform the same tasks he had done as an employee (i.e., "acting as a manager, employee and advocate for the affiliate").

KPMG agreed to pay in excess of US $ 8.2 Million to settle this matter.

Simultaneously with announcing this settlement, the SEC issued a separate report advising audit firms that they may not lend staff to audit clients in a manner that makes such employees tantamount to being company employees.

According the SEC, "no one factor is determinative" to assess whether a loaned employee acts as an employee of an audit client -- which is prohibited. However, certain characteristics do not assist the determination:

"For example, the fact that professionals loaned to an audit client may be junior- level in skill, experience or title, or are performing only ministerial tasks, does not exempt that individual from the prohibitions against acting as an employee of an audit client. Similarly, the fact that loaned staff were not directly paid by the audit client also does not exclude the relationship from the prohibition."

For the SEC, the provision of certain non-audit services to an audit client impairs the auditor's independence. Therefore, auditors that provide non-audit services in a way that compromises independence "…should expect to be held accountable."

Affiliates of Four Top US Accounting Firms Banned from Performing Audits of China-based Firms Listed on US Exchanges for Six Months

An SEC Administrative Law Judge banned the China-based affiliates of four top US-based accounting firms from performing audits of US-listed Chinese companies for six months for their failure to produce certain work papers to SEC staff in connection with investigations into such companies. The SEC was reviewing such companies for possible accounting fraud and served requests for documents on the respondents at various times between March 11, 2011 and April 26, 2012.

The four firms that were barred from appearing or practicing before the SEC for six months were Ernst & Young Hua Ming LLP, KPMG Huazhen, Deloitte Touche Tohmatsu Certified Public Accountants, Ltd., and PricewaterhouseCoopers Zhong Tian CPAs Limited. A fifth accounting firm, BDO China Dahua CPA Co., Ltd., was named in the relevant SEC action but solely was censured.

The accounting firms had failed to produce the requested documents for fear of violating Chinese laws and procedures related to producing documents to overseas regulators, including privacy requirements. In China, each of the accounting firms is licensed by the China Securities Regulatory Commission, and most by the Ministry of Finance too.

In 2011, each of the respondents had attended a meeting with MOF and CSRC officials where they "explicitly" were told "…that Chinese accounting firms must abide by Chinese laws and they cannot provide work papers and related documents to overseas regulators directly [and] ...that legal penalties would be imposed on firms that provide work papers without authorization." This position was confirmed by the regulators on subsequent occasions.

The respondents defended not only against the SEC's substantive allegations, but argued that the proposed ban against them performing auditing services in China would cause investor losses, US delisting by China-based companies and a loss of market capitalization. The ALJ rejected these arguments, claiming that there were "adequate substitute auditors" who had "all conducted audit work, including audit reports, and produced audit work papers without raising any issues…"

Respondents have 21 days to request a review by the Commission. The Initial Decision issued by the SEC ALJ will not become final until the Commission issues an Order of Finality.

And briefly:

My View: Although in recently years the failures of MF Global and Peregrine Financial Group grabbed the big headlines, the problem of fraud at some less reputable CPOs and CTAs has been far more pervasive and re-occurring. Accordingly, in my view, the NFA deserves a lot of credit for raising the issues addressed in its comment request. That being said, there are no easy answers to the NFA's questions, particularly regarding tracking customer funds invested by CPOs, because of their dispersed nature and wide investment mandates, especially within fund of funds. However customers placing money with CPOs or to be managed by CTAs deserve to be protected as much as customers of future commission merchants or introducing brokers. Whether the answers will include some or all of the NFA proposed ideas, entirely different ideas, or that no new measures are warranted at all, is surely worthy of a robust discussion. Just keep in mind: bad guys tarnish the reputation of an entire industry, and if there is a sufficiently large blow up, it won't be NFA but Congress that tries to impose a solution!

For more information, see:

US CFTC Matters:

CFTC v. CTI Group et al (Consent Order):
Interdivisional Group Established to Review Report and Recordkeeping Compliance:
trueEx IRS Made Available to Trade Mandate:

UK FCA: Decision Notice re: Standard Bank:
US Federal Reserve Bank: Principles and Practices for Recovery and Resolution Preparedness:
ICE Clear SEC Submission Related to Recovery and Wind-down:
NFA Comment Solicitation re: CPOs/CTAs:
SEC Actions related in Auditor Independence:

In the Matter of KPMG:
SEC Report Related to "Acting as an Employee" of an Audited Firm:

SEC v. BDO China et al.:

SEC: In the Matter of Brian Williamson:
UK v. Council of the European Union and the European Parliament:

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of January 25, 2014, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.


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