S.E.C. Charges 5 Firms Over Audits in China

9:06 p.m. | Updated

WASHINGTON — The Securities and Exchange Commission charged the Chinese affiliates of five big accounting firms on Monday with violating securities laws, claiming they failed to produce documents from their audits of several China-based companies under investigation for fraud.

The agency, which has been broadly investigating Chinese companies that have gone public in the United States, said that it had been trying for months to obtain certain paperwork from the accounting firms. But the government said the auditors “refused to cooperate,” citing prohibitions in local law.

“Only with access to work papers of foreign public accounting firms can the S.E.C. test the quality of the underlying audits and protect investors from the danger of accounting fraud,” Robert Khuzami, the commission’s enforcement director, said in a statement. “Firms that conduct audits knowing they cannot comply with laws requiring access to these work papers face serious sanctions.”

The accounting firms cited in the administrative proceedings by the S.E.C. are the Chinese affiliates of Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers — the so-called Big Four — and BDO. The agency did not name the firms’ Chinese clients.

Most of the accounting firms said they were cooperating with regulatory authorities. But they noted the difficulties of navigating the conflicting laws of the United States and China.

“The fact that the action is being taken collectively against all of the four largest audit firms and one other firm demonstrates that this is a professionwide issue, not unique to one firm,” PricewaterhouseCoopers said in a statement.

The potential stakes are high. As part of the administrative proceedings, the accounting firms could face sanctions. Under the law, the government could prohibit them from practicing before the S.E.C., on a temporary or permanent basis. In essence, that means their audits of publicly traded companies would not satisfy securities laws.

The actions by the S.E.C. stem from a broader inquiry into Chinese companies listed on American exchanges.

In recent years, dozens of Chinese-based businesses have raised money in the United States through so-called reverse mergers. Such backdoor listings allowed companies to go public without the high costs and regulatory scrutiny of traditional offerings. Investors, looking to capitalize on the growth in China, rushed to buy the stocks.

But such companies have been the subject of increased scrutiny, and investors have lost billions of dollars on the stocks. The S.E.C. has de-registered the securities of nearly 50 Chinese-based companies and has filed 40 related fraud cases.

Increasingly, regulators are focused on the auditors.

In May, the S.E.C. announced an enforcement action against a Deloitte affiliate, Deloitte Touche Tohmatsu, over failure to produce documents related to an S.E.C. investigation of one of its China-based clients. Deloitte said that it was cooperating with authorities on both matters.

Ernst & Young also faces additional legal challenges in Canada. On Monday, the Ontario Securities Commission charged the firm’s Canadian affiliate with failing to perform a sufficient audit in its work on the financial statements of Sino-Forest, a China-based forestry company.

In June 2011, an independent analyst posted a report online claiming that Sino-Forest was a fraud, prompting the company’s shares to plummet. An independent committee appointed by the company’s board later investigated and couldn’t locate the two million acres of forest plantations the company said it managed in rural China. Sino-Forest filed for bankruptcy in March.

On Monday, Ernst & Young said it had reached a $118 million settlement in a shareholder class-action lawsuit over Sino-Forest and Ernest & Young’s audit of the company.

In a statement, Ernst & Young Canada said it was confident that its work on Sino-Forest met “all professional standards,” including the so-called Generally Accepted Auditing Standards. “The evidence we will present to the O.S.C. will show that Ernst & Young Canada did extensive audit work to verify ownership and existence of Sino-Forest’s timber assets.”

The Public Company Accounting Oversight Board, an independent agency that oversees accounting firms, has also been pushing Chinese officials to improve the access to documents.

In October, representatives of the oversight board traveled to China, where they were allowed to observe an internal controls review by Chinese officials. Chinese regulators then came to the United States the next month to negotiate the sharing of work papers.

“I continue to believe the Chinese regulatory authorities have every reason to resolve these issues of transparency and access to audit work papers,” said James R. Doty, the chairman of the oversight board. “There is no question we are nearing a crossroads, a decision point.” But Mr. Doty added that if an agreement was not reached, “then we will need to consider other alternatives to protect the investing public.”