Tuesday, January 10, 2012

Federal Magistrate Grants SEC Request for Show Cause Order in Case Involving China-Based Accounting Firm

At the request of the SEC, a federal magistrate approved the issuance of a show cause order in an action brought by the Commission against a China-based accounting firm registered with the PCAOB. The court found, largely for the reasons offered by the SEC, that service of the application on the firm was not a prerequisite to the issuance of the proposed order directing the accounting firm to show cause why the court should not enter an order requiring the firm to produce documents responsive to an SEC subpoena. The SEC asserted that on May 27, 2011, it served an administrative subpoena on the accounting firm in connection with an investigation styled In the Matter of Longtop Financial Technologies Limited, SEC File HO-11698. The firm is a Chinese member firm of Deloitte Touche Tohmatsu Limited, a UK private company.

In her ruling, the magistrate cited a federal district court ruling granting the SEC’s application for an order to show cause noting that the Exchange Act permits worldwide service of process in cases involving the enforcement of subpoenas. SEC v. Lines Overseas Management, Ltd., D.D.C. No. Civ. A. 04-302, January 7, 2005. The SEC’s application for an order directing compliance with its subpoena will be a subject of a hearing, and, accordingly, remains pending. (SEC v. Deloitte Touche Tohmatsu CPA, Ltd., D.D.C, Miscellaneous Action No. 11-0512 GK/DAR, Jan. 4, 2012.)

The SEC filed the subpoena enforcement action against Deloitte Touche Tohmatsu CPA Ltd. for failing to produce documents related to the SEC’s investigation into possible fraud by the Shanghai-based public accounting firm’s longtime client Longtop Financial Technologies Limited. According to the SEC’s application and supporting papers filed in U.S. District Court for the District of Columbia, the SEC issued a subpoena on May 27, 2011, and D&T Shanghai was required to produce documents by July 8, 2011. The SEC said that, although the accounting firm is in possession of vast amounts of documents responsive to the subpoena, it has not produced any documents to the Commission to date. As a result, the Commission said that it has been unable to gain access to information that is critical to an investigation that has been authorized for the protection of public investors.

According to the court papers, D&T Shanghai was Longtop’s auditor since at least 2007, and the firm consented that its audit reports for Longtop could be filed annually with the SEC while knowing that they would be relied upon by U.S. investors. On May 22, the firm resigned as Longtop’s auditor after discovering numerous improprieties during an audit for the year ended March 31, 2011. In its resignation letter, which was included in a Form 6-K furnished by the company on May 23, D&T Shanghai identified numerous indicia of financial fraud at Longtop and indicated that the firm’s prior year audit reports for the company could no longer be relied upon by investors.

As part of the Longtop investigation, the SEC staff issued and served the subpoena on D&T Shanghai seeking production of documents related to the incomplete audit of the company for the year ended March 31 as well as prior year audits that the firm completed. According to the court papers, these documents may reveal information about the firm’s discovery of false financial records at the company, how any fraud schemes at the company were able to continue undetected, and basic information necessary to ferret out whether there was a fraud, who was behind it, how significant it was, and how it was conducted.

The SEC’s court papers note that the company is a foreign private issuer whose American depositary shares (ADSs) traded on the NYSE from the date of its initial public offering in October 2007 until May 17, 2011, when the NYSE halted trading prior to delisting Longtop’s securities in August 2011.

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