US probe into Chinese client deals fresh challenge to Deloitte

Reuters: A US probe into the accounts of one of China’s largest private education providers is a fresh challenge to its auditor Deloitte Touche Tohmatsu, which has run into more problems with New York-listed Chinese clients than other Big Four auditing firms.

The Securities and Exchange Commission (SEC) is investigating New Oriental Education & Technology Group Inc for possible accounting irregularities, the Beijing-based firm said on July 17. Deloitte has audited New Oriental since it went public in 2006.

Deloitte has been the slowest of the Big Four to expand in China, missing out on many major state-owned firms as clients. As a result, it has signed up more privately owned companies looking to list in the United States where rules are more flexible in allowing firms with a shorter operating track record to go public.

“It’s been my experience that Deloitte China’s due diligence, when it comes to taking on clients, is substantially similar to that conducted by other major audit firms,” said John Huber, senior managing director at global business advisory firm FTI Consulting and former head of the SEC’s corporate finance division. Huber has not been a Deloitte employee.

Nevertheless, auditing Chinese firms has been a challenge for Deloitte. Since January last year, it has resigned or has been dismissed from audit roles it held with seven US-listed Chinese companies, according to data from research firm Audit Analytics.

In five of those instances, it was due to difficulty verifying the accounts or alleged illegal behaviour by the company. Reasons were not disclosed for the other two.

No evidence suggests any of Deloitte’s departures involved wrongdoing on its part.

Pricewaterhouse Coopers has departed from five companies, KPMG three, and Ernst & Young two, according to Audit Analytics.

“Experience shows that financial issues can arise at any company whether large or small, listed or private,” Deloitte China said in a statement.

Deloitte has 44 US-listed Chinese clients compared with PwC which has 31, Ernst & Young 25 and KPMG 18, according to data compiled last November by Paul Gillis, professor of accounting at Peking University.

Deloitte’s China roster includes Agricultural Bank of China, the country’s fourth-largest bank by market value.

While all have had clients with accounting problems from China, Deloitte holds the record of having had the most, according to Muddy Waters, a research firm and short-seller.

“There are likely a number of problem audit clients at other Big Four firms to be unearthed. However, Deloitte is leading the pack in this measure,” Muddy Waters wrote in its report on New Oriental.

Deloitte China said its total portfolio of listed clients contains many large and well-established companies.

“US-listed Chinese companies facing issues represent just a minuscule proportion of our total portfolio of listed companies,” the firm said.

Deloitte has yet to sign off on the accounts of New Oriental for the year ended 31 May, according to the company’s chief financial officer.

Since the firm said on 17 July it was being investigated, around $1.6 billion has been wiped off New Oriental shares.

A day later, Muddy Waters said New Oriental had lied about its network of schools and learning centres being company-owned, alleging the numbers had been inflated.

Muddy Waters says it has seen contracts indicating New Oriental operates some of its outlets via franchises.

New Oriental has denied the allegations from Muddy Waters, which gained prominence last year from finding accounting problems at Chinese firms and shorting their shares. The short-seller has misinterpreted its financials, New Oriental said.

Deloitte has said it will cooperate with the SEC and consider the appropriate and necessary response to the Muddy Waters report.