by T. GormanPosted on Posted in SECActions

The resolution of a long standing dispute between the SEC, the PCAOB and the China Securities Regulatory Commission or CSRC over the availability of audit work papers which has spawned three pending actions may be about to end. While the Sarbanes-Oxley Act requires auditors registered with the Board to turn over audit work papers on request from the Commission or the PCAOB, audit firms based in China have declined based on the position of the CSRC. Now, according to a report from Thomsonreuters, the work papers are being produced under a recent agreement between the CSRC and the PCAOB. Soyoung Ho, “Chinese Are Prepared to Hand Over More Auditor Papers,” Thomsonreuters (Aug. 2, 2013). This could signal an end to the dispute and the litigation.

Presently, the SEC is litigating three actions against five PRC based audit firms centered on their failure to produce audit work papers. The most recent was filed in December 2012 against the affiliates of five major accounting firms based in the Peoples Republic of China. In the Matter of BDO China Dahua CPA Co., Ltd., Adm. Proc. File No. 3-15116 (Dec. 3, 2012). The Order names as Respondents: BDO China, Ernst & Young Hau Ming LLP, KPMG Huazhen (Special General Partnership), Deloitte Touche Tohmatsu Certified Public Accountants Ltd. and PricewaterhouseCoopers Zhong Tian CPAs Ltd.

The proceeding is based on Rule 102(e)(1)(iii) which permits the Commission to sanction any person found to have willfully violated or aided and abetted the violation of the Federal securities laws. The Order alleges that the provision was violated by each Respondent since it failed to comply with Section 106 of the Sarbanes-Oxley Act of 2002, as amended by the Dodd-Frank Act, which requires PCAOB registered firms to produce audit work papers pursuant to a Board or SEC request.

A similar proceeding had been instituted against the Deloitte PRC affiliate earlier. In the Matter of Deloitte Touche Tohmatsu Certified Public Accountants Ltd., Adm. Proc. File No. 3-14872 (May 9, 2012). That same firm is also a defendant in a subpoena enforcement action brought by the Commission on essentially the same basis. SEC v. Deloitte Touche Tohmatsu CPA, Ltd., File No. 1:11-MC-00512 (D.D.C. Filed Sept. 8, 2011).

Last month a resolution of these actions appeared eminent. The PCAOB, the China Securities Regulatory Commission and the Ministry of Finance in China executed a Memorandum of Understanding on Enforcement Cooperation. The agreement provides for the exchange of certain materials on request to assist in the enforcement matters. In the MOU the parties pledged the “fullest assistance permissible to secure compliance with the respective Laws and Regulations of the Authorities.” Under the MOU audit work papers are to be made available.

Recently, the work papers for Longtop, the Deloitte Touche Tohmatsu client in the subpoena enforcement action, were furnished to the Commission staff under the agreement. Other work papers are about to be produced, according to the Thomsonreuters report. Nevertheless, the Enforcement Division has continued to litigate the actions. Indeed, the hearing in the proceeding against the five firms was recently completed. Apparently the record in that action has been held open to furnish the Judge with information future developments however.

The production of the work papers in the subpoena enforcement action would effectively moot that proceeding. While the production of the work papers may not cure the violations in the two administrative proceedings, it should certainly have a significant impact on the resolution of those matters. Indeed, if the agreement between the PCAOB and the CSRC is effective, it would not seem to be in the interest of the SEC to bar the affiliates of the five largest international accounting firms from practicing before the agency if the goal is to ensure quality audits of PRC based companies. Accordingly, the long running dispute over audit work papers for PRC based issuers may well be about to come to an end.

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by T. GormanPosted on Posted in SECActions

The Commission filed two new market crisis cases, one in conjunction with the Department of Justice. Once action is against Bank of America, N.A. centered on the sale of interests in an entity known as BOAMS 2008-A. SEC v. Bank of America, N.A., Civil Action No. 3:130-cv-0447 (W.D.N.C. Filed August 6, 2013); see also U.S. v. Bank of America Corporation, Civil Action No. 3:13-cv-446 (W.D.N.C. Filed August 6, 2013)(similar action based on FIRREA). The second is a settled administrative proceeding against UBS Securities LLC focused on the sale of interests in a CDO. In the Matter of UBS Securities LLC, Adm. Proc. File No. 3-15407 (August 6, 2013).

Bank of America: This case is based on a failure to disclose the true nature of the collateral in the entity. In 2007 a Bank of America subsidiary originated $93.3 billion in first lien mortgage production. The mortgages were originated either directly by the subsidiary or through its direct or wholesale channels. The next year the bank’s mortgage subsidiary filed a prospectus supplement for BOAMS 2008-A with the Commission. A majority of the certificates were sold in a public offering. The remainder were sold in private placements.

BOAMS 2008-A was an RMBS backed by 1,191 residential mortgages. The loans were written between mid-July and late November 2007 and had an unpaid principle balance of about $855 million. All of the loans were “jumbo.” Most had been originated through either the bank’s direct or wholesale channels. The prospectus for the offering represented that the loans were written in accord with the bank’s general standards. In fact BOAMS 2008-A had a disproportionately high level of wholesale loans compared to earlier offerings.

At the time the BOAMS 2008-A offering was being sold to investors, the bank knew, according to the complaint, that the wholesale channel loans were significantly more likely to be subject to material underwriting errors, become delinquent, fail early in the life of the loan or prepay compared to those written directly by the bank. This factors negatively impacted investors.

The facts regarding the mortgages in BOAMS 2008-A were not disclosed as required by the Commission’s regulations in the filings. Rather, the materials filed with the SEC, and furnished to rating agencies, stated that the mortgages had been underwritten in accord with bank guidelines. This was a misrepresentation since the bank knew or should have known that a large percentage of the mortgage loans had significant deviation from its guidelines.

The bank, through its subsidiary, also provided investors and rating agencies with documents identifying key characteristics of the underlying mortgages. These documents falsely portrayed the mortgages as being less risky than in fact they were. In fact, only a few investors were told about the loan composition in the entity.

The Commission’s complaint alleges violations of Securities Act Sections 5(b)(1), 17(a)(2) and 17(a)(3). The case is in litigation.

UBS: This proceeding focuses on the failure to disclose certain fees in connection with the sale of interest in a largely synthetic collateralized debt obligation or CDO known as ACA ABS 2007-2. UBS structured the CDO and marketed it along with its collateral manager, ACA Management LLC. The collateral for the CDO was largely credit default swaps or CDS referencing subprime residential mortgage backed securities.

ACA was responsible for the price the CDO paid for the collateral. Typically the collateral manager would solicit bids. The counterparty selected would pay a spread to purchase protection against default on a designated reference obligation. That spread would be paid to the investment bank structuring the CDO. The investment bank would in turn agree to pay the notional amount to the counterparty in the event of default. The investment bank then would pay the spread the CDO which assumed the obligation to pay the default.

Here UBS and ACA agreed on a different plan. Under their agreement ACA had bidders split their bid. One part would be the spread that in the end would go to the CDO. The other part would be “upfront points,” a one time cash payment that would go to UBS.

At the launch of ACA 07-2, about $23.6 million in upfront points had been paid. The marketing materials did not disclose that UBS would retain those fees but only its transaction fee of about $9.7 million. Indeed, those materials represented that the CDO had acquired all the collateral on an arm’s-length-basis for fair market value or at the price the collateral was acquired by UBS. This representation was inaccurate, according to the Order, since it failed to mention the upfront points. The Order alleges violations of Securities Act Section 17(a)(3) and Advisers Act Section 206(2).

UBS settled with the Commission, consenting to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. The firm also agreed to pay disgorgement of $34,408,183 (the upfront points and its disclosed fees), prejudgment interest and a civil money penalty of $5,655,000.

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