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Agents of Trust in Conflict: Accounting Firms vs. SEC with the US and Chinese Governments as Warring Referees

Thu, December 06, 2012 8:45 AM | Deleted user

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The SEC has charged the world’s top five accounting firms with securities violations because they have refused to supply audit papers for examinations of U.S. listed firms operating in China. These firms are suspected of wrongdoing by the SEC. The audit firms say that Chinese state secrecy laws prevent them from releasing the documents and they are calling for the U.S. and China to reach a diplomatic resolution. They say that U.S. and Chinese laws relating to this matter are in conflict.

There are a few larger issues at play here. First, to what extent is transparency essential to trust? Second, what is the role of governments and regulators in creating the infrastructure of trust within an economic system? Finally, can trust and exchange be facilitated on a global basis if we have major conflicts among trading nations concerning core values related to sharing information and the rule of law?

Transparency ensures that trustors deciding to trust or distrust can get accurate information to assess trustworthiness and risk. Goldman Sachs paid one of the largest fines in SEC history for inadequate disclosure in the Abacus deal in which the firm created an instrument to sell that was designed to fail by Goldman Sachs and its client (Paulson) one side of deal. There are some scholars who believe that transparency is overrated because trustors often do not pay adequate attention and miss even transparent disclosures and because in many business settings, there is a buyer beware approach where people expect a degree of spin rather than truth. Do people in a used car lot expect the salesman to tell them what is wrong with the car or if they are a CFO of a company being acquired to describe where the hidden bodies or time bombs might be located?

But the SEC is not your typical trustor. They are an expert agent of trust who must have access to information to catch fraudsters and hold them accountable. U.S. trustors with limited time and expertise rely on them enforcing certain standards that make a system more trustworthy. In this sense the SEC cannot do their jobs without requiring some transparency. Trust and exchange will break down if they cannot get the accounting firms to comply with their information request. The Chinese secrecy laws must be a deal breaker for the SEC. It will be interesting to see if the U.S. government has their back (trust) or throws them under the bus (distrust).

The accounting firms and the SEC are caught in a conflict of laws and values between the U.S. and Chinese systems of governance. Underpinning this conflict is distrust between these two governments. This is the problem when there is a lack of trust. Without trust we cannot exchange freely and quickly. We must be careful and adopt self protective measures to limit our vulnerability. How this conflict gets resolved will tell us a great deal about the future of both the U.S. and Chinese economy. Research shows that low trust countries have slower GDP growth in part because money is not invested and sits on the sidelines. Trust requires the creation of trustworthy systems. The SEC and the accounting firms are part of a trustworthy system. Let’s hope the governments help them do their job.

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