As a young enforcement attorney in the US Securities and Exchange Commission's New York office, I recall fondly the challenge of accounting-fraud cases. These high-profile investigations were the essence of the SEC's mission - protect investors. A successful outcome could be a career-maker that jetted you up the management chain; a botched case might relegate you to small-bore matters until retirement.

The bedrock of investor trust is the integrity of financial statements. It is in them that an investor places the trust needed to make an investment decision. Is a company earning enough revenue to justify its market capitalization? Is there solid top-line revenue growth? Are expenses efficiently managed and visible?

So when analysts, whistleblowers or bloggers question a company's "financials", investors sit up and take notice. It is a big deal. As in any relationship, when trust falters, the relationship withers.

It's into this complicated, high-stakes dance between investor and investment that an enforcement lawyer wanders. But don't be fooled by his youth: He wields power as a US government attorney and needn't be invited to the dance.

An attorney's primary tool of investigation is the subpoena. Under US law, a subpoena can be used to compel any company or individual over which US courts have jurisdiction to hand over even the most sensitive and potentially incriminating information. An SEC lawyer can deploy this tool with about 15 minutes of tapping on his desktop and an overnight-delivery envelope.

When an SEC subpoena lands at a US company, it sets in motion a process that includes hiring a law firm and other advisers. The company must then undertake the arduous task of re-creating and defending financial information from previous years.

Accounting-fraud cases are built on seemingly insignificant decisions over a period that can reveal a pattern of fraudulent intent to deceive investors about a company's financial health. Intent rarely shows itself in broad strokes; more likely it's found in a single ill-considered exchange of e-mails showing that senior management succumbed to pressure and acquiesced to letting fictitious numbers into financials. Proving intent requires access to third parties such as vendors, bankers and auditors.

The auditor, as the SEC's night watchman, is expected to detect and challenge irregularities and insist on accurate disclosure - even when it may hurt the company's standing with shareholders. The SEC, like investors, relies on auditors to be an independent voice. For this reason, audit work papers and interviews of the audit team are the backbone of an accounting-fraud probe.

When I was leading these investigations in the early 2000s, the rules were pretty clear. Companies facing scrutiny and their audit firms were typically based in the US and there was no question they could be compelled to produce documents and witnesses for on-the-record testimony. Lurking behind these SEC investigations were criminal prosecutors who brought with them the power to imprison wrongdoers, with Enron and Arthur Andersen the most-publicized examples.

The imbalance of power and headline risk gave the US government a sizable advantage. Not only was there rarely a problem in obtaining documents, in many cases the company itself would report misconduct to the SEC, terminate the employees responsible, and undertake remedial action.

A decade later, Chinese firms seeking access to US capital markets have become a new target for the SEC. Not surprisingly, allegations of accounting fraud against these companies attract the attention of the current generation of ambitious SEC enforcement attorneys, who may want to flex muscle and deploy tools previously used to investigate fraud.

But today's young enforcement attorney faces challenges I never had. For example, that subpoena that once triggered capitulation lacks punch outside US borders.

Some subpoena recipients in China have taken the position that they're removed from US courts' jurisdiction. Others use Chinese laws that bar production of documents related to Chinese national interests or "state secrets".

These arguments, most often put forward by US lawyers advocating on Chinese clients' behalf, cannot be dismissed lightly. Neither the claims nor the lawyers who advance them are, I believe, intentionally obstructive or disingenuous but rely on solid facts and reasonable interpretations of untested laws and the sovereign intent behind them.

For its part, the SEC's expectation that companies that have raised capital in US markets permit an effective US enforcement process is also legitimate, reasonable and well-grounded. The SEC's mandate, its congressional overseers and US investors expect nothing less than vigorous enforcement of securities laws.

Clearing a path through this clash of good intentions and sovereignty is a duty not for zealous advocates or jurisdiction-constrained judges, but for senior government negotiators working diplomatic channels. It will be the dispassionate pursuit of mutual goals in commerce and trade that ultimately yields a solution to this regulatory impasse. Unfortunately, until these issues move up the bilateral agenda the SEC, US-listed Chinese companies and lawyers representing them will be left in suspense.

The author is a lawyer in the Hong Kong office of Kobre & Kim LLP, which specializes in litigation and arbitration of cross-border financial cases. He worked previously for the US Securities and Exchange Commission.

(China Daily 06/15/2012 page7)