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Deloitte’s China woes have gone from bad to worse.

Latest Muddy Waters target Focus Media (FMCN) is yet another company with serious fraud allegations leveled against them which was audited by Deloitte. Something that has led to serious suspicions against the auditors themselves.

The company was already in trouble with American authorities following the Longtop scandal and its aftermath, where they were unable to help in the on-going investigations against the fraudulent company. Should these latest fraud allegations be proven correct, and yet another client of the company found guilty of fraudulent activities, American authorities and investors will not stay silent.

Being audited by Deloitte is becoming a burden for Chinese companies, as the markets have lost so much confidence in the auditor that all of Deloitte’s clients are suspects by association. Deloitte-audited Chinese companies are traded at a discount by some investors, government authorities are increasing their scrutiny of them, and short sellers are looking at them specifically for potential short cases.

Trying to pitch clients on the idea of trading at a discount and facing extra scrutiny from authorities and shorts will make it exceedingly hard for Deloitte to maintain its current market position. This will be especially true for the IPO market where Chinese companies are already facing increased scrutiny from the SEC, which means companies are unlikely to want to add even more potential issues to their offering.

Deloitte needs to move fast to regain the confidence of the market if they want to stay competitive in China, but this will likely be neither easy nor cheap to accomplish.

In fact, the situation has deteriorated to a point where there might have to be a token leadership change at the top, followed by a purge of the company’s entire China operations to indicate that the company is serious about getting to grips with the situation.

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