Weblog with daily updates of the news on a frugal, fair and beautiful China, from the perspective of internet entrepreneur, new media advisor and president of the China Speakers Bureau Fons Tuinstra
Two hundred Chinese companies listed in the US thought they would get a pass when the PCAOB accepted late last year the auditing process for those companies. But financial analyst Winston Ma warns there are still significant uncertainties for those firms, as the SEC still indicates on its website those companies are still in danger of being delisted, he tells CNBC.
The Wall Street Journal says the proposed regulation is expected to be issued for public comment in December but would be finalized under the Biden administration. It appears to be part of Trump’s attempt to rush through policies before he is removed from office, betting that Democrats will not have the political will to reverse them.
There are no details available at this time. The SEC and PCAOB have always had the power to do this, but it was considered a ‘nuclear option” that would be a step too far for the regulators. Congress stepped in to propose legislative changes, and the President established a working group that made similar recommendations as the proposed legislation.
I expect the proposed regulation will have a long transition period of at least a year. In the end I expect the issue will be resolved through normal diplomacy, with China agreeing to allow inspections by the PCAOB.
Two financial regulators in the US, the SEC and the PCAOB, have joined the trade war of their country against China's accounting practices, writes Beida accounting professor Paul Gillisat his weblog. While the complaints are not new or surprising, he wonders about the timing, Gillis adds.
Paul Gillis:
For those have not been following the issue, the PCAOB is mandated by Sarbanes-Oxley to inspect accounting firms that audit U.S. listed companies, including foreign accounting firms. When the PCAOB attempted to come to China to inspect firms (mainly local affiliates of the Big Four) auditing U.S. listed companies China blocked them on the basis of national sovereignty. Attempts to find alternatives also foundered on arguments that the working papers might contain state secrets. The PCAOB was also blocked from inspecting Hong Kong firms to the extent the work related to the mainland.
After the wave of frauds by U.S. listed Chinese companies in the past ten years, the SEC finally got fed up with the intransigence of the Big Four firms about producing their working papers and brought charges against the firms. The firms argued to a SEC administrative trial judge that they were caught between a rock and hard place, having to decide whether to break Chinese or American law, and the judge appropriately observed that if that were the case, it was only because the firms put themselves in that position when they decided to do U.S. audits for Chinese companies. The judge threw the book at the Big Four, and BDO.
The firms appealed and settled with the SEC paying a $500,000 penalty each and promising not to sin again.
The PCAOB has succeeded in agreeing on enforcement cooperation with Chinese regulators, but has been unable to reach agreement on inspections, arguably a more important issue for investors than enforcement. Inspection are used to make certain that audits of U.S. listed companies comply with U.S. auditing standards, which is especially important in a market like China, where accounting practices are often “flexible”.
The primary champion of getting PCAOB inspections in China was former PCAOB chairman James Doty, who together with the rest of the PCAOB board and much of its management was forced out in a purge after the Trump election. This is the first comment on the issue that I am aware of by Doty’s replacement, Republican loyalist William Duhke III.
The remedy to China’s refusal to allow inspections has been what is referred to as the nuclear option. The PCAOB could deregister accounting firms that it cannot inspect. The consequence of that would be that most U.S. listed Chinese companies (and some multinational firms) would be unable to file audited financial statements with the SEC and without being granted an exception would be delisted from U.S. exchanges. This has been viewed as a step too far for the PCAOB, since it would likely hurt investors in the Chinese companies. Most of these investors are Americans, since it is difficult for Chinese to buy shares of companies listed in the U.S. because of currency restrictions. The result of a mass delisting would likely be a surge of IPOs on the Hong Kong exchange.
I suspect the SEC and PCAOB are raising this issue at this time because of the trade war. Allowing inspections would not seem to be a huge concession for China to make in a settlement of the trade war. Threatening to cut off access to U.S. capital markets for Chinese companies is yet another way for the U.S. to escalate the trade war.
The stand-off between financial regulars in the US and China, and the Big Four accounting firms might be over soon, expects accounting professor Paul Gillis, looking a a recent piece in the Wall Street Journal. Inculding a US$500,000 settlement fee for each of the four, he writes on his weblog.
Paul Gillis.
I suspect that a deal is imminent between the US and China over audit and securities regulation. Given China’s recent proposal to clean up the VIE structure, I think China has decided it wants access to US capital markets and has decided to cooperate with US regulators and remove obstacles to US listings. Consequentially, I expect we will see a deal between Chinese regulators and the SEC and PCAOB before the settlement with the Big Four is finalized. US regulators would be foolish to let the Big Four off the hook before they get such a deal.
The penalty of $500,000 to each of the Big Four also makes no sense to me. If you accept the firm’s arguments that they were caught between a rock and a hard place when deciding whether to break either Chinese or US law, then no penalty would be appropriate. If you buy the judge’s argument that if the firms had found themselves in such a place because it was their own decisions (to accept clients when they knew that they might be breaking US law) that put them there, then the penalties need to be much larger. Penalties of $500,000 neither punish the firms nor deter bad behavior in such a lucrative market. On the other hand I believe the PCAOB shares some of the blame, since it should never have registered these firms to audit U.S. listed companies when the firms said they might not be able to comply with all aspects of US law.
Settlement of the regulatory problems and a fix to the VIE structure will go a long way towards removing some of the three terrors associated with US listed Chinese companies. If only someone can find a way to stop accounting fraud.
The ongoing stand-off between securities regulators in China and the US keeps auditing firms hostage and might eventually lead to the delisting of Chinese companies at US stock exchanges. Beida accounting professor Paul Gillis tries to map out a way out of the maze in Forensic Asia.(pdf)
Paul Gillis:
A slew of frauds at US-listed Chinese companies have highlighted flaws in the attempts of US regulators to provide, what they believe is, adequate investor protection. The US Securities and Exchange Commission (SEC) demands the audits of all US-listed companies meet the standards established by the US Public Company Accounting Oversight Board (PCAOB). Unfortunately, Chinese-based auditors are unable to release their audit working papers to US regulators without breaching Chinese law. As such, complying with US regulations could land Chinese auditors in
Chinese jails and failure to comply could land them in US jails.
In order for overseas auditing firms to audit US-listed companies, they must submit to an inspection by the PCAOB to ensure they are following US standards. Chinese regulators have been reluctant to offer joint inspections as they believe this is a breach of national sovereignty and have pushed for the equivalent of the audit oversight systems in third countries, similar to the agreement China has struck with the EU. Unfortunately, the PCAOB has little statutory authority to offer this.
The China Securities Regulatory Commission (CSRC) may well cede to some form of joint inspections between Chinese and US regulators but on the condition that only they will be allowed to administer punishment to wayward Chinese auditors. However, approval from the Ministry of Finance is questionable given the issue of “face”.
And Gillis - at the end of high detailed article - cautions, as the situation is still developing:
The biggest risk is to China. If Chinese entrepreneurs are unable to obtain access to capital, indigenous innovation may suffer, and China’s long-term competitiveness may be affected. Chinese stock exchanges are not ready to replace U.S. markets for entrepreneurial companies. The CSRC recently announced it was liberalizing rules for Chinese companies to list overseas, motivated in part by a huge backlog of pending IPOs in China.
The only scenario that resolves the situation without kicking Chinese companies off of U.S. stock exchanges is where the United States and China reach a diplomatic solution. From the U.S. perspective, the PCAOB and the SEC have likely put their best offer on the table. Both regulators are bound to follow U.S. laws, which generally require them to regulate auditors as they have proposed. A law change seems unlikely, given it would propose a lower standard for Chinese companies than that imposed on other companies, including American companies. James Doty has pointed out that the Supreme Court case that upheld the constitutionality of the PCAOB established that the
PCAOB is in a reporting line to the President, but it is unlikely, and perhaps not legally possible, for the President to settle the dispute in another fashion.
Investors should watch this situation closely. The market is likely to move significantly if the issue is either resolved or the likelihood of deregistration and delisting increases.Much more in the ChinaAccountingBlog.(pdf)
The world´s four largest auditing firms are up in arms, as their China division as the SEC rules against them. But the real victims are their Chinese clients, warns Peking University professor Paul Gillison his accouting weblog. Not only listed firms, but all companies working with the big four.
Paul Gillis:
As much as the firms are feeling sorry for themselves, it is their clients and the investors in those clients who will be hurt if the firms are banned from practice. A ban could lead to the companies being kicked off of U.S. stock exchanges for failing to produce audited financial statements. IPOs would have to be post-poned until the bans were over. Financings would be delayed. Fortunately appeals are likely to delay this for a long time.
The effect would not be limited to U.S. listed Chinese companies. A ban from practice before the SEC would not allow the China member firms of the Big Four to do any audit work that is used in connection with a report filed with the SEC. That would preclude the China Big Four from working with their U.S. counter-parts on big U.S. MNCs like General Motors and IBM during the ban. That would increase the risk on MNCs with China operations which is not in anyone’s best interest.
The SEC tried to head this off. They asked the judge for a lifetime ban on the firms, but wanted it limited to engagements where the China firm does more than 50% of the audit. That idea was obviously designed to make sure the ban did not prevent the firms from working on MNCs. The judge disagreed, putting in place a six-month ban but making it a complete ban on the right to practice. That means the firms cannot work a single hour on MNC clients during the ban.
That is a bad result, not just for the firms, but also for the capital markets. I hope the SEC commissioners change that when they review the decision. The judge said he could not find a legal justification for a partial ban; I hope the SEC commissioners are more creative.
