The Kennedy bill has unintended consequences for MNC's - Paul Gillis

Paul Gillis

US legislators are preparing a law to allow US PCAOB inspectors to check US-listed Chinese firms. But - warns auditing expert Beida professor Paul Gillis - the so-called Kennedy law might have unintended consequences for all multinational companies, he writes on this Chinaaccountblog. 

Paul Gillis:

The bill essentially bans trading in companies whose auditors are not able to be inspected by the PCAOB. The bill is limited to covered issuers (essentially any public company) that are audited by an auditor with a branch or office in a foreign jurisdiction that does not allow inspections. 

Those definitions obviously bring most US listed Chinese companies under the jurisdiction of the Kennedy Bill. They are public companies and are mostly audited by the Chinese member firms of the Big Four accounting firms. 

But what about multinationals like IBM? IBM is audited by the US firm of PwC which uses PwC Zhong Tian CPAs, its China firm, to audit China operations.  PwC Zhong Tian is a Chinese limited liability partnership, not an office or branch of the US firm. The Big Four accounting firms are structured more like a franchise operation than an MNC.  Local operations tend to be owned by local partners.   On its face, I don’t think that Big Four firms in China constitute a branch or office of the US firm. This is not an insignificant point. The PCAOB has identified 207 multinationals where it can inspect some, but not all of the audit. 

I don’t think the Kennedy bill is intended to impact MNCs, and based on my analysis in the previous paragraph, I don’t think it does. However, Big Four firms would be wise to carefully review existing business operations to make sure the US firm has not inadvertently established a branch or office in China. I know many of the Big Four firms in China have seen firms in their network sneaking into China to do projects. There will be heightened concern over these activities out of fear they could be treated as a branch or office that would result in serious problems for their multinational clients, even where the activities of that branch or office had nothing to do with the audit.

More at the China Accounting Blog.

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Companies need guidance in dealing in auditing process - Paul Gillis

Paul Gillis

The ongoing coronavirus in China is going to disrupt the regular auditing process, warns Beida professor Paul Gillis on his weblog Chinaaccountingblog. Even for companies who do not get into financial problems, some guidance on how to deal with this crisis and the auditing process is urgently needed, he adds.

Paul Gillis:

Even when there is no going concern issue because the company is adequately capitalized, the issue of whether to accrue corona virus related losses in 2019 or to report them in 2020 is important. There are two significant components to this: 

Most companies will have done little business in January and February, 2020 first because of the normal Chinese New Year holiday and then because of mandatory closures related to the virus. Companies, however, are required to continue to pay employees. Should losses related to the virus be accrued as of December 31?  The event that caused the loss began in 2019.  By the time that financial statements are issued (April or later) the amount of loss can likely be determined. 

Secondly, each company must determine in the preparation of 2019 financial statements if any assets are impaired. Any impairment is recorded as an expense. Of particular concern will be intangible assets such as goodwill. Many Chinese companies have considerable goodwill on their balance sheet due to acquisitions. Goodwill is typically tested for impairment by looking at future cashflows from the related business. Those cash flows have been altered by the virus, and potentially significantly enough that goodwill must be impaired. 

I think it would be useful if accounting standard setters or the Emerging Issues Task Force would issue guidance as to the application of the subsequent event rules to the facts of the corona virus.

More at the Chinaaccountingblog.

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HK audit regulations go downhill to attract US business - Paul Gillis

Paul Gillis

Many Chinese companies took a listing at US exchanges because audits in Hong Kong and on mainland exchanges were stricter. The HK stock market now is watering down regulations for audits, notes Beida accounting professor Paul Gillis on his website to his shock, to pull back those Chinese companies from the US.

Paul Gillis:

The Hong Kong Stock Exchange (HKSE) has issued its latest proposal to weaken corporate governance standards in order to attract Chinese listings that have gone to the US. The US has won most of the listings of China's privately held companies, including bellwethers Alibaba, Baidu and Sina. There are several reasons for that, including the fact that the US permits weaker governance than Hong Kong or China, and that fees for investment bankers are considerably higher with US listings. The weaker governance rules led to the NYSE winning the Alibaba listing over the HKSE. Hong Kong faced the possibility it would not win another major IPO from China because most Chinese founders want a controlling vote, even when they no longer hold a majority of the shares. 

Much to the consternation of corporate governance advocates, Hong Kong proposes allowing control structures (called weighted voting rights - WVR).   Shareholder advocates in the US have opposed the proliferation of these structures in technology companies. Hong Kong is also proposing to relax other listing standards related to profitability. 

The proposed rules essentially allow unicorns to list in Hong Kong with control structures. More flexible rules are proposed for biotech issuers. 

In addition, the path is being cleared to allow overseas listed companies to seek secondary or main listings in Hong Kong after two years of compliance on a foreign exchange. 

Restrictions apply to prevent regulatory arbitrage, where a company lists overseas first in an attempt to circumvent tougher Hong Kong listing standards.

More at the Chinacountingblog.

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How to end double standards for US-listed Chinese companies - Paul Gillis

Paul Gillis

Oversight of Chinese companies listed in the US has been ongoing troublesome, as auditors miss access to much information considered a state-secret in China. Peking University accounting professor Paul Gillis told the  U.S.-China Security and Economic Commission 26 January how to solve the conundrum. (here in pdf)

Paul Gillis:

In my opinion, the major problem with respect to U.S. listed Chinese companies is the inability of the PCAOB to conduct inspections of China based accounting firms. This has resulted in a situation where there is a double standard in regulation. All auditors of companies listed in the U.S. must be inspected, except for auditors of Chinese companies (and companies of a few other minor countries), which are not inspected. While this fact is routinely disclosed in the issuer’s filings, the double standard makes a mockery of U.S. regulation. 

In my view, there are two alternatives to eliminate the double standards. First, Sarbanes Oxley could be amended to remove the requirement that the PCAOB inspect foreign accounting firms. Instead, the PCAOB could follow the lead of the European Union and negotiate regulatory equivalency under which the PCAOB would accept the work of Chinese regulators as their own. I do not think this is the best option, since I think it is unlikely that Chinese regulators will rigorously examine overseas listed companies nor do they have the necessary expertise in U.S. accounting and auditing rules. 

The second option is to terminate the registration with the PCAOB of any auditors that the PCAOB is unable to inspect. The U.S. should require companies that seek to list in the U.S. to agree to follow all U.S. laws. If China determines that a company has state secrets that cannot be disclosed, a company with such secrets should not be permitted to list in the U.S. 

Termination of accounting firm registrations would lead to the delisting of shares of companies audited by the deregistered firms, since financial statements audited by a PCAOB registered accounting firm are a requirement for continued listing. Delisted companies are likely to seek to relist in China or Hong Kong, although they may be required to restructure to eliminate control structures and/or variable interest entity arrangements that may not be permitted in the other jurisdiction. The PCAOB has so far been unwilling to go this far, likely due to opposition from capital markets. 

Another problem with U.S. regulation is the overlapping jurisdiction of financial regulators. There is little secret that there is considerable tension between the SEC and the PCAOB. I believe this both confuses Chinese regulators as well as creating opportunities for Chinese bureaucrats to play one regulator off the other. I think Congress should consider abolishing the PCAOB, transferring the inspection and enforcement activities to the SEC and sending standard setting back to the American Institute of CPAs.

The full statement by Paul Gillis.(pdf)

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