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Chinese Audit Firm Inspections May Start by Year-End

The PCAOB’s leadership expects to begin inspecting Chinese audit firms in the People’s Republic as soon as this year.The resurgent market in Chinese company initial public offerings (IPO) on U.S. stock exchanges gave the audit regulatory board an extra incentive to reach a deal.

PCAOB Chairman James Doty said on July 15, 2014, that he expects the regulatory board’s inspectors to have access by year-end to Chinese audit firms.

The announcement follows discussions with Chinese officials during the sixth round of the U.S.-China Strategic and Economic Dialogue in Beijing.The PCAOB offered no details on the manner in which the inspections would be conducted.

The July 9-10 discussions with senior U.S. and Chinese officials included Secretary of State John Kerry, Treasury Secretary Jacob Lew, Chinese State Councilor Yang Jiechi, and Vice Premier Wang Yang.The annual negotiations alternate between Beijing and Washington.

“The PCAOB and Chinese authorities committed to moving forward with a cooperative mechanism providing for cross-border inspections,” said Doty, who took part in the talks with representatives from China’s Securities Regulatory Commission (CSRC) and Ministry of Finance. “We continue to work out the details of such cooperation and expect the two sides to be able to reach agreement on a set of protocols in the coming months.”

Treasury Department officials reportedly stressed the importance of a deal with the PCAOB to their Chinese counterparts.

Doty said the resurgent market in the initial public offerings (IPO) of Chinese companies on U.S. stock exchanges gave the audit regulatory board an extra incentive to reach a deal.

The renewed optimism for cooperation between U.S. financial regulators and their Chinese counterparts comes almost on the eve of the IPO of Alibaba Group Holding Ltd., the Chinese Internet retail giant, in what may become the largest initial stock offering in history.News reports have pegged the company’s value at $130 billion, and the offering is expected to raise more than $20 billion.

The promise, and the risk, of Chinese IPOs prompted Senator Bob Casey, a Pennsylvania Democrat, to ask SEC Chair Mary Jo White to get more aggressive with enforcement efforts against Chinese companies.

“There are long-standing concerns about the transparency and legal structure of Chinese companies listed on U.S. stock exchanges,” Casey wrote to White on July 11. “American investors in Chinese companies often do not enjoy the same protections and legal guarantees that they are afforded when they invest in American firms.”

Casey asked the SEC for details on its efforts regarding the risks posed by Chinese companies that use the type of off-balance-sheet structure called a variable interest entity and its actions to get the Chinese to improve the quality of information they give shareholders.

An SEC spokeswoman said the agency had no comment.

A Casey aide called the PCAOB deal with Chinese regulators “a positive step in the right direction.”

For the PCAOB, direct access to a Chinese accounting firm would mean the culmination of a years-long campaign to impose tougher supervision of Chinese auditors.

One of the first signs of progress materialized in May 2013, when U.S. and Chinese officials signed a memorandum of understanding about enforcement activities.Since then, the CSRC has been providing audit documents after checking them for state secrets. China bars direct production of audit documents to foreign regulators, and the Chinese believe their sovereignty is compromised if foreign regulators are allowed to come and inspect firms on site in China.

Separately, the SEC in May said in Accounting and Auditing Enforcement Release (AAER) No. 3553,Order Granting Leave to Adduce Additional Evidence and Granting the Petitions for Review,that it will review a ruling that banned the Chinese affiliates of the Big Four audit firms for six months and censured a fifth firm.

In January, Administrative Law Judge Cameron Elliot said the firms “willfully refused” to hand over audit documents sought in investigations for alleged accounting fraud by their clients.Deloitte Touche Tohmatsu CPAs Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen, and PricewaterhouseCoopers Zhong Tian CPAs Ltd., got six month-suspensions.A fifth firm, Dahua CPA Co. Ltd., was censured but not banned because it had exited the U.S. market.The firm was called BDO China Dahua CPA Co. Ltd.until April 2013 when it dropped its affiliation with BDO International Ltd.

The SEC enforcement effort is distinct from the PCAOB initiative to gain direct access to the Chinese audit firms, but the two efforts share a common concern about the integrity of the financial statements Chinese companies and their auditors file with the U.S.

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