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Chinese Inspection Pact Remains Out of Reach

A year after the U.S. Treasury Department announced a pilot program to inspect a Chinese accounting firm, no inspections have occurred, and it is not clear if they will be. Chinese concerns about sovereignty and national security appear to be overriding any interest the nation’s securities regulators have in opening up their capital markets.

A year after the U.S. Treasury Department announced a pilot program letting the PCAOB inspect a Chinese accounting firm, a formal inspection agreement is still not in place and may never be.

The pilot program never took place after Chinese officials walked away from an October negotiating session with PCAOB representatives, and since that abrupt end, no progress has been made despite continued discussions. Treasury, for its part, issued a statement at the end of this year’s Strategic and Economic Dialogue (S&ED) that was, like statements from prior years, long on cheeriness and short on substance.

“Both sides express[ed] appreciation for the mutual efforts and extensive work undertaken since last year’s S&ED to advance cross-border cooperation on the oversight of the audits of public companies,” Treasury said in a summary of the results of the high-level talks in Beijing on June 7, 2016. “Building on the results of last year’s S&ED, both sides are to endeavor to begin inspections in the near future and are to continue to explore effective ways of long-term cooperation in this area in order to protect investors and promote public trust in each country’s capital markets.”

The annual talks attended by senior officials alternate between Beijing and Washington.

At the time the Treasury Department announced the pilot program in June 2015, PCAOB officials were optimistic that it would lead to regular joint inspections of auditors in China. But once the Chinese cut off negotiations, the audit regulatory board was left empty-handed. The PCAOB cannot inspect foreign audit firms without first reaching a deal with local regulators.

The PCAOB, whose Chairman James Doty has been participating in the dialogues, declined to comment.

Paul Gillis, an accounting professor at Peking University, said the latest announcement by Treasury may be a general indication that U.S. negotiators are ceding too many contentious issues to the Chinese. The U.S. and China differ on issues ranging from the value of China’s currency to territorial disputes in Asia.

“Looks like they copied the same promises from the last several S&EDs,” Gillis said. “Nothing ever happens. I wonder when the U.S. is going to realize that China is playing with them.”

The U.S. audit regulator has for years wanted to inspect the auditors of Chinese companies that trade their shares on U.S. exchanges, several of which have been the targets of enforcement actions by the SEC for questionable accounting. But China bars direct production of audit documents to foreign regulators, and the Chinese believe their sovereignty is compromised if foreign regulators are allowed to inspect firms on site on their territory. Some officials in China also fear that state secrets may be revealed during inspection.

A source who is familiar with the PCAOB’s dealings with the Chinese and asked for anonymity previously said the delay on a final deal may have to do with concerns among government officials about inspections of audits involving state-owned enterprises and Internet companies.

Some officials seem “to think the Internet companies are full of state secrets,” the source said, adding that the Ministry of Industry and Information Technology may have told the China Securities Regulatory Commission (CSRC) that the technology companies are off limits.

Chinese officials during the S&EDs over the years have not been shy about publicly telling the U.S. to mind its own business when U.S. officials criticized various Chinese policies, including human rights issues.

Nevertheless, others were not as pessimistic about a prospect of getting to an agreement, citing difficulties in all international negotiations.

“The ability to conduct inspections is a long-term project involving very different cultures,” said Tom Gorman, a partner at Dorsey & Whitney LLP in Washington. “On the one side is the U.S. and other international markets, which prize transparency. On the other is China, which has long focused on personal relationships and a fair amount of secrecy. This culture clash is in sharp focus here where Sarbanes-Oxley requires inspections and the availability of work papers and the China regulators do not.”

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