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U.S. Regulator: Speculation of Audit Inspection Agreement with China is ‘Premature’

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 6 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 6 minute read

After the SEC recently turned up the pressure by writing congressionally-mandated rules that would eventually stop stock trading of U.S.-listed Chinese companies like tech giants Alibaba Group Holding Ltd. and Baidu Inc. if they do not submit to PCAOB’s inspections of their external auditors, the Chinese authorities may have been more eager to get some kind of deal signed with the U.S. audit regulatory board.

And there has been some speculation that a final agreement between the PCAOB and the Chinese authorities—the China Securities Regulatory Commission (CSRC) and the Ministry of Finance—may be on the horizon.

However, the PCAOB told Thomson Reuters that such speculation “is premature” while adding that the board continues to engage with Chinese authorities in an effort to sign a deal that will allow the board to inspect and investigate “completely” the auditors that are in China and Hong Kong.

“We appreciate the engagement of the Chinese Securities Regulatory Commission and Ministry of Finance to work through several important threshold issues, though it remains unclear whether the PRC government, as a whole, will agree to permit and facilitate the access we require,” the PCAOB said on March 24, 2022. “While we will continue our work to find practical solutions to address the concerns of PRC authorities, ultimately, full access to relevant audit documentation is necessary to carry out our mandate on behalf of investors.”

The board emphasized that “this is not negotiable, even with respect to issuers in sensitive industries.”

The PCAOB and China have been in on-again, off-again negotiations to do joint inspections of auditors’ work papers, to no avail. In the meantime, there have been many accounting frauds at Chinese companies that cost a lot of money for U.S. investors, including at Luckin Coffee Inc., a coffee chain that competes against Starbucks Corp. in China.

China has so far not granted full access to audit papers fearing infringement to its sovereignty. Moreover, the communist regime is worried that such documents may contain state secrets.

The congressionally-mandated rules are in the Holding Foreign Companies Accountable (HFCA). Among other things, if the PCAOB cannot inspect auditors for three years in a row, the companies will face a trading ban. There is movement in Congress that this time frame could be shortened to two years.

To the PCAOB, its requirements are plain and simple: its inspectors and investigators must be able to do their job.

During a conference in November last year, Paul Munter, acting chief accountant of the SEC, pointed to HFCA’s emphasis on the PCAOB’s inability to inspect or investigate accounting firms “completely.” The SEC oversees the board.

The PCAOB “might be able to inspect one or some number of audit files; [this] isn’t the same thing as being able to inspect completely,” Munter said at the time. The PCAOB will be using the same approach for Chinese auditors that it inspects in the U.S. and in other parts of the world where it has agreements to inspect.

Investors have been complaining about an uneven playing field because Chinese companies’ auditors have not been inspected. HFCA is intended to change that.

“All firms auditing public companies must play by the same rules,” the PCAOB said.

“When they go to inspect, they need to have the ability to determine which firms they are going to inspect in a jurisdiction, and then in particular, they have a risk-based approach that they use to determine which engagements within that firm they are going to inspect and obviously, which areas of the engagement they want to focus on,” Munter said last year. “So, they need to be able to have access to whatever work papers they believe are appropriate to allow them to carry on the inspection and access to the professionals of that firm to be able to carry on the inspection.”

“Impediments to any of those are likely to lead to a conclusion by the PCAOB that it is unable to inspect or investigation completely within a jurisdiction,” he added.

The PCAOB said that it is not only full access to audit work papers but also firm personnel, and any other relevant information.

“Restrictions on PCAOB access to firms that have registered voluntarily with the PCAOB and that have chosen to perform required audits of companies that avail themselves of U.S. capital markets and are subject to U.S. federal securities laws deprive investors and the public of the benefits of the protections resulting from the work the PCAOB performs on behalf of investors,” the board said.

The laws, among other things, include the Sarbanes-Oxley Act of 2002, which established the PCAOB and gave it power to supervise accounting firms that audit public companies. Congress passed the law in response to accounting scandals at companies like Enron and WorldCom which cooked their numbers, costing investors an estimated $85 billion two decades ago.

To allay fears of state secrets being revealed, the PCAOB stressed that Sarbanes-Oxley provides strong confidentiality protections and creates a privilege for any information that the PCAOB get. And this laid a strong foundation for cooperation with other audit regulators around the world. Other countries have agreements with the PCAOB. China has been a hold-out for about 15 years.

“It is important to note that reaching an agreement, while an important and necessary first step, will not alone satisfy the requirements of the HFCAA,” the PCAOB further explained. “If an agreement is reached, we will then proceed with our inspection and investigation activities to determine if the agreement operates as intended such that we actually are able to inspect and investigate completely, in the long term, in mainland China and Hong Kong. An agreement without successful execution will not satisfy U.S. law.”

A former SEC official who asked not to be identified found the PCAOB statement to be good.

“If they stick to it, then I suspect there will not be an agreement as I believe the Chinese will not agree to what the PCAOB is insisting on,” the source said. “If the PCAOB members back off, then that will also be a great negative and tell us a lot about the new board. Time will be the judge.”

As of March 23, the SEC provisionally identified the following issuers that must comply with HFCA rules: BeiGene, Ltd.; Yum China Holdings, Inc.; Zai Lab Limited; ACM Research, Inc.; HUTCHMED (China) Limited; Weibo Corporation.

They have 15 days to contact the SEC if there are incorrectly identified. There are about 240 others that are within the rule’s scope.


This article originally appeared in the March 25, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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