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Yesterday, the SEC announced that it had filed charges against the Chinese arms of the “Big Four” accounting firms — the biggest in the world — PricewaterhouseCooper, KPMG, BDO, Deloitte, and Ernst & Young.The SEC claims that the companies are in violation of a provision of Sarbanes-Oxley which requires foreign accounting firms to provide proper audit work papers etc. in connection with clients that list in the United States. The complaint refers to 9 clients (but not by name) for which the SEC believes these firms have failed to properly disclose information.
In short, the SEC wants to see where these companies’ numbers are coming from.
This presents a major problem: China considers some of its companies numbers state secrets, and that means it’s a violation of Chinese law to share them with foreign governments.
So the ‘Big Four’ are between a rock and a hard place:
“Only with access to work papers of foreign public accounting firms can the SEC test the quality of the underlying audits and protect investors from the dangers of accounting fraud,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “Firms that conduct audits knowing they cannot comply with laws requiring access to these work papers face serious sanctions.”
If the SEC doesn’t get their papers, it won’t just impact the auditors. Sarbanes-Oxley created a non-profit corporation called the Public Company Accounting Oversight Board. It’s overseen by the SEC and carries out independent assessments of U.S. listed public company audits.
If the PCAOB doesn’t feel that Chinese companies are capable of giving them accurate information, they won’t be able to assess them. To Paul Gillis, a professor at Peking University’s Guanghua School of Management this could mean Chinese companies won’t be allowed to list on U.S. exchanges anymore.
I believe that this marks the beginning of the process to deregister Chinese accounting firms from the PCAOB and to ban them from practice before the SEC. Unless resolved, this will likely lead to the delisting of U.S. listed Chinese companies. Multinational companies in China may also face issues since PCAOB rules require an auditor playing a substantial role in the audit of an MNC be registered with the PCAOB. There are situations where the China Big Four are playing a substantial role in the audit of U.S. MNCs that have substantial operations in China. They may need to resolve this by dividing the work among several firms so that no single firm plays a substantial role.
The auditors are blaming this whole issue on Sino-U.S. relations (from Reuters):
The action “is the result of conflicting laws between the U.S. and China,” PwC China said in a statement. “This action involves an issue that needs to be resolved between the US and China.”
Deloittee said, “While it is unfortunate that the two countries have not yet been able to find common ground on these issues, we remain hopeful that a diplomatic agreement can be reached, and we stand ready to assist that effort in any way we can.”
That said, the U.S. has brought fraud charges against 40 U.S. listed Chinese companies, deregistered the securities of 50 of them over the past two years.
So it’s safe to say can’t sat someone probably saw this coming.