China Auditors, US In Dangerous Game Of Brinksmanship
I was a bit surprised to read that the US securities regulator is taking drastic action against the 4 main auditors for New York-listed Chinese firms, in its bid to get them to hand over records for companies suspected of financial fraud. Investors were also probably surprised by the move, which sparked a sell-off in shares of many of the US-listed Chinese firms that could suddenly lose their auditors if the US Securities and Exchange Commission (SEC) executes its decision. That decision had the SEC say it will impose a 6-month suspension on the China arms of the “Big 4” US accounting firms from doing audits on any US-listed companies.
Nearly all of the major US-listed Chinese firms rely on the China units of the Big 4 auditors, which consist of Deloitte & Touche, PricewaterhouseCoopers, Ernst & Young and KPMG. While I personally think these Big 4 deserve some punishment for their refusal to hand over records, I also think the SEC’s action seems a bit extreme. Such a move could create major disruptions for many US-listed Chinese firms that rely on these accountants to comply with US listing standards, making them victims even though they have done nothing wrong.
Investors were clearly worried about the latest escalation in the clash between the SEC and US auditors, sparking a sell-off in shares of many premier names. Leading search engine Baidu (Nasdaq: BIDU) and top Internet portal Sina (Nasdaq: SINA) both tumbled about 6 percent after the SEC announcement, while online game operator NetEase (Nasdaq: NTES) and leading online travel agent Ctrip (Nasdaq: CTRP) were both down more than 4 percent.
This dangerous game of brinksmanship began in 2011 when a series of US-listed Chinese firms collapsed after financial irregularities were uncovered in their accounting records. The SEC opened investigations into the cases, and in one high-profile instance asked Deloitte to hand over records related to its audit work for the now-defunct Longtop Financial. Deloitte refused, saying Chinese law forbid it from handing over the records. At that time I said that Deloitte was probably using the Chinese law to avoid handing over records that would show it was negligent in its Longtop audits.
In pursuit of its aim, the SEC went directly to China and last year signed a landmark information-sharing agreement with the Chinese securities regulator. (previous post) But that agreement didn’t help the SEC get the documents it was seeking, leading it to take its latest step.
That step has the SEC saying it will impose a 6 month suspension on the China arms of the Big 4 accounting firms, which will ban them from doing audit work for any US-listed company during that period. (English article) The Big 4 said jointly that they will appeal the decision, and noted they can continue to conduct audit work for their China-based clients during an appeal process that could last for several years. That would at least give the Chinese firms time to find new auditors if they thought the SEC suspension might ultimately be carried out.
The auditors argue the matter is one for Washington and Beijing to settle, since they worry that handing records to the SEC could violate Chinese secrecy laws. I’ve said before and I’ll say again that I think their explanation is just an excuse to avoid handing over records that could incriminate them for financial fraud or negligence. This latest development shows the SEC won’t just let the matter quietly drop, and I do expect that ultimately it will obtain the records it is seeking, possibly creating some major disruptions for US-listed Chinese firms in the process.
Bottom line: New SEC actions show it will continue its battle to get information from China arms of the Big 4 accounting firms, creating potential disruptions for New York-listed Chinese companies.
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