New regulations by the Ministry of Finance (MOF) will bring audits of overseas listed Chinese companies under Chinese rule. A long overdue improvement, argues accounting professor Paul Gillis at his weblog. “These requirements are promising.”
That is a good thing. Chinese regulators previously washed their hands of U.S. listed Chinese companies. I am unaware of any executive or auditor of an alleged fraud involving a U.S. listed company ever facing justice in China, yet China also blocked U.S. regulators from doing anything. Chinese accounting firms have been unfairly maligned by shoddy work done by fly-by-night reverse merger auditors from former U.S. penny stock havens like Salt Lake City and Denver. China is cracking down on those firms, and establishing regulatory control over the auditing of overseas listed Chinese companies. Some Hong Kong accountants may be unexpectedly caught in the process.
A number of small U.S. CPA firms set up shop in China. Some of them established companies in China so they could hire local accountants to do the work. They organized their companies as consulting WFOEs, and auditing was clearly not in the business scope of these companies. So they have been operating illegally in China. Other firms outsourced the audit to small local CPA firms, and some were busted by the PCAOB for signing off on audits without doing them. The proposed rules will shut down these practices. If the firms want to do this work going forward they must work with a Top 100 Chinese CPA firm (or one with a securities qualification – all of which are currently in the Top 100). Good luck with that – I expect many of the remaining reverse merger companies are going to have a tough time finding an auditor and they may have to leave the U.S. markets.
The proposed rules require that domestic firms that want to work on overseas listings must both register with foreign regulators (i.e. PCAOB) and comply with laws, regulations and auditing standards – presumably both Chinese and foreign auditing standards. Foreign firms associated with audits of overseas listed Chinese companies must report to MOF within 45 days of the audit report, and if they don’t MOF will “order them to make corrections” and turn them in to the overseas regulator.
These requirements are promising. China is acknowledging the role of foreign regulators with respect to overseas listings of Chinese companies. Requiring Chinese auditors to register and comply with foreign rules on overseas listings may foretell greater cooperation between China and foreign regulators on overseas listed Chinese companies. It is not a big step from here for the MOF to allow the PCAOB to “ride along” on inspections of the audits of U.S. listed Chinese companies. I expect China is going to insist on handing out any punishment to Chinese firms that do bad audits, but the PCAOB should not be in this for the fine money anyway.
The notice also refers to situations where an overseas firm issued an audit report, but when challenged attributed the responsibility for the audit to a mainland firm. I think they are talking about how EY HK was the accountant of record on Standard Water but pointed to EY China when SFC demanded to see the working papers. The proposed rules will make the foreign firm take responsibility for the work.
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