Chinese and US stock regulators have been at loggerheads on the rules US-listed Chinese companies have to follow. In that struggle, the SEC has caved in, according to a WSJ story, and accounting professor Paul Gillis complaints on his weblog that the effort to let those Chinese firms comply with US law has gone awry.
I believe that the SEC went after the Big Four firms intending to use the lawsuit as a way to coerce China to the negotiating table. The Big Four are not the problem with the widespread fraud that has plagued US listed Chinese companies. The problem, of course, is corrupt company officials. The firms should have done a better job vetting new clients, and have faced challenges with adapting audit processes to Chinese business practices. The explosive growth of these firms has left them short of experience – especially with inadequate numbers of “no-hair, gray haired” partners with well-seasoned judgment. In my opinion, the Big Four are doing their best in a difficult market, and because of the failure of the SEC and PCAOB to effectively regulate US listed Chinese companies, the Big Four are the only meaningful line of defense for investors.
In my view, banning the Big Four was never the objective of the SEC. The suit was a way to show Chinese regulators that the SEC was willing to deploy the “nuclear option” of kicking Chinese companies off U.S. exchanges. The SEC apparently believed that the threat of delisting Chinese companies would bring Chinese regulators to the negotiating table. The SEC miscalculated and Chinese regulators called their bluff. In the end, banning the firms, which would lead to a mass delisting of Chinese companies from US exchanges, was simply a step too far for the SEC to take. I am sure the SEC was heavily lobbied by US investment banks, lawyers, and accounting firms that have lucrative business interests in keeping capital flowing.
So today we have different rules for Chinese companies that list in the US than we have for others. Not only is the SEC dependent on Chinese regulators to decide what documents they can see, the PCAOB remains unable to conduct inspections of auditors. But the different rules go beyond auditing. Other rules, like Regulation Financial Disclosure, do not apply to US listed Chinese firms, creating an unfair market for investors.
The Wall Street Journal thinks the SEC should do more to flag the risks of investing in Chinese companies. I think it has done a fine job in that area, but few investors read or heed the disclosures. What we need are regulators willing to “just say no” to listing companies that are not willing or able to fully comply with US laws.
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