Cross-border audit negotiations between US and Chinese
regulators have reached a standoff over US oversight of Chinese
audits, according to a CPA licensed in both countries.
I dont see China as being willing to accept
anything that is different than the kind of deal the US reached
with some of the European regulators, said CPA Paul
Gillis, a visiting professor at Peking University in
The US Securities and Exchange Commission (SEC) and the US
Public Company Accounting Oversight Board (PCAOB) met with
China Securities Regulatory Commission (CSRC) and Chinese
Ministry of Finance and Commerce (MOFCOM) officials on July 11
and 12 in Beijing during the Sino-US symposium on audit
The meeting followed 24 securities fraud class-action law
suits, mostly on grounds of accounting fraud, against Chinese
reverse merger companies (CRMs) issued between January and June
of this year.
US accounting firms subject to triennial PCAOB inspections
audited most of these companies, but many of them delegated
accounting oversight to firms in China.
Last year the SEC requested information from US audit firms
to verify financials of foreign based companies traded on US
exchanges. Over 24 PRC-based companies responded with auditor
resignations, accounting problems, or both, according to SEC
Chairman Mary Schapiros April 27 2011 letter to
Congressman Patrick McHenry.
The SEC suspended trading and revoked registration of some
of these CRM companies for failing to make required
periodic filings. The agency also filed enforcement
actions against US auditors.
Stephen Mahinka of Morgan Lewis & Bockius believes some
of the problems arising from Chinese audits might be a case of
less evolved accounting practices, rather than intentionally
exaggerated income reports.
You certainly wouldnt be surprised if it was
simply the relative lack of sophistication of their accounting
practices, Mahinka said.
As an institutional matter, you have well developed
systems in Europe, the US and Japan, but you dont have
long-working systems developed to the same degree in China
because they werent needed for the first several decades
of the regime, he said.
In their July meeting, US and Chinese regulators expressed
their intention to increase cross-border audit cooperation, but
an agreement allowing the PCAOB to send investigators to
Chinese accounting firms was not reached.
Osler Hoskin & Harcourt partner Kevin Cramer is not
optimistic that the PCAOB will be given permission to do its US
statutory duty of investigating China based auditors of US
traded companies any time soon.
While a careful reading of the August 8th
[PCAOB] press release indicates incremental progress was made,
it is also clear that the process going forward will be a slow
one and unlikely that a bilateral agreement between US and
Chinese regulators will be achieved in the near future,
US exchanges have also tackled the problem.
Rules to be listed on the exchanges allowed for reverse
mergers to forgo stringent registration requirements. The NYSE,
NYSE Amex and NASDAQ have now proposed rules making it more
difficult for Chinese companies to list via a reverse
The NYSE and NYSE Amex would require a reverse merger
company to trade for at least a year in the US over-the-counter
market, while NASDAQ would require 6 months of trading in the
US over-the counter-market.
All of the exchanges would require the reverse merger
company to maintain a minimum share price of $4 for an extended
period and file audited financial statements and an annual
report with the SEC. They would also have the ability to make
stricter requirements if warranted.
I think it will have a significant cut back [in
reverse mergers] because essentially the NYSE regulation will
make it more difficult for companies to use the reverse merger
approach and avoid the full rigors of SEC review, Cramer
According to the SEC website, Gillis is the only person who
has posted a comment on NASDAQs proposed rule.
Weve had a lot of problems with some of these
[CRM] companies on NASDAQ. Most of the time, it was a small
accounting firm based in the US that goes to China, and that
was a formula for disaster, said Gillis.
PCAOB found situations where an auditor couldnt
speak Chinese, so they were relying on the local accounting
firms to do all the work, and that is just not
acceptable, he added
Gillis pointed to one thing that seems certain: Today,
I dont think a big four [firm] would take on a reverse
merger company outside some extraordinary levels of due