What new US-China accounting MoU really means

Author: Ashley Lee | Published: 4 Jun 2013
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KEY TAKEAWAYS

  • The PCAOB’s Memorandum of Understanding with the CSRC signals further cooperation between Chinese and US regulators on issues related to accounting fraud;
  • However the MoU represents a first step. There must be an investigation of conduct before the PCAOB can request financial records, and the regulator must approve them before they are turned over to the PCAOB;
  • This MoU does not affect companies already under SEC enforcement actions;
  • The MoU affirms that talks are ongoing between the PCAOB and CSRC, although it is unclear whether this will change the SEC’s stance.

The US Public Company Accounting Oversight Board (PCAOB’s) Memorandum of Understanding (MoU) with the China Securities Regulatory Commission (CSRC) is a step in the right direction. But it doesn’t solve the US Securities and Exchange Commission (SEC) remaining issues.

US-listed ChinaCos and their auditors have been hard hit by fraud allegations from both short-sellers and US regulators. Their case has not been helped by their inability to turn over their audit work papers – the CSRC has declared that these papers are state secrets and cannot leave the country.

However the CSRC’s MoU with the PCAOB doesn’t mean that all issues are resolved with the SEC. Although it probably eliminates the worst case scenario – that all ChinaCos must delist from US exchanges – an agreement with the SEC remains key.

Jones Day’s Gene Buttrill said that in obtaining this MoU, the PCAOB doesn’t want to indicate that it has somehow usurped the SEC’s ability to negotiate a resolution with the Chinese government or that all Chinese companies are safe investments.

However, he added that the point to make is that the PCAOB has actually done a great job in representing interests of auditors, regulators and investors, and has always been open to discussions when approaching PRC regulators.

They are very focused on not making this a public issue and addressing it in a more personal way, he noted.

But this approach unfortunately contrasts with that of the SEC, which he said has made it much more public and has been much more aggressive in addressing the issue.

Although this more adversarial approach may work for US regulators, Chinese regulators are less likely to appreciate interactions of that nature.

What’s in the MoU

The PCAOB will now be able to pull up financial records in relation to a conduct investigation and pass those documents on to the relevant regulators such as the SEC.

However Chinese regulators must approve the financial records of the company to ensure that giving the documents to the PCAOB doesn’t violate local law or national interest.

This is a potentially important exemption as some of the companies involved in alleged accounting fraud are in sensitive sectors.

Further, Buttrill added that the ability to pull up documents in relation to a conduct investigation is very different from the PCAOB’s ability to review audit papers in the course of reviewing that auditor.

In China, he said, the PCAOB will not be able to enter and ask for a sampling of work. Instead they must have grounds to start an investigation to request papers, which is only likely once the client of an auditor is in trouble.

"Essentially they won’t have the ability to prevent bad auditing practices from happening," he commented.

What this means for companies under scrutiny

Although Deloitte asked a US court to dismiss its hearing related to Longtop Financial Technologies after the MoU was signed, it is not expected to affect companies for which the SEC has already begun enforcement actions.

Buttrill added that as for companies already dealing with SEC enforcement actions, this MoU does not change their situation.

"They’ve already made mistakes, and the issue now is how they should be punished," he said.

What to expect

Sources noted that between the CSRC and PCAOB, the CSRC is more positive about this agreement as it represents a notable shift from its former position. However they added that the PCAOB is more cautious about this MoU, as it still provides less transparency than it sees from most other nations.

Regardless, the releases from both regulators made it clear that they are committed to finding a cross-border regulatory regime for audit firms in China working with US-listed companies.

As for the SEC’s ongoing issues related to the CSRC’s state secrecy statutes, this agreement may give the regulator more impetus to find a deal.

Buttrill stressed that the PCAOB’s MoU will not impact the SEC’s cases against the so-called Big Four, but instead puts political pressure on them to find another solution.

Hopefully, he added, this indicates that the US government is willing to take a less aggressive position on this matter.

Related links:

How China state secrecy law challenges HK independence http://www.iflr.com/Article/3084094/How-China-state-secrecy-law-challenges-Hong-Kong-independence.html

HK SFC’s CEO on the city’s financial hub future http://www.iflr.com/Article/3125118/Exclusive-Hong-Kongs-SFC-CEO-on-the-citys-financial-hub-future.html

Paul Gillis: SFC should not regulate auditors http://www.iflr.com/Article/3145672/Paul-Gillis-SFC-should-not-regulate-auditors.html