The refusal of China to allow access to the workpapers of Chinese company auditors was first reported on in this publication’s initial year, 2012. Since then, every time there appears to be a breakthrough, China ultimately backs out. The latest crack in China’s resistance came in August 2020. In response to pressure from a Presidential Working Group, as reported in our September 2020 issue, China proposed to allow U.S. regulators to audit its state-owned enterprises (SOEs), but would insist on editing some information for national security reasons. Under the proposal, U.S. authorities would pick one of China’s SOEs for a trial joint inspection.
Apparently, China’s proposal did not come to fruition. On December 16, 2021, the PCAOB issued a Determination Report under the auspices of the Holding Foreign Countries Accountability Act (HFCAA) that stated:
• A determination that the Board is unable to inspect or investigate completely registered public accounting firms headquartered in mainland China of the People’s Republic of China (“PRC”)1 because of a position taken by one or more authorities in mainland China (“the Mainland China Determination”); and
• A determination that the Board is unable to inspect or investigate completely registered public accounting firms headquartered in Hong Kong, a Special Administrative Region and dependency of the PRC, because of a position taken by one or more authorities in Hong Kong (“the Hong Kong Determination”).
The HFCAA had been enacted unanimously by the United States Congress in December 2020, requiring listed companies to make certain disclosures if the PCAOB has been unable to inspect the company’s foreign public auditing firm. The company must document to the Securities and Exchange Commission (SEC) and disclose in its annual report that it is not owned or controlled by a foreign government, as well as details of any amount of such ownership and/or certain relationships with the Chinese Communist Party. If the PCAOB is unable to inspect the auditor for three consecutive years, the company is to be banned from trading its securities.
The PCAOB’s Determination Report got the attention of the Chinese government. Only two days later, the South China Morning Post (SCMP) reported that the China Securities Regulatory Commission (CSRC) released a statement that “the relevant regulators of China and the US have started the negotiations over the regulatory cooperation issues [and] have made some progress.” Even so, the CSRC contended that talks had been ongoing. As our articles have shown over the past ten years, this may be the case, but such talks have been essentially unproductive.
In a separate SCMP January 3, 2022 article, the United Kingdom’s Financial Reporting Council (FRC) also challenged the claims of the PCAOB, claiming that “Hong Kong has always allowed the PCAOB access to its auditors and their working papers.” As the auditing regulator for Hong Kong, the FRC has gotten more active with investigations in the past year, having been granted broader powers.
The importance and urgency of full transparency and access to the audit workpapers of Chinese company auditors was strikingly displayed by the collapse of Luckin Coffee Inc in May 2020. The Bejing based company had only been listed on NASDAQ for a year when the discovery of accounting and financial statement fraud led to the company’s delisting. After settling with the SEC in December 2020 and declaring bankruptcy in February 2021, the court approved a restructuring plan in December 2021.
With China having emerged as such a dominating player on the world financial scene, the expectation is that the requirement for full auditor inspections to assure quality audits will finally be taken seriously.
Further details can be found at Rule Governing Board Determinations Under the Holding Foreign Companies Accountable Act, Open Your Books or Be Delisted: SEC Finalizes Rules for Non–PCAOB Compliant Foreign Companies and China, US regulators start talks on audit inspection of Chinese companies on American exchanges amid moves to delist these firms.
