SEC Revives Fight Over Inability to Inspect Chinese Auditors of Alibaba, Baidu

By Dave Michaels and Michael Rapoport 

American regulators resurrected a long-simmering fight over their inability to inspect audits of Chinese companies that are traded on U.S. stock exchanges, saying the situation prevents investors from getting information they need.

The U.S. Securities and Exchange Commission said Friday that, despite several years of talks with its Chinese counterparts, regulators still face obstacles to getting information needed for accounting investigations and inspections of China-based auditors.

The SEC issued the statement in advance of a major accounting conference on Monday where its chairman, Jay Clayton, plans to speak about the problem.

"China's state security laws are invoked at times to limit U.S. regulators' ability to oversee the financial reporting of U.S.-listed, China-based companies," the SEC said in a joint statement with the Public Company Accounting Oversight Board. "The inability to date to achieve this level of regulatory cooperation with Chinese authorities raises a number of investor protection and general oversight issues."

While the SEC enforces securities laws and can bring enforcement actions against public companies and accountants, the PCAOB focuses its efforts on inspecting the work of public-company auditors. The PCAOB's work is overseen by the SEC.

The Chinese Embassy in Washington didn't immediately respond to a request for comment.

The SEC's revival of the issue came at the end of a week when relations between Washington and Beijing were strained following the arrest in Canada of a top executive of Huawei Technologies Co. American authorities requested the arrest of Meng Wanzhou, alleging she covered up Huawei's control of a company called Skycom that was illegally doing business in Iran, a Canadian prosecutor said Friday. China has called on the U.S. to release Ms. Meng.

A person familiar with the SEC's thinking said the timing of its Friday statement was unrelated to the Huawei arrest or to broader tensions with Beijing. The statement was intended to remind accountants and American investors of financial-reporting risks at companies whose books and records are out of reach of U.S. regulators, the person said.

The SEC statement said U.S. regulators could impose more oversight on U.S.-listed companies that rely upon those auditors. The measures could include forcing the firms to disclose more about their business or accounting and restricting their ability to sell new shares.

The statement didn't raise the biggest threat American regulators hold over foreign auditors: the possibility they could be barred from auditing U.S.-traded companies if the U.S. can't exercise full oversight over them.

The fight over Chinese-based auditors dates back more than a decade, to when many Chinese companies went public on U.S. stock exchanges by merging with an American shell company. Such "reverse mergers" gave the Chinese companies access to a U.S. investor base with little upfront scrutiny from the SEC.

Many of the firms were a bust, and the SEC ultimately filed dozens of enforcement cases against Chinese companies and their auditors, attorneys and other "gatekeepers."

Representatives of the Big Four U.S. accounting firms -- PricewaterhouseCoopers, KPMG, Deloitte Touche Tohmatsu and Ernst & Young -- couldn't immediately be reached for comment Friday on the SEC's statement.

The Big Four are global networks with separate member firms in each country where they do business, and the PCAOB inspects each member firm separately.

Dozens of U.S.-listed companies from China were later delisted from the exchanges or subject to trading suspensions. Nasdaq and the New York Stock Exchange later raised their listing standards to make it harder for new overseas firms to suddenly list on their markets.

The SEC said 224 U.S. companies, with a combined market capitalization of more than $1.8 trillion, are located in countries where there are obstacles to PCAOB inspections. Almost all of them are in China or Hong Kong, and include giants like Alibaba Group Holding Ltd., Baidu Inc. and JD.com Inc. The bulk of the companies are audited by affiliates of one of the Big Four firms.

In addition, Chinese audit firms also contribute significant amounts of work to the audits of numerous U.S. multinational companies that do business in China, including Walmart Inc., Pfizer Inc., 3M Co. and Texas Instruments Inc., The Wall Street Journal reported in July.

PCAOB inspectors typically inspect the audits of companies trading on U.S. markets to gauge their performance and compliance with auditing rules, even if the firms or the companies are outside the U.S.

But the Chinese government has long prevented the U.S. accounting board from inspecting auditors in China and Hong Kong. Beijing is concerned about sovereignty, and regards the sensitive financial information about Chinese business that the audit firms hold as akin to "state secrets."

Write to Dave Michaels at [e-mail] and Michael Rapoport at [e-mail]

(END) Dow Jones Newswires

December 07, 2018 19:59 ET (00:59 GMT)

Copyright (c) 2018 Dow Jones & Company, Inc.