Sino-U.S. audit deal hailed, but questions remain

A deal between Chinese and U.S. regulators has been hailed as a key step toward opening the way to probes of bungled audits of U.S.-listed Chinese companies, but experts say questions remain.

The China Securities Regulatory Commission said last week that it had signed an agreement with the U.S. Public Company Accounting Oversight Board (PCAOB) to share audit records.

The regulators held investigative duties in their respective jurisdictions, and the agreement provided a mechanism for them to request and receive assistance from each other in obtaining documents and information, according to the PCAOB.

The deal came as a relief to auditors, who have long complained of being caught in regulatory conflicts between the world's two largest economies.

The U.S. Securities and Exchange Commission (SEC) has charged the China affiliates of each of the "Big Four" auditors and another large U.S. auditor for their refusal to provide audit work papers related to China-based companies investigated for potential accountancy fraud.

U.S. laws require auditors to provide the SEC upon request with audit work papers involving any company trading in U.S. markets.

Auditors of U.S.-listed companies are also legally obliged to be inspected by the PCAOB, which has the power to deregister auditors.

But the auditors maintained that they could not produce such documents as their hands were tied under Chinese laws.

Ernst & Young, one of the "Big Four," described the agreement as a significant step forward in cross-border cooperation.

Other members of the group -- PricewaterhouseCoopers, KPMG and Deloitte -- also welcomed the news, saying that the issue could only be resolved between the two governments.

"This agreement with China is an important step toward cross-border enforcement cooperation that is necessary to protect the interests of investors in U.S. capital markets," said PCAOB Chairman James R. Doty.

"We believe a cooperative working relationship of the regulators is in the best interest of the capital markets and the profession," said KPMG in an email statement.

Questions linger

Though this move has been hailed by members of the profession, experts have noted that significant challenges remain to be tackled in further talks between China and the United States.

One unresolved issue comes in worries whether file-sharing can be as effective as field inspections to ensure quality audits.

Paul Gillis, a professor at Peking University and a member of the PCAOB's Standing Advisory Group, expressed doubt whether the deal would address accounting problems at Chinese companies.

The deal has no direct impact on the SEC lawsuits as it is not party to the signed memo and will have to conclude a separate deal, Gillis said.

In December, the SEC charged the auditors amid a wave of fraud accusations against China-based companies listed in the United States, and in the past few months, Chinese companies' listings have been de facto frozen in the United States.

Neither does the deal have any impact on reopening the U.S. markets to Chinese companies wishing to conduct initial public offerings (IPOs). The SEC, not the PCAOB, decides whether to permit an IPO to proceed, according to Jacob S. Frenkel, who spent 10 years as an attorney in the SEC's Division of Enforcement.

"The SEC very much wants to send a message that it believes there was widespread fraud, including false financial statements and fake transactions, in the Chinese companies that traded in U.S. markets," Frenkel said.

Within the United States, fraud accusations were made by short sellers, and securities fraud lawsuits were filed by investors, which piled pressure on financial watchdogs.

Stakes were high for both sides. As China effectively shut down its domestic IPOs, many companies are looking overseas for capital.

The continued closing of the U.S. capital markets will only work to the benefit of other Western capital markets, Frenkel said.

Concessions in the signed memo between Chinese regulators and the PCAOB were widely noted, as China took a step back in allowing file access, and U.S. inspections in the Chinese jurisdiction were not mentioned.

Now, all eyes are turned to further negotiations, especially over whether there will be a deal involving the SEC.

"United States regulators, particularly the SEC, are not used to being told 'no' by other international regulators. China stood up to the SEC and said, 'Your regulations cannot interfere with the sovereign laws of China.' That has been frustrating and embarrassing to the SEC," according to Frenkel.

"The challenge for Chinese regulators and Chinese companies is that the SEC believes that all audits of Chinese companies are not reliable. Such a mindset is not fair to quality Chinese companies with full and fair audits," he added.

PCAOB advisor Gillis expects "an SEC deal will come soon, and it will be very similar to the PCAOB deal."