SEC Issues Warning to Chinese Companies concerning Auditor Switch
Heads Up: SEC Warns of Investigations for Chinese Companies and Auditors
As companies attempt to dodge U.S. delistings by switching auditors, the acting chief accountant at the Securities and Exchange Commission (SEC) issues a cautionary note about potential investigations and enforcement actions. This comes in the wake of the Holding Foreign Companies Accountable Act of 2020, which threatens to kick more than 200 Chinese companies off U.S. stock exchanges by early 2024.
Here’s the deal: the Act prohibits trading in companies whose auditors can't be inspected by the Public Company Accounting Oversight Board (PCAOB) for three consecutive years. Recognizing this, numerous Chinese companies have switched to U.S.-based accounting firms as their primary auditors. But, Paul Munter, acting chief accountant at the U.S. securities regulator, has raised questions about whether these newly engaged audit firms in the U.S. and abroad fare as lead auditors.
Now, leading auditors are required to gather written assurances from third parties regarding the quality of their work, as per PCAOB's refreshed criteria. However, Munter hints at the possibility of Chinese companies and auditors resorting to "efficient violations" of legal and auditing regulations, which may draw the PCAOB, SEC, or both for investigations and enforcement actions.
"Persistent violators should steer clear," Munter asserts.
To audit Chinese companies based outside the U.S., U.S.-based accounting firms often work alongside local accounting firms and independent contractors on their systems. PCAOB inspects only audit records maintained by accounting firms within the U.S.
Recently, the U.S. and Chinese governments struck an agreement to allow the PCAOB to inspect China-based audit firms. This accord grants PCAOB inspectors the right to conduct inspections in Hong Kong or mainland China.
Under U.S. standards, a lead auditor can utilize the work of another auditor as long as the lead auditor can fulfill its supervisory and documentation responsibilities. If the lead auditor fails to meet PCAOB's inspection requirements or other stipulations, the firm's personnel and the entity being audited could face significant liability.
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- SEC enforcement on Chinese companies and auditors: Learn more about SEC's enforcement actions concerning Chinese companies and their auditors, transparency challenges, and regulatory responses. The U.S. Securities and Exchange Commission has taken multiple enforcement actions and regulatory steps related to Chinese companies due to transparency issues, audit inspection limitations, and violations of U.S. securities laws. The PCAOB has declared it unable to inspect or investigate audit firms based in mainland China and Hong Kong due to obstruction by the Chinese government. This situation has led to historic sanctions on certain China-based audit firms and trading restrictions on numerous China-based companies whose auditors remain inaccessible for inspection. U.S. lawmakers continue to call for stronger measures to protect American investors from the risks associated with Chinese companies' opaque practices and governance shortcomings.
The SEC's concerns extend beyond domestic businesses, as they have raised questions about the quality of work performed by new audit firms handling Chinese companies amid potential investigations and enforcement actions.
This growing scrutiny could affect the finance sector significantly, as leading auditors may face ramifications for efficient violations of legal and auditing regulations, potentially resulting in liability for the involved personnel and entities being audited.
