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Regulation Fair Disclosure

One of the best rules that the SEC ever put in place was Regulation Fair Disclosure, or Reg FD, which was promulgated in 2000. Reg FD mandates that public companies must disclose material information to all investors at the same time. 

Prior to Reg FD, companies would often disclose market-moving information to certain investors before others, allowing them to profit by placing trades before the information became widely known.  

Unfortunately, Reg FD does not apply to foreign private issuers. Most US listed Chinese companies are classified as foreign private issuers. As foreign private issuers, the companies are also not required to file quarterly reports on Form 10Q nor get auditor review of the quarters. Most US listed Chinese companies do provide quarterly results anyway, although they usually do not include an auditor review report. For foreign private issuers, the annual report is filed on Form 20F instead of Form 10K, and is due a month later. 

I think the logic behind not applying Reg FD to foreign private issuers is based on an assumption that the companies are also listed on a foreign exchange, and the SEC is reluctant to add on additional requirements beyond what the regulators and exchanges in local markets require. That logic is invalid with respect to most U.S. listed Chinese companies, since they are not typically listed on any other stock exchange.  

SEC settles with China Big Four

The SEC has announced a settlement with the Chinese member firms of the Big Four over their failure to give the SEC auditing working papers when requested to do so.  The firms argued that they were unable to do so because of Chinese laws, but after the suit was filed the firms worked with Chinese regulators to release the working papers. An administrative trial judge banned the firms from practice for six months, and the settlement is a result of the firm’s appeal of the judge’s decision. 

The settlement falls far short of what is needed to protect investors. What is needed is a comprehensive deal between China and the US to allow the SEC unfettered access to documents necessary to enforce US securities laws on Chinese companies that have elected to list in the United States. Instead the settlement lets the accounting firms and their clients off the hook, providing only a mechanism to restart the proceedings if the firms fail to cooperate in the future.  

It appears that the SEC decided to kick the can down the road, rather than use the leverage of these cases to push China into greater cooperation on securities fraud by US listed Chinese companies. There have been many instances of fraud committed by US listed Chinese companies, and most perpetrators have escaped justice when China blocked the SEC from getting China documents. As far as I know, no Chinese person has faced prosecution in China for crimes associated with US listed companies, even when the purported acts – theft, kidnapping of auditors, fake bank confirmations, etc. are all crimes in China. 

Big Four settlement imminent?

The Wall Street Journal, citing unnamed inside sources, reported that the SEC is close to reaching a deal with the China’s member firms of the Big Four over the lawsuit over audit working papers. The firms would be sanctioned, pay fines of $500,000 each, and have the suspension from practice that was ordered by an administrative trial judge removed. The Journal reports the SEC Commission could vote on the settlement as soon as February 5, 2015.  

The article says that the settlement includes a strong framework for the firms to cooperate with the SEC and for the agency to obtain audit documents in the future. The problem is that the firms and the SEC have no ability to do that.  China has refused to allow the firms to turn over working papers to the SEC or PCAOB, and any deal to do so has to be with Chinese regulators and not with the accounting firms.   

I suspect that a deal is imminent between the US and China over audit and securities regulation. Given China’s recent proposal to clean up the VIE structure, I think China has decided it wants access to US capital markets and has decided to cooperate with US regulators and remove obstacles to US listings. Consequentially, I expect we will see a deal between Chinese regulators and the SEC and PCAOB before the settlement with the Big Four is finalized. US regulators would be foolish to let the Big Four off the hook before they get such a deal.  

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