I had dinner in Denver yesterday with Gaylen Hansen, vice-chair of the National Association of State Boards of Accountancy (NASBA). Gaylen will become the chair of NASBA in 2012, and also sits on a number of other important committees with the AICPA, IFAC, and the PCAOB. Yes, I do have to travel vast distances to find people who share my interest in the transnational regulation of accounting. After I pointed out the problems in China with U.S. CPA firms operating illegally in China that I have discussed in an earlier post, Gaylen told me about some similar cases of Chinese accounting firms operating illegally in the U.S.
The Texas State Board of Accountancy has identified 19 foreign CPA firms that were illegally providing audit services in Texas. The 19 firms include three from Hong Kong and one from Beijing. The three Hong Kong firms are now subject to cease and desist orders. The Beijing firm has signed a letter acknowledging that they do not provide audit services in Texas after the Texas Board was unable to determine whether their audits of reverse merger companies violated Texas law. The Texas Board has complained to the SEC and the PCAOB about these firms and the problem of foreign firms practicing in Texas.
There is an article in the New York Times today about how Republicans have cut the budget for the SEC by $229 million to last years $1.19 billion even though the responsibilities of the SEC have been significantly expanded under the Dodd-Frank Wall Street reforms. Republicans defend the cuts on the basis that the deficit must be tackled, even though Wall Street funds the SEC budget and will actually pay less next year.
The cuts will significantly undermine the ability of the SEC to regulate Chinese companies listed in the U.S. The SEC has been cracking down on Chinese companies due to the many scandals of the past year, but that may have to come to a close. An S.E.C. memo on the committee’s proposed budget warns: “We may be forced to decline to prosecute certain persons who violate the law; settle cases on terms we might otherwise not prefer; name fewer defendants in a given action; restrict the types of investigative techniques employed; or conclude investigations earlier than we otherwise would.” Robert Khuzami, the SEC’s head of enforcement said “you have to squeeze the savings out of what’s left, like travel, and especially foreign travel, at a time we see more globalization, more insider trading through offshore accounts. It’s highly cost-intensive.”
I have written extensively about regulatory holes with respect to the auditing of U.S. listed Chinese companies. While U.S. and Chinese authorities are meeting this week to try to close some of those holes, Chinese authorities have independently moved to gain greater regulatory authority over foreign accountants in China.
On March 21, 2011 the Ministry of Finance issued new rules for overseas accounting firms that want to do audit work in China. The Interim Provisions on Overseas Accounting Firms Engaging in Temporary Auditing Activities in Mainland China, update rules that have been in place since 1993. The rules permit foreign auditors to do work in China for foreign clients provided they register and obtain a Temporary Audit Practice Certificate (TAPC). The TAPC is obtained through application to the provincial finance department. The application requires identification of the client and the provision of certain documents, including copies of the CPA licenses of the people coming to China. The auditors must also agree to keep their working papers in China. Fagre & Benson has a good summary of the new rules here and China Briefing has one here.
The PCAOB has announced that it will be coming to China next week to meet with Chinese officials to forge a “cooperative resolution to cross-border auditing oversight.” The delegation of PCAOB and SEC officials will meet with representatives of the Ministry of Finance and the China Securities Regulatory Commission. The Ministry of Finance regulates auditors in China.
The meeting is a result of high-level discussions between the U.S. and China at the Third Meeting of the U.S. China Strategic & Economic Dialogue held in Washington in May, which reached the following conclusion:
The United States and China welcome continued dialogue between the bilateral competent authorities on the oversight of accounting firms providing audit services for public companies in the two countries, so as to enhance mutual trust and strive to reach agreement on cross-border oversight cooperation. Both countries agree to make joint efforts to accelerate the process.
The MOF now has the political cover it needs to make a deal with the PCAOB, and I expect that one will emerge from the meetings this week. The deal could take several forms – one might be inspections by the MOF that are made available to the PCAOB. This would be a poor result, since the MOF does not have the requisite skills in U.S. GAAP and auditing standards to effectively do these inspections. A better result would be some form of joint inspections, where PCAOB examiners are teamed with MOF examiners. That solution could provide benefits to both the PCOAB and the MOF, as the PCAOB would gain local language and business skills, and the MOF would get a chance to observe PCAOB regulators in action. I think it is unlikely that the PCAOB will be granted unfettered access to Chinese accounting firms.
In what may be an important development for VIEs, two Chinese scholars from the Chinese Academy of Social Sciences have published an article inStudy Times, a publication of the Communist Party School, that is critical of foreign investment in China’s internet sector. The article points to the recent Alibaba/Alipay dispute as evidence of this. The authors reach a conclusion that most of our readers have known for a long time – that despite the prohibition of any foreign investment in China's internet industry, it is controlled by foreigners. They suggest that the issue of control has not been given sufficient attention. Perhaps it will get this attention now.
We have already seen regulatory challenges to VIEs, leading toYahoo losing its interest in Alipay, and alleged theft of a VIE. Now we can add political risk. I think it is time to again ask the question whether VIEs are a going concern. I started this series suggesting that the VIE could be compared to the fable of the Emperor's new suit - not really doing what people are told they do. My recommendations to clean up this sector remain valid.
Second-tier accounting firms have long complained about provisions in financing agreements that require the use of Big Four audit firms. These “Big Four clauses” are viewed to give an unfair advantage to the Big Four over second-tier firms like BDO, RSM, Crowe Horwath, and Grant Thornton. In the United Kingdom, the Office of Fair Trading has been ordered to investigate whether these clauses are stifling competition in the market. The Big Four firms, while agreeing that the clauses are inappropriate, maintain there is little evidence that they exist.
In China, the dominance of the Big Four is mostly because of the mutually reinforcing behaviors of investment bankers, international lawyers and the Big Four firms, who insist on their mutual participation as a means of managing their risk. In my academic work I call these professionals members of the “transnational capital class” who are a major force in globalization. I have not seen any evidence of Big Four clauses in China – until now.