According to a Reuter’s report by Soyoung Ho that is currently behind Reuter’s paywall, PCAOB chairman James Doty said some discouraging things at the recent meeting of the PCAOB’s Standing Advisory Group about the prospects for an inspection agreement with China.
Doty is quoted to have said that the PCAOB’s effort to inspect auditors in China is “in a difficult and frustrating place”. Doty indicated that he was still hopeful that an agreement could be reached. However, according to the report he said: “It’s getting late to plan an inspection for 2015. That’s what’s discouraging about this. It’s not impossible, but it’s getting late to plan for the 2015 cycle.
According to the Reuters report, proposed agreements “are now in the hands of more senior Beijing officials, and it’s not clear what decision they’ll reach, or when. If PCAOB inspectors are allowed to review audit documents in the People’s Republic, it may not happen before 2016 at the earliest.”
In addition to the PCAOB inspection issue, the SEC decision against the Big Four firms has yet to be resolved. Filings in the appeal have been extended to the end of the year to allow time for settlement, and perhaps Chinese officials want to settle both issues simultaneously.
Back in May I raised the question of whether PwC Hong Kong is the principal auditor of Alibaba given that most operations are on the mainland. The SEC has now released its correspondence with Alibaba and I found that they raised this issue with Alibaba. Here is the SEC’s question (italics) and Alibaba’s response (bold).
We note that your audit report is signed by PricewaterhouseCoopers - Hong Kong, although the majority of your operations appear to be in mainland China. We also note your risk factor disclosure that “[i]f the affiliate of [your] independent registered public accounting firm were denied, temporarily, the ability to practice before the SEC, [you] would need to consider with [your] Hong Kong based auditor the alternate support arrangements they would need in their audit of [your] operations in mainland China.” Please tell us how you concluded that it is appropriate to have an audit report issued by an auditor in Hong Kong, in light of the location of your corporate offices, your principal operations, and your principal assets. Please also tell us your understanding of the nature and extent of the work conducted by each firm, including the participation of your Hong Kong based audit firm with respect to the work of its affiliated firm in mainland China.
On November 4, China updated the Catalogue for the Guidance of Foreign Investment Enterprises, which categorizes businesses into encouraged, restrict-ed, or prohibited for foreign investment. Dezan Shira’s China Briefing has a good summary of the changes.
Noteworthy is the inclusion of accounting and auditing as an encouraged in-dustry. Auditors will now be allowed to conduct these services using wholly foreign owned enterprises (WFOEs).
The Big Four currently conduct their auditing practices using limited liability partnerships that originally had 60% locally licensed partners and 40% un-licensed partners. The 40% reduces to 20% over the next few years, and I think it is at 35% for most of the firms right now.
The Big Four conduct their consulting practices (including tax) in wholly foreign owned enterprises that are typically owned by their Hong Kong member firm.
So, will this change result in the Big Four moving their auditing practices to WFOEs? I don’t think so. Under present Chinese rules, a partner in a CPA firm must be licensed as a CPA in China and I expect these rules will also apply to the shareholders of a WFOE. If ownership by unlicensed persons is allowed, then China has just opened the door wider than any other country on earth. Licensing requires the partner to pass the notoriously difficult Chinese CPA examination and meet other not so difficult requirements. The present rules, allowing a per-centage of owners to not have local licenses, is better for the Big Four than al-lowing them to have a WFOE. Additionally, an increasing number of Big Four partners are PRC citizens, and the WFOE alternative does not work for them.