Bloomberg reported this week that a final agreement between the PCAOB and Chinese regulators over inspections of Chinese audit firms has fallen through. The article says that the Chinese had so narrowed the terms of inspections that the PCAOB decided it was not worth pursuing the deal.
The PCAOB is the regulator of accounting firms that audit US listed companies, and its most important function is to periodically inspect the accounting firms to make certain that they are following US auditing standards. China has not allowed the PCAOB to conduct inspections in China, even of international firms, since it considers allowing foreign regulators to enforce foreign laws on Chinese soil to infringe on its national sovereignty.
There are no good options left for the PCAOB. Successful short seller attacks indicate that fraud and auditing failures continue to be a problem in China. The only real tool left in the PCAOB toolbox is to deregister the accounting firms that it cannot inspect. But this option would quickly lead to the delisting of Chinese companies from US markets, including companies like Alibaba and Baidu.
There are some tough decisions ahead for the PCAOB's Chairman. That is, if there were a PCAOB chairman. James Doty’s term as chairman expired on October 31, and SEC chairman Mary Jo White has not said whether Doty will be reappointed or replaced. Doty is popular with investors for his hardline positions on auditing but those same positions make him deeply unpopular with accounting firms and the business community. The latter have been supporting a Republican staffer to replace Doty, a Democrat, for this theoretically non-partisan job. There is precedent for a PCAOB chairman remaining in place after his term expires – Doty’s predecessor was in this status for some time. I think it is unlikely that Doty takes any strong action before he is reconfirmed.
I don’t expect the Chinese to come rushing back to the negotiating table. The status quo is fine with them, and with guided missile destroyer USS Lassen sailing through waters China claims as sovereign, relations with the United States are running a little cool right now.