A new front has opened in the dispute between China and the United States over audit regulation. China has blocked the PCOAB from required inspections of auditors of U.S. listed Chinese companies based on arguments of state secrecy and national sovereignty. Chinese regulators have argued that they cannot allow the inspections of audits where the working papers might include state secrets. An attempt to set up a pilot program apparently fell apart when U.S. and Chinese negotiators were unable to agree on which companies could be excluded from an inspection program. PCAOB Chairman James Doty in remarks to the Standing Advisory Group of the PCAOB suggested that the problem is the myriad of Chinese bureaus that have a say in the matter.
The new front is in banking. Kering SA, owner of the Gucci brand, has sued counterfeiters in U.S. courts and has issued subpoenas to the Bank of China for information about transactions of the counterfeiters. Despite orders from a federal judge, the Bank of China has refused to turn over the information, saying that to do so would violate Chinese law.
The issues at heart are essentially the same. Does Chinese law trump American law for Chinese companies (The Bank of China and the Big Four Chinese firms are all Chinese companies)? The U.S .-China Security and Economic Commission issued a research report in May on this topic: China’s Great Legal Firewall: Extraterritoriality of Chinese Firms in the United States.
I think Chinese and U.S. regulators are stuck. Neither can concede any turf due to local laws and the views of other local regulators. The obvious solution is that China should not permit companies that it considers sensitive to subject themselves to U.S. jurisdiction. But that may mean companies like Alibaba and Baidu cannot be listed on U.S. stock exchanges, and Chinese banks cannot have U.S. branches. I don’t think that is what anyone wants.
I also don’t see how the U.S. could ever concede that Chinese companies do not have to follow U.S. laws. So the Gucci case is important, and it is likely to move at a faster pace than the PCAOB action. PCAOB actions are slow and take place behind closed doors until resolved, whereas the Gucci case will play out in open court. Investors in U.S. listed Chinese companies would be wise to pay close attention to how it is resolved.