Advanced Battery Technologies (NASDAQ: ABAT) was delisted by NASDAQ on November 30, joining a long list of Chinese companies delisted by NYSE and NASDAQ this year. No news there, but there is an interesting story in the coup de grâce.
NASDAQ had requested that the company do a special audit of its cash accounts, requiring the auditors to physically visit the bank and to observe the completion of the confirmations. ABAT Chairman Zhiguo Fu was infuriated by the request, writing in a letter to his shareholders:
"At the end of the summer, however, as stories circulated regarding collusion between a small number of Chinese companies and their bankers, NASDAQ decided that, solely because we are Chinese, we should be required to provide an extraordinary level of confirmation from our banks. Despite the lack of any evidence of wrong-doing on our part, NASDAQ insisted that we approach our banks, inform them that our U.S. regulators consider them untrustworthy, and ask them to permit our auditors to "look over their shoulders," as it were, while they prepare bank confirmations. Initially NASDAQ insisted that this degrading procedure be conducted at the highest level of the bank. After we obtained written refusals from each of our banks, NASDAQ agreed to have the process carried out at our local bank branches."
Fu reports that his CFO and his controller then both resigned, and he had to go get medical attention. NASDAQ proceeded to delist the company.
The sordid incident raises some important issues. I have heard that a number of U.S. listed Chinese companies are facing similar demands from NASDAQ about cash audits. Should NASDAQ be dictating how audits of listed companies be conducted? That is the job of the PCAOB. Why is NASDAQ stepping onto the PCAOB's turf?
Obviously, this is because the PCAOB is not getting the job done. The PCAOB should be inspecting the audit firms of U.S. listed Chinese companies and determining whether they are performing the audits in accordance with PCAOB standards. If this process were working, NASDAQ should be relying on the professional judgment of the auditors and the PCAOB's oversight, not getting into the business of dictating auditing procedures.
The problem, however, is that the PCAOB has been blocked from coming to China to inspect audit firms. ABAT uses Friedman, LLP a U.S. based firm that remains subject to PCAOB inspection. However, Friedman would likely have to use its unregistered Beijing WFOE to do the work requested by NASDAQ, and the PCAOB cannot inspect that firm and the terms of Friedman's Temporary Audit Practice Certificate in China (assuming that they have one) prohibit it from removing working papers from China.
Obviously, the well-worn audit procedures for auditing cash have failed in China. I hypothesize that the reason for that can be found in the work of the influential Dutch social psychologist Geert Hofstede. Hofstede observed that the collectivist nature of Chinese culture differs significantly from the individualistic culture of the West. Modern conceptions of internal control design and audit procedures were developed in the West. Influenced by Western culture, these controls and audit procedures rely heavily on the assumption that collusion is difficult. That assumption is likely invalid in China's collectivist culture. Auditors, and audit standard setters, should keep this in mind.