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ZTE - Where were the auditors?

The US Department of Commerce has banned Chinese tech company ZTE (HK 763) from purchasing American components for seven years. Because American components are essential to its products, there is serious doubt as to whether the company can survive. The stock has been suspended from trading on the Hong Kong Stock Exchange.

The ban came about as a result of ZTE violating the terms of a settlement agreement entered into as part of its 2017 guilty plea for conspiracy to sell telecommunications equipment to Iran and North Korea that included American components that are forbid for export to those countries. ZTE agreed to pay a fine of $892 million and be under probation for seven years. An additional penalty of $300 million was suspended provided ZTE complied with the terms of the probation, which it is reported included the requirement for ZTE to fire four top executives and discipline 35 other employees. ZTE did fire the top executives, but instead of punishing the other employees it paid them bonuses. ZTE was also required to undergo independent compliance audits related to its observation of export controls.

What does the trade war mean for accounting?

Donald Trump has declared a trade war against China by threatening higher import tariffs on $153 billion of Chinese exports. China has said it is only polite to reciprocate.

Services are not subject to import duties, but China has shown no qualms about punishing foreign business for the sins of their government. The Big Four are technically not American companies. The operations in China are not subsidiaries, but more like franchises owned and operated mostly by local Chinese. But they are generally viewed as American and may face regulatory crackdowns and may see an acceleration of the process of transferring major accounts to local CPA firms. Some smaller US CPA firms operate in China in ways that are technically illegal under Chinese law and would be easy to crack down on.

It would be easy for the Chinese to crack down on the Big Four. They simply need to strictly enforce their own rules. Few audits can survive a critical examination by regulators, evidenced by the high rate of audit deficiencies identified during inspections by the Public Accounting Oversight Board (PCAOB) of domestic firms. Earlier this year China temporarily banned several local firms for audit deficiencies. The Big Four had best watch their back.

The China Hustle

A documentary on the many stock frauds in China was released this past weekend.

I have a cameo role in the movie, which has a rating of 74% on Rotten Tomatoes. It was released by Magnolia Pictures (owned by Mark Cuban) and is available for streaming and in selected theatres.

I think it is worth watching as a good review of the past decade in China investing.

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