Postings | China Accounting Blog | Paul Gillis


KPMG localization is a sham

The localization of the Big Four in China is turning out to be a sham. I predicted that would be the case.

 was approved by MOF last Friday. The other firms are expected to have their plans approved shortly. 

It turns out KPMG claims to have only 25 partners, of which 15 are locally qualified, allowing KPMG to just meet the 60% localization test. That is a joke. KPMG claims on its website to have 9,000 staff in China. It has hundreds of partners, who are apparently now going by some other title.  

Busy times

Things are moving at a head spinning pace in China accounting. There are three somewhat related issues that are developing very quickly.

The SEC asked the judge in the Deloitte case to stay the case for six months because of negotiations. I think this means that a deal is imminent,  which is probably a result of Mary Schapiro’s visit to Beijing a couple of weeks ago. 

MOF has approved KPMG’s localization plan. KPMG’s joint venture is the first to expire on August 13. Now the issue goes to the PCAOB, which must decide whether to allow KPMG to keep their old registration.  

The SEC launched an investigation of New Oriental’s VIE in what is likely the greatest challenge the VIE structure has faced. 

Taken together, I think these events indicate that U.S. and Chinese officials may have decided to step back from the abyss and look to find a way to solve the problems related to U.S. listed Chinese companies. 

There have been increasing indications that China wanted to stop the use of U.S. capital markets by its private companies. Perhaps the best evidence of this is the fact that there has only been one IPO in the past year and it essentially failed. The China Development Bank has been active in taking U.S. listed companies private. Officials were obviously frustrated with entrepreneurs evading Chinese laws through use of offshore companies and VIE structure. It is in the interest of both the SEC and Chinese regulators to shut down the use of the VIE structure and I would not be surprised to learn they are working together on this. 

SEC v EDU - the end of VIEs?

New Oriental Education and Technology Group (NYSE: EDU) dropped a bombshell in its fourth quarter earnings release this morning. The company reported that the SEC has issued a formal order of investigation captioned "In the Matter of New Oriental Education & Technology Group Inc." The Company believes that the investigation concerns whether there is a sufficient basis for the consolidation of Beijing New Oriental Education & Technology (Group) Co., Ltd., a variable interest entity of the Company, and its wholly-owned subsidiaries, into the Company's consolidated financial statements.

Investors are appropriately concerned. The stock is off 37% as I write this, with other companies with VIEs off by single digits. A formal investigation is far more serious than the normal comment letter process that usually deals with these kinds of issues. It means the Division of Enforcement of the SEC, rather than the Division of Corporate Finance is dealing with the issue.  

On July 11 EDU announced it had restructured its VIE ownership. The VIE had been owned by a number of shareholders, some of whom are no longer active in the company.  It is now held by an entity owned by Chairman Michael Yu. I don’t see anything wrong with that restructuring. The SEC investigation was launched on July 13.  I doubt that the restructuring led to the investigation. I suspect that the company has been responding to the normal comment letters that the SEC Division of Corporate Finance issues to all companies periodically. Something may have gone terribly wrong in this process and the issue was referred to the Division of Enforcement, which launched a formal investigation.  That is all my speculation, however. 

A deal? Not so quick

An article in the Oriental Morning Post on July 4 got everyone wondering if a deal had been cut on PCAOB access to China.  It appears premature to reach that conclusion.

Here is the article in English and Chinese, translated by Stacy Chen, one of my graduate students.    

The article cites a Big Four partner who speculates that an agreement will be reached. This seems to be based on the visit to China last week by SEC Chairman Mary Schapiro, which definitely took place (pictures here). There have been no announcements by the SEC or the PCAOB.  

I hope progress was made, but I think the unnamed Big Four partner interviewed by the Oriental Morning Post may be irrationally exuberant. 

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