Lew Ferguson, Board Member of the Public Company Accounting Oversight Board, today talked about the problems the PCAOB is facing in China at a speech at the California State University 11th Annual SEC Financial Reporting Conference in Irvine, CA. His comments are the most expansive to date from a senior PCAOB official on the issues related to inspections in China. The full speech is linked here.
Ferguson indicates that a tentative agreement on observational visits has been reached:
As a first step toward further cooperation, we are working toward and have tentatively agreed on observational visits where PCAOB inspectors would observe the Chinese authorities conducting their own audit oversight activities and the Chinese could observe the PCAOB at work. This would not be a substitute for a PCAOB inspection but would be a trust building exercise between regulators. Initially, such observations would focus on quality control examinations of the audit firm being examined rather than a substantive review of a specific audit. We hope such exercises will build trust and lead to further cooperation.
As Ferguson says, observing Chinese inspectors does not fulfill the requirement that the PCAOB inspect auditors of U.S. listed companies. This may be sufficient progress for the PCAOB to justify “kicking the can down the road”. I earlier forecasted a 70% probability that the December 31, 2012 deadline for inspections would be extended. I believe that to extend the deadline the PCAOB will have to do some formal rule making, and I expect we will see that very soon.
Most interestingly, Ferguson talked about the consequences if the PCAOB is unable to reach an agreement with Chinese regulators. According to Ferguson, those consequences could include revocation of a firm’s PCAOB registration, leading to the listed companies being in violation of SEC and exchange rules. Although I have been pointing out this risk for some time, this is the first time I have heard the PCAOB actually say it.
I think the bottom line here is that the potential December 31, 2012 deregistration of accounting firms and subsequent delisting of U.S. listed Chinese companies has become remote. I think the PCAOB will move to formalize an extension very soon. The problem, however, has not been solved. The are two issues to watch now while we wait to see what the PCAOB ultimately does. The first is the SEC's negotiations with China on Deloitte's working papers. The judge has given the PCAOB and China until January to work out a deal. The second is the suit against Ernst & Young in Hong Kong over access to China working papers. Either of these cases could disrupt the markets.