I have written extensively about regulatory holes with respect to the auditing of U.S. listed Chinese companies. While U.S. and Chinese authorities are meeting this week to try to close some of those holes, Chinese authorities have independently moved to gain greater regulatory authority over foreign accountants in China.
On March 21, 2011 the Ministry of Finance issued new rules for overseas accounting firms that want to do audit work in China. The Interim Provisions on Overseas Accounting Firms Engaging in Temporary Auditing Activities in Mainland China, update rules that have been in place since 1993. The rules permit foreign auditors to do work in China for foreign clients provided they register and obtain a Temporary Audit Practice Certificate (TAPC). The TAPC is obtained through application to the provincial finance department. The application requires identification of the client and the provision of certain documents, including copies of the CPA licenses of the people coming to China. The auditors must also agree to keep their working papers in China. Fagre & Benson has a good summary of the new rules here and China Briefing has one here.
These new rules will mostly affect the overseas accounting firms that audit Chinese companies listed in Hong Kong or the U.S. In order to come to China to do audit work, they must first obtain a TAPC. According to the MOF, 33 firms have obtained this license by 2010, yet many more firms will be required to do so now. The new rules apply to Hong Kong and Taiwan firms as well as those from other countries. The failure to obtain a TAPC has caused problems for one firm already. HQ Sustainable Maritime Industries (NASDAQ: HQS) got into a fight with its auditor Schwartz Levitsky Feldman LLP and asserted that the company did not have the required TAPC. The auditor responded to the SEC that it intended to get the TAPC, but is unable to do so without the consent of the client. I expect that most U.S. based auditors of U.S. listed Chinese companies do not have the required TAPC. Audit committees should inquire as to whether they do, and the PCAOB should also be checking this when they do their inspections. The requirement that the workpapers be kept in China will be problematic for the PCAOB (unless they negotiate a deal with China for access this week).
The new rules may also prove to be a significant burden for the Big Four firms. The China member firms are not subject to these rules, since they are already licensed to practice in China. A standard audit procedure on major multinational engagements is for the audit partner to visit key locations around the world. These visits are audit work, and appear to require that the foreign firm obtain a TAPC prior to the audit partner coming to China. For example, the American audit partner on large clients like Microsoft or General Motors often to comes to China to meet with client management, tour the operations, and discuss the audit with the local engagement team. The partner would typically not do any detailed audit procedures, but would usually write up his observations in a memo. Nevertheless, she is performing audit work in China and the U.S. firm must first obtain a TAPC. In addition, because the rules require that the working papers be left in China, the partner would have to leave his memo behind. Because the TAPC is client specific, each of the Big Four may face hundreds of these applications. The firms, and the MOF, should work out a less cumbersome procedure that gives China the proper regulatory control, yet is more practical to operate.