The PCAOB has announced a deal with CSRC and MOF on enforcement cooperation. The Memorandum of Understanding is here.The deal will allow the PCAOB to get access to audit documents, including working papers from Chinese accounting firms. There are a number of detailed operational rules, including one that requires the PCAOB to describe the conduct or suspected conduct which gives rise to the request. That implies that the deal works to get access to documents for specific investigations and cannot be used for “fishing expeditions” or inspections.
PCAOB chairman James Doty told Reuters that the agreement does not replace the need for the PCAOB to inspect audit firms in China. He called the deal a “step in the right direction”. I think it may be a step the other way.
The deal applies only to the PCAOB. I expect, however, that a deal is also being finalized with the SEC. There is growing pressure for this to happen. Earlier this week the Business Roundtable, FEI and several other organizations wrote to Jack Lew asking that a deal be done. The IPO market for Chinese companies is moribund. Billions of dollars of private equity money is locked up in China and a U.S. IPO may be the only key that works to set it free. While the regulatory disputes over auditing are not the only overhang on the market, they have been significant.
A similar deal with the SEC would presumably allow the SEC to get the working papers that it sued the Big Four and BDO over. That would end those lawsuits, and the risk that the SEC would ban the auditors from auditing U.S. listed companies – which would have led to U.S. listed Chinese firms being expelled from the U.S. markets. The PCAOB’s Doty told Reuters that the deregistration of China based auditors is not yet off the table. However, if the SEC reaches a similar agreement and drops its cases I cannot fathom how the PCAOB could take such a bold step on its own. The political backlash might threaten the very existence of the PCAOB, which many think was an overreaction to the Enron crisis.
While I expect negotiations will continue for inspection access, I do not expect there will be any further progress. The real leverage the U.S. had over China was access to its capital markets. With the shutdown of the IPO markets in both the U.S. and China, private enterprise in China is being starved of capital, and that threatens indigenous innovation and the future competitiveness of China. If a deal with the PCAOB and the SEC removes that threat and reopens the IPO markets, I think it is unlikely that China goes any further.
That does not bode well for investors. While a deal may remove the threat of delisting, it does little to address the underlying accounting problems that brought this whole situation about. Yes, the PCAOB can obtain documents to investigate audit failures, but it cannot do inspections designed to head off those failures in the first place.