The nuclear option and the PCAOB | China Accounting Blog | Paul Gillis

The nuclear option and the PCAOB

Adam Jones of Financial Times has an interesting article out today reporting on his interview with James Doty, chairman of the PCAOB. Doty is quoted as saying: "In my view it is not tenable to continue to indefinitely allow Chinese firms to remain registered with the PCAOB if the PCAOB cannot inspect their US-related audit work."

Doty has hinted at this before, but this is a clear statement that he believes the PCAOB may be forced to terminate the registrations of Chinese accounting firms should the PCAOB fail in its negotiations with China for access to inspect Chinese CPA firms.

The impact of such a decision would be severe. Mostly affected would be the Big Four's China affiliates, who audit most of the U.S. listed Chinese companies. All of these companies, from PetroChina to Baidu, would be suddenly without auditors. A CPA firm must be registered with the PCAOB before it can audit U.S. listed companies. These U.S. listed Chinese companies will not be able to find another China based firm to audit them, since they will all be deregistered. In theory, they could select a U.S. based accounting firm, even the U.S. affiliates of the Big Four, but those firms would be required to obtain temporary practice certificates in China. One of the conditions for obtaining those certificates will be that they leave the working papers in China, which is exactly the problem that the PCAOB is trying to deal with. So that hardly seems a viable alternative.

The inability to find an auditor will soon lead to the inability of U.S. listed Chinese companies to file audited financial statements. This will lead to the delisting of the companies from U.S. exchanges. Most of China's big SOEs like PetroChina and China Life already have listings in Hong Kong, and could possibly sell additional stock in Hong Kong, buy out U.S. shareholders, and give up the U.S. listings. That option is not easily available for the privately held Chinese companies like Baidu and Sina. They cannot list in China today because they are actually foreign companies, and a Hong Kong listing may take too long.

The article also points to the damaging knock-on effect for U.S. multinationals active in China. PCAOB rules require that any accounting firm participating significantly in the audit of a listed company must be registered. Most U.S. MNCs now have significant operations in China that are typically audited by the China affilate of the Big Four firm that the company uses in the U.S. If those operations cannot be audited, it may not be possible for the U.S. auditor to sign off on the financial statements. As a result, large American companies like General Motors, Microsoft, IBM, and Proctor and Gamble could all face a threat from this possible action.

As untenable as the present situation is, the option of deregistering the accounting firms is a step too far. As I was quoted saying in the FT article: "This can't be the solution. The solution has got to be found through diplomacy."

Copyright 2020 Paul L. Gillis all rights reserved