PCAOB and China reach an understanding on U.S. audit access as "a step in the process"

Following a Friday agreement between the Public Company Accounting Oversight Board (PCAOB) and Chinese regulators on a new access framework, U.S. audit regulators are about to remove longstanding inspection barriers to the work of public accounting firms with headquarters in mainland China and Hong Kong.

According to a statement from PCAOB Chair Erica Williams, the China Securities Regulatory Commission (CSRC) and the People's Republic of China's Ministry of Finance will grant the United States "complete access to the audit work papers, audit personnel, and other information we need to inspect and investigate any firm we choose, with no loopholes and no exceptions." The United States has maintained its position that full access is necessary before any agreement can be made in the months-long talks between the two parties.

Despite the agreement, which is a component of a signed statement of protocol, U.S. officials have made it plain that whether China would keep its end of the bargain still stands as the final test.

Gary Gensler, chairman of the Securities and Exchange Commission (SEC), said in a statement, "The proof will be in the pudding." The PCAOB is governed by the SEC.

"While important, this framework is merely a step in the process. This agreement will be meaningful only if the PCAOB actually can inspect and investigate completely audit firms in China," according to Gensler.

Since the Sarbanes-Oxley Act's adoption in 2002, which established the PCAOB to oversee the audits of publicly traded American corporations, the regulator's ability to inspect accounting firms operating in China and Hong Kong has proven to be the biggest challenge. When China-based Luckin Coffee was suspected of falsifying sales in 2020, the problem reached a head and its stock price on the Nasdaq crashed after an inquiry validated the accusations. In a deal with the SEC in December 2020, Luckin finally agreed to be delisted and to pay a $180 million fine.

Congress passed the Holding Foreign Companies Accountable Act in that same month (HFCAA). According to the law, publicly traded businesses in nations like China and Hong Kong that prohibit audit inspections by U.S. regulators may be delisted after three years of noncompliance starting in 2021. A corporation could be delisted as early as 2024.

Chinese regulators struck a deal with the United States to avoid the HFCAA deadlines preventing the trading of the securities of about 200 firms with headquarters in China. Among the major names the PCAOB highlighted as being at risk of delisting were social media platform Weibo, IT behemoths Baidu, and Alibaba.

According to CSRC officials who participated in a Q&A session with reporters following Friday's announcement, "the signing of the agreement is an important step forward for both sides toward resolving the oversight issue of audits of Chinese companies through enhanced cooperation, as is hoped for and expected by the market. Going forward, both sides will carry out regular inspections and investigations of relevant audit firms in accordance with the agreement and make objective assessments accordingly. If the upcoming cooperation concludes to the satisfaction of both sides’ regulatory mandates, it is hopeful that the audit oversight issue of the U.S.-listed Chinese companies will be resolved and delisting can be avoided."

According to Williams, PCAOB personnel are scheduled to arrive in China by mid-September and start working there. The agency has till the end of the year to reevaluate its conclusions about the availability of Chinese audits and whether they satisfy the HFCAA's requirements.

In accordance with the Agreement, PCAOB:

- Selects companies, audit engagements, and suspected violations at its exclusive discretion without input or consultation from Chinese authorities;

- Is permitted to view complete audit work papers with all information included and retain information as needed; 

- Has direct access to interview and take testimony from all personnel associated with the audits the PCAOB inspects or investigates; 

- Is permitted to view complete audit work papers with all information included and retain information as needed; 

"Now we will find out whether those promises hold up," Williams said.

Giving American authorities access to Chinese accounting companies has long raised national security concerns in China. This anxiety is made worse by the government's ownership of many of the biggest Chinese companies.

According to CSRC authorities, "the agreement has... made clear arrangements on the treatment and use of possible sensitive information during audit oversight cooperation, including procedures for processing personal information and other certain data categories. It provides a feasible path for both sides to discharge their regulatory mandates while protecting relevant information ."

By fLEXI tEAM