Viewpoint Part 1: Can the SEC demand information from the China arms of accounting firms?

The SEC believes that it ultimately has to do its own work to safeguard the interest of the shareholders

CKGSB Professor Qi Daqing and Peking University Professor Paul Gillis share their views on the regulatory battle between the US Securities and Exchange Commission and the China branches of five international accounting firms over access to work documents. In Part 1 of this Viewpoint series, Qi Daqing, Associate Dean and Professor of Accounting at CKGSB says that accounting firms are trapped between conflicting domestic regulations of two powerful states.

The SEC is doing what it must to protect the interests of US market shareholders. On the surface, the regulatory dispute between the US Securities and Exchange Commission (SEC) and the China arms of the major internatiol accounting firms is a technical issue. In truth, these firms are trapped between conflicting domestic regulations of two powerful states.

This intrinsic conflict would have to be rectified first to resolve the audit-related headache faced by Chinese companies listed in the US. In registering with the Public Company Accounting and Oversight Board (PCAOB) under the SEC, the China-registered entities of these international accounting firms have to agree to accept the oversights from the SEC and PCAOB, but Chinese domestic law regard certain information as state secrets and do not permit access by foreign regulatory bodies to detailed documents such as audit work papers.

While the Chinese side may reasonably feel that its own regulatory standards should be sufficient for US listings, the SEC believes that it ultimately has to do its own work safeguard the interest of the shareholders. The SEC believes that it has reasonable basis for requesting closer examination of some of the Chinese companies listed in the US, especially in the context of recent history whereas some US-listed Chinese companies were found to be fraudulent.

A company listed in the US must be audited by an accounting firm registered with the PCAOB. Should the dispute drag on, the uncertainty will negatively impact the value of Chinese companies which have already been or are planning to be, listed in US markets. Their options for auditors will be severely limited, possibly ruling out a US listing all together.

The SEC has to balance between the interests of the listed companies and the interests of the shareholders, but the shareholders interests are definitely foremost between the two. The dispute has one year to reach resolution under US law, which will likely arise from a middle ground, as opposed to one side fully conceding to the other. If no resolution is reached, companies which have a mind towards the US markets may have to turn to Hong Kong as an alternative, though for some companies no real substitute for the US markets may exist.

As of now, there is no real strategic move that either these Chinese companies listed in the US of the audit firms can make. They simply have to wait and see, until the two states work things out.