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SEC Warns Chinese Companies About Risks of Auditor Changes

Sept. 6, 2022

As businesses switch auditors to avoid U.S. delistings, the agency’s acting chief accountant cautions of potential investigations and enforcement actions

The Securities and Exchange Commission on Tuesday warned Chinese companies not to violate legal and audit requirements as they switch to auditors based in the U.S. to comply with a law that threatens to delist the businesses from American stock exchanges.

More than 200 U.S.-listed Chinese companies are in danger of being booted off U.S. stock exchanges starting in early 2024 under the Holding Foreign Companies Accountable Act of 2020. It prohibits trading in companies whose auditors cannot be inspected by the Public Company Accounting Oversight Board—the U.S. audit watchdog overseen by the SEC—for three consecutive years.

Many Chinese companies with multinational operations in recent months changed to U.S.-based accounting firms as their principal auditors to prevent a potential trading ban. These arrangements can raise questions about whether the newly engaged audit firms in the U.S. and elsewhere meet their responsibilities as lead auditors, Paul Munter, acting chief accountant at the U.S. securities regulator, said Tuesday.

The PCAOB recently strengthened the requirements for lead auditors in supervising other auditors outside their firms. Lead auditors are now required to obtain avowals from outsiders about the quality of their work in writing.

Chinese companies and accounting firms “may be tempted to engage in an efficient breach of other applicable legal and audit requirements” and should be forewarned that they could result in investigations and enforcement actions by the PCAOB, the SEC or both, Mr. Munter said.

“Any attempt by issuers or accounting firms to engage in such an efficient breach and avoid the consequences of HFCAA in contravention of other legal and audit requirements should therefore be avoided,” Mr. Munter said.

Several accounting firms based in the U.S. are able to audit companies in China in partnership with local accounting firms and individual contractors, who essentially conduct the work on the U.S. audit firms’ computer systems. Audit records maintained by U.S. accounting firms are subject to inspection by the PCAOB.

The U.S. and Chinese governments last month reached an agreement for the PCAOB to inspect China-based audit firms following a decadelong standoff over the audit of working papers of New York-listed Chinese companies. The agreement allows PCAOB inspectors to travel to Hong Kong or mainland China for inspections.

Accounting firms that issue an annual report on a company’s financial statements typically assemble a team involving several outside auditors, usually individual accountants or accounting firms. Under U.S. standards, audit firms are allowed to use the work of another auditor as long as the requirements for serving as the lead auditor can be met and the lead auditor is able to fulfill its responsibilities related to supervision and documentation.

If the lead auditor fails to meet any of the PCAOB’s inspection or investigative demands among other requirements, the firm’s personnel and the company it is auditing could face significant liability, Mr. Munter said.

The PCAOB didn’t immediately respond to a request for comment.

Zai Lab Ltd. , a biotechnology company located in Shanghai that is one of the largest companies that has switched to a U.S. auditor in recent months, said Mr. Munter’s statement reflects the considerations the business and its auditor, KPMG LLP, took earlier this year. The company switched its principal auditor from Deloitte Touche Tohmatsu Ltd.’s China unit to KPMG U.S. after being identified by the SEC as noncompliant.

The company welcomed the recent audit agreement, but said Zai Lab “will not be directly impacted by any further negotiations or agreements between the U.S. and China.”

Zai Lab has its financial systems and executive teams primarily based in the U.S., allowing KPMG’s Boston office to effectively audit its books, Deputy Chief Financial Officer Yajing Chen said. More than half of its revenue comes from the U.S., according to FactSet.

[The Wall Street Journal]

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