‘A step in the process’: PCAOB, China agree on U.S. audit access

The China Securities Regulatory Commission (CSRC) and the Ministry of Finance of the People’s Republic of China will allow 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,” said PCAOB Chair Erica Williams in a statement. Talks between the two sides have been ongoing for months, with the United States standing firm it must receive full access for any deal to be reached.

Despite the agreement, part of a signed statement of protocol, U.S. regulators have made clear the ultimate test remains in whether China will uphold its end of the deal.

“The proof will be in the pudding,” said Gary Gensler, chair of the Securities and Exchange Commission (SEC), in a statement. The SEC oversees the PCAOB.

“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,” Gensler said.

Since the passage of the Sarbanes-Oxley Act in 2002 created the PCAOB to oversee the audits of companies publicly traded in the United States, accounting firms based in China and Hong Kong have proven most problematic for the regulator to inspect. The issue came to a head in 2020 when China-based Luckin Coffee was accused of fabricating sales, sending its stock price on the Nasdaq plummeting after an investigation confirmed the allegations. Luckin would eventually be delisted and agreed to pay a $180 million penalty as part of a settlement with the SEC in December 2020.

That same month, Congress passed the Holding Foreign Companies Accountable Act (HFCAA). Under the terms of the law, publicly traded companies in countries that block audit inspections by U.S. regulators—namely, China and Hong Kong—can be delisted after three years of noncompliance, beginning in 2021. The earliest a company could be delisted would be 2024.

The deadlines of the HFCAA motivated Chinese regulators to reach a deal with the United States to prevent roughly 200 China-based issuers from facing prohibitions on trading of their securities. Companies including social media platform Weibo and tech giants Baidu and Alibaba were among the biggest names identified by the PCAOB as being at risk of delisting.

“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,” said CSRC officials as part of a Q&A with reporters regarding Friday’s announcement. “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.”

Access arrangements

Staff from the PCAOB are set to arrive in China by mid-September to begin their work, according to Williams. The regulator has until the end of the year to reassesses its determinations regarding access to Chinese audits and whether they meet the thresholds of the HFCAA.

As part of the agreement, the PCAOB:

• Has sole discretion to select the firms, audit engagements, and potential violations it inspects and investigates, without consultation or input from Chinese authorities;
• Is allowed 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; and
• Can share information with the SEC.

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

China has long held concern giving U.S. regulators access to accounting firms in the country poses national security risks. The government’s involvement in many of the largest firms in China exacerbates this fear.

“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,” said CSRC officials. “It provides a feasible path for both sides to discharge their regulatory mandates while protecting relevant information.”