U.S.-based audit firms seeking new public company clients in China should ensure they have full access to previous audits and work papers before taking the job or risk potential enforcement, the acting chief accountant at the Securities and Exchange Commission (SEC) warned.
Paul Munter said in a statement Tuesday that Chinese companies should not believe swapping out a China- or Hong Kong-based auditor for a U.S.-based firm will result in quick compliance with the Holding Foreign Companies Accountable Act (HFCAA). The U.S. firms in that scenario must similarly understand their responsibilities under standards established by the Public Company Accounting Oversight Board (PCAOB).
The HFCAA, signed into law in 2020, would delist any public company that does not meet U.S. audit inspection standards after three consecutive years of noncompliance. The SEC has identified approximately 200 Chinese companies listed on U.S. stock exchanges that face delisting.
Some Chinese businesses, including Zai Lab and BeiGene, have responded to this threat by retaining U.S.-based auditors to review their 2022 financials.
“If the issuer does not authorize appropriate communications, or places significant limitations on the responses of its predecessor accounting firm, the new accounting firm may not be able to accept the engagement and be in compliance with applicable PCAOB standards,” Munter said. “The same is true if the predecessor auditor creates roadblocks and fails to engage in appropriate communications or to provide requested information, including prior work papers.
“Therefore, accepting such an engagement to serve as the retained lead auditor creates risk for the new accounting firm of potential enforcement action by the PCAOB, the commission, or both and creates potential liability for the issuer.”
Munter said audit firms have “significant requirements and responsibilities” that should be addressed prior to accepting a lead auditor role. Those mandates, set out in the Sarbanes-Oxley Act, require the lead auditor to determine whether it can fulfill its responsibilities before it accepts an engagement, have supervisory responsibilities with an associated potential for liability, and require audit documentation be retained by or accessible to the lead auditor.
It is this last point—accessibility to financial information and work papers—that is most at issue regarding Chinese public companies listed on U.S. exchanges. The Chinese government has historically blocked access to audit reports of the country’s companies, citing national security concerns. The PCAOB and Chinese regulators reached an agreement in August designed to allow U.S. inspectors to review the work of public accounting firms headquartered in mainland China and Hong Kong.
Munter said some matters U.S.-based audit firms should press their predecessors for information about include:
- Integrity of the issuer’s management;
- Disagreements with management a predecessor firm might have had regarding accounting principles;
- Communications between the predecessor firm and the issuer’s audit committee;
- The predecessor firm’s understanding of the issuer’s relationships and transactions with related parties and any significant unusual transactions; and
- The predecessor auditor’s understanding regarding the change of auditors.
Munter closed his speech by reiterating potential lead auditors’ failure to meet their legal or professional obligations, or failure to comply with applicable audit standards, “can result in significant liability for not only the auditor and its personnel but also for the issuer.”