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PCAOB Deal with China Seen as Just the First Step

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May 30, 2013

The Public Company Accounting Oversight Board’s long-awaited agreement with Chinese authorities doesn’t really give the PCAOB everything it has been seeking, such as the ability to inspect auditing firms in China, but it does take the PCAOB closer to its eventual goal.

The PCAOB announced the deal last Friday, saying it had entered into a memorandum of understanding on enforcement cooperation with the China Securities Regulatory Commission and the Ministry of Finance that will give it access to audit work papers under some circumstances. The MOU will establish a cooperative framework for the production and exchange of audit documents relevant to investigations in both countries’ jurisdictions, and provide a mechanism for the parties to request and receive from each other assistance in obtaining documents and information to further their investigative duties.

However, the deal is limited to enforcement action cases and doesn’t give the PCAOB the ability to just request work papers willy-nilly, nor does it provide the ability to do inspections of firms in China that audit U.S.-listed companies, or work in affiliation with U.S.-based firms. Still, it does represent progress in the right direction.

“First I think you have to look at the memorandum of understanding as a very good accomplishment,” said Drew Bernstein, CPA, managing member of Marcum Bernstein & Pinchuk, a PCAOB-registered accounting firm headquartered in New York, which has local Chinese offices in Beijing, Hangzhou, Guangzhou and Shanghai. “There are a lot of people out there who don’t believe it went far enough, and I don’t believe it was meant to be the solution. It’s the first step. For those that really understand China and the history of this, it’s taken a lot longer than people would think. And China doesn’t typically take huge steps. Perhaps if this were being negotiated with a European country, you might have come away with a much more comprehensive agreement. But China typically takes baby steps. It’s also a logical thing to do because it takes off the immediate pressure. What I mean by that specifically is that the immediate pressure on the industry so far has been these lawsuits with the Big Four accounting firms, and this agreement right now, the implications are, with the protocol, the accounting firms would be permitted to send work papers outside of China and give them to foreign regulators.”

Drew Bernstein

The agreement may indeed help settle the Securities and Exchange Commission’s cases against the Big Four accounting firms and BDO seeking access to their work papers, but that isn’t really clear as yet (see SEC Charges China Affiliates of Big Four Firms). Deloitte has already asked a court to dismiss a lawsuit seeking access to its audit work papers on one of its Chinese clients, Longtop Financial Technologies (see SEC Charges Deloitte with Refusing to Produce China Work Papers and PCAOB Finds Problems with Deloitte Audits).

“That would seem like it would settle the cases with the accounting firms with the SEC and also the Hong Kong regulators,” said Bernstein. “I think that’s a very positive thing right now. It clearly is not the ‘be all, end all.’ It’s the beginning of the process. It doesn’t address inspections of accounting firms right now. There are a lot of things it doesn’t cover, but it’s hard to view it in any other way than as a very positive step.”

However, whether or not the agreement will eventually lead to inspections is a “guessing game,” according to Bernstein. “Drawing off the agreement right now, this has been, I would imagine, kind of a painful compromise for the PCAOB,” he acknowledged in an interview Tuesday. “It didn’t touch a lot of areas that I’m sure they would have to liked to put to bed. If you were to project this out to inspections, you would say that you probably could do inspections by mail. I would hope, and I think the community of people out there would hope these negotiations will continue and that they will be able to reach some agreement with respect to doing actual inspections. The investors can look to a third party to get some idea of the quality of the accounting firms doing the work, which has been a big issue in China. Certainly getting inspections done would be another positive step and you would hope that this would lead to that.”

Brian Fox

Brian Fox, founder of Confirmation.com, an audit confirmation technology provider, has another perspective on the deal. “It certainly doesn’t give the PCAOB what they want,” he said in an interview Tuesday. “Nor does it give the U.S. investor what they want. But we kind of have to take with China, at the moment, we’ve either got to take a step-by-step approach, or we’ve kind of got to go with the scorched earth policy here and really hold their feet to the fire. So I think if we’re going to go down the path of trying to negotiate access to the work files, certainly this is a good first step, that we’ve found some form of common ground.

“But at the same time, I think it’s really surprising as I talk to CPAs, or even to investors, and they find out that Chinese companies listed on the U.S. stock exchange are not playing by the same set of rules as every other company has to abide by, because it doesn’t give the PCAOB access to just go and do their standard review of an audit and inspection process like they have with every other firm and every other public company audit,” Fox added. “So they don’t just get the ability to do that as a normal course of business, nor do they get to do it if there’s just suspected fraud. Even if they suspect a company of fraud, they don’t really get to get access. It’s only, in a sense, once the fraud has been proven, but then the question is, ‘Isn’t that a little too late?’ Once the fraud has already been proven, then we have access to go in and look at the work files, and see what the auditors missed or if they could have done a better job, and look at the inspection report. That’s really all that it covers. Really, for the U.S. investors, they need to understand that the PCAOB still doesn’t have access to the work files in the normal course of inspections, nor do they have access even when fraud is suspected, both of which are the keys to what investors need if they’re going to get comfortable investing in these Chinese companies that are listed on the U.S. stock exchange.”

To listen to more of the interview with Fox, you can access a podcast of him here.

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