Officials from the Securities and Exchange Commission and the Public Company Accounting Oversight Board are heading to China later this month to meet with officials there to try to resolve the growing problems with audits of U.S.-listed Chinese companies.

The PCAOB has been pushing for inspections of auditing firms in China and other countries that to date have barred the way to outside inspections. But the problems with the accounting at Chinese companies, especially those that have attained listings on U.S. exchanges through reverse mergers with U.S.-listed shell companies, have grown more acute this past year. A string of Chinese companies have seen their shares pummeled by allegations of accounting fraud in recent months, and several of the Big Four audit firms have tried to distance themselves from their Chinese corporate clients and former clients.

However, the attractions of doing business in China have proven difficult to resist for many firms, which have been forced to rely on the auditing work of local Chinese firms that have been immune to inspections by the PCAOB. Twenty-eight auditing firms based in China and Hong Kong audited the financial statements of 230 U.S.-listed companies in 2009 and 2010, but were not inspected by the PCAOB. With the shares of more and more Chinese companies becoming attractive targets for short sellers, the Chinese government has become more open to talking with U.S. regulators about the problem.

Officials from the SEC’s Office of the Chief Accountant, along with PCAOB officials, are scheduled to visit China next week, according to Reuters and Bloomberg.com. Plans for the upcoming negotiations were helped along by recent meetings between the PCAOB and the China Securities Regulatory Commission during economic talks between the U.S. and China in May. The PCAOB is also considering requiring U.S. auditing firms that use outside firms to disclose the names of the firms and whether they are open to PCAOB inspectors.

PCAOB Chairman James Doty has made it a priority to open up the Chinese auditing firms to inspection, and he recently reported some signs of progress. “I believe Chinese authorities are beginning to understand, and do understand, that they have a real interest in solving what has been an impasse in this area,” he said in May. The PCAOB even denied one Chinese firm's application last month for registration with the PCAOB because its inspectors were unable to inspect the firm.

Even the largest accounting firms seem to be realizing that the ongoing accounting problems at Chinese companies are hurting the credibility of their audits. When KPMG told the board of directors of China Forestry Holdings of irregularities in its accounting, shares were suspended in January. Canadian regulators have also expressed concern after shares in companies like Sino-Forest Corp. plunged on the Toronto Stock Exchange amid allegations of accounting fraud that were denied by the company. And short sellers are beginning to look to companies trading on the Hong Kong and Singapore exchanges after Chinese companies have begun curtailing their listings in the U.S. amid the heightened scrutiny.

With China’s ability to attract investment capital from the public markets in jeopardy, it has become increasingly clear to Chinese officials that submitting to an inspection regime for the country's auditing firms is not only in its economic interest, but also imperative for future growth.

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