Media are buzzing with word that the US securities regulator is once again tussling with major auditors over access to the accounting records of US-listed Chinese firms, in the latest chapter of an ongoing story; but what has me more intrigued is the scramble that is probably taking place behind the scenes, as those same auditors try to figure out what they will do when the inevitable happens and they are forced to share their records with the US Securities and Exchange Administration (SEC).
Right now I can imagine what is happening: the auditors, including big names like Ernest & Young and Deloitte, are probably frantically poring over all their audits for US-listed Chinese firms from the last 2-3 years, and trying to decide which firms to sever their ties with. While big names like Baidu (Nasdaq: BIDU) and Sina (Nasdaq: SINA) are unlikely to see any big changes in their accounting partnerships, mid-sized and smaller players could see a big shuffling of the cards as their auditors abandon them over concerns about some of their past accounting practices.
Let’s take a step back and look at the history of this current tussle between the SEC and Chinese firms, which began last summer at the height of a series of scandals caused by aggressive or even fraudulent accounting by some US-listed Chinese firms. As the SEC began to investigate some of those cases, it quickly discovered that the companies’ external accountants, which often included big names like Deloitte, were unwilling to share information from their audits. (previous post)
The auditors said they weren’t allowed to share such information, since all of the companies being examined were based in China and therefore only Chinese regulators had the authority to demand such sharing of information. Of course, many observers, myself included, suspected the auditors were using the jurisdictional argument to avoid sharing data that would show they had either neglected their duty as auditors or, even worse, had actually colluded with Chinese companies to defraud investors.
The SEC responded by approaching Beijing and opening landmark talks with Chinese authorities designed to facilitate the access to auditing records they were seeking. Those talks are still in progress and could finally result in a breakthrough information sharing agreement by the end of next year.
But in the latest development of this ongoing case, the SEC has taken the equally aggressive tact of actually charging the Chinese units of 5 US accounting firms, including the so-called “Big Four” auditors, of potentially defrauding investors related to their accounting for 9 US-listed Chinese firms. (English article) The auditors have reportedly cited China’s “state secrets” law for their refusal to hand over the records, relying on this arcane and highly ambiguous law to avoid complying with the SEC’s order.
This SEC move to file criminal charges will add to the pressure on the auditors, and I suspect that we’re likely to see some cooperation between the 2 sides before the end of 2013. As this inevitable outcome approaches, the auditors are likely to quickly determine which of their clients might become the biggest liabilities and sever their relationships with those companies sooner rather than later.
We already saw solar panel maker Trina (NYSE: TSL) cut its ties with Deloitte back in June, though it’s unclear who initiated the split. (previous post) We should expect to see more similar divorces in the months ahead, with the rate accelerating as the SEC and auditors move closer to their final cooperation. As that happens, look for lots of volatility in the share prices of companies that get dumped by their auditors, as investors fret that such companies could eventually become the targets of SEC investigations and eventual de-listings.
Bottom line: Big US auditors are likely to sever their relations with a growing number of mid-sized and smaller US-listed Chinese firms in 2013 as they face growing pressure to comply with SEC investigations.
Doug Young has lived and worked in China for 15 years, much of that as a journalist for Reuters, writing about publicly listed Chinese companies. He currently lives in Shanghai where he teaches financial journalism at a leading local university. He also writes daily on his blog, Young’s China Business Blog, commenting on the latest developments at Chinese companies listed in the US, China and Hong Kong. He is also the author of an upcoming book about the media in China, The Party Line: How The Media Dictates Public Opinion in Modern China .