SEC Warns Chinese Companies Against Changing Auditors

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As companies change their auditors to avoid U.S. delistings, the agency’s acting chief accountant warns of possible investigations and enforcement actions. A representative of the Securities and Exchange Commission warned that Chinese companies and their auditors could face enforcement action if they violate legal or auditing regulations.

The Holding Foreign Companies Accountable Act of 2020 threatens to remove from U.S. stock exchanges, beginning in early 2024, more than 200 Chinese companies listed in the United States. It prohibits trading in companies whose auditors cannot be inspected for three consecutive years by the Public Company Accounting Oversight Board, the U.S. audit watchdog overseen by the SEC.

Tuesday, the Securities and Exchange Commission issued a warning to Chinese companies switching to U.S. auditors to comply with a law that threatens to delist them from American stock exchanges.

In order to avoid a potential trading ban, numerous Chinese companies with multinational operations have switched to U.S.-based accounting firms as their primary auditors in recent months. Paul Munter, acting chief accountant at the U.S. securities regulator, stated on Tuesday that these arrangements raise questions about whether the newly engaged audit firms in the U.S. and elsewhere fulfill their duties as lead auditors.

Recently, the PCAOB has strengthened the requirements for lead auditors supervising auditors from outside their firms. Now, lead auditors must obtain written assurances from third parties regarding the quality of their work.

Mr. Munter warned that Chinese companies and accounting firms “may be tempted to engage in an effective violation of other applicable legal and audit requirements,” which could result in investigations and enforcement actions by the PCAOB, the SEC, or both.

“Any attempt by issuers or accounting firms to commit such an efficient violation and avoid the consequences of the HFCAA in violation of other legal and auditing requirements should be avoided,” Mr. Munter said.

Several U.S.-based accounting firms are able to audit Chinese companies in collaboration with local accounting firms and independent contractors, who conduct the work on the U.S. audit firms’ computer systems. The PCAOB inspects audit records maintained by accounting firms in the United States.

Following a decade-long dispute over the audit of working papers of New York-listed Chinese companies, the U.S. and Chinese governments reached an agreement last month for the PCAOB to inspect China-based audit firms. The agreement permits PCAOB inspectors to conduct inspections in Hong Kong or mainland China.

Typically, accounting firms that issue an annual report on a company’s financial statements assemble a team of several external auditors, typically individual accountants or accounting firms. Under U.S. standards, audit firms are permitted to utilize the work of another auditor so long as the requirements for serving as the lead auditor can be met and the lead auditor can fulfill its supervision and documentation responsibilities.

Mr. Munter stated that if the lead auditor fails to meet any of the PCAOB’s inspection or investigative requirements, as well as other requirements, the firm’s personnel and the entity being audited could face significant liability.

 

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