In May 2013, the US Public Company Accounting Oversight Board ("PCAOB"), the China Securities Regulatory Commission ("CSRC") and the Chinese Ministry of Finance ("MOF") signed an MOU to exchange information necessary to secure compliance with securities laws, including certain audit requirements, in China and the US.
The MOU was a first step toward resolving an impasse regarding oversight by the PCAOB of auditors of Chinese US-listed companies. Among other things, the PCAOB is empowered to force disclosure of audit working papers, and to inspect the operations of auditors it oversees. However, auditors for a number of US-listed Chinese companies resisted disclosure of their working papers. They asserted that the working papers were protected under Chinese law and they could not disclose them to the US authorities without risking sanctions in China.
Solving this impasse is crucial. If it persists, delistings of affected Chinese issuers and disqualification of China-based auditors could follow. If these results come to pass, Chinese private issuers would find they have little, if any, access to US capital markets.1
The May 2013 MOU was initially criticized for failing to grant the PCAOB the right to inspect China-based auditors of US publicly traded foreign private issuers. Its terms also allow for refusal of disclosure when such disclosure is inconsistent with local laws, or contrary to public policy or essential national interest. Early commentators expressed concern that these broadly worded exceptions could be used to avoid any disclosures.
In recent months, however, it appears incremental progress has been made. Recent developments indicate that obstacles to disclosures have been overcome, at least for the purposes of an SEC administrative proceeding brought against a number of auditors affiliated with the Chinese auditors of several Chinese issuers. The CSRC has apparently released audit working papers for at least one of these issuers.2 However, disclosures remain confidential under the MOU. The PCAOB can only share information with the SEC, federal and state prosecutors and certain state regulatory agencies.
A decision in the SEC's administrative proceeding expected in January will likely clarify the extent of those disclosures, even if the full extent of the information disclosed is not made public. Crucially, the fact that information was disclosed seems to have had a positive effect on the market.
We expect to know more after a decision is handed down in later this month. Further developments in the application of the MOU will likely increase predictability for both issuers and the investing community, and foster continued access to US capital markets for Chinese issuers. That said, the broad wording of the MOU, together with on-going concerns regarding confidentiality and other Chinese regulatory implications of releasing audit working papers for particular issuers, will require each request for disclosure to be carefully analyzed, from both a Chinese and a US perspective.
1 We note that similar issues have arisen in Hong Kong. This Haiwen Alert does not address those issues, which can be viewed as distinct from the issues relating to PCAOB oversight of Chinese auditors.
2 Media reports indicate that audit papers for Longtop Financial Technologies Ltd. have been provided. See https://tax.thomsonreuters.com/media-resources/news-media-resources/checkpoint-news/daily-newsstand/chinese-audit-documents-remain-out-of-reach/
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