Will China Finally Permit Audit Inspections?

The Public Company Accounting Oversight Board declared victory yesterday in the battle to inspect audit workpapers for China based issuers whose shares are listed on U.S. exchanges, according to a press release dated December 15, 2022. Specifically, the release headline states “PCAOB Secures Complete Access to Inspect, Investigate Chinese Firms for First Time in History.” The release goes on to claim that the new policy has been verified: “Today’s announcement should not be misconstrued in any way as a clean bill of health for firms in mainland China and Hong Kong. It is a recognition that, for the first time in history, we are able to perform full and thorough inspections and investigations to root out potential problems and hold firms accountable to fix them.”

This success is based on the Foreign Companies Accountable Act of 2020. That Act sets up a procedure through which the SEC is required to ban an issuer if the PCAOB concludes that it has refused to permit inspection. It is the potential sanctions from this Act which the PCAOB claims have now changed the landscape.

Yet the the Board has conducted inspections for years pursuant to the directive of the Sarbanes-Oxley Act of 2002. China has always been the exception. The PRC government and the China Securities Regulatory Commission or CSRC have steadfastly declined to permit the required inspections with few exceptions.

In 2011 and 2012 it appeared there was a breakthrough. The SEC brought enforcement actions against foreign affiliates of the major accounting firms centered on the inspection question. Those actions, brought as Commission administrative proceedings, ultimately ended with an agreement between the PCAOB and CSRC under which the parties pledged the “fullest assistance permissible to secure compliance with the respective Laws and Regulations of the Authorities.” The MOU went on to detail procedures to facilitate the arrangement. Yet little in the way of tangible results can be found despite the fact that ultimately under SOX firms that are not in compliance can be delisted. The deal failed.

Now the PCAOB claims to have road tested China’s willingness to comply the success of the 2020 Act: “More than 30 PCAOB staff members conducted on-site inspections and investigations in Hong Kong, reviewing thousands of pages of documents, conducting interviews and taking testimony over a nine-week period from September to November,” according to the Board release. While this sounds promising, so did the earlier deal. The proof will come in the future: Will China and CSRC continue to permit full inspections?