(Bloomberg) -- Chinese companies are flailing in a fresh bid to avoid being booted off US stock exchanges for shirking Washington’s oversight demands.
American regulators say they doubt their calls for more transparency will be met by Chinese businesses simply hiring US auditors. Switching accounting firms had been seen by some companies as a way to satisfy a 2020 law that threatens to remove businesses from the New York Stock Exchange and Nasdaq if US officials can’t inspect their audit work papers.
While US inspectors have started reviewing those documents under a preliminary accord reached between the two governments, about 200 companies based in China and Hong Kong still face possible delisting. The pushback on the auditor switches is yet another hitch in the decades-old dispute over Beijing’s refusal to let Americans review the audit papers, a basic pillar of accessing US capital markets.
“What we’re concerned about is the possibility, you might have a fact pattern where the issuer has engaged a lead auditor who is not able to actually audit a substantial portion of the consolidated operations,” Paul Munter, acting chief accountant of the Securities and Exchange Commission, said in an interview.
The skepticism from senior SEC officials like Munter and the Public Company Accounting Oversight Board could be bad news for firms like Zai Lab Ltd. and BeiGene Ltd. So far there have only been a smattering of examples of companies switching to US-based auditors, but American regulators have indicated they’re concerned that others will soon follow.
The businesses have said the moves reflect their increased presence in the US, but the auditor swaps have been widely seen as attempts to avoid delisting. Zai Lab said in its second-quarter earnings release that hiring KPMG US “was a natural progression” of its global growth.
In response to questions about its auditor switch, Zai Lab referred to an Aug. 26 statement in which the company said it didn’t consider itself to be at jeopardy for delisting because “it remains fully subject to audit” by KPMG in the US. The arrangement, Zai Lab said, means that “the PCAOB is fully able to inspect and review KPMG’s audit work papers in the US relating to its audit of Zai Lab.” The company added that it didn’t consult with the SEC about the auditor change.
On Thursday, Zai Lab Chief Operating Officer Josh Smiley said that the company followed “a thorough process” in transitioning to its new auditor and that its executives and a majority of its board were located in the US. He also said that the firm’s process addressed concerns that Munter, the SEC acting chief accountant, raised earlier this month in a public statement about companies switching auditors.
KPMG said in a statement that it carefully vets whether it can deliver quality audits under PCAOB standards whenever taking on work, but declined to discuss its new client.
BeiGene, which calls itself a global biotech company, hired Ernst & Young’s US practice as its auditor this spring. Neither the company, which has administrative offices in Cambridge, Mass., nor EY responded to requests for comment.
The companies’ plans to switch audit firms predate the Aug. 26 agreement between US and Chinese regulators to allow for inspections to begin. SEC Chair Gary Gensler has said that American officials will assess by December whether their access is sufficient.
Companies like Zai Lab and BeiGene are relatively small, but the audit access issues are also casting a shadow on Chinese behemoths like Alibaba Group Holding Ltd. that trade in New York.
The 2020 US law set a three-year timeframe for booting public companies from American markets if PCAOB inspectors can’t review their audit documents as required by the 2002 Sarbanes-Oxley Act. That legislation was passed in the wake of the Enron Corp. accounting scandal and it’s meant to prevent fraud and wrongdoing that could wipe out shareholders.
China and Hong Kong are the lone two jurisdictions worldwide that haven’t allowed the PCAOB inspections, with officials there citing national security and confidentiality concerns.
Xiaomeng Lu, an analyst at Eurasia Group, called the auditor switches a potential “gray-area workaround” that’s unlikely to win over regulators in the US and China. “If large global Chinese stocks hope to maintain their listings in New York, it is better to be safe than sorry,” she said.
Neither the PCAOB nor SEC have said that companies can’t hire a lead auditor from outside their home country. Yet both regulators say there’s little room for error with accepting Chinese or Hong Kong clients.
“The PCAOB must have complete access, and there is no getting around that,” the watchdog said in a statement in response to questions about the recent auditor switches. “If a China-based company chooses to hire an audit firm located elsewhere in the world, that firm is required to cooperate with PCAOB inspections and investigations and produce work papers when requested.”
There’s also a possibility that China may view an auditor switch as an attempt to get around its own rules prohibiting firms from removing paperwork, which Beijing deems to contain sensitive data. “As long as the firms are still ‘Chinese firms’, it is hard to bypass the regulatory radar of Chinese regulators,” said Gary Ng, senior economist for the Asia Pacific region at Natixis.
The China Securities Regulatory Commission didn’t respond to a request for comment.
Meanwhile, in the US, the PCAOB has signaled a growing focus on relationships between auditors and recently brought a case against one firm for relying too heavily on another. More are expected as the PCAOB ramps up policing of its rules, said Sandra Hanna, who leads the securities enforcement practice for Miller & Chevalier Chartered.
(Updates with additional comment from Zai Lab executive in eighth paragraph. An earlier version was corrected because it incorrectly said Zai Lab declined to comment.)
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Author: Amanda Iacone, Yiqin Shen and Lydia Beyoud