December 4, 2012 6:51 am

Chinese companies caught in SEC crossfire

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The Big Four auditors have been caught in the crossfire of a US-China regulatory dispute, but the biggest casualty could be Chinese companies listed in the US.

The US Securities and Exchange Commission on Monday accused the Chinese affiliates of the Big Four – Deloitte, Ernst & Young, KPMG and PwC – plus one other firm, BDO, of breaking securities laws after they refused to produce paperwork related to investigations into accounting fraud at nine Chinese companies.

But by charging the Chinese affiliates of the leading global accounting firms, the SEC has begun a process that could hasten the wholesale delisting of Chinese companies from the US stock market.

The accounting firms are faced with a Catch-22 situation. The US says they must share audit documents from foreign countries, while China bars that practice.

Paul Gillis, a professor of accounting at Peking University, says the SEC action could mark “the beginning of the end” of US stock market listings for Chinese companies. “All the Chinese companies listed in the US will be without auditors and that will lead to their delisting,” he adds.

Caught in this tussle are dozens of small companies – some of which have been accused of business fraud by short sellers such as Muddy Waters – and a few larger groups such as the giants of the Chinese internet sector Baidu and Sina.

There has already been a wave of delisting from US markets by Chinese groups with private equity or mainland bank backing. Focus Media, a display advertising company, valued at $3bn is pursuing China’s largest ever buyout deal, while Asiainfo-Linkage, a telecoms billing group, is set to delist with backing from Citic Capital.

Bankers and lawyers in Hong Kong say many more groups are seeking funding to pursue similar deals. “For Chinese companies, a US listing used to be a badge of honour, but the regulatory burden, tax concerns and the poor performance of shares means they are no longer interested,” says one leading Hong Kong lawyer.

Yu Guofu, a lawyer with Beijing Shengfeng law firm, says a China-US auditing framework should have been worked out years ago.

“This is an issue that should have been dealt with before they were listed, so that it didn’t get to this point where auditing firms can’t do anything about it,” he says.

Instead, US-listed Chinese companies have existed in a grey area, with neither US nor Chinese regulators monitoring them closely, and some have exploited that ambiguity.

The issue has come to a head after the SEC began to investigate potential wrongdoing. To date the US regulator has filed fraud allegations against 40 individuals or companies.

Mr Gillis doubts a diplomatic solution can be achieved. He says the Chinese government objects in principle to the idea of allowing foreign regulators to oversee domestic companies. “I don’t think the Chinese are going to back down. This is too fundamental an issue.”

At the same time, US bankers in Hong Kong say the SEC can never allow lower standards for companies from a particular country because others would demand the same. “This is an issue that can only be dealt with at the government to government level,” says one US banker. “It looks like that diplomatic process may have broken down.”

Michael Andrew, KPMG global chairman, says the timing of the SEC move is “curious”, as it follows hard on the heels of the news of the departure of Mary Schapiro, SEC chairman, while coinciding with a change of political leadership in China.

He hopes the US will not trigger mass Chinese delistings: “When you are dealing with the Chinese, constructive engagement will always result in better outcomes.”

Hong Kong, where almost one-quarter of listings are mainland companies, has also faced problems getting audit papers out of China. The Securities and Futures Commission is pursuing Ernst & Young in Hong Kong’s courts over working papers related to Standard Water, a Chinese group that applied to list in the territory but later cancelled its flotation.

However, Tong Daochi, head of International Affairs at the China Securities Regulatory Commission, told a gathering of lawyers in Hong Kong only last week that audit working papers should be shared with other regulators to crack down on fraud and maintain market integrity. But he added there were legal hurdles in dealing with different rules in different countries. “I think we’ll shortly be able to work out a way to deliver those papers,” he said.

Additional reporting by Adam Jones in London

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