US regulators have barred two accountancy firms from performing future audit work after finding their reviews of Chinese companies listed in the US were “riddled with failures” and “botched”.
One of the companies audited by New York-based Sherb & Co – called China Sky One Medical – has already been charged with financial fraud itself by the US Securities and Exchange Commission.
The ban on Sherb & Co and New Jersey-based Patrizio & Zhao from carrying out audit work for any publicly listed company in the US, is expected to be followed by charges for other firms that performed audits for a wave of China-based companies that gained listings in the US through reverse mergers.
These mergers, where a Chinese company buys a listed shell company, were seen as a short-cut to American stock markets and became notorious after many of them were targeted by short-sellers and a number proved to be frauds.
Many investors lost money on these companies, but Paul Gillis, an accounting professor at Peking University, reckons they could have been better protected if the Public Companies Accounting Oversight Board, which monitors the industry, had been allowed to disclose the problems sooner.
The PCAOB, which was created after the frauds at Enron and WorldCom just over a decade ago, had identified problems with both the accountancy firms’ audit work as early as 2009.
The firms were named in public reports from the PCAOB that listed a string of failures, but none of their clients were identified so investors were not warned that they might own companies whose accounts were faulty.
Prof Gillis reckons however that some hedge funds and short-sellers were able to work out what was going on.
“In both cases, the PCAOB knew that the firms were doing shoddy audits, but the firms were allowed to continue to practice until the SEC finally shut them down [from auditing publicly listed companies in the US],” he wrote in his blog.
“Short-sellers figured this out, and targeted clients of Sherb and some other small audit firms that audited Chinese reverse mergers.”
These confidentiality rules may unfairly protect the reputations of CPA firms over the interests of investors said Prof Gillis . The accounting regulator is proposing that accountants give more details in company audits rather than issuing a straight “pass or fail” judgment in order to help prevent future frauds.
However, this could prove tricky with Chinese companies because of the dispute between US and Chinese authorities over what amount of company data can be released, although the two sides are getting closer to a deal.
Sherb & Co, which was charged by the SEC late last week, has agreed to be barred from performing audit work along with four of its partners, after the regulator found its audits “were riddled with failures and improper professional conduct”.
The firm was fined $75,000.
Patrizio & Zhao and one of its founders were charged at the end of September over their “botched audits of a China-based company that failed to disclose related party transactions by its CEO and others”.
The company was Keyuan Petrochemicals which itself was charged with accounting violation this year by the SEC. Patrizio & Zhao will pay a fine of $30,000.
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