Standoff Between US, Chinese Over Audits Of Chinese Firms Could Mean Delisting From US Exchanges For Many Chinese Companies

Simmering tensions between American and Chinese securities regulators threatened to reach the boiling point this week after the U.S. Securities and Exchange Commission filed charges against the Chinese affiliates of the world's five biggest accounting firms.

The SEC said on Monday that it is charging Deloitte Touche Tohmatsu Certified Public Accountants Ltd., Ernst & Young Hua Ming LLP, KPMG Huazhen, PricewaterhouseCoopers Zhong Tian CPAs Ltd. and BDO China Dahua Co. with failing to produce so-called work papers of their audits of several China-based companies that are listed on U.S. equity exchanges.

The Chinese affiliates of the big accounting firms, which say they are prohibited by Chinese law from disclosing details of their audits, could face the suspension of their right to practice, meaning their China-based clients could not continue to have their shares traded on U.S. stock exchanges.

According to the Financial Times, the Chinese affiliates of these accounting firms are faced with the dilemma of potentially breaking the law in two different countries. In the U.S., withholding foreign public accounting paperwork of U.S.-traded companies violates two laws -- the Securities Exchange Act and the Sarbanes-Oxley Act. In China, sharing the accounting information and removing audit papers from the country is illegal, for national security reasons. In addition to that, Chinese authorities do not allow non-Chinese regulators to conduct investigations in China.

China defines state secrets under a broad scope, preventing them from having to disclose information in situations like this. China's Law on Guarding State Secrets has been ammended a few times to be more inclusive of all kinds of information, including economic statistics. The legal repurcussions for releasing Chinese state secrets, like those that could be included in financial reports of state-owned companies, is most likely imprisonment.

As a result, auditing firms are not likely to give in to SEC pressure. A representative for PwC, Caroline Nolan, told Business Week that their China offices will ultimately abide by Chinese laws.

"PwC China has cooperated with the SEC at every opportunity. However, PwC China will, and must, comply with its legal obligations under China law,” Nolan said.

Some industry experts believe that this rising financial tension is the beginning of a souring of the financial relationship between the U.S. and China.

According to Paul Gillis, an accounting professor at Peking University, a mutually agreeable solution between the two nations is not likely, calling the SEC action to file "the beginning of the end" of Chinese companies listing in U.S. stock markets.

"I don't think the Chinese are going to back down. This is too fundamental an issue," he told the Financial Times.

If China authorities do not back down, Chinese companies may end up losing money and seeing investor confidence hurt, but the American side could be hurt as well by losing current and future investment opportunities. Having Chinese companies listed on U.S. markets is a way for American investors to tap into China's growth without wading into China's stock exchange.

The issue may trigger a mass of delistings, following a wave of Chinese companies that already have, perhaps seeing the regulations and tax concerns as more of a burden and turning to private backers for financing rather than the stock market.

The Financial Times reported that many are turning to Hong Kong banks for funding.

"For Chinese companies, a U.S. listing used to be a badge of honor, but the regulatory burden, tax concerns and the poor performance of shares means they are no longer interested," a Hong Kong lawyer said.

The standoff has sharpened the call by accounting firms for the two countries' authorities to come to a compromise.

"This action involves an issue that needs to be resolved between the U.S. and China," PricewaterhouseCoopers China said in a statement.