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Article / 29 May 2013 at 7:47 GMT

China Finance: Updated data on auditors linked with issues

Founder / ChinaRAI
China

There has been quite a bit of talk about a new accounting deal between the Public Company Accounting Oversight Board (PCAOB) and China. Most seem to agree with my assessment that while it offers more information for US regulators it does not really change the situation for investors.

My view is that this new deal is more likely to be the final deal that the PCAOB will get, rather than the first step in a deepening collaboration that they are hoping for. So with this in mind we should start making preparations for what this type of limbo deal will mean.

More risk and short sellers returning
The important change here is that there will be more information available on the auditors and how they conduct their work, and some of this information may also be available to the Securities and Exchange Commission (SEC). So we are likely to see more details on accounting practices and possibly some follow-up on previous fraud suspicions levied against US-listed Chinese companies.

However, the lack of bite in current regulations means that shareholders of companies affected by this still do not have any more venues to pursue justice once issues have been found. This could mean a slightly larger risk premium across the board for Chinese companies as a whole, and could also signal a return of the short sellers to this market.

PCAOB will likely start with backlog
From an investor perspective this new development signals that it might be time to have a look at exposure to accounting risk and potential short positions. My first instinct is that if the PCAOB is going to start looking into audit work by firms then once again we find that previous fraud accusations associated with the accounting firms might come into play.

The PCAOB is dealing with a backlog of frauds and accusations, and I would be surprised if this is not where they start using their new access to information. As such, it is very useful to get some idea of which firms will see most of this scrutiny.

I had a post about this last year as well, but as part of a larger project at ChinaRAI we looked into some data that included the auditors' US-listed companies that had been subject to fraud accusations or accounting issues.

This data is a bit different from what was published last time, as it focuses particularly on the US-listed firms, much like what the PCAOB is likely to do. This means that Sino-forest is not included, nor is the recent accusations against Zoomlion or other Hong Kong listed companies.

I cannot guarantee that the list is absolutely exhaustive. For instance what is deemed serious enough to classify as a legitimate fraud accusation is somewhat discretionary. However, with 158 companies on the list it offers good guidance for firms that might be more likely to have papers reviewed by the PCAOB, and thus where there might be more risk. 

Data on Accounting issues

Interestingly, if we compare to the previous data I had, it appears that the numbers of the big 4 have evened out a bit. Especially PWC has been a lot more prevalent this time around. Deloitte is still the outstanding leader of the table however, and it will be interesting to see what the PCAOB and SEC does with this.

Regardless of what the PCAOB does with the information it is clear that Deloitte’s track record remains an issue, and investors are likely to take this into account for risk evaluations.

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 Fredrik Oqvist writes regularly about Chinese equities, mainly those listed on foreign exchanges. If you'd like to comment on this story or be notified by email whenever a new China Finance story is published, become a member - it's free, and you can use your Twitter, Facebook, Google or LinkedIn login - and "follow" the China Finance blog during the sign-up process. You can also bookmark the China Finance blog page.

5y
Fredrik Oqvist Fredrik Oqvist
Latest short attack on VIPshop is not included in here as it seems to be based mostly on Alexa data, which is unreliable for China.

If you include it you can +1 for Deloitte
5y
nana Wan nana Wan
Can the U.S.-China deal be a good news to Chnese companies? At least, the Xinhuanet reported in Chinese that the official said (google-translated):
"Fighting against securities crime is the common goal of both sides. We do not support any violation of overseas rules of the Chinese enterprises, however, meanwhile we do not want the Chinese enterprises to be defamed by the short-sellers' baseless speculations. Providing audit records to the United States will be helpful for clarifying the facts and restoring reputation for the innocent enterprises, and it will also pave the way for more Chinese companies to list overseas for financing."
5y
Fredrik Oqvist Fredrik Oqvist
Hi Nana.

It can be good news if it increases investor confidence, but the deal currently isn't formulated in a way that is in investors best interest. This is basically a deal that allows the PCAOB to avoid deregistering accounting firms in China, sadly there's not much more to it.

There are simply too many concessions made by the US authorities to make the deal do what they need it to. China can still withhold information for 'national security' reasons. Papers will only be allowed to travel over to the SEC if this was specifically applied for and then approved by the Chinese government. There are no new venues for investors to pursue if there are new frauds discovered. There are no actual inspections allowed in China.

A strong deal that increased investor protection would have been good for Chinese companies, I fear this is not that deal.
5y
nana Wan nana Wan
Thank you for your reply. May I also ask your opinion on Sino-Forest case? Will the Canadian regulator, the OSC, be able to view the audit papers after this U.S.-China deal? E&Y said that it can prove E&Y has done nothing wrong after showing the audit papers to the OSC, and Mr.Ned Goodman blamed the OSC for the collapse of Sino-Forest after the OSC checked all Dundee's materials and found nothing wrong:
http://www.stockhouse.com/opinion/movers-and-shakers/may/canada-needs-a-better-stock-exchange,-says-ned-goo
http://business.financialpost.com/2013/03/05/pdac-2013-ned-goodman-blames-regulators-for-sino-forest-collapse/
5y
Fredrik Oqvist Fredrik Oqvist
Hi Nana,

Sino-forest is a tough nut. There were certainly many organisational problems that were present, even apart from the most cited ones, which will probably make it hard for them to start it up again. Further, some of these issues are also likely to influence people trading in their corporate bonds.

Sadly for investors in Canada the PCAOB deal will not provide them with anything, apart from possibly some negotiating power to strike a similar deal for themselves along the same lines in the future. At present though this doesn't change much for Canadian investors.
5y
nana Wan nana Wan
Thank you for the explanation about the PCAOB deal. I do hope that Canada can do something for investors.

For Sino-Forest shareholders who have lost everything invested in the stock, the most important thing is to clarify the issue on how many acres of forest assets the company actually owns in China. Even if the OSC can prove that there are business activities which do not meet the Canadian Standards, if the company owns the forest assets, they won't disappear even after the stock has been delisted.

The Chinese local governments have offered confirmations for Sino-Forest's forest assets, and according to the Forestry Law of PRC, the local governments have the authority to deal with all disputes on the ownership of forest rights. Meanwhile, apparently the OSC has its authority to deny the authority of the Chinese local governments.

In my view, that is the biggest issue of the Sino-Forest.

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