SEC Proceedings Against “Big Four” Could Affect SMEs in China

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How do the current SEC proceedings against the Chinese arms of the “Big Four” accounting firms affect foreign investors?

Jan. 23 – In December 2012, as part of U.S. Securities and Exchange Commission (SEC) investigations into potential wrongdoing by nine China-based companies whose securities are publicly traded in the United States, the SEC charged the Chinese arms of the “Big Four” accounting firms (and BDO) with violations of U.S. securities laws and the Sarbanes-Oxley Act for failing to provide audit working papers for U.S. listed companies.

These recent SEC charges follow court action against Deloitte earlier in 2012 for failure to produce the working papers for Longtop Financial Technologies, as well as a series of financial fraud exposures in U.S.-listed companies in China over the past two years, many via reverse merger activity.

“Here is where SME investors might be affected,” explains Paul Gillis, professor and program co-director at Peking University’s Guanghua School of Management. “Public companies from the U.S. must be audited by a public company accounting oversight board (PCAOB) registered auditor. That auditor will likely rely on a Chinese firm (either an affiliate of an international firm, or a local Chinese firm). If the local audit in China results in the Chinese auditor playing a substantial role in the audit (which is auditing more than 20 percent of assets or revenues, according to PCAOB rules), then the Chinese auditor has to be registered with the PCAOB. It the Chinese auditor cannot register, the home country auditor might not be able to sign off on the local audit.”

“SMEs are more likely to have trouble with the ‘substantial role’ rule than MNCs, since MNCs have such widespread operations and often no single country’s operations account for 20 percent of assets or revenues,” Gillis added. “For unlisted companies or companies listed outside the U.S., these proceedings affect possible IPO prospects. But this is mostly an issue for the big boys.”

Portions of this article came from the January/February 2013 issue of China Briefing Magazine titled, “Annual Compliance, License Renewals & Audit Procedures.” In this issue of China Briefing Magazine, we discuss annual compliance requirements for China foreign-invested entities and detail the full audit processes for representative offices, wholly foreign owned enterprises, and joint ventures in China. We also discuss IIT liability for expatriates in China, IIT rates and calculation methods, permissible tax deductions, and how working for a permanent establishment can change tax liabilities.

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