U.S. Regulators Warn on China

U.S. securities and audit regulators have issued an extraordinary warning that they are not getting the cooperation that they want from their Chinese counterparts, and that U.S.-listed companies with significant operations in China should prepare for more strained relations between U.S. and Chinese securities regulators.

The message came in two parts: first, in a special statement released on Friday by SEC chairman Jay Clayton, PCAOB chairman William Duhnke, and SEC chief accounting Wesley Bricker that faulted China’s reluctance to allow the PCAOB to inspect the work of audit firms working in China. Then they followed up with spoken comments on Monday at the annual AICPA public company conference happening in Washington this week.

“If significant information barriers persist, remedial actions involving U.S.-listed companies may be necessary or appropriate,” the trio said in their prepared statement. Those remedial actions could be anything from requiring those companies to make additional disclosures, restricting their ability to issue new securities offerings, or even forcing the companies off U.S. stock exchanges altogether.

If significant information barriers persist, remedial actions involving U.S.-listed companies may be necessary or appropriate.

Foremost, the agencies are aiming at Chinese companies that slipped onto U.S. markets through reverse mergers with U.S.-listed shell companies in the 2000s. Those companies offer shares to U.S. investors, but the bulk of their operations are in China and they’re audited by Chinese audit firms. The PCAOB can’t inspect the work of those Chinese audit firms because China severely restricts access — so U.S. investors are really at the mercy of Chinese regulators for investor protection. Which isn’t assuring, given how cozy and corrupt Chinese business and government are.

Or, as the U.S. regulators put it in their carefully couched statement:

[I]n the case of public companies that have substantial operations in jurisdictions other than the listing jurisdiction, for many important reasons, including legal requirements, investor expectations and the inefficiencies and ineffectiveness of a country-specific, silo approach, deference is not appropriate. Primary financial regulators must be able to supervise the entities and persons registered with them to the extent reasonably necessary to ensure compliance with the financial disclosure and other key securities laws in their jurisdiction.

Now It Gets Complicated

Unto itself, this statement griping about Chinese regulators doesn’t mean much for corporate risk and compliance officers as a whole. Unfortunately, however, you cannot take this statement unto itself — because it arrives amid a flurry of other U.S.-China tensions, and altogether, those tensions are something you need to consider.

For example, the SEC’s statement arrived one week after Canadian authorities arrested the CFO of Huawei Technologies, at the request of U.S. law enforcement who suspect Huawei is involved in suspicious transactions with Iran. It also lands in the middle of tense trade negotiations happening between the Trump Administration and Beijing.

All evidence suggests that the SEC and PCAOB did not time their statement to coincide with these other events. That is, their threat of pressure against U.S.-listed Chinese firms is not part of any grand Trump Administration strategy to strong-arm more trade concessions from China. The SEC and PCAOB have griped about lack of visibility into the Chinese market for years.

Still, try telling that to China. Many people there will perceive all of this as a coordinate push against their country, because that’s a plausible scenario in their world. Lines between business and government are blurry; political, legal, and regulatory instruments are all things that Beijing might manipulate to pursue its interests. So of course the Americans must be doing this all at once, with the ultimate objective of humiliating China on trade negotiations. That’s what China would do.

How will China respond? That remains to be seen. But if I were a U.S. company with significant exposure to Chinese regulators, or that has lots of senior U.S. executives visiting China regularly, I’d be thinking long and hard to answer that question.