SEC cautions auditors about dangers of working with Chinese customers

The acting chief accountant at the Securities and Exchange Commission (SEC) advised U.S.-based audit firms seeking new public company clients in China to make sure they have complete access to previous audits and work papers before accepting the position. Otherwise, they run the risk of potential enforcement.

According to Paul Munter, Chinese firms should not think that switching from an auditor located in China or Hong Kong to one based in the United States will result in immediate compliance with the Holding Foreign Companies Accountable Act (HFCAA). The U.S. companies in that case must equally comprehend their obligations under the Public Company Accounting Oversight Board's requirements (PCAOB).

After three years of noncompliance, the HFCAA, which was passed into law in 2020, will delist any public business that does not adhere to U.S. audit inspection criteria. About 200 Chinese businesses that are listed on American stock exchanges have been recognized by the SEC as being at risk of delisting.

In response to this danger, some Chinese companies, such as Zai Lab and BeiGene, have hired American auditors to examine their 2022 financial statements.

"If the issuer does not authorize appropriate communications, or places significant limitations on the responses of its predecessor accounting firm, the new accounting firm may not be able to accept the engagement and be in compliance with applicable PCAOB standards," Munter warned. "The same is true if the predecessor auditor creates roadblocks and fails to engage in appropriate communications or to provide requested information, including prior work papers."

"Therefore, accepting such an engagement to serve as the retained lead auditor creates risk for the new accounting firm of potential enforcement action by the PCAOB, the commission, or both and creates potential liability for the issuer."

Prior to assuming a lead auditor position, Munter stated that audit firms had "significant requirements and responsibilities" that should be handled. These requirements, outlined in the Sarbanes-Oxley Act, call for the lead auditor to assess its capacity before accepting an engagement, to have supervisory duties with a corresponding risk of responsibility, and to keep or have access to audit material.

Concerning Chinese public businesses listed on American markets, the main point of contention is access to financial data and work documents. Access to audit reports of the nation's businesses has historically been restricted by the Chinese government due to concerns about national security. In order to enable American inspectors to examine the work of public accounting firms with headquarters in Hong Kong and mainland China, the PCAOB and Chinese authorities came to an agreement in August.

According to Munter, some issues American-based audit firms could ask clients for information on include:

• Integrity of the issuer's management;

• disagreements over accounting principles that a predecessor firm might have had with management;

• communications between the predecessor firm and the audit committee;

• understanding of the issuer's relationships and transactions with related parties and any material unusual transactions; and

• understanding of the change of auditors by the predecessor auditor.

Munter reiterated in his speech's conclusion that potential lead auditors may face "significant liability for not only the auditor and its personnel but also for the issuer" if they failed to uphold their legal or professional duties or the appropriate audit standards.

By fLEXI tEAM