Chinese Auditors on Notice as Empowered US Regulator Digs Deep

Sanctions on Chinese and Hong Kong auditors announced this week reveal just the first problems the US audit regulator is expected to uncover as it uses new access to probe the work of firms that check the books of US-listed businesses based in the two Asian markets.

The Public Company Accounting Oversight Board on Thursday announced hefty penalties against the Chinese and Hong Kong affiliates of Big Four auditor PwC and a third Chinese auditor—its first set of sanctions under a historic deal with Beijing signed last year. Among the findings, the board said that Shandong Haoxin Certified Public Accountants Co., Ltd., audited three years of financial statements for a data analysis software company in a single day.

“In all likelihood, this is the tip of the iceberg,” said Jacob Frenkel, chair of the government investigations and securities enforcement practice at Dickinson Wright PLLC.

Risky Market

The vast Chinese economy is a lucrative market for both US investors and global audit firms. More than 200 Chinese-based companies worth roughly $1 trillion are listed on US exchanges. The market comes with major risks including that companies might inflate their sales, obscuring their true profitability and value.

Accounting analyst Ron Kiima said he wasn’t surprised to learn of audit failures involving a Chinese accounting firm. Still he called Haoxin’s work for its client Gridsum Holding Inc., “jaw-dropping.”

“As many crazy things that I’ve seen out of China, that has got to be contender for the pole position of the worst,” Kiima said.

Haoxin said in a statement that the firm cooperated with the board’s investigation “to the full extent we were allowed under Chinese regulation.” The firm said it would continue to provide “high-quality professional audit services” to Chinese companies looking to go public in the US market.

In addition to fining Haoxin, the board also sanctioned PwC China and Hong Kong, reaching a combined $7 million settlement with the two Big Four affiliates for widespread cheating on internal training assessments—misconduct discovered during an inspection of the Hong Kong organization.

The sanctions against Chinese and Hong Kong firms represent a significant milestone for a regulator that has been trying to oversee the work of auditors in the pair of jurisdictions for over a decade without success.

“This is a beachhead case for the PCAOB,” said Stephen Crimmins, partner at Davis Wright Tremaine LLP and a former SEC enforcement attorney. “This is the moment they’ve been waiting for.”

New Oversight Access

PCAOB Chair Erica Williams told reporters Thursday that the regulator would not have been able to hold Hoaxin accountable for what the board called a “false audit report” without a 2020 law that threatened to delist Chinese stocks from American exchanges unless they hired an auditor routinely inspected by the PCAOB.

The law, which Congress later toughened, brought the Chinese government to the negotiating table with the US audit board, ultimately resulting in an August 2022 deal that opened up internal work papers and staff to PCAOB scrutiny.

Soon after the agreement was signed, the board launched its inaugural inspections of a pair of Big Four affiliates based in Hong Kong and China. Sixteen months later, the board announced the trio of enforcement settlements—a lightning-fast turnaround for an agency that typically takes years to investigate and discipline auditors.

Cracking down on Chinese stocks that for years avoided US securities laws had bipartisan backing on Capitol Hill. And in July House lawmakers introduced legislation that would further tighten what is known as the Holding Foreign Companies Accountable Act.

The board’s announcement of enforcement actions “confirms what we long expected: not all companies are playing by the rules. This historic move both holds accountable bad actors attempting to take advantage of our markets and protects American investors,” Sen. Chris Van Hollen, a Maryland Democrat, said in a statement.

But audit watchers are skeptical that Chinese regulators will continue allowing American inspectors to probe the work of auditors and risk more bad headlines.

“I don’t see anything changing. The only thing that’s changed is the Chinese allowing them to come in and do these sample audits at this point, these inspections,” Kiima said. “But how long will that even last? Because the Chinese don’t take well to being embarrassed. They don’t like losing face.”

Bread and Butter

Routine reviews of auditors’ work have long served as the backbone of the PCAOB’s oversight of the audit industry. Congress gave the board that authority along with the power to police its rules when it created the board in 2002 after accounting scandals brought down Enron Corp. and WorldCom Inc.

Ethics charges involving the two PwC affiliates, meanwhile, reflect a more bread-and-butter type of enforcement case. The Asian affiliates are just the latest firms around the world where overseers have found widespread cheating on training examinations.

“That may sound technical but it’s something that really goes to the core of what the PCAOB does,” Crimmins said. “It also goes to the integrity of the process which is very, very important.”

Firms, however, are still learning what the PCAOB expects of them, said Rob Pawlewicz, assistant professor of accounting at the University of Richmond. He cautioned that changes will take time.

“It’s still really early. But I think the hope is that we may export some audit quality to those Chinese firms,” he said. “It’s not going to happen overnight and it’s probably going to be kind of messy and painful along the way.”