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The PCAOB’s Disappointing Deal with Chinese Regulators

Posted on by Caleb Newquist

As is its wont, the PCAOB has made a major announcement in very close proximity to a major American holiday. I've been assured in the past that this bad timing is not intentional, but from a PR perspective, it has the tendency to soften the thunder of an important message. But whatever, we'll go with it.

This time, it's the news that the Board has entered into an enforcement cooperation agreeement with Chinese regulators. They seem happy with the progress, as Chairman James Doty said, "This agreement with China is an important step toward cross-border enforcement cooperation that is necessary to protect the interests of investors in U.S. capital markets,” and also that he looks forward to "continued progress." 

That's all well and good, but everyone knows that the big one got away — the on-the-ground inspections. The New York Times, Economist, Wall Street Journal and Accounting Today all made it clear that this is gaping hole in the agreement between the PCAOB and China's Securities Regulatory Commission and Ministry of Finance, but that also said, "Hey, it's SOMETHING."

Speaking of gaping holes, that is, holes with loops, this Memorandum of Understanding ("MOU") has its share. You can read the MOU in its entirety on the next page if you're hard up for some weekend reading, but I'll just focus on one particular section that could cause a bit of a problem. It's Article III, Section (b) and it is mentioned in passing by Floyd Norris, but I'll give it the full spotlight here:

(b) A request for assistance may be denied on an exceptional basis by the Requested Party:
(i) where the request would require the Requested Party to act in a manner that would violate domestic law;
(ii) where the request is not made in accordance with the provisions of this MOU;
(iii) on grounds of public interest or essential national interest; or
(iv) where the information provided in the request is not sufficient or specific enough for the requested party to provide assistance, the requested party can deny the request or ask the requesting party to provide more information 
Now, I don't know how this will translate, but something tells me the Chinese will make use of these exceptions at some crucial point in the future. I know, I know — exceptions can't be avoided in agreements like these; there has to be a compromise of some kind. But COME ON, I mean, "on grounds of public interest or essential national interest" is just screaming, "EXPLOIT ME."
 
For its part, the Board remains optimistic. When asked about this area of the MOU, PCAOB spokesperson Colleen Brennan provided us with the following statement: “We are hopeful and fully expect the Chinese to interpret this narrowly, as they have indicated they would.” 
 
So a kinder, gentler, more transparent China? The Economist is similarly optimistic:
In the past, Chinese officials have taken a stubbornly nationalistic and unco-operative stance on paperwork that most other countries would consider to be mundane company documents. If this accounting goodwill expands, it might even lead to greater transparency and better corporate governance in China.  
Paul Gillis of the China Accounting Blog isn't convinced. He wrote us in an email that this deal is, ultimately, disappointing: 
The big problem here is that it does not allow for inspections.  Inspections are the raison d'être for the PCAOB.  I expect that a similar deal will soon be announced for the SEC that will resolve the lawsuits against the firms.  I think these agreements will make it very difficult for the PCAOB to reach a deal on inspections.  So, while the deals likely mean that Chinese companies won't be kicked off of U.S. stock exchanges, they do little to deal with the underlying accounting scandals that have plagued U.S. listed Chinese companies.
No inspections and a slew of exceptions for denying requests that are begging to cited. It's progress, I'll admit, but it's far from being a good deal for the PCAOB. 

MOU_China

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