China called out in U.S. audit warning over emerging market investing

When it comes to companies exposed to emerging markets — most notably China — investors should beware the lack of visibility into their books, U.S. Securities and Exchange Commission Chairman Jay Clayton said Tuesday.

Foreign jurisdictions aren’t maintaining adequate standards of investor protection, and the U.S. has little control over that, Clayton (pictured) and other officials said in a strongly worded statement. The group also underlined a longstanding point of conflict: that the main U.S. accounting watchdog can’t inspect the work that Chinese auditors do for companies that sell stock in American markets.

“In many emerging markets, including China, there is substantially greater risk that disclosures will be incomplete or misleading” and substantially less access to recourse in the event of investor harm, said the statement from four SEC officials and William Duhnke, chairman of the Public Company Accounting Oversight Board.

Zach Gibson/Bloomberg

The issue over inspections of Chinese accounting firms dates back more than a decade and has always been a point of tension between the two countries. While U.S. regulators can access work papers underlying audits in most countries, China’s prohibition hampers their ability to conduct investigations and inspections designed to catch mistakes or malfeasance by auditors.

In December 2018, Clayton and Duhnke issued a joint statement saying that U.S. regulators “currently face significant challenges” in overseeing the financial reporting for listed companies based in China. They said that among auditors of 224 companies with total market capitalization of $1.8 trillion that posed obstacles for U.S. inspectors, 213 were in China or Hong Kong.

Tensions with China have been rising as Republicans, under pressure as critics assail President Donald Trump’s handling of the coronavirus crisis, accuse the Asian nation of failing to give sufficient warning about the pandemic and offering misleading information about its severity.

Though the auditing issue hasn’t always been on the front burner, companies like Alibaba Group Holding Ltd. and Baidu Inc. have raised billions of dollars in the U.S. while avoiding regulatory scrutiny. Nasdaq earlier this month halted trading in Luckin Coffee Inc., a Chinese chain enmeshed in an accounting scandal, and said the shares will remain frozen until the company satisfies requests for information.

In their Tuesday statement, the U.S. regulators said investors should especially consider the potential effects of the PCAOB’s blind spot in China.

“Even when the auditor signing the audit report is not based in China, if the company has operations in China, investors should consider whether significant portions of the audit may have been performed by firms in China,” the group said.

The PCAOB keeps a list of companies whose auditors it can’t inspect on its website.