While much of the focus on the ongoing controversy over the audits of Chinese companies listed on U.S. exchanges has focused on the ability of the Public Company Accounting Oversight Board to access the workpapers of Chinese auditors, many of those Chinese companies have elected to use U.S.-based accounting firms as their lead or primary auditor. In some cases, the U.S.-based accounting firms have already or will begin working with affiliated entities in these foreign jurisdictions, and in other cases they have or will begin to contract with another independent accounting firm or individual accountants located in China or Hong Kong to assist the U.S.-based accounting firm perform portions of the audit work under the lead auditor's management and supervision.
For those accounting firms that have or are considering undertaking these engagements, it is important to keep in mind the related risks in order to best consider how to mitigate them. The acting chief accountant of the Securities and Exchange Commission, Paul Munter, has issued a statement directed at those newly engaged lead audit firms located outside of China and Hong Kong for issuer audits of companies based in China or Hong Kong or those considering such engagements to address the special challenges regarding whether such U.S.-based audit firms will be able to satisfy their responsibilities as lead auditor and perform high-quality audits where the issuer is located.
Under either of the alternative audit engagement structures described, to comply with the Sarbanes-Oxley Act and the Holding Foreign Companies Accountable Act and applicable auditing standards, the SEC has made clear that, "Both place a responsibility on the lead auditor to determine whether it can serve as lead auditor and fulfill those responsibilities prior to accepting the engagement, both place significant supervisory responsibilities, and the associated potential for liability, on the lead auditor that the issuer engages; and both require that audit documentation must be retained by or be accessible to the retained lead auditor's office that is issuing the audit report and must support the work performed by any other auditors involved, including auditors associated with other offices of the lead accounting firm, affiliated firms, or non-affiliates firms.
This recent statement from Munter should resonate with those accounting firms that audit issuer clients generally, but specifically if they are looking to expand their services to perform them for China-based issuer clients. Based upon the 2022 enforcement actions to date and before any PCAOB inspections were conducted in China or Hong Kong, the board has sanctioned various accounting firms, engagement partners, and engagement quality review partners for:
- Their failure to make timely and accurate Form AP reporting to disclose the participation of some "other accounting firm" if that firm incurs more than 5% of the total audit hours;
- Use of unregistered firms (including unregistered foreign firms or affiliates) that performed material services — services for which the engagement hours or fees constitute 20% or more of the total engagement hours or fees;
- Failure to reasonably plan the audit and supervise the audit work performed; and,
- Related quality control deficiencies.
PCAOB Chair Erica Williams has confirmed the board's commitment to continue to actively pursue enforcement efforts, stating, "Regarding the enforcement, those who break the rules should know that the PCAOB means business. Since January, the enforcement team has doubled our average penalty against individuals and increased the average penalty against firms by more than 65% compared to the last five years."
On Aug. 26, 2022, the PCAOB announced that it had signed a Statement of Protocol with the China Securities Regulatory Commission and the Ministry of Finance of the People's Republic of China, which grants the PCAOB complete access to the audit work papers, audit personnel, and other information and records needed to inspect and investigate any firms the PCAOB selects. The board began its inspections in September 2022 in Hong Kong offices of selected Chinese companies' audit firms.
In the coming months, we can expect to learn about whether China is in fact abiding by the agreement and no longer obstructing the PCAOB's efforts and the bases for determining whether any ongoing lack of cooperation in fact exists. As of mid-November, it was
As the PCAOB's inspections progress, it is likely we will see more enforcement actions related to the same violations seen in 2022 before these inspections took place related to use of unregistered firms, failure to supervise and plan the audit, and incomplete or untimely completion of related disclosure forms. We may also see more areas of risk related to privacy and data security issues and transfer of data between and among foreign countries.
Next steps for firms
To mitigate the risks to accounting firms that audit U.S.-listed foreign companies generally, there are several important considerations going forward, many of which should be undertaken before accepting any engagement. Here are some examples:
- Whether your firm can act as lead auditor on the engagement pursuant to the relevant rules, including planning the audit such that the lead auditor is performing the appropriate proportion of the audit hours and fees for the engagement and has the ability to meaningfully and properly supervise the work to be performed regardless of where that work will be done.
- If you are working with another accounting firm or individual accountants, consider what reporting or disclosure requirements may exist and whether the firm has complied with them.
- Whether you will have sufficient access to the predecessor's accounting firm to evaluate meaningfully their work papers and conduct inquiries without limitations.
- Whether there are privacy and data security laws that may limit or impact the access and use of information and work product, including the laws of foreign countries and the nature of the data that will be received or used during the audit work and thereafter.
- Challenges that may be impacted by effective communication, language barriers, local law, and business practices of foreign-based companies and how best to address them.
- Whether each member of the audit team and the audit team of any other participating accounting firm has the appropriate level of skill, knowledge, and training to perform the portion of the audit assigned.
- Whether there is sufficient time and dedicated professionals to execute the audit.
- Whether there were any past inspection findings that need to be addressed and, if so, how to confirm any required remedial actions that have in fact been designed, implemented, and are effectively working.
While there are many more important considerations for each accounting firm, the message here is that there should be a comprehensive discussion and meaningful evaluation by the accounting firm's decision-makers of whether to accept any new engagement and/or continue with an ongoing engagement, especially for U.S.-based accounting firms looking to expand their services into foreign countries and territories like China and Hong Kong, which appear to have the full attention of the SEC and PCAOB.
