Legislation passed unanimously by the US Congress to force American audit standards on US-listed Chinese companies has a giant loophole, analysts say.
217 Chinese companies are listed on US stock exchanges with a combined market capitalization of $2.2 trillion. The Trump Administration advertised the legislation as part of its package of economic strictures against China, including tariffs on Chinese imports and “entity list” restrictions on sales of sophisticated computer chips to Huawei, ZTE and other Chinese firms.
But the final version of the Congressional bill specifies that the US Securities and Exchange Commission should refrain from de-listing Chinese companies if most of their audit work is done under US regulatory supervision. Publicly traded US companies are subject to review by the Public Company Accounting Oversight Board (PCAOB), created by the 2002 Sarbanes-Oxley Act.
According to a blog post on the website of the US law firm Skadden Arps, “The sponsors of the Act, Sen. John Kennedy, R-La., and Rep. Brad Sherman, D-Calif., entered a statement into the congressional record in order to guide interpretation of the Act. The interpretation, which is aimed at protecting U.S. companies that use foreign audit firms for part of their annual audit, clarifies congressional expectation that the SEC will not prohibit trading in the securities of companies under the Act “as long as not more than one-third of the company’s total audit is performed by a firm beyond the reach of the PCAOB inspection. The Act provides the [SEC] with the authority to determine how the size of an audit would be measured and whether you would look at total revenue, assets or some other metric.”
As Skadden observes, the Securities and Exchange Commission can interpret the one-third rule any way it pleases.
The new legislation gives American regulators enormous latitude to determine whether Chinese companies meet the one-third criteria or not. American China hawks expressed disappointment. The Wall Street Journal editors complained in a Dec. 16 leader, “The decline of Congress is a growing problem in U.S. governance, not least the degree to which it writes vague legislation that lets administrative agencies determine the actual law… So now regulators will divine Congress’s unwritten intent amid frantic corporate lobbying for dispensations.”
In the past, China has withheld audit data for state-owned companies that are listed on foreign exchanges. Last week, however, Beijing provided full audit data for seven state-owned companies listed on the Hong Kong Stock Exchange, as Asia Times reported Dec. 15. The Chinese government may ease its previous policy and allow state-owned companies to comply with Western accounting standards in order to protect the foreign listings of these companies. The measure is consistent with Beijing’s campaign for greater transparency and suppression of corruption in China’s corporate sector.