|13 June, 2019

China audit crackdown is a Wall Street nightmare

The issue has been festering since 2011, when scores of Chinese corporates trading on U.S. exchanges were accused of accounting irregularities

The Wall Street bull is seen in the financial district in New York, U.S., March 7, 2017. Image used for illustrative purpose.

The Wall Street bull is seen in the financial district in New York, U.S., March 7, 2017. Image used for illustrative purpose.

REUTERS/Brendan McDermid

HONG KONG  - A Chinese listings purge would be a nightmare on Wall Street. Marco Rubio, a Republican U.S. senator, wants to force mainland companies that have gone public in New York to submit to audit oversight - or leave. It’s a radical solution to a real problem. But torching shares valued around $1.8 trillion is a harsh price to pay for transparency.

The issue has been festering since 2011, when scores of Chinese corporates trading on U.S. exchanges were accused of accounting irregularities. One of the worst offenders was Longtop Financial Technologies, a Xiamen-based firm eventually forcibly delisted for fraud. More than $1 billion in shareholder value was erased, and a standoff followed between the U.S. Securities and Exchange Commission and auditor Deloitte Touche Tohmatsu CPA's China entity, which refused to hand over documents.

Shareholders seeking compensation found many offending companies had no assets or executives outside China. Courts there refused to enforce U.S. judgements, as they largely still do.

The scandal fizzled out, and that suited U.S. banks just fine. In 2018, 36 Chinese companies raised $9 billion in New York, generating nearly $400 million in fees for financiers, according to Dealogic, a figure which does not include revenue earned from secondary trading.

Yet of the roughly 220 foreign companies whose auditors deny access to the Public Company Accounting Oversight Board, over 200 come from China or Hong Kong. They include heavyweights like $423 billion e-commerce champion Alibaba, which generated around $2.2 billion in daily trade for the New York Stock Exchange in the first quarter of 2019.

Rubio's solution is to block IPOs by companies that lock out PCAOB officials; already-listed firms get three years to comply, or get booted out.

The trouble is this comes late; more than 100 Chinese companies have floated since the Longtop scandal. With a trade war raging, Beijing is unlikely to give ground on secrecy laws: indeed, officials want Alibaba and peers to relist closer to home anyway. That sets the stage for heavy losses if the threat is carried out; investors might even dump the stocks in advance if they fear they could become untradeable. U.S. shareholders deserve better protection against fraud, but rushing through this sweeping fix would do as much harm as good.

CONTEXT NEWS

- U.S. Republican Senator Marco Rubio introduced the EQUITABLE Act in an opinion piece titled "You Can't Trust a Chinese Audit", published in the Wall Street Journal on June 4. EQUITABLE, an acronym for Ensuring Quality Information and Transparency for Abroad-Based Listings on our Exchanges, will "delist foreign companies that do not comply with U.S. accounting and oversight regulations from American exchanges”. The act would include a grandfather provision, “to avoid sudden losses to existing shareholders”.

- The law would disqualify foreign companies seeking to list on U.S. exchanges if they use accounting firms which withhold audit reports from American regulators.

(Editing by Clara Ferreira Marques and Katrina Hamlin)

© Reuters News 2019

More From Equities