By Anne Sherry, J.D.
The PCAOB determined that for the first time in its history, it has complete access to inspect and investigate audit firms headquartered in mainland China and Hong Kong. Chair Erica Y. Williams credited the Holding Foreign Companies Accountable Act of 2020 enabling unprecedented access. While both consider the determination a positive step, SEC Chair Gary Gensler said much work remains, while Commissioner Jaime Lizárraga encouraged Congress to shorten the clock for mandatory delisting from three years to two.
The PCAOB conducted thorough and systematic testing to determine that all three criteria for complete access were achieved. First, the PCAOB exercised sole discretion to select the firms, audit engagements, and potential violations it inspected and investigated, without consultation with or input from Chinese authorities. Second, PCAOB inspectors and investigators were able to view complete audit work papers without redactions. Third, the PCAOB had direct access to interview and take testimony from all personnel associated with the audits.
“I have been clear from day one, there would be no loopholes and no exceptions to our demand for complete access, and there were none,” said Williams. She added that this is only the beginning, and the Board is continuing to demand complete access in mainland China and Hong Kong. If Chinese authorities obstruct or fail to facilitate access, the PCAOB will immediately consider issuing a new determination.
PCAOB staff selected two firms for inspection. The eight engagements selected included several from categories that the PCAOB has been denied access to in the past, involving large state-owned enterprises and issuers in sensitive industries. The inspections identified numerous deficiencies, which Williams said are consistent with those encountered in other first-time inspections. While any deficiencies are troubling, the fact that they were found shows that the process worked as it should, Williams observed.
Final inspection reports will be completed and made public as soon as practicable in 2023. The PCAOB plans to resume regular inspections in early 2023.
Gensler statement. In a statement, Gensler stressed that much work needs to be done to protect investors and ensure ongoing compliance. First, Chinese authorities must allow the PCAOB complete access for inspections and investigations for three consecutive years, with the clock starting from the PCAOB’s 2022 determination. If Chinese authorities cut off access, the SEC will be required under the HFCAA to prohibit trading in the securities of issuers engaging those firms.
In addition to continued access by PCAOB staff, accounting firms in China and Hong Kong must work to strengthen audit quality. Finally, China-based issuers that access U.S. markets must provide specific, prominent disclosures about the heightened risks they face. These include disclosures under the HFCAA of governmental ownership in their companies and Chinese Communist Party representation on their boards. SEC staff have also been directed to seek enhanced disclosures from China-based issuers about their corporate structure, including whether the entity is a variable interest entity and whether it distributes cash to an offshore issuer that could be available to investors.
Lizárraga statement. Lizárraga also issued a separate statement to clarify that while the PCAOB determination is a positive development, it does not guarantee future success. Lizárraga supports an effort in Congress to shorten the three-year clock to two years. This would foster future compliance and strengthen the Commission’s ability to fulfill its mandate to ensure fair, orderly and efficient markets, the commissioner said.