Big Four Audit Independence and Oversight in China
Du, Ning, Stevens, Kevin, The CPA Journal
China has achieved impressive economic growth over the past three decades, and the resulting investor interest has led to a surge in public offerings by Chinese companies in the United States. More than 200 Chinese companies are currently listed on U.S. exchanges; hundreds more trade on over-the-counter bulletin boards. But since the latter part of 2010, investors have lost billions of dollars due to alleged financial frauds at many publicly traded Chinese companies. The loss in market value is attributed not only to the actions of short sellers, but also to these alleged frauds.
This string of accounting scandals has, in turn, sparked deep concerns about the quality of Chinese audits. Audit firms have recently resigned at many China-based companies, citing fake bank statements, made-up invoices, and-perhaps most disturbing- intimidation of staff during the audit. As of 2012, 67 China-based issuers have had their auditor resign and 126 companies have either been delisted or have stopped filing regular reports with the SEC, according to a PCAOB report (http://pcaobus.org/News/Speech/Pages/ 09212012_FergusonCalState.aspx).
Concerns over Chinese audit quality are not limited to smaller U.S. audit firms that lack a proper quality review program and do not have staff who speak Chinese; they also apply to the Big Four audit firms. These concerns are highlighted by a recent lawsuit brought by the SEC against the Chinese affiliates of global accounting firms for failing to hand over documents from their Chinese audit clients who are under SEC investigation for potential fraud.
The Big Four Audit Model in China
Auditing Chinese firms that are preparing to go public on overseas exchanges is a lucrative business. The Chinese arms of the Big Four- Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers-dominate China's accounting industry. In 2010, the combined revenue of their audit practices (excluding consulting business) was more than $1.75 billion, according to the Chinese Institute of CPAs (CICPA; http://www.cicpa.org.cn), and they employed approximately 40,000 people (including consulting services).
Because the Chinese government does not permit foreign ownership of private firms, all of the large accounting firms use a joint venture model to do business in China. The Chinese arms of the Big Four are affiliated with the Big Four global audit networks, but they are essentially Chinese audit firms and fall under Chinese local jurisdiction. For example, Ernst & Young in China is a local joint venture, with the global brand superimposed on the local firm Hua Ming. PricewaterhouseCoopers pays a significant "rental" fee for the license of a local joint venture partner, and the firm operates as PwC Zhong Tian in China. In short, the Chinese members of the Big Four global network do not belong to the same partnership structure that U.S. investors are familiar with.
Because the firm issuing the respective audit opinion is responsible for the quality of each audit, auditors of U.S.-traded companies must follow PCAOB rules in overseeing the quality of the audit. Although the joint venture model has worked well in other countries, in China it presents a challenge for reasons including China's political system; the complex Chinese corporate structure; and the significant language barrier or unique local customs, such as paying kickbacks. These issues will only become more complicated, given that most of the joint ventures will expire in a few years when the Big Four Chinese firms have to convert to local partnerships.
In China, the Ministry of Finance (MOF) and the China Securities Regulatory Commission (CSRC) jointly oversee the activities of the accounting and auditing profession. The MOF licenses all accountants in China and oversees accounting firms that audit private companies. The CSRC, created in 1992, has jurisdiction over accounting firms (including local Big Four audit firms) that audit the public companies with securities listed on the Chinese domestic market. …