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When in China do as the Chinese do?

Chinese Securities Regulator Agrees to Cooperate with the U.S. SEC? – OR NOT

The U.S. SEC has long sought the cooperation of the China Securities Regulatory Commission (CSRC) in the SEC’s investigation of U.S. audit firms with Chinese clients charged with improper accounting and financial reporting practices.

Last week, China's securities watchdog said it is ready to turn over audit documents of a Chinese company listed in the United States to U.S. regulators, signaling the latest breakthrough in a two-year international dispute over accounting scandals.

The U.S. Securities and Exchange Commission has been struggling to obtain papers from China to investigate possible accounting fraud at dozens of Chinese companies listed on U.S. stock exchanges. China has resisted for years turning over documents because of state-secrets and sovereignty concerns.

The CSRC is now ready to transfer audit papers to the SEC, and the Public Company Accounting Oversight Board (PCAOB), a CSRC spokesman said. He did not identify the company in question, or say when the handover will take place.

Optimists suggest that the gesture reflects China's willingness to improve co-operation with U.S. regulators, coinciding with high-level bilateral economic talks in Washington. It could also help restore confidence in China-based companies listed on U.S. exchanges and make it easier for firms in China to start tapping American capital markets again.

"If the SEC and CSRC are indeed singing from the same songbook on this and have found a way to resolve their stand-off over Chinese audit work papers, the capital markets will be safer for investors and a new era of cross-border comity between the world's leading economies may have dawned," said William McGovern, a partner at Kobre & Kim law firm in Hong Kong.

My take on the shifting of CSRC’s position that the information is tantamount to state secrets is China is playing the game it plays so well. That is, promise to do something to achieve a desired goal, delay releasing the sensitive financial information after getting what it wants, and then making excuses for the delay.

The reason I take this position is giving the SEC direct access to documents would allow much broader investigations of accounting frauds. China doesn’t want this because the government is the main stockholder in many state-owned enterprises and, even in private concerns, it weald’s a great deal of power and influence over decisions made by top management.

Should the SEC accept the reluctance of CSRC to release audit information? After all, the old adage “When in Rome, do as the Romans do” can be said to apply to all business operations in China including audit work product. It is true that cultural factors influence business and regulatory practice and China is known for its secrecy in all matters of state – and then some.

However, the fact is the practice of some Chinese companies and the government’s response to SEC requests for information, has been harmful to the U.S. stock exchanges. The U.S. capital markets all but shut down to China-based companies after investors lost billions of dollars to alleged accounting frauds in China since 2010.

Scores of China-based companies have already been delisted from U.S. exchanges and new listings have slowed to a trickle.

The spotlight has also been thrown on the world's top five accounting firms, which audited the financial statements of the U.S.-listed Chinese companies.

In December, the SEC charged the Chinese affiliates of accounting firms Deloitte, KPMG, PricewaterhouseCoopers, BDO and Ernst & Young with securities violations for refusing to produce documents. The firms said they could be prosecuted for violating state-secrets law if they released the papers.

The CSRC spokesman said that after papers are handed to U.S. regulators, there would be no legal basis to prosecute the accounting firms. Somehow I think that decision is up to the U.S. SEC, not the CSRC. China should stay out of our regulatory practices just as they want U.S. regulators to stay out of its government practices.

China is a partner in business regulation with U.S. regulators and other matters only when it suits its needs. China practices what I call “peekaboo” cooperation. It bobs and weaves and does the Texas Two-Step as if it was part of its collective DNA.

Blog posted by Steven Mintz, aka Ethics Sage, on July 25, 2013