PwC looks for way forward in increasingly difficult China terrain

The Big Four accounting firm was hit with a record fine for its auditing work of Evergrande, whose failure cost investors billions of dollars

Key Takeaways:

• China levied a record fine on PwC and suspended its China operations for six months as punishment for lapses in its audits of failed developer Evergrande
• Beijing is increasingly encouraging state-run companies to avoid big foreign accounting firms like PwC in favor of Chinese companies, partly due to data security concerns

By Warren Yang

PricewaterhouseCoopers (PwC) has become the latest high-profile victim of troubles spilling out of China’s property sector, receiving stiff punishment for its role as auditor of failed property giant China Evergrande Group (3333.HK). At the same time, the case underscores the perils of doing business for foreign firms in the world’s second-largest economy, as the accounting giant and its peers face growing headwinds due to Beijing’s data security concerns.

On what certainly will go down as a memorable Friday the 13th for the global accounting firm, China slapped PwC’s China affiliate with a record 441 million yuan ($62 million) fine and ordered its China operations suspended for six months over its auditing work of Evergrande.

China’s securities regulator said its investigation revealed that the Big Four firm’s PwC Zhong Tian LLP affiliate knowingly overlooked Evergrande’s fraud while auditing the developer’s key onshore unit, Hengda Real Estate, and helping it to issue bonds, according to a Reuters report. The Ministry of Finance also ordered the six-month closure of PwC Zhong Tian’s China offices.

The latest development came six months after Chinese regulators fined Evergrande’s founder, Hui Ka Yan, and cut his access to domestic financial markets for good for exaggerating the company’s revenue by more than $78 billion. He was accused of committing securities fraud as well. Evergrande itself has also been fined 4.2 billion yuan for fraudulent bond issuance and violations of disclosure rules.  

In its heyday, Evergrande led a property boom that helped to fuel China’s economic growth for more than two decades. But its demise began in 2021 and has had massive ripple effects across China’s entire real estate sector as many other developers have also defaulted on their debt. The sector’s woes are producing casualties across other industries as well, putting a dent in China’s broader economic growth with no easy fix in sight.

That’s why Chinese authorities are showing no mercy in punishing anyone involved in Evergrande’s case, living up to their promise to protect investors with “teeth and horns.” The China Securities Regulatory Commission found numerous violations of audit standards in PwC’s work for Evergrande, which was ordered by a Hong Kong court to liquidate in January.

Among other things, PwC Zhong Tian was found guilty of failing to take issue with the developer in numerous instances where it should have noticed red flags. Those included Evergrande’s dubious treatment of apartments under construction as ready to welcome buyers, and its booking of payments it received for them as revenue.

Such malpractice allowed the company to hugely inflate its revenue in 2019 and 2020, artificially propping up its Hong Kong-traded stock. The shares are now essentially worthless, costing investors billions of dollars in lost value.

Unacceptably below standards

In a statement issued last Friday, Mohamed Kande, PwC’s global chairman, said the firm is “disappointed” by the work of its Chinese unit, “which fell unacceptably below the standards we expect of member firms of the PwC network.” PwC Zhong Tian isn’t directly owned by the U.S. accounting giant, but functions like an independently owned franchisee of the brand.

PwC also took its own action, firing partners and staff involved in the audit of Hengda and starting a process to hand out financial penalties to current and former members of the leadership team responsible for the account.

“PwC China has a long history of high-quality audits and we do not believe that the behavior of a very small number of engagement team members is representative of the work of the vast majority of PwC China’s 18,000 professionals,” Kande said. “We recognize, however, that we need to take actions that continuously reinforce our values and expectations throughout the PwC network. This is a priority for all PwC leaders.”

PwC had long braced for punishment from Chinese authorities since quitting as Evergrande’s auditor in January last year. The conclusion of the case shows just how badly things can go wrong for a foreign business in China, especially when it comes under pressure to lower its standards to accommodate questionable practices by their major clients

The PwC case also shows how multinationals are coming increasingly under the microscope on government concerns about their potential to pose national security risks amid growing tensions between China and the U.S. Auditing is especially sensitive since it involves access to extensive market data that Beijing worries could be leaked to foreign governments. To avoid that, it has been urging state-owned enterprises to switch to local auditors from foreign ones like PwC. 

In this regulatory climate, foreign businesses wishing to stay in China have no choice but to walk a tightrope between keeping both their clients and the government happy. And as the Evergrande case shows, sometimes it’s not easy to do both. That can be problematic for the broader China business of a company like PwC, whose other clients have been jumping ship over concerns about the company’s future.

Big state-owned companies that take their cues from the government are especially sensitive to the situation, as reflected by PwC’s loss of Bank of China as a big client last month. The record amount of the latest fine and high-profile nature of the case sends a similar signal to other state-owned firms, making PwC’s situation in China even more precarious. 

Among other Big Four auditing firms, Deloitte last year was also fined $30 million for improperly auditing China Huarong Asset Management, which was on the brink of collapse, triggering a government bailout in 2021. Underscoring the magnitude of that scandal, two former Huarong officials were sentenced to death for taking bribes.

As to PwC, its future in China is anything but certain. For now, it appears to be committed to the country – or at least it’s trying to move on. After receiving the fine, it sent around an internal memo saying it’s making “tangible” investment to ensure that it has “long term, high quality and sustainable business” in China, according to another Reuters report.

But it’s unlikely to be business as usual for PwC in China anytime soon. The company recently halted construction of a fancy $140 million campus for training in south China’s Hainan province, and the project is under a strategic review, the Financial Times reported.

The company is obviously in damage control mode right now, which is normal after any crisis of such magnitude. But regardless of how things play out, it seems highly unlikely life will become any easier for the firm in a new Chinese climate of slower growth and increasing wariness toward big multinationals with access to large amounts of domestic data.

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This story has been corrected to show the six month suspension applies to all of PwC’s China operations