U.S.-China stock cooperation moves ahead with fines on two PwC China affiliates

The U.S. securities regulator’s accounting arm fined PwC’s Hong Kong and Shanghai units $7 million after hundreds of their workers cheated on online training tests

Key Takeaways:

• The accounting arm of the U.S. securities regulator has collectively fined two Chinese affiliates of PwC and a third company nearly $8 million for improper behavior
• The actions show the U.S. is satisfied with access it is receiving to China-based companies under a year-old cooperative arrangement with the Chinese securities regulator   

By Doug Young

As one of my brother’s elementary school teachers used to say, “Cheaters never prosper.”

The Hong Kong and Chinese affiliates of global accounting giant PricewaterhouseCoopers are discovering that lesson the hard way, after they were collectively fined $7 million for cheating on online training tests by the accounting arm of the U.S. Securities and Exchange Commission (SEC). In the same announcement of the fines, the SEC’s Public Company Accounting Oversight Board (PCAOB) also said it fined Mainland China-based accounting firm Haoxin nearly $1 million for failing to maintain its independence from one of the U.S.-listed companies it audited.

The fines are some of the largest ever handed out by the PCAOB, in the latest step by the SEC to hold U.S.-listed Chinese firms to the same standards as all other U.S.-listed companies. The regulator had previously threatened to delist all U.S.-listed Chinese companies unless it could get access to their China-based audit papers, and resolved the issue last year by signing a landmark information-sharing agreement with China’s securities regulator.

We’ll review the latest penalties in more detail shortly. But first we’ll look at some broader updates on the U.S.-China information-sharing deal contained in the PCAOB’s latest statement released last Thursday.

The agency revealed that it has been busy conducting more inspections this year since making its first round of inspections in Hong Kong in late 2022. It said it has now inspected 99% of U.S.-listed Chinese companies, based on the market value of the more than 200 such companies. It added it expects to finish inspections of 100% of those companies by the end of next year.

Here, we should note that most of the Chinese companies now listed in the U.S. are quite small, and that the 30 or 40 largest of those could easily account for 99% of the group’s total market cap. So, the PCAOB could be quite busy next year as it tries to inspect many of the smaller companies that could be more problematic than big names like e-commerce giants Alibaba (BABA.US; 9988.HK) and JD.com (JD.US; 9618.HK), which are each worth tens of billions of dollars or more.

The biggest takeaway from the latest announcement is that the SEC remains satisfied with its information-sharing agreement with the China Securities Regulatory Commission (CSRC), meaning a major regulatory obstacle that threatened to boot all Chinese companies from Wall Street has been removed, at least for now.

At the same time, a separate registration-based system rolled out by the CSRC this year for all Mainland-based companies seeking to list abroad is also up and running, removing another major regulatory obstacle. The CSRC reviewed 12 company applications in November, and 16 in October, showing it’s doing its part to keep the train moving for Chinese companies aiming to list overseas, mostly in Hong Kong and the U.S.

The list of approved companies is mostly small names. But it notably includes at least one major company, Geely-backed electric vehicle Zeekr, whose listing could raise up to $1 billion, showing that major U.S. listings by Chinese companies could finally make a comeback in 2024.

Uncooperative markets

Now, the markets just need to cooperate. The last two years have been dismal ones for Chinese IPOs in New York, at first due to the two regulatory obstacles we’ve already mentioned. But now it’s weak investor sentiment that’s holding things up. That might be more difficult to fix, since China’s economy has slowed sharply in the last two years after several decades of explosive growth.

Still, export-oriented companies should be less affected by that slowdown. So should companies that are relatively recession-proof, such as lower-end restaurants and sellers of low-cost everyday products that people will always need. Areas promoted by Beijing, such as artificial intelligence (AI) and autonomous driving, could also do well and file for IPOs.

Despite the broadly positive signs that the regulatory obstacles have been cleared, investors barely registered any reaction to the latest PCAOB announcement. The iShares MSCI China ETF (MCHI.US) rose slightly on the day of the news, roughly in line with the broader market. But the index is down more than 10% this year, in sharp contrast to a 13% gain for the S&P 500.

All that said, we’ll return to the latest fines on the PwC Hong Kong and Shanghai affiliates and on Haoxin. The two PwC units were collectively fined $7 million, including $4 million against the Hong Kong unit and $3 million against the Shanghai one. The PCAOB said that between 2018 and 2020, more than 1,000 people from the Hong Kong unit and hundreds from the Shanghai one engaged in “improper answer sharing” in connection with online training tests.

Meantime, Haoxin was slapped with $940,000 in fines in relation to work it did for a company called Gridsum, which was privatized in 2021. The PCAOB found that Haoxin failed to maintain its independence from a client. “Before even being engaged as Gridsum’s external auditor, the firm told the company that it was prepared to issue a clean audit opinion on three years’ worth of financial statements,” the PCAOB said. In addition to the fines, Haoxin has been banned from accepting new clients seeking U.S. listings, and was also ordered to retain an independent monitor at its own expense.

This isn’t the first time the PCAOB has found issues with Hong Kong and China-based auditors. In May, the agency said it found major problems with some of the independent audit work performed for U.S.-listed Chinese companies by the China affiliates of PwC and also KPMG. But it also noted that such problems are relatively common for first-time inspections.

The bottom line is that this latest announcement, combined with the CSRC’s steady approval of new overseas listing applications, shows that the regulatory obstacles that put a major damper on outbound Chinese IPOs for the last two years really do appear to be largely resolved. That means we’ll probably start to see a resumption of some major IPOs in New York next year, like the one for Zeekr. But that flow is likely to remain relatively muted unless we see stronger signs of improvement for the Chinese economy.

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