Trump’s China Financial Decoupling Move Has Roots in Enron Saga
Rising tensions between Washington and Beijing have prompted some White House officials to fixate on a provocative question with big implications for global markets: Why can Chinese companies sell shares in the U.S. when American regulators are barred from inspecting their books?
At issue is China’s longstanding refusal to allow the Public Company Accounting Oversight Board to examine audits of firms whose shares trade on the New York Stock Exchange, Nasdaq and other U.S. platforms. Alibaba Group Holding Ltd. and Baidu Inc. are among Chinese companies that have raised billions of dollars in the U.S. while avoiding PCAOB scrutiny, something the two countries have fought over for more than a decade.
The regulatory kerfuffle has become a focus for some White House officials who’ve also urged President Donald Trump to take a hard line in trade talks with China, according to people familiar with the matter who requested anonymity in discussing internal talks. They see forcing compliance as a potentially strong weapon in curbing capital flows to China and preventing Chinese companies with questionable financials from listing in the U.S.
White House officials are also emphasizing that any effort to limit investment flows into China or Chinese companies is separate from the ongoing trade negotiations.
Larry Kudlow, director of the White House’s National Economic Council, said the audit issue is being reviewed as part of a broader look into rising U.S. investment in Chinese firms.
“What we’re looking at is U.S. investor protections, transparency and compliance with a number of laws,” Kudlow told reporters Monday. “We’ve opened up a study group to take a look at it, but we’re very early in our deliberations.”
Kudlow said delisting companies isn’t on the table. Still, any crackdown that makes it harder for U.S. investors to buy Chinese shares could face stiff opposition from a powerful coalition including exchange operators, Wall Street banks and firms with affiliates in China. Another major hurdle is that accounting firms operating in China have said they are barred from sharing information with foreign entities.
The issue came up last month in a meeting in Washington between the PCAOB and Chinese securities regulators, according to people familiar with the matter. The talks included Liza McAndrew Moberg, who runs the PCAOB’s international affairs office, and Fang Xinghai, vice chairman of the China Securities Regulatory Commission.
The CSRC didn’t respond to a fax seeking comment.
White House adviser Peter Navarro, one of Trump’s most hawkish aides on trade with China, is among those calling for the U.S. to take a tougher tack. In a Sept. 30 interview with CNBC, Navarro said denying PCAOB inspectors access to Chinese audits is putting U.S. investors at risk.
“There are some significant issues related to Chinese stocks listed on public exchanges,” he said. “Fraud is ubiquitous, there’s issues related to fake receipts, fake invoices -- hardest stuff is fake cash balances because it’s very hard for auditors to penetrate that wall. This raises real issues that then go down the line.”
Navarro’s comments left unclear how far the Trump administration is willing to go in addressing the conflict. He made reference to legislation introduced by Senator Marco Rubio that would kick companies off U.S. exchanges if they refuse to share their audits, but didn’t say whether the White House backs the idea.
Though little-known outside of Washington, the PCAOB is a relic of one of the most high-profile corporate scandals: Enron Corp.’s massive accounting fraud. It was created in 2002 as a nonprofit corporation overseen by the Securities and Exchange Commission to inspect audits with the aim of preventing malfeasance that could wipe out shareholders.
While it isn’t a government agency, the PCAOB can move to bar firms that violate its rules from auditing companies that trade on U.S. exchanges. And the SEC, the nation’s main market regulator, can force the delisting of companies that aren’t audited by PCAOB-registered firms. Such strong actions are rarely taken because of the potential economic and political ramifications.
U.S.-China Trade Talks
Senior Chinese officials, led by Vice Premier Liu He, resumed talks in Washington this week with U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin. As the negotiations continued Friday it was unclear whether the PCAOB’s concerns were discussed, but people close to internal White House discussions have said the oversight issues have become part of the broader economic agenda with China.
The two countries have been negotiating on audit inspections for years, most recently in the context of bilateral investment treaty talks that broke down at the end of the Obama administration, according to people familiar with the negotiations.
“It’s a fact that listed Chinese companies are receiving, in effect, preferential treatment over their American corporate counterparts, which simply isn’t acceptable,” said Roger Robinson, former chairman of the congressional U.S.-China Economic and Security Review Commission.
The fight over PCAOB inspections is “just getting caught up in the politics looking for leverage,” said Stephen Myrow, a former Treasury Department official who’s now managing partner of Beacon Policy Advisors LLC in Washington “There have been real discussions about it, but I don’t think it’s ready for prime time. I don’t think it ever will be.”
The conflict over public company audits first attracted attention about a decade ago when Chinese companies were being accused of acquiring dormant U.S.-listed companies as a back-door way to access markets without the usual regulatory scrutiny. Efforts to resolve differences have faltered as China’s accounting firms, including affiliates of giants like Deloitte, Ernst & Young, PwC and KPMG, insist that Chinese law bars them from sharing information on grounds that it might contain state secrets.
Chris Iacovella, who represents regional brokerages as head of the American Securities Association, called Friday for “changes to protect investors and level the playing field for American companies competing for the same capital.”
In December, SEC Chairman Jay Clayton and PCAOB Chairman William Duhnke said in a joint statement that U.S. regulators “currently face significant challenges” in overseeing the financial reporting for listed companies based in China. They said that among auditors of 224 companies with total market capitalization of $1.8 trillion that pose “obstacles” for U.S. inspectors, 213 are in China or Hong Kong. The other 11 were in Belgium.
“We remain interested in establishing a cooperative relationship with China,” Duhnke said in a statement. “Such a relationship, however, must begin with our core principles: the ability to regularly conduct inspections and investigations; the ability to select the specific engagements and potential violations to be examined; and access to firm personnel, audit work papers and other information or documents deemed relevant by our teams.”
Natalie Strom, a spokeswoman for Clayton, declined to comment on any actions the SEC is considering or conversations with Chinese regulators. “We have undertaken a number of initiatives to ensure that our investors understand that investing in these various types of companies involves different risks,” she said, in part referring to the December statement.
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