Auditors and Regulators

American regulators regularly inspect American auditors—particularly the Big Four accounting firms, Ernst & Young, Deloitte & Touche, KPMG, and PricewaterhouseCoopers—in order to give confidence to investors and the market at large that the auditors are giving accurate and balanced reports on balanced and accurate audits of the companies they audit.

Inspecting the auditors in the People’s Republic of China is a different matter.

Big Four accounting firms use their Chinese and Hong Kong affiliates to do significant work on the yearly audits of dozens of US companies doing business in China, including Walmart, Pfizer, and 3M, according to regulatory disclosures the auditors recently made for the first time.

Those “affiliates” actually are separate entities, and the PRC won’t allow those auditors to be checked up on by our regulators.  That’s a problem, as The Wall Street Journal put it:

The arrangement could leave investors in some of the world’s largest multinationals feeling like they can’t have full confidence that the auditors who scrutinize the companies’ finances have themselves been fully vetted by US regulators. And the regulators have no way of knowing whether those companies’ tens of billions of dollars of Chinese business has been subjected to outside scrutiny to help prevent errors or fraud.

It’s not small potatoes, either.

Walmart, which has more than 400 stores in China, is primarily audited by the US arm of Ernst & Young, but Ernst & Young’s Chinese affiliate did 10% to 20% of the work on the company’s latest audit, according to an EY filing with regulators. Pfizer, which got 7% of 2017 revenue from China, is primarily audited by KPMGs US firm, but KPMG China did 5% to 10% of the work.

Obviously, the PRC’s block needs to be an item of “discussion” in trade talks between the US and the PRC.  In the interim, the regulators should think—hard—about requiring companies doing business in the PRC that are audited, at least in part, by PRC auditors to report the details of those PRC auditors’ audits.  That way investors and the market at large could have some idea, at least, of the quality of the books of those American companies’ PRC branches.

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