What does the US-China Agreement on Audit Inspections mean, really?
Close-up of Chinese Yuan
A Chinese company decides to list their stock on a US exchange, NYSE or Nasdaq. Investors buy, often on the assumption that since China’s economy is growing exponentially, their stock gains will, too. If the stock price later drops, for whatever reason, class actions follow. Shareholders demand access to documents that they believe will prove their case, including auditor reports and work papers from the Company’s past financial statements.
But, these shareholders soon realize that while the Company incorporated in the US to list on the US exchange, its operations, employees, and all business documents are usually in China. The audits are performed in China, and the board meetings are held in China. And in China, the government has an entirely different and often contradictory set of laws. In fact, Chinese law dictates that documents pertaining to China’s “national interest” all belong to the state.
In my work as a securities lawyer defending US-listed, Chinese companies, one of the hottest issue is this conflict–shareholders wanting documents to prove their case, and Chinese companies claiming that Chinese law prohibits them from producing documents of national interest. The issue has been deadlocked for years until now, when US regulator Public Company Accounting Oversight Board announced a memorandum of understanding with the China Securities Regulatory Commission and the country’s Ministry of Finance that will make it easier for regulators from both countries to get access to audit information when investigating potential fraud.
So, what does this mean, really?
First, “[t]his agreement with China is an important step toward cross-border enforcement cooperation that is necessary to protect the interests of investors in U.S. capital markets,” as PCAOB Chairman James R. Doty said in a statement.
Second, and more broadly, the agreement is a rare instance of US and Chinese regulators working together. This compromise, and the process taken to reach the compromise, may serve as a model for future conflicts of laws or even political disputes.
Third, the agreement may demonstrate that the Chinese government is now willing to, or understands that it must, cede some of its sovereignty as the price of participating in global markets. Whether this is true remains to be seen–it is quite possible that shareholders attempting to enforce this agreement may encounter other obstacles that render this agreement practically useless.