For the first time, PCAOB flexes its enforcement muscles in China and Hong Kong
The Public Company Accounting Oversight Board (PCAOB) is the independent regulatory agency established by Congress to oversee the audits of public companies and broker dealers. The PCAOB had long been frustrated in its attempts to inspect and investigate audit firms located in the People’s Republic of China (PRC), including the Hong Kong Special Administrative Region of the PRC. That began to change in late 2022 when the PCAOB announced that it had received unfettered access to inspect and investigate audit firms in the PRC.
Armed with that access, the PCAOB, on November 30, 2023 – for the first time in its history – announced several enforcement actions against China-based registered auditing firms and their personnel, imposing $7.9 million in total fines.
Historically, the PCAOB’s attempts to conduct unfettered inspections or investigations of PCAOB-registered PRC-based auditing firms was frustrated by positions taken by Chinese authorities, such as assertion of “state secrets” laws and protections over certain materials. To address these obstacles and to put the PCAOB on the same footing with respect to inspections and investigations of PCAOB-registered firms in other foreign jurisdictions, in 2020 Congress passed the Holding Foreign Companies Accountable Act of 2020 (HFCAA) which, among other things, granted the Securities and Exchange Commission (SEC) authority to delist companies from US securities exchanges if their accounting firms could not, as a result of local laws or otherwise, be inspected by the PCAOB for three consecutive years.
Thanks to the legislative pressure applied through the adoption of the HFCCA, the PCAOB, on December 15, 2022, announced that, in a historic first, it had been granted complete and unfettered access to inspect and investigate audit firms in the PRC. Following this agreement between the PCAOB and PRC authorities, the PCAOB launched inspections of several PRC- and Hong Kong-based registered accounting firms in early 2023.
In this latest development, the PCAOB issued two enforcement actions imposing a total of $7 million in penalties against two global network firms, one Shanghai-based affiliate ($3 million fine) and the other a Hong Kong-based affiliate ($4 million fine). The orders allege each firm violated PCAOB quality control standards related to integrity and personnel management. Both firms allegedly failed to detect or prevent extensive, improper answer sharing on tests for mandatory internal training courses related to the firms’ US auditing curriculum.
A third mainland China-based registered public accounting firm was sanctioned $750,000 for issuing an audit report that allegedly falsely stated that the firm’s audits of the 2015-2017 financial statements of a single issuer had been performed in accordance with PCAOB standards and that the firm was independent of the issuer, when it was not. The PCAOB’s order also imposed immediate practice limitations (including prohibitions on accepting new PCAOB audit clients), and an independent monitor to improve practices and ensure compliance with PCAOB standards and rules. In addition, the PCAOB sanctioned and fined four of the firm’s associated persons for alleged violations that included issuing a false audit report, failing to maintain independence from their issuer client, and improperly adopting the work of another accounting firm as their own. The PCOAB assessed a total of $190,000 in fines against these four individuals.
The total fines against these three firms represent the highest civil money penalties the PCAOB has ever imposed against firms in mainland China and Hong Kong, as well as some of the highest penalties it has ever imposed against any firm. Before November 30, the highest penalty imposed against a China-based firm was $50,000.
In announcing these historic enforcement actions, PCAOB Chair Erica Williams stated that the “days of China-based firms evading accountability are over.” She also thanked “the U.S. Congress for its leadership in passing the Holding Foreign Companies Accountable Act, which created the leverage for the PCAOB to secure the historic access which made these enforcement actions possible.”
In a separate statement on the recent enforcement actions, Chair Williams was quick to note that the PCAOB is “just getting started.” She announced that the inspections teams have completed fieldwork for 2023, with the unfettered access required under the HFCAA, and plans to begin 2024 inspections are underway.
The firms inspected by the PCAOB in 2022 and 2023 audited 99 percent of the total market cap of US-listed companies audited by Hong Kong and mainland China firms, and the PCAOB is on track to inspect firms that audited 100 percent of the total market cap by the end of 2024.
Chair Williams also noted that “should authorities in the People’s Republic of China obstruct the PCAOB’s access – in any way and at any point – the Board will act immediately to consider the need to issue a new determination.”
These historic PCAOB enforcement actions demonstrate the global reach of the PCAOB’s inspection and enforcement programs. The PCOAB’s aggressive inspection agenda in the PRC will likely result in additional enforcement activity in 2024.
PCAOB-registered PRC-based auditing firms should prepare for increased inspection and enforcement scrutiny. Further, those firms should ensure they are appropriately advised on how they can cooperate with the PCAOB without risking running afoul of PRC law.
If you have any questions regarding the PCAOB’s announcement or the impact on your business or auditor relationship, please contact any of the authors or your DLA Piper relationship attorney.
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