(Updates to add comments from lawyer in 10th paragraph)
July 6 (Bloomberg) -- U.S. and Chinese officials will meet next week to discuss giving American securities regulators the right to investigate companies within China for the first time, said two Chinese officials with direct knowledge of the plans.
Representatives from the Securities and Exchange Commission and the Public Company Accounting Oversight Board will meet with counterparts from the China Securities Regulatory Commission in Beijing from July 11 to 12, said the officials, who asked not to be named because the talks are private.
A joint delegation from the SEC and PCAOB will share “technical and practical information regarding audit inspection and cross-border oversight that we hope and expect should facilitate our achievement of our meaningful inspection procedure for Chinese audit firms going forward,” said Colleen Brennan, a PCAOB spokeswoman, declining to discuss the timing of any meeting. John Nester, an SEC spokesman, declined to comment.
China-Biotics Inc. and Heli Electronics Corp. are among dozens of companies traded in the U.S. that have disclosed auditor resignations or accounting irregularities this year, leading to the suspension or delisting of their shares. Some of the SEC’s previous investigations of such companies have been stalled by the inability to gather information in China.
Regulators in the Asian nation haven’t felt pressure to immediately address oversight of companies publicly traded in the U.S. because they weren’t responsible for approving the listings, one of the officials said.
The meetings next week will discuss the feasibility of U.S. regulators conducting field inspections of auditors and companies in China, the officials said. They’ll also include talks focused on companies that list in the U.S. through reverse mergers, said one of the Chinese officials.
Reverse mergers allow closely held firms to buy publicly traded shell companies, thereby gaining a stock listing without the scrutiny of an initial public offering. Chinese companies listed in the U.S. have had $4.1 billion wiped off their market value this year amid a wave of auditor resignations and fraud allegations by short-sellers including Carson Block’s Muddy Waters LLC. Auditors have cited problems ranging from forged paperwork to a suspected fake bank website.
The SEC cautioned investors last month, saying that companies gaining listings this way may be prone to “fraud and other abuses.”
PCAOB Chairman James R. Doty said in April that the inability to inspect auditors in China represents a “gaping hole in investor protection.” The board regulates and inspects registered auditors under the oversight of the SEC.
“We’re at a time where the integrity of the financial statements of so many companies has been challenged, that the natural place to look for some reassurance is the regulator with oversight responsibility,” said Jacob Frenkel, a former SEC lawyer now with Shulman Rogers Gandal Pordy & Ecker PA in Potomac, Maryland. “But if the regulator cannot oversee, that in and of itself diminishes confidence.”
Access that U.S. regulators have requested doesn’t comply with China’s existing laws, one of the Chinese officials said. The Chinese regulators were offered equal access to conduct field inspections in the U.S., according to the officials. No foreign companies are currently listed in China.
The China Securities Regulatory Commission didn’t immediately respond to faxed requests for comment.
U.S. regulators previously met with officials from the China Securities Regulatory Commission in May in Washington. Doty said at the time that those talks may lead to “something conclusive” on how the nations handle the situation.
“Both sides have agreed to accelerate efforts, including undertaking a process for negotiations and engaging in technical assistance activities, to reach a bilateral agreement,” the PCAOB’s Brennan said.
Some SEC investigations have been stalled as Chinese regulators blocked attempts to gather data even when the firms were willing to cooperate, a person with direct knowledge of the matter said in May.
The Nasdaq Stock Market has delisted companies such as China MediaExpress Holdings Inc. and China Agritech Inc. China Agritech spokesman Fan Bin said the company’s delisting hasn’t affected its business. Zheng Zhuofeng, China MediaExpress’s financial controller, wasn’t available to comment.
More than 150 Chinese companies with a market value of $12.8 billion have entered U.S. markets through reverse mergers since 2007, according to the PCAOB. During that same period, only about 50 Chinese companies filed IPOs. The Bloomberg Chinese Reverse Mergers Index, which tracks 78 shares listed in the U.S., has dropped 44 percent this year.
The accounting board last month rejected an application by Hong Kong-based Zhonglei CPA Co. to become a registered U.S. auditor, citing an inability to inspect its work for companies based in China. It was the first time the board had rejected an application since tightening rules in October.
The PCAOB issued a new policy in October making the inability to inspect auditors in nations such as China a factor when considering whether to approve them. The organization is currently blocked from inspecting firms based in China.
Most of the customers of the firms that are under investigation by the SEC are in China, not regulated by the SEC. Without the ability to subpoena information from the firms’ customers, it’s been difficult for the SEC to corroborate sales records, a person familiar with the matter said in May.
The SEC in March suspended trading of Heli Electronics after faulting the company for a lack of current and accurate information in its financial statements. MaloneBaily LLP resigned as the company’s auditor that same month after it identified irregularities with Heli Electronics’s financial statements. Calls to the company’s offices in the city of Guangzhou went unanswered.
China-Biotics said June 29 that the company intended to voluntarily delist its stock from trading on the Nasdaq exchange. BDO Ltd. resigned June 22 as the company’s auditor citing irregularities it had uncovered that likely constituted “illegal acts,” including being directed by China-Biotics staff during audit work to a suspected fake bank website. An operator who answered calls to the company’s offices in Shanghai said no one was available to comment.
--Eva Woo, Dune Lawrence. With assistance from Charles Li in Beijing, Neil Western in Hong Kong and Jesse Hamilton in Washington. Editors: John Liu, David Scheer
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