US-China Deal: A Big First Step in Stock Regulation

SEC in landmark deal with China stock regulator

Nearly two years after US securities regulators first held breakthrough meetings with their Chinese counterparts, the two sides have reached an agreement that marks a big step forward in making cross-border stock listings more transparent. The agreement will pressure overseas-listed Chinese firms and their independent auditors to become more accountable to both regulators and shareholders, helping to restore confidence to battered shares of these companies.The agreement announced late last week between the US Securities and Exchange Commission (SEC) and China Securities Regulatory Commission (CSRC) marks a major milestone in Sino-American information sharing, as the two sides try to stop companies from using territorial issues to commit fraud. (English article) Rather than stop at this initial deal, the two sides should continue to strengthen their cooperation to further improve the quality of Chinese companies that list abroad.

The chain of events that led to the milestone agreement began more than two years ago, when a series of scandals exposed the creative and sometimes illegal accounting practices at many overseas-listed Chinese firms. The crisis saw shares of many accused companies plummet and ultimately de-list, and cast doubt over the reliability of accounting statements from all US-listed Chinese firms.

As the crisis was peaking, the SEC sent a delegation to Beijing two years ago to meet with Chinese officials to discuss the cross-border nature of the problem and explore future cooperation on the matter.

The SEC also started its own investigations into many of the problematic Chinese companies, including Longtop Financial, one of the first firms to fall in the crisis. But that investigation hit a roadblock when Longtop’s independent auditor, the Shanghai office of Deloitte Touche Tohmatsu, refused to hand over accounting records related to the case. Deloitte cited territorial issues behind its refusal, though some suspect it was using the excuse to avoid sharing documents that might have exposed its own negligence.

The SEC finally grew frustrated at Deloitte’s lack of cooperation, and formally charged the auditor a year ago with failing to assist in its financial fraud probe against Longtop.

This new agreement between the regulators should help the SEC finally get access to Deloitte’s records, since the non-binding deal applies to law enforcement cases against auditors in this kind of cross-border case. But the agreement only marks a partial victory for the restoration of confidence in these cross-border listings, since it only allows US inspectors to examine China-based records from company auditors in suspected fraud cases. China-based records from the companies themselves are still exempt.

Meantime, many of China’s most entrepreneurial companies have seen their reputations unfairly hurt and billions of dollars wiped off their market values during the confidence crisis as investors have shunned their stocks.

While the US and China should be commended for their determination to stamp out fraud and restore investor confidence in these companies, they need to seize this new momentum and keep working to create a more comprehensive agreement that addresses all the issues. Otherwise, overseas-listed Chinese companies will continue to suffer as doubts linger over their reliability.

Bottom line: A new agreement between US and Chinese securities regulators is an important first step to restoring confidence in US-listed Chinese stocks.

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