There has been a great deal of discussion about the implications of the SEC case against the five Chinese accounting firms and its potential impact on multinational companies operating in China. I posted on this when the issue first came up, and it is worth a more detailed look.
There are two possible actions involved here. First we have the present case already filed by the SEC against the firms. Next we have a potential change in the rules by the PCAOB that would deregister Chinese accounting firms. The PCAOB has yet to act.
The SEC case could lead to the Administrative Trial Judge penalizing the five firms for failing to provide working papers to the SEC. Those penalties could range from censure to completely banning the firms from practice before the SEC. A complete ban could include prohibiting them from serving multinationals. I think the chance of that is remote. More likely, the judge will ban them from auditing foreign private issuers and will leave the MNC clients alone. In that case, there is no issue for MNCs. Nonetheless, I think the SEC process will be subsumed by a PCAOB rulemaking process that proposes to deregister accounting firms that it cannot inspect.
If the PCAOB moves to deregister the firms, then the risk for MNCs is more serious. PCAOB rules require any firm that plays a substantial role in the audit of a U.S. listed company must be registered with the PCAOB. If the firms lose their registration, then they cannot play a substantial role.
Here is the definition of substantial role from the PCAOB rules:
(p)(ii) Play a Substantial Role in the Preparation or Furnishing of an Audit Report
The phrase "play a substantial role in the preparation or furnishing of an audit report" means –
-1 to perform material services that a public accounting firm uses or relies on in issuing all or part of its audit report with respect to any issuer, or
-2 to perform the majority of the audit procedures with respect to a subsidiary or component of any issuer the assets or revenues of which constitute 20% or more of the consolidated assets or revenues of such issuer necessary for the principal accountant to issue an audit report on the issuer.
Note 1: For purposes of paragraph (1) of this definition, the term "material services" means services, for which the engagement hours or fees constitute 20% or more of the total engagement hours or fees, respectively, provided by the principal accountant in connection with the issuance of all or part of its audit report with respect to any issuer. The term does not include non-audit services provided to non-audit clients.
Note 2: For purposes of paragraph (2) of this definition, the phrase "subsidiary or component" is meant to include any subsidiary, division, branch, office or other component of an issuer, regardless of its form of organization and/or control relationship with the issuer.