China May Change Audit Rules to Avoid Mass Delisting of Chinese Companies

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News Analysis

Over 200 Chinese companies, with a combined value of at least $1.1 trillion, face the risk of getting delisted from U.S. securities exchanges for violating accounting rules such as disclosure requirements.

Despite past refusals and harsh words to the contrary, Chinese regulators have signaled possible cooperation with the U.S. Securities and Exchange Commission (SEC), although no formal agreements have been made.

As of May 2021, the SEC reported that 248 Chinese companies totaling $2.1 trillion were listed on U.S. exchanges.

By allowing Chinese companies to list, the United States grants Beijing access to U.S. investment capital—which ultimately fuels China’s technological development and military expansion. Rather than treating this access as a privilege, Beijing demands that U.S. regulators ignore mandatory transparency requirements.

Over the past several years, the United States has passed several new disclosure laws and increased its enforcement, threatening violators with delisting. Losing access to U.S. investment markets would be a huge financial blow to China, resulting in a setback to their economic and technological development.

The Chinese coffee franchise Luckin Coffee Inc. has become a prime example of why the audit and disclosure requirements demanded of listed international companies must also apply to Chinese firms.

Between May 19 and June 17, 2020, Luckin Coffee received three notices from the Listing Qualifications Staff of the Nasdaq Stock Market LLC (Nasdaq), indicating that the company was being delisted for failure to file an SEC financial disclosure report, SEC Form 20-F. Not providing English-language financial reports accessible to the public was cited as an additional offense.

Long before the delisting, the firm had been under scrutiny from regulators for an unaudited claim of a 500 percent growth in annual revenue. In December 2020, Luckin agreed to pay $180 million to the SEC for defrauding investors by materially misrepresenting earnings and expenses.

LUCKIN-COFFEE-INVESTIGATION-NASDAQ
Jenny Qian Zhiya, CEO of Luckin Coffee, and Charles Zhengyao Lu, non-executive chairman of Luckin Coffee, ring the Nasdaq opening bell with employees to celebrate the company’s IPO at the Nasdaq Market site in New York on May 17, 2019. (Brendan McDermid/Reuters)

The SEC requires publicly-traded companies to publish their financial data so that investors can make informed decisions about the company’s health and profitability.

Since the 2002 Sarbanes-Oxley Act, all publicly traded companies must have their audits reviewed by the U.S. Public Company Accounting Oversight Board (PCAOB) to ensure that the financial filings and the audits are authentic. PCAOB rules state that companies that do not provide financial records for three consecutive years will be forcibly delisted.

The problem with Chinese companies is that Beijing sees audited financial reports as state secrets. The Chinese Communist Party (CCP) maintains that granting access to U.S.-based regulators poses a threat to national security because the financial reports may contain data related to state-backed projects.

Consequently, the CCP demands that onsite audits of overseas-listed Chinese firms must be carried out by Chinese regulators only. This stance has historically allowed China to skirt U.S. regulations. However, since 2020, the rules have become stricter, and the days of Chinese firms being given a “free pass” are numbered.

On Dec. 18, 2020, the Holding Foreign Companies Accountable Act (HFCAA) was enacted. It required the SEC to identify public companies whose complete investigation or inspection was restricted by a foreign government. The PCAOB was required to make a list of companies whose audits the CCP had prevented the PCAOB from verifying. Additionally, under the SEC amendment to the HFCAA on Dec. 2, 2021, Chinese companies must disclose to what extent a foreign government entity owns them.

Now, over 200 Chinese firms worth about $1.1 trillion collectively risk being delisted from U.S. securities exchanges for failing to meet audit requirements. The risk of delisting and disclosing that a CCP entity owns a company has serious repercussions as a firm becomes less attractive to investors.

Troubles with the SEC, paired with the Ukraine war and the threat of secondary sanctions for aiding Russia, have caused the prices of U.S.-listed Chinese companies to experience the worst declines since the 2008 global financial crisis.

The Nasdaq Golden Dragon China Index has trended steadily downward for about a year, losing 57 percent of its value.

Over the same period, the Hang Seng Tech Index has lost approximately 45 percent of its value, going from 8,569 on April 1, 2021, to 4,769 on April 4, 2022.

The MSCI China Index has lost about $1.45 trillion in value since February 2021.

Prices tend to plummet when the SEC names specific companies marked for delisting. This is what happened on March 10 and March 11 when the stocks of  Yum China Holdings (YUMC), ACM Research (ACMR), BeiGene (BGNE), Zai Lab (ZLAB), and Hutchmed took a severe dive. Additionally, Alibaba (BABA) lost 7.9 percent on U.S. exchanges on March 10, JD.com (JD) lost 16 percent, and Baidu (BIDU) dropped 6.3 percent.

The China Securities Regulatory Commission issued a statement on March 11, saying that it “opposes the politicization of securities regulation.” Still, it is now willing to consider coordinating with U.S. regulators to avoid a mass delisting.

On April 2, Beijing proposed changing the confidentiality rules for offshore-listed companies to comply with U.S.-listing audit requirements; however, the firms are expected to maintain and protect state secrets.

While this pronouncement from the CCP is promising, no concrete agreements have been reached with U.S. securities and audit regulators.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

Antonio Graceffo

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Antonio Graceffo, Ph.D., has spent more than 20 years in Asia. He is a graduate of the Shanghai University of Sport and holds a China-MBA from Shanghai Jiaotong University. Graceffo works as an economics professor and China economic analyst, writing for various international media. Some of his books on China include “Beyond the Belt and Road: China’s Global Economic Expansion” and “A Short Course on the Chinese Economy.”



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