U.S. audit watchdog nearing China deal to inspect audit firms

By Sarah N. Lynch

WASHINGTON, Feb 5 (Reuters) - The top U.S. audit watchdog said on Wednesday that the United States and China are close to striking a deal that would allow Washington to inspect the audit work of accounting firms in China.

Such a deal would alleviate a long-running dispute between the two global powers regarding oversight of auditors, an issue aggravated by a series of accounting scandals in recent years at U.S.-listed Chinese companies.

The United States escalated the standoff last month when a judge moved to temporarily suspend the Chinese units of the "Big Four" accounting firms from practicing in the United States. It has been unclear how that move would impact negotiations for a broader solution.

"I am also optimistic that we will be able, during 2014, to sign a long-sought agreement to inspect the audit work of PCAOB-registered firms based in China," Jim Doty, the chairman of the Public Company Accounting Oversight Board (PCAOB), said in prepared remarks to the Securities and Exchange Commission.

The topic of China came up as part of a hearing before the U.S. SEC to discuss the PCAOB's budget and 2014 policy initiatives.

Later, in a conversation with reporters, Doty said the Chinese and the PCAOB are still exchanging draft agreements and have not decided how the inspections would be conducted.

Throughout the negotiations, the Chinese negotiators have said they would not be comfortable with U.S. examiners conducting the inspections on Chinese soil.

"Without commenting on what we think we are going to get, there are various ways of dealing with that, including moving the papers, making people available outside of China, conducting inspections through other means," Doty said. "It may be that we do not necessarily need to be on the ground."

He also struck a serious tone about the need to reach an agreement soon. "Patience is limited for getting this solved," Doty said. "This is the end of the line."

The PCAOB and the SEC have been struggling for years to gain access to work papers at audit firms in China, including units of the "Big Four" firms, amid a burst of accounting scandals. The scandals have affected dozens of Chinese companies traded on U.S. exchanges, many of which were later delisted or deregistered.

Doty estimated on Wednesday that more than 50 auditors have also resigned after the accounting problems at these companies surfaced.

The SEC has sued some of the questionable Chinese companies, but it has complained that many of its investigations were thwarted by the Chinese units of accounting firms including PricewaterhouseCoopers, KPMG, Deloitte , Ernst & Young, and others who refuse to share their audit work.

They say such a move would violate Chinese secrecy laws.

The SEC and PCAOB contend access to the work is crucial, both for investigating wrongdoing, and also to police the quality of audit work through routine inspections.

The SEC eventually hit an impasse during talks with China, and filed an enforcement action against the Chinese units of the Big Four in late 2012, saying they were violating U.S. laws by failing to hand over the audit workpapers.

The PCAOB has continued talks with the Chinese and in May 2013 were able to strike a deal to get access to audit work in connection with investigations.

That deal, however, did not give the PCAOB the ability to conduct routine inspections of the audit firms - a key responsibility of the board to ensure the quality of the work.

Last month, the SEC prevailed in its case against the Big Four, after an SEC administrative law judge sided with the agency and ruled the audit firms were intentionally withholding documents. The judge suspended the firms from practicing in the United States for six months, but the suspensions will not go into effect until the appeals process is exhausted.

Many observers had said they feared the ruling by the judge could hurt the progress the PCAOB had made so far in its talks with the Chinese.

Doty declined to comment on the SEC judge's ruling Wednesday, or the impact it might have on his efforts.

He added, however, that he is hoping to make progress on a deal before this year's annual U.S.-China Strategic (HKSE: 0235.HK - news) and Economic Dialogue in the summer.

Securing this agreement is crucial for U.S.-listed companies and audit firms in China. If a deal falls through, it could lead the PCAOB to deregister Chinese audit firms - an action that would prevent them from signing audit opinions for U.S. listed companies.