On Thursday, Reuters reported that SEC Administrative Law Judge Cameron Elliot believes “Chinese units of the global ‘Big Four’ accounting firms (KPMG, Deloitte & Touche, PricewaterhouseCoopers and Ernst and Young) should be suspended from auditing U.S.-listed companies for six months in an escalation in a long-running dispute over regulators’ access to documents.” Though the accounting firms have indicated that they intend to appeal against the ruling, the article did unnerve investors in many US-listed Chinese stocks, including Baidu (BIDU), which notes Ernst & Young Hua Ming LLP as its principal external auditor. This is not “new” news. Baidu goes to great lengths to highlight this scenario as a risk in its 20-F on page 32, with potential de-listing (not bankruptcy or shareholder value destruction) as a very remote possibility:
The SEC has brought administrative proceedings against five accounting firms in China recently, alleging that they refused to produce audit work papers and other documents related to certain China-based companies under investigation by the SEC for potential accounting fraud. We were not and are not subject to any SEC investigations, nor are we involved in the proceedings brought by the SEC against the accounting firms. However, the independent registered public accounting firm that issues the audit reports included in our annual reports filed with the SEC is one of the five accounting firms named in the SEC’s proceedings and we may be adversely affected by the outcome of the proceedings, along with other U.S.-listed companies in China audited by these accounting firms. If the SEC prevails in the proceedings, our independent registered public accounting firm and other four accounting firms in China that were named in the proceedings may be barred from practicing before the SEC and hence unable to continue to be the auditors for China-based companies listed in the U.S. like ourselves. If none of the China-based auditors are able to continue to be auditors for China-based companies listed in the U.S., we will not be able to meet the reporting requirements under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which may ultimately result in our deregistration by the SEC and delisting from NASDAQ.
We do not believe the SEC will take things that far, where de-listing becomes likely. From what we can tell by the Reuters report, “auditors…refused to turn over…papers (of certain Chinese companies under investigation for accounting fraud) for fear of violating Chinese secrecy laws,” and the auditors believe “it is up to Washington and Beijing to resolve the dispute,” not the accounting firms. Baidu and many other Chinese firms that sold off aggressively Thursday are not being investigated for any wrongdoing, nor are they under suspicion of any wrongdoing. The auditors are simply waiting for “Washington and Beijing to resolve the dispute,” as outlined in the Reuters piece, and appear to be caught in the middle of a game of “political chess.” In any case, the judge’s ruling won’t go into immediate effect, if it goes into effect at all, and US-listed Chinese companies relying on the Big 4 will still be able to have their 2013 books reviewed.
Valuentum’s Take
We think shares of US-listed Chinese companies faced a perform storm Thursday: poor Chinese manufacturing data, a weak overall market, and the Reuters piece. From our perspective, nothing has changed. We remain very cautious on the Chinese economy and think the domestic market may experience multiple contraction in 2014, but we continue to like Baidu as a holding in the portfolio of the Best Ideas Newsletter. We’re not making any changes at this time.
Monitoring #accounting developments in #China closely. No fundamental change to $BIDU story; chart still in uptrend. pic.twitter.com/vjccl5QDax
— Brian Nelson, CFA (@ValuentumBrian) January 24, 2014
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