Will SEC Crossfire Affect Chinese Companies Trading in the U.S.?

On December 3, the United States Securities and Exchange Commission “began administrative proceedings against the China affiliates of each of the Big Four accounting firms and another large U.S. accounting firm for refusing to produce audit work papers and other documents related to China-based companies under investigation by the SEC for potential accounting fraud against U.S. investors.”

These firms — the Chinese affiliates of Deloitte, Ernst & Young, KPMG, PwC, and BDO — are violating U.S. laws that state they must provide auditing documents to the SEC for foreign companies listed on U.S. exchanges. These companies include Baidu, Inc. (NASDAQ:BIDU), Qihoo 360 Technology Co. Ltd. (NYSE:QIHU), Sina Corporation (NASDAQ:SINA), and Renren Inc. (NYSE:RENN), all popular stocks among investors.

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But the accounting firms — and stocks — in question are caught in a catch-22: the law in the U.S. is clear that they must produce auditing documents, but the law in China prohibits that action. As a result, publicly-listed Chinese companies operate in a sort of accounting gray area that has been historically abused. The SEC has filed fraud allegations against 40 individuals or companies to date related to this issue.

Why Does this Matter?

Anybody who has money invested in a Chinese company listed on a U.S. exchange has a financial stake in how the SEC and Chinese authorities proceed with this issue. Anybody interested in ensuring that legal shenanigans don’t open the doors for fraudulent behavior in the markets also has a stake. Negotiating dubious legal territory is nothing new for the Big Four accounting firms, but this situation has far-reaching consequences. Some investors and the accounting firms involved are worried that if a resolution to the contradictory legal situation is not found, then the markets could be subject to a wave of de-listings…