CHINA CRACKING DOWN ON WEAK AUDITING OF ACCOUNTING CRIME
February 24th, 2025Major companies in China are under tightening scrutiny for accounting fraud, with major audit firms facing punishing penalties for turning blind eyes. Keith Nuthall, Jens Kastner and Sara Lewis report.
The Chinese auditing unit of accounting giant PwC has been fined a record Chinese Yuan Renminbi CNY441 million (USD62.7 million) and banned from auditing in mainland China for six months after a regulator concluded it had “covered up and even condoned” fraud.
The China Securities Regulatory Commission (CSRC) fined PwC Zhong Tian LLP CNY297 million (USD42 million) for failing to exercise due diligence in its auditing of the now bankrupt Evergrande Real Estate Group, notably its Hong Kong subsidiary Hengda.
“PwC’s actions were not merely simple audit negligence or failure,” said the CSRC (1). PwC had “violated multiple audit standards” and “and failed to detect significant and widespread financial fraud”.
Separately, China’s ministry of finance fined PwC Zhong Tian another CNY116 million (USD16.5 million), suspended the company’s operations for six months and closed its Guangzhou office. The ministry also confiscated PwC Zhong Tian’s CNY325 million (USD46 million) revenue from Evergrande.
“The work performed by PwC Zhong Tian’s Hengda audit team fell well below our high expectations and was completely unacceptable. It is not representative of what we stand for as a network and there is no room for this at PwC,” commented Mohamed Kande, global chair, PwC (2).
It is a tough line and follows another Big4 accounting firm – Deloitte – falling foul of Chinese regulators, with the finance ministry announcing last March (2023) a fine of CNY211.9 million (USD30.8 million) over failures in assessing China Huarong Asset Management Co Ltd.
Unsurprisingly, international accounting networks are now keeping a warier eye on China’s lucrative audit market, which is becoming a riskier proposition through changes in regulation as well as such enforcement. They are also making major Chinese commercial clients less willing to choose firms with global connections over local outfits.
The impact of the Deloitte fines, noted Magnus Sprenger, the vice chair of the European Union Chamber of Commerce in China finance and taxation working group, were compounded by February (2023) media reports that the government had instructed companies in China not to use audit firms with international links. And while this was “really quickly refuted by an article in the Global Times”, which is controlled by the Chinese Communist Party. Sprenger noted that this was in the English language edition only, not the Chinese, “which means that potentially clearly the Chinese audience may not have read it”.
A ministry of finance hotline started buzzing, but officials did not clarify who Chinese companies should hire as auditors, so, said Sprenger, as usual in China: “If you ask a question and you don’t get an answer you still want to protect yourself…If there’s potential information out there about not using certain companies then you better stay away from them. That’s clearly led to a significant move away of business from the international audit firms to local firms over the past year.”
These concerns were further intensified by PwC facing fines and a market suspension for months before the regulatory axe fell. Beijing-based news service Caixin Media reported August 22 that PwC had lost its largest Chinese mainland client – state lender Bank of China said it would hire EY for its 2024 audit, replacing PwC China, with domestic audit firm BDO China Shu Lun Pan CPAs LLP as secondary auditor (3).
An economist at a mainland Chinese bank in Shanghai who requested anonymity, said he knows that China’s government-owned enterprises have been instructed, through informal guidance from regulators rather than official announcements, not to use PwC or Deloitte as auditors. The banker commented: “It is part of a general trend of domestic replacement and the result of heightened sense of national security.”
These actions have been compounded by decisions made in mainland China and Hong Kong to tighten financial information controls, heightening caution in Chinese businesses over hiring auditors. China’s cabinet, the State Council, on April 12, 2024, issued a national policy ‘Guo Fa [2024] No. 10’ beefing up controls on capital markets, entitled ‘Several opinions of the State Council on strengthening supervision and risk prevention and promoting the high-quality development of the capital market’, for example.
The April decision said financial intermediaries aiding investments in share issues could henceforth be blacklisted if they supply faulty information (3). Moreover, it said intermediaries discovering financial fraud involving securities issuers and listed companies had to promptly report such concerns to financial and securities regulatory authorities, said the guidance (4).
Of concern was the decision stating: “Intermediary institutions that have committed major violations of laws and regulations shall be suspended or prohibited from engaging in securities service business…,” with controls “revoking practice licenses and prohibiting practitioners from entering [offering such services being] strictly implemented.”
A June 29, 2024, State Council national policy ‘Guo Fa [2024] No. 34’ entitled ‘On Further Improving the Financial Fraud Prevention in the Capital Market’, and a related notice on ‘Comprehensive Opinions on Punishment and Prevention’ also raised compliance pressure on auditors, urging accounting firms, asset appraisal institutions and law firms to strengthen practice quality control (5).
The banker added pressure to replace international auditors by Chinese firms had also been encouraged by training among major Chinese companies to comply with China’s 2023 Counter-Espionage Law (6), which outlaws the collection of “all documents, data, materials and articles concerning to national security and interests included for protection.”
He said: “I can actually see from our clients that they try to avoid using any foreign service companies if they can. It has made doing business in China even less transparent, which can drive more capital outflow and drop in FDI [foreign direct investment].”
While this will worry international accountants and the major companies using them, Chinese-owned media news articles signal that domestic accountants also could be targets of incoming tougher controls. On May 15, the 21st Century Business Herald reported that Beijing-based Da Hua Certified Public Accountants was docked CNY40 million (USD5.6 million) in fines and confiscations by the Jiangsu Securities Regulatory Bureau, being suspended from engaging in securities services business for six months for diligence failures when providing auditing services to listed company Shenzhen-based Jin Tongling, which develops, manufactures and sells compressors, blowers, and turbines (7).
Similarly, the Chinese-language newspaper Economic Observer reported two certified public accountants and a site supervisor of a Hong Kong-based accounting firm Asia-Pacific (Group) Accounting Firm (Special General Partnership) (8) in mid-May being fined by the Shenzhen regulatory bureau of the China Securities Regulatory Commission CNY400,000 (USD56,100), CNY300,000 (USD42,100) and CNY200,000 (USD23,000) for failing to perform their duties diligently and responsibly during the audit of the 2019 financial statements of the Shenzhen Danbang Technology, an electrical company (9).
But this is loose change compared to the PwC and Deloitte fines, which Sprenger said had shifted how the major international networks assessed risk when taking on jobs in China, where good practice has been “you limit your liability to three times fee and now comes the regulator that doesn’t have a law to base its decision upon and fines you 33 times fee. You have to reassess the financial impact of faulty audits…”
Moreover, a pattern has emerged of Chinese regulators picking sectors for additional scrutiny, from education to tech and now real estate: “It’s hard to predict what the next industry is going to be. If you had a crystal ball that would be extremely helpful,” said Sprenger.
Will all these concerns drive international audit networks from China? Sprenger thinks not: “Ultimately the networks are where the clients are,” and major clients working in China headquartered outside are likely to want auditors who are part of international groupings. But major Chinese companies focusing on and headquartered in China are more likely to plump for local firms.”
Smaller international accounting firms may also stay put. Kristina Koehler-Coluccia
head of business advisory, Woodburn Accountants & Advisors, said: “We are a small foreign-owned accounting firm in China working with small foreign-owned companies in China. As such we have not been investigated as we are not dealing with the big fish. I believe firms like the Big 4, even the Big 8 are being looked at more closely in this regard.”
EU Chamber of Commerce in China president Jens Eskelund added: “The chamber has long advocated for China to increase the predictability and transparency of its business environment, and to ensure that both foreign and domestic enterprises are treated equally based the rule of law. The tightening of oversight in the accounting sector could therefore be a positive development, provided it is done in an open manner and all enterprises are held accountable to the same standards.”
NOTES
1 – http://english.scio.gov.cn/m/pressroom/2024-09/14/content_117428541.html
3 – https://www.gov.cn/zhengce/content/202404/content_6944877.htm
4 – https://www.chinadaily.com.cn/a/202405/22/WS664d4206a31082fc043c8691.html
5- https://www.gov.cn/zhengce/content/202407/content_6961454.htm
6 –https://www.loc.gov/item/global-legal-monitor/2023-09-21/china-counterespionage-law-revised/#:~:text=The%20revised%20law%20is%20dedicated,the%20government%27s%20counterespionage%20work%20(art.; https://www.crowell.com/en/insights/client-alerts/chinas-revised-counterespionage-law-and-recent-actions-highlight-challenges-for-us-companies-operating-in-china
8 – http://www.apag-cn.com/about Full Chinese name 亚太（集团）会计师事务所（特殊普通合伙）
9 – https://36kr.com/p/2793595020706697
This article first appeared in the December 2024 edition of Commercial Crime International, published monthly by Commercial Crime Services, published monthly by Commercial Crime Services, of the International Chamber of Commerce.
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