By Dena Aubin
NEW YORK (Reuters) - The path to a deal that would allow U.S. inspections of China's corporate auditors is getting rockier in a volatile diplomatic climate, raising questions about whether regulators will take harsher measures to combat alleged accounting shams.
Responding to a rash of accounting scandals at China-based companies that sell shares in the United States, the U.S. Public Company Accounting Oversight Board -- the main watchdog for the audit profession -- has been trying for months to gain access to China to inspect auditors there.
Though it held talks with Chinese regulators in Beijing in July, no date has been set for the next round of negotiations, and mounting U.S.-China trade tensions have sparked concerns that a deal may be difficult to reach.
Without an inspection agreement, the PCAOB may be forced to start taking actions against auditors that it cannot inspect, legal experts said. It has the authority to de-register audit firms that cannot be inspected, though that could push Chinese companies out of the public markets, which also carries risks.
"The downside is that the Chinese company may go private, thereby eliminating the Securities and Exchange Commission's and PCAOB's jurisdiction so that there's less transparency in the market," said Elizabeth Gray, a partner at law firm Willkie Farr and Gallagher LLP.
INSPECTIONS ARE STILL PREFERRED SOLUTION
Other legal experts agreed that de-registering auditors would be a last resort, as it could erect a wall against the global flow of capital.
"The PCAOB has negotiated the right to come into most countries around the world and conduct these inspections, and I believe it is in everybody's interest to find a set of terms to allow the PCAOB to do that in China as well," said Scott Univer, general counsel at accounting firm WeiserMazars.
De-registering could fall heavily on the Chinese arms of the Big Four auditors, which audit many Chinese firms listing in the United States, said Paul Gillis, a visiting accounting professor at Peking University in Beijing.
The Big Four -- PwC, Deloitte & Touche, KPMG and Ernst & Young -- audit the books of most of the world's largest corporations through networks of legally separate audit firms. Their Chinese arms, which also audit Chinese operations of large multinational companies, have also been beyond the reach of PCAOB inspections.
"If the PCAOB were to pull those registrations, the Big Four in China could no longer audit big multinational companies like General Motors, IBM or Nokia," Gillis said.
One temporary solution may be heightened disclosure, including measures proposed by the PCAOB this week to require auditors to name the various firms contracted to do audit work.
Currently, small U.S. auditors sometimes contract with China-based firms to do on-the-ground auditing in China, but investors may not know that the audit was done by a firm never inspected by the PCAOB.
Though the PCAOB has said it is still hopeful for a deal with China, its chairman, James Doty, said last week the board cannot wait indefinitely for an agreement.
The PCAOB is already investigating audits where allegations of fraud have surfaced, he said.
SINO-U.S. TENSIONS RISE
China, meanwhile, seems poised for harsher crackdowns, including limits on a favored corporate structure used by almost half of all Chinese companies listing shares in the United States.
That move underscores a desire by some Chinese authorities to lure U.S.-listed Chinese companies back to Chinese exchanges, Gillis said.
Increasing trade tensions between the United States and China cloud prospects for an audit inspection deal.
After the U.S. Senate passed a controversial currency bill this week, prompting strong criticism from China, "the Chinese aren't in any mood to be conciliatory to the United States," said Michal Meidan, an analyst at the Eurasia Group, a political risk consulting firm.
Though China may want its companies to have access to U.S. markets, it is reluctant to relinquish auditing oversight to a foreign regulator, she said.
"The stakes are high for everyone because this is reputation risk for Chinese firms and by extension for China, which doesn't want to be seen as the bad boy on the international stock markets," she said.
(Reporting by Dena Aubin, editing by Kevin Drawbaugh, Karey Wutkowski and Matthew Lewis)