Maybe Regulators Should Be Having a Macau, Man
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CPA and Big Four survivor Francine McKenna uncovers the games multinational accountants play in her regular Forbes column, Accounting Watchdog and on her indispensable blog re: The Auditors. Her diligence often illustrates that what investors find so egregious in other countries’ financial markets not only can impact Americans, but is also taking place in the US as well – courtesy of the global auditing firms.
Nick Slepko: The SEC recently issued an administrative order formally accusing the major accounting firms (Deloitte, Ernst & Young, KPMG, PricewaterhouseCoopers, and “little” BDO) of obstructing the fraud investigations of nine Chinese companies operating in the United States. You’ve been writing for years about these issues which the SEC and media are just now getting around to covering. Is there trouble ahead for the Big Four, or will they claim they aren’t related to their Chinese partners?
Francine McKenna: There are two problems for the Big Four in general – reputational and practical. Recall, the scandal around Longtop (NASDAQOTH:LGFTY) was not that it was a reverse merger. It was a traditional listing and went through all the due diligence by the SEC, investment bankers, etc. Whether these Chinese companies are a traditional or reverse merger listing should not be the main concern. If a company is listed or quoted here in the US, and it has a Big Four as its auditor (even if it’s a Big Four China partner that signs the audit report), then the brand is synonymous with the firm no matter where the audit is signed…When you are talking about a company that is listed in the US or has US investors, the lawsuits get filed in the US (or Canada). So it doesn’t really matter if it’s the Chinese part of the firm that is doing the auditing or if the audit was run out of the firm’s Florida office. In fact, I suspect that the American part of the audit firm has a higher than average involvement in the Chinese audits because the financials and audits have to be done in IFRS or US GAAP, so the Chinese firms are naturally going to ask for advice from US colleagues, whether they are back in the US, or sitting in China for that purpose (and all the firms have that arrangement). They also need to make sure they meet the auditing standards of America’s [Public Company Accounting Oversight Board] because even though the PCAOB can’t inspect now, that will eventually change.
All the Big Four firms market “seamless international services” to US and Chinese investors and companies that want to raise money in the US. You can’t say the frauds or the audits are isolated to China– though [the Big Four] will try to say that. But the reason why anyone outside of China is investing in these [Chinese] companies (and other foreign companies like them) is that they are listed on US exchanges and they figure that the financials are being done to a certain standard acceptable to the SEC and that they have the guidance and support of the US audit firms.
A point that’s not being raised often enough in the media is that there is a lot of North American and European multinationals that depend heavily on those Chinese [audit] firms to do a significant part of a consolidated global audit. The ones that I’ve written about are the casinos – Wynn (NASDAQ: WYNN), MGM (NYSE: MGM), and Las Vegas Sands (NYSE: LVS) – which are much more Chinese than most people realize. They all now have significant operations in Macau and their audits are being done primarily out of Hong Kong – and both of these places are ultimately China (as US regulators are learning now that they are trying to investigate).
Casinos are just one industry example. The challenge now is to determine who has significant operations in China – possibly Caterpillar, possibly GM, possibly a major pharmaceutical. But we don’t know because it’s not disclosed. Assuming you could get segment reporting from a big multinational, anything that involves over 10% of China is definitely material. MGM receives 19% of its revenues from Macau (and its Macau associations have created some governance issues in the US as well). Macau represents 52% of Las Vegas Sands’ revenue, and for Wynn over 70% of its revenue is coming out of Macau. That’s a big (billions of dollars) deal.
Slepko: That sounds like Canadian companies operating in Cuba. Canadian coal king Sherritt International (TSX: S) says that Cuba will account for an increasingly smaller share than the 18% of its current revenues. However, when you drill down on their own numbers, its Cuba-related revenues are easily over 43% – and if you move past revenues and look at profits, that percentage soars to 65%. Moreover, other publicly available reports projecting yields from their other ventures don’t show their dependence on their Cuba operations changing much.
McKenna: Exactly. This is the same thing with some European companies and their involvement with Iran…But bringing it back to America and using the current issues with China as an example, those Chinese member [audit] firms are doing in some cases 70% of the work, but they have never been inspected, they are shielded from the SEC since they are in Hong Kong, and none of the regulators or watchdogs can see any of their work papers. So, if any of the firms are de-registered or made not legitimate somehow, then they have de-legitimized a material portion of an audit for a number of companies.
[continued in “The Long-Term Value of Short Sellers”]
Nick Slepko (hukgon) has no position in any company mentioned here at the time of publication. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!