BIDU Baidu Inc

A long-running dispute between the U.S. and China over the ability to vet auditors of Chinese companies listed on American exchanges could be edging toward a breakthrough.

Two big U.S.-listed Chinese companies—Alibaba Group Holding Ltd. and Baidu Inc.—and their outside auditors are preparing for audit inspections by officials from the Public Company Accounting Oversight Board, the U.S. audit-industry regulator. The PCAOB is expected to gain access in coming months to audit firms' records of the work they did to review Alibaba's and Baidu's books, according to people familiar with the situation. That could be a prelude to fuller PCAOB inspections of the audit firms, a move long blocked by the Chinese government.

PricewaterhouseCoopers' Hong Kong affiliate is Alibaba's auditor; Ernst & Young's Beijing affiliate is Baidu's auditor.

The ability to check auditors of foreign firms listed in the U.S. is important to ensure auditing standards are upheld and investors in U.S. markets are protected, experts say. U.S. regulators have been particularly eager to vet how Chinese companies have been audited, after a wave of alleged accounting fraud and investor complaints about lack of financial transparency at smaller U.S.-listed Chinese firms starting around 2011.

"It's critical for investors in the U.S. market that the PCAOB is able to inspect Chinese audit firms," said Joseph Carcello, a University of Tennessee accounting professor.

The PCAOB has long attempted to inspect the performance of China-based firms that audit many U.S.-traded Chinese companies, the way the accounting board regularly inspects other audit firms. But to date, the Chinese government has refused to allow the inspections, citing sovereignty concerns: The Chinese government has indicated the information contained in audits of Chinese companies could be considered "state secrets."

The new developments may be a move toward resolving that yearslong dispute, which has been marked by seeming steps toward agreement followed by reversals. Most recently, the PCAOB last year said publicly it was close to an agreement to proceed with inspections, only to have negotiations break down.

One person at a Big Four accounting firm said that the firm has been preparing for years for the possibility that the PCAOB will inspect its working papers for U.S.-listed Chinese companies. The firm has been conducting mock reviews of PCAOB audits for the past few years, going over questions and grading the employees on how well they answered, the person said.

It is still possible the Alibaba- and Baidu-related inspections might not proceed. The audit documents provided to the PCAOB may be heavily redacted and the board may face other restrictions in conducting the inspections, said the people familiar with the situation, raising questions about whether the board will be allowed to conduct the thorough inspections it is seeking.

The move toward inspections is a "good first step" in thawing relations between U.S. and Chinese regulators, said Paul Gillis, an accounting professor at Peking University's Guanghua School of Management. "But that doesn't mean that the inspections will be meaningful."

Mr. Gillis says he expects audit work papers to be moved to Hong Kong for inspection, a way to ease the Chinese government's concerns about foreign regulators working on Chinese soil.

The PCAOB wouldn't confirm the move toward inspections, saying only that it continues "to work toward obtaining access to the information we need in order to conduct the necessary inspections of registered firms in China and Hong Kong." The auditing regulator said it doesn't comment on specific audits.

PwC in Hong Kong didn't immediately respond to a request for comment. E&Y's affiliate in Beijing declined to comment. The China Securities Regulatory Commission had no immediate comment.

PCAOB inspections are meant to assess the performance and compliance with auditing rules of firms that audit U.S.-traded companies. They are done on a regular basis and aren't a sign the auditors or the companies have done anything wrong. But an inspection would come at a sensitive time for Alibaba in particular, as the U.S. Securities and Exchange Commission is investigating the accounting practices of the e-commerce giant.

Alibaba and Baidu are among the biggest U.S.-listed Chinese companies. More than 130 Chinese companies trade on the Nasdaq Stock Market alone.

U.S. and Chinese regulators reached an agreement in 2013 to give the U.S. access to audit documents of U.S.-traded Chinese companies that are under investigation for potential wrongdoing, by routing the documents through Chinese regulators. But that agreement doesn't cover documents sought in connection with audit-firm inspections.

In theory, the impasse over inspections could lead the U.S. to bar audit firms that haven't been PCAOB-inspected from auditing U.S.-traded companies, which would force those companies to find an acceptable auditor or be delisted. U.S. regulators have continually held back from such a step, however.

The Chinese "are trying to do whatever is necessary to prevent a disaster, which is their companies being delisted," said Mr. Gillis. "U.S. regulators are trying to make this problem go away."

Alyssa Abkowitz contributed to this article.

Write to Kathy Chu at kathy.chu@wsj.com, Chao Deng at Chao.Deng@wsj.com and Michael Rapoport at Michael.Rapoport@wsj.com

(END) Dow Jones Newswires

August 05, 2016 03:05 ET (07:05 GMT)

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