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China’s SOE Reform: Privatization or Taking over the Private Sector?

By He Qinglian, published: September 30, 2015


A flood of commentary has come out since the release of the long-anticipated Guiding Opinions on Strengthening and Reform of State-Owned Enterprises (《中共中央、国务院关于深化国有企业改革的指导意见》; “SOE Reform Program” or “Program” hereafter), jointly issued by the Central Committee of the Chinese Communist Party and the State Council. Some say that the Program is aimed at expanding and strengthening SOEs, while others say that the government is using market forces to promote privatization. That the same plan can yield two radically different suppositions is due to the Program’s strong “Xi Jinping quality”: It tries to combine the governance characteristics of both Mao Zedong and Deng Xiaoping and gain some advantage from both sides, thereby introducing a whole bunch of mutually contradictory formulations.

Key Points of the Program

The SOE Reform Program is 10,141 characters long and comprises 30 opinions in eight sections. It makes its purpose clear from the very outset: “SOEs are owned by the people as a whole . . . and are an important material base and political foundation for the development of our party and state.” This message infuses the Program throughout. Below are a few of its key points that must not be overlooked:

I. A highlight of the Program is the mixed-ownership system. Pundits have different opinions about this system based on their different understandings of the word “mixed.” Some (including foreign experts) see the word “mixed” and believe that the plan encourages privatization. But the original language in the Program says: “Actively encourage ownership diversification through introduction of other state-owned capital or various types of non-state-owned capital. State-owned capital may retain absolute or relative majority share positions, or it may be a [non-controlling] equity participant. Encourage the integrated companies to go public.”

The drafters of the Program seemed to worry that people would not fully understand their meaning, so they made a special point of noting in Opinion 2 (under the “General Principles” section): “Public ownership occupies the dominant position. It remains the basic economic system, the key point for consolidation and development. The non-public sector occupies a subordinate position.” “Upholding and improving the basic economic system are the fundamental requirements for deepening SOE reform that must be grasped.”

So, “mixed ownership” means that private companies can make cash purchases of shares in SOEs and become shareholders. But since the equity allocation ratio is based on the state-owned capital being the controlling party, private companies can only remain in a subordinate role, without any decision-making power or right to a say in matters. To prevent the public from getting the wrong idea, after releasing the program the Xinhua News Agency promptly issued a piece entitled “We Must Unequivocally Oppose Privatization” (《须旗帜鲜明反对私有化》).

II. The Program calls for fostering “market-oriented management mechanisms” while strengthening the Party’s leadership. Marketization is mentioned a total of 14 times, as if it were a theme of the Program. But in Opinion 24 it says: “Give full play to the key political role played by the Party organization within SOEs. Unite the goals of strengthening party leadership and improving corporate governance. Put a general requirement for Party-building work into the corporate charters of SOEs and clarify the statutory role of the SOE Party organization in the corporate governance structure.”

“Party leads everything” was the lifeblood of political and economic life during the Mao era. “Marketization” has been the theme of SOE reform ever since Deng Xiaoping took over. When Zhao Ziyang was General Secretary, he worked very hard to separate government from enterprise in the hopes that it would bring an end to the misadministration that came when the party managed companies. Originally, he even planned to build on his successes in this area and promote separation between the party and the government, but all of those efforts went down the drain after the events of June 4, 1989.

More than 60 years of Communist rule has shown that, under Party control, SOEs can use the Party’s support to grow large but not strong. This is because, growing strong means that a company increases its operational capabilities and management capacity, achieves a reasonable input-output balance, and gains market share through competition, rather than monopoly. These are precisely the things that it is impossible for Chinese SOEs to achieve.

III. Private companies with “great development and growth potentials” will become the primary target of SOE enterprise reform. Opinion 18 of the Program states: “Encourage state-owned capital to pursue various ways of investing in non-state-owned companies. Fully realize the capital operation role of state-owned investment and operations companies and use market forces to make quality investments in non-state-owned companies with great development potential and strong growth in the key sectors of public services, high-tech, environmental protection, and strategic industries.”

In other words, private companies with weak prospects can rest easy that SOEs won’t come knocking at their door. But if you’re a private company with high efficiency and good market prospects, the SOEs won’t even knock—they’ll come right in and purchase some of your shares or shell resources. There will be nowhere to hide.

 Why Do the Chinese Authorities Insist on Making SOEs Big and Strong?

You can tell what a government considers its key interests to be by looking at the companies it chooses to support. Take, for example, the acquisition of the largest American pork processor, Smithfield Foods, by China’s Shineway Group. With a total of 48,000 jobs at stake, including around 1,300 newly added jobs, local residents and governments all welcomed the deal and didn’t care that the new owners were Chinese.

In China, the private sector has long provided more employment opportunities for Chinese people than SOEs. According to official statistics for 2007, SOEs accounted for only 9.2 percent of industrial jobs, compared to 44.4 percent for the private sector. In January 2011, the All-China Federation of Industry and Commerce published a report indicating that small and medium enterprises accounted for more than 99 percent of all Chinese companies and accounted for more than 70 percent of urban employment and 90 percent of newly added jobs. In 2014, the State Administration for Industry and Commerce announced that sole proprietorships and private companies accounted for approximately 90 percent of all new urban jobs nationwide.

As foreign investors have begun to leave China, rural-based laborers are returning to the countryside in great numbers and more than half of all university graduates are forced to return home and live off their parents. In principle, the government ought to encourage development of the private sector and make raising the employment rate its primary consideration. So why do the authorities instead want to make SOEs, which account for comparatively fewer jobs, “big and strong” and adopt a “reform” strategy of “advance the public sector and diminish the private sector”? It is based on the following two considerations:

  1. As the economy has begun to slide, the Chinese government is facing an enormous financial dilemma. Private companies already represent the largest share among all Chinese companies when it comes to number of enterprises, assets, or main revenues, whereas SOEs are at a disadvantage on all accounts. But when it comes to the share of taxes paid to the state, private companies paid only 13.0 percent in 2012, according to official figures, compared to 70.3 percent paid by SOEs. As original sources of tax revenue increasingly dry up, the fact that SOEs are the main pillar of public finances is a sufficient reason for the government to make such efforts to support them. Whether or not SOEs can increase the employment rate is not among the government’s primary concerns. Premier Li Keqiang has already told the hundreds of millions of unemployed to follow a path of starting their own businesses.
  1. Restructuring and listing is the Program’s ultimate goal. Currently, there is a very high rate of debt among SOEs. At the end of July 2015, the average asset-liability ratio among Chinese SOEs was 65.12 percent, with the overwhelming majority of those debts owed to state-owned banks. This kind of relationship between banks and companies ensures that if SOEs cannot perform better, the state-owned banks will also collapse.

Over more than two decades, the main way that SOEs have gotten out of their difficulties has been to follow the brilliant idea of former Premier Zhu Rongji, who first allowed SOEs to raise money by going public. But today this idea seems to have lost its magic, and the national team appears stuck after being forced by the government to take part in efforts to save the stock market. So, the SOE Reform Plan is only an attempt to come up with a new tactic: have SOEs reform and, after mixing ownership with private companies, “encourage restructuring for going public.” After the assets have been restructured, the companies can go to the markets to float IPOs under a new name.

Does the Private Sector Want to “Mix” with SOEs?

This talk of a mixed-ownership system is something the public is familiar with, having first appeared in the 2014 Guiding Opinions on Deepening State-Owned Enterprise Reform (《深化国有企业改革的指导意见》) and the public consultation draft of the Guiding Opinions on Improving the Forms of Realization of Public Ownership (《关于完善公有制实现形式的指导意见》). But private companies are not in the least bit enthusiastic. In my earlier article, “SOE Reform: Government and the Private Sector Each See Things Differently,” I explained how private companies commonly perceive “mixed ownership” as a trap. They believe that if they take part in a mixed-ownership company, the private company can’t get a controlling stake so it’s very likely to be neutralized and, in the worst case, caught with no means to defend itself.

Wanda Group Chairman Wang Jianlin (王健林) told the Sina website: “If I’m going to ‘mix,’ the private company definitely needs to have a controlling share, or at least I want relative control . . . If the SOE has the controlling share, isn’t that the same as me helping out the SOE by giving it money? Wouldn’t that be crazy of me to do? I can’t do that kind of thing.”

In the article Mixed-Ownership: Six Big Risks for Private Companies Investing in SOEs (《混合所有制:民企参股国企的六大风险》), the author got several private entrepreneurs to share their opinions about the mixed-ownership system. The main risks they raised were: (1) the people with responsibility over state assets were not actually required to take responsibility; (2) concern about loss of state-owned assets will become a high-tension line used to keep private-sector shareholders under control; (3) state-owned shareholders are much more powerful than private-sector shareholders, making it difficult to cooperate; and so on. The point is that private companies cannot cooperate with SOEs, because for them “cooperation” means getting caught in a trap.

It’s clear that even if private companies don’t want to “mix,” the government is determined to “mix” them. Chinese private entrepreneurs have weathered many storms over the years, and as soon as they saw the government getting ready to position itself for mixed ownership, they started “investing overseas” in great numbers. As the saying goes: “Of the 36 stratagems, fleeing is best.” Since August of this year, Beijing has imposed stricter foreign exchange controls. Rather than targeting those small holders of foreign exchange, the controls are aimed at those rich businessmen who are trying to transfer their assets overseas. “Shorting China” is becoming an up-and-coming crime.

To put the private sector at ease and keep them from seeing the government as the wolf dressed up in Grandma’s clothes, Opinion 16 of the Program states: “Uphold the principle of implementing policy according to location, according to industry, according to company. Decide whether to remain independent, take a controlling share, or make an equity investment based on what is appropriate. Don’t make arbitrary matches between companies or try to apply mixed ownership across the board. Don’t set timetables; move forward when the time is ripe. Reform must be carried out in accordance with law and regulation, in strict accordance with procedure, and in a transparent and fair manner. Ensure protection of the rights and interests of the various investors in mixed-ownership enterprises and root out state-owned asset loss.”

The real problem is that the Chinese government has always treated law as something used to constrain the people. Private entrepreneurs know what’s really behind this kind of reform intended to “preserve the leading position of the state-owned sector” and “root out state-owned asset loss.” Under this kind of “reform,” just watch and see whether the private companies that SOEs have taken a fancy to can avoid becoming “Little Red Riding-Hoods.”


何清涟He Qinglian (何清涟) is a Chinese economist who lived in China before 2001. In her bestseller The Pitfalls of Modernization (《现代化的陷阱》), she argues presciently that, as the power of local governments grows, officials who have favored reform would come to oppose further reform because it would limit their ability to trade power for money and money for power. The book was banned in China, Ms. He was forced into exile. In 2006, she published China Shrouded in Fog (《雾锁中国》) which studies how the Chinese government manipulates and, to some degree, controls overseas Chinese-language media. Ms. He lives in New Jersey with her family.



What’s the Murderous Intention Behind “Don’t Let Li Ka-shing Run Away”?, Xiao Zhonghua, China Change, September 19, 2015.


中文原文《何清涟:国企改革方案的风,姓私还是姓公?》, translated by China Change.



Why Aren’t Shanghaiers Angry? An Online Discussion

The End

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When the number of dead pigs over Huangpu River reached 6,000 a few days ago, I tweeted, puzzled by the lack of public outcry in Shanghai, “Shanghaiers, how many dead pigs do there have to be before you go to the streets to protest? Can you give us a number?” Now the number has more than doubled, and the Shanghaiers are still cool as a cucumber.

I’m not the only one who is puzzled. A Chinese tweep who also lives in the US asked the day before yesterday, “Why is there no discussion about the dead pigs? In the face of serious pollution, large protests have erupted in small cities, but in Beijing and Shanghai, there has been nothing but dead silence. Someone in Shanghai called for a mass walk, but it has come to nothing. Sure, government control is a factor, but in small cities, there is control too” (@liberty8964). He wanted to have a discussion. A Chinese journalist in Canada joined in, “Still I’m bewildered. Because of tight control? But we are talking about drinking water!” (@liangyanr)

It’s somewhat a consensus among China watchers that mass revolt in China will happen when the interest of the broad population is undercut and their lives take a considerable turn for the worse. The projected scenarios include worsening inflation, a real estate collapse, environmental pollution, etc. I also hold such a view, and that’s why I am puzzled by the total inaction in Shanghai with regard to the dead pig event that’s making international headlines and that, water quality aside, obviously poses public health risks and affects everyone in Shanghai, a city of 20 million residents.

So I asked around for opinions on Twitter and through emails. “‘Inaction’ is very normal,” replied my nephew Youfang, a system biologist living in Chicago, who went to graduate school in Shanghai and worked there for several years. “It would be extraordinary if the dead pig incident leads to large-scale street demonstrations.” He went on to give me four reasons.

“First of all, the dead pigs didn’t originate in Shanghai, but from Jiaxing, Zhejiang. The Shanghai municipal government has taken measures to pull out, and dispose of, the pig carcasses. Although the public is suspicious of the government’s claim that the ‘water quality is unaffected,’ it doesn’t have a clear target to protest against because, after all, the municipal government is not the culprit.”

Twitter user @ahrism confirmed Youfang’s view:  “I spoke to my childhood friend in Shanghai who also worked in Shanghai media before, and she said, even though everyone felt sick in the stomach, but since it affected only a part of Shanghai and the municipal government seems to be doing a good job dealing with it, who do we turn against?”

Only a part of Shanghai is affected? The exiled economist @HeQinglian, whom we translated before, and another twitter user @shengzhaozhang point out that, in Shanghai, only 20% of the drinking water is taken from Huangpu River and it supplies the outlying suburbs of Songjiang, Jinshan, Fengxian and Minxing on the south side of Shanghai and the rest of the city gets its water from Yangtze River.

Ms. He also points out the difference between the struggle of an individual family whose property is being demolished, or a village for that matter such as Wukan, and that of a large metropolitan area. “Shanghaiers’ inaction in the dead pig event can be explained with ‘the logic of collective action’ as explained by the American economist Mancur Olson in his book The Logic of Collective ActionPublic Goods and the Theory of Groups in 1965.” Instead of being the driver, everybody wants to take a ride with it.

While in smaller cities people can come together to protest against pollution, @fightcensorship and I agreed, it is considerably harder, if not outright impossible for that to happen in big metropolitan areas, given that people living in large cities lack the kind of close ties existing in a village or a community in small cities, and, without modern forms of organization, which the Party fears the most and clamps down on the hardest, it’s inconceivable for residents in large cities like Shanghai to take collective actions.

“The second reason,” my nephew continues, “has to do with the timing of the event. It occurred during the Two Meetings. In a sensitive time like this, media coverage on ‘bad news’ is minimal and probably not telling the whole truth either.”

Government control on media coverage of the incident is confirmed by an edict (Chinese) issued by the Party’s propaganda department that singled out two Shanghai media outlets Dongfang Daily (《东方早报》) and Dragon TV (东方卫视) for “hyping” the dead pig event over Huangpu River.

“In the forbidding political environment in mainland China,” Youfang wrote, making his third point, “people have little appetite to take it to street even when they are very unhappy. Nowadays, the government takes strict, elaborate control to prevent possible eruption of mass events; anything slightly out of the ordinary would draw attention from the government, or the state security police. A couple of years ago, a young woman from my neighborhood protested in the People’s Square with a sign about something that happened to her, and she has been put under surveillance ever since. Unless under extreme circumstances, people do not want to confront the government by taking it to the streets. Meanwhile, Shanghaiers care more about making money. People talk more about real estate and money when they are together than anything else. Even when venting discontent for the government or the system, they are more resigned than indignant. Those with means would rather emigrate and leave the country.”

Radio Free Asia reported (Chinese) that Shanghai poet Pang Ting (潘婷) posted questions for Shanghai municipal government on Weibo, and her posts were repeatedly deleted. On March 14, she posted a call for mass walk on March 23, and after that post, her account was canceled altogether.

RFA also reported (Chinese) that a Shanghai lawyer and a college student requested, respectively, the municipal government to publish water information at the six water intake points and nine water plants, but we have not heard any follow-up news on that.

“Finally,” Youfang wrote, “many people may not even feel it’s a big deal to have dead pigs floating down the Huangpu River, and their logic goes like this: The Huangpu River is very polluted to begin with. Upstream, god knows what stuff—sewage, industrial waste and whatnot—has been discharged into the river, several thousand dead pigs  probably wouldn’t make it much worse, and it will be gone after a while……”

“In China,” Youfang continues, “the public is misled in many of their ideas. For example, the Chinese public cries out loud about GMO foods but remains indifferent to air and water pollutions. In any case, most Chinese care only about themselves and their own businesses, and have little regard for the interest of the greater population. But over the last few years, I have seen many good changes through social media, though it takes time, perhaps several generations, to change the character of a people.”

As I was wrapping up this post, a Twitter user (@wayinfinite) joined the conversation, saying “Nobody beats Shanghaiers in putting up with things. If Shanghaiers ever go on the street, that would be big, bigger than Beijingers taking to the street, so big it will change the regime. When Shanghaiers cannot bear it anymore, that would mean no one in China can bear it anymore.”

“Oh really,” I hit the “reply” button, “I’m going to take a nap now. Wake me up when Shanghai sinks to the bottom of the sea.”

Accounting Firms’ Gold Rush Puts US Credibility on the Line


By He Qinglian

He Qinglian (何清涟) is a Chinese economist who lived in China before 2001. In her bestseller The Pitfalls of Modernization (《现代化的陷阱》), she argues presciently that, as the power of local governments grows, officials who have favored reform would come to oppose further reform because it would limit their ability to trade power for money and money for power. The book was banned in China, Ms. He forced to exile. In 2006, she published China Shrouded in Fog (《雾锁中国》) that studies how the Chinese government manipulates and, to some degrees, controls overseas Chinese-language media. Ms. He lives in New Jersey with her family. The Chinese original is here. 

The Securities and Exchange Commission in December charged the Chinese affiliates of five big accounting firms Deloitte, Ernst & Young, KPMG and PwC and BDO for failing to comply with laws requiring access to the work papers of their audit on Chinese companies. The SEC was supposed to make a decision at the end of the December, including the possibility of delisting all Chinese companies in the US exchange. But the “deadline” has long passed and we haven’t heard the outcome of the suit. I am afraid it has probably disappeared into the black box called “diplomatic solutions.”

The fate and the practice of the five accounting firms in China are tied to one word: professional standing. In 2001 when native Chinese accounting firms were embroiled in fraud scandals, the Chinese government granted special audit concessions to the five largest US accounting firms for their trustworthiness,  and the big five’s China business has subsequently skyrocketed. But now the Big Five are embroiled in alleged fraud in their Chinese business. Over the last 12 years, the Big Five’s attitude towards their own reputation has undergone quiet change, and it all has to do with them seeking gold in China.

In this article, I would like to examine four issues:

I. Did the Big Five know that Chinese companies had falsified their financial documents?

The SEC said that the Big Five refused to provide required documents partially because their accountants believed that “the law of the People’s Republic of China” prohibited them from providing them.

It’s very clever for the Big Five to place the burden of “Chinese law” that the SEC couldn’t do anything about. But the key issue remains: Did the Big Five know whether Chinese companies had falsified their financial documents when they conducted audits?

When a Chinese company issues an APO in the American exchange, it must hire American-trained professionals in order to understand financial literature. It was possible that, at the beginning of the APO business, the American executives of the Big Five didn’t know what their Chinese subordinates were doing, but it’s hard to believe they still didn’t know by 2004.

China’s APO industrial chain started around 2001. Some US-trained Chinese professionals, in cooperation with accountants, lawyers and investment banks in the US, scouted Chinese companies suited for reverse merger and acquisition. After a few years of practice, an APO industrial chain matured between 2003 to 2005 that helped Chinese companies to issue APOs in the US market. During this period, there had been a stream of bad news coming from the US market about Chinese stocks. In 2005, 90% of the 70+ Chinese companies had become trash stocks in less than a year after they had been issued. It’s hard to believe that, faced with such a deluge of bad news, the American executives of the five accounting firms did not suspect a possible audit on their Chinese subordinates. But common interest had already made it difficult for them to cut their connections.

II. Chinese business is an enormous gold mine for the Big Five

The five largest accounting firms entered China in the 1990s one after another. Arthur Andersen bankrupted in 2001 because of its involvement in the Enron scandal, so the Big Five became Big Four. But a few years later, BDO joined the other four, so it was the Big Five again. In their earliest days in China, the American brand and reputation brought these firms good fortunes. In 2001, the Chinese government dropped them a big piece of cake. That year, many native Chinese accounting firms were implicated in a series of accounting scandals such as Guangxia (银广夏), Baiwen (郑百文), Lantian (蓝田股份), and as a result, the Chinese Securities Regulatory Committee (CSRC) implemented supplementary audit policies requiring all public companies to provide not only the statutory audit by a domestic accounting firm, but also a “supplementary audit” by an international audit firm, when issuing an IPO or refinancing.

With the statutory requirement, in place to correct rampant accounting fraud in China, the business of these international firms exploded. According to statistics of the Chinese Institute of Certified Public Accountants, the total revenue of Deloitte, Ernst & Young, KPMG, and PwC (before BDO joined them) in 2002 was close to RMB1.7 billion, or 38.23% of the total revenue of China’s 100 biggest accounting firms. In 2005, the percentage increased to 49.46%. In a matter of a few years, while more than 5,600 Chinese accounting firms had to tear each other into piece to fight for piecemeal businesses, the Big Five had monopolized China’s high-end audit business and the entire audit business of all of China’s companies listed overseas. Of the 1,400 plus companies issuing RMB denominated common stocks (or the A stocks), over 40% of the assets were audited by the Big Five.

Director of Economic Security Research Center Jiang Yong (江涌), of China Institutes of Contemporary International Relations, thought this situation “seriously threatened the security of China’s financial information.”

In China where the government routinely fabricates statistics, it’s very difficult for outsiders to know just how strictly the Big Five have conducted their audits, and what they have done to stay clean of all sorts of accounting scandals. But this much I can say for sure: the Big Five would not be able to have so much business in China without conceding to China’s “hidden rules.”

Several hundred Chinese companies had gone public in the US exchange through “back-door listing,” each audited by one of the Big Five. But soon, accounting problems plagued Chinese stocks in the US, and many Chinese companies were suspended by SEC. In March 2007, CSRC announced that public companies in the category of finance were no long required to undergo supplementary audit by an international firm, the reason being “to ensure fair competition between international and domestic accounting firms.”

CSRC had thus far hoped to regulate Chinese stock market by granting special status to Big Five, knowing perfect well about accounting frauds among Chinese companies. Now, since the Big Five did the same things as their Chinese colleagues, CSRC had no reason to give them privileges. But CSRC would never let the US know what they knew, because China stood to benefit, without consequences, from disqualified Chinese companies going public in the US stock market.

III. Have the Big Five been knowingly engaged in helping clients to cheat? 

The Chinese white-collar elites, who serve in the Big Five, would no doubt see problems in the books of Chinese companies, and they have chosen to “package” these companies, with the assent of their bosses, to make them meet the American requirements in appearance. Providing “packaging” is the business secret of the Big Five.

The Big Five know very well the truth about their clients. I will give Ernst & Young’s flip-flop on Bank of China’s bad debt for example. On May 4, 2006, Ernst & Young stated in an annual report that the Bank of China had a staggering $US 911 billion bad debt. The Chinese government protested angrily, as the Bank of China was due to be listed in overseas markets on May 25. Paul Ostling, Global Chief Operating Officer at Ernst & Young at the time, ordered an internal investigation on its report, and concluded that its report on the bad debts of China’s four biggest state-owned banks had errors, didn’t pass Enrst & Young’s formal review procedures before it had been issued, and promised “such an embarrassing situation will not happen again”(link in English).

However, Enrst & Young had its “Achilles’ heel”: its current report contradicted its audit report on ICBC the year before. If you look up news in 2005, you will know that China’s state-owned banks had been making preparations for listing in Wall Street, and hired American accounting firms for audit. Enrst & Young was the auditor of ICBC. Now, if Enrst and Young insisted its numbers of Chinese banks’ bad debts were accurate, then its audit on ICBC and a few other banks couldn’t possibly be true, and its reputation would suffer greatly. If it insisted  the ICBC audit was correct, then the veracity of its report on the bad debts would be called into question. Between the two traps, Enrst & Young chose the one that hurt itself less.

Enrst & Young had issued hundreds of reports before and was highly regarded by its peers. And the conclusions of the 2006 report did not differ from other independent financial advisors, including PwC, that examined China’s bad loans. On May 16, 2006, Financial Times asked “Has Ernst & Young forgotten the importance of being independent?” wondering whether Enrst & Young had made a “Faustian bargain” with China as Microsoft and Google had done.”

The episode in 2006 might have faded into the past, but now, Enrst & Young and the other major international accountancies are facing fresh allegations from the SEC.

IV. Do China and the US have a legal compatibility problem, or have Chinese companies cheated on purpose?

China has never been known for information transparency, and it finds all sorts of excuses to evade it, security reason being a favorite excuse. This time around, the excuse is that the Chinese law prohibits handing audit working papers to the SEC. Inside China, there were people who defended China and the Big Five by claiming that the two countries’ laws have a compatibility problem.

This last defense is rather far-fetched. Chinese companies of course have to obey American laws if they are to be listed in the US market. In 2004, China’s Construction Bank and ICBC attempted to go public on Wall Street, but after about a year of public relation campaigns and lobbying, including the courting of the American banking industry by both Hu Jintao and Wen Jiabao, these banks failed to gain approval for not meeting SEC’s criteria.

I remember on August 11, 2005, Congress held a specific hearing on the issue of China raising capital in the United States. From the remarks of the participants, we get the sense that the accountants and lawyers involved in auditing Chinese companies knew very well that China’s state-owned banks fell short of the SEC requirements. But Donald Straszheim, former chief economist for Merrill Lynch, believed that the US decision makers should trust the judgment of the market, and should not impose special restrictions on Chinese state-owned enterprises seeking to be listed in the US stock market. Robert DeLaMater, partner at Sullivan & Cromwell, had advised many Chinese companies in their securities offerings, suggested in his testimony that, if the US set the threshold too high for overseas issuers, the American capital market might lose its attractiveness. Without naming the “special restrictions,” both Straszheim and DeLaMater were referring to the Sarbanes-Oxley Act, a law passed in 2002 after the Enron and Worldcom scandals. What the two were really advocating was to lower standards, and open up special channels outside the Sarbanes-Oxley Act, for Chinese companies.

Looking back now, the SEC was wise not to have done that, given that Chinese state-owned banks have been mired in loans by local governments. Or the American stock market would have been the best place for Chinese state-owned banks to rid of its bad loans and financial risks.

This time around, the question is, for the safety of the American capital market, should the SEC make concessions to the Big Five who are allegedly playing a part, along with Chinese corporations, in financial fraud?

To be sure, the Chinese players will not provide audit working papers, because those papers will only confirm the Big Five’s collaboration with China. It is in the interest of the Big Five to stay in sync with Beijing and to keep the SEC from finding out the truth.

The US really doesn’t have too much choice. It either relaxes its regulatory demands in exchange for temporary “Chinese interest”, or holds steadfast the principles and punishments for cheaters. How the US handles the case would be an indication of how much the US cares about its national credibility.